Solving the Riddle of Globalization and Development (Routledge Studies in the Modern World Economy)

Solving the Riddle of Globalization and Development

In the past two decades many developing countries have embraced the challenge of globalization by rushing to dismantle trade barriers and promoting increasingly liberal market-oriented policies. However, a broader response to globalization is both possible and necessary if countries are to develop as quickly and as fully as possible. Here, an internationally renowned team of contributors examines the complex network of connections between globalization, liberalization and human and social development, and the implications for international development policy, strategy and practice. Solving the Riddle of Globalization and Development advocates the inclusion of sustainable human development as a key element in countries’ responses to globalization and builds on many of the best responses to globalization that the programme has encountered, from governments, business and civil society. Key points include the need to nurture an enabling environment, promote education and R&D, expand economic choices for everyone and foster a policy-making process that connects all social groups to the economy. These elements, coupled with sound macroeconomic management, are all required in equipping a country to integrate more effectively into the world economy. The innovative new approach to globalization and development set out in this volume will be essential reading for academics and practitioners alike. Manuel R. Agosín is Professor at the University of Chile and David E. Bloom is Professor at Harvard University. Georges Chapelier is at the United Nations Development Programme and Jagdish Saigal is at UNCTAD.

Routledge studies in the modern world economy

1 Interest Rates and Budget Deficits A study of the advanced economies Kanhaya L. Gupta and Bakhtiar Moazzami 2 World Trade after the Uruguay Round Prospects and policy options for the twenty-first century Edited by Harald Sander and András Inotai 3 The Flow Analysis of Labour Markets Edited by Ronald Schettkat 4 Inflation and Unemployment Contributions to a new macroeconomic approach Edited by Alvaro Cencini and Mauro Baranzini 5 Macroeconomic Dimensions of Public Finance Essays in honour of Vito Tanzi Edited by Mario I. Blejer and Teresa M. Ter-Minassian

6 Fiscal Policy and Economic Reforms Essays in honour of Vito Tanzi Edited by Mario I. Blejer and Teresa M. Ter-Minassian 7 Competition Policy in the Global Economy Modalities for co-operation Edited by Leonard Waverman, William S. Comanor and Akira Goto 8 Working in the Macro Economy A study of the US labor market Martin F. J. Prachowny 9 How Does Privatization Work? Edited by Anthony Bennett 10 The Economics and Politics of International Trade Freedom and trade: volume II Edited by Gary Cook 11 The Legal and Moral Aspects of International Trade Freedom and trade: volume III Edited by Asif Qureshi, Hillel Steiner and Geraint Parry

12 Capital Markets and Corporate Governance in Japan, Germany and the United States Organizational response to market inefficiencies Helmut M. Dietl 13 Competition and Trade Policies Coherence or conflict Edited by Einar Hope 14 Rice The primary commodity A. J. H. Latham 15 Trade, Theory and Econometrics Essays in honour of John S. Chipman Edited by James C. Moore, Raymond Riezman and James R. Melvin 16 Who benefits from Privatisation? Edited by Moazzem Hossain and Justin Malbon 17 Towards a Fair Global Labour Market Avoiding the new slave trade Ozay Mehmet, Errol Mendes and Robert Sinding 18 Models of Futures Markets Edited by Barry Goss

21 Multimedia and Regional Economic Restructuring Edited by Hans-Joachim Braczyk, Gerhard Fuchs and Hans-Georg Wolf 22 The New Industrial Geography Regions, regulation and institutions Edited by Trevor J. Barnes and Meric S. Gertler 23 The Employment Impact of Innovation Evidence and policy Edited by Marco Vivarelli and Mario Pianta 24 International Health Care Reform A legal, economic and political analysis Colleen Flood 25 Competition Policy Analysis Edited by Einar Hope 26 Culture and Enterprise The development, representation and morality of business Don Lavoie and Emily Chamlee-Wright

19 Venture Capital Investment An agency analysis of UK practice Gavin C. Reid

27 Global Financial Crises and Reforms Cases and caveats B. N. Ghosh

20 Macroeconomic Forecasting A sociological appraisal Robert Evans

28 Geography of Production and Economic Integration Miroslav N. Jovanovic´

29 Technology, Trade and Growth in OECD Countries Does specialisation matter? Valentina Meliciani 30 Post-Industrial Labour Markets Profiles of North America and Scandinavia Edited by Thomas P. Boje and Bengt Furaker 31 Capital Flows without Crisis Reconciling capital mobility and economic stability Edited by Dipak Dasgupta, Marc Uzan and Dominic Wilson 32 International Trade and National Welfare Murray C. Kemp 33 Global Trading Systems at Crossroads A post-Seattle perspective Dilip K. Das 34 The Economics and Management of Technological Diversification Edited by John Cantwell, Alfonso Gambardella and Ove Granstrand 35 Before and Beyond EMU Historical lessons and future prospects Edited by Patrick Crowley 36 Fiscal Decentralization Ehtisham Ahmad and Vito Tanzi 37 Regionalisation of Globalised Innovation Locations for advanced industrial development and disparities in participation Edited by Ulrich Hilpert

38 Gold and the Modern World Economy Edited by MoonJoong Tcha 39 Global Economic Institutions Willem Molle 40 Global Governance and Financial Crises Edited by Meghnad Desai and Yahia Said 41 Linking Local and Global Economies The ties that bind Edited by Carlo Pietrobelli and Arni Sverrisson 42 Tax Systems and Tax Reforms in Europe Edited by Luigi Bernardi and Paola Profeta 43 Trade Liberalization and APEC Edited by Jiro Okamoto 44 Fiscal Deficits in the Pacific Region Edited by Akira Kohsaka 45 Financial Globalization and the Emerging Market Economies Dilip K. Das 46 International Labor Mobility Unemployment and increasing returns to scale Bharati Basu 47 Good Governance in the Era of Global Neoliberalism Conflict and depolitization in Latin America, Eastern Europe, Asia and Africa Edited by Jolle Demmers, Alex E. Fernández Jilberto and Barbara Hogenboom

48 The International Trade System Alice Landau 49 International Perspectives on Temporary Work and Workers Edited by John Burgess and Julia Connell 50 Working Time and Workers’ Preferences in Industrialized Countries Finding the balance Edited by Jon C. Messenger 51 Tax Systems and Tax Reforms in New EU Members Edited by Luigi Bernardi, Mark Chandler and Luca Gandullia 52 Globalization and the Nation State The impact of the IMF and the World Bank Edited by Gustav Ranis, James Vreeland and Stephen Kosak 53 Macroeconomic Policies and Poverty Reduction Edited by Ashoka Mody and Catherine Pattillo 54 Regional Monetary Policy Carlos J. Rodríguez-Fuentez 55 Trade and Migration in the Modern World Carl Mosk

56 Globalisation and the Labour Market Trade, technology and lessskilled workers in Europe and the United States Edited by Robert Anderton, Paul Brenton and John Whalley 57 Financial Crises Socio-economic causes and institutional context Brenda Spotton Visano 58 Globalization and SelfDetermination Is the nation-state under siege? Edited by David R. Cameron, Gustav Ranis and Annalisa Zinn 59 Developing Countries and the Doha Development Round of the WTO Edited by Pitou van Dijck and Gerrit Faber 60 Immigrant Enterprise in Europe and the USA Prodromos Panayiotopoulos 61 Solving the Riddle of Globalization and Development Edited by Manuel R. Agosín, David E. Bloom, Georges Chapelier and Jagdish Saigal

Solving the Riddle of Globalization and Development Edited by Manuel R. Agosín, David E. Bloom, Georges Chapelier and Jagdish Saigal

Published by Routledge for and on behalf of

UNCTAD UNCTAD–UNDP Global Programme on Globalization, Liberalization and Sustainable Human Development

First published 2007 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Ave, New York, NY 10016 Routledge is an imprint of the Taylor & Francis Group, an informa business

This edition published in the Taylor & Francis e-Library, 2009. To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk. © 2007 editorial matter and selection, Manuel R. Agosín, David E. Bloom, Georges Chapelier and Jagdish Saigal; individual chapters, the contributors and the UN All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-08725-9 Master e-book ISBN

ISBN10: 0-415-77031-9 (hbk) ISBN10: 0-203-08725-9 (ebk) ISBN13: 978-0-415-77031-6 (hbk) ISBN13: 978-0-203-08725-1 (ebk)

Contents

List of figures List of tables List of contributors Foreword

xi xii xiv xviii

RUBENS RICUPERO AND MARK MALLOCH BROWN

Preface

xx

REINALDO FIGUEREDO

1 Introduction

1

MANUEL R. AGOSÍN, DAVID E. BLOOM, GEORGES CHAPELIER AND JAGDISH SAIGAL

PART I

The analytical framework 2 Analytical perspectives on global integration in pursuit of sustainable human development

17

19

MANUEL R. AGOSÍN AND DAVID E. BLOOM

3 Trade, investment, and human and social development

39

MANUEL R. AGOSÍN

4 Foreign direct investment, growth, and human and social development

72

DANIEL CHUDNOVSKY AND ANDRÉS LÓPEZ

5 Improving health: a key to halving global poverty by 2015 DAVID E. BLOOM, DAVID CANNING, BRYAN GRAHAM AND JAYPEE SEVILLA

104

x Contents PART II

National and regional perspectives

125

Latin America and the Caribbean 6 Globalization, liberalization, and human and social development in Central America

127

MANUEL R. AGOSÍN, DAVID E. BLOOM AND EDUARDO GITLI

7 Closing the loop – Latin America, globalization and human development

174

DAVID E. BLOOM, DAVID CANNING AND RIVER PATH ASSOCIATES

Africa 8 Continental drift: globalization, liberalization and human development in sub-Saharan Africa

193

DAVID E. BLOOM, MARK WESTON AND DAVID STEVEN

Asia 9 Economic growth, liberalization and human development in Asia: learning from the miracle workers

223

DAVID E. BLOOM, LARRY ROSENBERG, MARK WESTON AND DAVID STEVEN

10 Gendered labour markets and globalization in Asia

252

GITA SEN

Country studies 11 The three spheres: experiences from Latin America, Africa and Asia

277

DAVID E. BLOOM, LARRY ROSENBERG AND MARK WESTON

Index

294

Figures

1.1 2.1 2.2 2.3 3.1 5.1 5.2 5.3 5.4 5.5 5.6 5.7 6.1 6.2 6.3 6.4 6.5

The analytical framework The three spheres of development policy The conventional approach The vision from SHD Correlation between life expectancy and the log of per capita GNP (US$, PPP), 1997 Purchasing Power Parity and life expectancy Absolute poverty rate in 1981–95 and life expectancy Annual growth in per capita GDP (1965–90) and life expectancy Average Gini coefficient (1985–95) and life expectancy Graphical representation of the absolute poverty rate P For a given level of inequality, higher income means lower poverty For a given mean income, higher inequality means higher poverty Age dependency ratio, 1960–97 Infant mortality rate, 1962–97 (per 1,000 births) Health expenditures per capita (US$ PPP) Persistence to grade five Fraction of the population living on less than US$1 and US$2 per day

2 21 31 31 42 105 106 107 107 110 111 111 153 155 157 160 163

Tables

3.1 A3.1 A4.1 A4.2

A4.3 A4.4

5.1 5.2 5.3 5.4 5.5 5.6 A5.1 A5.2 6.1 6.2 6.3 6.4 6.5 6.6 6.7

Net foreign capital flows, as a share of M2, in selected developed and emerging economies Welfare indicators, 1997 Main FDI and human and social development indicators for developing countries, 1997 FDI and human and social development indicators for developing countries: (a) countries with GDP per capita below US$1,000; (b) countries/territories with GDP per capita above US$1,000 Correlation tests between FDI and main human and social development indicators Human and social development and FDI growth in developing countries, 1980–95: (a) countries with GDP per capita below US$1,000; (b) countries/territories with GDP per capita above US$1,000 Population-weighted descriptive statistics, 1990 Explaining poverty Summary statistics of data for poverty regression Results of 2SLS regression for growth rate of per capita GDP, 1965–90 Results of Gini coefficient panel regression Simulation results for the year 2015 Data sources Samples of countries Military expenditure, 1989 and 1996 Central America: intraregional trade Evolution of the real exchange rate, 1990–98 Central American countries: per capita GDP and population, 1998 Exports of goods and services Rates of growth of total and per capita GDP, 1970–99 Per capita GDP in PPP US dollars

56 64–6 97

98 99

100 108 113 113 116 117 118 120 120 130 133 135 140 140 141 141

Tables xiii 6.8

Gini coefficients and income shares of highest and lowest quintiles: actual and predicted values 6.9 Gross investment-to-GDP ratios, 1960–98 6.10 Growth of exports of goods and services, in constant prices, 1971–98 6.11 Traditional and non-traditional exports: shares in total exports and average annual rate of growth, 1990–98 6.12 Importance of the maquiladora industry 6.13 Foreign direct investment, as a share of GDP 6.14 Debt indicators for Honduras and Nicaragua, 1991 and 1998 6.15 Population growth 6.16 Crude death rate 6.17 Crude birth rate 6.18 Fertility rates 6.19 Contraceptive prevalence 6.20 Life expectancy at birth 6.21 Indicators of malnutrition 6.22 Immunization rates 6.23 Number of physicians 6.24 Illiteracy rates 6.25 Gross school enrolment rates 6.26 Public spending on education 6.27 Indicators of living conditions 6.28 Simulating the impact of improved demographics, openness and health on per capita GDPs in 2015 10.1 Indicators of female labour supply 10.2 Indicators of labour force quality 10.3 Indicators of labour force quality, c.1965 10.4 Structure of GDP – value added as per cent of GDP 10.5 Labour force distribution 10.6 Share of women among manufacturing workers and non-agricultural employment 10.7 Share of women in EPZ industries 10.8 Occupational segregation 10.9 Typical female and male occupations in the Asia-Pacific region 10.10 Female–male wage ratios in manufacturing 11.1 A simplified taxonomy of the six countries’ approaches to globalization

142 143 143 144 145 148 150 151 152 152 152 153 155 156 156 157 158 159 161 162 164 255 256 257 258 259 259 260 263 264 265 291

Contributors

Manuel R. Agosín is at present Professor of Economics of the University of Chile. Between 2001 and early 2006 he was Chief Economist for Central America, Mexico, Haiti and the Dominican Republic in the InterAmerican Development Bank. He obtained his PhD in Economics from Columbia University. During his long career with the United Nations, he was an economist and manager of various units within the Secretariat in charge of economic research and technical assistance in areas related to development and international trade, finance and foreign direct investment. He has published numerous articles in international journals and edited books published in Chile and abroad. He has also been adviser to Latin American governments and consultant to CEPAL, UNCTAD, UNDP, the Inter-American Development Bank, the World Bank and the OECD. David E. Bloom received a BSc in Industrial and Labor Relations from Cornell University in 1976, an MA in Economics from Princeton University in 1978, and a PhD in Economics and Demography from Princeton University in 1981. He has taught at Carnegie-Mellon University, was Chairman of the Department of Economics at Columbia University, was Deputy Director of the Harvard Institute for International Development, and is currently Clarence James Gamble Professor of Economics and Demography and Chairman of the Department of Population and International Health at the Harvard School of Public Health. A fellow of the American Academy of Arts and Sciences and a faculty research associate of the National Bureau of Economic Research, his recent work has focused on health and education in developing countries and on the links between health status, population dynamics and economic growth. David Canning is Professor of Economics and International Health at Harvard University. He has a PhD in Economics from the University of Cambridge and has held faculty positions at the London School of Economics, the University of Cambridge, Columbia University and Queen’s University, Belfast. He has carried out extensive research on the impact

Contributors

xv

of health improvements and demographic change on macroeconomic performance and served as a member of Working Group One of the World Health Organization’s Commission on Macroeconomics and Health. Georges Chapelier received his doctorate in Development Economics from La Sorbonne in 1972. Working most extensively in Africa and Asia, he has advised national authorities on regional planning and rural development issues and worked at UNDP to develop relief programmes for drought-stricken countries in sub-Saharan Africa. He contributed to launching several major regional technical cooperation programmes, such as Africa Futures and Social Dimensions of Structural Adjustment. He served as senior policy advisor on the UNCTAD/UNDP Global Programme on Globalization, Liberalization and Sustainable Human Development. Daniel Chudnovsky holds a DPhil in Economics from the University of Oxford. He has taught at the University of Buenos Aires and is currently Full Professor at the University of San Andrés, where he teaches development economics, international business and technological innovation. He has done research and published many articles and several books on industrial competitiveness, foreign direct investment, regional integration and environmental management. Eduardo Gitli, an Uruguayan economist, was affiliated with the International Centre for Economic Policy at the National University of Costa Rica. A well-known economist working on international trade issues in Central America, Dr Gitli passed away in 2002. He was a highly regarded economist and a very fine person. Bryan S. Graham received a BA in Quantitative Economics from Tufts University, an MPhil in Economics from the University of Oxford and a PhD in Economics from Harvard University. He was a Fulbright Scholar at the Australian National University and a Rhodes Scholar at St Antony’s College, Oxford University. He is currently an Assistant Professor of Economics at the University of California, Berkeley. Andrés López is Doctor in Economic Sciences from the University of Buenos Aires. Currently he is Associate Professor at the Facultad de Ciencias Económicas, University of Buenos Aires, and Main Researcher at the Centro de Investigaciones para la Transformación (CENIT). He is also a researcher at the National Council of Science and Technology (CONICET). He specializes in industrial economics and the economics of technical change. River Path Associates is a knowledge consultancy providing research, strategic counsel and creative solutions to public, private and not-for-profit sector organizations. Founded in 1997, recent clients include the

xvi

Contributors

World Economic Forum, the UK’s Foreign and Commonwealth Office and Department for International Development, and the World Bank. Larry Rosenberg is a research associate at the Harvard School of Public Health. His research interests include political and economic development in Latin America and Asia, alternatives to the existing global economic system, cross-country comparisons of development models, and the definition of steps developing countries can take that are distinct from those advocated by the international financial institutions. A graduate of Harvard’s Kennedy School of Government, he has worked on projects relating to health, higher education, the use of computers in primary and secondary education, demographic change, municipal solid waste, wind energy, tax policy, and project appraisal. Jagdish Saigal received a PhD in Economics in 1965 from the Netherlands School of Economics (now Erasmus University) and subsequently taught at the London School of Economics and several universities in India. Working at the United Nations from 1966 to 2001, he served as Head of Research and Training in the UN Institute for African Development and Planning; Director of the International Trade Programme Division of UNCTAD; and Senior Programme Manager of the joint UNCTAD/UNDP Global Programme on Globalization, Liberalization and Sustainable Human Development. Gita Sen is Sir Ratan Tata Chair Professor at the Indian Institute of Management, Bangalore (IIMB), India, and Adjunct Professor of Population and International Health at Harvard University. She is a member of IIMB’s Board of Governors, and Chairperson of IIMB’s Centre for Public Policy. She received her BA in Economics from the University of Poona, her MA from the Delhi School of Economics and her PhD from Stanford University. She is a development economist whose research focuses on gender and development, including the implications of globalization and economic liberalization, the gender dimensions of population policies, and the equity dimensions of health. She is on the Board of the Institute of Development Studies, Sussex, and has been on the Boards of the UN Research Institute for Social Development (UNRISD), the Society for International Development, the International Women’s Health Coalition, the International Advisory Group on Population of the MacArthur Foundation, and the External Gender Consultative Group of the World Bank, and a member of the Global Advisory Committee on Health Research of WHO. Jaypee Sevilla is a health economist and an Assistant Professor at the Harvard School of Public Health. His research interests include the relationship between population age structure and macro-social characteristics, ethical issues in resource allocation, quality of life measurement, HIV prevention and health promotion among adolescents,

Contributors

xvii

and international migration. He is from the Philippines, received his PhD in Economics from Harvard in 1999, and is currently on leave from Harvard, living in South Africa. David Steven is a policy analyst, writer and researcher, and co-founded River Path Associates in 1997. He works with government departments, multilateral agencies and large corporations on a range of international issues such as international development, public health and climate change. Mark Weston is an independent policy consultant specializing in international development. Having obtained a BA in Modern Languages at the University of Bristol, he taught English in Spain and Turkey and worked in advertising. Since moving into the development field, he has worked on projects in Ghana, India, Indonesia and South Africa, with clients including the World Economic Forum, the Harvard School of Public Health, and the Africa Centre for Health and Population Studies. His work on public health, HIV/AIDS, education and corporate social responsibility has been published widely in academic journals and the international press.

Foreword Rubens Ricupero (UNCTAD Secretary-General 1995–2004) and Mark Malloch Brown (UNDP Administrator 1999–2005)

The last ten years have seen barriers to trade, investment and knowledge dismantled the world over as developing countries have increasingly opened their economies to unprecedented opportunities and exciting challenges. Their leaders have pledged themselves to a system of rules and standards that defines much of the policy space within which they act, while many of their people look to globalization to deliver a more equitable distribution of power, wealth and opportunity. In this era, the ability of governments and their development partners to achieve the UN’s Millennium Development Goals is the yardstick by which the success or failure of globalization will be judged. But in order to meet these expectations of increasing income and better livelihoods, the poor must be given the space to play a greater role in steering global integration in a direction that better addresses their own needs. This book takes up the fundamental question of how this can best be achieved. Drawing on the expertise of UNCTAD, UNDP and a wide range of contributors, it argues that expanding choices allows people to decide on a better future for themselves and their children. Enlarging their capabilities and putting their skills to good use drives the technological and innovative infusion that industries need in order to gain a competitive edge and succeed in world markets. Promoting an enabling environment unleashes the entrepreneurial power that allows people to generate wealth and enjoy the fruits of their hard work. However, societies do not act alone. In a world of global challenges, this book highlights the need for a more sophisticated approach to governance. The freedom to choose should encompass a framework of decision-making that links deliberations in business, government and civil society with negotiations at the international level. Globalization can be a force for development – the need to forge and sustain the link between the two has been articulated at the highest levels. The Doha meeting and the prospect of negotiations in services brought a new dynamism to the developing world in its approach to trade. Now the poor wish to build on that, seeking the capacities that will enhance their participation in the multilateral trading system and ensure an integration that is socially efficient.

Foreword

xix

The international community has a duty to support these aspirations. Although the complexities of today’s globalization are beyond the scope of any single organization, UNCTAD and UNDP have shown models to help achieve this – identifying new ways to channel expertise and capacity development support to where they are needed most and in ways that help developing countries better realize their goals within the global economy. But as this book clearly shows, there is a vast unfinished agenda for the international community in its quest to solve the globalization and development riddle. Governments, business, the UN and its partners are called on to work with each other and take bold decisions. The opportunities are there for globalization to shape a more equitable society, and together we must seize them.

Preface

Solving the Riddle of Globalization and Development marks the culmination of several years’ work by a wide range of highly respected academics working in this field. It is a project that was initiated in 1998 at the creation of the UNCTAD–UNDP Global Programme on Globalization, Liberalization and Sustainable Human Development, of which it has shown itself to be part and parcel. Over the years this academic partnership has allowed the authors to share and cross-fertilize their different strands of development thinking, while testing their ideas through UNCTAD’s and UNDP’s work at the ground-level and its expanding repository of practical know-how. The result is a comprehensive examination of sustainable human development that has survived rigorous intellectual scrutiny and extensive fieldwork. It has also benefited from the rich exchange of ideas in national and regional policy dialogues and through scores of research networks. As the events of recent years have shown, the challenges and opportunities offered by dismantling barriers to trade, capital and knowledge, are still being assessed. It is in this context that the book presents a form of sustainable human development that is easily adaptable and builds on many of the best responses to liberalization that UNCTAD and UNDP have encountered, from governments, business and civil society. This includes the need to nurture an enabling environment, promote education and R&D, expand the economic choices of all people and foster a policy-making process that connects the economy to every social group. These elements, coupled with sound macroeconomic management, are all required in equipping a country to integrate more effectively into the world economy. While reading this book, I urge you to bear in mind that with the nature of globalization constantly evolving and with the remit of bilateral, regional and multilateral trade agreements expanding into areas of traditional domestic policy-making, the debate on this issue can only grow. I hope that this book will provide a foundation for filling this growing gap and draw greater discussion on the subject of sustainable human development from a wider audience. By doing so we need to start laying

Preface

xxi

the foundation for a more inclusive globalization that meaningfully brings the oft-quoted words of “globalization” and “development” closer together. Reinaldo Figueredo Director, UNCTAD–UNDP Global Programme on Globalization, Liberalization and Sustainable Human Development (2002–04)

1

Introduction Manuel R. Agosín, David E. Bloom, Georges Chapelier and Jagdish Saigel

In 2000, the United Nations Conference on Trade and Development (UNCTAD) and the United Nations Development Programme (UNDP) launched the joint Programme on Globalization, Liberalization and Sustainable Human Development. The central objective of the Programme, which concluded in 2005, was to help promote more effective integration of developing countries into the global economy. An exploration of the complex network of connections between globalization, liberalization and human and social development and their implications for development policy, strategy and practice was a fundamental part of the Programme. An analytical framework designed to help development policy-makers draw optimal benefit from these connections helped guide much of the work done. This framework marks a new way of thinking about development, based on the emerging realization that a focus on economic liberalization alone has generally failed developing countries; rather, and as argued by UNDP,1 inequality between rich and poor countries has continued to grow. While opening up to the global economy can attract foreign investment and increase trade, without investment in education, health and other human-capital-enhancing areas, developing countries will remain at the lower end of the value chain, perennially dependent on cheap labour and limited regulation for competitive advantage. The traditional implementation of liberalization, therefore, needs to be replaced by a range of active policies that strive to realize the opportunities provided by liberalization but that ensure all sectors of society are engaged in and benefit from the process. In many countries, this has been difficult to achieve so far. The analytical framework consists of three partially overlapping policy spheres (Figure 1.1). •

Sphere 1 covers integration into the global economy and liberalization of markets. It includes policies to facilitate cross-national trade and investment flows, and the national macroeconomic policies needed to manage the process by which an economy is integrated into the regional and world economies. As discussed below, the role

2 Agosín et al.

Liberalization Consistent economic growth Development of human and social capital

Figure 1.1 The analytical framework.

•

•

of liberalization in promoting development has come under increasing scrutiny in the years since the Programme began. Sphere 2 covers the need for economic growth. It includes policies to facilitate capital accumulation, enable the growth of the labour force and improve productivity. Economic and political governance are also vital to the facilitation and promotion of growth. Sphere 3 covers human and social development, seen as the fundamental end of the development process. Human development refers to the capacities and roles of people within society, while social development includes vastly improved health, education, human rights, gender relations and equality, environmental protection, and the adoption of democratic practices. Such emphases will, in turn, ensure the cohesion of communities, promote social capital more broadly, stimulate innovation and enterprise, and help countries reap the potential benefits of demographic change.

The framework proceeds from the assumption that democratic governments need to pursue a policy portfolio balanced between the three spheres, as confining policy action to a single sphere is likely to deliver disappointing results. For example, it is difficult for small economies to achieve stable and robust economic growth in isolation from global markets for capital, technology and knowledge. Conversely, liberalization policies impose punitive political costs if they fail to deliver economic growth and higher living standards. Human and social development, meanwhile, are seen as both inputs to and outputs from the growth and development process. In the years since the Programme began, economic events have thrown

Introduction

3

new light on the relationship between the three spheres. Economic growth has in many instances not been accompanied by measures to cushion the blow for those who lose out in the process. The poor often benefit with economic growth, but in most instances some remain untouched by it while others see a decline in living standards as jobs are lost in unproductive sectors and re-training programmes prove inadequate. If inequality increases, as it has in several growing economies, the political viability of growth may be threatened, making the task of ensuring that the poor do not suffer critical to its sustainability.2 Pro-poor growth strategies such as microfinance programmes, land tenure reform, removing institutional biases that hurt the poor, and increasing the poor’s access to health and education may enhance overall economic growth efforts. Political developments, too, have focused attention on the relationship between the spheres in new ways. The international community has become increasingly aware of the importance of the third sphere, covering human and social capital, to development. The United Nations Millennium Development Goals, which were adopted by UN member states at the Millennium Summit in September 2000, highlighted the importance of strengthening human capabilities, both as an end in itself and as a means of economic and social development.3 The Goals include commitments to reduce poverty and hunger; improve health, sanitation and access to water; and improve the environment. The emergence of the Bill & Melinda Gates Foundation as a major donor, and recent pronouncements by world leaders at the G8 summit in Edinburgh in 2005 and the World Economic Forum in 2006, have given further momentum to health and education in particular as vital drivers of development. It is the liberalization sphere of the framework, however, that has been thrown into sharpest relief since the joint Programme was launched. The benefits of liberalization are increasingly contested. Communities on the ground, politicians in developing and donor countries, and the academic community have questioned whether the liberalization-led policy prescriptions of international financial institutions are the most effective means to promote development. Some have pointed out that liberalization may in fact harm economies, and in particular the poor. The troubled progress of recent trade negotiations is an indicator of the growing disenchantment with liberalization as it has been promoted until recently. The collapse of the Multilateral Agreement of Investment, which was rejected by OECD members in 1998 amidst widespread protests by developing countries and civil society groups, was an early sign that poorer countries were no longer willing to be dictated to by the West. (Although the negotiators expected all countries to sign up to the agreement, which proposed to liberalize international investment and make its governance more systematic, it was drawn up exclusively by OECD member states with little consultation with developing countries.)

4 Agosín et al. The ongoing struggles between developed and developing countries to reach agreement on the Doha Round of World Trade Organization negotiations mark a further indication of the increasing cohesion of developing country resistance to the liberalization urged by the developed world. Disagreements over rich countries’ farm subsidies and access to markets led to the failure of talks in Cancun, Mexico, in 2003, and further talks in Hong Kong in 2005 produced only limited progress. This was due in part to the developing country bloc’s belief that wealthy countries were less keen to liberalize their own economies than to gain freer access to those of middle- and low-income nations.4 As well as suspicion of the motives of rich countries in promoting economic openness, there are other factors behind the questioning of liberalization in recent years. Devastating financial crises in Argentina and Russia which followed over-hasty liberalization, and continued stagnation in Latin America, sub-Saharan Africa, and the Middle East and North Africa, have undermined international financial institutions’ insistence that liberalization is a vital precondition for development.5 Many countries in these regions have opened up their economies with little obvious benefit. Although some have argued that liberalization was only half-hearted, with tariffs and subsidies remaining high in some sectors,6 electorates, particularly in Latin America where efforts were perceived to have been made in all three spheres, have displayed a rising discontent with actions promoting liberalization. Another important factor lies in the growing body of research suggesting that liberalization was not as important to economic progress as was previously thought. Again this is contested by economists. Major studies such as that conducted by Jeffrey Sachs and Andrew Warner in 1995 showed that economies that were open to international trade grew faster than closed regimes between 1970 and 1989.7 David Dollar and Aart Kraay, meanwhile, found that living standards in developing countries that are opening up the world economy rise much more quickly than in those that are not opening up.8 On the other hand, Dani Rodrik and others have argued that most countries that have experienced rapid and enduring economic progress in recent centuries, including industrialized Western nations as well as more recent success stories in East and South-East Asia, were sheltered by high tariff barriers through much of the progress. Only when economic growth was well under way did they liberalize.9 Other studies have shown that growth in some developing economies was faster during the importsubstitution regimes of the 1960s and 1970s than in the liberalized 1980s and 1990s.10 It may be, of course, that such a slowdown is inevitable as diminishing returns set in. It is easier to attain rapid growth from a low base than a high one, and the fact that a slowing of growth coincided with the progress of liberalization does not indicate that liberalization caused the

Introduction

5

slowdown (growth in recent years might have been even slower if importsubstitution had persisted). This argument would have greater traction if there had, in fact, been a significant increase in incomes in Latin America and sub-Saharan Africa during the liberalizing period, but there was not. Nevertheless, there is a consensus, even among those who have highlighted its short-term negative impacts, that trade liberalization is essential for growth in the long term,11 and some studies have shown that it also has positive effects on the institutions needed for sustained growth.12 However, the problems encountered by Argentina and Russia and the economic stagnation in other areas point to a need to find a way to promote human and social development within a liberalizing environment, while at the same time protecting vulnerable sections of society against shocks. In other words, they highlight the importance of “managing” liberalization. Recent developers such as South Korea, Mauritius and Venezuela integrated with the global economy under the guidance of the state. In Mauritius integration went hand in hand with the development of export processing zones, while in Venezuela revenues from oil imports have been invested in improving the health and education of the poor.13 Developing countries may not have the resources to make a comprehensive push in all three spheres, but it is important that they undertake a limited set of actions in each area rather than focusing all their efforts on liberalization alone. This book represents a blend of conceptual thinking, empirical analysis and country case studies. It is aimed at exploring the complexity of the development process, and interactions between policy interventions in different areas. It seeks to outline the utility of the three spheres framework, and asks whether this new view of development can have practical impacts. The chapters in the book, which were written between 1998 and 2003, provide a record of the work of the joint Programme, and showcase the thinking of some prominent thinkers on development at the turn of the millennium. Notwithstanding the developments in the years since the UNCTAD/UNDP joint Programme got under way, the analysis presented in these chapters offers a valuable contribution to the development debate. Country-determined and country-specific economic engagement with the world, economic growth and a focus on human development remain essential for improving quality of life in developing countries, and those countries that have developed have benefited from action in each of the three spheres. The book is divided into two parts. The first discusses the analytical framework. In Chapter 2, Agosín and Bloom outline the background to the “three spheres” approach to development. Chapters on trade and finance, foreign direct investment (FDI) and health improvements follow, assessing their likely impact on the ultimate goal of development – improving people’s quality of life.

6 Agosín et al. In the second part, regional and country assessment studies apply the framework to individual national policy environments in Latin America and the Caribbean, Africa and Asia. Focusing on attempts by developing countries to implement reform programmes in the 1980s and 1990s, the studies aim to inform debate about the opportunities and threats a country faces within the global economy, and to reflect on the impact of the interaction of the three spheres on the quality of life of its citizens. Brief chapter summaries follow.

Part I Chapter 2 – Analytical perspectives on global integration in pursuit of sustainable human development Chapter 2 describes the three policy spheres outlined above. It highlights the need to trigger virtuous development spirals, where investments in improving human capabilities enable a country’s people to use liberalization policies to promote economic growth. This in turn fosters greater and more sustainable human and social development. Similarly, policymakers must guard against the emergence of vicious spirals such as those likely to be set off by the AIDS epidemic in sub-Saharan Africa, where ill health reverses economic gains and pushes people into poverty traps. Stretched developing country governments, the authors argue, should not attempt, initially, to act on all three spheres at once. Instead, they should attempt to identify “strategic points of entry” (such as action to tackle social exclusion or support small businesses, for example), which can set virtuous spirals in motion. Once the benefits of the first action are released, they should move on to other areas. Tackling social exclusion, for example, or promoting small businesses, can have strong beneficial impacts on the other spheres. Chapter 3 – Trade, investment, and human and social development The remainder of Part I develops the analytical framework outlined in Chapter 2. Chapter 3 looks specifically at the role of international trade and finance as a means for countries to integrate into the global economy, focusing particularly on the crucial role of policy in enhancing these areas’ potential to promote human and social development. Although many developing countries have begun to liberalize their economies, none has left underdevelopment behind without also pushing more active policies to promote structural change in the economy, infrastructure and employment, technological upgrading, and poverty reduction. Indeed, as discussed above, liberalization alone may be detrimental to countries without the right policy environment, as increases in unemployment and poverty are not offset by increased opportunities in new areas.

Introduction

7

In order to counter the negative effects of trade liberalization a phased approach is recommended, with tariffs, for example, being removed depending on technological sophistication and the availability of knowledge capital. Tariff reductions should be backed up by export diversification, and based on a coherent plan to identify comparative advantages and obstacles and bring businesses together to ascertain how best to penetrate foreign markets. Gradual liberalization is not the responsibility of national governments alone – international trade negotiations also play a part, and the chapter calls for bodies such as the World Trade Organization (WTO) to show flexibility towards reforming developing countries, allowing them temporary relief from certain WTO strictures to smooth implementation of a sustainable human development strategy. Chapter 4 – Foreign direct investment, growth, and human and social development The fourth chapter examines the conditions under which foreign direct investment (FDI) can promote economic growth and lead to human and social development. With many developing countries competing to attract FDI, a dispassionate look at the costs and benefits, and the policy framework required to maximize the positive impacts on development, is timely and necessary. Quality of FDI is at least as important as quantity. Transnational corporations (TNCs) have the potential to spur growth, increase employment, improve technological capabilities and encourage good environmental management. On the other hand, they may deplete a host country’s resources, force local industries to close down, or take advantage of lax standards to pollute the local environment. Policy is crucial in determining whether the effects of FDI are positive or negative. The chapter assesses the impact of FDI on three areas. First, the chapter looks at the impact on host-country technology. The technological impact of FDI will be strongly influenced by the host country’s capacity to absorb TNCs and their knowledge. Human resources and technological and communication infrastructure are vital to successful absorption. Second, the effect on employment, poverty alleviation and income distribution is considered. Many have attributed the negative effects of globalization – increased unemployment, poverty, rising inequality – to the growing presence of TNCs in developing countries. In reality, many of these effects are a result of economic restructuring processes undertaken by governments. Without proactive policy to move economies up the value chain via investment in infrastructure and education, the employment created by FDI may fail to contribute to human and social capital development.

8 Agosín et al. Finally, the chapter assesses the potential environmental spillovers from FDI. In the past it was thought that TNCs would move to countries where environmental standards were lower than those in their home countries – so-called “pollution havens” – in order to continue their polluting activities without fear of punishment. More recently, however, perceptions have been changing, as TNCs have brought sound environmental management practices and more efficient, environmentally-friendly technologies to host countries. Some sectors are more vulnerable than others to environmental damage, and the chapter calls for further studies into the impact of TNCs in the mining and forestry industries to assess how natural resources are exploited. The chapter concludes by recommending that a two-pronged approach to attracting FDI be adopted, whereby on the one hand fiscal and financial incentives are provided to companies likely to enhance human and social development, while on the other institutions and infrastructure are bolstered, and education and training systems adapted to meet TNCs’ skills requirements and ensure that host countries gain maximum benefit from FDI. Chapter 5 – Improving health: a key to halving global poverty by 2015 While the link from high incomes to human development has long been accepted, the link back from human development to higher incomes has only recently emerged as a topic for research. Part I of the book concludes by looking at the impact of health on economic growth, and measuring how far health improvements are likely to assist countries in meeting the United Nations Millennium Development Goal target of reducing global poverty by half between 1990 and 2015. Health improvements can boost incomes via a number of interlinked mechanisms. Decreased child mortality leads to a demographic transition, where the proportion of workers to dependants rises for a time – a “demographic dividend” with potentially significant effects on economic growth. Good health also makes workers more productive. Finally, the expectation of living longer will lead many to invest more money in saving for retirement, and the boost in savings increases the amount of capital in the economy. Cross-country simulations suggest a modest correlation between increased life expectancy and income growth: a 10 per cent rise in life expectancy is shown to raise annual per capita income growth by onefourth of a percentage point. This effect arises because improved health predicts both higher average income and lower income inequality. More importantly, however, the simulations in this chapter show that current trends make the Millennium Development Goals’ poverty reduction aims an easy target. Even without pro-poor commitments from governments or development organizations, global rates of extreme poverty are likely to

Introduction

9

fall from 30 per cent in 1990 to 12 per cent in 2015. Failing to meet these targets, therefore, would, according to the authors, be a “humiliating catastrophe”. Improvements in life expectancy would reduce poverty rates still further, but policy-makers would also be well advised to guard against the negative impacts of serious health shocks, such as HIV/AIDS or the resurgence of TB, which have the potential to reverse life expectancy gains and increase poverty rates. The poor suffer most from poor health, and better health is crucial to providing the security poor people need to take advantage of opportunities to pull themselves out of poverty.

Part II Latin America and the Caribbean Chapter 6 – Globalization, liberalization and human development in Central America Part II begins with a study of four Central American countries – El Salvador, Guatemala, Honduras and Nicaragua – in the context of the three spheres framework outlined in Chapter 2. Although these countries have made much progress in terms of opening up their economies, attracting FDI and building a sustained peace, economic growth and human development indicators have proved disappointing. Low levels of human development, indeed, are holding back growth. Internal disagreements over liberalization have continued since the 1990s. The transition to democracy has led to dramatic reductions in military spending. These have been complemented by impressive macroeconomic adjustment programmes across the region, with all countries succeeding in cutting inflation and reducing fiscal deficits in the 1990s. The phasing out of high-inflation, low-tax, high public-spending policies has been accompanied by a move away from protectionism towards an opening up to foreign trade and the promotion of exports. The revitalized Central American Common Market (CACM), which collapsed under the strain of conflict and debt in the 1980s, has promoted the integration of Central America’s economies and resulted in widespread tariff reductions under a new common external tariff (CET). There have also been many successes in promoting exports, with growth in exports the primary driver of economic growth in all four countries in the 1990s. Diversified export crops and some new light manufactured goods have reduced the region’s dependency on traditional commodity exports such as bananas and coffee. FDI has also increased, as foreign firms have been attracted by the region’s proximity to the US and low wages. However, high levels of debt mean that countries have often been unable to take advantage of liberalization, as export earnings are

10 Agosín et al. eaten up by debt-servicing costs. This threatens to discourage further FDI as it reduces governments’ capacity to invest in essential human development-related programmes. Partly as result of this lack of investment, human development indicators across the region have remained low – and this has a kickback effect on growth. Analysis shows that demographic and health improvements (which lead to reduced dependency ratios and increased life expectancy respectively) would have a significant impact on per capita GDP, with better education having the potential to enhance these gains still further. Central America faces many challenges on its road to development. Social exclusion and poverty abound in the region; tax revenues are limited by the abundance of informal labour, the lack of progressive income taxes and the lack of property taxes; and labour forces do not have the skills to upgrade the quality of the economy and integrate into the modern economy. However, there are also opportunities, and the burgeoning garment industry in particular has the potential to become a focal point for action that addresses the synergies between human and social development and economic growth. If it can move from stitching together imported materials to higher-value activities that draw on local suppliers, the “maquiladora” industry can have broad benefits for society as a whole. Chapter 7 – Closing the loop – Latin America, globalization and human development Chapter 7 outlines the importance of human development as not just an end of economic development, but a means as well. Human and social capital are vital to economic growth, and it is up to policy-makers to ensure that pro-human development policies help countries to benefit from globalization. The chapter focuses on Latin America, where human development weaknesses have played a large part in poor economic performance. Education, health, demographic patterns and social capital all act to strengthen economies. Education clearly has impacts on a country’s skills base, and more educated societies have been shown to be more productive. Modernization of Latin America’s education system is essential, and in today’s knowledge economy a focus on improving the quality and quantity of tertiary education can bear rich dividends. The private sector is already involved in higher education in Latin America, and policy-makers should seek to expand this involvement in areas where the private sector can add value. Good health, too, improves productivity, with increases in life expectancy strongly correlated with income per capita growth. Related to health improvements is a country’s demographic situation. In the lag between falls in mortality and fertility rates, a bulge in the population dis-

Introduction

11

tribution is created. As this bulge reaches working age a country can benefit from a “demographic dividend”, as a large working-age population has a relatively small number of dependants to support. This generation can give a significant boost to savings, as longer life expectancy gives them greater incentives to save for retirement. However, Latin American countries currently have poor financial sector risk ratings and poor country credit ratings, which act as a deterrent to both savings and investment. The region’s governments should encourage savings in order to take better advantage of the demographic opportunity. Latin America suffers from weak social capital. Tax evasion and corruption are rife, crime levels are problematic, and support for small businesses is lacking. Youth unemployment is also high, and women are under-represented in the labour market. Child labour is a further concern for those wishing to build sustainable human development in the region. If Latin America is to begin to benefit from globalization, and to take advantage of its demographic dividend, good governance will be required. The long-term direction of economic policies in Latin America has become less clear in recent years. Regardless of the direction ultimately taken, the region will need to see an improvement in the quality of human development if economic growth and quality of life improvements are to be sustainable. Africa Chapter 8 – Continental drift: globalization, liberalization and human development in sub-Saharan Africa Sub-Saharan Africa has lagged behind the rest of the world in terms of both economic and human development. Per capita gross domestic product fell in real terms in many countries throughout the 1990s, infectious diseases are ravaging much of the continent, and democracy is under threat in many areas. Chapter 8 examines Africa’s development in terms of the three spheres framework, outlines the obstacles to progress, and suggests areas where interventions have the most potential to promote virtuous development spirals. Africa’s efforts to promote economic development have so far focused more on the liberalization sphere of the framework than on the economic growth and human and social development spheres. However, those countries where liberalization has been successful in promoting economic growth have generally complemented tariff reductions and privatization with proactive growth-promotion methods as described in the second sphere of the three spheres framework. Liberalization by itself has often made matters worse rather than better. In order to begin to catch up with other developing regions, African governments now need to shift their focus to the economic growth and,

12 Agosín et al. particularly, human and social development spheres. Investment in education and health is crucial to sustainable growth in the region, with measures to empower women and to tackle AIDS in particular likely to have wide-ranging collateral benefits. Sustained economic growth requires a range of actions. Upgrading of Africa’s physical and communications infrastructure will benefit from foreign investment and international donor involvement. The international community also has a role to play in reducing tariff barriers that discriminate against African producers, and in implementing and expanding debt-relief initiatives. Finally, and partly in order to circumvent these tariff barriers, export diversification and upgrading of production will leave the continent less exposed to long-term declines in primary commodity prices and mean that its exporters do not compete in world markets solely on the basis of price. Improved governance at all levels is also essential – corruption is endemic to many countries, and civil society and international donors can play a key role in monitoring government activity. Fortunately, there is an increasing number of African governments that are not corrupt and that are striving to improve the lives of their citizens. Heightened collaboration between African governments as well as links with other developing regions can also provide benefits in a multiplicity of realms, while developed countries could help promote African development by reducing subsidies, allowing greater access to their markets and increasing aid. Asia Chapter 9 – Economic growth, liberalization and human development in Asia: learning from the miracle workers East Asia has reaped great benefits from globalization. Its export-oriented growth strategy allowed the region to invest the earnings from exports in upgrading industry. Many of the region’s economies thereby progressed from exports of primary commodities to cutting-edge high-technology goods and services. Strong links between countries enabled others to follow where Japan, Hong Kong, Singapore, Taiwan and Korea led. The rest of Asia has been slow to follow East Asia’s lead. Parts of SouthEast Asia and, in particular, South Asia have suffered from weak human development and the stagnating effects of closed economies. In recent decades, however, India, China, Vietnam and others have begun to open up to the world economy, with sometimes spectacular results. The first part of Chapter 9 reviews East Asia’s development, and concludes that, despite the setbacks in the late 1990s, the region has been notable for maintaining a remarkable balance between measures to promote economic growth, liberalization, and human and social development. Going forward, however, new reforms (of banking, industry,

Introduction

13

education and health systems) will still be essential if the region is to strengthen its drive for innovation-led growth. The second part of the chapter assesses the rest of Asia’s attempts to emulate the East Asian “tigers”. Human development weaknesses must be addressed in order to both spread the benefits of economic growth and ensure its continuation. Chapter 10 – Gendered labour markets and globalization in Asia This chapter looks at the effect of globalization on labour markets in Asia, with particular reference to the role of women. The Asian economic success stories in the past forty years have all relied to a large extent on female labour in the fast-growing manufacturing and services sectors. Women’s share of the labour force in many of these countries has risen dramatically, with women workers dominant in export production and increasingly important in services. Women in developing countries have three main roles in export production: work in export processing zones (EPZs), labour outside EPZs (for example in garment factories), and piece-work in the home. In services, women in higher-income countries are employed in high-skill jobs in the financial sector, while data-entry and tourism have seen increasing numbers of female workers in lower-income countries. Women are far from fully integrated into Asia’s labour markets, however. Sex-based occupational segregation and differences in earnings between men and women are prevalent throughout the continent. Even women who are educationally qualified are mainly found in lower-paid and lower-status occupations – a situation that appears, if anything, to be worsening in many areas. Stereotypes suggesting that women are more willing and more able to do low-value work are often used to justify this discrimination, which frequently leads to poorer working conditions for women than for men. These gender inequalities serve to keep wages low. Countries and industries therefore compete on the basis of the cheapness of their labour, with little attention paid to increasing productivity and improving skills. This is what has been called the “low road” to industrialization. Low wages and low value added mean that, inevitably, export prices will remain low. In some respects this may be a route to growth, although in the long run the low road tends to act as a low-income trap. Most countries in South Asia have been at the lower end of the road to economic growth, while those in East Asia have largely taken the high road to development. For the low-road countries to catch up, policymakers need to strengthen women’s capabilities and improve the quality of outputs. Systematic policies to tackle gender bias are needed, as well as education and training programmes targeted at women, both at school and in the workplace.

14 Agosín et al. Without a transition from the low road to the high road, the chapter concludes, Asian economies that rely on cheap labour from women in a “race to the bottom” against other such markets will find it increasingly difficult to bridge the gap between South and North. Chapter 11 – The three spheres – experiences from Latin America, Africa and Asia The final chapter assesses the three spheres framework in the light of six countries’ recent experience. The six – Botswana, Brazil, Jamaica, Malawi, Nepal and Zimbabwe – have all undertaken liberalization of their economies in recent decades, but not all have prospered. Although external constraints, including debt and colonization, undoubtedly contributed to some of the problems faced by the six countries, the internal policy environment, and in particular the balance between the three spheres of the policy framework, was also critical. Botswana, for example, began its independence period as one of the world’s poorest countries, but a balanced approach to development, whereby a liberal economic policy has been accompanied by measures to promote growth and strengthen human capabilities, has helped the country to thrive. In the other countries, progress has been uneven. Most focused their policy efforts on liberalization, often in response to international pressure. Those that paid insufficient attention to the other spheres – consistent economic growth and human and social capital development – have on the whole experienced mainly the negative effects of globalization. Uncompetitive industries and agriculture, when exposed to international competition, have generally wilted, causing job losses and poverty increases. Even in Jamaica and Brazil, which attempted to promote human capabilities at the same time as they liberalized their economies, quality of life improvements have been limited by a failure to promote growth. Debt burdens have been such that many countries found it difficult to invest in all three spheres. In relation to this, the development framework, notably, emphasizes the need to look for “strategic entry points” to trigger virtuous spirals – not to attempt to change everything at once. Small, cost-effective actions, it is argued, can set off broad, beneficial effects. Moving forward, and with fewer resources to invest now than when they began to liberalize, Malawi, Zimbabwe and Nepal will be forced to focus on small-scale measures. Brazil, Jamaica and even Botswana, which has seen serious setbacks to its human development indicators in recent years, will also benefit from pursuing a balanced approach. Applying the three spheres framework to the countries and regions studied provides several valuable lessons. The central thesis of this book is that human development is not only the fundamental end of the develop-

Introduction

15

ment process, but an essential means to development as well. The addition of the human and social capital development sphere to the more traditional growth and liberalization spheres provides policy-makers with a further entry point into the complex task of promoting development. It also sheds further light on (positive or negative) feedback effects. Thailand’s successful efforts to combat AIDS, for example, sent powerful signals to its neighbours (Cambodia has mimicked the programme), the international community and foreign investors that Thailand can mobilize society and provide strong governance. On the other hand, good policies in one sphere can be offset by bad or inconsistent policies in another arena – Jamaica’s strong performance in health and education, for example, is now threatened by chronic fiscal stringency and weak macroeconomic performance. The above examples demonstrate the usefulness of the three spheres framework. The narrow view of equating development with economic growth, with human development as an afterthought, has proved inadequate in countries like Malawi, Zimbabwe and Nepal. Many of the lessons learned are portable across countries, although some, such as the impacts on economic development of political turmoil in countries such as Nepal and Zimbabwe, may be idiosyncratic to a particular country context. More research is clearly needed, but the analysis presented in this book goes some way towards showing that the framework can usefully be applied, and that policy coordination, which considers the interactions between the spheres, is needed at every stage. In the final analysis, the studies in this volume highlight the importance of integrating human and social development considerations into strategies for national and regional economic development.

Notes 1 UNDP (2003), Making Global Trade Work for People, UNDP, New York. 2 N. Kakwani and E. Pernia (2000), “What is pro-poor growth?”, Asian Development Review, 18(1), 1–16; S. Mahendra Dev (2002), “Pro-poor growth in India: what do we know about the employment effects of growth, 1980–2000?”, Working Paper No. 161, Overseas Development Institute, London. 3 Available at http://www.developmentgoals.org/index.html. 4 BBC Online (2005), Winners and losers in Hong Kong (available at http://news.bbc.co.uk/1/hi/business/4542152.stm). 5 D. Rodrik (2004), Getting Institutions Right, Harvard University, Kennedy School of Government, Cambridge, MA. J. Stiglitz (2003), Ethics, Market and Government Failure, and Globalization, Columbia University, Department of Economics, New York. 6 P. LeGrain (2002), Open World: The Truth about Globalisation, Abacus Press, London. 7 J. D. Sachs and A. M. Warner (1995), “Economic reform and the process of global integration”, Brookings Papers on Economic Activity, 1, 1–118. 8 D. Dollar and A. Kraay (2001), Trade, Growth and Poverty, World Bank, Washington, DC.

16 Agosín et al. 9 D. Rodrik (2001), “Trading in illusions”, Foreign Policy, March–April. 10 M. Weisbrot, D. Baker and D. Rosnick (2005), The Scorecard on Development: 25 Years of Diminished Progress, Center for Economic and Policy Research, Washington, DC. 11 D. Rodrik (2000), Development Strategies for the Next Centuries, Harvard University, Kennedy School of Government, Cambridge, MA. 12 D. Acemoglu, S. Johnson and J. Robinson (2001), “The colonial origins of comparative development: an empirical investigation”, American Economic Review, 91(5), 1369–1401; F. Rodriguez and D. Rodrik (2000), Trade Policy and Economic Growth: A Skeptic’s Guide to the Cross-National Evidence, Harvard University, Kennedy School of Government, Cambridge, MA. 13 S. James (2004), “Antidote to apathy”, Guardian, 13 August.

Part I

The analytical framework

2

Analytical perspectives on global integration in pursuit of sustainable human development Manuel R. Agosín and David E. Bloom

I. Introduction In the closing years of the twentieth century, most developing countries adopted increasingly liberal strategies of economic development. They opened domestic markets to international trade, gave market forces greater play in the allocation of resources, and privatized many stateowned enterprises. There was also a sea change in policies towards foreign direct investment (FDI), with liberalizing measures far exceeding restrictive ones throughout the 1990s (UNCTAD, 2000). However, liberalization has not delivered the expected rates of economic growth and the gap between rich and poor countries has continued to grow. According to the World Bank (1999), between 1985 and 1997 more than half of the poor countries fell further behind the world leader (the United States), while fewer than a quarter made significant gains. The output gap is measured in terms of the ratio of a country’s per capita GDP, measured in units of equivalent purchasing power (PPP), to that of the United States. Data are available for one hundred countries, of whom fifty-four saw an increasing gap and twenty-two a decreasing one. Furthermore, UNDP (1997) points out that the ratio of income of the world’s top 20 per cent of the population to the world’s poorest 20 per cent rose from 61:1 in 1991 to 78:1 in 1994. The breakdown of the World Trade Organization (WTO) meeting in Seattle in 1999 marked the start of a period of reflection on the direction of globalization, among both proponents and opponents. At the time, strongly liberal voices such as The Economist described the breakdown as “a global disaster” and claimed, “the poor will be the real losers”.1 Others welcomed what they saw as the humbling of the WTO, arguing that “globalization is hurting too many and helping too few”, and that “the forces behind global economic change – which exalt deregulation, cater to corporations, undermine social structures, and ignore popular concerns – cannot be sustained.”2 However, Claude Smadja, Managing Director of the World Economic Forum, warned of the danger of a backlash against globalization, which “may put at risk the benefits that globalization has

20 M. R. Agosín and D. E. Bloom brought to both the developed world and the emerging-market economies”.3 Yet globalization has proven resilient to these setbacks and is now linked more than ever before with hopes for the development of poor countries. Attempts to cement this relationship took place in the course of three international conferences, starting with talks in Doha on a new round of negotiations in November 2001, earning the sobriquet “development round”, followed by Monterrey, which expounded the importance of financing development through trade and investment, and ending with the World Summit on Sustainable Development in August 2002, which affirmed the importance of public–private partnerships in alleviating poverty. However, at each stage, agreement was only achieved through concessions to third world governments, allowing them more flexibility in their liberalization and perhaps reflecting the concerns of all those who made their voices heard in 1999 and the aftermath. Even today, however, in light of continued reluctance by the developed countries to eliminate agricultural subsidies, and in light of new trade disputes, developing countries are continuing to wonder whether they will realize the promises of globalization. NGOs such as Oxfam International and the Third World Network have expressed similar concerns.4 Along with the changes in approach at the global level, it is now clear that a “passive policy” of liberalization is no longer sufficient and that a range of “active policies” is needed (see Chapter 3 of this book). From an economic perspective, these policies recognize that liberalization offers economies opportunities. These opportunities will only be successfully exploited if sufficient capacity is developed to enable a range of actors to engage successfully with the new market conditions. Furthermore, a broader perspective reminds us that economic growth is only a means to the more significant goal of human and social development. Human capital, social capital and economic growth are all intricately bound in a series of complex relationships. Each has the potential to support the other, but equally deficits in one area can lead to deterioration in the others. Virtuous and vicious spirals are therefore possible, indicating the necessity for a balanced approach to development, although there is some evidence that a policy environment that emphasizes human development is more likely to lead to a virtuous spiral than one that stresses economic growth. This chapter discusses three complementary policy spheres, covering: • • •

Integration into the global economy and liberalization of markets The promotion of fast economic growth Development of human and social capital.

The three policy spheres can be characterized as intersecting circles (see Figure 2.1). Confining policy initiatives to a single sphere tends to

Analytical perspectives on global integration 21

Promotion of fast economic growth Capital accumulation Labour force growth TFP Infrastructure

Integration into the global economy Trade liberalization FDI liberalization Exchange rate Macro adjustment

Development of human and social capital Health Education MSEs Gender Democracy Social capital Environment

Figure 2.1 The three spheres of development policy.

deliver disappointing results. Sustained development (economic, human and social) is most likely to be achieved at the intersection of the three spheres. Democratic governments must therefore develop a balanced policy portfolio, at the same time commanding electoral support and likely to contribute to the development of virtuous spirals of development. They must be aware of the extent of their power to promote change in any area, and of the possibility that government intervention may inhibit action by other actors. In many cases, civil society and the business sector may be able to play a significant and increasing role in promoting broadbased development. For aid organizations (operating at national or international levels) and other multilateral actors, there is a strong case for a more broadbased approach to providing development assistance. The World Bank, for example, has come up with its Comprehensive Development Framework, which aims to promote partnership between different institutions and maintain progress along a number of fronts. There are still unanswered questions about whether this approach will increase the effectiveness of development assistance and how to reconcile the agendas of different national and multinational actors. Nevertheless, there is now a growing body of evidence and analysis available to policy-makers seeking to develop a context in which liberalization and globalization deliver

22 M. R. Agosín and D. E. Bloom enhanced benefits to people while simultaneously ameliorating some of the harsher impacts of these processes.

II. The three spheres Sphere 1: Integration into the global economy For most developing countries, openness to the international economy provides the best environment for stimulating growth. Many developing countries are small, and inward-looking economic strategies can therefore quickly come up against demand constraints. Countries that export are able to grow much faster, especially if they can diversify the products they bring to international markets. Openness, of course, is a two-way process. Export earnings allow increased investment in imported capital equipment, which combines capital accumulation with access to modern technologies to improve productivity. At a time when markets are developing so fast, closed economies are becoming ever less viable. To achieve openness, developing countries have adopted a number of policies: •

•

•

•

Trade liberalization – most developing countries have significantly lowered their trade barriers, with average tariff levels down, and tariff dispersion narrowed considerably. Countries joining the WTO, in line with their new international obligations, have dismantled a variety of subsidies and non-tariff barriers to trade. Many countries have also signed free trade agreements with neighbours and occasionally with developed countries. Liberalization of FDI – most developing countries have liberalized their FDI regimes. Indeed, some now have FDI regimes that are distinctly more liberal than those in the developed world (Agosín, 1999). Freeing of non-FDI capital flows – many developing countries now look to international financial markets to supplement investment from domestic saving, and the flow of capital to the developing world has increased, though with uneven results. Macroeconomic adjustment – inflationary conditions discourage investment, weaken the ability of relative prices to act as a guide to resource allocation, and act as serious discouragement to the private sector. Recently, inflation rates have come down almost everywhere in the developing world, and many countries have made significant progress in balancing their budgets (United Nations, 2000).

Achieving these reforms has not been easy, and there is now a vast literature analysing the obstacles societies face in adopting policies that encourage openness. Much less attention has been paid, however, to the fact that even as openness is achieved, many developing countries are still

Analytical perspectives on global integration 23 failing to generate strong economic growth. This is confirmed by a crosscountry study undertaken by UNDP (2003) in which no significant link between openness and growth is detected. There is, of course, no single explanation for these failures. The international economy is fast-moving and demanding. Thus it is not sufficient for countries simply to dismantle inefficient industries in order to reallocate resources to traditional exports, themselves often of declining value. Countries must engage in a continual search for new competitive advantage, and strive to develop capacity in high-productivity sectors. Coherent price signals are therefore needed to steer resources towards promising new export sectors. Exchange rate policies are extremely important in this respect. Often, trade liberalization is accompanied by capital inflows that appreciate the exchange rate. This ends up stimulating the production of non-tradables rather than encouraging nascent exports. The experience of the successful Asian countries is instructive. For over two decades, while their exports grew at unprecedented rates, the Republic of Korea and Taiwan (Province of China) were able to stabilize their real exchange rates through active management of the market. This clearly contributed to their export performance. On the other hand, experience shows that countries using the exchange rate as an anchor for domestic prices have found that real exchange rate appreciation is very difficult to avoid, with adverse effects on the growth of new exports. However, even when price signals are strong, supply responses to price signals are weak in many developing countries. Markets are often segmented regionally, and labour may be geographically immobile as well as uninformed about risks and opportunities. Small producers are unable to seize new opportunities due to poor levels of education or health, a lack of organizational or technological capabilities, or inadequate access to financial markets. Poor-quality management, meanwhile, can leave larger enterprises unable to respond rapidly to changing market conditions. Meanwhile, with FDI, investors look for resources relevant to their needs before committing themselves to investing in a particular country. With the emergence of increasing numbers of high-value industries, human assets have become a crucial factor for investment decisions. Thus the capacity, flexibility and initiative of a country’s human resources have come to lie at the heart of many, if not most, investment decisions. Finally, increased capital flows can pose serious threats to the stability of a country’s economy. While direct investors are likely to have at least a medium-term stake in a country’s future, portfolio investors and foreign creditors have tended to exhibit herd-like behaviour. Waves of enthusiasm in “emerging markets” have given way to waves of panic (Furman and Stiglitz, 1998; Radelet and Sachs, 1998). The result has been extraordinary booms, followed by deep recessions. These have had demonstrable effects on human and social development. The East Asian financial crisis has not

24 M. R. Agosín and D. E. Bloom only had economic effects, such as bankruptcies, increased poverty and rising unemployment; it has also led to reduced schooling, diminished public services, and increased social stress and fragmentation. While the Asian economies are now recovering, the adverse social effects are proving long-lasting (UNDP, 1999). Meanwhile, there is little evidence that countries have increased their ability to manage foreign capital flows, or have reached consensus on the features of “a new international financial architecture” (see Eichengreen, 1999; Ocampo, 1999; Agosín and Ocampo, 2000; Ahluwalia, 2000). In sum, the liberalization of markets is a necessary condition for rapid, SHD-centred growth, but is highly insufficient, for two reasons. First, it must be adequately managed, at the national and international levels. Second, countries must ensure strong supply responses to new price signals from a wide variety of actors, including foremost the poor. We deal with this latter issue when we discuss Sphere 3. Sphere 2: The promotion of fast economic growth Liberalization offers great economic development opportunities to a country, but active policies are needed to ensure those opportunities are taken up. Coherence in policy-making is also needed if fast and sustained economic growth are to be promoted. By establishing growth-friendly policies, policy-makers not only increase international confidence in the development prospects of their countries, they also enhance domestic confidence that the future can offer rising levels of prosperity. Economic growth depends upon factor accumulation and improvements in total factor productivity (TFP). In recent years our understanding of factor accumulation has been broadened by a wider appreciation of the nature of capital. Physical capital has become less important, as knowledge- or information-based products and services grow in value. Even in traditional industries, a growing information element may come to constitute the core of competitive advantage and be the source of most profit (Evans and Wurster, 1999). The “knowledge economy” is thus increasingly reliant on the accumulation of social and human capital (and this will be discussed in more detail in the next section). The accumulation of physical capital depends on the rate of investment in an economy. While FDI and other international capital flows can make a contribution to financing investment, domestic rates of saving remain crucial. In East Asia, for example, saving rates have been exceptionally high (averaging over 30 per cent for decades), enabling these countries to achieve the level of investment necessary to sustain rapid growth. In other regions, however – Latin America is a good example – saving rates have been much lower. In most developing countries, including those introducing economic reforms, investment rates have rarely surpassed 20 per cent of GDP. This is well below the 25–30 per cent that is needed to raise

Analytical perspectives on global integration 25 growth of income per capita to more than 5 per cent per annum over the long term. Many factors act to depress domestic saving. Excessive government involvement in financial markets and inflation both discourage saving, and so does lack of public confidence in the soundness of domestic financial systems. Rather than providing a sound prudential regulatory framework, governments in many countries engage in unjustified intrusions into financial markets that distort the allocation of financial resources. It is not enough for markets to attract savers. They must also be able to deliver capital to those in need of credit. Micro-enterprises and small firms are typically cut off from financial markets. For those who do have access, the spread in many developing countries between the rates of interest paid to borrowers and those demanded from lenders is notably high, reflecting lack of competition, inefficiency and the high-risk nature of their financial markets. Policy-makers therefore need to facilitate a well-functioning financial sector by offering a stable and predictable macroeconomic environment as well as a regulatory environment that upholds the rule of law, respects private property and promotes the enforcement of legitimate contracts. Prudential oversight of the banking system to ensure, for example, adequate bank capital, reserves for bad and risky loans, and restrictions on loans to related parties is also necessary to inspire confidence in the system. Without such confidence, financial markets will be less active and savings will be concentrated offshore. Private and public investment are often complementary. For example, without roads (typically built by governments), private investment for large markets is just not feasible. There is a large number of constraints to efficient public investment. Budget cuts in the context of macroeconomic adjustment policies have tended to fall disproportionately on public investment. In other cases, governments have attempted to do too much at the same time, overestimating their capabilities to carry out investment projects efficiently. Sphere 3: Development of human and social capital The case for giving increased priority to human and social capital development has been advanced on many fronts over recent years. Two main arguments have been made: •

Development of human and social capital is the ultimate end of the development process, with economic growth simply representing an important means to that end. This view has been strongly advanced by the United Nations Development Programme (UNDP), which opened its first Human Development Report with the following statement (UNDP, 1990):

26 M. R. Agosín and D. E. Bloom The real wealth of a nation is its people. And the purpose of development is to create an enabling environment for people to enjoy long, healthy and creative lives. This simple but powerful truth is often forgotten in the pursuit of material and financial wealth. •

There is increasing acceptance of the view that, as well as being the main objective of broad-based development, human and social capital development is an exceedingly powerful instrument of economic growth and development. This has long been understood with respect to education, but evidence has accumulated in recent years that it applies to health as well. In this view, human and social capital are recognized as economic inputs, not simply outputs.

In discussing human and social capital, we note the importance of both as legitimate ends to development, but also explore their role as a vital instrument in the development process itself.

Human capital The study of human capital focuses on the role of people in society, with increases in human capabilities improving the opportunities that people enjoy.5 Education, for example, increases social mobility, allows enhanced participation in a range of social activities, and has well-documented effects on health and perceptions of quality of life. It is also an important determinant of economic growth, offering clear private and public economic benefits. The better educated are more productive and have greater opportunities to succeed in the labour market. With the knowledge economy demanding ever-greater levels of skills from its workers, educated people are in turn better equipped to respond to changing market signals. This is especially important when an economy must restructure. Asian countries with a strong developmental record during the latter half of the twentieth century have all placed a strong emphasis on improving both the quantity and the quality of their educational systems. If education offers people opportunity, then health provides them with security – and its importance is increasingly being recognized (Bloom and Canning, 2000). The burden of poor health falls most squarely on the poor in any society. Not only do they have the worst access to quality healthcare, but they also rely most on their labour – and poor health reduces people’s ability to work. A health shock can quickly wipe out the savings of a poor or middle-income family in a developing country, while simultaneously decreasing investment in other forms of human capital (as a child is removed from school, for instance, both to save money and to act as a carer). Again, better health has measurable effects on the

Analytical perspectives on global integration 27 economy. Healthy people are better able to work, as well as more likely to save for their retirement and to invest in their (healthier) children’s education. Improvements in health can significantly enhance the opportunities of the poorest in society.6 Just as health impacts on poverty by both pushing some families into poverty and making it difficult for poor families to get richer, so does poverty affect other human development indicators. Across the world, the poor have less access to education than do wealthier communities, and worldwide 110 million children remain out of the schooling system (UNDP, 1997). Where they do have access, the opportunity cost of sending a child to school when he or she could be earning a muchneeded income for the family may outweigh longer-term considerations – girls in particular are likely to be kept at home where this cost is perceived as too high. The poor also have more limited access to healthcare, which leaves them more vulnerable to infectious diseases (there is evidence that HIV/AIDS, for example, hits the poor hardest in many countries) and less capable of boosting their capabilities and escaping poverty. Poverty, then, is a crucial determinant of a country’s human development, and also, therefore, of its economic prospects. Inequality matters too. A growing gap between rich and poor may have the effect of increasing political and social problems – social exclusion can be a powerful driver of crime and unrest, which can act as a serious drag on economies. Moreover, rising inequality may eventually threaten the process of globalization itself, if the political backlash reaches the heights it reached in the 1920s and 1930s, which forced countries to close their economies with disastrous effects. Health, education and poverty reduction can all have positive impacts on demography, which offers all developing countries favourable economic opportunities in the years to come. Demographic change can be seen as a link between SHD and faster economic growth. Demographic change is already happening everywhere, but poverty, lack of education and inadequate access to healthcare can retard it significantly. Per contra, poverty reduction, improved education and health, and improvements in the status of women can act to speed up demographic change and can assist countries to reap a growth-enhancing demographic dividend. As life expectancy increases, there is a lag before people start to choose to have fewer children. However, once fertility declines it does so steeply (though how steeply varies from country to country) as people choose to invest more resources in fewer children. This demographic transition is at the heart of the development process. When large families are common, universal education is difficult to provide. Further, rural families look to their children to become productive on the land from a young age. The role of women also changes rapidly when smaller families are common. They are more likely to receive education and to become more active outside the family. This in turn increases the opportunities available to

28 M. R. Agosín and D. E. Bloom children, who tend to receive better education and more access to resources as their mothers become more highly educated. Research shows that these processes can be accelerated by policies that actively promote the capability and autonomy of women and that seek to protect them from discrimination and physical abuse. Efforts to educate women and improve their health status also have disproportionately positive effects on a family’s development. Thus there is a clear positive relationship between the protection of gender equality, other elements of social development, and economic growth. Demographic transitions clearly have economic effects. Reductions in mortality initially affect infants and children most and set forces in motion that create a bulge (or “baby boom”) in the age distribution. More specifically, the mortality decline creates the leading edge of the bulge while the trailing edge is formed by the subsequent decline in fertility. Once this enlarged cohort has been educated, they become available to the labour market, causing a sharp rise in the ratio of workers to dependants. If these workers can be gainfully employed, then a country has an opportunity to seize a substantial one-off demographic dividend. This demographic dividend is intensified by the high likelihood that the baby-boom generation – with higher life expectancy and fewer children – will save more if the right policies are in place (Bloom and Sachs, 1998; Bloom and Williamson, 1998; Bloom et al., 2000). It may also be more entrepreneurial in its attitudes, as a consequent shift from country to town and city promotes more individualistic attitudes. Social capital The idea of social capital broadens human capital’s focus on individuals to explore the importance of their relationships with others. The Human Development Index, according to UNDP, reflects “the most basic human capabilities – leading a long life, being knowledgeable and enjoying a decent standard of living”. These are measured through life expectancy at birth, educational attainment (adult literacy rate and combined primary and secondary enrolment ratio) and income per capita. However (as UNDP underlines), other choices are important to people, including political freedom and participation, the development of the family, the rights of women, and social cohesion (especially, the avoidance of crime and corruption). Democratic government balances the rights and responsibilities of citizens – and seems to be the form of government best adapted to the modern world.7 The strength and effectiveness of a democracy – and popular confidence in, and support for, its survival – has important implications for the quality of life people enjoy. Democracies also seem most suitable to fostering values relevant to successful modern economies. The myth that pro-market reform can only be implemented under dicta-

Analytical perspectives on global integration 29 torships has now been dispelled. Democratic governments have demonstrated that they are capable of designing and implementing farreaching economic reforms, and that their politicians can build popular support for such reforms. In fact, without democracy, economic reform lacks legitimacy and can be easily turned back. It is also easier to foster widespread entrepreneurial attitudes within a democracy, as individuals enjoy the risks and benefits of taking responsibility for their own actions. Strong democracies rely on institutional strength – which is also vital to economic development and the efficient functioning of markets, as the disastrous experience of the former USSR shows. Russian democratization and market liberalization were accompanied by rapid deterioration in almost all institutions and, as a result, the country faces economic decay, increasing poverty, and a precipitous decline in health status (Becker and Bloom, 1998). Even countries with functioning institutions cannot afford complacency, as a rapidly evolving environment (owing, among other things, to integration into the global economy) requires appropriate institutional responses. Many institutions find this process of continual reform difficult to achieve. Rich and poor countries alike are struggling with a reliance on outmoded institutions that continue to offer poor value and levels of service. Social capital describes more than the formal relations in society, however. Indeed, many have argued that it is best confined to describing informal relations. For example, Fukuyama (1999) argues that “social capital can be defined simply as a set of informal values or norms shared among members of a group that permits cooperation among them”, but warns that the sharing of values and norms does not automatically produce social capital. Some cohesive groups, for example organized criminal gangs, may substantially diminish a society’s share of social capital. Like human development, social development is hard to analyse and measure. It is also difficult to say which social change is likely to contribute to significant levels of social development. Social capital may be interpreted as the degree to which society promotes the identification of individuals with its institutions. In a society with a great deal of social capital, individuals restrict the range of their actions to those that promote the growth of the economy and the strengthening of its institutions. This requires building social institutions that reward individual effort in a fairly equitable manner. In other words, a minimum degree of equality of opportunity needs to be present. Thus it can be said that, in its broadest sense, the accumulation of social capital lessens conflicts of interest and channels the efforts of individuals towards goals in which individual enhancement is aligned with the common good. This positive outcome requires that individuals perceive that they have a stake in their society, and will therefore want to work to promote its development. Tools for building social capital relate to policies that foster equality of opportunity. In this area, the availability of quality education and

30 M. R. Agosín and D. E. Bloom healthcare is essential. As already noted, participatory democracy in which individuals feel that they do make a difference in the way their society is run is another important tool.

III. Interactions None of the three policy spheres can be developed in isolation. Fast economic growth is exceedingly difficult to achieve in isolation from global markets. Technology now advances too rapidly for any country to proceed alone, and knowledge shows little respect for national borders. Policies to encourage openness, however, are impossible to sustain without economic growth. Global markets change fast, and demand economies that are responsive to their signals. Sluggish economies will not experience sufficient benefits from liberalization to offset the inevitable costs. The consequences for all societies, and especially for democracies, will be growing protectionist pressures and reversals of liberal policies. Nor can economic development be seen in isolation. Human development is the ultimate aim of development policy, but it is also a vital route to economic development and to enabling a society to benefit from openness. However, human development cannot be pursued by itself and is illusory in the absence of economic growth. While it is possible for a society to get richer without its poorest people seeing their prospects improve, it is unheard of for large numbers of people to escape poverty while the economy as a whole remains stagnant or suffers reverses. Equally, an open society offers many advantages to those trying to achieve human development. Enhanced communication and a greater awareness of living conditions in other societies is a fundamental threat to repressive regimes – and liberal policies stress individual responsibility, which is impossible to achieve when human and social capital have been diminished. By working at the intersection between the policy spheres – and creating a balanced policy portfolio – policy-makers can seek to set up a positive feedback loop between different policy elements. By delivering sustained improvements in health, for example, policy-makers will create a direct effect on demography, women’s status, investment in education, physical capital accumulation, and the efficient functioning of the labour market. Further, smaller families spend more on the health of their children. And just as the educated are better able to extract benefits from health systems, as well as be more receptive to preventive health messages, so do those with productive jobs spend more on nutrition and healthcare. Similar interactions can be seen across all policies. Formal analysis, for example, has been used to explore the interaction between demography and openness to trade. A country whose working age population grows at 3 per cent a year (and twice the pace of overall population growth) can reap a demographic dividend three times as large if its economy is open. In other words, a rate of growth of the working age population of 3 per

Analytical perspectives on global integration 31 cent boosts output growth by 1.5 per cent in open economies, as compared to only 0.5 per cent in economies that are not open to world trade (Bloom et al., 2000b). Policy-makers should therefore strive to achieve virtuous spirals, whereby the outputs of interactions between policy elements generate a positive and reinforcing set of development benefits. Conversely, policy-makers must also act quickly and decisively to tackle a serious deterioration in any policy area, as this risks starting a vicious spiral causing declines across other indicators. In sub-Saharan Africa, for example, the AIDS epidemic is having a dramatic effect on life expectancy, the productivity of the workforce and the ability of parents to invest in their children’s future. As a result, the wider prospects of the region are deteriorating rapidly. The differences between the conventional approach to development and our advocacy of working at the intersection of policy spheres can best be visualized with the assistance of Figures 2.2 and 2.3. Figure 2.2 is a Increase in wages

Increase in expenditure on education and health

Increase in income

Increase in tax revenue

Figure 2.2 The conventional approach. Increase in expenditure on education and health Decline in fertility

Increase in life expectancy

Increase in saving

Increase in private expenditure on education and health

Increase in productivity

Figure 2.3 The vision from SHD.

Increase in income

SHD

32 M. R. Agosín and D. E. Bloom flow-chart outlining (in a drastically simplified manner) the stylized facts of the conventional approach to development policy. Briefly, this approach emphasizes, in one way or another, a trickle-down model of human development. Human development is viewed as the end result of policies that first promote growth. For example, as shown in Figure 2.2, the accumulation of capital and productivity improvements lead to higher growth, which raises wages and increases tax revenues. These in turn induce an increase in both public and private expenditures in health and education, both of which lead to an improvement in wellbeing (human capital development, in our scheme). The view of development from human development is quite different, and is illustrated in the flow-chart shown in Figure 2.3. For illustrative purposes, we concentrate here only on efforts to raise public expenditures on health and education, but we could have taken any other point of departure (for example, efforts to promote greater gender equality and poverty reduction). Improvements in people’s access to good health and education have a number of positive effects on human development directly, and on an economy’s capacity to grow. Better health and education by themselves broaden people’s choices: they live better and longer lives, and these, in their own right, must be counted as important steps towards development. In addition, they have positive effects on growth. In the first place, women who expect to live longer and are better educated prefer a smaller number of children with a higher quality of life. Therefore, fertility rates decline, and families spend more of their own income on the health and education of their children. The enhanced private and public expenditures on health and education have positive effects on productivity and competitiveness. On the other hand, as people live longer lives they increase their saving for retirement, which also has a favourable impact on long-term growth processes. The value of these simple examples is to illustrate the powerful outcomes that can be obtained from working at the intersection of policy spheres. Of course, as already noted, the positive effects of enhancing human development-related variables directly will be greater in an open economy than in a closed one. In an open economy, people have the entire world as potential suppliers of their needs and as potential users of their products. But they must be given the proper tools to respond productively to the stimuli they receive from the broader world into which they are integrating. They must also be protected against the traumas that are likely to arise during the transition to a more internationally integrated economy.

IV. Action points It may be claimed that our emphasis on three highly complex and multifaceted development policy spheres makes the task of governments all but

Analytical perspectives on global integration 33 impossible. Can governments act at once in a large number of directions? One of the basic problems of developing countries is the poor capacities of governments to deal with the multifaceted problems posed by development. This is certainly one aspect of the much-abused call for better governance in developing countries. The concept of the virtuous spiral provides a route out of this impasse, offering the opportunity to take complexity into account, act in a limited number of directions and adopt a number of different approaches. Instead of advancing on all fronts, governments can identify strategic points of entry that can be used to push the spiral into action. If governments succeed in identifying the strategic points of entry, they can set in motion virtuous spirals, with effects on variables in other policy spheres. However, as the first benefits are released, it is important to ensure that governments shift their attention to other areas of the policy portfolio. Balance, in other words, is most practically achieved as a dynamic process, rather in the way that a cyclist stays upright by continually adjusting to a permanent state of disequilibrium. One consequence of this approach is to sound a long overdue death knell for the single model of development. Whatever the idea may be, it usually claims dogmatically to be the only fruitful approach to the development problem. Of course, the “right model” changes with the intellectual fashion du jour. Instead, it is increasingly recognized that there are now multiple models that can deliver results (though there are many more models that are unlikely to be successful). There is also some evidence that a bias towards human development is more likely to start the spiral moving than a bias towards short-term economic growth. Ramírez and colleagues (1997) argue that countries displaying “human development lopsidedness” moved to virtuous spirals in around a third of the cases, while all cases of “economic growth lopsidedness” resulted in only temporary gains. They also suggest that models need to change as progress is made, with basic health and education favoured in the earliest phases, but with resources gradually being shifted towards science, technology and more advanced education. They also note that labour-intensive rural employment may be an initial priority, but economic growth in higher-productivity sectors will be essential to sustain growth. Another consequence is to emphasize the need for cooperative actions between developed and developing countries. It is now amply clear that development will not occur unless developing countries pursue a portfolio of policies that leads to human development and growth at the same time. It is also clear that the international environment must be helpful to the efforts of developing countries to promote their own development. Otherwise, such efforts will fall on barren soil. Currently, it is possible to identify a number of strategic points of entry that offer policy-makers an opportunity to make significant development progress. Examples include:

34 M. R. Agosín and D. E. Bloom 1

2

3

Tackling social exclusion. To date, governments have been less than successful in shielding the most vulnerable groups in society from the disruption of pro-market reform. Reforms are therefore threatened by rising inequality. Measures to tackle social exclusion have two aims. The first is to increase the security of the socially excluded through safety nets protecting the vulnerable members of society from the inevitable social side effects of a liberalized market economy.8 These safety nets should be structured in ways such as to induce individuals and groups to move towards increasingly independent and risk-taking behaviour, rather than simply encouraging dependency (as, for example, have many developed country welfare systems). The second aim is to enhance opportunities by offering the excluded a range of ways to increase their participation in society, through education, support for small businesses, micro-credit facilities and so forth. Raising the status of women. Promoting female education has strong potential for triggering virtuous development spirals. Educated girls have fewer children, so families can invest more in each child’s education. Educated women’s children tend to be healthier than those of less educated mothers, and thus better able to learn themselves. Women’s health status is also vital. Women are generally the gatekeepers of family health, so improving their access to healthcare and knowledge about health will have large long-term benefits for their children – both boys and girls. Moreover, women’s direct contribution to economies will be strengthened by education and health improvements. Women’s skills are currently drastically underutilized by developing countries, which are thereby failing to make the most of a large proportion of their human capital. Progress towards targets for indicators of female welfare is therefore critical to overall human development gains. Poverty reduction. Inequality is a significant drag on society, especially in countries where a significant minority, or a majority, of people lives in poverty. Poverty is associated with higher fertility, which impedes the demographic transition. It also diminishes the demand for education. Large numbers of poor people also make a country more vulnerable to disasters and to internal wars. Sri Lanka, for example, is frequently praised for the priority it has given to human development. Poverty levels, however, remain high, a civil war has cost tens of thousands of lives, and few would claim that the country has made broad development gains in recent years. Pro-poor growth should focus on achieving and ensuring the maintenance of full employment; removing anti-poor biases from macroeconomic policies;9 investing in the capabilities of poor people; ensuring the access of poor people to resources, including credit; increasing the productivity of small-scale agriculture and small businesses; and promoting labour-intensive industrialization. These approaches to development policy are very much in line with UNDP’s emphasis on human capital development.

Analytical perspectives on global integration 35 4

5

6

Support for small businesses. The small business sector is increasingly important to modern economies, but many small businesses – especially in developing countries – suffer from low productivity, lack of skills, and archaic methods of production. In fact, many such “businesses” are no more than a symptom of disguised unemployment. Action to strengthen the small business sector can help mitigate unemployment by transforming under-employed workers into selfemployed entrepreneurs, who may eventually employ others, while improving skills, increasing access to technology and providing access to credit for working capital and investment. Recent experience shows that a particularly useful point of entry is support for financial institutions catering to the needs of micro- and other small enterprises. There is a large number of successful experiences in the developing world with financial institutions that rely on innovative credit technologies for delivering services to microenterprises and small firms. The most famous example is, of course, the Grameen Bank in Bangladesh, but there are many others, including Banco Sol in Bolivia, Financiera Calpiá in El Salvador, Bank Rakyat Indonesia unit desa, etc. (Morduch, 1999; see also Chapter 6 of this book). These innovative institutions allow poor people and small firms to help themselves by enabling them to become entrepreneurs. Policies to promote these institutions are an example of working at the intersection of policy spheres: they are welfare-enhancing in their own right and thus promote human development, and they also foster growth by enabling people to raise output and investment. Such efforts need the support of the international community. Action targeted at potential entrepreneurs is effective even when people move into other forms of employment, helping to create employees with the “intrapreneurial” attitude that modern businesses value. Most excitingly, today’s first-generation entrepreneurs may breed a second generation with vastly increased ambition and scope. Higher education. Today, higher education has become, in many ways, the basic education of the knowledge economy. Yet in developing countries resources for higher education, and indeed higher education systems themselves, remain very inadequate. Urgent action is therefore needed to plan their expansion and diversification as well as to build systems that will meet the requirements of tomorrow’s world. Enhanced higher education will not only lead to better-trained graduates, it will also provide developing countries with important points of contact with the global economic “commons” as well as exerting upward pressure on education quality throughout the rest of the education system. Action on health. As argued above, improved health is crucial to combating poverty, while health shocks can threaten the whole development process. As successful immunization programmes have shown,

36 M. R. Agosín and D. E. Bloom

7

action on health is especially suitable for international cooperation. There are many areas where renewed action is needed. In Eastern Europe, for example, deteriorating health (along with the breakdown of governance) is at the heart of the disastrous performance of many countries (see Becker and Bloom, 1998). HIV/AIDS, meanwhile, can be tackled through education and the effective marketing of health messages (as the examples of Uganda and Thailand show). A renewed global campaign, with substantial private sector involvement, could have a huge impact on the prospects of much of the developing world. An especially contentious area, needing international discussion and action, is access to pharmaceuticals. Once a drug is developed the cost of producing it is low, and there is surely scope to exploit the difference between the market price and marginal costs to ensure that people the world over can have access to drugs that can make them happier and more productive. Imaginative solutions to this problem could form the basis for a future international agreement on health. A start in the field of AIDS has already been made with the willingness of pharmaceutical companies that have developed drugs for this disease to market them in developing countries at an eighth of their price in developed countries. We recommend that a new “Compact for Global Health” be launched under the auspices of the World Health Organization, with the support of national governments and private firms. The Compact would have as its major objective to generalize the practice of providing pharmaceuticals to people in developing countries at marginal cost. It would also seek to ensure that this practice becomes feasible through policies that prevent unlawful arbitrage between markets. Institutional renewal. The need for new forms of governance has already been discussed. In a global economy, there is also a need for strong international institutions as well as for action to equip national institutions to engage more effectively within the global system (UNDP, 2003). The disagreements voiced at the Doha negotiations in November 2001 revealed very different approaches between developed and developing countries. Developing countries have been told that liberalization is the best policy, but they have not always found markets in developed countries opening for them. Many developing countries have also been shown to lack the capacity to negotiate effective agreements, especially in the emerging field of services. Technical and financial assistance is also clearly needed to help countries implement new trade rules and to adapt to new requirements in the North. While they may be intended to improve consumer protection, they are all too often criticized from the South’s perspective as examples of, in effect, covert protectionism. There are needs for greater governance at the international level in

Analytical perspectives on global integration 37 other realms as well. International finance has the first priority on the list. The most recent world financial crisis revealed that the globalization of finance has proceeded at a much faster speed than the capacity of the international system to govern international finance so as to ensure that it contributes to development. The crisis and its aftermath showed that financial crises can inflict enormous harm on fragile countries and that there exists an urgent need to work on the design of an international financial system that serves the needs of people everywhere. Poised on the threshold of a new century, policy-makers across the world have a great opportunity – and responsibility – to help define this new epoch. The last century delivered a number of major improvements to the lives of many of the world’s poor, disadvantaged and excluded. Yet there is still much work to be done. New technology has profound implications. It can help disseminate decades of developmental “knowledge capital”, and open up an incredible range of new opportunities. Equally profound, however, is the responsibility on all of us to help ensure those opportunities are used to deliver a humane, liberal and global future for all of our planet’s inhabitants.

Notes 1 See various articles in The Economist, 11 December 1999. 2 Jay Mazur (2000), “Labour’s new internationalism”, Foreign Affairs, January/ February. Jay Mazur is Chair of the American Foundation of Labour and Congress of Industrial Organizations (AFL–CIO) International Affairs Committee, as well as President of the Union of Needletrade, Industrial, and Textile Employees. 3 Claude Smadja (2000), “Time To Learn From Seattle”, Newsweek International, January 17. 4 For Oxfam International’s view, see www.oxfam.org/eng/pr011114_Doha_ victory_on_public_health.htm; for the views of the Third World Network, see www.twnside.org.sg/title/dohamain.htm. 5 This is the perspective taken by Amartya Sen (1999), Nobel Prize winner in Economics for 1998. Sen prefers the expression “human capabilities” to the more conventional one of human capital. We retain the term “human capital” but give it the scope of Sen’s “human capabilities”. 6 See Chapter 5 of this book. 7 The number of democracies increased rapidly in the last decades of the twentieth century. For a more detailed discussion, see Dahl (1998). 8 For a similar view, see Rodrik (1997). 9 It is a well-known fact that macroeconomic adjustment programmes often include cuts in expenditures that benefit the poor.

References Agosín, M. R. (1999), “Liberalization and the International Allocation of Foreign Direct Investment”, Working Paper No. 8, Centre on International Economics and Development, Universidad de Chile, Santiago.

38 M. R. Agosín and D. E. Bloom Agosín, M. R. and J. A. Ocampo (2000), “La Arquitectura Financiera Internacional: Hacia la Creación de un Marco Propicio para la Estabilidad de los Mercados Financieros y Cambiarios”, CEPAL, November, unpublished. Ahluwalia, M. S. (2000), Reforming the Global Financial Architecture, Commonwealth Secretariat, London. Becker, C. and D. E. Bloom (1998), (eds), The Demographic Crisis in the Former Soviet Union, Special Issue of World Development, November. Bloom, D. E. and D. Canning (2000), “The health and wealth of nations”, Science, February. Bloom, D. E. and J. D. Sachs (1998), “Geography, demography, and economic growth in Africa”, Brookings Papers on Economic Activity, 2: 207–95. Bloom, D. E. and J. G. Williamson (1998), “Demographic transitions and economic miracles in emerging Asia”, World Bank Economic Review, 12: 419–55 Bloom, D. E., D. Canning and P. Malaney (2000a), “Demographic change and economic growth in Asia”, Population and Development Review, 26, 257–90. Bloom, D. E., D. Canning, D. Evans, B. Graham, P. Lynch and E. Murphy (2000b), “Population change and human development in Latin America”, background paper prepared for Inter-American Development Bank, Economic and Social Progress in Latin America, 1999–2000 Report. Dahl, R. A. (1998), On Democracy, Yale University Press, New Haven. Eichengreen, B. (1999), Towards a New Financial Architecture – A Practical Post-Asia Agenda, Institute for International Economics, Washington, DC. Evans, P. and T. S. Wurster (1999), “Getting real about virtual commerce”, Harvard Business Review, November–December. Fukuyama, F. F. (1999), The Great Disruption: Human Nature and the Reconstitution of Social Order, The Free Press, New York. Furman, J. and J. E. Stiglitz (1998), “Economic crises: evidence and insights from East Asia”, Brookings Papers on Economic Activity, 2: 1–135. Morduch, J. (1999), “The microfinance promise”, Journal of Economic Literature, 37: 1569–614. Ocampo, J. A. (1999), La Reforma del Sistema Financiero Internacional: Un Debate en Marcha, Fondo de Cultura Económica, Mexico City and Santiago. Radelet, S. and J. D. Sachs (1998), “The East Asian financial crisis: diagnosis, remedies, prospects”, Brookings Papers on Economic Activity, 1: 1–90. Ramirez, A., G. Ranis and F. Stewart (1997), “Economic Growth and Human Development”, Yale University Economic Growth Centre Discussion Paper No. 787, December. Rodrik, D. (1997), Has Globalization Gone too Far? Institute for International Economics, Washington, DC. Sen, A. K. (1999), Development as Freedom, Knopf, New York. United Nations (2000), World Economic and Social Survey 2000, UN, New York. United Nations Conference on Trade and Development (UNCTAD) (2000), World Investment Report, 2000, UNCTAD, Geneva and New York. United Nations Development Programme (UNDP) (1990), Human Development Report, 1990, UNDP, New York. UNDP (1997), Human Development Report, 1997, UNDP, New York. UNDP (1999), Human Development Report, 1999, UNDP, New York. UNDP (2003), Making Global Trade Work for People, 2003, UNDP, New York. World Bank (1999), World Development Indicators, 1999, World Bank, Washington, DC.

3

Trade, investment, and human and social development Manuel R. Agosín

I. Introduction Policies towards international trade and finance are central to how countries manage their integration into the international economy. They have also been identified as critical to human and social development. The purpose of this chapter is to provide a tour d’horizon of trade and finance policies for development, in particular as they relate to a human and social development-centred strategy. There are basically two polar approaches to this set of issues. At one extreme, there are the advocates of de-linking in trade and finance. Delinking in trade, according to this view, is necessary because developing countries are at a serious competitive disadvantage and, if they are to gain in relation to their trading partners and build new capabilities, they need to be spared a competition that can only destroy existing industries and capabilities. In finance, the argument tends to be similar: transnational corporations (TNCs), which can be expected to be more efficient than national firms in the same sectors, can pre-empt the development of a strong national enterprise sector. The policy implications are very simple: protectionism in trade and closure of the economy to foreign direct investment (FDI). This approach has undoubted attractions. Virtually none of the few countries to make it out of underdevelopment in the twentieth century did so without passing through a period, sometimes quite prolonged, of protectionism. While experiences with regard to FDI have been more varied, most successful newcomers have also practised selective policies towards foreign investors. However, a large number of developing countries that resorted to protectionism and restrictive FDI policies failed to achieve sustained growth and development, basically because such policies failed to promote learning and knowledge accumulation and, instead, degenerated into rent-seeking (Bruton, 1998). At the other extreme, one finds the advocates of unrestricted trade and FDI liberalization. One of the central tenets of mainstream economics is that free trade maximizes economic efficiency and current welfare.

40 Manuel R. Agosín With regard to FDI, it is argued that TNCs can only bring good things with them: capital, technology, access to markets. A view that has been gaining ground in recent years is that FDI is nothing other than a form of trade: TNCs must choose between supplying a foreign market through FDI or through producing in situ. Therefore, the new argument in favour of liberalizing policies towards TNCs tends to be assimilated with the older advocacy of free trade. The classical arguments in favour of free trade have been recast in terms of growth. It is now claimed that free trade is beneficial for growth because it fosters competition (and, hence, productivity growth) and it allows countries to reap the benefits of the economies of scale associated with exporting (see Edwards, 1993). Openness to international trade (in producer goods containing new technologies) and to the good things that TNCs can contribute may also be desirable for other reasons: most technical change in developing countries is imported, be it in the form of capital and intermediate goods or in the form of FDI. A closed economy implies low ratios of trade to GDP and either no or very little FDI. When trade shrinks, countries are unable to purchase the technology embodied in imports; likewise, when countries are closed to FDI, they forego the proprietary technology that TNCs possess. However, building up national capabilities and improving the way a country is integrated into the international economy are sine qua non aspects of development. And this goal may involve a degree of temporary protection of national producers (where markets are large enough), deliberate export promotion, policies to stimulate technological upgrading, the improvement in the quality of national human resources, policies to encourage production by micro- and small enterprises (MSEs), and policies to steer TNCs in new directions for the economy. Besides technology and access to new markets, these include the development of domestic suppliers of inputs and of users of their outputs. There is an ample, although not always conclusive, literature on the relationship between trade liberalization and growth (see UNCTAD, 1989: Ch. V; Helleiner, 1990; Rodrik, 1992a; UNCTAD, 1992: Part III, Ch. I; Sachs and Warner, 1995; UNDP, 2003). On the other hand, much has also been written about the relationship between FDI and development (for a summary of this literature, see Caves, 1996: Ch. 9; UNCTAD, 1999). In the light of this literature, the standard hypothesis that both trade liberalization and liberalization of FDI policies are inevitably growth-enhancing needs to be strongly qualified, and we will undertake part of this task below. The UNCTAD and UNDP secretariats have both persuasively argued that unfettered globalization has led to greater inequality among countries and within countries (UNCTAD, 1997: Part II; UNDP, 2003). The implication is that more purposeful policies, both at the international and national levels, are needed in order to achieve fast growth across a broad spectrum of developing countries.

Trade, investment and development 41 So far, we have said nothing of international financial flows. As the recent world financial crisis has shown, policies towards non-FDI financial flows should be very prudent in countries where domestic financial markets are undeveloped, banking regulation is incipient, and the real sector is very vulnerable to excessive volatility in the exchange rate and in interest rates. Otherwise, any development strategy, no matter how carefully designed and implemented, can simply be derailed by forces beyond the country’s control. There is a role for tapping international financial markets for development purposes, and we explore some of them below. Given the fragilities that are typical of low-income countries, however, these should normally involve national official development finance institutions or be heavily regulated. Multilateral financial institutions, particularly those dealing with private sector finance, should have a very important role to play in assisting developing countries in this respect and in providing technical cooperation in this critical area. This chapter deals with the elaboration of a human and social development-oriented growth strategy from the point of view of its requirements in the areas of international trade, domestic labour and financial markets, international finance, and FDI. Section II deals with the notion of human and social capital development. In Sections III through VI, we take up issues relating to trade, domestic labour and financial markets, international financial flows, and FDI, respectively. Section VII wraps up the discussion. We assume from the outset that stabilization issues are conceptually separate from those dealt with here. Since no programme of structural change can be successful in the absence of prior stabilization, we are implicitly assuming that an acceptable degree of price stability has been achieved. There are, however, a large number of connections between policies oriented to the structural change objective and those that aim at stabilization, and there can often be contradictions between these two objectives. These clearly must be kept in mind in policy design.

II. What is meant by human and social capital development? There is widespread agreement that development without economic growth is unviable. No country has been able to attain higher levels of income for a broad spectrum of its population without a high rate of growth in income per capita sustained over several decades. There is also agreement that development is a broader process than growth, encompassing considerations of poverty reduction, equity, greater gender equality, greater productive employment for all, higher quality of employment, access to social services (e.g. education and health) that are indispensable for life with dignity, and preservation of the environment for future

42 Manuel R. Agosín generations; in sum, the enhancement of the capabilities of people to satisfy their own needs (Sen, 1984, 1999). The United Nations Development Programme refers to human and social capital development to describe this broader notion of development. Annex 3.1 shows 1997 data for per capita GNP (in US$ in purchasing power parity terms, PPP) and other human welfare indicators – life expectancy at birth, infant mortality and UNDP’s Human Development Index (HDI).1 Although there is a high correlation between each of the three non-income indicators of human welfare and per capita GNP, these correlations are far from being perfect (see Figure 3.1, which shows the correlation between the log of per capita GNP and life expectancy at birth). Some countries with a relatively high per capita GNP (Botswana or Gabon) have a very low life expectancy and a high infant mortality. On the other hand, countries such as Sri Lanka, Georgia or Albania have a very low income per capita, and life expectancies and infant mortality rates that are much higher than what could be predicted from their per capita GNPs. Costa Rica is a middle-income country, but its life expectancy is higher than that of the United States, a country that has three times its per capita income. The same is true of the HDI. Differences in the ranking of countries according to the HDI and according to per capita GNP can be quite striking. Canada occupies the ninth place in the world according to per capita GNP, but it is first in terms of the HDI. Other countries with higher per 90

80

Life

70

60

50

40

30 4

6

8

10

12

LGNPC US$

Figure 3.1 Correlation between life expectancy and the log of per capita GNP (US$, PPP), 1997 (source: World Bank, World Development Indicators, 1999, Washington, DC).

Trade, investment and development 43 capita GNPs, such as Singapore, Hong Kong or Switzerland, are much lower in the ranking according to the HDI. Among developing and transitional economies, the differences in the rank-ordering of countries can also be significant. Guatemala, Bulgaria and Lithuania have very similar incomes per person, but Guatemala is ranked 117th in terms of the HDI, Bulgaria is 63rd and Lithuania is in the 62nd position. The reasons for this discrepancy are not too hard to find. The two transition economies have life expectancy, infant mortality and education indicators (the latter not shown in Table 3.1) that are vastly superior to Guatemala’s. Something similar happens when we compare Saudi Arabia and Argentina. Both countries have per capita incomes around US$10,000. However, Argentina is in 39th place according to the HDI, while Saudi Arabia is ranked 78th. Human development, then, is a multidimensional process. If growth is to be compatible with human development, it will have to be accompanied by changes in a wide variety of indicators. Some of these are: 1

2

3

4

Variables related to the rate of economic growth. A spurt of growth, followed by stagnation or declining output, is not conducive to human development. This has been the characteristic of growth in many countries that have followed exchange-rate-based stabilization policies. Therefore, one of the major characteristics of human and social development is sustained long-term growth. Indicators of poverty alleviation, improvements in income distribution, and the distribution of productive assets (land, physical capital and human capital). These are complementary to high growth and indispensable in the achievement of human development. Indicators of the quality of life. These include indicators of health (availability of medical services, incidence of disease), education (school enrolment ratios, literacy), life expectancy at birth, and gender-related indicators of welfare. Variables related to the structure of the economy. Another important aspect of human and social development is structural change, with regard to the structure of both production and exports. In fact, it will be difficult to achieve high growth, poverty alleviation and improved income distribution without structural change. On the other hand, structural change is intimately related to the manner in which the domestic economy articulates itself to the international economy. Therefore, structural change has two aspects: •

Most low-income countries have large subsistence or very lowproductivity sectors, usually in agriculture and urban informal services. The elimination (or drastic reduction in) structural heterogeneity is a precondition for achieving higher wages, better quality employment and improvements in the standard of living of the majority of the population.

44 Manuel R. Agosín •

5

6

7

8

9

Exports are concentrated in one or a few primary commodities, where wages are low and labour skills are rudimentary. Structural change implies diversifying the export basket and moving towards international competitiveness in a wider range of activities.

An aspect intimately related to structural change is employment in the modern sector of the economy and shift over time in the structure of employment. An important objective of social development is to improve the conditions of women. Therefore, attention needs to be given to the labour force participation rates of women, the share of women in modern-sector employment, the quality of women’s employment and the relative wages of women. Greater gender equality is a goal in itself, and increases welfare directly. It is also a means to more rapid growth. Equal access to education and health for women makes them more productive and sets off a growth-enhancing chain of events: fertility rates decline, and families save more and invest more in the quality of life of their children. The extent to which the economy is preparing for structural change in the ways defined above and for a better quality insertion into the international economy will depend in no small measure on the training activities that are undertaken at the enterprise level. Therefore, labour force training at the enterprise level and its evolution are leading indicators of the gains in human development that can be expected in the future. So are indicators of technological upgrading at the firm level. The evolution of micro-, small and medium-sized firms is of particular importance for a human and social capital-centred development strategy. The transformation of these firms into competitive and productive entities is conducive to growth and human welfare. Growth with environmental preservation is an integral part of human and social development.

The remainder of this chapter will deal with how policies that foster integration to the world economy can promote human and social development. We posit that such policies will fulfil this objective if they promote: (a) sustained growth; (b) sustained increases in national investment and saving ratios; (c) the structural transformation of the economy in the direction of reducing subsistence, low-productivity sectors and increasing the importance of high-productivity, modern sectors; (d) diversification in the structure of exports; (e) increases in labour productivity and wages; (f) poverty alleviation; and (g) improvements in income distribution. These will be the main criteria against which a country’s strategies of liberalization and integration into the world economy must be assessed.

Trade, investment and development 45

III. International trade issues Trade policies at the national level: general considerations At the outset, it must be recognized that initial conditions with regard to trade liberalization vary between different developing countries. Some countries have already completed a wide-ranging trade liberalization, others are in the midst of such a programme and still others have not have yet embarked on one. This is true not only of trade but also of all policy areas covered by this chapter. Thus the analytical framework for assessing a country’s policies as regards the extent to which it fosters human and social capital development needs to take into account the stage at which each country finds itself in the process of reform. Whatever the point of departure, it is safe to say that the vast majority of low-income countries have not been successful in launching a process of self-sustained growth, let alone one in which there are concurrent improvements in income distribution and poverty alleviation. Therefore, at the individual country level it is important to identify the complementary policies that are needed in order to put trade liberalization to work in spurring long-term growth, reducing poverty and improving income distribution. It is often assumed that trade liberalization, by itself, will result in a more equitable income distribution. This presumption is based on the notion that most developing countries have a relative abundance of unskilled labour and that the protected sector (manufactures) is capitalintensive. If this were so, trade liberalization would, by the Stolper– Samuelson theorem, raise real wages and depress the rate of return on capital. However, in actual fact, in many countries the relatively abundant factor is land (or, more precisely, natural resources) and labour is second – sometimes a distant second – in the ranking of relative factor abundance. In such countries, the labour-intensive sector is, indeed, manufactures. In such cases, trade liberalization tends to depress real wages. Although the creation of new comparative advantages is a goal of all countries, policies to achieve it will be particularly important in resourceabundant countries. Trade and exchange rate policies: the essential relationship Many developing countries have embraced trade liberalization as an important element in their development strategies. This is appropriate, as far as it goes. Most countries have very little scope for protection, in the sense that domestic markets are small and do not allow for the efficient production of a large range of goods. However, it should be remembered that prior to the 1960s, a decade when import substitution began to be widely pursued as a development strategy, most developing countries had

46 Manuel R. Agosín very liberal trade policies; nonetheless, no country was able to leave underdevelopment behind with free trade policies alone. Moreover, policy-makers are not always fully aware that the goal of liberalization is to reallocate resources, not mainly to traditional exports but to new activities that create new comparative advantages, be they exports or efficiently-produced import substitutes. There is enough historical evidence to warrant the generalization that trade liberalization, by itself, does not guarantee that fast growth or other constituent elements of human development will follow automatically from the dismantling of trade barriers. More purposeful policies to develop national capabilities will be required. If anything, this is the lesson to be derived from the more developed and successful countries of East Asia, where fast exportoriented growth has been accompanied by steep reductions in poverty and relatively equal income distributions, by developing country standards.2 In fact, pure and unalloyed liberalization may, at least in the short to medium run, work against growth and some of the variables encompassed in the notion of human and social development. For example, because in backward economies resources are extremely inflexible geographically and sectorally, the transition to a liberalized price system may be accompanied by a great deal of unemployment and an increase in poverty. Resources are eventually reallocated to export sectors, but with enormous losses of output during a transition that can be very drawn out. Moreover, in the absence of deliberate policies to foster it, the upgrading of the production structure towards technologically more sophisticated sectors may fail to take place altogether.3 The first conclusion that can be drawn from historical experience is that, in order to avoid transition problems and permanent damage stemming from the dismantling of trade barriers, the liberalization programme needs to be phased in gradually. It is best to proceed in the following stages: 1 2 3

Begin by reducing very high tariffs so as to eliminate “water” in tariff rates Convert non-tariff restrictions into tariffs of a reasonable level Reduce very high tariffs first, then those at lower rates.

How long should the process take? The answer depends on a number of variables, including what happens to the exchange rate, and the supply response of private agents to new incentives increasing the profitability of the export sector. In poor economies, markets are often segmented along regional or linguistic lines, which makes any process of sectoral reallocation of resources very difficult and sluggish. Moreover, diversifying into new products and becoming competitive in them requires investment, labour-force training and mastering new technologies, all of which are drawn-out processes.

Trade, investment and development 47 Should countries aim at a single tariff rate? Definitely not. Low-income countries have inadequate capacity to produce capital goods and sophisticated inputs. These goods should have a zero tariff, because otherwise the capital formation process and the incorporation of new technologies would be penalized, and this is the last thing a country in need of growth wants. On the other hand, in some countries there is scope for temporary and moderate protection in some sectors. Even where this is not so, tariffs also serve as important government revenue earners that are difficult to replace. Tariffs on consumer goods, particularly luxury goods, can also act as consumption taxes in economies where more sophisticated alternatives are difficult to implement. Therefore, reforming developing countries ought to aim at two or three tariff rates (Rodrik, 1992b). The standard recommendation that trade liberalization is tantamount to a depreciation of the exchange rate and leads to larger exports is derived from a two-good model of the economy, with one importable and one exportable. This simplification ignores the fact that the most important sector in practically all economies is the one producing non-tradables (usually encompassing services but not restricted to them). Once we introduce the non-tradable sector, the exchange rate takes centre stage. If the liberalization programme is to yield the desired results in terms of reallocating resources from importables and non-tradables to the sector producing exportables, the exchange rate must depreciate. In fact, it is possible to calculate the precise amount of the required real depreciation. The exchange rate must depreciate according to the following formula (see derivation in Annex 3.2): ˆt ê   h(x/m)  1 where e is the exchange rate,4 t is the average tariff, a “hat” over a variable reflects percentage change, x and m are (average) export and import price elasticities, respectively, and h is the initial ratio of export to import value (in foreign exchange). If the depreciation does not occur, or is insufficient, the economy winds up producing more non-tradables and less exportables and importables. And that, clearly, is not the objective of policies. In fact, in the absence of changes in capital flows, market forces will by themselves produce the required depreciation. This ceteris paribus condition is, or course, fundamental: in some cases, capital flows become endogenous to the success of the liberalization programme. The experience of several middle-income countries (e.g. Chile, Mexico, Turkey)5 suggests that this is because trade liberalization, especially when accompanied by other reforms viewed favourably in international financial markets, tends to attract large flows of financial capital to the reforming country, appreciating the real exchange rate. This is one powerful

48 Manuel R. Agosín reason to maintain prudential regulations on the capital account when liberalizing trade (more on this below). Another important cause for fluctuating real exchange rates in developing countries is the heavy dependence of most countries on one or a few primary commodities whose prices exhibit a great deal of variability. The terms of trade of developing countries are much more volatile than those of developed countries; moreover, developing countries are very vulnerable to the effects of terms of trade changes. One of those effects is a widely fluctuating real exchange rate, which renders uncertain the profitability of new exports and discourages investment in them. Moreover, highly variable foreign exchange availability is damaging to the investment process, which depends heavily on imported capital goods. A more stable availability of foreign exchange requires policies at the national and international level. At the national level, countries ought to constitute effective price-stabilization funds, contributing to them in times of increasing prices and thus relieving downward pressures on the exchange rate.6 When prices are below a benchmark level, the monetary authority would be entitled to draw on the fund, in this case helping to prevent excessive depreciation of the currency. However, exchange rate management is insufficient to ensure that domestic producers will reorient their activities towards producing for export markets. Other policies will also be necessary. Import duty drawbacks on inputs incorporated into export products are permissible under World Trade Organization (WTO) disciplines. It is also important to grant such drawbacks to indirect exporters, i.e. to domestic producers of inputs for exporters who themselves use imported inputs. In low-income countries with small shares in export markets, export subsidies are still possible. A kind of moderate export subsidy that is highly efficient is one that is given to producers of new export products until exports reach a certain threshold, at which point the subsidy disappears automatically.7 Higher-income countries, for which export subsidies are prohibited, must devise more sophisticated ways of fostering exports, in areas that are essential to the success of the liberalization programme’s goal to foster the emergence of new comparative advantages and that are characterized by notorious market failures. These areas are technology, the quality of human resources, marketing, and investment finance. Non-trade policies having a bearing on export diversification Creating capabilities to participate in the international economy in a way that is conducive to human development will involve a much more complex set of policy actions than the mere manipulation of incentives. These include the strengthening of MSEs, accelerating the transfer of technology and the development of indigenous technology, the construction of appropriate infrastructure, support in marketing efforts in key

Trade, investment and development 49 foreign markets, and the attraction of joint venture partners from abroad to assist in marketing and technological upgrading. This is not intended to be the usual list of market failures that one can find in practically all developing countries. What is required is the elaboration of a coherent plan whose constituent parts are those items mentioned above and whose objective is to acquire comparative advantages in new areas that are able to support higher salaries and entrepreneurial incomes of MSEs. In the construction of such a plan, which ought to be undertaken in a fully democratic manner, the following stages are critical. The first one is the identification of potential new comparative advantages. These new sectors or subsectors to be developed do not come out of a random process; they build upon a country’s existing comparative advantages. The identification of new products for export markets is not meant to discriminate against existing exports but to allow the new ones to grow faster. Not much needs to be done to export what a country is already exporting. A big push is necessary to develop new production capabilities. The novelty of the human and social capital approach in the context of integration into the international economy lies in the emphasis that is given to both international competitiveness and the incorporation into the process of broad segments of the population. In fact, as already noted in Chapter 2, working on human and social capital-related variables may be essential for fostering competitiveness and growth. The identification of the sectors that merit development leads to the second step, which involves the evaluation of difficulties and bottlenecks in areas such as: • • • • • •

Training and education Technology absorption and development Reaching consumers in key markets (product specification and quality, information requirements) Infrastructure needs (port and airport development, roads, electricity and telecommunications) Placing particular attention on ensuring that MSEs have adequate access to investment resources (more on which below) Identification of technical assistance needs in all of these areas.

Some comments on these tasks may help to illustrate the efforts that are needed and how different they are from mere trade liberalization. As already noted, in most of these areas market failure, incomplete markets or non-existent markets are the norm. Innovation and on-the-job training are usually in short supply in all market economies (because the innovator cannot reap all the benefits of such actions and must bear all the costs). Some form of subsidization for the introduction of new technologies, the domestic development of technology and the training of the labour force in new skills is indispensable if such activities are to be undertaken in a

50 Manuel R. Agosín scale commensurate to the need for them. WTO subsidy rules allow for subsidies on innovation, training and education, as long as the subsidies are potentially available to all producers and are not above certain limits (Tussie and Lengyel, 1998). Another area that suffers from market failure is the effort to obtain information about foreign markets and the actions actually to penetrate foreign markets. Investment in information about consumer tastes in target markets, quality requirements, marketing channels and the technology needed to produce to the standards of foreign markets may be too costly for individual prospective exporters (commonly small or mediumsized enterprises). Moreover, the information obtained by a single producer can be used by another who has not incurred the costs of obtaining it. These indivisibilities, externalities and potential free-riding problems of information gathering suggest the need for the involvement of a government agency or of producer associations (who must know what they are looking for, no small task!), which can then actually charge users the average cost of providing the information. This is typically a collective action problem and some form of coordinating action (by governments or business associations) is necessary to overcome it. In some cases, the public sector’s role can be confined to promote the initial thrust for private firms to band together. Policies to ensure adequate access to finance for MSEs which will have to do the investing that brings about structural change is perhaps the single most important complementary action that governments will have to undertake. No subsidies are involved here. The question is not one of providing subsidized credit, but of ensuring that MSEs, which are normally shut out of credit markets because they lack collateral, have access to financial resources at market-related interest rates. This will normally involve quite a bit of imagination and institutional innovation. International trade negotiations Action at the international level in support of human and social development-oriented policies must necessarily involve the opening up of markets in developed countries.8 Liberalizing world markets for agricultural products, textiles and footwear are tasks the Uruguay Round left unfinished. Low-income countries can be expected to begin to penetrate new export markets in these goods. Another area of growing importance is the one related to antidumping procedures in industrialized countries. Many countries have encountered this form of protectionism, which is growing in incidence. It will be incumbent on them to prepare to make proposals (or support the proposals of others) to modify existing international disciplines in this area. Most low-income countries already benefit from special and differential treatment (S&D) in some areas, particularly as regards export subsidies.

Trade, investment and development 51 Still, the concept of S&D suffered a major setback during the Uruguay Round and it has insufficient recognition in the WTO. It may be useful for developing countries to press for having it redrawn with a firmer hand, but with substantial modifications to prevent abuse. One can argue that reforming developing countries are, indeed, “infant exporters”, and that the full brunt of international disciplines, in areas such as export subsidies or intellectual property (TRIPS), should not apply to them during the transition period to the launch of export-oriented growth. Thus developing countries that meet certain criteria (e.g. as regards low income, unacceptable poverty levels, concentrated production and export structures) should be allowed temporary derogation from certain WTO disciplines, in particular those related to intellectual property and export subsidies. The adoption of temporary S&D could be accompanied by strict criteria for graduation. In other words, the classification of a country as an “infant exporter” would not be a matter of self-election. A change such as the one proposed here would give countries the degree of freedom in policy-making that they require in order to implement a human development strategy. Participation in regional integration schemes may be a particularly effective way of gaining new comparative advantages. Traditional exports normally go to industrial countries, and most developing countries do not have domestic markets of a size that is sufficient for producing many manufactured goods efficiently. The major role of regional integration is to develop new comparative advantages. But negotiating regional integration agreements, implementing the decisions made, and ensuring that partner countries live up to their commitments is no easy task for countries with very scarce human resources. Countries could benefit from very focused technical assistance in this area.

IV. Labour and financial markets In the old literature on the sequencing of liberalization, it was often argued that domestic factor markets should be liberalized first, before attempting trade liberalization, simply because, in the presence of distorted factor markets, firms would not be able to respond to the new price signals emitted by liberalized goods markets.9 Reality in developing countries is often more complicated than the advocates of liberalizing factor markets assume. To give an example, it is true that if firms are unable to fire redundant workers, or if firing is very expensive, the reallocation of labour will be more difficult than in the absence of such restrictions. Undoubtedly, rigid labour markets are not appropriate to poor countries where the reallocation of labour is difficult to begin with. But there are other, endogenous and not policy-induced rigidities that need to be removed. The new activities that might be stimulated by, say, lower tariffs cum exchange rate depreciation may require

52 Manuel R. Agosín very different skills than protected manufacturing production. And these do not arise simply with passive policies.10 More active policies are essential, and these are inherently more difficult, one reason being that most governments do not have the precise knowledge of what is needed and how to go about obtaining it. The same can be said of domestic financial markets. It is true that in many countries domestic financial markets are repressed, credit at negative real interest rates often being directed to politically favoured clients. However, one suspects that this problem is much less intense today than it was, say, twenty years ago, when financial repression was typical of many (if not most) developing countries. Over the last couple of decades, many countries have undertaken domestic financial reforms, only to find that financial market liberalization also requires a commensurate improvement in their supervision and regulation, for which most developing countries are very inadequately prepared. For other reasons as well, mere liberalization will be insufficient. Financial systems work notoriously poorly and tend to shut out of the market those firms that have neither reputation (usually large firms) nor collateral. MSEs are the ones that struggle hardest, and the ones that are most needed as active investors in a programme of structural transformation. As financial markets normally shut out small firms or charge them much higher interest rates than large firms, many are unable to take off, and those that do often go bankrupt. The result is the disappearance of jobs, and increasing unemployment. Financing is also required for other purposes, and it is unlikely to be forthcoming simply by liberalizing. For example, as trade liberalization proceeds, workers that lose their jobs could become entrepreneurs. If financing is not available, this possibility is foreclosed. Financial innovation will be essential. Structural change will also give rise to demands for new and different kinds of human capital, the supplies of which will not rise spontaneously, owing to liquidity constraints to human capital investment. Markets fail notoriously in providing finance for education, again because the potential borrowers lack collateral, and there is no legal way for the lender to lay claim on the future income streams of the borrower should the latter fail to repay. The question thus boils down to finding assets that can serve as collateral, or ways to get around the need for collateral. For example, Ramos (1993) has suggested that workers’ savings in social security plans could be used as collateral for loans with the purpose of paying for their children’s higher or technical education expenses. Following the experience of Bangladesh’s Grameen Bank, micro-finance institutions have sprung up in a good number of developing countries, using lending technologies where collateral is made unnecessary through a series of devices which essentially bridge the asymmetry of information between lenders and borrowers that is an abiding trait of all credit markets. Such devices include

Trade, investment and development 53 group-based lending (in which a default by one member implies default by all other members of the group), using consumer goods with high use value as collateral, financial incentives for timely repayment, compulsory participation in periodic meetings, access to bigger loans for good debtors, and risk-pooling through the use of a small fraction of loans for the purchase of insurance. It is clear that financial markets not only need to be liberalized. A good deal of institutional innovation will also be required. Development banks could make an important contribution in breaking the financial bottlenecks that afflict most small and medium-sized enterprises (SMEs). As discussed below, in some countries that have a good credit rating in international markets, the development bank can act as an intermediary between international financial markets and the SME sector, passing on to SMEs the benefits of interest rates that are usually much lower in international than in national markets. Development banks do not need to be in the daily business of making loans; they can act as second-storey banks, auctioning off specially earmarked funds to the banking system. As noted by Díaz-Alejandro (1985) in his posthumously published paper, active use of development banks can greatly mitigate the failure of private financial markets to generate the volumes of financial resources required for development: Latin American experience, and indeed that of continental Europe during the last century, makes one skeptical that private markets alone will generate a flow of financial intermediation high enough to support a rate of long-term fixed capital formation which fully exploits available high social rates of return to long-term investments . . . By providing long-term credit to new, non-traditional activities, development banks would eliminate one of the excuses frequently given for extravagant protection against imports.

V. Capital account issues We have argued that the trade regime for most developing countries, and particularly the low-income countries, ought to be essentially liberal. Should the same be said about capital flows? Should capital flows be viewed simply as intertemporal trade, as some economists propose? Should some sequence be imposed on liberalization in the area of capital flows? As in trade, developing countries come to this issue from very different points of departure. Some maintain varying degrees of control over capital flows. Others have never had them. Still others have recently undergone extensive capital account liberalization, only to find that their economies have become more closely linked to the ebbs and flows of international finance. We shall argue that some forms of control over

54 Manuel R. Agosín capital flows are desirable. Those countries that still have them should be quite circumspect in liberalizing their capital accounts entirely; those that do not apply capital controls ought to retain the right to put them in place should the situation require it. The experience of different countries should be useful in this respect. In recent years, developed countries have attempted to bring the issue of liberalizing capital flows to the arena of trade negotiations within WTO and have pushed for such liberalization in other fora, especially in the OECD, inviting developing countries to subscribe to a Multilateral Agreement on Investment (MAI) that they have had no part in negotiating. How should developing countries approach this issue? National policies towards the capital account We first deal with national policies, to take up next the issue of international negotiations. Of course, both sides of the coin cannot be adequately dealt with separately, since from the moment one advocates the notion that some controls are appropriate, this has immediate implications for international negotiations. We argued in the foregoing section on trade policy that maintaining an appropriate level for the real exchange rate and avoiding excessive exchange-rate fluctuations were sine qua non requirements for the successful launching of a competitiveness-oriented development strategy. In “emerging market” countries, the real exchange rate is now determined largely by capital movements. Since certain types of capital flows can be large relative to the size of the economy and can also be extremely volatile, in order to maintain the exchange rate at a level that supports the diversification of production and exports it is advisable that full capital account liberalization be eschewed while a policy of opening up to trade is being implemented. Capital account liberalization should not be undertaken until the domestic corporate sector is strong enough to withstand sharp exchange-rate fluctuations and the banking sector has been strengthened and appropriately regulated. Both of these tasks are normally achieved late in the development effort. It is thus better not to open fully the capital account of the balance of payments as regards lending to the private sector and portfolio investments. Both of these forms of capital are very volatile and can be dangerous to a fragile developing economy. Most lending to the private sector is essentially short-term, and international banks can easily fail to roll over credits at the first sign of trouble. Portfolio investments are not usually thought of as short-term, but they really are. Most portfolio investors (purchasers of stocks and, in those few countries where they are available, bonds) typically seek short-term appreciation in their home-country currency and high liquidity. Financially fragile economies such as those of most developing countries stand more to lose than to gain from this kind

Trade, investment and development 55 of “investment”. As shall be argued below, there is a role that portfolio investment can play, but it needs to be regulated in order to avoid excessive volatility. Potentially, international finance has numerous microeconomic benefits for borrowing countries: it allows them to decouple investment from national saving and it helps in smoothing consumption patterns when countries are faced with reversible external shocks. However, these benefits do not always materialize, and even if they do they must be weighed against the negative macroeconomic externalities associated with some forms of international finance. International financial flows are undertaken by numerous agents with widely differing objectives and time horizons.11 These run the gamut of foreign direct investors with long time horizons and large sunk costs, to portfolio investors and interest-arbitraging agents who invest only in highly liquid instruments. It is these latter that cause difficulty, since they tend to be extremely skittish, subject to sudden changes of mood and to herd-like behaviour, basically owing to the asymmetric (and incomplete) information that characterizes financial markets in general and financial flows to emerging market countries in particular.12 Financial markets are inherently unstable, because asset prices are determined by expectations about future returns, and these are essentially unknown. Even in the case of fixed income securities and non-securitized lending, there are several sources of uncertainty about future yields which render security prices unstable and which could lead to changes in the assessment of lenders about the desirability of renewing short-term loans to borrowers. This is all the more the case in financial transactions between creditors in developed countries and debtors in developing countries, where the sources of risk are particularly varied and the degree of risk associated with each is especially high. In developing countries, exchange rates and interest rates tend to be highly unstable, and individual firms and banks have sources of fragility not found in the developed world. Therefore, the continuous changes in information that normally occur in any market economy are exacerbated when it comes to developing country settings, and these can produce excessive volatility in flows to and from these economies.13 These considerations suggest that the best approach to capital account liberalization is one of caution. In the same way as an optimal sequence for liberalization exists between the current and the capital accounts, there is also an optimal sequence within the capital account. FDI provides the most benefits and represents the least danger for countries undertaking reform. In fact, FDI, under certain circumstances, can make a contribution to the structural transformation of the economy. Therefore, it should be liberalized first. Long-term suppliers’ credits for the purchase of capital goods are also a good candidate for early liberalization. But it is

56 Manuel R. Agosín best to retain prudential regulations on the participation of the national banking system in international financial markets. Finally, the liberalization of domestic stock purchases by foreigners should be left for a very late stage in the development process. Two powerful reasons combine to make caution the most advisable course of action. The first is the sheer volatility of short-term and portfolio flows, a volatility that is largely exogenous to the recipient economy. An emerging market can receive large flows because of developments in financial centres (declines in interest rates, for example) or because a certain class of emerging markets becomes fashionable, as investors and creditors seek higher returns than those available in their home markets. The second reason is the undeveloped nature of financial markets in developing countries. Financial markets in developing countries tend to be much shallower than their counterparts in mature economies. Even their degree of monetization is much lower. This means that international capital flows can be very sizeable relative to domestic financial markets. As can be seen in Table 3.1, while in developed countries international capital flows account for 1–5 per cent of the money supply (measured by M2), in emerging markets this proportion is often in the 15–25 per cent range. An exception to policies to limit access by national banks to international financial markets can perhaps be made for trade credits, which, Table 3.1 Net foreign capital flowsa, as a share of M2b, in selected developed and emerging economies (percentage) Country

1990–98

1990–94

1995–98

Japan Canada United States Switzerland Korea, Republic Brazil Indonesia Malaysia Venezuela Chile Colombia Mexico Ecuador Argentina

1.7 3.1 3.1 5.7 5.7 7.2 9.1 11.2 14.5 18.6 18.5 18.9 19.6 22.0

1.8 4.2 2.1 5.3 4.7 3.3 8.9 13.2 18.5 18.9 11.8 23.8 16.4 25.5

1.7 1.7 4.2 6.0 7.0 10.4 8.4 6.3 11.4 19.2 26.0 12.9 19.3 18.2

Source: International Monetary Fund, International Financial Statistics, February 2000, Washington, DC. Notes a Net inflows or outflows (outflows from Switzerland and Japan, inflows into other countries). b Bills and coins in circulation, demand deposits, saving deposits, and time deposits.

Trade, investment and development 57 in low-income countries, have traditionally been the domain of transnational banks operating in their domestic markets. It should be recognized, however, that money is fungible and that it is not always possible to place different items of the capital account in watertight compartments. Controls on capital movements involve not only the possibility of leakages and fraud, but also an inevitable price in terms of microeconomic efficiency. However, they are indispensable in order to safeguard the economy from the serious negative macroeconomic externalities involved in wholesale liberalization. The problem is clearly more acute in middleincome than in very low-income countries, where private capital flows are likely to be incipient. Clearly, the management of the capital account represents one of the most difficult challenges to developing countries. However, it is essential for a successful human development strategy that seeks to deepen ties to the real side of the international economy. We thus posit that there can be a conflict between trade integration into the international economy and financial integration, and that countries must choose which one they prefer. An human development strategy involves giving primacy to trade integration. There are two types of departures from capital account liberalization that ought to be distinguished. In the first place, restrictions can be placed on inflows and on outflows. Since crises are brewed during periods of excessive inflows, restrictions or disincentives on inflows may be necessary in order to prevent future crises (Agosín and Ocampo, 2000). Restrictions on outflows are required in order to minimize the damage caused by a crisis that is already under way. Then there is the distinction between market-based measures (which affect the effective interest rate at which domestic agents can borrow abroad) and quantitative restrictions. The former are more suited to controlling inflows than outflows. The latter are particularly useful in times of crisis. Is there a role for portfolio capital in fostering human development? In countries with incipient domestic capital markets, the participation of foreign capital in domestic equity and bond markets is best handled through special vehicles rather than directly. Some developing countries have experience in this regard and allow, for example, individual equity funds to participate in domestic equity and bond markets, with limits on their participation in the equity of individual companies. Closed- or openended funds can also be created to channel resources into promising private investments and venture capital projects. Where private financial markets have a reasonable degree of development, and where regulation and supervision of financial intermediaries is reasonably good, such activities can be entrusted essentially to the private sector, the authorities retaining the role of regulators to ensure that the excesses endemic to financial markets are not committed.

58 Manuel R. Agosín In countries with undeveloped financial markets, specialized development banks can play a role in setting up funds, the objectives of which would include long-term lending to and taking up equity stakes in promising local firms. These banks can tap international markets for resources with which to jump-start these funds. The International Finance Corporation (IFC) and other multilateral and regional institutions can provide initial financial resources, assistance to countries in tapping international financial markets, and technical advice. In fact, supplementing and complementing domestic capital markets could have important pay-offs in terms of human development and should become one of the major forms of official development finance in the years to come. Infrastructure is one of the most serious bottlenecks to development. The capacities of governments to design infrastructure projects efficiently and to fund them are often the biggest stumbling blocks to solving this problem. As regards the financing, one novel approach could consist of creating specialized funds for investing in privately built and operated infrastructure works. Infrastructure funds could be operated by a development agency which would tap international markets for financing or, in countries with more developed financial markets, this role could be performed by private managers. In both cases, technical assistance from institutions such as the IFC may be important. Where necessary, aid agencies and the soft loan windows of the multilateral development banks can provide the technical and financial assistance for the design and engineering of the required infrastructure projects. International negotiations regarding the capital account Liberalization of capital account transactions has been a policy thrust of the major developed countries pursued insistently in recent years in a number of fora, including the OECD, the WTO and the IMF. The discussions in different fora differ as to the coverage of the contemplated disciplines on domestic policy and the approach taken with regard to commitments. An effort to push through a wide-ranging agreement at the OECD (the Multilateral Agreement on Investment, MAI) came to naught, but left no doubt as to the position of the major advanced countries: full liberalization of all forms of capital movements was the stated aim of the draft MAI. Likewise, in the IMF developed countries have called for “capital account convertibility”, a euphemism for the unfettered liberalization of capital transactions. On the other hand, efforts in WTO to launch negotiations towards a Multilateral Framework for Investment (MFI) deal essentially with the liberalization of FDI. While the MAI had a negative-list approach to liberalization (everything is liberalized unless a specific waiver is obtained), the WTO Agreement on Financial Services approved in 1997, which covers FDI in services, has a positive-list approach (only what is specifically offered is liberalized). The

Trade, investment and development 59 draft MAI had absolutely nothing to say on key issues of interest to developing countries, including the responsibilities of TNCs to host countries or the granting of incentives to foreign firms. Presumably, the discussions in the WTO, where developing countries are represented, would deal with these issues (Agosín, 1999c). As already argued, prudential regulation on international capital movements may be necessary in order to avert large macroeconomic costs in countries that are not ready to adopt full capital account convertibility.14 Recent papers on disincentives to short-term capital inflow show that they can be successful in limiting the size of total inflows and changing their composition towards the more desirable longer-term flows (see Agosín and Ffrench-Davis, 1997; Barrera and Cárdenas, 1997; Ocampo and Tovar, 1999; De Gregorio et al., 2000; Le Fort and Lehmann, 2000). Even if they do not use it, developing countries should retain the right to impose capital controls on outflows, particularly in times of crisis. Therefore, Fund policy ought to recognize that developing countries and transition economies are simply unprepared to liberalize their capital accounts and should stop insisting that they do so. From the point of view of developing countries, the worst outcome would be for capital account convertibility to become another item in the list of conditions attached to the use of Fund resources. It is often argued that, in practice, it is difficult to distinguish between FDI and other types of flows, because a large part of FDI is akin to portfolio investments. Mergers and acquisitions are, nowadays, more important than greenfield investments, and divestments are as frequent as investments. On the other hand, reinvested earnings also represent a large part of total FDI, and these are often invested in liquid assets or even in the stock market of the host country (Kozul-Wright and Rowthorn, 1998). Moreover, TNCs are able to move funds in and out of markets in ways that national firms cannot. While all of this is certainly true, it still seems worthwhile retaining the distinction between FDI and other flows. Statistically recorded FDI was much more stable than other flows during the recent world financial crisis (see UNCTAD, 2000). And, of course, there is no reason why the financial transactions of TNC affiliates cannot be treated in the same manner as all other international financial transactions and made to comply with regulations applying to national agents. There are other issues that merit consideration when it comes to international policies towards the capital account.15 Since developing countries are particularly vulnerable to reversible external shocks – be they on the current or capital account side – it is important for them that international arrangements protect their development efforts from derailing owing to circumstances beyond their control. The late-1990s financial crisis has made it clear that the International Monetary Fund has not been an effective instrument in containing the spread of the crisis or assisting affected countries to surmount it as speedily as possible.

60 Manuel R. Agosín In order to be of greater assistance to developing countries experiencing a reversible deterioration in their terms of trade, the Fund ought to be willing to give such countries more liberal access to its Compensatory Financing Facility (CFF), which was created expressly for that purpose but which has fallen into disuse in recent years. Primary commodity producers are the prime candidates to draw more actively from the CFF. In most cases, commodity prices tend to be stationary variables experiencing eventual mean reversal. For such cases, liberal lending from the CFF during price slumps is fully justified. Since most developing countries do not have access to international financial markets to finance temporary shortfalls in export earnings, support from the CFF is the only avenue open to them to avoid having to pursue excessively restrictive domestic demand policies during periods of primary commodity price declines. In recent years, as emerging economies have gained access to international financial markets, the world economy has been hit with increasingly frequent and virulent financial crises, one of whose traits is the phenomenon of contagion (for a discussion, see Agosín, 1999b; Agosín and Ocampo, 2000). Even countries that have good macroeconomic management have been hit by financial crises that started elsewhere. Recent examples are Hong Kong and Singapore in Asia, and Chile and Argentina in Latin America. It can even be argued that financial markets inflicted a punishment on the Republic of Korea that was incommensurate with its real problems, and that such punishment was mainly the result of contagion (Agosín, 2001). After the Mexican financial crisis of late 1994, the Fund established mechanisms that enable it to act more speedily in cases of severe crises. In addition, it set up two additional facilities: the Supplemental Reserve Facility, aimed at exceptional financing needs, and the Contingency Credit Lines (CCL), designed to assist countries that face financial contagion. To be able to draw on the CCL, countries must have been positively evaluated during the Article IV Consultations (involving de facto ex ante conditionality) and must have adopted the tight standards for the dissemination of information recently adopted by the Fund. For resources to be made available, countries must enter into a standard stand-by agreement with the Fund, implying a second round of conditionality. In view of the lack of the ambiguities that surround the use of these resources, the possible negative signals that an application may send to financial markets, and the modest amount of resources available, it should not come as a surprise that no country has requested funds from this source. There is thus the need to make further progress towards the creation of a true contingency financing facility at the IMF (see Agosín and Ocampo, 2000; Ahluwalia, 2000). This facility ought to be endowed with sufficient resources; they ought to be fast-disbursing, relatively short-term, and interest rates ought to be high enough to encourage rapid repayment. It does not make much sense to attach conditions to the use of these resources,

Trade, investment and development 61 since this would slow down disbursement. In order to ensure that its resources are not being used to defend unsustainable policies, the Fund could use certain basic and uncontroversial criteria related to macroeconomic stability and current account balance. The best way to finance such a facility is through the allocation of SDRs. There are several proposals to this effect on the table (Williamson, 1996; Ezekiel, 1998; Ahluwalia, 1999), some of them requiring an amendment to the Fund’s Articles of Agreement. Another approach is to develop a set of rules for orderly suspensions of payments when a country is facing capital flight for reasons that are unrelated to its own policies (UNCTAD, 1998). A true contingency financing facility and orderly suspensions of debt repayments are not substitutes. In fact, they are complements, and they are both needed. In the absence of rules for suspending payments, the creation of a contingency financing facility can induce imprudent behaviour on the part of both debtors and lenders. On the other hand, orderly debt suspensions do not solve the problem of contagion. Besides, in the absence of contingency financing, countries affected by capital flight that must avail themselves of suspensions in the repayment of their obligations may take a very long time to return to international financial markets. The Fund also needs to take a new look at its conditionality policies, which are designed for situations in which a country has gotten into trouble owing to overly expansive macroeconomic policies or inappropriate exchange rates. Conditionality should continue to operate when the source of the applicant’s problems is in fact inappropriate macroeconomic policies, but it should not be imposed on countries suffering from reversible shocks to their current or capital accounts. The introduction of structural reforms, particularly in times of financial crisis, should not be a condition for drawing on Fund resources. And neither should capital account convertibility.

VI. Policies towards FDI It has already been suggested above that policies towards FDI ought to be liberalized ahead of those towards other items in the capital account. The reason is that, potentially, FDI can make an important contribution to human and social development (see Chapter 4 of this book). FDI is often valued for its contributions to capital formation, access to new export markets, training of the labour force, potential backward and forward linkages, and introduction of new technologies and managerial skills. Of course, not all FDI does so. Some foreign investments may displace domestic entrepreneurs or domestic investment (see Agosín and Mayer, 2000). Others may fail to contribute significantly in any of the dimensions noted. However, all things considered, a liberal policy towards FDI is more likely to have favourable effects on development than a restrictive one.

62 Manuel R. Agosín Many developing countries do not possess the human resources or governmental capabilities to design and manage a successful selective policy towards FDI. In these countries, selective policies are more likely to discourage potential investors than discriminate between better or worse projects. In these countries, the best policies are those which establish clear and stable rules of the game and national treatment at the post-investment stage. Countries with greater experience in managing FDI policies can afford to apply more selective policies. Since the objective is to attract foreign firms, selectivity should not be implemented via controls, which are more likely to discourage investors generally. There are several ways of putting in place selective polices that are market friendly. For example, firms that train their labour forces, carry out research and development, develop local suppliers and subcontractors and assist local suppliers with the upgrading of product quality or technology could be allowed to discount from their taxable income a certain multiple of the expenses incurred in carrying out these socially desirable tasks. Of course, these incentives should also be open to national companies. Even within a basically liberal approach to FDI, much can be done to attract desirable TNCs. The essential component of a policy towards FDI that fits with a human and social capital development strategy is to define the basic building blocks of the development strategy. For this, policymakers need to have a clear idea of what clusters of activities have a good chance of arising in the next stage of gaining comparative advantages, and, therefore, which activities should be promoted. This will determine needs for the development of human resources, infrastructure requirements, etc. Then policy-makers can in fact attempt to target TNCs that present the most desirable characteristics and ask of them what it is that they need to invest in their country. A very good example of this kind of effort is the success of Costa Rica in attracting INTEL to build a US$500 million semiconductor plant that has already changed the profile of Costa Rican production and exports and is expected to develop significant backward linkages to the rest of the economy (ECLAC, 1998: 48–9). Investment incentives may have a place in this strategy, but it should be remembered that they often wind up being transfers from the treasury of a poor host country to that of a rich home country. A better policy is to have in place double taxation treaties with home countries of investing companies so that taxes paid in the host country can be deducted from tax liabilities of the investor in its home country. It should also be remembered that tax exemptions are considered subsidies in WTO and, therefore, are liable to attract countervailing duties in importing countries.16 Official development assistance (ODA) can also be very important in helping countries to attract the FDI they require for the implementation of a human development strategy. Often FDI is not attracted to developing countries because a large number of complementary inputs are not to

Trade, investment and development 63 be found in these economies. Perhaps the most important ones are infrastructure (roads, ports, airports), human resources and public utilities (telecommunications and electricity). As noted above, some of these needs can be addressed through novel ways of mobilizing private financial resources from international markets. But in the poorest countries, ODA will remain essential.

VII. Concluding remarks Human and social development are complex goals requiring complex policies. Their very complexity is already an indication that they may be difficult to design and implement in low-income countries. Therefore, policy-makers have to be objective as to the capabilities of national institutions, both public and private. This argues for identifying key bottlenecks and working on them, using wherever possible market solutions that economize on centralized decision-making. In the context of human and social development, liberalization should be seen as a tool, not as a goal in itself. Our contention is that, while in many instances appropriate, liberalization will almost never be enough. In some cases, in fact, it may not be desirable. This is particularly the case with capital flows. Liberalization is a passive policy approach consisting in dismantling market distortions. Human and social development will also require active policies to build supply capabilities and strong supply responses to price signals, in a way such that sustained growth, structural change, poverty alleviation and improvements in income distribution might be achieved. While the situation will vary from country to country, the key areas to work on are improving and supplementing domestic capital markets, technology acquisition and development, training and higher and technical education, the acquisition of information on foreign markets, and the development of new infrastructure. National policies must be accompanied by support at the international level. Therefore, countries must become aware of what policies at the international level in the fields of trade, investment and finance will be supportive of human and social development. This will allow them to participate more actively (and, hopefully, successfully) in international negotiations.

64 Manuel R. Agosín

Annex 3.1: Welfare indicators, 1997 Country

Life expectancy at birth (years)

Infant mortality (per 1,000 children born alive)

Human Development Index (rank)

Sierra Leone Ethiopia Tanzania Burundi Rwanda Mozambique Malawi Mali Yemen Congo, Democratic Republic of Angola Niger Nigeria Madagascar Zambia Chad Burkina Faso Eritrea Bangladesh Nepal Uganda Kenya Benin Haiti Cambodia Republic of Congo Laos Central African Republic Sudan Togo Moldova Gambia Mongolia Azerbaijan Comoros Pakistan Vietnam Ghana Mauritania India Senegal Ivory Coast Cameroon Guinea Georgia Albania

37 43 48 42 40 45 43 50 54 51 46 47 54 57 43 49 44 51 58 57 42 52 53 54 54 48 53 45 55 49 67 53 66 71 60 62 68 60 53 63 52 47 57 46 73 72

170 107 85 119 124 135 133 118 96 92 125 118 77 94 113 100 99 62 75 83 99 74 88 71 103 90 98 98 71 86 20 78 52 20 65 95 29 66 92 71 70 87 52 120 17 26

174 172 156 170 164 169 159 166 148 141 160 173 146 147 151 162 171 167 150 144 158 136 155 152 137 135 140 165 142 143 104 163 119 103 139 138 110 133 149 132 153 154 134 161 85 100

Per capita GNP (PPP US$)

410 510 620 620 650 690 710 720 720 760 820 830 860 900 910 950 1,000 1,040 1,090 1,090 1,160 1,160 1,260 1,260 1,290 1,290 1,300 1,310 1,370 1,440 1,450 1,470 1,490 1,520 1,530 1,580 1,590 1,610 1,650 1,660 1,690 1,690 1,770 1,790 1,980 2,170

Trade, investment and development 65 Country

Life expectancy at birth (years)

Ukraine Kyrgyz Republic Zimbabwe Honduras Solomon Islands Sri Lanka Lesotho Armenia Guyana Bolivia El Salvador Cape Verde Syria China Egypt Macedonia Morocco Vanuatu Swaziland Maldives Jordan Indonesia Jamaica Kazakhstan Samoa Philippines Paraguay Fiji Bulgaria Latvia Dominica Guatemala Belize Lithuania Algeria Romania Russian Federation Peru Dominican Republic Ecuador Belarus Tunisia Estonia Namibia Lebanon Brazil

67 67 52 69 70 73 56 74 64 61 69 68 69 70 66 72 67 65 60 67 71 65 75 65 69 68 70 73 71 69 76 64 75 71 70 69 67 69 71 70 68 70 70 56 70 67

Infant mortality (per 1,000 children born alive) 14 28 69 36 23 14 93 15 58 66 32 56 31 32 51 16 51 37 65 32 29 47 12 24 22 35 23 18 18 15 16 43 32 10 32 22 17 40 40 33 12 30 10 65 28 34

Human Development Index (rank) 91 97 130 114 118 90 127 87 99 112 107 106 111 98 120 73 126 116 113 93 94 105 82 76 70 77 84 61 63 74 53 117 83 62 109 68 71 80 88 72 60 102 54 115 69 79

Per capita GNP (PPP US$)

2,170 2,180 2,240 2,260 2,270 2,460 2,490 2,540 2,800 2,860 2,880 2,950 3,000 3,070 3,080 3,180 3,210 3,210 3,330 3,340 3,350 3,390 3,440 3,530 3,570 3,670 3,860 3,860 3,870 3,970 4,020 4,060 4,080 4,140 4,250 4,270 4,280 4,580 4,690 4,700 4,820 5,050 5,090 5,100 6,090 6,460 continued

66 Manuel R. Agosín Country

Life expectancy at birth (years)

Trinidad and Tobago Turkey Thailand Poland Gabon Colombia Costa Rica Hungary South Africa Botswana Malaysia Slovak Republic Mexico Venezuela Uruguay Mauritius Argentina Czech Republic Saudi Arabia Slovenia Chile Greece Malta Korea Portugal Spain New Zealand Ireland Israel Sweden Australia Finland Italy United Kingdom Germany Canada Austria France Belgium Denmark Hong Kong Japan Norway Switzerland United States Singapore

73 69 69 73 52 70 77 71 65 47 72 73 72 73 74 71 73 74 71 75 75 78 77 72 75 78 77 76 77 79 78 77 78 77 77 79 77 78 77 75 79 80 78 79 76 76

Infant mortality (per 1,000 children born alive) 12 40 33 10 87 24 12 10 48 58 11 9 31 21 16 20 22 6 21 5 11 7 7 9 6 5 7 5 7 4 5 4 5 6 5 6 5 5 6 6 5 4 4 5 7 4

Human Development Index (rank)

Per capita GNP (PPP US$)

46 86 67 44 124 57 45 47 101 122 56 42 50 48 40 59 39 36 78 33 34 27 32 30 28 21 18 20 23 6 7 13 19 10 14 1 16 11 5 15 24 4 2 12 3 22

6,460 6,470 6,490 6,510 6,560 6,570 6,610 6,970 7,190 7,430 7,730 7,860 8,110 8,660 9,110 9,230 10,100 10,380 10,540 11,880 12,240 12,540 13,380 13,430 14,180 15,690 15,780 17,420 17,680 19,090 19,510 19,660 20,100 20,710 21,170 21,750 22,010 22,210 23,090 23,450 24,250 24,400 24,450 26,580 29,080 29,230

Source: World Bank, World Development Indicators, 1999, Washington, DC; UNDP, Human Development Report, 1999, New York.

Trade, investment and development 67

Annex 3.2: Derivation of the compensatory depreciation Assume that, to start out, the economy is in balance-of-payments equilibrium. Letting F* be equilibrium capital flows, the balance-of-payments equilibrium can be described as follows: p *m *qm(pm)  p*x *qx(px)  F *

(II-1)

where asterisks denote international prices (assumed to be independent of the levels of trade of our country). We can differentiate (II-1) to obtain: p *m *dqm  p*x *dqx  0

(II-2)

Under the small country assumption, the price for the importable and exportable are, respectively: pm  e*(1  t)*p *m px  e*p*x

(III-3)

where t is the (ad valorem) tariff and e is the nominal exchange rate (“pesos” per “dollar”). By the definition of elasticity, we obtain expressions for dqx and dqm: dqm  qm*m*(ê  ˆt ) dqx  qx*x*ê

(II-4)

where a “hat” over a variable denotes percentage change. Replacing (II-4) and (II-1) into (II-2): ˆt ê   h(x/m)  1

(II-5)

where h is the initial ratio between the value of exports and the value of imports expressed in foreign currency. If the current account is in balance to begin with, (II-5) reduces to: ˆt ê   x/m  1

(II-5a)

Notes 1 The HDI is a composite of several dimensions of human development, including life expectancy, adult literacy, school enrolment rates, and GDP per capita in PPP dollars. See UNDP (2000) for the way it is calculated.

68 Manuel R. Agosín 2 This is not the place to discuss the causes of the East Asian countries’ success. Interested readers are referred to Amsden (1989, 1993, 1994); Wade (1990); World Bank (1993); Lall (1994); Page (1994); Yanagihara (1994). 3 For the Chilean experience, see Ffrench-Davis et al. (1993); a review of the experience with trade liberalization in Latin America can be found in Agosín and Ffrench-Davis (1995). 4 Defined as units of domestic currency per unit of foreign currency. 5 The case of Chile is analysed in detail in the already cited paper by FfrenchDavis et al. (1993). For the cases of Mexico and Turkey, see Ten Kate (1993) and Uygur (1993). 6 The way we have defined the exchange rate implies that a downward movement is an appreciation, an upward movement a depreciation. 7 For the Chilean experience with this kind of subsidy, see Agosín (1999a). 8 Further mutual trade liberalization in developing countries is also important. Some developing countries have began to emulate the bad protectionist habits of developed countries by, for example, closing off their agricultural sectors to imports or resorting to anti-dumping duties. 9 This view has come to be closely associated with the World Bank. For variants, see Edwards (1984), Michaely (1986) and Papageorgiou et al. (1990). 10 We label “passive policies” those policies which consists of basically eliminating policy-induced distortions. Sometimes these policies are not easy to implement, but they are still passive in that they do not require that the government works to create new assets or capabilities. 11 There are differing views on this issue. Claessens et al. (1995) argue that it is impossible to differentiate the behaviour of what the IMF classifies as foreign direct investment (FDI) from that of other types of flows. However, an analysis for Chile (Agosín and Ffrench-Davis, 1997) shows that FDI is much more persistent and has much less variance around its time trend than portfolio flows or short-term lending. As Radelet and Sachs (1998) point out, in the financial crises of the 1990s FDI has been quite stable, and all the volatility has been due to the behaviour of short-term lending and portfolio flows. 12 See Calvo and Mendoza (1996, 2000) for a plausible model of portfolio investments in emerging markets. 13 See Agosín (1999b) for a more developed argumentation. 14 The term “prudential”, which is borrowed from banking regulation and supervision, is not usually associated with international capital flows. However, given the volatility of certain kinds of capital flows and the widespread contagion effects that have recently become evident, national controls on international capital movements do, in fact, acquire a prudential nature. The use of capital controls and disincentives for the purpose of improving the effectiveness of macroeconomic management, banking supervision and regulation, and corporate governance is discussed at length in UNCTAD (1998: 101–5). 15 For a more articulated discussion of these issues, see Agosín (1999a). 16 The only countries that still have the right to use export subsidies are those with a per capita GDP of less than US$1,000 and that have a world market share of less than 3.25 per cent in the subsidized export.

References Agosín, M. R. (1996), “El Retorno de la Inversión Extranjera a América Latina”, in M. R. Agosín (ed.), Inversión Extranjera Directa en América Latina – Su Contribución al Desarrollo, Fondo de Cultura Económica, Mexico City and Santiago. Agosín, M. R. (1999a), “Trade and growth in Chile”, CEPAL Review, 68: 79–100.

Trade, investment and development 69 Agosín M. R. (1999a), “Towards a New Architecture for the International Financial System: Lessons from the Financial Crisis”, Working Paper No. 1, Centre on International Economics and Development, Universidad de Chile. Agosín, M. R. (1999c), “Capital account convertibility and multilateral investment agreements: what is in the interest of developing countries?”, International Monetary and Financial Issues for the 1990s, Vol. X, UNCTAD, Geneva and New York. Agosín, M. R. (2001), “Korea and Taiwan in the financial crisis”, in R. FfrenchDavis (ed.), Preventing Financial Crises in Successful Emerging Economies, to be published by ECLAC, Santiago. Agosín, M. R. and R. Ffrench-Davis (1995), “Trade liberalization and growth: recent experiences in Latin America”, Journal of Interamerican Studies and World Affairs, 37: 9–58. Agosín, M. R. and R. Ffrench-Davis (1997), “Managing capital inflows in Chile”, Estudios de Economía, 24: 297–326. Agosín, M. R. and R. Mayer (2000), “Foreign Investment in Developing Countries: Does it Crowd In Domestic Investment?”, UNCTAD Discussion Paper No. 146, Geneva. Agosín, M. R. and J. A. Ocampo (2000), “La Arquitectura Financiera Internacional: Hacia la Creación de un Marco Propicio para la Estabilidad de los Mercados Financieros y Cambiarios”, CEPAL, Santiago, unpublished. Ahluwalia, M. S. (1999), “The IMF and the World Bank in the new financial architecture”, International Monetary and Financial Issues for the 1990s, Vol. XI, UNCTAD, Geneva. Ahluwalia, M. S. (2000), Reforming the Global Financial Architecture, Commonwealth Secretariat, London. Amsden, A. H. (1989), Asia’s Next Giant: South Korea and Late Industrialization, Oxford University Press, New York and Oxford. Amsden, A. H. (1993), “Trade policy and economic performance in South Korea”, in M. R. Agosín and D. Tussie (eds), Trade and Growth: New Dilemmas in Trade Policy, Macmillan, Basingstoke. Amsden, A. H. (1994), “Why isn’t the whole world experimenting with the East Asian model to develop? Review of The East Asian Miracle”, World Development, 22: 627–33. Barrera, F. and M. Cárdenas (1997), “On the effectiveness of capital controls: the experience of Colombia during the 1990s”, Journal of Development Economics, 54: 27–57. Bruton, H. (1998), “A reconsideration of import substitution”, Journal of Economic Literature, 36: 903–36. Calvo, G. A. and E. G. Mendoza (1996), “Petty crime and cruel punishment: lessons from the Mexican debacle”, American Economic Review, 86: 170–5. Calvo, G. A. and E. G. Mendoza (2000), “Capital-markets crises and economic collapse in emerging markets: an informational-frictions approach”, American Economic Review, 90: 59–64. Calvo, G., L. Leiderman and C. Reinhart (1993), “Capital Inflows and Real Exchange Appreciation in Latin America: The Role of External Factors”, IMF Staff Papers, 40. Caves, R. E. (1996), Multinational Enterprise and Economic Analysis, Cambridge University Press, New York and Cambridge.

70 Manuel R. Agosín Claessens, S., M. P. Dooley and A. Warner (1995), “Portfolio capital flows: hot or cold?”, The World Bank Economic Review, 9: 1–17. De Gregorio, J., S. Edwards and R. O. Valdés (2000), “Controls on capital inflows: do they work?”, Journal of Development Economics, 63: 59–83. Díaz-Alejandro, C. F. (1985), “Goodbye financial repression, hello financial crash”, Journal of Development Economics 19: 1–24. ECLAC (1998), La Inversión Extranjera en América Latina y el Caribe, ECLAC, Santiago. Edwards, S. (1984), “The Order of Liberalization of the External Sector in Developing Countries”, Essays in International Finance No. 156, International Finance Section, Department of Economics, Princeton University, Princeton. Edwards, S. (1993), “Openness, trade liberalization, and growth in developing countries”, Journal of Economic Literature, 31: 1358–93. Ezekiel, H. (1998), “The role of special drawing rights in the international monetary system”, in UNCTAD, International Monetary and Financial Issues for the 1990s, Vol. IX, UNCTAD, Geneva and New York. Ffrench-Davis, R., P. Leiva and R. Madrid (1993), “Trade liberalization and growth: the Chilean experience, 1973–89”, in M. R. Agosín and D. Tussie (eds), Trade and Growth: New Dilemmas in Trade Policy, Macmillan, Basingstoke. Helleiner, G. K. (1990), “Trade strategy in medium-term adjustment”, World Development, June. Kozul-Wright, R. and R. Rowthorn (1998), “Spoilt for choice? Multinational corporations and the geography of international production”, Oxford Review of Economic Policy, 14: 74–92. Lall, S. (1994), “The East Asian Miracle: does the bell toll for industrial strategy?”, World Development, 22: 645–54. Le Fort, G. and S. Lehmann (2000), “El Encaje, los Flujos de Capitales y el Gasto: Una Evaluación Empírica”, Documento de Trabajo No. 64, Banco Central de Chile, Santiago. Michaely, M. (1986), “The timing and sequencing of a trade liberalization policy”, in A. M. Choksi and D. Papageorgiou (eds), Economic Liberalization in Developing Countries, Blackwell, Oxford. Ocampo, J. A. and C. Tovar (1999), “Price-based Capital Account Regulations: The Colombian Experience”, Serie Financiamiento del Desarrollo No. 87, ECLAC, Santiago. Page, J. (1994), “The East Asian miracle: an introduction”, World Development, 22: 615–25. Papageorgiou, D., A. M. Choksi and M. Michaely (1990), “Liberalizing Foreign Trade in Developing Countries – The Lessons of Experience”, World Bank, Washington, DC. Radelet, S. and J. D. Sachs (1998), “The East Asian financial crisis: diagnosis, remedies, prospects”, Brookings Papers on Economic Activity, 1: 1–90. Ramos, J. (1993), “El Problema del Empleo: Enfoques Ortodoxos y Estructurales”, Cuadernos de Economía (Santiago), 90: 225–46. Rodrik, D. (1992a), “Closing the productivity gap: does trade liberalization really help?”, in G. K. Helleiner (ed.), Trade Policy, Industrialization, and Development, Clarendon Press, Oxford. Rodrik, D. (1992b), “Conceptual issues in the design of trade policy for industrialization”, World Development, 20: 309–20.

Trade, investment and development 71 Sachs, J. D. and A. Warner (1995), “Economic reform and the process of global integration”, Brookings Papers on Economic Activity, 1: 1–118. Sen, A. K. (1984), “Goods and people”, in Resources, Values and Development, Harvard University Press, Cambridge, MA. Sen, A. K. (1999), Development as Freedom, Knopf, New York. Ten Kate, A. (1993), “Structural adjustment in Mexico: two different stories”, in M. R. Agosín and D. Tussie (eds), Trade and Growth: New Dilemmas in Trade Policy, Macmillan, Basingstoke. Tussie, D. and M. Lengyel (1998), “Compromisos en la Organización Mundial de Comercio sobre Promoción de Exportaciones”, Integración y Comercio, 2(4/5): 77–96. United Nations Conference on Trade and Development (UNCTAD, 1989), Trade and Development Report 1989, UNCTAD, Geneva and New York. UNCTAD (1992), Trade and Development Report 1992, UNCTAD, Geneva and New York. UNCTAD (1997), Trade and Development Report 1997, UNCTAD, Geneva and New York. UNCTAD (1998), Trade and Development Report 1998, UNCTAD, Geneva and New York. UNCTAD (1999), “Foreign direct investment, transnational corporations, and development”, MFI Series No. 1, UNCTAD, Geneva. UNCTAD (2000), World Investment Report, 2000, UNCTAD, Geneva and New York. United Nations Development Programme (UNDP, 2000), Human Development Report, 2000, UNDP, New York. UNDP (2003), Making Global Trade Work for People, 2003, UNDP, New York. Uygur, E. (1993), “Trade policies and economic performance in Turkey in the 1989s”, in M. R. Agosín and D. Tussie (eds), Trade and Growth: New Dilemmas in Trade Policy, Macmillan, Basingstoke. Wade, R. (1990), Governing the Market – Economic Theory and the Role of Government in East Asian Industrialization, Princeton University Press, Princeton. Williamson, J. (1996), “A new facility for the IMF?”, in UNCTAD, International Monetary and Financial Issues for the 1990s, Vol. VII, UNCTAD, New York and Geneva. World Bank (1993), The East Asian Miracle, Oxford University Press, New York. Yanagihara, T. (1994), “Anything new in the Miracle Report? Yes and no”, World Development, 22: 663–70.

4

Foreign direct investment, growth, and human and social development1 Daniel Chudnovsky and Andrés López

I. Introduction Foreign direct investment (FDI) is generally considered as a driving force in the integration of developing countries into the globalization process that characterizes the world economy. Although most FDI is concentrated in developed countries, developing countries made important gains in the 1990s in terms of flows of inward FDI: from US$34 billion in 1990 to US$239 billion in 2000 (UNCTAD, 2002). However, a small number of developing countries in Asia and Latin America (notably China and Brazil) has attracted most of the recent flows of FDI. The majority of the low-income developing countries (LIDCs) – which are defined, for the purpose of the present chapter, as those with a per capita gross domestic product (GDP) of less than US$1,000 – have received small, if any, amounts of FDI. Nonetheless, some of the LIDCs have recently received higher inflows (e.g. Angola, Bangladesh, Uganda and the Republic of Tanzania), and a number of them have significant stocks of FDI in relation to their GDP (though their GDP is often quite low). These countries have generally attracted FDI in mining, tourism, export-processing zones and, to a lesser extent, in manufacturing or services oriented to the domestic market. Since most developing countries are eager to attract FDI, it is not surprising to find that competition among governments for FDI has heated up in recent years (Aranda and Sauvant, 1996; Oman, 1998). Developing countries engage in this kind of competition because they take for granted that FDI is a key instrument for fostering growth and competitiveness. Nonetheless, it is by no means clear that FDI generates more benefits than costs for host countries, as is often assumed. In this connection, the main objective of this chapter is to examine under what conditions and policy framework FDI may indeed contribute to improving a host country’s competitiveness and its fulfilment of human and social development objectives. The purposes of this chapter are as follows: first, to highlight the bene-

Foreign direct investment, growth and development 73 fits and costs of FDI in the context of trade liberalization and other structural reforms undertaken in developing countries; and second, to examine the impact of FDI on growth and human development processes under three headings – (i) innovative activities and technological spillovers, (ii) employment, poverty alleviation and income distribution, and (iii) environment. Though these issues are strongly related, they are examined one by one for analytical convenience. As a survey of the literature is beyond the scope of this chapter, only a brief examination is made of the main arguments under discussion. For each topic, the relevant issues to be addressed in empirical work are listed and discussed. Third, on the basis of the experiences of developed as well as of developing countries, some policy options are considered. Our attention is not only focused on policies aimed at increasing the volume of FDI. Rather, we are interested in the set of policies required to develop a competitive domestic enterprise sector and, if possible, to create dynamic knowledgeintensive clusters in which environmentally friendly technologies are used. Policy suggestions are geared not only to enhancing the contribution of FDI to growth, competitiveness, and human and social development, but also to improving the capacity of developing countries and especially of LIDCs to participate in a proactive manner in regional and international negotiations on a possible multilateral framework for investment.

II. Benefits and costs of FDI in the context of structural reforms Most developing countries have made a shift in their economic policy regimes in the last two decades. Leaving behind the regulatory regime characteristic of the import substitution industrialization (ISI) stage, these countries have generally liberalized their economies and dismantled their trade barriers, and have often privatized their public enterprises. In addition to domestic forces working in this direction, pressures from international financial organizations (like IMF and World Bank) and the increasing enforcement of multilateral trade disciplines within the World Trade Organization (WTO) have been important determinants of this shift. As a key part of the reform package, most developing countries have dismantled the restrictions and regulations which were in place on FDI, and are now welcoming transnational corporations (TNCs) and competing to attract them. There are two main reasons for this changing attitude towards TNCs. At the microeconomic level FDI is acknowledged as a potentially powerful instrument for improving access to international markets, for obtaining the technological and organizational capabilities required for producing and exporting new goods and services, and for fostering backward and forward linkages. In this way, FDI may enhance the international competitiveness of a host country. At the macroeconomic

74 D. Chudnovsky and A. López level, FDI can contribute to financing current account deficits in the balance of payments of host countries. Moreover, since TNCs invest in a country following strategies with long time horizons and objectives and, once installed, have large sunk costs in host countries, FDI is considered less volatile than portfolio investment and other types of international financial flows. For both reasons, an increasing volume of FDI is often a vital contribution to the development process. However, neither of these potential benefits should be taken for granted and, perhaps more importantly, they should be evaluated against the potential costs of FDI. As Dunning (1993: 284) states, “many countries in the world are dependent on TNCs as providers of resources, capabilities, and markets, as creators of jobs and wealth, as suppliers of foreign currency, as stimulators of entrepreneurship and worker motivation, and as harbingers of rising demand expectancies.” But while TNCs are interested in a limited number of private economic goals, nation states have a broader range of both economic objectives (GNP growth, full employment, improvements in income distribution, environmental protection) and non-economic objectives (sovereignty in decision-making, political and cultural identity). Also, whereas TNCs are interested in maximizing global profits or sales, states are interested in maximizing the welfare of their citizens. In view of this divergence, some host countries may be worse off as a result of the activities of TNCs. They may lose control over strategic economic sectors, indigenous enterprises may be displaced in certain activities, jobs may be lost, and the local environment may suffer. As Dunning (1993) has pointed out, this implies a difficult counterfactual analysis. In other words, the question to be answered in each case is: what would have occurred in the absence of TNCs or in the absence of a set of policies aimed at maximizing the net benefits of TNCs and building national capabilities? The contribution of FDI to the economic development of a host country depends not only on its volume but also on its quality. The type of investment, the sector of destination, the kind of assets brought by the TNCs and the role played by the affiliates within the global network of the TNCs are important determinants. At the same time, the characteristics of host countries affect not only the amount and kind of FDI that is attracted, but also its contribution to growth, competitiveness, and human and social development. As Dunning (1994) has noted, these characteristics include policies (macroeconomic, trade, competitions, FDI), economic performance (GDP growth, price stability) and structural factors (market size, the availability of natural resources, the quantity and quality of human resources, physical and technological infrastructure, business ethics, the legal system). The characteristics of indigenous entrepreneurs (i.e. the sectors in which they operate, their corporate structures, strategies, innovative

Foreign direct investment, growth and development 75 capabilities, organizational procedures, attitudes towards risk) are also a major determinant of the contribution of FDI. Although FDI may have a positive role leading to economic diversification and higher exports, generating employment and externalities and strengthening the local system of innovation (see below), it may also have a negative role. This is the case when FDI remains an enclave operation exploiting natural resources with bad environmental practices, when foreign affiliates take advantage of their proprietary assets to crowd out local competitors, or when they engage in market distorting practices. Regarding the contribution of FDI to the balance of payments of a host country, more than just the initial entry of capital must be considered. Profit flows from FDI operations sooner or later will have a negative impact on the balance of payments. These profits are remitted abroad as dividends and, sometimes, as royalty and interest payments, and through transfer pricing of merchandise imports and exports. Moreover, TNCs may have a greater import propensity than local firms, as documented in several studies (Chudnovsky and López, 1998). Thus, in the long term, many FDI projects may make a negative contribution to the balance of payments of host countries. FDI projects in net export generating activities and in which the foreign investors repatriate low dividends and reinvest most of the profits within the host country would be the more favourable from this point of view. FDI in non-tradable sectors would be, prima facie, the least favourable ones (South Centre, 1997). At the same time, doubts have been raised regarding whether in fact FDI is a more stable form of foreign capital inflow. New developments in financial markets such as derivatives and the expansion of existing instruments (e.g. hedging) have greatly blurred the distinction between FDI and portfolio investment with respect to the relative stability of these flows. Moreover, profit remittances may be as volatile as portfolio investment flows, especially during an economic crisis (South Centre, 1997). Notwithstanding these reasonable doubts about the net contribution of FDI to host countries, governments are compelled to compete with each other in order to attract FDI, and a kind of “prisoner’s dilemma” has emerged. While governments have a collective interest in refraining from engaging in bidding wars to attract FDI, individual governments fear that if they refrain from bidding, FDI will be diverted to those countries which offer investment incentives (Oman, 1998). Of course, these incentives – which are mostly fiscal and financial – are part, and often a very significant part, of the costs of attracting FDI, and may imply the diversion of resources from other socially desirable activities (e.g. education, housing, health, etc.). In summary, FDI can certainly make a positive contribution to growth, competitiveness and human development in host developing countries, but may have some significant costs that have to be considered as well.

76 D. Chudnovsky and A. López As a consequence, a careful assessment of the impact of FDI must be made in order to design and implement policies – at the national as well as international levels – aimed at enhancing the benefits and reducing the costs of FDI for host countries.

III. FDI, growth and sustainable human development: some key issues The main issues regarding the impact of TNCs on growth and sustainable human development are examined in this section. Those issues directly involved in the concept of human and social capital development (e.g. employment, income distribution, environment) are dealt with mostly in relation to technology and innovation, since they play, in our view, a crucial role in fostering growth and human and social development objectives. At the same time, technology and other innovation-related phenomena represent one of the pillars of competitiveness, at the national and firm level. The other pillar is, of course, formed by price and cost determinants, which have extensively been dealt with in the traderelated literature. In Annex 4.1, some statistical exercises regarding the complex relationships between FDI and human and social development are shown. Even if the available indicators are too rough and the exercise itself needs to be refined, the main results are worth bearing in mind. First, a positive correlation is apparent between FDI stocks as a share of GDP, on the one hand, and GDP per capita and human and gender development indicators, on the other. This suggests that a feedback process between HDI and FDI growth may have been taking place in the last two decades. Conversely, the levels of FDI seem to be negatively correlated with environmental indicators in host countries. Nonetheless, a cursory examination of the data reveals significant differences among host countries regarding the relationship between FDI and human and social development indicators. Thus, to learn more about the causality and dynamics of these relationships, it is important not only to carry out further statistical exercises, but also to go beyond them and examine the pertinent issues at specific country levels and for specific FDI projects. One dollar of FDI has different impacts in terms of growth and sustainable development according to the type of FDI, the sector in which it operates, and the structural characteristics, development styles, and available price and non-price incentives in host countries. In what follows, we discuss briefly the impact of FDI on three main human and social development-related issues (technology; employment, poverty alleviation and income distribution; and environment).

Foreign direct investment, growth and development 77 Innovative activities and technological spillovers Many analysts have regarded TNCs as one of the main vehicles for allowing developing countries to begin to close the gap with world leaders in technology, or at least to be able to keep up in a more open and competitive economic environment. In many sectors, especially the most dynamic and knowledge-intensive ones, TNCs have important technological assets. Besides, TNCs are often at the cutting edge in terms of process and organizational technologies. Hence, the key questions are the manner and extent to which developing countries may benefit from TNCs in order to foster their social and economic development, and enhance their competitiveness. Even if most technological inputs can be imported, developing countries have to foster what has been termed a “social” or “absorptive” capability (Abramovitz, 1986; Dahlman et al., 1987; Albuquerque, 1997). In other words, developing countries must create a basic endogenous capability to assimilate and take advantage of foreign technology inputs. This endogenous capability is a crucial element in what has been termed “structural competitiveness” (OECD, 1992). It is based on the idea that the competitiveness of firms is not only a reflection of successful management and technological practices, but also stems from the strength and efficiency of a national economy’s productive structure, the collective learning process associated with innovation, and the proper use of human capital. Empirical evidence shows that those developing countries which have reached a relatively high level of industrialization and structural competitiveness have done so by building domestic technological capabilities which go beyond those required for choosing, adapting and efficiently using foreign technological inputs. The experience of the most advanced developing economies, especially the Republic of Korea, Taiwan Province of China, Singapore and Hong Kong (China), indicates that major improvements are possible. Local firms in developing countries can also create new technologies, as they progress through their learning process. In this way, firms can progressively become “genuine innovators” (Ernst et al., 1998). Although there are other ways of obtaining technology from foreign firms (such as through licensing), this chapter will concentrate on the role of FDI. In order to assess the technological impact of TNCs on a host economy, one must answer the following question: to what extent does the presence of TNCs foster or inhibit the creation and the upgrading of domestic absorption capabilities of host countries? Through FDI, TNCs may bring to the host country their best technological and organizational practices or, at least, they may introduce technologies and practices which are more up-to-date (though not necessarily more attuned to local conditions or domestic factor prices) than those applied by local firms.

78 D. Chudnovsky and A. López Furthermore, TNCs may generate technological spillovers from which indigenous institutions and domestic entrepreneurs can benefit. In this case, the social benefits of TNC activities are enhanced, since TNCs are not the only ones to enjoy the economic benefits arising from their technological assets. TNCs may be an important source of spillovers. First, their entry may lead to increasing competition in domestic markets, forcing local firms to enhance their productivity by being more efficient in using existing technologies and, eventually, by adopting new and more efficient technologies. Second, local firms may take advantage of the superior technologies and organizational and management practices of TNCs by imitating them, hiring workers trained by TNCs, or establishing forward and backward linkages with their affiliates (Blomström and Kokko, 1997). Finally, if TNCs undertake innovative activities in the host country, they could generate significant externalities (through the innovation itself and through human capital upgrading). It has been suggested also that TNCs may help developing countries, and especially the least developed countries, to foster an entrepreneurial culture. At the same time, cultural barriers, and especially the lack of a “scientific outlook” in host countries, may help to explain why spillovers from TNC operations are often so limited (Buckley and Casson, 1993). The available evidence on the actual magnitude of this kind of spillover is inconclusive. According to Blomström and Kokko (1997: 139), “many analyses of the linkages between MNCs [multinational corporations] and their local suppliers and subcontractors have documented learning and technology transfers that may make up a basis for productivity spillovers.” However, “these studies seldom reveal whether the MNCs are able to extract all the benefits that new technologies or information generate among their supplier firms, so there is no clear proof of spillovers.” Nonetheless, they readily argue that it “is reasonable to assume that spillovers are positively related to the extent of linkages.” Regarding spillovers through the training of workers, Blomström and Kokko (1997) find evidence of accumulation of human capital skills among the TNC employees, but the extent to which these skills can be appropriated by local firms when these employees move to new jobs is an open question. Although empirical evidence is scattered, most studies suggest that management skills are less firm-specific than technical skills, and can more easily be used in other contexts. It is well known that TNCs undertake only a small proportion of their research and development (R&D) activities outside their home countries. Although information technology may facilitate greater decentralization of R&D activities, it may also lead to a concentration of such activities in a few developed countries. Whereas in some cases affiliates in developing countries undertake some R&D work, the total expenditure on R&D in the host country could be reduced with the entry of TNCs. For example, a

Foreign direct investment, growth and development 79 TNC which takes over an existing local firm that used to make significant investments in R&D activities may decide to discontinue these activities since it centralizes them in its home base or in affiliates in developed countries. Even without takeovers, the presence of TNCs may discourage innovative activity in domestic enterprises and induce them to substitute licensing agreements for such activity. At the same time, TNCs may not necessarily bring their latest technologies to host countries. This depends on a number of factors. These include relative prices, the intensity of competition, the requirements of industrial and end customers, and the global strategy followed by TNCs. Nonetheless, FDI is generally regarded as being more conducive to the transfer of modern technologies than other ways of technology transfer such as licensing. The relationship between FDI and the technological performance of host countries cannot be easily assessed with conventional indicators. When technological performance is measured by R&D expenditures in GDP or the number of patents issued in the United States of America, the two outstanding cases among developing countries are the Republic of Korea and Taiwan Province of China. These economies have relied heavily on foreign technology and have been rather selective in their FDI policies, in particular the Republic of Korea. They have used mostly contractual arrangements, joint ventures and reverse engineering. At the same time, there are cases with a penetration of FDI and good technological performance (Singapore), as well as other cases with relatively low presence of TNCs and poor technological performance (India). From this complex picture, it can only be concluded that the technological impact of TNC activities should be assessed on a case-study basis. The following variables seem to play a significant role: 1 2 3 4 5 6 7

The type of FDI (whether it is resource-seeking, efficiency-seeking, market-seeking or asset-seeking) The stage in the life cycle of the product or sector receiving the investment The extent to which it is oriented to domestic or export markets The role played by the affiliate in the global corporate network The mode of entry, whether “greenfield” or acquisition Whether the foreign corporation has a domestic partner, and The sector in which the firm is doing business.

On the other hand, the characteristics of the host country have an obvious influence. Increasingly, a key element is the magnitude and quality of what has been termed “created assets” (human resources, technological and communication infrastructure, etc.), which are more prone to attract high quality FDI. At the same time, as already mentioned, the social or absorptive capability of host countries has a significant role,

80 D. Chudnovsky and A. López especially when a dynamic analysis is made. The regulatory and institutional environment, which defines the basic price and non-price incentives for firms to compete, and the public policies in force in host countries are key elements as well. In this sense, the “national innovation system” (NIS) framework seems to be a promising way to analyse the impact of FDI on the technological performance of host countries. This relatively recent framework has some weaknesses – it is conceptually diffuse, and it is hard to operationalize. However, as Edquist (1997) has observed, it has several interesting features: it is holistic and interdisciplinary, it emphasizes the role of history and institutions, it stresses the interactions and interdependence between agents, and it allows the use of different approaches (sectoral, regional or national, even multinational or transnational). Furthermore, it has elements in common with the notion of “structural competitiveness”, which emphasizes the role of the socio-economic environment in the competitiveness of firms. In sum, it is a promising research framework for the more systematic and holistic analysis of the interactions between technological and innovative capabilities and economic and social development. Even if important adaptations need to be made before applying the NIS approach to developing countries (see Albuquerque, 1997), it should be useful as a basic conceptual framework for studying the technological impact of FDI. At the same time, if it is applied in developing countries, the approach itself will be improved and better adapted to the specific conditions of these countries. There are a number of questions regarding the impact of TNC activity on indigenous technological and organizational assets and skills which empirical studies should address: 1

2

3 4 5

What kind of product and process technologies do TNC affiliates employ in host countries, both in tradable and in non-tradable sectors? How much of a gap is there between those technologies and those employed in TNCs’ home countries or in their affiliates in developed countries? Has the gap been reduced after trade and FDI liberalization measures? To what extent is the gap due to the relative prices of capital and labour or to non-price factors? Do TNC affiliates engage in innovative activities in host countries? If so, what are the characteristics of those activities and the main motivating factors? In what way do TNC affiliates interact with different host country science and technology (S&T) institutions? Are there technological partnerships between TNCs and local firms? If so, what are the features and prospects of these kinds of alliances? What kind of technical assistance do affiliates of TNCs provide to their suppliers and customers in the host country?

Foreign direct investment, growth and development 81 6

7

To what extent do TNCs train and upgrade the technical skills of their labour force? Are there any spillovers from these activities through workers’ mobility? Does the presence of TNCs in low-income developing countries (LIDCs) help foster the development of an entrepreneurial and innovative culture in local firms and institutions?

Besides their intrinsic relevance, these questions are significant for host countries seeking to put in place a policy framework geared not only to attract more FDI, but also to enhance its quality, increase its social spillover and contribute to domestic technological capacity-building and national competitiveness. In this context, it is important to distinguish LIDCs from other developing countries. LIDCs have weak or almost non-existent NISs; there are few, if any, enterprises with technological capabilities; their S&T institutions are poorly endowed; there is a dearth of skilled human resources, and their manufacturing sector and domestic markets are small. In short, they have not even begun to build the above-mentioned social or absorptive capability that is needed if they are to take advantage of foreign sources of technology. Almost by definition, FDI should help to reduce the gap with the world leaders in process and product technologies. However, it cannot be expected that TNC affiliates will undertake significant innovation activities in these countries, and their linkages with domestic firms and local S&T institutions will be generally very weak (especially when TNCs are located in export processing zones (EPZs)). Domestic competitors, if there are any, will find it hard to learn from TNC technologies, which are likely to be well beyond their national capabilities. The technology indicators often employed in developed countries must be adapted if they are to have a meaningful use in developing countries. It is evident that they are totally inappropriate for LIDCs, and there are very few studies concerned with the development of S&T indicators suitable for these kinds of countries (UNCTAD, 1996). This fact complicates the analysis of the technological impact of FDI even further. How, then, are we to evaluate this issue? First, it would be advisable to learn about the existence of clusters or networks built around TNCs’ activities. At the same time, the impact of TNCs on existing clusters should also be studied. The main objective of this analysis should be to determine whether the presence of TNCs fosters entrepreneurial and innovative attitudes in their suppliers and customers. Second, the employment of local engineers and scientists in the labour force of TNCs, as well as the employment of native human resources in jobs which require significant skills, should be examined. It would also be interesting to learn whether TNCs have any specific policies for training, qualifying and upgrading the skills of local human resources. The mobility

82 D. Chudnovsky and A. López of skilled workers is, as mentioned above, one of the possible spillovers from FDI. Since it is plausible to assume that few local existing firms could employ these workers in LIDCs, it would be interesting to study cases in which workers trained by TNCs created new enterprises in which they took advantage of skills learned in the TNC. Third, it is important to find out whether the presence of TNCs fosters, or inhibits, the ability of LIDCs to gain expertise in identifying the technologies which are most suitable to their needs, including “hard” as well as “soft” technologies (UNCTAD, 1996). Finally, possible differences in the technological performance and in the generation of spillovers for host countries between “conventional” TNCs and so-called “Third World” TNCs – a growing phenomenon, especially in some East Asian and Latin American countries (Lall, 1983; Dunning et al., 1997; Narula, 1997) – should also be verified. A different approach is required to analyse the technological impact of FDI in more advanced developing countries. Even if these countries are, in general, far from having a mature NIS, they have generally built an S&T system and have at least some local base of skilled human resources. Analysing the changes in the technological regimes in Latin America in the 1990s, Katz (1998) suggests some key issues on which empirical studies should be able to shed light. Taking the privatization process, where FDI presence has been significant, Katz argues that, on one hand, the technological modernization of infrastructure inherited by new owners has nurtured a number of locally owned firms specialized in systems engineering, computer software, etc. On the other hand, privatization has meant the contraction, and even the disappearance, of the domestic R&D infrastructure developed by former state enterprises. At the same time, TNCs in developing countries, as part of the globalization of their production strategies, have often discontinued local engineering activities in order to adapt and improve product and process technologies provided by their parent companies. Moreover, the increasing use of imported components may have a negative impact on local firms which were suppliers of TNCs. Of course, the same arguments apply when new TNCs take over local existing firms. Thus, we seem to be witnessing a process of “creative destruction”. The society’s pre-existing human, engineering and technological capabilities are devalued. The new innovation systems rely more on external sources of technology, and are more responsive to the influence of global technological trends. How beneficial this is for developing countries undergoing this process is an open question. The answer will depend on the quality of the previous technological base, on the extent on which it has been eroded, preserved or transformed, and on the new linkages or spillovers arising from new productive and innovative strategies by the affiliates of TNCs. In this case, several sectors where the presence of TNCs is widespread should be selected for study in different countries. It would be advisable to

Foreign direct investment, growth and development 83 choose sectors with different characteristics – consumer durables (e.g. automobiles), a scale-intensive sector (e.g. petrochemicals) and a hightech sector (e.g. electronics or biotechnology), and countries with different structural features, economic policy regimes and levels of development. A study of some activities that have been privatized and are now under foreign control could be relevant as well. Employment, poverty alleviation and income distribution Although TNCs employ only 2 to 3 per cent of the world’s workforce (providing approximately seventy-three million jobs, twelve million of which are located in developing countries), they are particularly important employers in certain sectors and countries. TNCs account for one-fifth of all paid employment in non-agricultural sectors in developed and some developing countries, and are very relevant in capital and technologyintensive manufacturing industries. TNCs may also generate jobs indirectly by stimulating the development of backward and forward linkages within host countries. It has been estimated, in the case of a number of developing countries, that at least one or two jobs are generated indirectly for each worker employed by an affiliate of a TNC (UNCTAD, 1994). Overall, the net effect of FDI on the quantity and quality of employment depends on a variety of factors. These include relative labour costs in the host country, the employment elasticity of output in sectors with FDI, the relative importance of greenfield and takeover investments, the creation or displacement of local linkages, the displacement of local firms by TNC competition, and labour market regulations in host countries. As a consequence, the relationship between the strategies of a TNC and its employment effects are intricate, although some effects are relatively easy to predict. For example, employment creation should be greater in cases where local labour costs are low, in greenfield investments rather than in takeovers, and in services rather than in manufacturing. In turn, employment is generally reduced when affiliates of TNCs undertake efficiencyseeking investments and switch from stand-alone operations to complex integration strategies. Things are further complicated since, as previously mentioned, most developing countries have implemented deep structural reforms in recent years, in a context where competition is more intense and globalized, and new technologies and organizational practices are being introduced. In this scenario, both foreign and domestic firms located in developing countries have been under strong pressure to restructure and rationalize their activities. Since affiliates of TNCs have more financial and technological resources than do domestic firms in order to cope with the new situation, foreign firms are likely to have increased their presence. The negative social consequences (greater unemployment, poverty, and rising inequality) that may arise from these restructuring processes may be attributed to

84 D. Chudnovsky and A. López a growing presence of TNCs, when in reality they are a result of the adjustment process itself and the policies used for that purpose. Thus, the key question is this: even if the consequence of FDI is the loss of jobs in the host country, what would have happened in the absence of TNCs? This, in turn, makes way for a second question: what would have happened with or without the implementation of policies aimed at making domestic firms more competitive? To approach this issue, it is useful to distinguish between tradable and non-tradable sectors. In tradable sectors, trade liberalization in previously protected domestic markets implies new rules for existing firms and opportunities for newcomers. The main strategy to survive and prosper in a more competitive local and international environment is to enhance productivity and improve quality. Some firms may be able to keep up with the changing situation, but other firms may not. This means that unless specific policies for assisting domestic firms to become more competitive are put in place in conjunction with trade liberalization measures, employment is likely to fall, or will grow much more slowly than total production. In this context, the key question is: will a TNC-led restructuring process have more or less deleterious effects on employment as compared to a similar process led by local firms?2 If local firms are able to adjust successfully to the new situation, they will probably expand output and exports, preserve more jobs, and, more importantly, should be able to maintain more domestic linkages with suppliers and subcontractors, some of which would be broken if TNCs relied on their affiliates. On the other hand, it is also possible that local firms would not have survived foreign competition and the number of lost jobs would have been even greater than in TNC-led restructuring process. In the case of non-tradables, the dynamics will be different depending on the sector concerned. In retailing, for example, even if TNCs create a large number of direct jobs, they may also displace many small shops unable to compete with hypermarkets and supermarkets. In tourism, TNCs may have a more positive effect on employment, since they generally contribute to the creation of a previously non-existent infrastructure (hotels, transport, car rental, etc.). All these arguments show that caution is needed when it comes to analysing the impact of FDI on employment. A proper definition of both the issues to be studied and the methodology to be employed is required, taking into account the specific conditions of host countries and the type of FDI involved in each case. Nevertheless, some comments are in order. LIDCs have a significant surplus of labour engaged in low-productivity or subsistence activities. An essential feature of the development process is that part of this labour force is gradually hired by the “modern” sector of the economy. This may mean that disguised unemployment decreases and, eventually, real wages begin to rise. The entry of a TNC may accelerate this process, and that is one of the reasons why so many countries

Foreign direct investment, growth and development 85 compete to attract FDI. In this context, almost by definition, TNCs provide jobs to individuals who otherwise would have been unemployed or under-employed. Furthermore, it is very likely that these jobs will be related to export activities. However significant this contribution may be, it would be advisable to learn about other potentially more “qualitative” contributions of TNCs to the long-term development goals of host countries. This requires analysing specific aspects of the impact of investments on the labour market. These factors include the wage structure and wage/profit ratio in TNC affiliates; the skill and gender composition of their labour force; the extent to which TNC affiliates meet their needs for skilled human resources through expatriates from their home countries or other affiliates; whether there is a gradual displacement of expatriates in favour of local personnel; and the indirect employment effects of TNC presence through subcontractors, suppliers, repairs and maintenance. One of the mechanisms preferred by developing countries to attract FDI is the establishment of EPZs. According to the International Labour Organization (ILO, 1998), some twenty-seven million people work in nearly 850 EPZs worldwide. An increasing number of governments is considering establishing EPZs in their countries, and compete with each other by granting incentives to potential (and generally foreign) investors. Many of these EPZs are located in countries with a GNP per capita of less than US$1,000: in Africa (mostly in Kenya), Central America (e.g. Honduras) and Asia (notably in China, where 124 EPZs were operating in 1997). Even when the objective of EPZs is to contribute to economic development and employment creation, labour and social problems are widespread – especially when labour standards are not enforced. In turn, the generation of employment through FDI in EPZs has limitations, in terms of both the kinds of jobs generated and the sustainability of those jobs, given that as labour costs increase, TNCs in EPZs often relocate to other, lower-wage countries (UNCTAD, 1994). These considerations raise a number of questions: what is the standard of the working conditions in EPZs, especially for women? To what extent do TNC affiliates employ not only unskilled domestic labour, but also skilled workers? What has been the “life cycle” of FDI in EPZs? And what happens when real wages begin to rise and the host country begins to lose its comparative advantages over other locations? Another issue is the role that TNCs might play in promoting or inhibiting employment discrimination and sex segregation in developing countries. In this connection, Buckley and Casson (1993) have pointed out the impact of TNCs on labour markets, and their potential to lead or reinforce the dualist tendencies in many societies. For example, the tradition of subservience to despotic authority can sometimes be exploited by TNCs searching for cheap unskilled labour that is easily disciplined by

86 D. Chudnovsky and A. López intimidation. Women and children accustomed to absolute paternal authority may become useful factory or plantation employees. Besides paying attention to the attitude of TNCs towards gender discrimination in host countries, it would also be advisable to learn about the possible relationships between the existence of overt gender discrimination and certain aspects of the national culture of the home country of the TNC (see Lawler, 1995). At the same time, it would be useful to learn about cases where FDI has been attracted to the host country by the existence of a labour force accustomed to paternal authority. In more advanced developing countries, growing FDI inflows have often been part of the results of structural reform packages which have had a significant impact on productive activities. Labour markets have been deeply affected by these processes, which have had major impacts on employment rates, wage structures, the demand for skilled and unskilled labour, poverty, and income distribution. Since there are so many causes and effects behind recent trends, examining the specific influence of TNCs on changes in labour markets and social development conditions is clearly impossible. Hence, a more focused approach to the impact of FDI on these issues through case studies is required. As a result of privatization and deregulation, TNCs have been able to acquire assets in public utilities and industries and services in which the involvement of foreign private capital was once either prohibited or restricted. The impact of these changes on employment, wages, working conditions, training and industrial relations can be assessed through relevant case studies. A sectoral or “cluster” approach could be useful as well, perhaps including tradable as well as non-tradable sectors. Regarding income distribution and poverty alleviation, there are clearly many different factors besides FDI which have a significant influence on them. In fact, probably the main impact of FDI on these matters occurs through its effects in terms of employment. Nonetheless, besides a direct impact on income distribution through their wage and employment policies, TNCs can have significant indirect effects arising from their production and pricing strategies and their oligopolistic behaviour. The direct impact of TNCs on income distribution can be examined by the evolution of productivity and wages paid to different categories of workers and, if data are available, through the ratio between the wages paid by those firms and the profits which they earn. If possible, such data should be compared with income distribution trends in the areas where the foreign firms are located. TNCs can have a significant influence on income distribution and welfare indirectly, when they introduce new products, services or processes. Thus, they may affect consumption styles as well as the relative access of different segments of the population to the products or services they supply. This influence may be positive or negative, depending on, for

Foreign direct investment, growth and development 87 example, the pricing and advertising strategy of a TNC which is introducing a new product that may have significant consequences on the health or nutrition levels of the population of the host country. While the entry of foreign firms may increase competition in domestic markets and benefit industrial users or households through lower prices or higher-quality products and services, it may also lead to a more concentrated supply structure and restrictive business practices which worsen income and assets distribution. Although in the tradable sector a more concentrated supply structure can be disciplined through competing imports, to counteract the adverse welfare effects of a growing supply concentration in both tradables and non-tradables a well designed and implemented domestic competition policy is required. Since this is not the case in most developing countries, the indirect effects of FDI on welfare and income distribution are unlikely to be very positive. Indirect effects can only be examined through case studies, but, unfortunately, the data necessary to assess these effects are very difficult to obtain. Environment 3 The effects of FDI on the environment in developing countries have been assessed in quite a different manner in the past than in the present. Once often accused of investing in developing countries in order to take advantage of lax environmental regulations and hence being responsible for many environmental problems in such countries, nowadays TNCs are increasingly considered as leaders in the introduction of good environmental management practices and in the diffusion of environmentally sound technologies in developing countries. While the evidence in support of both arguments is limited, there is no doubt that many TNCs are potentially important agents for the introduction of environmentally sound technologies. However, their actual environmental management depends on the age of their facilities, the presence of sunk costs, host country environmental regulations and the extent to which they are enforced, the availability of pollution prevention technologies, and the global environmental policies of the TNC in question. The traditional argument against TNCs in this regard suggests that developing countries will become “pollution havens” in order to attract more FDI, since TNCs are interested in escaping from countries with high environmental standards. Despite the popularity of this argument, there is little evidence of the existence of such pollution havens. Most investment decisions are not made on the basis of environmental criteria. Since environmental costs represent a small share of total costs in most sectors, it is difficult to imagine that they have any significant weight in location decisions. Furthermore, countries that operate transparent and efficient environmental regulations are often quite successful in attracting new investment.

88 D. Chudnovsky and A. López Countries with high environmental standards are the major producers and exporters of most environmentally sensitive goods and have the highest living standards. If anything, the imposition of higher environmental standards seems more likely to generate a technological response than to lead to capital mobility (OECD, 1998) However, in particular sectors, such as chemicals, oil, steel, mining or cement, the costs of complying with more stringent environmental regulations might be greater and therefore might play a more significant role in the decision-making process. In these sectors there is a common fear that some developing countries may use lower environmental standards to attract new FDI, and that by lowering their environmental standards, or by just not raising them, some countries could gain a competitive advantage over others. There is also some tendency for certain types of firms in specific industries to seek cost relief related to environmental parameters. This tendency will be strongest in those industries whose products are undifferentiated and where the competitiveness of firms is heavily dependent on small (and environmentally-based) cost differences. Although the fear of a general “race to the bottom” in environmental standards, based on competitiveness concerns, may be somewhat exaggerated, there are a few sectors of the economy in some countries where such a race may well be taking place, but this does not seem to be the general case (OECD, 1998). More recently, an opposing hypothesis has emerged. It has been increasingly argued that FDI can facilitate access to environmentally sound technologies that might result in a technology-based improvement for the host country’s environment. Furthermore, FDI may lead to some standardization of technologies used across countries and may also promote the diffusion of environmentally friendly technologies through the expansion of environmental goods and services (OECD, 1998). As some TNCs are at the frontier in research on, and the application of, pollution prevention technologies, their affiliates may play a positive role in diffusing these technologies in developing countries. Pollution prevention measures have economic as well as environmental advantages over more conventional solutions (“end-of-pipe” treatments). According to many observers, pollution prevention technologies may not only be less costly than end-of-pipe treatments. They may also, in some cases, generate additional pecuniary benefits. Hence, it comes as no surprise that they have been warmly received in developing countries, where social problems such as poverty or unemployment can only be mitigated in a context of sustained and sustainable economic growth. The idea is, thus, to shift from a corrective approach to a preventive one in environmental management. The development of an innovative capability to find preventive solutions for pollution problems in the productive sector should therefore be a key element in making this fundamental change (Chudnovsky et al.,

Foreign direct investment, growth and development 89 1997) and an integral part of any policy framework aimed at developing a national system of innovation. Insofar as TNCs move from end-of-pipe towards pollution prevention environmental management approaches, they may not only employ pollution prevention technologies in their affiliates in developing countries. They may also influence the environmental management activities of suppliers, competitors and customers of their affiliates, both by setting an example and by introducing their own environmental standards. Furthermore, parent companies may also provide local engineers and technical staff with training in pollution prevention technologies and practices, as well as waste minimization (O’Connor and Turnham, 1992; UNCTAD, 1993). In this sense, a key question is whether TNCs follow the same environmental standards applied in their home country when operating abroad (regardless of a host country’s own environmental regulations), and whether their affiliates in developing countries may or may not impose those standards on their suppliers and subcontractors. There are several examples of TNCs which apply the same environmental standards in affiliates operating abroad as in their home country, but these tend to be corporations operating in several industrial and service branches,4 rather than those involved in the exploitation of natural resources. In fact, the liberalization of FDI may encourage some TNCs to rely on the export of domestic natural resources without due regard to the limits of sustainability. Furthermore, TNCs generally do not employ the same technologies in developing countries that they use in their headquarters or in their affiliates in developed countries. A survey of eighty TNCs (Levy, 1995) found that the adoption of cost-effective and environmentally friendly practices such as pollution prevention or “eco-efficiency” had no significant relationship with environmental performance. These findings leave TNCs open to the charge that they avoid costly environmental investments and perhaps engage in “window-dressing” in their environmental practices. Even when TNCs do impose codes of conduct on their affiliates abroad, their suppliers or subcontractors may not be requested to meet these codes. Many TNCs subcontract the production of some goods or components and act as global distributors. This de-coupling has prompted TNCs to assert that they are not responsible for the environmental conditions or wage levels in factories that manufacture parts of their products (Kolodner, 1994). Nevertheless, some companies do impose codes of conduct on their subcontractors, which can have a positive spillover on local conditions. Such codes of conduct may go beyond environmental issues and also cover ethical, health and safety standards. Bearing all of these points in mind, it is important to pay attention to the situation in LIDCs where environmental priorities and FDI characteristics differ widely from other developing countries. LIDCs are generally

90 D. Chudnovsky and A. López resource-based, with a weak industrial sector, and with large proportions of the population living in conditions of extreme poverty. The environmental problems confronting LIDCs generally belong to the “brown agenda”. In other words, they face problems mostly generated by poverty, and which represent a threat to human health and life: lack of drinking water and sewage systems, pollution of water flows, erosion of soil resources, and deforestation (mainly as a result of the use of wood for fuel). Therefore, researchers analysing the effects of FDI on the environment in LIDCs need to be aware of the environmental conditions prevailing in the country in question. They need to take into account not only strictly environmental problems, but also issues related to social and economic development, such as sanitary conditions, education and poverty indicators. Environmental regulations in developing countries tend to be, in general, more lax than in developed countries. This fact should be taken into account when studying the relationship between FDI and the environment in these countries. As previously stated, low environmental standards and poor levels of enforcement may become an incentive for investment decisions in certain sectors such as mining and other resourcebased activities. Thus, the environmental regulatory framework and its enforcement should also be taken into account in any assessment of this subject. As already mentioned, most FDI directed to LIDCs is resource-seeking. As local regulations are less strict and less strictly enforced than in TNCs’ home countries, the environmental impact of TNC operations to a great extent depends on the age of the facilities, on their own environmental performance, and on the imposition of standards and codes of conduct not only in affiliates but also on their suppliers and subcontractors. If TNCs apply higher environmental standards in their operations than those required by local regulations, or even simply comply with such regulations, there might be a positive spillover not only on the environment and social welfare of the host country but also on the technological upgrading of national firms and competitors. However, as this is not always the case, special attention should be given to the way TNCs operate, taking into account working conditions and the way natural resources are exploited. TNCs can have a negative social development impact through “resource degradation”. The mining sector provides a good case study for the analysis of the relationship between FDI and the environment in LIDCs. On the one hand, mining is considered a highly polluting activity, largely because the environmental impacts of mining are often dramatic and obvious. The main environmental impacts of mining are surface and underground water pollution, air pollution, solid waste, loss of flora and fauna habitats due to excavation, and damaging effects on human health and buildings through noise and vibration (UNCTAD, 1997a).

Foreign direct investment, growth and development 91 Government regulations covering new mining projects are relatively recent in most countries and, indeed, do not exist in many developing countries. The absence of legislation can result in environmentally harmful operations in many mining sites in developing countries, not to mention poor working conditions and safety standards. Moreover, although some developing countries have adopted administrative regulations related to products, technology or emissions standards, in many cases these regulations have proved to be legally or practically unenforceable, technically difficult to monitor and generally to have an insufficient deterrent effect (UNCTAD, 1997a). Since mining implies only a temporary use of the land, there is one issue of special concern to developing countries related to the mineral sector’s sustainability that should be taken into account: the rehabilitation, restoration and reclamation of mining sites. Rehabilitation refers to the processes where unavoidable impacts on the environment are repaired, and suggests returning the site to stable and permanent use in accordance with a pre-mining plan. These processes include revegetation with native species and restitution of topsoil (Clark, 1997). Restoration denotes returning to the conditions existing prior to mining activities if possible, whereas reclamation is a less stringent concept implying that land disturbed by mining activities should be returned to the approximate pre-mining use when economically and technically feasible (Marsh, 1997). The conditions under which TNCs may engage in these kinds of activities should be included in studies on the mining sector. The forestry sector may also be a good case to study in analysing the relationship between FDI and the environment. Although deforestation in many LIDCs is a result of the use of fuel wood and the conversion of forest into cropland, there are cases where TNC operations have been devastating. Some examples of this can be found in the contribution of TNCs to deforestation in Gabon or the Congo, where they control 90 per cent and 77 per cent of commercial logging, respectively. Such logging activities entail negative externalities such as rapid run-off of rainwater, which leads to flooding and the loss of topsoil (Kolodner, 1994). However, some changes may be occurring in TNC practices partly because of increasing public pressure, but also as a result of the growing implementation of environmental management systems and internal or external environmental audits. There are also conditionalities for credit access aimed at ensuring good environmental practices that are being required by international financial institutions and commercial banks, putting extra pressure on TNCs to improve their environmental performance. It is important to verify how these recent changes are applied in actual operations in LIDCs, especially in new undertakings. When studying the impact of FDI on the environment in more advanced developing countries, other factors should be taken into account. As income rises, some environmental problems are likely to be

92 D. Chudnovsky and A. López attenuated and eventually disappear, while others increase. In the first group are the problems associated with the lack of infrastructure, such as sewage systems and the supply of drinking water. In the second group are the environmental problems related to higher levels of development and industrialization, such as industrial emissions, toxic waste and urbanization. It is also possible that there will be greater demands for environmental quality at higher income levels. As income rises, more pressure for environmental regulations may appear, demanding more environmental protection and higher levels of enforcement. Pressure for more stringent environmental regulations may also occur at the international level, where industrialized countries demand the implementation of international environmental standards as a way of preventing the creation of pollution havens and eventual losses in the international competitiveness of their own products. In industrialized countries, the diffusion of pollution prevention technologies plays a crucial role in improving the environmental performance of the production sector without lowering its competitiveness. Special attention should thus be paid to this issue and to the role played by TNC affiliates in this respect. At the same time, there is a crucial need to develop the knowledge and expertise to handle technological change among local firms in order to take advantage of environmental spillovers from TNC affiliates, and to implement the organizational changes required if they are to move towards pollution prevention technologies. This analysis should be made for both resource-seeking investments (e.g. mining) and market-seeking investments. In both cases, it would be useful to compare, where appropriate, the environmental management systems and performance of the affiliates of TNCs and those of local firms, as well as internal-market oriented investments and export-oriented ones. Again, a key issue is whether these affiliates are “environmental islands” or whether they diffuse their environmental systems and technologies to their suppliers, customers and competitors.

IV. FDI, human and social development, and development: policy and institutional framework In recent years, restrictions on FDI have been substantially reduced in the majority of countries. As previously mentioned, many governments have also implemented incentive regimes designed to attract FDI. Since incentives can be more easily manipulated by governments than other factors which influence investment decisions, the “incentive-led” competition for FDI makes some sense (Aranda and Sauvant, 1996). This competition for FDI is not necessarily bad in itself. The problem is the form that it assumes in many cases. Host governments are often only interested in the quantity of FDI, paying little if any attention to the externalities which it generates, or to its impact on income distribution or the

Foreign direct investment, growth and development 93 environment, for example. Furthermore, there has been criticism of the use of incentives as the predominant tool for attracting FDI. However desirable, “rules-based competition” includes broad and heterogeneous groups of government actions, which could include the lowering of standards regarding worker’s rights or environmental protection (with obvious negative effects in terms of human and social development), but also the signing of regional integration treaties or the strengthening of judicial systems (Oman, 1998). Different surveys on this issue suggest that there are more influential determinants of FDI attraction – namely, host market size and rate of growth, physical and communications infrastructure, and the quality of human resources – than fiscal or financial incentives. These other determinants of FDI are especially important when governments are trying to attract high-quality FDI, from which substantial externalities could be obtained in terms of employment, human resource upgrading, value-added exports, technology and enhancement of environmental performance. It is acknowledged, however, that incentives can be important in the margin, when TNCs are choosing amongst a shortlist of fairly similar alternative locations. Nonetheless, there seem to be some successful examples of a promotional policy for FDI based on fiscal and financial incentives. The first step in designing policies to attract and enhance the contribution of FDI in developing countries is to study the preconditions for this success, and the modalities and objectives of the instruments implemented. The example of Ireland is useful in this respect. From the 1980s onwards, Ireland’s FDI policy was based on: (i) selecting leading, high value-added industries (electronics, software, medical instruments, financial services); (ii) creating specialized industrial clusters in designated locations; and (iii) promoting links with domestic firms (UNCTAD, 1998). FDI policy included grants for establishing R&D facilities. At the same time, fiscal and financial incentives were not the only factors used for attracting FDI; education and training efforts were fostered by the Government of Ireland in order to upgrade the qualifications of the labour force. As for the East Asian “tigers”, Lall (1997) illustrates the different policy approaches followed with regard to FDI and describes some cases in which a policy for guiding or selecting FDI has been successfully implemented. Singapore probably has the world’s highest reliance on FDI. The Government of Singapore has intervened to guide TNCs to higher valued-added activities and has developed an educational structure designed to provide the technical skills required for such activities. Besides financing R&D expenditure by private firms, the government has also established an impressive technological and scientific infrastructure in the targeted sectors. Taiwan Province of China offers an example of an approach to FDI which has also tried to benefit from the technological capabilities of

94 D. Chudnovsky and A. López TNCs. The promotion of linkages with domestic firms, especially small and medium-sized enterprises (SMEs), has been one of the elements of this policy. The strategy also targeted industries where domestic capabilities were insufficient, but which were considered strategic by the government. Of course, these kinds of interventions are prone to failure as well. From an institutional point of view, they have very stringent requirements. They involve the capacity to identify desirable objectives, design instruments, implement policies, monitor results and discipline private firms when their performance does not fulfil policy objectives. They also often imply, especially when complex incentives packages are involved, policy coordination at various levels of government. Another danger is that excessive competition for FDI could result in excessive transfer of rents to TNCs (Aranda and Sauvant, 1996; Haaland and Wooton, 1998). These arguments reveal the need for a cautious balance between the costs and benefits of these kinds of policies. To accomplish this task, profound institutional transformations are needed in most developing countries, and especially in LIDCs. In this sense, it has been suggested that developing countries should move from incentive-based to rules-based competition, without impairing their domestic labour or environmental standards (Oman, 1998). This suggestion also makes sense considering that rules-based competition may not only benefit TNCs, but also enhance the country’s structural competitiveness and significantly contribute to human development objectives. This institutional capacity-building should be the first step in designing new policies to attract FDI and maximize the potential benefits which TNCs can offer. Besides the need for this kind of institution-building, developing countries must take into account the evolving international policy framework. The Agreement on Trade-related Investment Measures and other agreements within the framework of WTO constrain the use of some policy instruments, but they leave some options open for developing countries and especially for LIDCs. If developing countries decide to take part in the negotiation of a multilateral investment treaty, they must try to ensure that it takes adequate care of their developmental as well as political and social needs and concerns (see Agosín, 1999; Ganesan, 1999). One of the key issues requiring the special attention of developing countries is that of performance requirements and investment incentives. Developing countries must try to preserve flexibility so that they can employ instruments that further their development objectives. This implies that, at least for some time, this group of countries should receive special treatment in any internationally negotiated agreement on investment. For that objective to be attained, developing countries face the difficult task of preparing for long negotiations, which will place an extra burden on them as they work towards institutional transformation. International

Foreign direct investment, growth and development 95 technical assistance could help in strengthening their capacity to evaluate and negotiate the options which are best suited to their interests.

V. A framework for policy-related country studies The arguments presented in this chapter call for a systemic approach to analysing the relationship between FDI on the one hand, and growth and human and social development on the other. This needs to be done in the context of the strategies pursued by host countries to open up their economies, privatize state-owned enterprises and give market forces a larger role in the economy. Thus, instead of analysing each topic (competitiveness, technology, employment, environment, etc.) separately, they should be approached jointly. At the same time, a dynamic, historical and institutional analysis of the impact of FDI is required. The main issues to be addressed before, during and eventually after the key structural reforms have been implemented are as follows: 1

2 3

4 5

The contribution of FDI to export diversification, increasing the value added of traditional exports, and creating backward and forward linkages from the export sector to the rest of the economy The contribution of FDI to the introduction of new imported capital and intermediate goods The impact of FDI-related technology transfer both on the technological capabilities of affiliates and on domestic enterprise and institutional innovative capabilities; if possible, FDI-related technology transfer should be compared with other forms of technology transfer, such as licensing agreements, consultancy and engineering services The direct and indirect impacts of different forms of FDI on employment, gender and income distribution The environmental management practices of foreign affiliates, the factors accounting for the adoption of environmentally friendly technologies, and the spillover effects on domestic suppliers, competitors and clients.

An analysis of the policy framework within which TNCs have been doing business in the host country is crucial in any attempt to determine the actual impact of FDI on growth and human development. In this connection, it is not only the impact of macroeconomic policies, trade and FDI liberalization and privatization that should be assessed. Specific policies to assist domestic firms (and especially SMEs) in adapting to the new rules, the enforcement of environmental regulations, the training and human resource development programmes and the technology policies in force should also be examined. Furthermore, the institutional framework in which policy is designed, applied and enforced should especially be taken into account.

96 D. Chudnovsky and A. López As mentioned above, for host countries to reap most of the potential benefits which could arise from the presence of TNCs, a social or absorptive capability is needed. Empirical evidence shows, in turn, that this capability is often insufficient in most developing countries. Thus, the policy agenda must include several instruments aimed at creating or enhancing this capability. Fostering domestic entrepreneurship is a key issue in this respect. For TNCs to develop linkages with local suppliers, or to generate spillovers which could be reaped by subcontractors, customers or competitors, it is essential that local enterprises have the human resources, skills and capabilities required to take advantage of these spillovers, or to qualify as suppliers for TNC affiliates. If policies are to evolve beyond merely trying to attract FDI, instruments geared towards enhancing the technological, marketing and productive capabilities of domestic firms (especially those of SMEs) are a crucial component of any policy towards TNCs. Policy recommendations should take cognisance of the lessons learnt from horizontal and sectoral policies in selected developed and developing economies (such as Ireland, Singapore or Taiwan Province of China) geared to strengthening the competitiveness and technological capabilities of domestic enterprises and to increasing the spillover effects of TNCs. The kinds of policies that host countries should put in place in order to achieve these objectives and the institutional capacity-building required to overcome the failures of coordination and government intervention should be assessed in each case. Such an approach could serve not only to improve public policies in LIDCs but also to orient the requirements for international cooperation – especially regarding the institutional capacity-building objectives – and the position which developing countries should take in international forums where policies towards TNCs are discussed and negotiated.

Annex 4.1: FDI and human and social development – some statistical tests5 It is worth examining the general information available on FDI, growth, and sustainable human development indicators in developing countries to see if any relationship between those indicators can be detected. To do this, we use a sample of eighty-eight developing countries for which FDI stock, Human and Gender-related Development Indexes (HDI and GDI, respectively) and environmental indicators are available.6 We are fully aware of the limitations of these data – for example, FDI stock is not always adequately measured – and of the criticisms which have been raised about HDI and GDI. Thus, the following results should be interpreted only as a preliminary effort that needs to be complemented with analyses for specific countries.

Foreign direct investment, growth and development 97 When the sample is classified according to the importance of FDI stock in GDP, the data suggest a positive correlation between FDI on the one hand, and HDI and GDI on the other. At the same time, larger FDI stocks as a share of GDP are positively associated with worsening environmental performance, as measured by the energy intensity of GDP, the CO2 emissions per capita and the deforestation rate (see Table A4.1). If developing countries are divided into two groups according to whether their per capita GDP is above or below US$1,000, the picture for LIDCs is the same as that for all developing countries (Table A4.2a). For the rest of the developing countries, there also seems to be a positive association between FDI and human development indicators, although the latter are very similar for the three groups. In terms of the impact of FDI on environmental performance, the pattern is difficult to discern, since the three indicators suggest different results (Table A4.2b). Taking the sample as a whole as well and the two sub-samples of countries grouped by income level, countries with higher FDI stocks relative to GDP have higher levels of GDP per capita (Tables A4.1 and A4.2). If a Spearman rank correlation test is applied to these data, it is possible to reject the null hypothesis that there is no association between FDI stock as a share of GDP on the one hand and GDP per capita, GDI and HDI levels on the other, but only in the case of LIDCs. The null hypothesis can also be rejected for the whole sample in the cases of FDI on the one hand, and GDI and HDI on the other. However, the null hypothesis Table A4.1 Main FDI and human and social development indicators for developing countries, 1997 Stock of FDI (% of GDP)

No. of GDP per countries capita

Above 20%a 27 10–20%b 22 Below 10%c 39

3,985 1,790 3,366

HDI

GDI

GDP per unit of energy

0.645 0.599 3.40 0.597 0.569 3.60 0.547 0.507 4.91

CO2 Deforestation emissions rate per capita 3.90 1.26 1.34

1.29 1.09 1.24

Source: UNCTAD (1997b, 1998); World Bank (1998); UNDP (1998). Notes a Angola, Bolivia, Chad, Chile, Congo, Costa Rica, Egypt, Equatorial Guinea, Fiji, Gabon, Gambia, Guyana, Hong Kong (China), Indonesia, Jamaica, Malaysia, Mexico, Nigeria, Panama, Papua New Guinea, Saudi Arabia, Singapore, Togo, Trinidad and Tobago, Tunisia, Viet Nam and Zambia. b Barbados, Botswana, Brazil, Brunei, Burkina Faso, Cameroon, China, Colombia, Dominican Republic, Ecuador, Ghana, Guatemala, Honduras, Lebanon, Lesotho, Malawi, Mozambique, Nicaragua, Niger, Oman, Paraguay, Rwanda, Thailand and Yemen. c Algeria, Argentina, Bangladesh, Benin, Burundi, Central African Republic, Côte d’Ivoire, El Salvador, Ethiopia, Guinea, Guinea-Bissau, Haiti, India, Jordan, Kenya, Kuwait, Madagascar, Mali, Mauritius, Morocco, Myanmar, Nepal, Pakistan, Peru, Philippines, Qatar, Republic of Korea, Senegal, Sri Lanka, Syrian Arab Republic, Turkey, Uganda, United Arab Emirates, United Republic of Tanzania, Uruguay, Venezuela and Zimbabwe.

98 D. Chudnovsky and A. López Table A4.2 FDI and human and social development indicators for developing countries, 1997: (a) Countries with GDP per capita below US$1,000 Indicators c

GDP per capita HDI GDI GDP per unit of energy CO2 emissions per capita Deforestation rate

Countries with FDI/GDP: Below 10%a

Between 10% and 20%b

Above 20%c

390 0.371 0.353 7.294 0.255 0.760

423 0.437 0.421 4.367 0.544 0.845

505 0.440 0.430 4.525 0.589 1.100

Notes a Angola, Bolivia, Chad, Gambia, Guyana, Nigeria, Pakistan, Papua New Guinea, Republic of Congo, Togo, Vietnam and Zambia. b Cameroon, China, Ghana, Honduras, Lesotho, Malawi, Mozambique, Nicaragua, Niger, Rwanda and Yemen. c Bangladesh, Benin, Burkina Faso, Burundi, Central African Republic, Côte d’Ivoire, Ethiopia, Guinea, Guinea-Bissau, Haiti, India, Kenya, Madagascar, Mali, Myanmar, Nepal, Senegal, Sri Lanka, Uganda, United Republic of Tanzania and Zimbabwe.

(b) Countries/territories with GDP per capita above US$1,000 Indicators c

GDP per capita HDI GDI GDP per unit of energy CO2 emissions per capita Deforestation rate

Countries with FDI/GDP: Below 10%a

Between 10% and 20%b

Above 20%c

5,729 0.745 0.709 2.433 2.833 1.767

3,156 0.757 0.703 2.738 2.075 1.438

6,377 0.780 0.714 2.629 5.793 1.562

Source: UNCTAD (1997b, 1998); World Bank (1998); UNDP (1998). Notes a Algeria, Argentina, El Salvador, Jordan, Kuwait, Mauritius, Morocco, Peru, Philippines, Republic of Korea, Syrian Arab Republic, Turkey, United Arab Emirates, Uruguay and Venezuela. b Barbados, Botswana, Brazil, Colombia, Dominican Republic, Ecuador, Guatemala, Lebanon, Oman, Paraguay and Thailand. c Chile, Costa Rica, Egypt, Equatorial Guinea, Fiji, Gabon, Hong Kong (China), Indonesia, Jamaica, Malaysia, Mexico, Panama, Saudi Arabia, Singapore, Trinidad and Tobago and Tunisia.

Foreign direct investment, growth and development 99 cannot be rejected in any of the three cases when high- and mediumincome developing countries are considered. Regarding environmental performance, the only indicator for which the null hypothesis can be rejected is that based on CO2 emissions per capita (Table A4.3). When the impact of FDI growth (relative to GDP) on sustainable human development indicators is estimated for the period 1980–95, there is a positive association between FDI growth and improving HDI indicators for LIDCs, as shown in Table A4.4a.7 It should be emphasized that those countries with higher FDI growth also had higher levels of HDI at the beginning Table A4.3 Correlation tests between FDI and main human and social development indicators Countries with GDP per capita

Total

Above US$1,000

Below US$1,000

GDP per capita rSa Sample size Decisionb

0.13 44 Do not reject Ho

0.31 44 Reject Ho

0.19 88 Do not reject Ho

HDI rS Sample size Decision

0.18 44 Do not reject Ho

0.38 43 Reject Ho

0.25 87 Reject Ho

GDI rS Sample size Decision

0.13 44 Do not reject Ho

0.36 43 Reject Ho

0.23 87 Reject Ho

GDP per unit of energy rS Sample size Decision

0.09 37 Do not reject Ho

0.15 38 Do not reject Ho

0.16 75 Do not reject Ho

CO2 emissions per capita rS Sample size Decision

0.35 37 Reject Ho

0.47 39 Reject Ho

0.36 76 Reject Ho

Deforestation rate rS Sample size Decision

0.04 37 Do not reject Ho

0.26 39 Do not reject Ho

0.10 76 Do not reject Ho

Notes a Spearman rank correlation test. rS  1  (6di2)/[n(n2  1)] di  range yi  range xi yI  FDI/GDP (1995) xI  GDP per capita; HDI; etc. b Ho: rank correlation coefficient equal to zero Level of significance: 0.05.

0.303 0.296 0.275

0.432 0.401 0.380

42 36 38

3.13 5.75 7.58

3.97 4.86 7.39

1995

1980 0.68 0.30 0.26

27 15 3 0.80 0.32 0.28

1995 19 8 4

% change

CO2 emissions per capita

% change

1980

% change

1980

1995

GDP per unit of energy

HDI

0.85 1.01 0.76

1990–95

Deforestation rate

0.646 0.561 0.618

0.790 0.722 0.786

22 29 27

2.76 2.91 2.76

1980 4.87 1.47 2.25

% change 7 17 5

5.46 2.08 3.21

1995

12 42 43

% change

CO2 emissions per capita

1.35 1.77 1.88

1990–95

Deforestation rate

Notes a Growth of more than 10%: Brazil, Chile, Costa Rica, Ecuador, Egypt, Gabon, Hong Kong, Indonesia, Jamaica, Malaysia, Mexico, Oman, Saudi Arabia, Singapore, Trinidad and Tobago and Tunisia. b Growth of between 5% and 10%: Colombia, Dominican Republic, Guatemala, Jordan, Morocco, Panama, Paraguay, Peru, Philippines, Thailand, Turkey, United Arab Emirates and Venezuela. c Growth of less than 5%: Algeria, Argentina, Barbados, Botswana, El Salvador, Kuwait, Lebanon, Mauritius, Republic of South Korea, Syrian Arab Republic and Uruguay.

2.56 2.40 2.89

1995

1980

% change

1980

1995

GDP per unit of energy

HDI

Source: UNCTAD (1997b, 1998); World Bank (1998); UNDP (1998).

High growtha Medium growthb Low growthc

Growth of FDI/GDP

(b) Countries/territories with GDP per capita above US$1,000

Notes a Growth of more than 15 per cent: Angola, Chad, China, Gambia, Lesotho, Nigeria, Pakistan, Papua New Guinea, Republic of Congo, Vietnam and Zambia b Growth of between 5 and 15 per cent: Bolivia, Cameroon, Ghana, Guinea-Bissau, Honduras, Malawi, Mozambique, Nicaragua, Niger, Rwanda, Togo, Uganda, United Republic of Tanzania and Yemen. c Growth of less than 5 per cent: Bangladesh, Benin, Burkina Faso, Burundi, Central African Republic, Côte d’Ivoire, Ethiopia, Guinea, Haiti, India, Kenya, Madagascar, Mali, Myanmar, Nepal, Senegal, Sri Lanka and Zimbabwe.

High growtha Medium growthb Low growthc

Growth of FDI/GDP

(a) Countries with GDP per capita below US$1,000

Table A4.4 Human and social development and FDI growth in developing countries, 1980–95

Foreign direct investment, growth and development 101 of the period (1980). At the same time, higher FDI growth is associated not only with higher CO2 emissions, but also with greater energy efficiency. In the case of medium- and high-income developing countries, those with low or medium FDI growth are those where the HDI indicators have grown faster. They are also those countries where environmental performance seems to have been deteriorating more rapidly, especially in terms of CO2 emissions per capita and deforestation (Table A4.4b). Taken as a whole, these findings suggest a positive correlation between FDI and GDP per capita, HD and GD indicators, at least for the group of LIDCs. At the same time, a negative correlation between FDI and environmental indicators appears, which seems to be particularly strong when CO2 emissions are considered. However, no causal relationship can be inferred from these findings. They do not indicate for instance, whether FDI contributes in a positive manner to human and social capital development or whether higher human development indicators attract more FDI. Nonetheless, it is interesting to observe that FDI growth has been higher in the group of countries where, at the beginning of the period under analysis, HDI levels were, on average, higher. This suggests that a feedback process between human and social development and FDI growth may have been taking place.

Notes 1 This chapter is based on an earlier version published in Kevin P. Gallagher and Jacob Werksman (eds) (2002) International Trade and Sustainable Development, London: Earthscan. 2 In their restructuring process, domestic firms should certainly rely on foreign technological and organizational inputs (see below), which may include the non-controlling participation of TNCs. 3 The useful research assistance of Sebastian Rubin in this section is acknowledged. 4 Even in these sectors, only the largest TNCs operate with the same environmental production standards in all their locations, to preserve the corporate image and to avoid the possibility of being sanctioned in their home countries (Jha and Teixeira, 1994). 5 The useful research assistance of Silvana Melitsko in preparing the material of this annex is acknowledged. 6 Transition economies are excluded because of the lack of data. 7 When the Spearman rank correlation test was applied to these data, it was not possible to reject the null hypothesis.

References Abramovitz, M. (1986), “Catching up, forging ahead, and falling behind”, Journal of Economic History, June. Agosín, M. R. (1999), “Capital account convertibility and multilateral investment agreements: what is in the interest of developing countries?”, International Monetary and Financial Issues for the 1990s, X, UNCTAD, Geneva.

102 D. Chudnovsky and A. López Albuquerque, E. (1997), “National Systems of Innovation and Non-OECD Countries: Notes about a Rudimentary and Tentative ‘Typology’ ”, Paper presented at the Annual Conference of the European Association for Evolutionary Political Economy (EAEPE), Athens, November. Aranda, V. and K. P. Sauvant (1996), Incentives and Foreign Direct Investment, Current Studies, Series A, No. 30, UNCTAD, Geneva. Blomström, M. and A. Kokko (1997), “How Foreign Investment Affects Host Countries”, International Trade Division, Policy Research Working Paper 1745, World Bank, New York. Buckley, P. and M. Casson (1993), “Multinational enterprises in less-developed countries: cultural and economic interactions”, in S. Lall (ed.), Transnational Corporations and Economic Development, United Nations Library on TNCs, Vol. 3, Routledge, London. Chudnovsky, D. and A. López (1998), “La inversión directa extranjera en la Argentina en los años 1990: tendencias, determinantes y modalidades”, in Argentina de Cara al Mundo III, Argentina, Ministerio de Relaciones Exteriores, Comercio Internacional y Culto, Buenos Aires. Chudnovsky, D., A. López and V. Freylejer (1997), “Environmental Management in Argentine Industry: The Diffusion of Pollution Prevention Measures”, Final Report of the Project on Competitiveness, Technological Innovation and Sustainable Development: Case Studies in the Argentine Manufacturing Sector, IDRC/North South Centre of the University of Miami/Avina Foundation. Clark, I. (1997), “Rehabilitation of mining sites”, in Environmental Policies, Regulations and Management Practices in Mineral Resources Development in Asia and the Pacific, Mineral Resources Assessment, Development and Management Series, Vol. 2, United Nations, Geneva. Dahlman, C., B. Ross-Larson and L. Westphal (1987), “Managing technological development: lessons from the newly industrializing countries”, World Development, 15(6). Dunning, J. (1993), Multinational Enterprises and the Global Economy, AddisonWesley, London. Dunning, J. (1994), “Re-evaluating the benefits of foreign direct investment”, Transnational Corporations, 3(1). Dunning, J., R. Van Hoesel and R. Narula (1997), “Third World Multinationals Revisited: New Developments and Theoretical Implications”, Discussion Papers in International Investment and Management, No. 227, University of Reading, Reading. Edquist, C. (ed.) (1997), Systems of Innovation: Technologies, Institutions and Organizations, Pinter, London. Ernst, D., T. Ganiatsos and L. Mytelka (1998), Technological Capabilities and Export Success in Asia, Routledge, London. Ganesan, A. V. (1998), “Strategic options available to developing countries with regard to a multilateral agreement on investment”, International Monetary and Financial Issues for the 1990s, X, UNCTAD, Geneva. Haaland, J. and I. Wooton (1998), “International Competition for Multinational Investment”, Paper presented at the Conference on Competition and Industrial Policies in Open Economies, Bergen, May. ILO (1998), Labour and Social Issues Relating to Export Processing Zones, ILA, Geneva. Jha, V. and A. P. Teixeira (1994), “Are Environmentally Sound Technologies the Emperor’s New Clothes?”, UNCTAD, Discussion Papers No. 89, UNCTAD, Geneva.

Foreign direct investment, growth and development 103 Katz, J. (1998), “Structural Reforms and Technological Behaviour. The Sources and Nature of Technological Change in Latin America in the 1990s”, Paper presented at the seminar on The Economics of Industrial Structure and Innovation Dynamics, INTECH, Lisbon, October. Kolodner, E. (1994), “Transnational Corporations: Impediments or Catalysts of Social Development?”, Occasional Paper No. 5, World Summit for Social Development, United Nations Research Institute on Social Development, Geneva. Lall, S. (1983), The New Multinationals. The Spread of Third World Enterprises, Wiley/IRM, London. Lall, S. (1997), “East Asia”, in J. Dunning (ed.), Governments, Globalization and International Business, Oxford University Press, Oxford. Lawler, J. (1995), “Multinational Firms, National Culture, and Gender-based Employment Discrimination”, Working Paper, Institute of Labour and Industrial Relations, University of Illinois, Illinois. Levy, D. (1995), “The environmental practices and performance of transnational corporations”, Transnational Corporations, 4(1). Marsh, B. (1997), “Successful reclamation”, in Environmental Policies, Regulations and Management Practices in Mineral Resources Development in Asia and the Pacific, United Nations Mineral Resources Assessment, Development and Management Series, Vol. 2, United Nations, Geneva. Narula, R. (1997), “The role of developing country multinationals in the acquisition of industrial technology in Nigeria”, Science, Technology and Development, 15(1). O’Connor, D. and D. Turnham (1992), “Managing the environment in developing countries”, Policy Brief No. 2, OECD Development Centre, Paris. OECD (1992), Technology and the Economy: The Key Relationships, OECD, Paris OECD (1998), “Foreign direct investment and the environment: an overview of the literature”, mimeo, prepared for the Negotiating Group on the Multilateral Agreement on Investment, OECD, Paris. Oman, C. (1998), “Policy competition and foreign direct investment”, draft, OECD Development Centre, Paris. South Centre (1997), “Foreign Direct Investment, Development and the New Global Economic Order. A Policy Brief for the South”, South Centre, Geneva. UNCTAD (1993), Report of the Workshop on the Transfer and Development of Environmentally Sound Technologies, Technology Programme, UNCTAD, Geneva. UNCTAD (1994), World Investment Report 1994: Transnational Corporations, Employment and the Workplace, UNCTAD, New York and Geneva. UNCTAD (1996), Fostering Technological Dynamism: Evolution of Thought on Technological Development Processes and Competitiveness: a Review of the Literature, UNCTAD, Geneva. UNCTAD (1997a), “Management of Commodity Resources in the Context of Sustainable Development: Governance Issues for the Mineral Sector”, Report by the UNCTAD secretariat, UNCTAD, Geneva. UNCTAD (1997b), World Investment Report 1997: Transnational Corporations, Market Structure and Competition Policy, UNCTAD, New York and Geneva. UNCTAD (1998), World Investment Report 1998 – Trends and Determinants, UNCTAD, New York and Geneva. UNCTAD (2002), UNCTAD Handbook of Statistics 2002, UNCTAD, Geneva. UNDP (1998), Human Development Report 1998, UNDP, New York. World Bank (1998), World Development Report 1998, World Bank, New York.

5

Improving health A key to halving global poverty by 2015 David E. Bloom, David Canning, Bryan Graham and Jaypee Sevilla

I. Health and poverty Introduction Few statements in the development literature command as much universal assent as the claim that higher incomes lead to higher human development. The reverse statement, that human development can lead to higher incomes, is a different matter. It is less familiar, newer, and has the ability to surprise people in a way that the first no longer does. The first statement enjoys the status of a truism. Its reverse requires argument. Bloom and Canning (2000) provide such an argument. They argue that the demographic transition from high mortality and fertility rates to low mortality and fertility rates, with the changes it produces in the age structure, life expectancies and demographic patterns of a population, provides a powerful stimulus to economic growth. The present chapter takes this argument a step further. To the extent that human development, in the form of improved health, facilitates more rapid economic growth, and to the extent that economic growth lifts people out of poverty, then human development can be an effective mechanism for poverty alleviation. In other words, more health means less poverty. We argue the relevance of this effect in a very concrete setting, using the first Millennium Development Goal on eradicating extreme poverty, established by the United Nations Millennium Summit. Its target is to halve, between 1990 and 2015, the proportion of the world’s population living in absolute income poverty, using the United Nations’ definition: living on less than US$1 per day. This implies cutting the proportion of those living in absolute poverty from 30 per cent of the world’s population in 1990 to 15 per cent by 2015. Most multilateral organizations concerned with international development, such as the United Nations and the World Bank, have adopted this target, as have most national governments. In the United Kingdom, for example, the Minister for the Department for International Development (DFID) has explicitly focused the work of her department on the target.

Improving health 105 Recently, in a publication intended for the British electorate, DFID described poverty reduction as “the greatest moral challenge the world now faces” (DFID, 2000) This chapter explores how difficult it will be to meet the poverty reduction target. It focuses on health and the contribution of health improvements, as measured by increased life expectancy, to poverty reduction. It also explores the relationship between health and wealth, demonstrating the need for a stronger focus on health-led development. However, it should be understood that in this context the use of the term “poverty” relates to income poverty. From health to wealth Health has traditionally been seen as an output of rising incomes, a “good” that people consume as they become richer. In the second half of the twentieth century, however, human and social capital have been gradually accepted as critical determinants of the development process. Great value is clearly contained in people and the strength of their society. In the absence of a sufficient accumulation of human and social capital, economies do not perform well. This effect is undoubtedly becoming even more potent, as economies become both more global and based, increasingly, on intangible assets such as knowledge. (Bloom and River Path Associates, 2000) The relation between health and wealth is strong. There is a close correlation between life expectancy and average income (Figure 5.1). 20,000

US$, Purchasing Power Parity

18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 0

10

20

30

40

50

60

Life expectancy (years)

Figure 5.1 Per capita GDP and life expectancy.

70

80

90

106 Bloom et al. Further, countries with high life expectancies tend to have lower poverty rates as well as higher rates of income growth (Figures 5.2 and 5.3). They also tend to have more equal income distributions (Figure 5.4). There is a number of mechanisms through which health improvements can improve incomes. For example, health interacts with: •

•

•

•

•

Demography: as child mortality falls and life expectancies rise, people tend to invest more resources in fewer children. This demographic transition slows population growth and results in a period where there is a significantly increased proportion of workers to dependants. Education: healthy children miss school less and learn more effectively when in school. If their family is healthy, they are less likely to be removed from school due to the illness of a family member. Investment in education: returns to education rise steeply with improved health. Increased life expectancy raises the period over which returns to education can be earned. In addition, due to the demographic transition, people tend to spend more resources educating fewer children to a higher level. The labour market: healthier workers are physically and mentally more energetic and robust. They are more productive and earn higher wages. They are also less likely to be absent from work due to illness (or illness in their family). Saving: healthy people expect to live longer and are therefore more likely to save for retirement. The money they save increases the amount of capital in the economy. 100 90

Absolute poverty rate (%)

80 70 60 50 40 30 20 10 0 0

10

20

30

40

50

60

70

80

90

Life expectancy (years)

Figure 5.2 Absolute poverty rate in 1981–95 and life expectancy (source: World Bank (1998)).

8

6

Growth rate

4

2

0 10

20

30

40

50

60

70

80

90

2

4 Life expectancy (years)

Figure 5.3 Annual growth in per capita GDP (1965–90) and life expectancy (source: World Bank (1998)). 70 60

Gini coefficient

50 40 30 20 10 0 0

10

20

30

40

50

60

70

80

90

Life expectancy (years)

Figure 5.4 Average Gini coefficient (1985–95) and life expectancy (source: World Bank (1998)).

108 Bloom et al. The relationship also continues to run from wealth to health, of course. Societies can therefore enter a period in their development where a large number of factors positively reinforce each other, creating a “virtuous spiral” that significantly boosts their development. For example, the East Asian economic miracle was driven by just such a virtuous spiral. Quantifying the effect of health on poverty Approximately 28 per cent of the developing world is currently thought to be living in extreme poverty (see Table 5.1). The highest rates of income poverty are found in India (53 per cent) and Africa (39 per cent). As of 1990, 1.2 billion people were estimated to be living on less than one US dollar a day (measured in terms of purchasing power over a standard international basket of goods). We quantify the effect of health on poverty using three equations. The first is developed from the fact that absolute poverty is related both to income growth and to the extent to which poor people benefit from that growth. It therefore expresses absolute poverty as a function of average incomes and income distribution. The second equation is an orthodox growth equation expressing growth in real incomes as a function of its current level; the health status of a population as measured by average life expectancy; and other covariates including the secondary school gross enrolment rate, the working-age share of the population and whether it will decline or fall over time, the geographical location of a country, its openness to trade and the quality of its institutions. Table 5.1 Population-weighted descriptive statistics, 1990 Region

Per capita GDP in 1990 (1985 US$)

Gini coefficient in 1990

Absolute poverty rate 1981–95

Population in 1990 (’000)

Population in absolute poverty, 1981–95 (’000)

Africa Asiaa China India E. Europe L. America Middle East

1,166 2,457 1,324 1,264 4,424 4,146 2,639

45 35 36 31 38 54 35

39 11 22 53 4 20 5

486,930 865,759 1,155,305 850,793 345,004 432,486 277,681

124,363 50,073 256,478 446,666 11,763 68,585 5,684

Totalb

1,977

37

28

4,476,858

963,612

Notes The columns on per capita GDP, the Gini coefficient, the absolute poverty rate, and the population in absolute poverty in 1990 contain population-weighted averages of these statistics only for the countries for which they are available. a Asia does not include China and India, which are described separately. b Includes countries not included in separate regions.

Improving health 109 The third equation expresses income distribution as a function of average incomes and health. Health improvements have little impact on someone in very poor health, but have a dramatic effect beyond a certain threshold. This effect in turn persists beyond a second threshold, at which point it becomes subject to the law of diminishing returns. This third equation reflects the fact that health enforces the Kuznets effect, where countries become less equal in the initial stages of development, but more equal as they pass a certain stage. Taken together, these estimated relationships between health, economic growth, income distribution and poverty allow us to simulate the consequences of recent and foreseeable improvements in life expectancy on poverty. The simulations cover thirty-one countries for which sufficient data are available, with a combined population of 3.1 billion as at 1990. At that time, 30 per cent of their populations, or some 900 million people, were estimated to live in extreme poverty. The simulations were conducted using three different scenarios: • • •

Simulation A: life expectancy follows the trajectory predicted by the UN’s projections for 2015 (United Nations, 1998) Simulation B: life expectancy follows a trajectory that is 10 per cent higher than the UN projections for 2015 Simulation C: life expectancy is 10 per cent higher than that actually observed in 1990 and follows a trajectory that leads to a value 10 per cent higher than the UN’s projections for 2015.

II. Empirical methodology A poverty model We model poverty as a function of average income and income distribution. We measure the former by per capita GPD and the latter by the Gini coefficient. That is, pt  f0(yt, gt) where p, y, and g represent a nation’s poverty rate, per capita GDP, and Gini coefficient respectively. The subscript t denotes time. We argue that the level of health in an economy, which we denote by h and measure by life expectancy, has important effects on the annualized growth rate of per capita incomes and on income distribution: ln yt  ln yt1   f1(yt1, ht1, xt1) t gt  f2(yt, ht, zt) where x and z are vectors of other variables that determine income growth and income distribution, and t is the number of years between t 1 and

110 Bloom et al. t. A reduced form statement of our central argument – that health can be an effective tool for reducing poverty – is obtained by substituting the expressions for y and g implied by f1 and f2 into p: pt  f3(yt1, ht1, xt1, ht, zt). In other words, both past and present health matters for poverty. Our objective is to simulate the effect that health improvements over the fifty-year period 1965 to 2015 could have on global poverty in 2015, as defined by the United Nations. We proceed in the following stages. First we specify and estimate our econometric model’s three equations f0, f1 and f2, using historical data from 1965 to 1990 on p, y, g, h, x and z. Next, we construct alternative counterfactual trajectories for h over the period 1990–2015, as noted in Section I. Scenario A adopts the UN’s low projections for life expectancy in 2015, scenario B assumes 10 per cent improvement in life expectancy over scenario A, and scenario C assumes a 10 per cent improvement in 1990 over and above scenario B. For each of these cases, we combine the hypothesized values for h1990 with actual data on y1990 and x1990, and the estimated function fˆ1 to obtain a predicted value for y2015. Analogously, we combine the hypothesized value for h2015, projected values for z2015, and the estimated function fˆ2 to obtain a predicted value for g2015. The predicted values for y2015 and g2015 yield predictions for p2015 through the estimated function fˆ0. Poverty as a function of income and its distribution Figure 5.5 shows the absolute poverty rate as the area under the distribution of annual incomes, and to the left of the vertical line representing an annual income of US$365 (US$1 per day). The poverty rate can thus be modelled as a function of the mean and dispersion of the distribution of annual incomes. In other words, absolute poverty is a function of mean income and the distribution of income.

Income distribution

P $365

Annual income

Figure 5.5 Graphical representation of the absolute poverty rate P.

Improving health 111 This functional dependence is intuitive and evident from Figures 5.6 and 5.7. For a given level of inequality, we expect that when mean incomes rise, absolute poverty falls because the entire income distribution shifts to the right without changing its shape. Since everyone is wealthier, there are fewer poor. In Figure 5.6, the area A  B gives the initial absolute poverty rate. When mean income rises, the income distribution shifts to the right and the absolute poverty rate is lower at B. Analogously, for a given average income, we expect that the more unequal the distribution of this income, the higher the average poverty rate. From Figure 5.7, we see that as the dispersion of income increases, the income distribution becomes flatter, leaving its centre in the same place, but putting larger

Income distribution

A B $365

Annual income

Figure 5.6 For a given level of inequality, higher income means lower poverty.

Income distribution

A

B $365

Annual income

Figure 5.7 For a given mean income, higher inequality means higher poverty.

112 Bloom et al. numbers of people in the tails. This causes the absolute poverty rate to rise from B to A  B. To formalize this intuition into a specification we can estimate econometrically, we start with the UN’s absolute poverty rate pa, defined as the fraction of the population living on less than one dollar a day, and transform it logistically in the following way: pa p  ln a 100  p





The reason for this transformation is simply that absolute poverty rate is expressed as a fraction of a population. It is therefore naturally bounded between 0 and 100, and not suited to linear regression techniques that assume the dependent variable is not constrained to be in any fixed interval. The logistic transformation avoids this problem by mapping the absolute poverty rate onto the entire real number line so that a poverty rate of zero implies a logistic poverty rate of negative infinity while a poverty rate of 100 implies a logistic poverty rate of positive infinity. The transformation is fully invertible. We can derive the absolute poverty rate from the logistic transformation with 100e p pa  p 1e For f0, which expresses the functional dependence of poverty on mean incomes and the distribution of income, we choose the specification pt  0  1(ln yt)  2(ln yt)2  3(ln gt)  4(ln gt)2  etp. That is, logistic poverty is a linear function of the logarithms of per capita GDP and the Gini coefficient, and the squares of these logarithms. We estimate the poverty equation for 1990 using a cross-section of fortytwo countries for which absolute poverty data are available. These data come from the World Development Indicators (World Bank, 1998), and although we treat these data as cross-sectional, they are actually observed at different times for different countries, though only once for each country. They are observed from as early as 1981 and as late as 1995. One should therefore keep in mind this underlying (and ignored) difference in the timing of the data. For our Gini data, we take five-year Gini data from Deininger and Squire (1996) for the two periods 1985–89 and 1990–94, and average them. Per capita GDP figures from 1990 are from version 5.6 of the Penn World Tables (Summers and Heston, 1991), and are measured in 1985 purchasing power parity (PPP) dollars. Our preferred way of estimating the poverty equation is by ordinary least squares (OLS). Unfortunately, this causes a problem. It yields predicted values that are at considerable variance with the actual data. For

Improving health 113 example, OLS estimation yields a predicted absolute poverty rate for India of 15 per cent, a very long way from the actual value of 53 per cent. We conclude from this that there are important country-specific determinants of absolute poverty rates that cannot be observed in cross-sectional data or measured by OLS. Unfortunately, we do not have the panel data that would allow us to control for these country specific unobservables. We cannot perform useful simulations of future poverty rates using the simple OLS results because if they imply 15 per cent poverty rates for India in 1990, they will imply even more implausibly optimistic poverty rates in 2015. This is particularly damaging, since almost half of the developing nations’ absolute poor are in India. To remedy this situation in a simple way, we perform OLS on the poverty equation anyway and treat the residuals as estimates of the fixed effects. This implies that when we compute predicted values for absolute poverty rates in 2015, we include these fixed effects. The OLS estimation results and the summary statistics for the variables are shown in Tables 5.2 and 5.3, respectively. Annex 5.2 lists the countries included in the regression analysis. Determinants of economic growth Much attention has been paid in recent years to the determinants of economic growth across countries. According to neoclassical growth theory, the growth rates of countries depend on two things. First, they depend on the inherent long-run ceiling on the level of income per worker that a country can attain. This ceiling, usually denoted by the country’s steadystate level of income, depends on those characteristics of a country that Table 5.2 Explaining poverty Logistic poverty rate

Dependent variable

Intercept Log of per capita GDP Log of per capita GDP, squared Log of Gini coefficient Log of Gini coefficient, squared

127.795 (38.781) 12.814 (4.183) 0.732 (0.276) 43.103 (19.138) 6.163 (2.567)

Standard errors in parentheses.

Table 5.3 Summary statistics of data for poverty regression

Poverty rate Per capita GDP Gini coefficient

Mean

Standard deviation

Minimum

26.7 2,422 44.6

23.7 1,607 10.0

2.0 544 27.3

Maximum 88.2 6,397 62.3

114 Bloom et al. dictate its long-run growth potential. For our purposes, we focus on the following: 1

2

3

4

5

6

7

8

The log of life expectancy. Life expectancy is our measure of health. We expect this to have a positive effect on economic growth for all the reasons explained in Section I: its positive impact on labour supply, accumulation of financial wealth and human capital. The log of the secondary-school gross enrolment ratio. Higher enrolment rates imply higher stocks of human capital and a more productive workforce, allowing for more rapid growth. The working age share of the population. This measures the fraction of the population that is potentially economically productive. A higher working-age share implies a higher potential growth rate. The difference in growth rates between the working-age subpopulation and the entire population (GDIF). This measures the evolution in the age structure of a population that can be caused by demographic transitions from high mortality and fertility rates to low ones. More rapid growth in the working-age sub-population relative to the entire population implies changes in the age structure that raise the share of the potentially economically productive segment of the population. It is a dynamic counterpart to (3). The percentage of a country’s land mass in the tropics. Geography has recently been shown to be a crucial determinant of economic growth (see Bloom and Sachs, 1999). Proximity to the tropics, for example, implies a higher incidence of disease burdens and greater difficulty in growing cash crops. A higher percentage of a country’s land-mass in the tropics should imply slower growth. A measure of openness to trade. Openness to the world economy enables a country to harness world demand for its outputs as well as source world supply for its inputs. More openness should be associated with more rapid growth (Sachs and Warner, 1995). An interaction between the degree of openness to trade and GDIF. The potential for more rapid growth made possible by the changes in a country’s age structure is not automatic and depends for its realization on the quality of policies that harness this potential. Openness is one such policy. Therefore the interaction between GDIF and openness can be a significant determinant of growth. A measure of the quality of institutions. Higher quality of institutions implies less corruption, more consistent application of rules of law, and a stable and predictable environment for economic activity. This also facilitates capital accumulation and entrepreneurship and should be conducive to growth.

The second determinant of growth is the current distance of a country from its long-run potential. The theory assumes diminishing returns to

Improving health 115 capital accumulation. This implies that countries that are relatively far away from their steady states, or equivalently, countries that have low incomes relative to their long-run potential incomes, should experience relatively larger returns to capital accumulation than countries with high incomes relative to their long-run potential. More rapid capital accumulation and growth can therefore be expected in these countries that are poor relative to their steady states. In order to capture both these sets of determinants of economic growth, we specify our growth equation f1 as ln yt  ln yt1 – –   0  1 ln yt 1  2 ln ht1  3x t 1  t 1y t where an overbar denotes vectors of either parameters or regressors. This specification is traditional in the empirical growth literature (e.g. Barro and Sala-i-Martin, 1995; Bloom and Sachs, 1998; Bloom and Williamson, 1998; Sachs and Gallup, 1999). The dependent variable is the annualized growth rate in per capita GDP. The log of life expectancy (ln h) and the vector of independent variables x– are determinants of the long-run steady states, while the log of initial per capita income (ln yt1) captures the conditional convergence effects of distance from the steady state. We estimate our growth equation on a cross-section of eighty-two countries. The dependent variable is the annualized growth rate of GDP per capita between 1965 and 1990. All independent variables except GDIF are observed in 1965. GDIF is constructed as the difference in growth rates of the working age and total population from 1965 to 1990. The possibility of reverse causation from income to population growth makes GDIF an endogenous regressor, leading to biases in OLS estimates. This endogeneity problem leads us to instrument GDIF and its interaction with the openness indicator using the following instrumental variables: the logs of infant mortality, fertility, and the youth dependency ratio in 1965, and the average growth of working-age and total population from 1960 to 1965. This procedure is equivalent to regressing the endogenous regressors on the instrumental variables and using the predicted values of the endogenous regressors as the data in the actual growth regression. These predicted values are purged of endogeneity and restore unbiasedness to the coefficients. Data sources are listed in Annex 5.1. The countries in the sample are listed in Annex 5.2. The Instrumental Variable regression results are shown in Table 5.4. The estimation results are as follows. The log of initial per capita incomes and unfavourable geography have the expected negative coefficients and are both significant at the 1 per cent level. While neither openness nor the dynamics in the age distribution are significant, their interaction is at the 1 per cent level, as we hypothesized. Life expectancy is significant at the 10 per cent level, while the log of the working-age share

116 Bloom et al. Table 5.4 Results of 2SLS regression for growth rate of per capita GDP, 1965–90 Explanatory variable

Coefficient

Intercept Log of 1965 per capita GDP Log of 1965 working-age share of the population Percentage of area in tropics Log of 1965 secondary school gross enrolment rate Percentage of years open to trade, 1965–90, OPEN Quality of institutions, 1980 Log of 1965 life expectancy Difference in growth rate between working-age and total population, GDIF OPEN*GDIF

2.717 (6.215) 1.69 (0.315) 2.158 (3.277) 1.043 (0.360) 0.409 (0.314) 0.597 (0.589) 0.103 (0.116) 2.81 (1.56) 0.386 (1.179) 3.388 (1.204)

Note Standard errors in parentheses.

of the population in 1965, the log of the secondary school enrolment ratio and the measure of institutional quality are not. Life expectancies seem to have some effect on the pace of economic growth. To anticipate our simulation results, we use our estimates to predict growth from 1990 to 2015 using 1990 data on independent variables and the sample of thirty-one developing countries for which both absolute poverty data and data on the independent variables in the growth equation exist. When we do so, we find that the average per capita incomes in these countries will grow from $1,812 (in 1985 dollars) to $3,685. When we assume, counterfactually, that life expectancies in 1990 were 10 per cent higher than they actually were, average per capita incomes are almost $300 higher at $3,953. The 10 per cent higher life expectancy raises the annualized growth rate from 2.84 per cent to 3.12 per cent. Determinants of the distribution of income We extend recent research on the determination of inequality (Barro, 1999; Higgins and Williamson, 1999; Lundberg and Squire, 1999) to include a role for health improvements. Economic theories about the long-run evolution of inequality centre on the idea of the Kuznets curve. According to Kuznets (1955), inequality tends to worsen as a poor country develops, and it is only after it passes some threshold level of development that the relationship inverts itself and inequality diminishes as living standards rise. Current research is divided as to the empirical relevance of the Kuznets curve. Some authors, such as Gallup and colleagues (1997) and Anand and Kanbur (1993), find little evidence for it, arguing that on average, the income of the poor grows as quickly as average income. This implies that the distribution of income tends to remain stable as a country grows, displaying neither a tendency to increasing or decreasing inequal-

Improving health 117 ity. Others argue that interactions between growth and inequality exist. For example, according to Timmer (1997), growth exacerbates inequality where a great deal of inequality exists, and reduces it where there is little of it to begin with. On the other hand, greater inequality seems to retard growth, and lesser inequality speeds it up. While testing for the presence of a Kuznets effect is not the focus of this chapter, we allow the log of per capita incomes to have a non-linear effect on inequality in a manner consistent with its existence. We do this because previous experience shows that these non-linear effects tend to have a strong statistical significance. To this specification, we add health as measured by life expectancy as another determinant of inequality. There are good reasons to believe that improvements in health have a progressive impact – that is, their benefits are larger for the poor than for the rich. This is so because the poor have more of their assets concentrated in their labour and so disproportionately benefit from the labour enhancing effects of improved health. Our specification for fˆ2, which relates inequality to income and health, is gt,i  0  1(ln yt.i)  2(ln yt.i)2  3(ln ht.i)  zi  t,ig. That is, we model the Gini coefficient as a function of the log of per capita income, its square, health and country-specific fixed effects. Log income and its square capture Kuznets effects, and the log of life expectancy captures the health effects. We include fixed effects to capture unobservable omitted variables that are constant through time and may be important determinants of cross-country differences in inequality. In contrast to the poverty and growth regressions, we estimate the Gini equation on a panel of ninety-seven countries observed over a number of five-year periods from 1960–64 to 1990–94. We attempted to include explicit conditioning variables such as measures of openness to trade and workingage fraction of the population, but these were not significant, so we limit ourselves to time invariant country-specific fixed effects. The countries in the sample are given in Annex 5.2 and the estimation results are in Table 5.5. We see from the estimates that both components of the Kuznets effect are significant at the 2 per cent significance level and have the expected signs: the coefficient on log per capita income is positive while the coefficient on its square is negative. That is, a country becomes more unequal as Table 5.5 Results of Gini coefficient panel regression Explanatory variable

Coefficient

Intercept Log of per capita GDP Log of per capita GDP, squared Log of life expectancy Number of observations

15.899 (29.441) 20.158 (8.472) 1.24 (0.490) 9.966 (5.192) 97

Note Standard errors in parentheses.

118 Bloom et al. it grows, except at higher incomes when the relationship inverts itself. The point at which this inversion occurs is $8,100. Life expectancy has a negative effect on the Gini coefficient, and is significant at the 6 per cent level. Longer-lived populations will tend to be more equal: a 10 per cent increase in life expectancy reduces the Gini coefficient by about 1 point.

III. How health reduces poverty The results The results of these simulations are arresting. Even Simulation A, with its conservative assumptions, shows an increase in per capita income and a modest tendency towards decreasing inequality, which will lower poverty (Table 5.6). This simulation implies that poverty rates will fall by at least half in Asia and the Middle East, and by 45 per cent in Africa. Dramatic falls are also seen in the world’s most populous countries, India and China. In China, the fall is over 75 per cent. Meanwhile, poverty rates will fall less steeply in Latin America. Against these positive expectations, poverty is predicted to rise sharply in Eastern Europe, with many people likely to fall into poverty for the first time in their lives. Overall, however, good outcomes outweigh the bad, with global rates of extreme poverty predicted to fall to just over 12 per cent. Simulation A demonstrates that the OECD/DAC poverty target, far from being challenging, is in fact distinctly conservative. The target can be met merely by relying on the persistence of current trends, and with no special commitment to pro-poor policies by developing country governments or development organizations. Table 5.6 Simulation results for the year 2015 Region

Per capita GDP, 1985 US$

Gini coefficient

1990

A

B

C

1990

A

B

C

Africa Asia China India E. Europe L. America Middle East

1,312 2,174 1,324 1,264 4,149 4,483 2,225

1,876 5,086 3,477 2,625 7,161 6,148 4,392

1,876 5,086 3,477 2,625 7,161 6,148 4,392

2,013 5,457 3,730 2,816 7,682 6,595 4,712

46.4 35.4 36.2 31.0 27.3 55.2 34.9

44.7 33.4 33.5 30.8 23.7 52.6 36.6

43.7 32.9 32.6 29.9 22.7 51.6 35.7

43.8 32.4 32.6 29.9 22.6 51.5 35.6

Total

1,812

3,685

3,685

3,953

37.2

35.7

34.8

34.8

Note Regional results are weighted summaries of results for individual countries. The weights used are United Nations population projections for 2015.

Improving health 119 Simulations B and C show the power of the interaction between health and wealth. Simulation B, where life expectancy is 10 per cent higher than predicted by the UN in 2015, shows only minor improvement over Simulation A, with only a million or so more people escaping poverty. However, the improvement shown by Simulation C is more significant. If life expectancy had been 10 per cent higher in 1990, this would have had a powerful effect on growth over the following twenty-five years. By 2015, thirty million more people would have been lifted from poverty relative to the scenario of simulation A. Two-thirds of these would have lived in India and a third in Africa, showing the huge importance of health for regions at an early stage of development. Notwithstanding the sizeable effect of health improvements on income growth, its effects on poverty reduction, while certainly not negligible, are considerably more modest. Policy implications These results have a number of intriguing implications. Reaching the Millennium Development Goals should not be considered a particularly notable achievement. However, to miss them, when the signs are so good, would be a humiliating catastrophe. We therefore suggest increased attention to those factors that could derail the poverty reduction process. To escape poverty, the poor need both opportunity and security. If education is framed as the main source of improved opportunity, then better health in turn is crucial to enhanced security. Health shocks can quickly drive people back into poverty,1 often reversing years of painfully made gains. Health is especially important to poor people, for a number of reasons. While rich households possess an array of material and financial assets, the assets of the poor consist almost entirely of their labour and human capital. Ill health therefore has a disproportionate impact on a poor household. Healthcare costs can quickly appropriate a large fraction of a poor family’s income and divert expenditure from, for example, schooling costs. Such problems are magnified when health across a society starts to deteriorate. In Eastern Europe and sub-Saharan Africa, the significant health gains of the twentieth century are under assault. In Russia, in particular, life expectancy is tumbling, as a vicious spiral of deteriorating health, falling incomes and evaporating social capital overtakes the region. In sub-Saharan Africa, one disease – HIV/AIDS – has sent life expectancies back to levels not seen since the 1950s. Eighty per cent of those dying are in their twenties, thirties and forties. Rather than enjoying the benefits of a demographic dividend conferring a higher proportion of energetic and productive workers, many African countries are seeing dependency levels rising, as adults sicken and children are orphaned (Bloom et al., 2000).

120 Bloom et al. Such health reversals must therefore be targeted for swift and decisive action. Beyond that, health-led development offers a natural partner for improved access to education. Opportunity and security thus yoked together offer poor people the best chance to pull themselves – and their families – out of poverty.

Annex 5.1: Data sources Variable

Source

Absolute poverty rate in 1990 Per capita GDP, various years Gini coefficient, various years Working-age share of population Percentage of area in tropics Secondary school gross enrolment rate Percentage of years open to trade Quality of institutions Life expectancy Growth rate of working-age population Growth rate of total population

World Bank, World Development Indicators, 1998 Penn World Tables 5.6 Deininger and Squire (1996) United Nations Population Statistics, 1998 Sachs and Gallup (1999) World Bank, World Development Indicators, 1998 Sachs and Warner (1995) Knack and Keefer (1995) United Nations Population Statistics, 1998 United Nations Population Statistics, 1998 United Nations Population Statistics, 1998

Annex 5.2: Samples of countries A. Sample of countries for poverty regression Algeria Brazil Bulgaria Chile China Colombia Costa Rica Côte d’Ivoire Dominican Republic Egypt Guatemala

Guinea Guinea-Bissau Honduras Hungary India Indonesia Jamaica Jordan Kenya Lesotho

Madagascar Malaysia Mauritania Mexico Morocco Nicaragua Nigeria Pakistan Panama Papua New Guinea

Poland Senegal South Africa Sri Lanka Thailand Tunisia Uganda Venezuela Zambia Zimbabwe

Improving health 121 B. Sample of countries for growth regressions Algeria Argentina Australia Austria Bangladesh Belgium Bolivia Brazil Burkina Faso Cameroon Canada Chile China Colombia Congo Costa Rica Côte d’Ivoire Denmark Dominican Rep. Ecuador Egypt

El Salvador Finland France Gabon Gambia Ghana Greece Guatemala Guinea Guinea-Bissau Honduras Hong Kong India Indonesia Ireland Israel Italy Jamaica Japan Jordan

Kenya Korea, Rep. Madagascar Malawi Malaysia Mali Mexico Morocco Mozambique Netherlands New Zealand Nicaragua Nigeria Norway Pakistan Papua N. G. Paraguay Peru Philippines Portugal

Senegal Sierra Leone Singapore South Africa Spain Sri Lanka Sweden Switzerland Syria Thailand Togo Trinidad Tunisia Turkey Uganda UK Uruguay Venezuela Zambia Zimbabwe

Kenya Korea, Rep. Laos Lesotho Luxemburg Madagascar Malawi Malaysia Mali Mauritania Mauritius Mexico Morocco Nepal Netherlands New Zealand Nicaragua Nigeria Norway Pakistan Panama Paraguay Peru Philippines

Poland Portugal Puerto Rico Romania Rwanda Senegal Sierra Leone Singapore South Africa Spain Sri Lanka Sweden Switzerland Thailand Trinidad Tunisia Turkey Uganda UK US Venezuela Yugoslavia Zambia Zimbabwe

C. Sample of countries for Gini regression Algeria Australia Austria Bahamas Bangladesh Barbados Belgium Bolivia Botswana Brazil Bulgaria Burkina Faso Cameroon Canada Central. Af. Rep. Chile China Colombia Costa Rica Côte d’Ivoire Denmark Dominican Rep Ecuador Egypt El Salvador

Fiji Finland France Gabon Gambia Germany Ghana Greece Guatemala Ginea Guinea-Bissau Guyana Honduras Hong Kong Hungary India Indonesia Iran Ireland Israel Italy Jamaica Japan Jordan

122 Bloom et al.

Note 1 There are, of course, other issues. People are pushed back into poverty by economic and environmental shocks, natural disasters and war. Clearly, much work is needed to create a more stable global economy and to ensure wider access to the opportunities offered by the knowledge economy – but this is beyond the scope of this chapter.

References Anand, S. and S. Kanbur. (1993) “Inequality and development: a critique”, Journal of Development Economics, 41: 19–43. Barro, R. J. (1999), “Inequality, Growth and Investment”, NBER Working Paper 7038, Cambridge, MA. Barro, R. J. and X. Sala-i-Martin (1995), Economic Growth, McGraw-Hill, New York. Bloom, D. E. and D. Canning (2000), “Economic Development and the Demographic Transition: The Role of Cumulative Causality”, CAER II Working Paper, USAID, Washington, DC. Bloom, D. E. and River Path Associates (2000), Social Capitalism and Human Progress, OECD, Paris, forthcoming Bloom, D. E. and J. D. Sachs (1998), “Geography, demography, and economic growth in Africa”, Brookings Papers on Economic Activity, 2: 207–73. Bloom, D. E. and J. G. Williamson (1998), “Demographic transitions and economic miracles in emerging Asia”, World Bank Economic Review, 12: 419–55. Bloom, D. E., A. Rosenfield and River Path Associates (2000), “A moment in time – AID$ and business”, American Foundation for AIDS Research, AIDS Patient Care and STDs, 14(9), 509–17. Deininger, K. and L. Squire (1996), “A new data set measuring income inequality”, The World Bank Economic Review, 10: 565–91. Department for International Development (DFID) and Christian Aid (2000), Target 2015, Halving World Poverty in 15 Years, DFID, London. DFID (2003), Making Globalization Work for the World’s Poor, White Paper introduction, London. Gallup, J., S. Radelet and A. Warner (1997), “Economic Growth and the Income of the Poor”, CAER II Working Paper 36, USAID, Washington, DC. Higgins, M. and J. G. Williamson (1999), “Explaining inequality the world round: cohort size, kuznets curves, and openness”, Federal Reserve Bank of New York, New York, unpublished. Knack, S. and Keefer, P. (1995), “Institutions and economic performance: crosscountry tests using alternative institutional measures”, Economics and Politics 3: 207–27. Kuznets, S. (1955). “Economic growth and income inequality”, American Economic Review 45: 1–28. Lundberg, M. and L. Squire (1999), “Growth and inequality: extracting lessons for policymakers”, World Bank, Washington, DC, unpublished. Sachs, J. D. and J. L. Gallup (1999), “Geography and Economic Development”, CID Working Paper No. 1, Centre for International Development, Harvard University, Cambridge, MA. Sachs, J. D. and A. M. Warner (1995), “Economic reform and the process of global integration”, Brookings Papers on Economic Activity, 1: 1–95.

Improving health 123 Summers, R. and A. Heston (1991), “The Penn World Table (Mark 5): an expanded set of international comparisons, 1950–1988”, Quarterly Journal of Economics 106: 327–68. Timmer, C. P. (1997), “How Well do the Poor Connect to the Growth Process?”, CAER II Working Paper 17, USAID, Washington, DC. United Nations (1998), World Population Prospects, New York, electronic data. World Bank (1998), World Development Indicators 1998, CD-ROM, Washington, DC.

Part II

National and regional perspectives

6

Globalization, liberalization, and human and social development in Central America Manuel R. Agosín, David E. Bloom and Eduardo Gitli

I. Introduction and summary The present chapter applies the perspective developed in Part I of this book to data derived from a group of four Central American countries – El Salvador, Guatemala, Honduras and Nicaragua. It sets out to provide an informed overview of the key economic aspects relevant to the region’s growth, to identify those economic components on which policy-makers should concentrate their energies, and to detail the important ways in which a renewed focus on human and social capital development interacts with economic growth. While all four countries have made often dramatic progress across several economic indices in recent years, both human development gains and economic growth have continued to prove disappointing. Strong and sustained economic growth in these countries requires much greater emphasis on human and social development in economic development strategies. Macroeconomic adjustment in the region has, to date, wrought mixed impacts on human development. The “peace dividend” is obviously welcome in a region wracked by decades of civil war. Likewise, macroeconomic adjustment has helped deliver dramatic reductions in inflation and, in some cases, in the public sector’s deficit. However, the costs to human development – and in turn to the economy – remain high. For example, levels of malnutrition among children under five – a key human development indicator, with important implications for individuals’ future health – are still alarming. All four governments have made considerable progress in liberalizing and opening up their economies. Foreign direct investment (FDI) is starting to flow in, and new exports are emerging. However, the toughest challenge lies ahead: creating new production patterns and consolidating recently acquired comparative advantages. The Central American Common Market (CACM) can be utilized as a powerful development tool. In addition to adopting a true common external tariff (CET), a viable common market needs agreement on common rules and taxation for export-oriented investments, be it in Export

128 Agosín et al. Processing Zones (EPZs) or elsewhere. The basic objective ought to be encouraging the emergence of direct and indirect regional exporters in an increasingly diversified range of products.1 The physical integration of the region’s infrastructure also requires emphasis to facilitate trade and the growth of strong, internationally competitive regional industries. Exchange rates will continue to require careful management, and greater exchange rate coordination across CACM members (including Costa Rica) would undoubtedly facilitate regional integration. The maquiladora industry constitutes a new “growth pole”. It is currently generating significant employment in all four countries, although its full potential as a “development pole” has yet to be explored, as it has focused to date almost exclusively on processing of imported clothing components for the United States market. Low levels of human development in all four countries are conspiring against faster progress towards self-sustaining growth. In general, a much more rigorous and consistent approach to promoting human and social development will be needed. The changing demands of modern economies will require policy-makers to give priority to health and educational improvements across the population, and serious fiscal reform will be necessary to fund increased investment in human development. Debt relief in Honduras and Nicaragua can make an important contribution towards funding a human and social capital-oriented growth strategy. Health indicators in all four countries remain very poor. For example, while progress on immunization has been made, over one in ten Honduran children are still not immunized against measles, while about a quarter of Guatemalan children have not had jabs for either measles or DTP.2 Malnutrition is rife and health expenditures low. Urgent and sustained attention is needed in this area, for poor health in children translates into a lifelong cost borne by the entire economy. The micro-enterprise and small entrepreneur sectors are also vital sources of economic growth in need of urgent attention. Both training programmes and the rationalization of micro-finance are needed to make best use of the significant resources already being devoted to this sector. Like health, the importance of education cannot be underestimated. Unfortunately, the four countries studied have made even less progress in education than in health. For example, a Zimbabwean teenager is four times more likely to have received at least five years of education than her peer in Guatemala – even though Zimbabwe is a significantly poorer country (Bloom and Craig, 1998). The quality of education is crucial, as is attention to providing better access to educational opportunities for women and girls. While progress in primary enrolment has been made, a significant gap between poorer and richer countries remains at the secondary level, and this gap widens alarmingly at the tertiary level. Poor living conditions, such as the absence of sanitation or a decent dwelling, breed disease, are

Central America 129 demoralizing and an affront to human dignity. All four countries made significant gains on this dimension in the 1990s, although by 1995 a significant share of households was still without access to safe drinking water or plumbing. This problem is particularly severe in Nicaragua and in the rural areas of all four countries. In this chapter, we concentrate on recent developments and prospects for the four Central American countries in the various dimensions of global integration, human and social development, and economic growth. There are six sections: •

•

•

•

•

•

Given its overwhelming importance in the region, the chapter starts with a section on Peace, democracy and governance, which are essential components of human and social development. Progress in opening up to trade and investment is then discussed in the context of recent advances in global integration. The potential for regional integration is also explored, and exchange rate policies and regimes are considered. Policies towards FDI are documented. Next, we evaluate recent trends in Economic growth in Central America, looking at overall economic performance, the role of exports, the growth of FDI, and the debt issue. The economic context outlined in the preceding sections is pulled together when we consider Progress in human development and several of the urgent tasks in this area. These include the demographic transition, health, education, poverty and living conditions. Issues that cut across all of these dimensions include the roles of women and girls as well as those of indigenous and rural populations. Given its importance to both economic growth and as a potential locus for human development, we devote a separate section to The problems of micro- and small enterprises. The last section brings Conclusions. We highlight the challenge facing policy-makers in the four countries. Strengthening Central American integration and building links between the maquiladora industry and the rest of the economy – now in a regional context – are offered as examples whereby policy-makers can make gains for both economic growth and human development.

II. Peace, democracy and governance Up until the last decade, the Central American countries went through prolonged civil conflicts that had enormous personal, social and economic costs. El Salvador and Guatemala experienced outright civil wars that hampered any serious effort at economic and social transformation. In Nicaragua, the Sandinista forces that overthrew the Somoza Government in 1979 faced permanent armed threats from their opponents. In addition to civil strife, the economic and social fabric was subjected to

130 Agosín et al. severe strains, as the main orientation of policy swung first towards a radical state-led model of development and later towards a more marketoriented approach. Since the assumption of the elected government in 1990, the strengthening of the market economy has been a major policy objective. Even countries that were not directly involved in the civil conflicts of the region (Honduras and Costa Rica) suffered the spillover effects in the form of large waves of migration from their neighbours and the use of their territory as sanctuary. The peace process began in 1987 with the Second Presidential Summit of Esquipulas, which established a programme to pacify and democratize the region. Although it took almost ten years to achieve its objective, its success demonstrated to Central American governments that they could work together to solve their urgent problems (ERDSH, 1999: 37). In particular, the success of Esquipulas II gave a renewed impetus to regional integration efforts. Today, all Central American countries have democratically elected governments committed to market-oriented reforms, the armed forces are increasingly subordinated to civil authorities, and human rights violations are no longer state policy anywhere in the region. Economically, pacification has yielded a large peace dividend. In all four countries, military spending as a share of GDP has declined remarkably (see Table 6.1). In addition, the disappearance of armed conflict, the establishment of the rule of law and the replacement of military by civilian governments have had a very positive effect on economic growth. However, there are still several important problems to be resolved in relation to human rights and personal security. Crime rates are high, and people continue to have a sense of insecurity about life and property. Human rights violations by the police, often with the complicity of the armed forces, have been reported in all four countries, but particularly in Guatemala and El Salvador (ERDHS, 1999: 204). The judiciary is slow and inefficient. Although governments have made efforts to convert the judiciary into a bona fide separate power of the State, progress to date has been slow. In Honduras there are reports of widespread illegal seizures of land by organized groups, and affected parties have scant possibilities of redress in Table 6.1 Military expenditure, 1989 and 1996 (percentage of GDP)

El Salvador Guatemala Honduras Nicaragua

1989

1996

3.5 2.6 8.4 28.3

1.5 1.4 1.3 1.5

Source: Estado de la Región, 1999, Proyecto Estado de la Nación, San José, Costa Rica, 1999: 197.

Central America 131 the courts. In Nicaragua, protection of property rights is still inadequate. There still exist a large number of unresolved disputes surrounding expropriations of real estate and commercial property carried out during the 1980s (ERDHS, 1999: 210). Uncertainties surrounding the validity of claims to property rights are acting as a serious deterrent to foreign and domestic investment. In 1997, Congress passed a new property law with a view to putting an end to these conflicts. However, Nicaragua still suffers from a general weakness in its institutions and in the enforcement of laws and contracts that discourages domestic and foreign investment. The distribution of basic services is patchy. In Guatemala, for example, one-half of the population is indigenous. Although enshrined in the law, equality of opportunity is in practice denied to half the population. Indigenous people, heavily rural, have inadequate access to education, health, drinking water and plumbing. They remain poorly integrated into modern society. Women, particularly in the rural sector, have even less adequate access to health and education than do men. All countries have serious problems of governance. The capacity of governments to design and execute policy is low, owing to the low quality of human resources available to them. The low level of remuneration of government officials perpetuates corruption, a culture that needs to be eradicated and replaced by much higher standards of probity in high government officials. An encouraging sign with regard to the strengthening of peaceful democracies is the emergence of civil society groups committed to democratization, social development, and the protection of human rights and the environment. These groups ought to play an increasingly important role in preserving the gains already made and in moving forward to higher levels of democracy.

III. Progress in opening up to trade and investment Impressive macroeconomic adjustment It has become conventional wisdom that it is impossible to bring about structural adjustment without first having achieved effective and lasting stabilization. In turn, this latter objective depends fundamentally on prudent fiscal and monetary policies. Perhaps the single most important reform in this regard is the reduction of the public deficit. If human development objectives are to be preserved, expenditure cuts must fall on items other than investments in people (basically health, education and housing). Indeed, in most countries, such expenditures will have to increase. Where the tax burden is low, an important contribution to the needed reductions in the deficit will have to come from tax reform. Three of the four countries have made impressive gains in reducing

132 Agosín et al. inflation. Nicaragua’s adjustment programme brought down the rate of inflation from well over 13,000 per cent per annum in 1990 (Decemberon-December) to between 10 and 20 per cent in the second half of the 1990s. In El Salvador, the rate of inflation declined gradually from 19 per cent in 1990 to between 2 and 5 per cent in recent years. In Guatemala, inflation fell from over 60 per cent in 1990 to 7.5 per cent in 1998 (Urízar, 2000). In Honduras, inflation has come down, but is still in double-digit figures. All four countries, and particularly Nicaragua, have implemented important programmes of fiscal adjustment. In Nicaragua, the reductions in public spending have been draconian. Public employment fell from 208,000 in 1990 to 100,000 in 1994. Most of the cuts took the form of reductions in the armed forces, from more than 100,000 soldiers to barely 24,000 over the same period (Agudelo, 2000). But Nicaragua has also implemented tax reform and has succeeded in raising its tax burden from 15 per cent of GDP in 1990 to over 30 per cent in 1998. As part of the effort to put its fiscal house in order, the Nicaraguan government has made efforts to charge users for public services. The conjunction of spending cuts and revenue increases resulted in a reduction of the public deficit from over 20 per cent in 1990 to 2.2 per cent in 1998 (Solórzano, 2000: annex tables). In spite of the loss of revenue as a result of tariff reductions, El Salvador has been successful in raising tax revenues, from 11 per cent of GDP in 1990 to almost 15 per cent in 1998 (Sorto, 2000). This is the major factor behind the reduction in the fiscal deficit from 6.5 per cent of GDP in 1992 to less than 3 per cent in 1990. Tax revenues in Honduras also rose from 12.5 per cent of GDP in 1989 to 17 per cent in 1998. Together with cuts in public expenditures, the increase in the tax burden allowed the government to cut the fiscal deficit from 7.4 per cent of GDP to 1.6 per cent over the same period (Mejía, 2000). Guatemala has also brought down its budget deficit in an impressive manner, and it now stands at 1 per cent of GDP, compared to close to 5 per cent in the first half of the 1980s (Urízar, 2000). However, Guatemala’s tax burden, at less than 10 per cent of GDP, is the lowest in the region. Thus Nicaragua has very little space left to raise taxes and will have to finance increases in indispensable human development spending from debt forgiveness and cutbacks in other less essential expenditures. By contrast, it is difficult to see how the other three countries, and particularly Guatemala, can raise their human development spending without increasing the tax burden. This will involve serious fiscal reform, not just to cut back on expenditure (which has already been done), but also to collect the tax revenues that heavy investments in human development will require.

Central America 133 A decisive move towards open regionalism After a long period of protection, in the 1990s the Central American countries adopted an export-oriented model of development. At the beginning of this decade, the bulk of tariffs in the four countries ranged from 5 to 95 per cent, with occasional tariff peaks well over 100 per cent. Countries also resorted to a variety of non-tariff measures to restrict imports. As a result of negotiations to revive the CACM, at the end of 2000 the four countries will have tariffs in the range of 0 to 15 per cent on about 90 per cent of their tariff lines. Most non-tariff barriers have been eliminated. By the end of the 1970s, the CACM had been responsible for the high degree of integration achieved by the Central American economies. About a quarter of the total exports of the five signatories (our four countries plus Costa Rica) had the region as destination, free trade in manufactures had been practically achieved and a common external tariff (CET) applied to most goods. Buffeted by the disintegrating effects of civil strife and the external debt crisis, the CACM unravelled in the 1980s. With the re-establishment of peace, signatories have been in the process of bringing the CACM back to life. A new CET was agreed, and the principle of free trade among the five member states was reaffirmed. As a result, the share of regional trade in the total foreign trade of member countries has staged a comeback (see Table 6.2). The Central American Import Tariff is divided into three parts. Part I encompasses goods to which common tariffs are expected to apply at the latest by December 2000 (about 90 per cent of tariff lines). Part II covers tariff lines that have not yet been harmonized, and Part III includes goods that will retain national tariff treatment, essentially for revenue purposes. The CET pertains, then, to Part I goods and contains only four tariff rates: (1) zero for raw materials, intermediate goods and capital goods not produced in Central America; (2) 5 per cent for raw material produced in the region; (3) 10 per cent for capital goods produced in the region; and (4) 15 per cent for finished goods. Some examples of goods excluded from the CET are certain agricultural goods, meat, poultry, tobacco, nonalcoholic and alcoholic beverages, petroleum and automobiles. Tariffs on Table 6.2 Central America: intraregional trade (percentage of total trade)

Exports Imports

1960

1968

1980

1985

1990

1998

6.8 –

23.5 21.3

25.4 18.5

13.9 9.9

17.0 9.7

20.2 13.3

Sources: Authors’ calculations, based on data of Secretaría para la Integración Económica de Centroamérica (SIECA) and World Bank, Trade Liberalization and Economic Integration in Central America, March 1989, Report No. 7625-CAM, Washington, DC.

134 Agosín et al. these goods can be much higher than the maximum of 15 per cent agreed to for the CET. However, these higher rates are often justifiable on government revenue or equity grounds. The CET is, on paper, a reasonable tariff structure. However, there is no agreement among member countries as to where different goods ought to be classified, with the result that individual countries are adopting their own classifications. Efforts to establish a CET have been undermined by other unilateral actions as well. In the first place, individual countries are able to negotiate exceptions to the CET. Nicaragua has obtained agreement from its partners to reduce its top two tariff rates to 5 and 10 per cent respectively. In some cases, tariff surcharges that affect other member countries are imposed without consultation. Nicaragua, for example, is using a schedule of temporary surcharges (Arancel Temporal de Protección) that applies to all imports regardless of origin, with rates which, in 1999, ranged from 0 to 20 per cent. These surcharges are due to be reduced gradually over time and to be eliminated by the end of 2001. Second, each country has bound its tariffs in WTO at different rates. Honduras’ entire tariff is bound at 35 per cent, El Salvador’s and Nicaragua’s at 40 per cent, while Guatemala has bound tariffs on agricultural goods at 40 per cent and tariffs on industrial goods at 45 per cent. This means that, faced with balance of payments difficulties, the CET could once again unravel. This is precisely what happened during the debt crisis. Each country attempted to compress foreign exchange use by raising tariffs individually, with little concern for its obligations towards its partners in the CACM. Third, countries are pursuing free trade agreements with third parties in an individual manner. For example, Nicaragua has signed a comprehensive free trade agreement with Mexico; El Salvador, Guatemala and Honduras are still negotiating a joint agreement with that country. Fourth, groups of countries within CACM are pursuing the formation of more exclusive “clubs”. Before their recent dispute over maritime jurisdiction, Nicaragua had started negotiations with Honduras towards the formation of a complete customs union by 2002. In January 2000, Guatemala and El Salvador signed a Framework Agreement to establish a customs union in their territories. In May 2000, Honduras announced it would be joining El Salvador and Guatemala in the establishment of a customs union. A shared vision of a united Central America with a working common market at its core has yet to emerge. This would require a cession of individual country prerogatives for which there still does not appear to be a political will. There are yet other challenges ahead for the CACM. One of them is agreement on a uniform drawback and export-subsidy scheme for exports outside the region. As will be discussed below, individual countries have

Central America 135 gone their own way in this area. The distortive effects of excluding these policies from regional harmonization efforts are bound to grow as integration deepens. A second concern is failure to arrive at a common regional approach towards FDI in general and towards Export Processing Zones in particular. Third, effective integration will require a concerted effort to improve regional infrastructure. Fourth, greater exchange rate and macroeconomic coordination will have to be pursued. In spite of these difficulties and while much remains to be done, the efforts to strengthen regional integration can be judged as very successful. Moreover, regional integration is being pursued in the context of a very significant reduction of tariffs on a Most Favoured Nation (MFN) basis. Thus the Central American countries are faithful adherents to “open regionalism”. This is undoubtedly more favourable to development than the protectionist policies of the past. The exchange rate regime: an unresolved problem If the Central American countries are to succeed in changing their production and export patterns, it is essential that they avoid premature real exchange rate appreciation, which discourages investment in new export sectors (see Chapter 3 for an analysis of this issue). Unfortunately, three of the four countries – El Salvador, Guatemala and Nicaragua – already have a serious problem in this respect. Regardless of how real exchange rates are measured, over the 1990s El Salvador and Guatemala have experienced severe exchange rate appreciation (Table 6.3). The major cause has been large wage remittances by workers in the United States – a manifestation of the political, social and economic difficulties of the Table 6.3 Evolution of the real exchange ratea, 1990–98 (1990  100)

1991 1992 1993 1994 1995 1996 1997 1998 1999

El Salvador

Guatemala

Honduras

Nicaragua

96.1 92.9 83.7 78.3 73.2 68.6 67.2 66.6 66.7

87.6 84.4 84.7 79.9 76.6 74.4 69.5 69.5 74.1

100.9 98.9 108.1 118.4 105.9 108.8 103.0 94.7 90.8

91.3 89.1 93.3 98.4 102.5 105.6 112.9 108.3 110.0

Source: Authors’ calculations, based on data of International Monetary Fund, International Financial Statistics, various issues. Note a Price for the United States dollar, deflated by domestic consumer prices and multiplied by United States wholesale prices.

136 Agosín et al. region. In the case of Guatemala, unrecorded capital inflows also appear to have played a role. Remittances have been particularly large in El Salvador and now account for almost one half of all foreign exchange earnings (Sorto, 2000). In Guatemala, their share in foreign exchange receipts is between 15 and 20 per cent (Urízar, 2000). El Salvador has in effect maintained a pegged nominal exchange rate since 1992. However, until 1997, sterilization of the monetary effects of remittances was incomplete, domestic inflation exceeded international inflation, and the real exchange rate appreciated substantially. Since 1997, the Central Bank has been pursuing complete sterilization of reserve accumulation, resulting in very high interest rates which attract even larger remittances. El Salvador’s Central Bank could consider a policy of sterilizing remittance inflows by issuing bonds denominated in dollars and backed by the accumulation of Central Bank reserves. This would allow firms with liabilities in dollars, in effect, to purchase foreign exchange cover. Stronger incentives to save a larger proportion of the increase in family incomes associated with remittances would assist in preventing further currency appreciation. To this effect, banks and other authorized financial intermediaries could be encouraged to offer instruments in dollars backed by the dollar-denominated sterilization bonds. In the longer run, it would seem wise for the Central Bank to stop guaranteeing the maintenance of a fixed price for the dollar. Once domestic firms have covered their net debtor positions in foreign exchange, this could be accomplished without inducing a run on the colón. The other three countries have pursued more active nominal exchange rate policies. Honduras’ crawling peg has been quite successful in preventing large real exchange rate fluctuations. Guatemala practises a dirty float, and Nicaragua has been following the policy of pre-announcing nominal currency devaluations. However, Nicaragua appears to have a serious currency overvaluation problem, mainly as a result of wage remittances and large volumes of foreign assistance. Wage remittances are estimated at US$400 million to US$600 million, compared to about US$700 million in goods exports. On the other hand, ODA amounts to some 20 per cent of GDP. In the absence of such aid, the currency would have to depreciate substantially. Thus Nicaragua must be gradually weaned of its dependence on unhealthy levels of foreign assistance. The process must be gradual in order to avoid dislocation and to allow enough time for the emergence of strong supply responses to a more depreciated currency. These supply responses should be promoted with investments in human development, particularly through policies targeted at making micro- and small enterprises more competitive. As in El Salvador, rapid growth of non-traditional exports from Nicaragua will also depend on the skill with which the monetary authorities can prevent wage remittances from continuing to appreciate the currency.

Central America 137 As the Central American countries advance towards higher stages of integration, they will undoubtedly have to coordinate exchange rate policies much more closely. Current exchange rate regimes are clearly incompatible with one another. Higher levels of trade integration will require stable exchange rates within the integration area. A gradual move towards a common exchange rate regime is thus essential. This regime ought to have two basic characteristics: a high degree of stability in bilateral exchange rates and a joint approach towards exchange rates for major currencies (in practice, the United States dollar). Recent advances in macroeconomic stabilization facilitate the task of devising such a system. Some observers have advocated dollarization as a solution to the recurrent foreign exchange crises of these countries. Arguments in favour of dollarization have been advanced most insistently in El Salvador, where it almost became policy in the late 1990s. Besides eliminating the possibility of monetary mismanagement (by doing away with national money), it is hard to see what the benefits of a currency union with the United States would be. The economies of the Central American countries are continuously subjected to large idiosyncratic external shocks (e.g. sharp temporary movements in their terms of trade), which can be dealt with at reasonable cost only if the authorities are able to modify the nominal exchange rate. This tool of economic policy would be lost with dollarization. In fact, a softer version of dollarization (a currency peg to the dollar) has been in force in El Salvador for several years, with ill effects on competitiveness and growth. Labour mobility between partners in a currency union is one of the fundamental prerequisites for a successful and stable arrangement of this type.3 However, faced with declines in real incomes, people in Central America are certainly not free to move to the United States. Without nominal exchange rate adjustment and without labour mobility to its partner, a country facing deteriorating terms of trade would simply be condemned to shrinking real incomes without any possibility of redress. Another damaging argument against dollarization is the loss of the Central Bank as a lender of last resort. Even countries with good banking supervision and regulation (for example, the United States and Sweden) occasionally have banking crises that require the intervention of a Central Bank to create the liquidity needed to prevent a collapse of the banking system. All the more so in countries with undeveloped traditions of banking regulation and supervision. A final argument against dollarization is its cost. Central Banks would have to purchase the entire money supply with dollars. Not only would they have to sacrifice interest on their foreign currency reserves; in addition, if they were to dollarize unilaterally, they would have to borrow large sums from international capital markets. As for the alleged benefits of dollarization in preventing monetary mismanagement, it should be noted that Central American countries have

138 Agosín et al. already travelled a long stretch of the road towards greater monetary responsibility. Now they have to go the distance. Export incentives and Export Processing Zones A strong push into export markets and a decisive change in the pattern of comparative advantages require a package of measures that includes appropriate and well-designed export incentives. At the very least, a system of drawbacks of duties on imported inputs paid by exporters needs to be in place. Ideally, drawback schemes ought to apply to direct exporters and to producers of inputs for exporters (so-called “indirect exporters”). Moderate and temporary export subsidies have proven to be quite useful in other parts of the world. In the case of Central America, these facilities ought to be available, of course, only to exports outside the integration area. In order to avoid an artificial allocation of investment between countries, regional integration arrangements must include the adoption of uniform drawback and export support schemes. The four Central American countries have used duty drawbacks only sporadically. In lieu of a drawback, some countries give exporters a subsidy that is tied to the value of exports. In El Salvador, exporters of non-traditional goods (and even traditional exports with a national value added exceeding 30 per cent of the value of exports) are entitled to an export subsidy of 6 per cent, down from an original 8 per cent (Sorto, 2000). In Nicaragua, exporters of non-traditional goods simply do not have to pay duties or sales taxes on imported capital goods or raw materials. In addition, all exporters receive a subsidy of 1.5 per cent of the value of exports, in order to compensate for existing tax distortions (Solórzano, 2000). As the economy becomes more complex, it will be increasingly difficult to distinguish between producers oriented to export and domestic markets, and a genuine drawback scheme will be required. The design and implementation of a moderate and temporary subsidy for exports outside of Central America (and excluding firms operating in Export Processing Zones) is a pending challenge in all four countries. In Nicaragua, until the beginning of 1998, non-traditional exporters were granted income tax exemptions and received Tax Benefit Certificates equivalent to a certain percentage of the value exported. These incentives were eliminated at the beginning of 1998. Allegedly, beneficiaries were not complying with requirements as regards domestic value added and percentage of exports in the value of output. Some blame the decline of non-traditional exports from US$385 million in 1997 to US$210 in 1998 on the elimination of the incentive scheme.4 The Central American countries have been much more successful in setting up EPZs for the assembly of goods with components imported from the United States (under so-called maquila regimes). Firms establishing themselves in these zones have benefited from duty-free imports of

Central America 139 capital goods and intermediate inputs. They have also been granted income tax exemptions, which vary in length from country to country. As will be discussed below, one of the great successes of the four countries, and particularly of Honduras, has been to expand exports from these zones very vigorously since the early 1990s. It is fully expected that this process will continue in the coming years. Stimulating FDI The liberalization of FDI regimes is part and parcel of global integration, and the Central American countries have understood this well. Accordingly, all four countries have liberalized very considerably their FDI regimes. National treatment is guaranteed to foreign investors. In addition, they have complete freedom to invest in any sector of the economy (except those related to defence) and to remit earnings or repatriate their capital abroad. Performance requirements are generally not applied. All four countries have signed the World Bank’s Multilateral Investment Guarantee Agreement (MIGA). In Nicaragua, foreign investors who register with the Foreign Investment Committee enjoy additional assurances from the government and can benefit from specific sectoral incentives that are available to national investors. However, such registration is not a legal requirement, and most investors do not register. Foreign investment legislation is in the process of being simplified.

IV. Economic growth in Central America A bird’s-eye view of Central American development over the last ten years cannot fail to notice signs of promise alongside signs of foreboding. Positive economic growth has resumed, after two decades of shrinking incomes, massive dislocation, emigration and dismal economic performance. Exports are booming, and new export sectors are emerging. While much remains to be done to endow the CACM with the strategic importance it once had, intraregional trade is once again growing, and governments have made renewed commitments to regional integration, now as part of a strategy of “open regionalism”. But growth rates remain low, the long-awaited upturn in domestic and foreign investment is still in its early stages, and poverty remains widespread. Overall economic performance The Central American economies are all small and low-income (see Table 6.4). They rank among the poorest in Latin America and the Caribbean: after Haiti, Nicaragua and Honduras have the lowest per capita GDPs (in equivalent purchasing power) in the region; and El Salvador matches the

140 Agosín et al. Table 6.4 Central American countries: per capita GDP and population, 1998 (GDP in US$, Purchasing Power Parity; population in millions of inhabitants)

El Salvador Guatemala Honduras Nicaragua

Per capita GDP

Population

4,036 3,505 2,433 2,142

6.06 10.80 6.16 4.79

Source: World Bank, World Development Indicators, 2000. Note Purchasing Power Parity calculations are carried out by the World Bank in order to render possible intercountry comparisons of real incomes. They approximate calculations of per capita GDP in United States prices of the stated year.

per capita GDP of the poorest country in South America (Bolivia). While Guatemala’s per capita GDP is higher than that of the other three countries, its income distribution is considerably more unequal, and many of its human development indicators are worse. The smallness of these economies means that they are heavily dependent on foreign trade. With the exception of Guatemala, in all four countries exports account for between one-quarter and one-half of GDP (Table 6.5). The relatively low share of foreign trade in Guatemala’s GDP is explained by its large subsistence sector. As a direct result of the advent of peace, in the 1990s per capita incomes began to grow again, after having declined during the 1980s (Table 6.6). In the case of the countries most severely affected by civil strife (El Salvador and Nicaragua), absolute declines in per capita incomes and standards of living had taken place for two decades. In this context, even the modest rates of growth achieved in the 1990s must be considered a great success. However, in spite of liberalization and integration into the world economy, during the 1990s per capita incomes rose very slowly: annual growth rates were in the 0–2 per cent range. The relative dynamics of growth differed from country to country. On the one hand, the Nicaraguan economy spent much of the first half of the Table 6.5 Exports of goods and services (percentage of GDP)

1980–82 1990–92 1993–95 1996 1997 1998

El Salvador

Honduras

Guatemala

Nicaragua

28.2 17.7 19.4 21.3 24.0 23.1

31.3 32.4 38.6 47.1 46.6 45.8

17.7 18.7 18.2 17.8 17.9 18.6

21.2 22.6 27.0 40.8 42.9 39.1

Source: World Bank, World Development Indicators, 1999 and 2000.

Central America 141 Table 6.6 Rates of growth of total and per capita GDP, 1970–99 (percentage) El Salvador

Guatemala

Honduras

Nicaragua

GDP 1971–80 1981–90 1991–99 1991–95 1996–99

2.3 0.4 4.4 5.7 2.9

5.7 0.9 4.2 4.3 3.9

5.4 2.4 3.1 3.4 2.6

0.0 1.5 3.2 1.7 5.2

Per capita GDP 1971–80 1981–90 1991–99 1991–95 1996–99

0.2 1.5 2.3 3.6 0.7

3.0 1.6 1.5 1.6 1.3

2.1 0.8 0.2 0.4 –

3.2 4.1 0.3 1.2 2.3

Sources: World Bank, World Development Indicators, 1999; United Nations Economic Commission for Latin America (ECLAC), Balance Preliminar de las Economías de América Latina y el Caribe, 1999, Santiago.

decade in severe adjustment and transition to a market economy. Since 1996, there have been signs that growth is accelerating. By contrast, as the economy recovered from the ravages of civil war, El Salvador experienced positive economic growth in the period 1991–95. Subsequently, there has been a marked retardation in growth momentum. In Guatemala and Honduras, growth was sluggish throughout the 1990s.5 As a result of slow growth, the gap that separates these countries from the developed world continued to widen (Table 6.7). Again, El Salvador and Nicaragua were the countries whose per capita GDPs (in comparable purchasing power) fell most relative to that of the United States. In 1995, the per capita GDP of Nicaragua was less than 7 per cent that of the United States, compared to over 20 per cent in 1975. El Salvador’s per capita GDP fell from 15 per cent that of the United States in 1975 to less than 10 per cent in 1997. Reflecting their low levels of human development, incomes are unevenly distributed in all countries (Table 6.8). The Gini coefficient, which takes values between 0 and 100 (when expressed in percentage Table 6.7 Per capita GDP in PPP US dollars (as a percentage of the per capita GDP of the United States)

El Salvador Guatemala Honduras Nicaragua

1975

1985

1995

1998

21.7 16.2 10.5 22.0

13.6 13.2 9.7 10.0

14.8 12.6 8.8 7.6

13.6 11.8 8.2 7.2

Source: World Bank, World Development Indicators, 2000.

142 Agosín et al. Table 6.8 Gini coefficients and income shares of highest and lowest quintiles: actual and predicted values El Salvador

Guatemala

Honduras

Nicaragua

Gini coefficient Actual Predicted

49.9 51.9

59.6 51.1

53.7 51.9

50.3 52.3

Share of lowest quintile Actual Predicted

3.7 3.8

2.1 3.9

3.4 3.8

4.2 3.7

Share of highest quintile Actual Predicted

54.4 56.0

63.0 55.6

58.0 56.0

55.2 55.0

Ratio of highest to lowest quintile

14.7

30.0

17.1

13.1

Source: Authors’ calculations, and World Bank, World Development Indicators, 1999. Note Numbers in bold reflect higher than expected levels of inequality. Predicted values are calculated by estimating an equation in which the Gini ratio and the two income shares are made to depend on the square of the log of per capita GDP and dummy variables for Africa and Latin America. Data for per capita GDP are for 1990, and they are expressed in PPP dollars.

terms), is the most widely employed measure of inequality. The closer this ratio is to unity, the more unequal is income distribution. In Guatemala and Honduras, the Gini coefficient is not only high but it is significantly higher than expected, once one controls for the impact of income levels.6 By the same token, the share of income of the lowest quintile is lower than expected, and the share of income of the highest quintile is higher than expected. The deviations with respect to expected values are particularly large in the case of Guatemala. Undoubtedly, differences in incomes between indigenous and white people (each roughly half of the population) account for a good share of the high degree of inequality in that country. International experience shows that it is very difficult to achieve a growth rate above 5 per cent on a sustainable, long-term basis without raising the investment rate above 25 per cent of GDP. In Central America, unfortunately, investment rates are, on average, still very low (Table 6.9). The median annual rate remained in the range of 15–20 per cent during 1991–97 in three of the four countries. The only country where the median annual investment rate exceeded 25 per cent was Honduras.7 Exports lead economic growth Since global integration is one of the key objectives of the new development strategies adopted by all Central American governments, particular

Central America 143 Table 6.9 Gross investment-to-GDP ratiosa, 1960–98 (percentage)

El Salvador Guatemala Honduras Nicaragua

1960–70

1971–80

1981–90

1991–98

12.1 14.9 23.5 19.8

14.5 18.4 27.1 19.0

11.5 13.4 21.1 24.9

17.0 14.9 28.0 19.6

Source: World Bank, World Development Indicators, 1999 and 2000. Note a Denominator and numerator are both in 1995 prices. Period ratios are medians for individual years.

importance attaches to the evolution of exports in the 1990s. A good sign that change has begun is, indeed, the performance of the export sector. Exports have led economic growth in all four countries in the 1990s, and there is evidence that export growth is accelerating (Table 6.10). In the 1996–98 period, the annual rate of growth of exports of goods and services ranged between 9 and 10 per cent. The transformation of the structure of exports since the early 1990s has been remarkable. Indeed, export growth has concentrated on new exports. The share of traditional commodity exports (bananas, coffee, sugar, cotton and meat) fell dramatically in the 1990s in all countries with the exception of Guatemala (Table 6.11). Since the arrival of peace, new export crops have been developed, especially fruits and vegetables (socalled “dessert products”), ornamental plants and new agricultural staples. Some light manufactures have also been added to the export basket. Exports to Central America have grown very rapidly, but so have nontraditional exports to destinations outside the region. In addition, Central America has emerged as a big assembler of garments (and, marginally, of other manufactured goods, such as plastic Table 6.10 Growth of exports of goods and services, in constant prices, 1971–98 (average annual rate, percentage)

1971–80 1981–90 1991–98 1991–95 1996–98

El Salvador

Guatemala

Honduras

Nicaragua

4.1 3.5 10.7 11.2 10.0

6.5 1.5 6.9 5.6 9.1

4.6 0.8 3.1a 0.9 9.0b

7.2 5.7 7.6 6.1 10.1

Source: World Bank, World Development Indicators, 1999; and CEPAL, Estudio Económico de América Latina, 1999, Santiago. Notes a 1991–97. b 1996–97.

144 Agosín et al. Table 6.11 Traditional and non-traditional exports: shares in total exports and average annual rate of growth, 1990–98 (percentage) Share in total, 1990

Share in total, 1998

Growth, 1990–98

El Salvador Traditional Non-traditional Central America Rest of the world Maquila value added Total Total (million US$)

50.9 49.1 (30.1) (19.1) – 100.0 581.5

26.8 51.6 (37.6) (14.0) 21.6 100.0 1,569.2

4.5 13.9 (16.4) (9.0) 45.1a 13.2

Guatemala Traditional Non-traditional Central America Rest of the world Maquila value added Total Total (million US$)

47.1 49.7 (23.0) (26.7) 3.1 100.0 1,250.4

41.4 48.6 (26.1) (22.5) 9.9 100.0 2,866.6

9.1 10.6 (12.7) (8.6) 28.3 10.9

Honduras Traditional Non-traditional Central America Rest of the world Maquila value added Total Total (million US$)

82.7 17.3 (4.2) (13.0) – 100.0 831.5

37.0 41.3 (11.3) (30.0) 21.7 100.0 2,011.0

1.0 24.5 (26.2) (23.9) 45.2a 9.8

Nicaragua Traditional Non-traditional Central America Rest of the world Maquila value added Total Total (million US$)

79.2 20.8 (13.2) (7.6) – 100.0 330.5

56.5 32.7 (19.2) (13.5) 10.7 100.0 642.2

4.2 15.0 (13.8) (16.8) 96.2b 8.7

Sources: Authors’ calculations, based on data from Banco Central de Guatemala, Banco Central de Reserva de El Salvador, Banco Central de Nicaragua, SIECA, Banco Central de Honduras, Consejo Monetario Centroamericano, and Gitli (1997). Notes a 1991–98. b 1992–98.

goods, metal products and consumer electronics) for the United States market (Gitli, 1997; Jenkins et al., 1998). Honduras has taken the lead in this regard, with over 100,000 jobs generated in EPZs by foreign firms and their domestic subcontractors. These maquiladoras are concentrated in a corridor outside San Pedro Sula, which has become the main industrial centre in the country.

Central America 145 The heavily globalized garment industry is built around a dozen or so layers of subcontractors. The entrepreneurial structure can be viewed as a pyramid, which has at its upper apex a big production or marketing transnational corporation (TNC). When one reaches the Central American layers, one finds a few United States, Korean and Taiwanese TNCs with their own facilities, as well as domestic enterprises working on a subcontracting basis for a TNC. From the point of view of the development of domestic entrepreneurship this is a favourable characteristic, because it makes for the strengthening of domestic businesses. The growth of the maquiladora industry has been phenomenal (Table 6.12). In 1990, national value added by maquiladoras constituted barely 3–4 per cent of total export earnings from goods, and they employed no more than 50,000 workers in the four countries. In recent years, national value added is up to 10–20 per cent of export earnings from goods. Total employment generated is probably above 200,000 workers. In Honduras, employment in maquiladoras represents nearly 25 per cent of total manufacturing sector employment. Table 6.12 Importance of the maquiladora industry 1990

1996

El Salvador National value added (US$ million) Percentage of exports Employment (thousands) Percentage of industrial employment

22.0 3.8 31.4a 30.6a

213.6 20.9 38.4 28.4

Guatemala National value added (US$ million) Percentage of exports Employment (thousands) Percentage of industrial employment

38.9 3.3 – –

183.6 9.0 68.0 –

Honduras National value added (US$ million) Percentage of exports Employment (thousands) Percentage of industrial employment

31.6 3.9 17.5 22.3

132.6b 12.5b 76.4 50.0c

Nicaragua National value added (US$ million) Percentage of exports Employment (thousands) Percentage of industrial employment

– – – –

53.1 8.0 11.0 30.0c

Source: Gitli, 1997: 32–4, 38. Notes a 1992. b 1995. c Estimate.

146 Agosín et al. The maquiladora industry constitutes, then, a potentially interesting new growth pole for the Central American countries. However, its contribution to development is still weak. Governments have tended to see it mainly as a source of employment, rather than as part and parcel of a development strategy. The industry remains poorly integrated into the domestic economy, domestic value added representing only a quarter to a third of the value of exports (Gitli, 1997: 32–4). In addition, governments are not making efforts to target specific sectors and firms to attract to their EPZs. Products other than textiles, such as assembly of electronic and plastic goods, have greater potential for developing stronger linkages with the domestic economy, and their producers are less footloose than garment assemblers. Each Central American country has its own EPZ legislation, with varying provisions regarding tax benefits and the length of income tax exemptions. Besides being an unjustifiable exception to the regulations governing the CACM, the disparities in EPZ legislation across individual countries lend themselves to incentive wars and to distortions in the allocation of investment. While income tax exemptions for a limited number of years may be necessary to stimulate the initial development of the sector, they are hard to justify over the long haul, especially when one considers that investors benefit from public expenditures in infrastructure, education and healthcare for their workers. There is evidence that, since 1994, the development of clothing exports from Central America has been adversely affected by the North American Free Trade Agreement (NAFTA), which granted Mexico duty-free access to the United States market. Maquila exports from Central America are basically sewn garments from components imported from the United States. Until the recently approved “NAFTA parity” legislation (the so-called Caribbean Basin Trade Partnership Act, CBTPA, which came into effect in October 2000), the possibilities of developing backward linkages from the maquiladoras to the rest of the regional economy were very limited. Garments that were cut, pre-washed or subjected to perma-pressing in a Central American country, even with United States fabric, lost their favourable tariff treatment under the United States outward processing regime (so-called 807 provisions) and had to pay tariff on their total value. While average tariffs for garments originating in Central America were about 18 per cent, those originating in Mexico benefited from duty-free access to the United States market (Gitli, 1997). The CBTPA loosened some of these restrictions, particularly in the manufacture within the region of cloth for knitted goods made with United States thread (Gitli and Arce, 2000). The CBTPA is thus a good beginning towards trade liberalization in clothing and textiles in favour of Central America. It gives Central American producers greater room to move backward from clothing to textile production. However, its provi-

Central America 147 sions are still quite restrictive. Much greater liberalization will be required if Central American countries are to begin production of the “whole package” of clothing goods. In order to transform the maquiladora industry into a true “development pole”, greater attention must be devoted to encouraging the growth of stronger linkages with the rest of the domestic economy.8 For starters, EPZ legislation ought to be harmonized across countries. It is important to avoid incentive wars among countries in the region that wind up transferring most of the economic benefits to foreign companies or to their home governments. In the case of EPZ legislation in Central America, the length of income tax holidays varies considerably from country to country, from six years in Costa Rica to indefinitely in Honduras. A uniform length of five to ten years ought to be adopted by all countries. Second, countries ought to sign double taxation treaties with the United States, the main home country of foreign investors in EPZs, and with other home countries of TNCs investing in Central America. As regards foreign investors in EPZs, double taxation treaties with the United States (and other countries of origin) are probably just as useful as tax exemptions. Once such a treaty is in place, taxes paid in Central America would simply be credited to their income tax liabilities back home. This is true, of course, only if income tax rates in host Central American countries remain lower than in the home countries, which is likely to be the case. Third, efforts should be made to identify key industries and to attract specific companies from developed countries in those industries. This is exactly what Costa Rica has done in the field of electronics. Its efforts culminated, in 1997, in Intel deciding to site in Costa Rica an important new semiconductor assembly plant. So far, in other countries in Central America, backward linkages have been conspicuous for their absence. Thus the third element of a growthoriented strategy towards the maquiladora industry is a deliberate effort to encourage the development of strong regional industries supplying inputs for the maquiladoras. The EPZs constitute a natural point of contact between the regional economies and the international marketplace. A multifaceted programme to develop regional supply capabilities should be the major component of a new export-oriented strategy. This strategy ought to include: • • •

A region-wide programme of tariff drawbacks for indirect exporters The harmonization of income tax holidays on a region-wide basis, including agreement on a maximum exemption period Favourable income-tax treatment beyond the exemption period for firms that raise domestic content beyond a certain threshold level (say, 40 per cent of exports)

148 Agosín et al. • • •

Double taxation treaties with the United States and other home countries of investing companies Special training and technology upgrading programmes oriented to the development of efficient suppliers of intermediate inputs Training programmes for skilled workers at the vocational and secondary school level targeted at the skill requirements of domestic firms producing inputs for exporters.

The latter two elements in the strategy are particularly suited for foreign technical and financial assistance. Donors rightly emphasize the need for recipients to give proof that they are making national efforts towards their own development. This objective would be easily met by channelling a share of foreign assistance to a programme of the characteristics we are recommending. Growing FDI inflows FDI has increased considerably in recent years (Table 6.13). In El Salvador, the main recorded investments were one-off inflows for the purchase of privatized electrical utilities and telecommunications in 1998. However, there is evidence that foreign direct investment is underreported and could, in effect, be quite a bit larger than recorded figures (Sorto, 2000). In Guatemala, privatizations also accounted for the bulk of the increase in FDI in 1998 (Urízar, 2000). In Nicaragua, beginning in 1996, there have been important new investments in the energy and mining sectors. Other sectors that have received significant foreign investments are hotels, shrimp farming and cell phones. Although the amounts are still small, FDI into Honduras has held steady at about 2 per cent of GDP since 1995. Most of it has gone into EPZs. There is thus evidence that FDI is beginning to pick up in the region as a whole. If countries are able to maintain currently favourable conditions for investors, it is likely that the region will see substantial new flows FDI in the near future. The destinations are likely to be privatized utilities and export-oriented sectors. The attractions of Central America to foreign investors have changed Table 6.13 Foreign direct investment, as a share of GDP (percentage)

El Salvador Honduras Guatemala Nicaragua

1990–92

1993–95

1996

1997

1998

0.3 1.5 0.8 0.3

0.2 1.5 0.7 2.8

0.0 2.2 0.5 4.9

0.0 2.7 0.5 8.6

7.4 1.9 3.5 10.2

Source: World Bank, World Development Indicators, 1999; and Central American Monetary Council.

Central America 149 dramatically. While in the 1960s and 1970s most investment into the region sought to benefit from protected markets, in the 1990s investment is much more export-oriented. In line with this change in orientation, foreign firms investing in the area are attracted by good infrastructure facilities (ports and airports), low wages (adjusting for productivity), a favourable geographic position close to United States markets, the absence of what investors view as onerous regulations, and reasonable macroeconomic stability (Gitli, 1998). These locational advantages need to be cultivated and improved. The pressing debt problem of Honduras and Nicaragua Honduras and Nicaragua are facing a strangling debt problem that requires immediate attention and is choking off fast growth and improvements in human conditions. Both countries are candidates for inclusion in the Debt Initiative for the Heavily Indebted Poor Countries (HIPC). As in other low-income countries, most of the foreign debt of Nicaragua and Honduras is official. Both countries have been important recipients of bilateral and multilateral overseas development assistance (ODA), and their public finances are heavily dependent on these resources. This is particularly the case with Nicaragua. Efforts to become less dependent on ODA received a rude setback from Hurricane Mitch. Nicaragua was able to negotiate very substantial debt relief in 1996. The decrease in debt stocks from US$10.3 billion to US$6.1 billion was due mainly to debt forgiveness granted by Russia and Mexico (Esquivel et al., 1998). The contributions of Paris Club members and other developed countries were very modest. As already noted, Nicaragua has made important and sustained efforts to open its economy and increase export earnings. Owing to the decrease in debt stocks, the rescheduling of some other debt and the rise in export earnings, the debt service–export ratio declined from 150 per cent in 1991 to 24 per cent in 1998. While much more manageable, devoting one-quarter of its export earnings (and 13 per cent of its GDP) to debt service is a very heavy burden to bear. Thus debt service is restricting the government’s capacity to implement human development-related programmes. The debt stock indicators for Honduras look a lot less dramatic. However, its debt service-to-exports ratio (at 21 per cent) is of the same order of magnitude as Nicaragua’s (Table 6.14). By comparison, Guatemala and El Salvador both face a ratio less than half these figures. It should be noted that Honduras has also experienced a decline in its debt service–export ratio. However, debt relief has played no role in this favourable development, which is exclusively the result of successful efforts in raising exports. An early resolution to this long-lasting problem is up to the governments of creditor developed countries and multilateral financial

150 Agosín et al. Table 6.14 Debt indicators for Honduras and Nicaragua, 1991 and 1998 (percentage) 1991

1998

Honduras Debt stock to GNP Debt stock to export earnings Debt service to GNP Debt service to export earnings

118 307 11 28

103a 195a 11a 21a

Nicaragua Debt stock to GNP Debt stock to export earnings Debt service to GNP Debt service to export earnings

831 3,136 40 152

295 824 13 24

Source: World Bank, Global Development Finance, 1999; Esquivel, Larraín, and Sachs (1998). Note a 1997.

institutions. Inclusion in the stock-of-debt reduction exercise of the Enhanced Initiative for Highly Indebted Poor Countries (HIPC) launched by the international financial institutions is essential. Both countries have now reached the so-called “decision point” where they have been declared eligible for a rescheduling of their debts on “Naples conditions” (involving a reduction of 67 per cent of the debt coming due). According to the terms of the Initiative, they have already prepared an Interim Poverty Reduction Strategy Paper (PRSP), and are receiving special World Bank, IMF and Inter-American Development Bank (IADB) assistance. If within three years they complete a final PRSP and still have unsustainable debt servicing difficulties, they will become eligible for debt relief of up to 90 per cent of the net present value of their debt stock (or higher, if needed). While the Enhanced HIPC Initiative will help, much more could be done to lighten the burden of debt and allow these countries to reallocate these resources to human development. Therefore, it is important that the process of debt relief be simplified and speeded up.

V. Progress in human development If one takes a longer-term perspective, it is evident that all four Central American countries have made progress towards improved health, longer life and longer years of education. However, a cursory inspection of human development indicators in the areas of demographic transition, health, education and living conditions reveals that there remains much to be done. This is particularly so in Guatemala, Honduras and Nicaragua. El Salvador appears to have taken significant strides towards raising its

Central America 151 levels of human development along several important dimensions. It is also more advanced than its neighbours in the demographic transition, and health and education indicators are somewhat better. Adjustment programmes in the 1990s prevented the Central American countries from increasing the levels of spending on health and education, and in some cases those levels fell as a share of GDP. For example, in Nicaragua, where fiscal adjustment was most dramatic, public expenditures in education per student fell from US$49 to US$36 between 1993 and 1997. Public spending on health fell from 4.2 per cent of GDP in 1991 to 3.5 per cent in 1998. The number of public employees in the health and education sectors shrunk considerably during 1991–94, the period of most intense fiscal adjustment (Agudelo, 2000). The low levels of human development that are still prevalent in the four countries are conspiring against faster progress towards selfsustaining growth. In this section, we compare the evolution of selected human development-related variables in the four countries, and in the tables we use Costa Rica as a regional benchmark. Costa Rica is the country within the Central American region that has achieved the highest level of human development. UNDP’s Human Development Index ranks Costa Rica in the 45th place. By contrast, El Salvador is ranked 107th, Honduras 114th, Guatemala 117th, and Nicaragua 121st (UNDP, 1999: 135–6). While the human development issue has many additional dimensions, we concentrate on five that are readily quantifiable: the demographic transition, health, education, poverty and living conditions. Demographic transition As a consequence of advances in public health, over the past few decades, many low-income countries have experienced significant reductions in their death rates. Infant mortality in particular has declined – leading to a greater number of living children per woman and, indeed, to a greater number of children. To date, in Central America declines in birth rates and in fertility rates have been slower than could have been predicted. Population growth rates are coming down, but they are doing so very gradually, and they still hover close to 3 per cent per annum (Table 6.15).9 Table 6.15 Population growth (annual rates, percentage)

1961 1970 1980 1990 1998

El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

3.0 3.3 1.5 1.8 2.2

3.0 2.8 2.5 2.4 2.6

3.4 2.9 3.3 3.0 2.8

3.2 3.2 3.5 2.3 2.6

4.1 3.2 3.0 2.3 1.8

Source: World Bank, World Development Indicators, 2000.

152 Agosín et al. Crude death rates are now almost at the same level as Costa Rica’s (Table 6.16). Except for El Salvador, however, crude birth rates are substantially higher (Table 6.17). By the same token, fertility rates are still between four and five live births per woman, again with the exception of El Salvador (Table 6.18). Costa Rica’s fertility rate is well below three births per woman. Fertility rates remain high for a variety of reasons. One is that, in traditional societies, children are economically valuable as workers and as social insurance for retirement. In an area where economic stability is not guaranteed, children are a surer way of providing for old age than are pensions. Another reason is simply unwanted births. Contraceptive prevalence has not surpassed one-half of women in all four Central American countries. In Guatemala, it is around one-third (Table 6.19). This compares with rates around 75 per cent in East Asia (Bloom and Sachs, 1998: 247). Table 6.16 Crude death rate (per 1,000 inhabitants)

1962 1970 1980 1990 1998

El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

15 12 11 7 6

18 15 11 9 7

18 14 10 7 5

17 14 12 8 5

8 7 4 4 4

Source: World Bank, World Development Indicators, 2000.

Table 6.17 Crude birth rate (per 1,000 inhabitants)

1962 1970 1980 1990 1998

El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

48 44 36 30 27

48 45 43 39 33

51 48 43 38 33

50 48 46 39 31

41 33 30 27 22

Source: World Bank, World Development Indicators, 2000.

Table 6.18 Fertility rates (live births per woman)

1962 1970 1980 1990 1997

El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

6.8 6.3 4.9 3.7 3.3

6.9 6.5 6.3 5.3 4.4

7.4 7.2 6.5 5.2 4.2

7.3 6.9 6.3 4.7 3.7

6.9 4.9 3.7 3.1 2.6

Source: World Bank, World Development Indicators, 1999 and 2000.

Central America 153 Table 6.19 Contraceptive prevalence (percentage of women aged 15–49)

Late 1970s Late 1980s Mid-1990s

El Salvador

Guatemala

Honduras

Costa Rica

34 47 53

18 23 32

12 41 50

64 68 –

Source: World Bank, World Development Indicators, 1999.

Third, fertility is negatively correlated with the level of education of women. This finding has been verified in El Salvador and Nicaragua (Agudelo, 2000; Molina, 2000). In Nicaragua, while women with no education had, on average, 6.1 children, women with university education had only 1.5. Thus, progress in providing better access to education to all people can have an important demographic dividend by helping to reduce the birth rate – and the ratio of dependants to workers. High population growth translates into high ratios of dependants (children younger than fifteen and people older than sixty-five) to working-age population (fifteen- to sixty-five-year-olds). In countries other than El Salvador, the age dependency ratio is closer to unity than it is to one-half (Figure 6.1). This means that for every working-age adult there is almost 1.200

Age dependency ratio

1.000

0.800

0.600

0.400

0.200

0.000

Costa Rica

El Salvador

1960

1970

Honduras Nicaragua Guatemala 1980

1990

1997

Figure 6.1 Age dependency ratio, 1960–97 (source: World Bank, World Development Indicators, 1999).

154 Agosín et al. one dependant. By contrast, in Costa Rica this ratio is 0.63, and in the successful economies of East Asia it is well below 0.5 (Bloom and Sachs, 1998: 245). What implication does this carry? Low dependency ratios are desirable because they allow families to save a larger share of their incomes (providing the economic environment is stable). Private expenditures on education are also likely to be higher in families with fewer children. Longer life expectancy makes that investment more worthwhile. More importantly, the ability of the public sector to provide adequate educational services is challenged by a high dependency ratio. A large proportion of young people to workers places heavy demands on the public sector to provide educational services. At the same time, other things being equal, a high dependency ratio implies a small tax base and, in this way, reduces the potential resources the public sector can raise via taxes. Thus a delayed demographic transition is acting as a brake on economic growth in three of the four countries. El Salvador is the exception: its demographic behaviour is well ahead of its level of economic development and is rapidly becoming similar to Costa Rica’s. However, it is critical that this does not stop investment in education. Policy-makers must take a long-term view, realizing that the many young dependants will soon be adults. Central America’s young people need to be productively employed. If they are not, they will not only continue to be an economic drain, they will also be socially and politically marginalized and, in large numbers, will then pose a threat to the stability of society. The young dependants today will be the workers of tomorrow: if they are not educated they will be less able to participate in today’s global economy; and if they do not have access to the world’s markets they will not be able to compete. To take advantage of the window of opportunity that Central America’s demographic transition presents, governments must be able to create effective policies – and plan for the changing demographics. Health Good health, desirable in itself, improves labour productivity – and thus income, which in turn is positively correlated to improved health. Additionally, a highly productive work force is attractive to investors. Good health encourages people to invest in their education and in the education of their children. Good health encourages people to save for their old age. Improving health is therefore one prong of the attack on national poverty. There is no one indicator that measures the quality of a country’s health. Here we look at a few, some being indicative of outcomes (life expectancy at birth, infant mortality rates and malnutrition indicators)

Central America 155 while others measure effort (physicians per 1,000 inhabitants, health expenditures per person and immunization ratios). While life expectancy has been rising in Central America (as everywhere in the world), at 64–69 years it remains well below the leading countries, which record a figure of around eighty years (Table 6.20). Infant mortality rates have also declined over time. Nonetheless, at 32–43 per 1,000 children, they are between three and four times that of Costa Rica (Figure 6.2). Our three malnutrition indicators (Table 6.21) show that infant and child malnutrition is widespread in all four countries. The large share of low birth-weight babies is indicative of maternal malnutrition. The ratios of children under five years of age that have low height and low weight for age are extremely high. In Guatemala and Honduras, 40–50 per cent of all children under five years old have lower than normal heights. These are Table 6.20 Life expectancy at birth (years)

1962 1970 1980 1990 1998

El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

52 57 57 66 69

47 52 57 61 64

48 53 60 67 69

49 54 59 64 68

63 67 73 75 77

Source: World Bank, World Development Indicators, 1999 and 2000.

140 120 100

1962 1970 1980 1990 1997

80 60 40 20 0

Costa Rica

El Salvador

Honduras

Nicaragua

Guatemala

Figure 6.2 Infant mortality rate, 1962–97 (per 1,000 births) (source: World Bank, World Development Indicators, 1999).

156 Agosín et al. Table 6.21 Indicators of malnutrition El Salvador Low birth-weight babies (% births) Early 1980s 9 Late 1980s 8 Early 1990s 9 1995 –

Guatemala

Honduras

Nicaragua

Costa Rica

10 14 14 –

9 – 9 –

15 8 8 15

12 6 7 7

Low height for age (% children under 5) Early 1980s – – Late 1980s 30 58 Early 1990s 23 – Mid- to late 1990s 23 50

– 37 36 40

22 – 24 –

13 – 9 6

Low weight for age (% children under 5) Early 1980s – – Late 1980s 15 33 Early 1990s 11 – Mid- to late 1990s 11 27

– 21 18 18

10 – 12 –

6 – – 5

Source: World Bank, World Development Indicators, 1999; Molina (2000).

indicators of severe child undernourishment. Malnourished children have serious learning disabilities – which in turn affects their prospects for engaging in the knowledge economy. There has been significant progress in immunizing children against contagious diseases. However, about one-quarter of children in Guatemala are still not immunized against DTP10 or measles (Table 6.22). Eleven per cent of Honduran children are not immunized against measles. These figures indicate that dramatic gains in health can be made in Guatemala and Honduras at relatively low cost. Expenditures on health are abysmally low in all four countries. In El Salvador, Guatemala and Honduras, in 1994, per capita dollar expenditures on health (in equivalent purchasing power) were barely US$100, Table 6.22 Immunization rates (percentage of children under 12 months) El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

DPT 1980 1990 1997

43 80 97

43 66 78

31 84 94

15 66 94

86 95 91

Measles 1980 1990 1997

45 98 97

23 68 74

35 90 89

15 82 94

60 90 99

Source: World Bank, World Development Indicators, 1999.

Central America 157 compared to over US$500 in Costa Rica (Figure 6.3). As already noted, per capita spending on health fell in Nicaragua over the first half of the 1990s, a period that coincided with severe macroeconomic adjustment. A reflection of the inadequacy of health expenditures is that the number of physicians per 1,000 inhabitants (Table 6.23) remains extremely low in all countries, but particularly so in Guatemala and Honduras. Little progress has been made over the 1990s towards changing this sorry situation. Education Improving education is of prime importance to Central America. The examination of a variety of indicators shows that, over the 1990s, there has been even less progress in education than in health. The quality of education is a key concern. At the primary level, all students should acquire at least basic literacy and numeracy. However, 600 500

US$ PPP

400 300 200 100 0 El Salvador

1994 Guatemala

Honduras

Nicaragua

1990 Costa Rica

Figure 6.3 Health expenditures per capita (US$ PPP) (source: World Bank, World Development Indicators, 1999). Table 6.23 Number of physicians (per 1,000 people)

1960 1970 1980 1990 1993 1997

El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

0.2 0.2 0.3 0.8 0.7 1.0

0.2 0.3 – 0.8 0.3 0.9

0.1 0.3 0.3 0.7 0.4 0.8

0.3 0.5 0.4 0.6 0.6 0.8

0.4 0.6 0.7 1.3 0.9 1.4

Source: World Bank, World Development Indicators, 1999 and 2000.

158 Agosín et al. between 25 and 40 per cent of adult females remained illiterate in 1998 (Table 6.24). The figures for adult males ranged between 19 and 34 per cent. Lack of access to literacy and numeracy is a serious drawback to productive participation in the economy. The education of women and girls is a significant factor in improving health and education – and reducing poverty rates. More education encourages women to have fewer (and healthier) children, and it increases their own earning power, thereby increasing the spending power of a household. Educated women add to the strength and size of the educated workforce. There is also evidence that better educated and wealthier women pass on the benefits of their education to their family and their communities in a more direct way than men – especially when diffusing medical knowledge. For example, vaccination rates for children increase with the education level of the mother. The education of women and girls needs to be targeted specifically – especially in El Salvador and Guatemala, two countries where illiteracy is significantly higher among women. Discrimination against women thus deprives half the population of the minimum skills needed for responding to potential opportunities opened up by liberalization and global integration. The costs of attaining universal literacy and numeracy ought to be well within the capabilities of Central American governments, since in labourintensive economies the wage rates, even for skilled workers, are low. All four countries have made significant progress in raising their primary enrolment rates (Table 6.25). The deficiencies lie on either side of primary education: despite some progress during the 1990s, school enrolment rates are still inadequate in pre-primary and in secondary education. Pre-primary education is not a luxury: it has been demonstrated that success in primary education requires the socialization and basic skills acquired in pre-primary school. It is interesting to note that these countries have a large percentage of Table 6.24 Illiteracy rates (percentage of people aged fifteen and above) El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

Women 1970 1980 1990 1998

47 38 31 25

62 54 46 40

49 41 34 27

46 39 34 31

12 9 6 5

Men 1970 1980 1990 1998

36 29 24 19

46 38 31 25

43 37 32 27

45 39 36 34

11 8 6 5

Source: World Bank, World Development Indicators, 2000.

Central America 159 Table 6.25 Gross school enrolment rates (percentage of cohort) El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

Pre-primary 1980 1990 1996 1998

11 20 34 –

21 25 33 –

9 16 31 33

8 12 20 33

39 61 72 –

Primary 1960 1970 1980 1990 1995 1998

80 85 75 81 88 –

45 57 71 78 88 –

67 87 98 109 108 –

66 80 94 98 101 96

96 110 105 101 103 –

Secondary 1960 1970 1980 1991 1996 1998

13 22 24 25 34 –

7 8 19 23 26 –

8 14 30 34 32 34

7 18 – 31 36 42

21 28 48 43 47 –

Higher 1977 1992 1997

2 13 17

2 8 8

1 8 9

2 13 9

6 21 22

Source: World Bank, World Development Indicators, 1999; Agudelo (2000); Ramos Lobo (2000).

dropouts in primary school (Figure 6.4). With the exception of El Salvador, in the other three countries barely 60 per cent of children make it through fifth grade. It has also been reported that it takes children in the four countries an average of over ten years to complete the six years of primary education (Alvarez et al., 1999). Because comparatively few children finish primary education, few enrol in secondary school. Secondary enrolment rates still range between 26 and 42 per cent of their cohort. This is a serious drawback for participating in a world economy where a premium is increasingly placed on knowledge. Education reformers need to concentrate on improving the quality of the experience people receive whilst in the education system. If the quality improves, children are less likely to drop out. Primary schools must lock people into education, by providing them with the two essential tools to continue: literacy and numeracy. Secondary schools should focus on getting more students into tertiary education – and enriching their learning experience. Better teacher training, both initial and in-service, will improve the educational experience for students.

160 Agosín et al. 100 90

Early 1980s Mid-1990s

80

Percentage

70 60 50 40 30 20 10 0

El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

Figure 6.4 Persistence to grade five (% of cohort) (source: World Bank, World Development Indicators, 1999).

As can be seen in Table 6.26, during the 1990s public spending on education rose in three of the four countries (all except Honduras). However, in two of them, El Salvador and Guatemala, it is still very inadequate in quantitative terms (around 2 per cent of GDP). The poor quality of education is an acknowledged problem in all four countries (see Alvarez et al., 1999). While much more than increasing public spending will be needed to overcome the problem, it is inconceivable that educational quality can be tangibly improved with these low levels of spending. The gap between rich and poor countries’ higher education enrolment is increasing alarmingly. Higher education in the global knowledge economy is essential for long-term success. Not only are highly educated people well placed to become economic and social entrepreneurs, but they also help create, or strengthen, the institutions (including government) and the infrastructure needed to sustain development. The quality of public policy formulation and implementation – an important component of governance – depends to a large extent on the pool of available human resources with higher education. In the case of the Central American countries, in three of the four countries (the exception being El Salvador) enrolment rates in higher education are still below 10 per cent. This compares very unfavourably with a rate of 22 per cent for Costa Rica, our benchmark country. It is imperative that policy-makers in Central American countries acquire a vision of why higher education is important to guide their

Central America 161 Table 6.26 Public spending on education (percentage of GDP)

1960 1970 1980 1990 1995 1997 1998

El Salvador

Guatemala

Hondurasa

Nicaragua

Costa Rica

2.1 2.6 3.9 2.0 2.2 2.5 –

1.4 2.0 1.8 1.6 1.7 1.8 –

2.2 3.1 3.2 4.2 3.9 4.1 –

– 2.3 3.4 4.9 5.1b 5.1 4.6

4.1 5.2 7.8 4.4 4.6 –

Source: World Bank, World Development Indicators, 1999; Agudelo (2000); Ramos Lobo (2000); Molina (2000); Lavarreda (2000). Notes a As already noted, there is evidence that GDP has been underestimated in the last two decades, which could be overestimating the ratio. b 1994.

decisions – and they need to promote that vision. The vision must be tempered with what their national higher education system can be expected to achieve. New players, especially from the private sector, must become involved in funding and providing advanced education. One consequence of continuing poor education in these four countries is persistent unemployment and under-employment. The job opportunities that do arise are in the modern sector of the economy. Most people, however, do not possess the skills that would make them employable in the modern sector. Adult training and retraining programmes should also be considered to enable workers to acquire the skills they need to adapt to the changing distribution of work opportunities. Strengthening basic education, while essential, has positive impacts on labour productivity after a long lag, whereas retraining programmes offer more immediate benefits. Living conditions As with other dimensions of human development, improving living conditions for the population is an objective in itself and a means to higher productivity. The absence of drinking water, sanitation or a decent dwelling is a breeding ground for illness and demoralization as well as being an affront to human dignity. In this dimension of human development, the four Central American countries made significant gains in the period from the mid-1980s to the mid-1990s. However, by 1995 a significant share of households in all four countries still did not have access to drinking water or plumbing (Table 6.27). This deprivation was particularly severe in Nicaragua and in the rural areas of all four countries.

162 Agosín et al. Table 6.27 Indicators of living conditions (percentage of the population with access) El Salvador

Guatemala

Honduras

Nicaragua

Costa Rica

Safe water, total 1970 1985 1995 1998

40 51 53 –

38 58 67 –

34 50 77 –

35 50 62 61

79 93 100 –

Safe water, rural 1970 1985 1995 1998

20 47 – –

12 39 48 –

10 49 66 –

16 13 28 30

59 82 99 –

Sanitation, total 1985 1995 1998

62 77 –

54 67 –

32 82 –

27 59 61

95 97 –

Sanitation, rural 1985 1995

35 65

42 50

38 71

16 28

88 95

Source: World Bank, World Development Indicators, 1999; Agudelo (2000).

Poverty The bottom line of the bleak human development picture that we have described is widespread poverty. Poverty measurements tend to be noncomparable across countries, because poverty lines differ from one country to another. The closest one can come to an internationally comparable measure is the fraction of the population living on less than one and two US dollars a day. Unfortunately, this figure is usually available for one year per country. Nonetheless, a comparison for our four countries is quite instructive. No data are available for El Salvador. As can be seen in Figure 6.5, for the other three countries, almost one-half of the population lives on less than one US dollar per day and fully three-quarters has incomes of less than two dollars per day. The figures for our benchmark, Costa Rica, are 19 and 44 per cent, respectively. Putting it all together Can we say something about how much per capita GDP would rise if the Central American countries would find the wherewithal to improve their demographics (by diminishing significantly their dependency ratios), health (as measured by life expectancy) and openness (as measured by the degree of openness to trade)? We attempt to do this by using the empirical model of Chapter 5. As will be recalled, this model explains

Central America 163 90 80 70 $1 per day $2 per day

Percentage

60 50 40 30 20 10 0 Guatemala

Honduras

Nicaragua

Costa Rica

Figure 6.5 Fraction of the population living on less than US$1 and US$2 per day (percentage) (source: World Bank, World Development Report, 1998).

differences in growth rates in the period 1965–90 with the following variables: 1 2 3 4 5 6 7 8 9

The log of per capita GDP in 1965 (in 1985 dollars of internationally comparable purchasing power) The log of the share of the working age population in the total population in 1965 The percentage of area in the tropics The log of the secondary school gross enrolment rate in 1965 A measure of openness to trade over the period from 1965 to 1990 A measure of institutional quality in 1980 Life expectancy in 1965 The difference in the growth rate between the working age and the total population (GDIF) The interaction between openness and GDIF.

For deriving benchmark estimates of per capita GDP in 2015 (in 1985 international dollars), we use the parameters from the growth regression and the 1990 values of the independent variables. The simulations of per capita GDP in 2015 labelled “Improvements in demography”, “Improvements in openness” and “Improvements in demography and openness” use, respectively, data values for Chile in 1990 for GDIF only, for openness only, and for GDIF and openness together. The simulations labelled

164 Agosín et al. “Improvements in health” measure the effect on per capita GDP in 2015 of life expectancies in 1990 that were counterfactually 10 per cent higher than they actually were. The results of the simulations are shown in Table 6.28. Improvements with respect to their values in 1990 in demographic characteristics, health and openness to trade can raise very significantly the levels of per capita GDP in all four countries by 2015 (between 75 and 80 per cent). It is important to stress that the combination of the three policy changes is what yields the big gains. A good part of the task of opening up the economy to trade has already been achieved. In fact, as already noted, during the 1990s all four countries implemented policies to open up their economies to trade and investment. The big challenges ahead relate to human development. It should be noted that these simulations do not include the impact of better education. The favourable effects of more and improved education ought to be very considerable, and should exceed by a big margin the boost that improved demographics and health alone can be expected to give to incomes per head. Of course, as noted at several points in this book, demographics, health and education are all interdependent variables.

VI. The problems of micro- and small enterprises The micro- and small enterprise sector is a hinge between economic growth and human development. A development strategy focusing on human and social development ought to pay specific attention to this segment of the enterprise sector. Success in promoting the upgrading of Table 6.28 Simulating the impact of improved demographics, openness and health on per capita GDPs in 2015 (per capita GDP in 1985 international US dollars) El Salvador Guatemala Honduras Nicaragua Historical data: 1965 1980 1990 Simulations for 2015: Benchmark Improvements in: Demography Openness Health Dem. and openness Health, demography and openness Source: Authors’ calculations.

1,739 2,004 1,824

1,781 2,574 2,127

1,121 1,559 1,377

2,246 1,861 1,294

2,671

2,795

2,265

2,129

3,268 4,519 2,865 4,517 4,711

3,714 4,324 2,997 4,936 5,138

2,791 4,093 2,430 3,840 4,005

2,665 3,860 2,283 3,705 3,859

Central America 165 these firms has a double dividend: since poverty is heavily concentrated in this sector, progress can simultaneously foster both economic growth and increased equity. The incapacity of a developing economy to generate output growth that is commensurate with the growth of its labour force shows up in burgeoning open unemployment and a swelling of the ranks of the selfemployed. All four countries face problems of unemployment, under-employment and employment-informality. In all four countries, a large share of employment is in micro-enterprises, the majority of which are, in turn, at the subsistence level. These are not really firms in the formal sense of the term. Most of them are precarious, do not carry books and are unable to generate surpluses leading to reinvestment and growth. In Nicaragua and El Salvador, efforts have been made to measure under-employment, defined as people who are self-employed because they are unable to find a job in the formal sector of the economy. In both countries, under-employment has been estimated at over 30 per cent of the labour force (Solórzano, 2000; Trigueros, 2000). This figure underestimates the true prevalence of under-employment because it does not include the large number of low-productivity self-employed people. In Nicaragua, for example, the informal sector of the economy absorbs twothirds of the working population. For this segment of the labour force, working conditions are deplorable, incomes insufficient to provide for subsistence, and social security non-existent (Agudelo, 2000). In Guatemala, it is estimated that micro-enterprises, mostly informal in nature, account for one-quarter of total employment. In the case of women, the informal economy accounts for up to 70 per cent of employment. Almost all rural women work in informal micro-enterprise settings (Colom, 2000). In Honduras, although unemployment is not a serious problem, wages are too low to allow workers to meet even subsistence needs. In agriculture, economically unviable farms represent over 70 per cent of all production units (Ramos Lobo, 2000). In Guatemala, poverty is also concentrated among rural producers, the vast majority of whom are indigenous. Three-quarters of all micro-enterprises are indigenous. In El Salvador, in 1996 a comprehensive study was carried out by fourteen interested institutions in order to understand better the characteristics and problems of the micro-enterprise sector (Trigueros, 2000). This study – entitled Libro Blanco de la Microempresa – determined that microenterprises accounted for between 24 and 30 per cent of GDP and employed 31 per cent of the country’s labour force.11 About three-quarters of the enterprises are urban,12 and about 65 per cent of microentrepreneurs are women.13 Most micro-enterprises were to be found in commerce (almost one-half of the total), about a quarter in manufacturing and 15 per cent in personal services. At the time of the survey (1996),

166 Agosín et al. 23 per cent of all micro-entrepreneurs did not have any schooling, and 50 per cent had between one and six years of schooling; 11 per cent were illiterate. The survey classified micro-enterprises into three categories: subsistence, primitive-accumulation and amplified-accumulation. Subsistence enterprises are those with very low productivity and whose incomes do not cover the consumption needs of the entrepreneur. They are concentrated in retail trade and personal services and headed mainly by women – who are also heads of household. Simple-accumulation enterprises are those whose income is sufficient to cover subsistence costs but not high enough to allow for growth. Enterprises with amplified accumulation can save and invest. According to sales, subsistence micro-enterprises represent about 70 per cent of the total, with simple-accumulation firms taking up somewhat over a quarter. The potential for growth is concentrated in the last two categories. Policies to enhance the production capacities and competitiveness of these firms are important not only from the point of view of their effects on the incomes of their owners. More viable small firms can be the source of employment for other unemployed or under-employed workers as well. Therefore, they should be the targets for financial and technical assistance aimed at transforming them into productive small enterprises. The needs of these firms are of three different kinds. First, their technologies and forms of organization do not allow them to participate in global integration. In fact, micro- and small enterprises in handicrafts and simple manufactures are probably adversely affected by trade liberalization, in that they are ill equipped to compete with cheap imports. Interestingly, in El Salvador, micro-enterprises are very active in fishing and export part of their production to other Central American countries. The appreciation of the Salvadoran colón, already referred to above, has affected adversely these exports, since firms are unable to introduce new technologies to increase productivity and remain competitive. Effective programmes of technical assistance aimed at raising the ability of microenterprises to compete could have a very significant impact on both growth and human development. Second, as the results of the Salvadoran survey indicate, the education of the micro-entrepreneurs and their employees is very deficient and needs to be improved through effective programmes of basic adult education. Third, micro-enterprises are often unable to finance investment projects because they do not have access to capital markets. The financial constraints they face originate in the nature of financial markets. The basic trait of financial markets, and the main reason why they do not conform to textbook competitive markets, is the existence of asymmetric information: lenders do not know what borrowers will do with their money. This gives rise to two different kinds of risk. One is risk attached to the

Central America 167 borrowers themselves, who can use the borrowed funds for purposes that are quite different from those for which the money was lent. The other kind of risk is commercial: all projects are uncertain, and some will undoubtedly fail to yield expected returns. In the first case, borrowers may be able to repay but may be unwilling. In the second, they may be unable to do so. These two sources of risk induce creditors to demand collateral from untried borrowers. Since small firms often are unable to put up collateral, financial markets tend to ration them out of the market. In addition, there are important economies of scale in the finance industry, which means that small loans tend to be more costly than large loans. Fortunately, it has been shown that small firms are usually willing to defray higher interest costs and that the main problem they face is not high interest rates but inadequate access to credit. Financial institutions catering to the micro-enterprise sector have sprung up all over the world, often with the assistance of donor agencies and NGOs (Agosín, 1999; Morduch, 1999). Central America is no exception. One of the main problems facing these institutions is how to solve the problem of non-existent collateral. There are several well-known alternative financial technologies, including collective credits (particularly suited to small agricultural concerns),14 the monitoring of borrower balance sheets and performance, tying initial lending to previous deposits, and testing borrowers’ creditworthiness through gradual increases in loan sizes. Experience demonstrates that, when micro-finance banks are perceived by their clients to be permanent institutions, the amount of subsidization needed for them to continue to operate declines very considerably. Some in fact outgrow dependence on their original funding sources to become economically viable. In countries that have developed successful microfinance institutions, bad loans are a smaller proportion of total assets in these institutions than in conventional banks.15 In all four Central American countries there have been numerous efforts to set up micro-finance institutions, with rather mixed results so far. The most successful experience is that of Financiera Calpiá in El Salvador. This institution was born from a 1988 grant by the German aid agency, GTZ, to the Salvadoran Association of Medium and Small Enterprises (AMPES). In 1995, with financial contributions from the InterAmerican Development Bank, the Central American Bank for Economic Integration, and domestic institutions, Financiera Calpiá became totally independent. It provides credits and other financial services such as current accounts, time deposits and savings deposits to micro-enterprises and poor people. The institution operates on the same principles as a bank, and its shareholders expect it to be profitable. In its lending operations, it considers that the production and consumption activities of its clients are

168 Agosín et al. inseparable; money being fungible, it is not possible to prevent poor families from using credits to finance consumption that were originally intended for production activities. Therefore, its credit technology consists in obtaining detailed knowledge about the repayment capacity of each borrower through visits by loan officers to clients’ homes. As collateral, borrowers pledge goods that have a high use value for the family (for example, a bed or consumer durable). The size of loans is increased gradually over time as the borrower establishes a reputation for repayment. In line with its relatively high costs, Financiera Calpiá charges higher interest rates than conventional banks (Trigueros, 2000). Financiera Calpiá’s activities have grown rapidly since it began operations as a full-fledged bank. The number of credit operations rose from 18,000 in 1996 to almost 29,000 in 1998. Over the same period, the amounts lent practically doubled, to about US$22 million in 1998. It has also been very successful in attracting savings and time deposits. In other countries, experience has been much less favourable, basically because Financiera Calpiá’s commercial approach to micro-finance has been absent. There have also been surmountable legal problems. In Nicaragua, the main problem is that the banking law does not allow these institutions to receive deposits from the public (Ruiz, 2000), an indispensable precondition for becoming economically viable. This limits existing micro-finance institutions to being conveyor belts for what are in effect gifts to under-employed people. Unsurprisingly, the ratio of bad loans to total assets of these “banks” is very high. The many institutions that have been created with the assistance of donor governments and non-profit institutions from developed countries are not economically viable, and are still dependent on the good will of donors. As Financiera Calpiá’s experience shows, micro-entrepreneurs have potential demands for many types of financial services, not just loans. An essential condition for becoming self-sustaining in the financial sector is to be able to offer clients a wide range of services. These include deposits, savings instruments, retirement accounts and insurance. With the exception of Financiera Calpiá, none of the micro-finance institutions in Central America fulfils this condition. Micro-finance has a great potential and can play an important role in fostering the transformation of micro-enterprises in Central America. If it is to fulfil its promise, however, the sector must be reformed thoroughly. An assessment of resource needs and availability has not yet been undertaken, but it would not be surprising to find out that sufficient resources are already being devoted to the problem. The task is then to put them to good use through organizational reform. A key issue is to allow microfinance institutions to become true banks offering services to people who have potential demands for them. The distinction made in El Salvador’s Libro Blanco between subsistence and other types of micro-enterprises is useful in formulating

Central America 169 policy towards micro-finance. Subsistence firms basically require working capital to purchase inputs for very simple production processes. Collective credit technologies and those pioneered by Financiera Calpiá are well suited to this segment of the micro-enterprise sector. As firms grow in size, they begin to demand longer-term credit to finance investments in fixed capital. For this group of firms, other solutions are needed for the problem of inadequate access to credit. A development bank approach may be one of them. Development banks can auction off to the private banking system special lines of long-term credit for investment projects of small firms. Another interesting approach involves the establishment of a public credit guarantee agency. The objective of these institutions is to provide credit insurance (for a fee, of course).

VII. Conclusions In the years ahead, Central American countries face a number of daunting challenges to human and social development and rapid growth: • •

• • •

•

A labour force with insufficient basic skills Micro- and small enterprises unable to contribute to growth because of inadequate access to credit and uncompetitive technologies High levels of civil insecurity (despite progress towards democracy) Uncertainty as to the enforcement of laws and contracts (especially in Nicaragua) A large share of the population outside the modern market economy (for example, a significant proportion of the indigenous population of Guatemala) A low-productivity informal sector that absorbs a disproportionate share of the labour force.

Sustained attention to the synergies between human development and economic growth offer the best prospects for policy-makers striving to tackle these problems. In light of this, it is worrying that some countries have either cut back on, or failed to increase in a sustained manner, key human-development expenditures, such as those on education, health and decent housing. Progress along the many dimensions of human and social development should be protected from the vagaries of macroeconomic adjustment. The reduction in military spending, quite impressive so far, is an optimistic sign that it is possible to reach much higher levels of human development. More needs to be done at the national level to achieve a lasting peace, solidify democracy and the rule of law, and put an end to corruption.

170 Agosín et al. In Honduras and Nicaragua, an essential component of any strategy to foster human development is early debt relief. Since most of the debt of these countries is official, the objective of debt relief ought to be well within the capacities of donor governments. Debt relief programmes can be structured in such a way that, as a quid pro quo, the governments of the two recipient countries make measurable progress in reaching quantifiable human development targets. The Enhanced HIPC Initiative is already doing this. Now debt relief ought to be speeded up. A further difficulty is that individual countries have had problems designing and implementing coherent policies, particularly in the area of trade and the exchange rate. Exchange-rate policy needs to be supportive of export diversification by maintaining competitive domestic prices in foreign currency. Unfortunately, sustained currency overvaluation is threatening export-oriented growth. A major challenge ahead refers to the strengthening of the CACM. Central American integration has great potential for fostering human and social capital development and sustained growth. A true common market is yet to emerge. This will involve agreeing on common rules not only for imports but also for export incentives, foreign investment, and the treatment of investment in EPZs. If the CACM is to become a true “engine of growth”, the harmonization of exchange-rate policies (and of the macroeconomic policies that underpin the exchange rate) will need to be tackled sooner rather than later. A regional infrastructure policy is also a must. Finally, the maquiladora industry has the potential to become a pillar of a new development strategy. In all four countries, this industry is already an important generator of employment. However, up to now, it is oriented almost exclusively to stitching together imported clothing components. It is time for countries to diversify the industry mix in the Export Processing Zones and to develop strong and competitive suppliers for these firms, so that the positive growth impulses emanating from them can reach the broadest segments of the region’s population. Regional integration ought to be seen not only in terms of the benefits of a larger internal Central American market, but also as the best option for developing regional input suppliers to export-oriented firms. Without wishful thinking, one can envisage a maquiladora industry that becomes the focal point for an integrated development strategy based on the acquisition of new comparative advantages. Such zones can also make an effective locus for a range of initiatives, such as retraining programmes and health service delivery. The tasks ahead, then, involve continuing efforts in the intelligent design and effective implementation of policies in the two areas that are the subject of this assessment: on the one hand, more sophisticated trade and finance policies and, on the other, policies oriented towards the deepening of human development. In order to end the scourge of poverty in

Central America 171 low-income countries such as those analysed here, policy-makers must learn to consider both of these approaches simultaneously. Indeed, the two must become one.

Notes 1 Indirect exporters are producers providing inputs to direct exporters. 2 Diphtheria, tetanus and pertussis (or whooping cough). 3 There is an ample literature on optimum currency areas. The classic reference is Mundell (1961), for which the author won the 1999 Nobel Prize in Economic Science. It is an irony that, at the same time as that prize was being awarded, some influential observers were advocating currency unions with the United States for countries that were very far from meeting the conditions set down by Mundell and widely accepted by the profession. 4 Information based on interviews conducted by the authors in Managua in July 1999. 5 However, there is evidence that growth in Honduras is underestimated in official statistics. Evidence from household survey data yield growth rates in real household incomes of about 2 per cent per annum (UNDP, 2000). 6 We regressed the Gini ratio for ninety countries against per capita income and found that the latter is negatively associated with the former. In other words, as income per capita rises, inequality declines. For a discussion of the relationship between inequality and income levels, see Kuznets (1955), and Anand and Kanbur (1993a, 1993b). 7 There is some evidence that investment is systematically overestimated in Honduras. It is also possible that GDP may be underestimated (Ramos Lobo, 2000). Therefore, the median investment-GDP rate calculated for the 1991–97 (32 per cent) is likely to exaggerate actual performance. The high rates of investment reported in the national accounts are not credible in light of the modest rate of growth of GDP recorded during the same period (3.7 per cent). 8 We endorse the recommendations in this respect made by Jenkins et al. (1998). 9 In El Salvador, the low rates of growth of population since the 1970s are due to emigration caused by the civil war, as people of reproductive age migrated, and a rise in male mortality (Molina, 2000). 10 Diphtheria, tetanus and pertussis (or whooping cough). 11 According to the Libro Blanco, micro-enterprises are production units with up to ten workers and with annual sales of up to 600,000 colóns (about US$75,000). 12 This proportion is surely lower in the other countries, and particularly in Guatemala, where the agricultural sector is larger relative to the economy, and rural poverty is a more important problem. 13 It is interesting to note that the experience of the Grameen Bank, one of the world’s foremost micro-finance institutions, has led them to discriminate heavily in favour of women clients. 14 This involves forming groups of debtors who are all guarantors of each other’s loans. If one member fails to pay back a loan, all other members of the group are liable, and they all lose their creditworthiness. 15 Two classic cases of successful micro-finance institutions are Grameen Bank in Bangladesh and Banco Sol in Bolivia. Grameen Bank was started with aid money in 1978. Now it is a self-sustaining bank with over US$271 million in loans outstanding to micro-enterprises and poor people (which it has aided to go beyond the subsistence level). Grameen Bank pioneered the use of collective credits (see Yunus, 1999).

172 Agosín et al.

References Agosín, M. R. (1999), “Private finance for development: analytical underpinnings and policy issues”, Office of Development Studies, United Nations Development Programme, New York, unpublished. Agudelo, I. (2000), “Implicaciones de la Reforma Económica para el Desarrollo Humano Sostenible en Nicaragua”, UCTAD/UNDP Global Programme, Managua, unpublished. Alvarez, B., J. Dassin, L. Rosenberg and D. Bloom (1999), “Education in Central America”, Harvard Institute for International Development, Harvard University, unpublished. Anand, S. and R. Kanbur (1993a), “The Kuznets process and the inequality-development relationship”, Journal of Development Economics, 40: 25–52. Anand, S. and R. Kanbur (1993b), “Inequality and development: a critique”, Journal of Development Economics, 41: 19–43. Bloom, D. E. and P. Craig (1998), “Basic education and competitiveness in Central America”, Report on a dialogue held in collaboration with IBM’s Latin America Advisory board, General Business Machines (GBM), and Instituto Centroamericano de Administración de Empresas (INCAE), San José, Costa Rica, June. Bloom, D. E. and J. D. Sachs (1998), “Geography, demography, and economic growth in Africa”, Brookings Papers on Economic Activity, 2: 207–95. CEPAL (1999), Estudio Económico de América Latina, 1999, CEPAL, Santiago. Colom, A. (2000), “Promoviendo el Desarrollo Humano en Guatemala por Medio de las Microfinanzas y las Microempresas”, UNCTAD/UNDP Global Programme, Guatemala City, unpublished. ECLAC (1999) Balance Preliminar de las Economías de América Latina y el Caribe, 1999, ECLAC, Santiago. Esquivel, G., F. Larraín and J. D. Sachs (1998), “The External Debt Problem in Central America: Honduras, Nicaragua, and the HIPC Inititative”, Development Discussion Paper No. 645, Harvard Institute for International Development, Harvard University, Cambridge, MA. Estado de la Región en Desarrollo Humano Sostenible, 1999 (ERDHS) (1999), Proyecto Estado de la Nación, San José, Costa Rica. Gitli, E. (1997), La Industria de la Maquila en Centroamérica, International Labour Organization, Office for Central America and Panama, San José, Costa Rica. Gitli, E. (1998), Estrategia Nacional de Atracción de Inversiones, Ministerio de Comercio Exterior, San José, Costa Rica. Gitli, E. and R. Arce (2000), “¿Qué Significa la Ampliación de Beneficios para los Países de la Cuenca del Caribe?”, Centro Internacional de Política Económica para el Desarrollo Sostenible (CINPE), Universidad Nacional, Heredia, Costa Rica. Jenkins, M., G. Esquivel and F. Larraín (1998), “Export Processing Zones in Central America”, Development Discussion Paper No. 646, Harvard Institute for International Development, Harvard University, Cambridge, MA. Kuznets, S. (1955), “Economic growth and income inequality”, American Economic Review, 45: 1–28. Lavarreda, J. (2000), “Desarrollo Humano de Guatemala y Políticas Sociales”, UNCTAD/UNDP Global Programme, Guatemala City, unpublished. Mejía, M. C. (2000), “Ejecutando Reformas de Política en Honduras: Elementos

Central America 173 Principales y Estrategia”, UNCTAD/UNDP Global Programme, Tegucigalpa, unpublished. Molina, F. (2000), “Reforma Económica en El Salvador y Repercusiones para el Desarrollo Humano Sustentable”, UNCTAD/UNDP Global Programme, San Salvador, unpublished. Morduch, J. (1999), “The microfinance promise”, Journal of Economic Literature, 37: 1569–614. Mundell, R. (1961), “A theory of optimum currency areas”, American Economic Review, 51: 657–64. Ramos Lobo, M. (2000), “Implicaciones de la Reforma Económica para el Desarrollo Humano Sostenible en Honduras”, UNCTAD/UNDP Global Programme, Tegucigalpa, unpublished. Ruiz, M. (2000), “Promoviendo el Desarrollo Humano Sostenible por Medio de las Microfinanzas y las Microempresas en Nicaragua”, UNCTAD/UNDP Global Programme, Managua, unpublished. Solórzano, O. (2000), “Implementación de Reformas de Política Económica en Nicaragua: Temas Principales y Estrategia”, UNCTAD/UNDP Global Programme, Managua, unpublished. Sorto, F. (2000), “Implementación de las Reformas Económicas en El Salvador: Principales Aspectos y Estrategias”, UNCTAD/UNDP Global Programme, San Salvador, unpublished. Trigueros, A. (2000), “Promoviendo el Desarrollo Humano Sostenible por medio de las Microfinanzas y las Microempresas en El Salvador”, UNCTAD/UNDP Global Programme, San Salvador, unpublished. United Nations Development Programme (UNDP, 1999), Human Development Report, 1999, UNDP, New York. UNDP (2000), Informe del Desarrollo Humano en Honduras, 2000, UNDP, Tegucigalpa. Urízar, C. (2000), “Estrategias para Implementar Reformas de Política Económica en Guatemala”, UNCTAD/UNDP Global Programme, Guatemala City, unpublished. World Bank (1989), Trade Liberalization and Economic Integration in Central America, Report No. 7625-CAM, World Bank, Washington, DC. World Bank (1999), World Development Indicators 1999, CD-ROM, Washington, DC. World Bank (2000), World Development Indicators 2000, CD-ROM, Washington, DC. Yunus, M. (1999), “The Grameen Bank”, Scientific American, November.

7

Closing the loop – Latin America, globalization and human development1 David E. Bloom, David Canning and River Path Associates Ultimately, people and nations will reject global integration and global interdependence if they do not gain from it. (United Nations Development Programme) Globalization is largely exogenous and inexorable. (United Nations Agencies) Latin America has a very sad tale to tell. (Inter-American Development Bank)

I. Vision of development As world markets expand and integrate, the stakes rise for developing countries. Will increased investment, market liberalization and access to the knowledge economy help kick-start development? Or do countries face a future of increasing instability, inequality and marginalization? In order to benefit from the many opportunities globalization offers, developing countries need to do more than follow what Manuel Agosín2 calls “the passive policy” of liberalization. They need active policies too, he argues. They must improve domestic capital markets, acquire and develop technology, build new infrastructure and access information on foreign markets. They also need policies that ensure stability and minimize economic shocks. As the East Asian crisis has highlighted, there is considerable potential volatility in the globalized system. There is a growing consensus that stronger global governance is needed, with the World Economic Forum identifying “a short-run global financial cycle that can gravely disrupt national and regional economies, even economies that are relatively well run and highly competitive”.3 The challenges of globalization call for more than economic policies, however. Wealth is only one indicator of wellbeing. As well as rising incomes, people care about health, education, equality, security and the environment. Policy-makers in democracies (the vast majority of Latin American countries) need to address these concerns.

Latin America 175 This chapter argues that human development is not just an end of economic development, it is a means as well. Health, education and institutional strength positively influence income, while inequality and insecurity have negative effects. Social and economic factors reinforce each other and generate positive (or negative) feedback. On their own, trade and finance will not make the most of what globalization offers. Active policies for human development must join them in any forward-looking policy portfolio.4 Why rich? Why poor? Since Adam Smith, many economists have asked what makes one country rich and another poor. The wealth of a nation comes from three sources: 1 2 3

What a country has – the resources it can exploit and the capital it has accumulated What a country does with what it has – the value it adds to these resources through the efforts and skills of its labour force How it sells what it has – the success it has in marketing its value-added products and its ability to position itself for maximum competitive advantage.

Successful countries, it is argued, need to exploit their natural resources, accumulate physical capital and build infrastructure. They need to develop a more sophisticated division of labour, to allow workers to become more productive and to hone their skills at specialized tasks, while also exploiting labour-saving technologies. They must trade vigorously, exporting products and services, while importing more productive technologies. Policy-makers can help their countries become more successful by encouraging savings that can be recycled for domestic investment. They need to set tax policies that encourage investment and ensure wages are kept at competitive levels. Markets should be as open as possible, with tariffs set low and state interference minimized. There is much to be said for this liberal worldview. Over the period 1965–90, for example, analysis suggests that if Latin America had been completely open to the world economy, as East Asia was throughout most of the period, Latin America’s annual growth rate would have been on average 0.9 per cent higher. This would have seen a doubling of growth from 0.9 to 1.8 per cent for each year from 1965 to 1990. Per capita GDP in 1990 would have been almost 25 per cent higher, at just under US$4,000 instead of the actual US$2,950, with poverty levels substantially lower.5 However, two issues remain to be addressed. First, for many countries, the adjustments needed to achieve this kind of economic openness are extremely painful in the short term, while there is a delay before benefits

176 Bloom et al. come on stream. In Latin American economies, market liberalization has been accompanied by increases in inequality, with some sections of the population dramatically affected by re-structuring. Alongside the moral need to provide a safety net for the poor, there is also the probability that short-term disturbance can limit, or even reverse, the impact of long-term benefits. The World Bank, for instance, contrasts “China’s cautious and measured road to market reform, starting with agriculture and small and medium enterprises, versus Russia’s rush into liberalization”. China, it notes, has achieved “perhaps the most spectacular poverty reduction in the history of the world”, while Russia faces falling incomes and health outcomes accompanied by rising poverty and crime levels. Mansoob Murshed6 argues that there is now direct evidence that the deleterious side-effects of globalization undermine its overall prospects. “Unlike in the past,” he writes, “it is now widely believed that income inequality actually hampers growth prospects”. The costs of internal conflict can be extremely high. Instability discourages investment, while there are suggestions in the literature that countries with a highly asymmetrical income distribution report lower levels of contentment and happiness – factors that affect productivity. The second problem with the traditional liberal worldview is that empirical evidence shows that it explains only some of the gaps between rich and poor nations. With labour and capital considered as basic inputs, a rich country can (a) have more of these resources per capita; (b) be better at exploiting resources through technology, institutional strength and a refined division of labour; or (c) be more effective at transforming outputs into income, through advantageous location, openness to markets or more skilful marketing. Empirical analysis, however, shows that these possible sources of advantage account for, at best, only half of the income differences we see in the world. There are four possible explanations for this disparity. First, we may have the right framework, but have underestimated in our measurement of inputs. Second, we may have underestimated the differences in technology available to different countries. Third, we may have failed to take into account significant positive feedback between the different types of input. Finally, there may be other factors of production that we have failed to take into account. We believe, along with most economists, that while the first two explanations may explain some of the disparity, they are not sufficient on their own. Instead, we argue that there are other significant inputs and that these multiple factors, in turn, interact to generate a powerful stimulus for growth.

Latin America 177 Knowledge revolution Recent work has changed our understanding of the nature of capital. Our perspective on natural resources, for example, has shifted in parallel with a changing appreciation of the environment. Many are non-renewable, while a healthy environment has indirect and direct value. To maximize national prospects, therefore, it can be sensible to reduce the use of material inputs. Environmental legislation has encouraged several industries to reduce the material intensity of their goods and services, limit their toxic dispersion, enhance material recyclability and extend their product durability. Many companies have used such approaches to gain material advantage, generating new resources from existing waste, for example. Multinational corporation 3M uses the following formula in its groundbreaking (and much imitated) “pollution prevention pays” programme: Pollution (waste materials)  Knowledge (technology)  Potential resources. A complementary trend has been the growing dematerialization of the world economy. Knowledge is now increasingly valuable in the world economy, as economies become increasingly based on intangible rather than tangible assets.7 Spectacular advances in computerization, communications and information technology have greatly enhanced the ability of researchers and entrepreneurs to create new knowledge, products and services. New services have also proliferated, while brand and reputation are now key assets on company balance sheets. A thriving knowledge economy places increased emphasis on innovation, not only in producing new products and services but also in their marketing and delivery. The importance of knowledge has placed a renewed emphasis on people. Labour must be more highly skilled, as scientists, technologists and inventors drive technological progress.8 And developing new technology is only one element of success: turning it into useful (and economically productive) services requires further expertise. Disciplines like management and marketing have become increasingly influential and are at the root of much business success. These changes have swept through companies and are by no means confined to elites. Take car manufacturing, for example. Adam Smith’s conception of the division of labour was most fully developed by Alfred P. Sloan at General Motors in the 1920s and 1930s, with an emphasis on centralized policy-making to control workers who were directed to clearly defined tasks. Over the last twenty years, however, and in response to Japanese pressure, the US motor industry has increasingly adopted a decentralized, team-based manufacturing model. Decision-making (and the expertise it requires) is distributed throughout the organization, with what Adam Smith describes as the

178 Bloom et al. “dexterity in every particular workman” a critical business asset. Simultaneously, marketing departments have grown up to dictate what kind of cars are made, based on information about consumers and their preferences, while each model produced is expected to contribute to the value of the company’s brand. Again, elusive but vital creative and imaginative skills come to the fore. Human capital The study of human capital has developed to focus on the impact of people on the economy. The importance of education as a determinant of growth has been recognized since at least the late 1950s. There is strong evidence to show that a large part of the East Asian “miracle” is attributable to education (World Bank, 1993).9 Clearly, there are significant private benefits to the consumption of education. In Latin America as a whole, according to the Inter-American Development Bank, a worker with six years of education earns 50 per cent more than someone who has not attended school. This gap increases to 120 per cent for those with twelve years of education (i.e. completing secondary school), and exceeds 200 per cent for those with seventeen years of education (i.e. completing a university diploma).10 Society clearly benefits as well. More educated people are more productive (and may be becoming more so as the knowledge economy develops). Just as individuals with better education tend to succeed more in the labour market, so economies with higher enrolment rates and years of schooling appear to be more dynamic, more competitive in global markets and more successful in terms of higher income per capita.11 Once again, the point is dramatically illustrated by East Asia. From 1991 to 1995, East Asia’s economy grew 4.6 points faster per year than that of Latin America. Economists calculate that the higher education levels of the East Asian workforce account for a full half point of that difference. A much newer perspective on human capital suggests it does not simply consist of education. Health is normally viewed as an end product of the growth process. People with higher incomes have a greater command over the goods and services that promote health, such as better nutrition, access to safe water, sanitation and good quality health services. Wealth undoubtedly leads to health, but there is also a clear link in the other direction – from health to wealth. Healthy workers are physically more energetic, mentally more robust and miss less work through illness. Their productivity makes companies more profitable, while a healthy workforce is important when attracting foreign direct investment. At the macroeconomic level, the effects of health on growth are significant and surprisingly strong. If two countries are compared that are identical in all respects, except that one has a five-year advantage in life expectancy, real income per capita in the healthier country will grow

Latin America 179 0.3–0.5 per cent faster than in its less healthy counterpart.12 This added spurt of growth is not trivial, especially given that the rate of income growth in Latin America averaged less than 1 per cent each year from 1990 to 1995. In addition, a rapid increase in the relative size of the working-age population increases the economy’s productive capacity. It also serves to encourage women to participate in the labour force, and raises the potential for saving and for the accumulation of capital in different forms, such as plant and equipment, infrastructure and skills. A third and equally important factor is demographic change. Population debate has traditionally pitted population pessimists against the population optimists. The pessimist argument originated with the Reverend Thomas Malthus who, in 1798, predicted that populations would be under continual pressure to grow as a result of “the passion between the sexes”. However, land, physical capital and knowledge would not increase at the same pace and famine would force population levels back down. Escape from subsistence would be possible only for a tiny fraction of a country’s population. Population optimists, meanwhile, have argued that rapid population growth stimulates innovation, with larger populations developing new technologies that lead to increased wealth creation.13 Economists traditionally tend towards a middle position of “population neutralism”, their research showing no link between the size of a population and growth. Again, however, they stand guilty of treating people as a homogenous entity. A demographic perspective combines a qualitative and quantitative approach to the question of population. To the demographer, it is not just the absolute numbers of people that matter, but the profile of the population and how that changes over time. For developing countries, the most important concept is the demographic dividend, which is available as a “baby boom” generation moves through the population. Basic health improvements, which have occurred throughout the world since 1945, tend to be concentrated initially amongst the very young, as infant and child mortality falls dramatically. They also have a secondary, behavioural effect (and one which Malthus did not expect). As parents realize their children have a dramatically improved chance of survival, they act to have fewer children. This effect is then magnified as parents realize that investment in their children is more certain to be realized over long and productive adult lives. Most therefore reduce their expectations of what is an ideal family size, in order to invest more in fewer children.14 These falls in fertility only follow the health gains after a lag, however. The result is that a bulge in the population distribution occurs. This “baby boom” generation must first be educated, but there then follows a period where there is a vastly increased proportion of workers to dependants. If these workers find productive employment, the impact on the economy is substantial. Perhaps a third or more of the phenomenal burst of growth we know as the East Asian “miracle” can be attributed to this demographic

180 Bloom et al. dividend, a boost to the growth of income per capita of at least two percentage points a year.15 In the twenty years to 2020, Latin America’s total population is projected to grow at a rate of 1 per cent per annum, with a rate of growth for those of working-age projected at 1.4 per cent per annum. If the policy regime stays broadly unchanged from that seen between 1965 and 1990, Latin America’s demographic dividend will translate into a 1 per cent boost to the growth rate. Under the ideal policy environment, however, this same pattern of demographic change could be expected to boost growth by 2.1 per cent per annum. In short, good policy has the power to more than double the demographic dividend. Social capital Social capital broadens the focus from the individual to the society, exploring the relationships between people. A market does not exist in a vacuum. It relies on mutually understood rules, which can be effectively enforced. Strong and fair government, freedom from corruption, and powerful institutions are all important for a market to function. Campos and Nugent (1999)16 identify the following five aspects of good governance: an accountable executive; an efficient civil service; the rule of the law; the participation of “civil society” in law making; and an open and transparent policy-making process. The World Bank also emphasizes the importance of institutional reform for growth and development, pointing out that successful corporations regularly reinvent themselves, “continuously adapting their internal rules, centralizing some functions, decentralizing others, adding discretion where advantageous, and modifying the criteria for rewards when doing so is likely to improve performance”. Yet most countries, developing and developed, continue to use dated and poorly functioning institutional models. In Latin America, the effects of limited social capital can be seen in the rampant nature of tax evasion (Venezuela, Bolivia, Brazil, Argentina and Ecuador rank 43rd, 52nd, 56th and 59th respectively out of fifty-nine countries, according to the World Economic Forum), corruption (Bolivia 55th and Ecuador 59th out of fiftynine) and compromised judiciaries (Ecuador, Bolivia, Venezuela and Peru, 56th through 59th respectively).17 Social capital is about more than the formal relationships within a society, it also refers to the ability of people to work together for a common purpose. Francis Fukuyama argues18 that competitiveness relies on “groups of individuals who, because of a preexisting moral community, are able to work together effectively”. The importance of social cohesion to economic success demands action to combat inequality as well as to increase the stake people of all types feel in national progress. A positive engagement with the forces of civil society (especially NGOs) is increas-

Latin America 181 ingly important, as are measures simultaneously to widen and deepen participation in the political and economic process. The most basic unit of social capital is the family, which is experiencing change throughout the world. The developed world has so far failed to provide very good models for these changes. Family welfare policies have tended to promote dependency, children in single-parent families have often been disadvantaged, and family breakdown has been associated with rising crime levels. The decline of the family has become a focal point for those nostalgic for the “old certainties”, and is linked to a lack of engagement with society prevalent in many Western countries. Latin America is far behind US rates for those living alone; 28 per cent of wealthy Americans – and 6 per cent of poor – live alone, whereas 70–90 per cent of children in Latin America live in nuclear or extended families. This ranges from 66.3 per cent in El Salvador to 81.8 per cent in Paraguay and 83.4 per cent in Mexico. There is a desperate need for fresh thinking in this area. The role of women is, of course, critical. Women contribute more of their income than men to the family purse. Their influence is also essential to the education of children who, across the developing world, are making considerable progress in health, education and other key dimensions of gender equity. Strong families contribute to strong economies, but need considerable support to balance the demand for work, and for care for children and the elderly. The importance of social capital can be seen in two contrasting (though occasionally related) phenomena: entrepreneurship and crime. Crime is a major deterrent to business. It is widely believed, for example, that concern about the level of crime in some South African cities may have contributed to the decision to award the 2006 soccer World Cup to Germany. This decision not only robs Africa of an event of enormous symbolic importance, it also removes significant direct and indirect economic benefits – from the tourism which the World Cup promotes, for example, or the chance for South Africa to demonstrate its organizational efficiency to potential foreign investors. Entrepreneurship, meanwhile, is essential to economic success, especially during periods of rapid change. For entrepreneurship to flourish, governments must make efforts to assist its growth. John Kay19 points out how culturally mediated this individualistic pursuit is. It is, he says, a disciplined form of pluralism, whereby people are given the freedom to act to make ideas concrete, but are reined in by social structures when the results are unsuccessful. It may also be infectious. Many governments certainly hope so, and are setting policy to try and encourage more people to catch the disease. Capital interactions Human and social capital not only interact with income, they also affect each other, setting up strong multiplier effects that can transform an

182 Bloom et al. economy’s prospects. The effects of health are wide ranging, for example. People are likely to invest more in educating their children in a healthy society, as they pursue a policy of investing more in smaller families, confident that children have a high chance of reaching maturity. They also have stronger incentives to develop their own skills in a process of lifelong learning, as they can expect returns over a longer period. In addition, healthy people learn more easily and are less likely to miss vital stages in their education through illness. Healthier people have more incentives to save for their retirement, increasing the availability of capital in the economy. Poor health, meanwhile, leads to significant strains on the public purse. In sub-Saharan Africa, for example, AIDS is impeding economic growth by killing adult workers in large numbers, depleting the wherewithal for dealing with other diseases such as diarrhoea, hepatitis, malaria and tuberculosis. Education has significant impact on income (as discussed above), but it also affects health, with the education of women being one of the best ways of improving their children’s health (women are also consistently better at sharing medical- and health-related information than men, in both developing and developed countries). Education is also currently the most effective weapon in the battle against AIDS. Investment in women’s education also increases their economic productivity. In Venezuela, for instance, 85 per cent of female university graduates work, compared to 30 per cent of women who only received primary education. There is another and very compelling reason for countries to invest in higher education: as the world becomes more complex, with rafts of international legislation and multilateral agreements in play, each country needs its own cadre of intelligent, educated and well-trained people to maximize their nation’s interests.20 Insights about the demographic transition offer a powerful planning and management tool to help deliver the region’s demographic dividend. The dividend itself, of course, emerges from the sustained inputs of an earlier generation of policy-makers and planners, working in particular on health and education. However, it is crucial for policy-makers to understand the substantial ways in which the demographic transition operates across multiple sectors. There are complex effects on almost every main area of consideration for policy-makers and planners: education and health, micro-finance and support for small businesses, savings and capital availability, pensions and even political stability – high numbers of unemployed, for example, are destabilizing. Yet it is a one-off gift – and will only be a gift if there are appropriate policies in place to use it. The idea of a “spiral”, which can be virtuous or vicious, captures much of the realities policy-makers face. Increasing education promotes health and wealth in a positive ascending loop. Conversely, decreasing the quantity and quality of education available to this generation will reduce health and wealth. This spiral is phenomenally

Latin America 183 complex, with multiple inputs from multiple sectors. Yet as a system, it can operate in only three ways: it can remain in a stable state of equilibrium (although the sheer energy of liberalization, globalization and a large generation of young people would suggest this is highly unlikely); it can lead to self-reinforcing improvements (where, for example, improving the base of healthy and educated workers increases the range and depth of entrepreneurial activity, in turn increasing the amount and quality of employment, which then delivers increasing savings and available capital to entrepreneurs); finally, it can deteriorate. Here the demographic transition meets failures in the education and health systems, for example, delivering a worsening spiral of decline, rising unemployment and so forth.21 It’s a nightmare scenario – as Russia, for example, is only too painfully aware. Development action Developmentalists are currently struggling with the sheer complexity of the problems faced by poorer countries. Several frameworks are being developed to grapple with the holistic nature of the problem. One example is the World Bank’s Comprehensive Development Framework (CDF), currently at a pilot stage.22 In the CDF, each country is called on to “own its development strategy” and to determine goals, timing and sequencing of programmes. Simultaneously, they are exhorted “to build partnerships” with a vast number of actors, while also developing “a long term vision” with national support. Further, “structural and social concerns should be treated equally and contemporaneously with macroeconomic and financial concerns”. Although there is much value in this approach, we would point out that it may take a great deal of time to develop and implement an all-encompassing strategy and sets of tactics that are “all things to all men and women”. Neither is there sufficient institutional capacity to go round. Governments and development agencies are increasingly honest about their past failures. It is unlikely these failures were due solely to poor policy. Implementation is clearly a problem, and one which will grow as increasingly complex approaches are prescribed. An understanding of the virtuous spiral offers the opportunity to proceed in a way that takes complexity into account, but offers the possibility of directed action. Instead of advancing on all fronts, governments need to take sufficient action to push a spiral into action and then ensure that beneficial effects are quickly fed into other areas. A strong, effective and positive push in one or more areas – education, health or microfinance, for example – should be used to start the process of social and economic renewal. If the initial concentration is economic, it is essential to ensure that benefits are quickly fed into human development (the converse also applies).

184 Bloom et al. The single model for development (which changes over time, like fashion) thus gives way to multiple possible models, which can be adopted according to national strengths and preferences. Not all models are viable, of course, and some will work better than others. But policy-makers need the vision to adopt one model, explain their vision with clarity and fulfil it in the medium to long term.

II. The Latin American story A focus on the links between the quality of life and growth has major implications for the policy-maker. Public policy needs to focus on three areas. First, it is important to balance the rights and responsibilities of individuals within society, in order to develop a sense of a social contract. Policy-makers need to carry their populations with them as they institute market sharing, which means encouraging risk-sharing between business, government and the labour force. Social exclusion is an insidious threat, and creative policies are needed to develop a stake for marginalized groups in social development. Second, governments need to act to develop public goods, where benefits above and beyond private benefits accrue as a whole to society. Spending on these goods is an investment in the future and one for which the market inadequately provides. Finally, the importance of stability should not be underestimated. The changes associated with globalization can have dramatic affects on some groups, with consequent impacts on the nation’s supply of human and social capital. Education Latin America needs to modernize its education system, and to concentrate on offering as many young people, as quickly as possible, a better quality education. It also needs to deal with major shifts in the pattern of demand. The region has made great strides towards providing universal access at primary level, with universal access in many countries. But as the demographic wave works through, it will see demand for primary education fall, while pressure builds at secondary and tertiary levels.23 It must therefore develop radical new initiatives to meet the more complex, diverse and costly demands of more advanced education. Higher education should be an increasing priority. Narrow – and misleading – economic analysis has traditionally shown that investment in higher education attracts much lower social and private returns than investment in primary education. This analysis is based solely on increases in earnings, rather than the contribution a highly-educated people make as economic and social entrepreneurs, leaders and representatives of their countries on the world stage. The need for increases in the quantity and quality of higher education will become even more pressing as globaliza-

Latin America 185 tion and liberalization continue. Within the knowledge economy, higher education institutions play a critical role in generating new knowledge, making the global stock of knowledge accessible at national level and educating young people to take advantage of new economic opportunities. Already, Latin American higher education institutions are stretched by increased demand. Argentina, Brazil and Mexico, for example, currently enrol between one and two million students in tertiary education, while “mega-universities”, such as the National University of Mexico and the University of Buenos Aires, each have over 200,000 students. The private sector is playing an increasingly important role. Over 65 per cent of tertiary students in Colombia now attend private institutions, as do 60 per cent in Brazil and over 40 per cent in Paraguay. Some countries have actively set about encouraging the private sector. Mexico and Brazil offer tax exemptions, while Chile provides direct grants to help bolster enrolment in private institutions (World Bank, 1994).24 However, policy-makers will wish to make sure that quality control is built into the system as it diversifies to meet demand. Latin American societies need to engage in a debate about the aims and objectives of higher education, in order to design a system that will meet their future needs. The resulting systems will differ widely, therefore, but common features are likely to include being: • •

•

•

relatively autonomous, with governments providing clear supervision, but not day-to-day management explicitly stratified, allowing institutions to play to their strengths and serve different needs; to compete for funding, faculty and students; and to innovate to take advantage of the opportunities offered by communication technology cooperative as well as competitive, as human, physical and knowledge capital are shared within the system creating, for example, a “learning commons” where facilities – computers, libraries, laboratories – are open to any and all students open; encouraging higher education institutions to develop knowledge- (and revenue-) sharing links with business and to deepen the dialogue with society leads to stronger democracy and more resilient nation states.

Policy-makers must explore new funding options, adopting models that maximize the input of the private sector (both profit and non-profit making) and students, while using public funds to secure public goods, such as increased access and courses in the national interest. Resources must also be more effectively used and a renewed focus on governance should be a priority in all countries. New curricula are also needed, especially in two contrasting areas: science and technology, and general education. The knowledge economy demands a mix of highly trained

186 Bloom et al. generalists and specialists – Latin American countries need a sufficient supply of both. Some innovation is already under way. In response to growing demand for private higher education in Bolivia, the Foundation for the Integral Development of Bolivia (FDIB) created the first private university in the country. Nur University (Universidad Nur) began its first academic year in 1985 with only eighty-five students. It has since grown to enrol some 5,000 students per year. Nur became a government-recognized and affordable alternative to the traditional national public university system. In Chile, meanwhile, a reform programme implemented during the early 1980s led to eighty-two professional institutes and 186 two-year technical centres being established. Chilean reform included introducing tuition fees and diversifying funding sources. New evaluation systems were created with a focus on fostering accountability and improving quality – and incentives are increasingly based on performance rather than seniority. Mexico has focused on curriculum reform, improved evaluation and increased student enrolment in graduate programmes – many of whom will be future university professors. This is an essential investment in the future – for without suitable faculty, the system will be unable to grow, except at the expense of quality. Health and demography Policy-makers can develop health policy with the knowledge that health and demography are among the most potent influences on economic growth. Latin America is now well into its demographic transition, but it needs to ensure that its policies take advantage of this opportunity and that the demographic dividend is collected in full. Policy-makers should concentrate on ensuring that health gains are maintained and felt consistently across the population. The size of the demographic dividend depends on falling fertility, and this will happen faster in a healthy population. Some groups are currently marginalized, while HIV/AIDS is a particular, but poorly combated, threat to the working-age population. Health education is especially important here, with HIV/AIDS infection rates best reduced through imaginative information campaigns, using the best in modern marketing to effect behavioural change, and through sustained health improvements elsewhere. Health education is also needed to help complete the demographic transition, by ensuring that fertility continues to fall. Many Latin American families report problems in achieving their desired family size, with a survey of married women in El Salvador, Guatemala and Mexico showing more than a quarter do not want to have another birth within the next two years (Inter-American Development Bank, 1999).25 Helping to meet existing unmet demand for birth control would itself be enough to drive fertility levels down to the replacement level of 2.1 live births per woman.

Latin America 187 Reproductive health services also reduce death, morbidity and illness rates among women. Latin America currently has a patchy record in their provision. In Bolivia, Peru and Honduras, maternal mortality rates are very high – at 390, 265 and 221 maternal deaths per 100,000 live births respectively, with the burden disproportionately carried by poorer households. Savings and pensions Knowledge of demographic change provides policy-makers with a powerful tool to predict demand for a range of other services, such as education (discussed above), savings and pensions. Saving rates are heavily dependent on age, with ages forty to sixty-five the peak savings years, after children have left home and as people prepare for their coming retirement. Up to now, increases in the working-age population in Latin America have been concentrated in the under-forty age group; this group typically saves relatively little. However, Latin America is set to experience a dramatic growth in the forty to sixty-five age group in coming years, and savings can be expected to increase. How much they increase relies on policy decisions. Currently, savings rates are much lower than might be expected and about half the level found in East Asia. Latin Americans are not saving as much as they might because of historic financial instability. The region’s governments need to do more than passively accept the increased savings generated by changed demography. They must explore ways of encouraging savings in order to magnify the effects generated by the demographic portal of opportunity. Latin American countries currently score particularly poorly in both financial sector risk ratings (Brazil, Argentina and Ecuador come 54th, 55th and 58th in a recent fifty-eight-country study26) and country credit ratings (Peru, Brazil, El Salvador, Venezuela, Bolivia and Ecuador coming 48th, 49th, 50th, 51st, 53rd and 57th respectively in another study27) – factors which act as a huge deterrent to both saving and investment. The demographic transition will eventually lead to increasing numbers of old people, by which time it is vital that countries have become rich enough to support decreasing worker/dependant ratios. Currently only Argentina, Uruguay and Barbados have six or less people of working age for each person older than sixty. As time goes by, this ratio will drop to four and then, in the most demographically mature countries, to three. By 2050, elderly people will make up 15 per cent of the population, compared to 5 per cent today. It is important to start saving a proportion of the demographic dividend now in order to pay these bills tomorrow. Pension schemes need to be funded through direct contributions, so that this generation is responsible for its retirement, thus improving income distribution among present generations, but also between this one and future ones. Increased health

188 Bloom et al. bills, which will have to be paid for by a dwindling working-age population, will place great pressure on both the tax burden and public debt as governments are forced to borrow to keep up.28 Public/private partnerships in healthcare provision will be essential for easing the pain.29 Family/gender Developmental changes mean that Latin America is becoming predominantly urbanized, with family structure changing as family units shrink and the number of both single-parent and dual-income families rises. This could have potentially huge social impacts, and policy-makers need to develop bold initiatives to enable new types of family to develop and thrive. A successful family policy will be based in a clear understanding of the changing roles of men and women. It will seek to help families maximize their investment in the smaller number of children they bring up, and it will look at the problems faced by elderly relatives – who may no longer be able to rely on their children to provide for them in their old age. Reforms will be greatly facilitated by a change in attitudes towards and among older people. If the elderly can come to be seen as a valuable resource rather than a burden – a process which will be helped by all the new industries likely to flourish in the wake of the demographic shift – they will be able to enrich society rather than be seen to impoverish it. Four elderly, illiterate Bolivian women in La Paz have shown that the elderly are willing to respond to the challenge and use their skills to benefit society. The traditional respect in which the elderly are held in Bolivian communities such as the Aymara is dying out as many rural families move to the city, where they often live in extreme poverty with little time to care for older relatives. Realizing that they now have to earn respect by becoming less of a burden to their children, these women set up a group spinning Alpaca wool. They made contact with a group of elderly people in Sweden, who helped to sell the wool there. From the proceeds, the women have now built a house which provides lunch every day to twenty local older people and rooms for nine others, who have joined the weaving workshops.30 Currently, a relatively small percentage of women participates in the Latin American labour market compared to other regions, even though education levels are close to parity in many countries. Increasing this will have a major impact on the economy as well as on poverty. A Latin American woman is currently 50 per cent less likely to work if she is married, while family size further decreases the chances of her working by 3–5 per cent for each child. Advanced education also encourages labour participation, as women seek to maximize their own investment in education. In Venezuela, for instance, 85 per cent of female university graduates are working, compared to 30 per cent of women who only received primary education. Women are also 25 per cent more likely to work when they

Latin America 189 head a single-parent family. Given that the proportion of female-headed households is increasing throughout the region, this will continue to have a significant impact. Action from policy-makers is also needed on equal wages (women earn just 60–80 per cent of the male wage for similar jobs in Latin American countries). Increased child care is also badly needed. Child labour and exploitation is another area demanding much more serious attention. An estimated 10 per cent of children aged ten to fourteen work in Latin America (down by 5 per cent since 1960). Although this may serve a family’s short-term interest, it is not in the long-term national interest for these children to be kept away from school. There is also increasing resistance to child labour from the global consumer, a pressure being passed down the supply chain by multinational corporations. Employment and security Latin America currently suffers high rates of youth unemployment. An understanding of the demographic transition should highlight the importance of tackling this problem. This requires a significant philosophical shift in thinking. No longer should Latin America be seen as having an unemployment problem, but instead a labour force advantage. A large and youthful (and flexible and hopefully well-educated) labour force must be put to good use, contributing to growth – as it did in East Asia – and enabling countries to exploit the demographic dividend. Increased labour-market flexibility is needed, as restrictive labour legislation clearly hinders job creation.31 However, policy-makers need to balance costs and benefits, to ensure that workers feel they have a stake in the globalized economy (with all the benefits for social cohesion discussed above). Young workers are more likely to have internalized flexible attitudes and to accept the pressure for greater productivity. They expect to benefit from inter-sectoral and inter-occupational mobility, however – and are less likely to feel loyal to an individual employer. Management of globalization requires concerted action to help groups excluded from its benefits. An economic safety net can be used to increase the willingness of people to take risks, while loans for re-training are important in creating a mobile workforce. The state needs to design programmes that foster independence, however. A dependency culture is clearly unhelpful for growth. The knowledge economy is also likely to see growth in the importance of small businesses, with micro-enterprises already thought to account for up to 20 per cent of Latin American GDP (Westley, 1997).32 Small businesses find it especially hard to attract the credit that they need to grow, with a very small share of micro- or small enterprises receiving credit from the banking system. The past two decades have seen the development of successful new models of micro-finance by the private sector, NGOs, and the state. By targeting low-income households, and giving credit that is

190 Bloom et al. often collateral-free and at significantly lower interest rates than those in the informal credit market, these institutions help micro-enterprises to develop and provide income-generation opportunities to poorer segments of the rural population. Models of commercially sustainable micro-finance are now emerging, such as Banco Sol in Bolivia and Calpia in El Salvador. The operation of these banks (and reportedly dozens of others worldwide) demonstrates that, among the poor, the demand for loans is strong enough to elicit a commensurate supply of savings at a rate of interest that is adequate to cover the cost of transactions.

III. Future agenda Progress in the modern world comes through a process that the Xhosa people of South Africa call ubuntu, which translates roughly as “people help people through people”. As Desmond Tutu explains it: “None of us comes into the world fully formed. We would not know how to think or walk or speak as human beings unless we learned it from other human beings. We need other human beings to help us to be human.”33 Globalization is more than an economic phenomenon. It is pulling people and encouraging them to interact in different ways. As the world of work changes, so do national and international economies. This chapter calls for quality of life to be seen as an integral part of the economic development agenda. Human and social capital are key determinants of income growth. Healthy, educated, confident, entrepreneurial people make successful societies. A policy agenda that reflects this will be successful and gain popular support. This new agenda suits Latin America in many ways. It is educating large numbers of its people and is not suffering the health reverses seen in subSaharan Africa or Eastern Europe. It is also in the middle of a demographic transition which, with the right policies, will lead to a substantial demographic dividend. It is also – at last – adopting sound economic policies which are opening its markets, while building financial systems that encourage people to save and invest. Problems and obstacles remain, however, as the deep recession in Argentina and the recent political upheavals in Peru and Ecuador have shown. Latin America has not seized its opportunities in the past, due to poor policy. This presents a major challenge for the future. It is time for the region to fulfil its potential.

Notes 1 An earlier version of this chapter was presented at the United Nations Economic Commission for Latin America and the Caribbean (ECLAC), Santiago, Chile, 8–10 November 1999 (“Latin American Regional Policy Dialogue”). The

Latin America 191

2 3 4

5

6 7

8

9 10 11 12

13

14

authors are grateful to the Dialogue attendees for valuable comments, and to Manuel Agosín, Francesca Castellani, Ricardo Menendez-Ortiz, Lucas Assuncao and Ali Dehlavi for many helpful discussions and assistance. M. Agosín (1999), Trade and Finance: A SHD Centred Conceptual and Operational Framework, unpublished. World Economic Forum (1999), The Global Competitiveness Report, OUP, Oxford. For a full discussion of how liberalization and globalization can contribute to economic growth when combined with sustainable human development, see Chapters 2 and 6 of this book, also D. E. Bloom, A. S. Mahal, D. King, F. Mugione, A. Henry-Lee, D. Alleyne, P. Castillo and River Path Associates (2001); “Jamaica: Globalization, Liberalization and Sustainable Human Development”, UNCTAD/UNDP Programme on Globalization, Liberalization and Sustainable Human Development, UNCTAD, Geneva. D. Bloom, D. Canning, D. Evans, B. Graham, P. Lynch and E. Murphy (2000), “Population change and human development in Latin America”. In 1999–2000 Report on Economic and Social Progress in Latin America, Inter-American Development Bank. S. Mansoob Murshed (1999), UNU/WIDER, Globalization and Small Vulnerable Economies: A Survey of the Issues, UNU/WIDER. World Bank (2000), Task Force on Higher Education and Society (2000), Higher Education in Developing Countries: Peril and Promise, World Bank, Washington, DC; World Bank (1997), World Development Report 1997: The State in a Changing World, Oxford University Press, New York. Six of seventeen countries that spend less than 0.5 per cent of GNP on research and development spending are found in Latin America – with only El Salvador (2.2 per cent) of the ten Latin American countries in the fifty-ninecountry study spending more than 1 per cent of GNP in this crucial area (1999 UNESCO Statistical Yearbook). D. E. Bloom and J. G. Williamson (1998), World Bank Econ. Rev. 12(3): 419; D. E. Bloom, D. Canning and P. N. Malaney (2000), Popul. Dev. Rev. 2000, 26(Suppl.): 257–90. Inter-American Development Bank (1999), Facing up to Inequality in Latin America, IDB, Washington, DC. D. E. Bloom, P. Craig and P. Malaney (2001), The Quality of Life in Rural Asia, Oxford University Press, Oxford. See D. E. Bloom and D. Canning (2000a), “The health and wealth of nations”, Science, February 18. See also World Health Organization (1999), World Health Report, 1999, WHO, Geneva; D. E. Bloom and D. Canning (2000b), “The Health and Poverty of Nations: From Theory to Practice”, Paper presented to the WHO Commission on Macroeconomics and Health, November. Friedrich Engels noted how science solves the population/food conflict: “Malthus puts forward a calculation upon which his whole system is based. Population increases in geometrical progression . . . [and] The productive power of the land increases in arithmetical progression . . . The difference is obvious and horrifying – but is it correct? Where has it been proved that the productivity of land increases in arithmetical progression? The area of land is limited – that is perfectly true. But . . . there still remains . . . science, the progress of which is just as limitless and at least as rapid as that of population.” Nobel Prize-winning economist Gary Becker has suggested that the fall in fertility in the West can be attributed to parents behaving towards children in a similar way to consumers’ behaviour towards durable goods. He notes an increasing tendency, driven by increased knowledge of contraception and the higher costs of having children, towards “consuming” fewer children of higher quality (healthier and better educated).

192 Bloom et al. 15 D. E. Bloom and J. G. Williamson (1998), World Bank Econ. Rev. 12(3): 419; D. E. Bloom, D. Canning and P. N. Malaney (2002), Popul. Dev. Rev. 2000, 26(Suppl.): 257–90. 16 N. F. Campos and J. B. Nugent (1999), “Development performance and the institutions of governance: evidence from East Asia and Latin America”, World Development, 27(3): 439–52. 17 World Economic Forum (2000), The Global Competitiveness Report 2000, Oxford University Press, Oxford. 18 F. Fukuyama (1995), Trust, Penguin, New York. 19 J. Kay (1999), “The glittering upstarts”, Management Today, October. 20 See the Task Force on Higher Education’s report, Higher Education in Developing Countries: Peril and Promise, available at www.tfhe.net. 21 D. E. Bloom and J. Williamson (1998), “Demographic transitions and economic miracles in emerging Asia”, World Bank Economic Review, 12: 419–56. 22 World Bank (2000), Entering the 21st Century: World Development Report 1999/2000, World Bank, Washington, DC. 23 Only a third of Latin Americans attend secondary education, compared with around four-fifths in South-East Asia (P. Hakim (2000), “Is Latin America doomed to failure?” Foreign Policy, Winter.) Enrolment in tertiary education varies widely across the region, from 30 per cent in Chile to 8 per cent in Paraguay, but even Chile is some way behind the likes of Canada (88 per cent), the US (81 per cent), Australia (80 per cent) and Finland (74 per cent), and Ecuador, Colombia, Mexico and Brazil all fall in the bottom fourteen of the fifty-eight countries measured (UNESCO 1999 Statistical Yearbook). 24 World Bank (1994), Higher Education: The Lessons of Experience, World Bank, Washington, DC. 25 Inter-American Development Bank (1999), Facing up to Inequality in Latin America, IDB, Washington, DC. 26 International Country Risk Guide, Political Risk Service January 2000 (cited in WEF, 2000, ibid). 27 Institutional Investor March 2000 (cited in WEF, ibid). 28 For a fuller discussion of the impact of aging, see D. E. Bloom, A. K. Nandakumar and M. Bhawalkar (2001), “The Demography of Aging in Japan and the United States”, Paper presented at the American Academy of Arts and Sciences, March 2001. 29 D. E. Bloom, P. Craig and M. Mitchell (2000), Public and Private Roles in Providing and Financing Social Services: Health and Education, ADBI Publishing, London. 30 HelpAge International (1999), The Ageing & Development Report, Earthscan, London. 31 Peru, Brazil, Bolivia, Venezuela and Ecuador are all in the bottom quarter of the fifty-nine countries assessed by the World Economic Forum in terms of how burdensome administrative regulation is. Only Colombia and Chile fall in the top half (WEF, 2000, ibid). 32 G. Westley (1997), Credit Union Policies and Performance in Latin America, OCE Working Paper No. 355, IDB, Washington, DC. 33 Dunrossil Lecture speech delivered by Archbishop Desmond Tutu in the Great Hall, Parliament House, Canberra, on 6 December 1994.

8

Continental drift Globalization, liberalization and human development in sub-Saharan Africa1 David E. Bloom, Mark Weston and David Steven

I. Introduction One of globalization’s most enthusiastic proponents, Tony Blair, has described Africa as a “scar on the conscience of the world”. While much of the developing world has experienced strong economic growth and improved standards of living, Africa, with very few long-term exceptions, has been left behind. Half of the continent’s population lives in poverty; nearly one adult in ten is infected with HIV (in seven countries, one in five is infected); and two out of every five of the world’s wars occur in Africa.2 In many areas, things have been getting even worse: growth in real per capita gross domestic product (GDP) was negative in the region during the 1990s;3 one-quarter of African countries have seen human development indicators deteriorate in recent years;4 and democracy is under threat across the continent, with Zimbabwe, Ghana, Zambia and Kenya the most prominent manifestations of the weakness of democratic institutions.5 Many have blamed Africa’s ills on globalization itself. International donor policies, the global decline in primary commodity prices, rich-world protection of agriculture and textile markets, and the increased mobility of people that has exacerbated the spread of AIDS have all had an impact on Africa. Although historical, geographical and internal political factors have also played a large part in Africa’s plight, there is no doubt the continent presents a challenge to globalization’s advocates. This chapter attempts a broad summary of Africa’s development. Part one examines the state of Africa in the context of the liberalization, economic growth, and human and social development framework.6 Part two looks at the role of geography, health, policy and the international environment in Africa’s development. And the final section makes recommendations on the strategic interventions likely to trigger virtuous development spirals.

194 Bloom et al.

II: The state of Africa Liberalization There is plentiful evidence that Africa’s failure to sufficiently open up its markets has hampered its integration into the global economy. Importsubstitution strategies predominated in the immediate post-colonial era, with industries relying on protection for their survival. This strategy failed to build productive industries, and left Africa ill equipped for opening up to the global economy.7 Although protectionist policies gave way to economic liberalization in the 1980s and 1990s, it has nevertheless been estimated that over 25 per cent of Africa’s slower growth relative to East Asia is due to its lack of economic openness.8 While not the only factor, therefore, the relatively limited and belated liberalization of its economies has made a significant difference to the region’s prospects. Exports make up 29 per cent of Africa’s GDP – similar to the world average of 27 per cent.9 The region’s share of world trade, however, is less than 1 per cent.10 Most of the continent’s exports are low-value primary goods, with manufactures making up less than 20 per cent of total exports.11 Africa has increased its dependence on primary commodities since 1980,12 and worldwide falls in primary product prices (prices fell by an average of 25 per cent from 1997 to 199913) have magnified the effects of the continent’s heavy reliance on primary goods and highlighted the need to diversify. High tariff barriers on imports, however, have hindered diversification. Tariffs in Africa have fallen more slowly than those in other developing regions in the past two decades: while average developing country tariff rates were reduced by roughly half from the early 1980s to the late 1990s,14 Africa’s fell less rapidly. Obtaining the imported inputs needed for upgrading industries, therefore, is becoming easier for the rest of the developing world than it is for Africa. Even between African countries, trade barriers have remained high. Average developing country tariffs on manufactured goods are much higher than industrial countries’ tariffs on developing world products. With one-sixth of Africa’s exports going to other African countries, lowering intra-regional import duties would provide some incentive to the region’s industries and farmers to expand and upgrade their production base. Liberalization of domestic industries has also been slow. The opening up of state-run service sectors in many areas has been either non-existent or half-hearted. Yet greater foreign investment in services and industries could provide Africans with new knowledge, technology and skills. While Africa’s progress on liberalization is slow, however, it is not insignificant. In most countries, restrictions on imports have been lifted, tariffs reduced and measures to attract foreign investment put in place.

Sub-Saharan Africa 195 Foreign direct investment (FDI) in the continent rose from $834 million in 1990 to $7 billion in 1998.15 FDI’s contribution to Africa’s GDP has risen from 0.3 per cent in 1990 to 2.4 per cent today.16 Exports, too, have become increasingly important, rising from an average annual growth rate of 2.4 per cent in the 1980s to an average of 4.1 per cent in the 1990s.17 And while the region’s share of world trade remains extremely low, the steady decline that began in the 1950s has recently been halted.18 As well as the steady lowering of barriers to trade and foreign investment, there is also evidence of a desire to speed up regional cooperation. Trade agreements such as the Common Market of Eastern and Southern Africa (COMESA), the Economic Community of Western African States (ECOWAS) and the Southern African Development Community (SADC) have arisen in order to liberalize regional trade, although many of these blocks overlap and the system is as yet far from streamlined. Furthermore, negotiations by the “G77” group of developing countries have become increasingly effective in recent years. A minority of African countries have already seen benefits from liberalization. Uganda’s liberalization policies have contributed to annual GDP growth since 1995 of 6 per cent. FDI, which has been particularly concentrated in manufacturing, mushroomed between 1991 and 1997,19 enabling the country to diversify its export base, and coinciding with a rise in domestic savings from 0.7 per cent of GDP in 1991 to 7.9 per cent six years later.20 This in turn facilitated greater investment in manufacturing and export promotion, and the share of the industrial sector in GDP has increased by one-sixth since 1996.21 Uganda has achieved impressive growth despite starting from a much weaker position than most of its neighbours. The country is landlocked, its infrastructure weak, poverty rates hover around 40 per cent and debt is among the highest in the world. Moreover, world prices for its main export – coffee – have been falling. Export promotion, however, combined with deregulation and privatization policies that are friendly to foreign investors (who receive tax incentives and may own 100 per cent of investments in companies), has helped Uganda’s people to turn the corner. Per capita GDP growth averaged 3.8 per cent from 1992–98, and poverty reduction proceeded six times faster than in the rest of Africa.22 Liberalization combined with export promotion and measures to attract FDI have also contributed to growth in Mauritius and Mozambique. FDI in export processing zones spurred Mauritius’ successful diversification efforts, and Mozambique, whose GDP growth since 1996 has been among the fastest in the world, has used foreign investment to boost domestic industries (the Mozambique Government responded to the global increase in the price of fertilizers, for example, by targeting foreign investment that would boost domestic fertilizer production23). Liberalization has not produced benefits for all, however. Another

196 Bloom et al. landlocked, heavily indebted African country, Malawi, shows how liberalization by itself is not sufficient for growth, or even for integration into the global economy.24 Malawi began its structural adjustment programme in the mid-1980s, but since liberalization began, and despite opening up its export regime, the share of exports in the country’s GDP has fallen, from 30 per cent in 1994 to 27 per cent five years later. Economic growth, not helped by declining world tobacco prices (tobacco makes up 66 per cent of Malawi’s exports25) and a fall in foreign investment, has slowed.26 Foreign firms have been deterred by a weak investment climate, and liberalization has not been complemented by infrastructure improvements or the investment in the country’s human capital base needed to promote export diversification and greater productivity. Malawian firms and farmers have, as a consequence, been unprepared for the opening up of their markets to global competition.27 Governance of the economy has been much weaker in Malawi than in Uganda. The Ugandan Government embarked on reform in 1987, with a strong commitment to achieving macroeconomic stability. Inflation has been contained, privatization of utilities has begun, and the exchange rate has been allowed to float. At the same time, higher salaries for public sector workers have been a key component of civil service reform, thus reducing the temptations of corruption; infrastructure has improved, with a particular focus on increasing the efficiency of the energy and transport sectors; and export promotion has proceeded apace. As a result of its strong macroeconomic performance, Uganda has become the first country to receive debt relief under the Heavily Indebted Poor Countries (HIPC) initiative, and the country’s increased attractiveness to foreign investors is reflected in the fact that Uganda’s improvement in the 1997 Institutional Investor ratings was greater than that of all other countries.28 Malawi, on the other hand, has failed to achieve macroeconomic stability. Annual inflation and real interest rates remain high, and reform plans have not been successfully implemented. The unstable economic environment has deterred foreign investors and made it difficult for Malawian producers to diversify. Privatization has been slow, and inefficient state-owned communications and energy utilities continue to hinder efforts to increase manufacturing productivity and facilitate trade. Although tariffs have been reduced, non-tariff factors such as price controls, continued civil service corruption and weak physical infrastructure have kept production costs high. As a consequence, while Uganda has become an attractive destination for foreign investment, many foreign firms have left Malawi, which is rated by investors as one of the least attractive countries in Africa.29 Interestingly, Uganda, which has benefited so much from liberalization, has retained relatively high import tariffs on sugar and textiles. Another African success story, Mauritius, has also protected its domestic

Sub-Saharan Africa

197

industries with high tariffs.30 Zimbabwe and Malawi, on the other hand, saw food prices rocket after liberalization, increasing poverty and deepening poverty traps for those who were already poor.31 Tariffs, as developed world import duties on agriculture and textiles implicitly acknowledge, protect the sectors that are most vulnerable to globalization (many of East Asia’s successful globalizers, too, protected consumer goods while liberalizing tariffs on the imports needed to develop exports). They allow industries time to modernize and improve productivity in advance of opening up to world markets, and facilitate the diversification that is essential both for spreading risk and for moving up the economic value chain. Targeted tariff reductions on inputs needed for exports and modernization (for example, sewing machine parts, which would help more African cotton producers to upgrade to textile production) are likely to be more palatable to domestic producers than across the board tariff reduction. Liberalization in Uganda, in sum, has been accompanied by efforts to strengthen institutions, stabilize the economy and promote exports. In Malawi, however, attempts to improve governance have been inadequate and liberalization has been held back by continued state intervention. Both more thoroughgoing liberalization and a greater emphasis on government-led macroeconomic and institutional reforms will be required for Malawi to begin to catch up. African governments’ efforts to liberalize have in many cases been a response to international donor encouragement. The next section will review how much these policies have contributed to economic growth, the second sphere of the development framework, and whether the overall policy environment has been conducive to growth. Economic growth The growing economic divide between Africa and the rest of the world is not a recent phenomenon. In 1820, per capita income in Africa was 68 per cent of the world average. Despite increasing by a factor of almost 2.5 since then, by 1992 African income levels had fallen to 25 per cent of the world average. Consistent with these figures, absolute growth was considerably slower than in other regions – per capita incomes in Asia and Latin America were 5.9 and 7.4 times higher in 1992 than they had been in 1820. In Western countries, they were 14.9 times higher.32 Since reaching a peak growth rate of 1.5 per cent in the 1960s, per capita incomes in Africa have declined and are now 10 per cent lower than they were in 1980.33 GDP growth throughout the 1990s was negative and, whereas in the 1960s the continent was economically on a par with much of Asia, it is now by far the poorest region in the world. Per capita GDP, investment, exports and savings all declined between 1970 and 1997 – in most of the rest of the developing world these measures advanced significantly.34 As a consequence, many African economies have become

198 Bloom et al. heavily dependent on loans, and by 1997 foreign debt was equal to 80 per cent of the region’s GDP. Progress over the next decade is expected to be more encouraging, albeit slow compared to all other regions. Africa’s economy is forecast to grow by 3 per cent per annum between 2000 and 2010.35 However, even if this forecast is accurate (notwithstanding threats such as rising numbers of AIDS deaths, war and the dangers of faltering democracies in nations such as Zimbabwe threatening its neighbours’ stability), such growth will not be sufficient to prevent an increase in poverty rates, much less promote a decline in rates by half to the Millennium Development Goal target. According to the United Nations Conference on Trade and Development (UNCTAD), a continued growth rate of at least 6 per cent will be required if a “significant reduction” in poverty rates is to be achieved.36 In the 1990s, however, only Botswana, Mauritius, Uganda and Mozambique approached sustained growth at this level. A failure to keep up with global markets has contributed to Africa’s slow growth. Colonialism, migration and the continent’s heavy dependence on exports have meant that Africa has historically been at least as globally oriented as other developing regions,37 but it is now being rapidly overtaken. A World Bank study has examined the differing performances of those developing countries whose ratio of trade to GDP has risen in the last twenty years – that is, they have become more globalized – and those that have become less globalized. Although, as some critics have noted,38 the study does not claim that the more globalized countries adopted protrade policies, they did have deeper tariff cuts than the less globalized group, and it is probable (although not made clear in the report) that, in at least some cases, these cuts came as part of a deliberate strategy to open up to the global economy. Forty-three of the forty-seven sub-Saharan African countries have become less globalized over the last twenty years, with significant consequences. It is estimated that the decline in Africa’s share of world trade from 3 per cent in the 1950s to less than 2 per cent in the 1990s represents an income loss equivalent to 21 per cent of regional GDP.39 While per capita GDP growth in the more globalized developing countries outstripped that of rich countries during the 1990s, average growth in the less globalized nations was negative. And while wages increased overall in the less globalized countries, they did so at a rate less than half of that in the more globalized group.40 Poverty declines, too, are slower in Africa than elsewhere. Fifteen of the world’s twenty poorest countries are in Africa and, while African poverty rates41 fell by one percentage point to 47 per cent from 1990 to 1999 and are expected to decline further to 39 per cent by 2015, poverty rates in South Asia will more than halve during the same period.42 Africa’s reliance on primary commodities has been a major factor behind its weak integration into the global economy, and policies to encourage export diversification are essential if the growth pattern of

Sub-Saharan Africa

199

recent years is to be reversed. East Asia’s successful growth experience was founded not just on economic liberalization, but also on drives to promote and upgrade exports. Sachs and Warner (1997), in their Paper “National Resource Abundance and Economic Growth” (NBER Working Paper Series), suggest that economic growth based on manufacturing-led exports would be higher than from a natural-resourced based economy. The dollar value of manufactures trade showed a cumulative annual increase of 2.7 per cent over the period, compared to an average world commodity trade increase of 0.65 per cent.43 In Africa, however, the share of industry in GDP declined from 39 to 32 per cent from 1980 to 1997,44 and UNCTAD estimates that, without the continued terms of trade losses suffered by non-oil exporters in the region since 1980, per capita incomes would have been 50 per cent higher than current levels.45 Although a step forward from primary agricultural products, in the longer term manufactured exports with a low technology content are unlikely to provide consistently strong gains to Africa. UNCTAD has highlighted the “fallacy of composition” problem faced by exporters of labourand resource-intensive products, where increases in export volumes precipitate falls in prices.46 The 1998 Trade and Development Report describes how East Asia’s industrializing economies benefited from a virtuous spiral whereby revenues from exports of primary commodities were invested in resource-based industries which facilitated productivity improvements and diversification of primary products. Revenues from the latter, in turn, enabled the establishment of manufacturing industries, which became increasingly sophisticated as export earnings funded their development. “Such a pattern”, the Report explains, “has characterized the export-investment nexus in East Asian NIEs [newly industrializing economies] ever since their initial stages of development.”47 Only Mauritius, where profits from sugar exports were re-invested in textile production and exports, has so far followed this pattern in Africa. Elsewhere, even where primary commodities have brought in substantial revenues, the investment climate has generally been too weak for savings to be productively allocated. In the continent as a whole, both savings and investment rates were lower in the 1990s than in the 1980s,48 with weak financial institutions discouraging domestic investment and hampering the development of private sector firms.49 Insecurity has also deterred investors – war, political instability and crime are rife across the continent, and, even in peaceful countries, property rights are often fragile. Obstacles to foreign investment also abound. High corporate taxes not only raise costs – they have also pushed many into the informal sector and increased the likelihood of tax evasion and corruption in the formal sector.50 Red tape is another deterrent. According to the UNDP, for example, twenty-four-hour delays at customs checkpoints in southern Africa are “routine”, and “it can take more than a week for intermediate inputs to clear customs on the Ugandan border”.51 Such inconveniences

200 Bloom et al. act as a disincentive to overseas investors and also deter African producers from diversification and expansion. Coupled with continued state intervention in many sectors, the outlook for Africa’s entrepreneurs is bleak. As a 1998 UNCTAD report put it: “Stalled growth across much of Sub-Saharan Africa is linked to the failure of the State to gradually cede its initial economic power to a nascent independent entrepreneurial class which could assume the lead role in a dynamic accumulation process.”52 Infrastructure is a further impediment to both domestic and foreign investment. Poor transport infrastructure, which has persisted despite the historic concentration of World Bank loans on its development,53 increases the costs of doing business for both agriculture and industry. African businesses frequently highlight infrastructure as a major barrier to expansion and diversification,54 and a 1995 study by Amjadi and Yeats found that transport costs in the region are a higher barrier to trade than tariffs.55 Energy infrastructure has also impeded growth. In Nigeria, for example, inadequate electricity provision has forced more than 90 per cent of manufacturing firms to buy their own generators, which has increased equipment costs.56 Energy sectors in the region remain largely under the control of governments and, without broad-ranging liberalization, will continue to be plagued by inefficiency. While much of the rest of the world has benefited from the communications revolution in terms of increased trade and cooperation, state-governed infrastructure provision continues to hamper Africa’s prospects. Low investment has severely hampered Africa’s technological development, and is a major threat to its efforts to create an export–investment virtuous spiral. Africa currently lags far behind other developing regions in terms of the use of technology. As reflected in the technological indicators listed in the United Nations Development Programme (UNDP)’s Technological Achievement Index, growth in research and development expenditure, number of Internet hosts, number of telephones, electricity consumption, and fertilizer and tractor use are all considerably slower than in the rest of the developing world.57 There is clearly catch-up potential for Africa, however, and the World Bank believes Africa has “huge potential for more diversified production and exports, including in agroprocessing, manufacturing, and services.”58 A twin-pronged focus on immediate diversification (into low-value manufacturing) and forward planning (for moving towards higher-value goods and services) is likely to pay dividends in terms of long-term sustainability. The growth of the palm oil industry in Malaysia is instructive in this regard. With rubber prices either unsteady or declining in the 1950s and 1960s, the Malaysian Government began to invest in the country’s nascent palm-oil industry, responding to increasing international demand as well as Malaysia’s physical and human resource advantages. Government research into palm oil was carried out in conjunction with industry (which

Sub-Saharan Africa

201

also funded the research through a levy on production), ensuring that data would be relevant to producers’ needs. Palm oil products were also exempted from export duties, which encouraged domestic industries to process and refine the oil as well as to produce it. According to UNCTAD, “The ensuing massive investment in processing capacity led to intense competition among refiners, which forced them to enhance their industrial and technological capabilities rapidly. As a result, within a decade, Malaysia was able not only to reach the world technological frontier in palm oil refining, but even to push back this frontier.”59 Liberalization and export promotion clearly contributed to the development of the palm oil industry, but government provided the vision and brought stakeholders together to facilitate its rapid growth. Despite the historical barriers, some parts of Africa have made progress in recent years. Trade liberalization has begun to provide benefits, privatization is under way in many sectors, and foreign investment has increased. Macroeconomic and political stability have also been achieved by some nations. However, without greater and more sustained growth, poverty reduction and quality of life improvements will continue to be limited. Human development The interaction between economic and human development is a key driver of both virtuous and vicious development spirals. Weak human development is both a cause and a result of Africa’s failure to integrate into the global economy. Writing on the effect of human development on successful global integration, Amartya Sen has compared the experiences of China and India since moving towards more open, market-driven economies. He argues that China’s more rapid progress has been driven by its pre-reform focus on improving the education and health of its people. This left the country much better prepared for marketization and globalization than India, where illiteracy rates were high and the health of its population poor.60 Conversely, a failure to globalize has weakened Africa’s human capital base. Poverty rates in developing countries that are less globalized today than they were twenty years ago (which includes most of Africa) are rising – in the globalizing countries they are falling – leading to deteriorating health and declining school enrolment.61 Human development in Africa is in an even more perilous state than in India. All of the bottom twenty-eight countries on the United Nations Development Programme’s Human Development Index are in Africa.62 Average life expectancy is below fifty years. Infant mortality, malnutrition, AIDS and tuberculosis rates are by far the highest in the world, and nearly half of Africans lack access to clean water.63 In education, school enrolment ratios and adult literacy lag behind other developing regions. And social capital is weak, with crime rife, slavery still far from abolished, and war on the increase.64

202 Bloom et al. Vicious development spirals, where poor performance in one area triggers problems in others, proliferate. Weak funding of higher education institutions, for example, means that countries often lack the leadership skills needed to successfully manage integration into the global economy. Training of primary and secondary school teachers is also affected, which trickles down to children’s education prospects and, ultimately, to a country’s potential for sustained economic growth.65 Poor education also contributes to a lack of awareness of infectious disease transmission, thus increasing the risk of infection. If a family member becomes infected with a serious disease such as AIDS, children may have to be withdrawn from school to help with caring tasks or to help cover the lost income. Their own education is therefore hampered, and the family’s prospects of escaping poverty further diminished. Africa’s efforts to improve its human development have followed a pattern similar to its progress on global integration – where Africa has made steps, others have made strides. Life expectancy in Africa has risen by 3.5 years since the early 1970s, while South Asia has seen increases of twelve years, and the developing country average increase is just under nine years. Infant mortality meanwhile has fallen by 22 per cent – far from insignificant, but only half the developing country average decline.66 Fertility rates, moreover, have fallen only slightly, from 6.8 children per woman in the early 1970s to 5.8 per woman today. African children remain a source of income and old age insurance for their parents and, because of the risks that infectious disease, drought, food scarcity and war will affect a child’s chances of survival, couples have a large number of children to reach their desired family size. Because of the sustained growth of the youth population, Africa’s continued high fertility in the face of mortality declines has meant that the share of the working-age population in the total population has fallen since 1950. Unlike other developing regions, therefore, Africa has been unable to reap a demographic dividend, where a boom generation resulting from the lag between decreased mortality and decreased fertility temporarily bolsters a region’s working-age population and, where the policy environment is conducive, provides a major boost to its economy.67 In Africa, instead of this scenario, the high youth dependency burden combines with poor economic performance to create high youth unemployment rates which, in another vicious spiral, can lead to social unrest, increased drug and alcohol use (and, therefore, a greater incidence of behaviour that increases the risk of HIV infection) and increased crime. Africa’s progress on education has been more encouraging, with increases in primary and secondary enrolment rates since 1965 the most impressive in the developing world. Adult literacy rates, too, have also almost doubled, to 60 per cent, since 1970.68 However, continued high fertility means that population growth will put increasing strain on the

Sub-Saharan Africa

203

region’s education systems. The school-age population in the least developed countries is expected to grow by 71 per cent between 1995 and 2030,69 and absorbing the extra children will be a difficult task. Challenges also remain in expanding tertiary education, which is crucial if a country is to acquire the skills needed in the knowledge economy. Increasing girls’ participation in education will have broad collateral benefits. Girls’ net secondary enrolment ratios declined in nine African countries between 1985 and 1997,70 and 12 per cent fewer girls than boys are enrolled in primary education across the continent.71 Female education has powerful impacts on fertility rates, family health and poverty reduction, and is especially important in the fight against AIDS. Data from Vietnam and Cambodia have shown that more educated women are both more knowledgeable about transmission of the virus and less likely to behave in ways that increase the risk of catching it.72 With HIV infection rates in Africa considerably higher than in Asia, and more women than men infected, female education clearly has the potential to dramatically cut transmission rates. Africa’s health challenges are no less complex. Tuberculosis rates are rising, driven by the HIV epidemic, and malaria, which has long been a deterrent to potential foreign investors, is still rife.73 HIV/AIDS is a further potential deterrent, with the chief executive of DaimlerChrysler South Africa recently reporting that “AIDS is definitely one of the factors inhibiting investments” in Africa’s automotive industry.74 AIDS weakens a country’s attractiveness to investors in various ways. It erodes the productivity of the workforce and reduces the size of local markets. It also exposes the inability of African society to mobilize against the disease, reducing investor confidence in the competence of African governments and the effectiveness of African institutions. Human development is crucial to economic growth in Africa. As an UNCTAD review of Ethiopia has suggested, “liberalization and the process of globalization have considerably increased the choices available to foreign firms over where to invest . . . Therefore, countries competing to attract FDI need to offer more than a liberal environment.”75 If any African countries are to approach the long-term success of East Asian economies like Korea and Japan, whose economic growth and success in attracting foreign investment were spurred by their focus on expanding education and improving health in advance of economic reform,76 reinvigorating society will have to become a priority rather than a luxury. The next part of this chapter will look at some of the reasons why Africa’s human and economic development has lagged so far behind other developing regions.

204 Bloom et al.

III. Africa’s slow progress A bad start Many causes have been put forward for Africa’s ills. They can be broadly grouped under three sometimes overlapping headings: intrinsic disadvantages, a poor policy environment and international pressures. Bloom and Sachs (1998) estimate that between 60 and 90 per cent of Africa’s slow growth is attributable to geography, health conditions and age structure. “At the root of Africa’s impoverishment”, they suggest, “lies its extraordinarily disadvantageous geography.”77 Both between and within countries, economic development is much greater in non-tropical than tropical areas, so the fact that 93 per cent of Africa lies in the tropics presents the continent with inherent disadvantages compared to all other regions. In Africa’s equatorial zones, high evapotranspiration and heavy rains weather the soil, leaving it unfit for agriculture; in semi-arid or arid zones, drought is a constant threat; and in more moderately watered woodland areas, pests and poor soils diminish crop yields. In these circumstances, food production is a constant struggle. Many countries in the equatorial zones are net importers of foodstuffs. Weak food production also leads to low levels of urbanization where food production is insufficient to support a large population. In a continuation of this vicious spiral, low urbanization rates limit infrastructure development, as the return to building roads or installing telephone lines to scattered villages does not merit the cost (Poland, with 1.4 per cent of Africa’s land area and 8 per cent of its population, has more paved roads than the whole of sub-Saharan Africa outside South Africa78). Location is also important to global integration – most of Africa is a long way from the major world markets of Europe, North America and East Asia, and high transport costs make this geographical barrier hard to overcome. In most of the world, falling transport costs have driven globalization, but in Africa costs are rising. Freight rates by rail are double those in Asia; port charges are higher, with customs officials’ low salaries often making corruption difficult to resist; and air transport in Africa is four times as expensive as in East Asia. By 1991, freight and insurance payments on trade equalled 15 per cent of export earnings – well above the developing country average of 6 per cent.79 Africa suffers from further geographical handicaps that keep transport costs high and affect exports. Relative to its land area, Africa’s coastline is small, and the continent lacks natural harbours. Because of the coastal climate’s unsuitability for agriculture, only 19 per cent of Africans live within 100 kilometres of the coast. Twenty-eight per cent of the population, moreover, live in landlocked states – a far higher proportion than in any other continent. Much of the most successful agriculture takes place in the eastern highlands, away from the arid coastal zones,

Sub-Saharan Africa

205

but as Bloom and Sachs (1998) suggest, “what is gained in agriculture is sorely lost in transport costs”. Adam Smith noted the importance of coastal population density to the division of labour in his The Wealth of Nations: As by means of water-carriage a more extensive market is opened to every sort of industry than what land-carriage alone can afford it, so it is upon sea-coast, and along the banks of navigable rivers, that industry of every kind naturally begins to subdivide and improve itself, and it is frequently not till a long time after that those improvements extend themselves to the inland part of the country.80 Smith also noted the lack of navigable rivers leading from the coast into inland parts of Africa. Only 3 per cent of Africans live near oceannavigable rivers, and a total of 22 per cent of the population living near coasts and rivers is dwarfed by the US’s 67 per cent and Western Europe’s 89 per cent.81 Tackling high transport costs is a major challenge for Africa’s policy-makers, and intra-regional cooperation and liberalization of transport industries will be crucial if Africa is to reap the same benefits from cheaper transport as the rest of the developing world. Health is another major hindrance to Africa’s development, and is in part related to geography. The infectious disease burden is substantially higher in tropical than in non-tropical zones, and tropical populations’ life expectancy is lower, even after controlling for per capita income levels.82 The annual economic burden of malaria, whose transmission in Africa is more rapid than in other regions due to the prevalence of the highly infective Anopheles gambiae mosquito, has been estimated at 1 per cent of Africa’s GDP,83 and the spread of AIDS is reducing life expectancy in several countries, with effects not just on economic productivity but also on poverty rates, morale and social cohesion. In Asia, successful action to prevent the spread of AIDS has been shown to provide a significant return on investment.84 The medical expenditures avoided and income losses averted by Thailand’s efforts to tackle the virus provide a rate of return between 37 and 55 per cent – the minimum return deemed acceptable by the World Bank is 10 per cent. Without preventive action, it is estimated that the impact of the virus on Thailand’s dependency ratios would have reduced per capita GDP in 2015 by over 20 per cent. Africa, with much higher AIDS prevalence than Thailand, clearly has even more to gain from interventions to tackle the disease. So far, however, only Senegal and Uganda have made substantial progress. Governments have a vital role in combating Africa’s health problems – health information campaigns, preventive measures and distribution of treatment all depend on strong governance and effective public health systems. In the next section, we will look at the role of African governments in tackling the continent’s problems.

206 Bloom et al. The African policy environment Grouping all sub-Saharan African states under one banner obviously has its limitations, but many of the region’s developmental weaknesses are common to many of its countries. War and corruption have plagued the region, with impacts not only on African citizens but also on its reputation abroad. Traditionally, the primary objective of a state has been to guarantee the security of its citizens. Many African states have failed to fulfil this responsibility. One-fifth of Africans live in countries affected by armed conflict.85 The incidence of civil war, which has declined in the last twenty years in globalizing developing countries, has risen in Africa. Between 1987 and 1997 there were fourteen civil wars in Africa, and many of these wars, such as the troubles in the Democratic Republic of Congo and Sierra Leone, had impacts beyond national boundaries.86 Refugees from Sierra Leone flooded into neighbouring Guinea and Liberia, and the post-Mobutu conflict in Congo has been complicated by the involvement of Rwanda, Uganda, Angola, Namibia and Zimbabwe.87 Average military expenditure as a proportion of GDP in Eritrea, Angola and Nigeria is over five times the world average. In seven other countries, the proportion is over 50 per cent higher.88 This creates numerous vicious spirals. In 2001, economic growth in African countries in conflict or experiencing severe governance problems was negative, at 0.4 per cent, compared to a continent-wide average of 2.7 per cent.89 By deterring foreign investment, damaging infrastructure and killing large numbers of the working-age population, war makes global integration and economic development extremely difficult. The conflicts in Congo and Sierra Leone have been fuelled by the region’s dependence on primary commodities such as diamonds and coltan (according to the UN, Uganda and Rwanda have recently become exporters of these goods even though they do not produce them90), demonstrating that Africa’s inability to diversify away from primary goods has repercussions beyond the purely economic. The political instability that has led to many of these wars has been in part driven by a lack of public confidence in the legitimacy of both politicians and democratic institutions themselves. Harmful policies directed at certain communities, such as commercial farmers in Zimbabwe, as well as attempts at constitutional change to hold onto power, have highlighted the relative fragility of democratic institutions By giving a voice to people, democracy can be a positive force for reforming administrations and building institutions, but East Asia’s experience showed that it is not essential to economic development. Many of Asia’s most successful economies have been managed by authoritarian regimes, with economic advances generally being followed, rather than preceded, by greater pressure for democracy. What all the Asian regimes

Sub-Saharan Africa 207 had in common, however, was a strong commitment to economic growth based on solid institutions and competent administration. However, instances of inappropriate use of public funds, curbs on press freedom (the number of attacks on journalists in SADC countries more than doubled between 1994 and 200091), the involvement of foreign companies in corruption scandals,92 and a sometimes half-hearted approach to eliminating corruption show that in Africa this commitment has some way to go before becoming a reality. Ten of the fourteen sub-Saharan African countries listed in Transparency International’s 2001 Corruption Perceptions Index fall into the bottom third of the Index’s ninety-one countries. Only Namibia, South Africa and Mauritius are in the top half.93 Corruption is both a cause and a result of Africa’s economic marginalization. On the one hand, many foreign firms will be deterred from investing in Africa by the hidden and unpredictable costs of corruption and the added risks imposed by weak institutions – perceptions of corruption are an important factor in foreign investors’ “systematic bias against Africa”, revealed in Institutional Investor polls, and Lambsdorff and Cornelius (2000) find that reducing corruption increases FDI.94 On the other, Africa’s failure to liberalize and open up to the global economy has meant its industries have avoided much of the scrutiny that companies competing in international markets have had to face. Furthermore, privatization programmes have been adversely affected by what a Transparency International report on corruption in southern Africa describes as “cumbersome bureaucracies and entrenched patronage networks”.95 The report goes on to suggest that international donors have sometimes been part of the problem: “By overlooking the parallel existence of corrupt practices in commercial business, critics say, donors who pushed for speedy divestment and companies that invested in former parastatals have been complicit in the creation of greater opportunities for private corruption.”96 There have been efforts to control corruption (including regional agreements drawn up by SADC and ECOWAS), but many leaders, such as Nigeria’s Olesegun Obasanjo, who came to power on an anti-corruption platform, have found corruption to be so endemic that even small changes have been extremely difficult to implement. Getting an AntiCorruption Act through Nigeria’s parliament, for example, took over a year, and the Nigerian Accountant General reported in April 2001 that 40,000 staff on the government payroll were no longer employed. With so many people making money out of corruption, leaders have found it difficult to make much progress towards eradicating it. International donors have attempted to include corruption control as a condition for financial assistance, but until the benefits to both rich and poor are demonstrated conclusively, the success of such efforts will inevitably be limited. High levels of corruption are associated with lower growth and lower per capita income (although causality here is likely to run both ways), and bribes have been estimated to increase Ugandan firms’ costs, for example, by

208 Bloom et al. 8 per cent.97 However, The Economist, which recommends that multinational enterprises encourage governments to pay higher wages to fewer civil servants in order to stamp out “power without pay” situations, claims that investor interest in eliminating bribery has long been “half-hearted”, as the benefits of such measures are not widely perceived. Strengthening of democratic institutions and press freedom and liberalization will also help increase the accountability of politicians, and many NGOs, such as the Uganda Debt Network, which publishes a roll call of corrupt public figures, have set an example for their regional peers.98 Disseminating best practice in tackling corruption and facilitating the creation of region-wide NGO anti-corruption networks may be promising avenues for international donors to explore. The “cumbersome bureaucracies” noted by Transparency International as such a breeding ground for corruption are a legacy of Africa’s postcolonial statist policies which, combined with the economic protectionism to which many countries turned in a reaction against colonialism, pushed Africa into what Jeffrey Sachs has described as “largely self-imposed economic exile”.99 Foreign aid, Sachs argues, propped up these policies and delayed economic reform while the continent plunged into debt and economic stagnation: “Since the onset of the African debt crises of the 1980s,” he says, “the guidance [of donors and international financial institutions] has become a kind of economic receivership, with the policies of many African nations decided in a seemingly endless cycle of meetings with the IMF, the World Bank, donors and creditors.”100 International pressures African governments, with few exceptions, have yet to make dramatic progress in the economic sphere. Foreign institutions, too, however, clearly bear some responsibility for Africa’s problems, and if globalization is to provide opportunities rather than threats to the continent, the international community’s cooperation is vital. Currently, though, three internationally driven factors – trade barriers, debt, and strict migration controls – are aggravating Africa’s exclusion from the global economy. First, trade barriers. Although structural adjustment policies have been the focus of international efforts to bring Africa into the global economy, the World Bank estimates that firms exporting from poor countries face barriers twice as high as those exporting from rich ones. “Rapid trade liberalization in Africa”, an UNCTAD document explains, “has not been reciprocated in terms of better access to markets for African producers”.101 According to The Economist, if North America, Europe and Japan were to eliminate all barriers to imports from sub-Saharan Africa, the region’s exports would rise by 14 per cent.102 Subsidies, which cost developed countries the equivalent of 241 per cent of sub-Saharan Africa’s combined GDP, correspond to ten times the official development assistance granted

Sub-Saharan Africa 209 to developing countries and more than half of developing country exports to developed countries.103 Rich-country protection of textiles and agriculture, which costs poor countries huge sums a year, is particularly damaging to Africa. Africa has a comparative advantage in both these areas through its abundant cheap labour supply, but massive agricultural subsidies in high-income countries and high tariffs on textiles prevent the continent from exploiting its main asset.104 Until international tariffs on agriculture are cut, inland parts of the region will be left to stagnate and rural poverty, which already accounts for most of African poverty,105 will increase as populations grow. Although the incentive created by high tariffs could theoretically provoke diversification into tariff-free areas, in practice it appears to limit rural populations to subsistence farming, where households produce just what is required for their survival. As well as leaving families at the mercy of climate and pests, a subsistence existence also encourages high fertility rates and low school enrolment rates, as families need their children to work on the land. Such spirals further limit prospects for future development. Coastal zones’ prospects of diversifying into manufacturing are more promising. Low transport costs and greater proximity to trade routes enable both cheaper exports and better access to the imported components needed for many manufacturing outputs. According to Bloom and Sachs, “the success stories in manufacturing export-led growth are almost all coastal economies well connected to international shipping routes”.106 They note that in Africa, however, coastal cities such as Abidjan, Accra, Dar es Salaam, Lagos, Maputo and Mombasa, which, as cities, would have the economies of scale necessary for infrastructure development, “play almost no role as export-oriented manufacturing centres”. If tariffs within Africa were reduced, there would be potential for new coastal manufacturing bases to buy primary products, such as cotton, from inland areas and produce textiles. Eventually, the increase in income, if productively invested, could enable landlocked countries to move towards processing commodities themselves. If African coastal cities are to develop manufacturing exports, then, in addition to reduced transport costs, efficient customs administration and low labour costs, they would benefit greatly from foreign direct investment. South-East Asia’s export-led growth was driven in part by its targeting of foreign investors via export processing zones (EPZs), which cut transaction costs for multinational enterprises and in some countries have provided permanent 100 per cent tax holidays.107 In South-East Asia, Hong Kong, Korea, Taiwan, Singapore, Malaysia, Thailand and Indonesia all adopted this approach, but in Africa only Mauritius has so far followed. Outside Mauritius, and unlike all other developing regions, Africa plays very little part in the global textile industry, where its abundant labour supply has the potential to give it a strong comparative advantage.

210 Bloom et al. This failure to diversify has in part been influenced by IMF and World Bank opposition to EPZs and tax concessions aimed at attracting exportoriented manufactures, and it is becoming clear that the structural adjustment programmes these institutions promote have not yet produced the desired results.108 The Economist has argued that the programmes have “all too often led to stable but stagnant economies in Africa. A preoccupation with fiscal balance has, for instance, kept tariffs high.”109 Former World Bank economist William Easterly agrees. In the ten years to 2001, he says, the IMF and World Bank gave thirty-six poor countries ten or more loans each, with conditions attached. “The growth rate of income per person of the typical member of this group during the past two decades was zero.”110 Either the conditions or their implementation (and possibly both) have been at fault, therefore, and new thinking and new strategies are clearly required. Fast-growing economies like Mauritius would appear to offer a good example for others to follow. The second major international constraint on Africa involves debt. When measured as a proportion of exports and GDP, Africa is by far the world’s most indebted region.111 The ratio of debt to gross national product (GNP) has increased since 1990, and lay at 66 per cent in 2000.112 Official aid from international institutions to sub-Saharan Africa amounted to $23 per capita in 1998;113 annual payments on Africa’s debt, however, amount to nearly $40 per capita.114 In 1999, moreover, over 26 per cent of Africa’s debt was made up of interest and principal arrears (up from 15 per cent in 1990).115 Many countries spend substantially higher proportions of their national budgets on debt service payments than on health and education.116 Development assistance, therefore, has clearly been inefficient in many areas, and the IMF/World Bank Heavily Indebted Poor Countries (HIPC) initiative, which relieves extremely indebted countries of some of their debt burden, is a response to this failure. Thirty-three out of forty-seven sub-Saharan African countries are being considered for debt relief, but so far, due to stringent criteria for the granting of relief, only Uganda and Mozambique have seen any cancellation of their debts. Africa’s debt mountain creates a plethora of obstacles to its development. Debt-servicing payments constrain investment in infrastructure, health, education and social security. The availability of foreign exchange needed for capital goods imports is also limited. Many countries ran up debts under leaders who are no longer in power, but private investors inevitably tar today’s leaders with the same brush, and countries saddled with severe debt problems are often unattractive to domestic and foreign investors regardless of the new leadership’s good intentions. The HIPC initiative attempts to use debt relief as a policy tool in a similar way to aid by tying it to conditions. Bloom and Sachs hypothesize that structural adjustment has failed because programmes have not addressed “nitty-gritty” details, while William Easterly has claimed that

Sub-Saharan Africa 211 conditions on previous loans were not enforced and receiving governments found it easy to ignore donor recommendations. If debt relief is not to go the same way as aid, conditions may need to be made tougher, but more sensitively designed. Uganda’s response to debt relief has been to set up a publicly monitored fund that spends the money saved only on specific development projects.117 Donors therefore know that relief is being put to constructive use. Debt relief not only eases a country’s economic pressures and frees up government money for spending on vital social improvements – it can also stimulate public pressure for change. According to Romilly Greenhill of Jubilee Research, the non-governmental organization (NGO) behind the global debt relief campaign, people in Uganda have responded to news of the relief of their country’s debt by asking leaders where the money is going.118 In the past, donors have been criticized for imposing conditions on developing countries. A bottom-up approach, whereby a government asks for a certain amount of debt relief to pay for a project or programme of its own rather than the donor’s choosing, might help to deflect future criticism and transfer responsibility to the developing countries themselves. If the project is not completed or a goal such as a reduction in HIV infection rates is not met in the time specified by the government, relief for future projects may be reduced or, in some cases, a need for greater technical assistance and capacity-building identified. Similarly, if the project is completed before time, interest payments on remaining debts may be reduced. Projects’ performance should also be monitored in the longer term so that interest payments are also reduced if, for example, a school built with debt-relief money outperforms enrolment targets. In this way, donors operate more like conventional banks, and receiving governments are more accountable for their actions. Simultaneous increases in NGO and UN agency monitoring will make it more likely that this kind of relief will be directed to genuine reformers than leaders who prefer to spend money on arms or divert it into their own bank accounts. Along with trade barriers and debt enforcement issues, migration controls are the third major international obstacle to Africa’s development. Many of the overpopulated countries in inland tropical Africa would benefit from increased outward migration. By reducing an economy’s pool of labour, outmigration will tend to push up domestic wages, help to reduce poverty and ease demographic pressures which might otherwise lead to severe social unrest;119 remittances from émigrés give a country more capital to invest in development; returning workers bring back new skills and knowledge to upgrade a country’s human capital base – they also set an entrepreneurial example for those remaining at home; and links between domestic firms and expatriates increase export and technology-transfer opportunities. However, despite the opening up of world markets in terms of trade, the world has recently become much less globalized in terms of labour flows. Between 1870 and 1910, 10 per cent of the

212 Bloom et al. world’s population relocated permanently from one country to another; over the past twenty-five years only 1–2 per cent have done so.120 Rich-world controls on labour flows have a disproportionate effect on Africa. Faced with aging populations, and therefore reduced workforces and possible pensions crises, the West is likely to derive significant economic benefits from relaxing immigration controls. So far, however, Western leaders have failed to make the case for increased immigration, and political pressures have kept the numbers down. Labour is Africa’s biggest competitive advantage, but in many areas this labour is crammed into small, landlocked economies with extremely limited employment opportunities. Widely heralded increases in education enrolment are more likely to lead to unrest than growth if people have no jobs when they finish school, and the caveat that “brain drain” will deprive countries of their most talented workers is likely to be balanced by the increased stability, knowledge transfer and remittances that emigration provides. In Latin America, for example, workers’ remittances have overtaken foreign aid as a source of revenue, and in El Salvador and the Dominican Republic remittances are even higher than exports.121 Programmes such as the Colombian government’s network of expatriate researchers and engineers, whose members, covering thirty countries, carry out joint research projects with foreign universities in areas such as biotechnology, can help home countries to benefit from the skills acquired by expatriates. There is potential for Africa’s leaders to use international negotiations on liberalization of markets to call for increased movement of labour, with benefits to both industrialized and developing economies.

IV. Virtuous spirals Africa’s leaders have attempted to map out a strategy for the regeneration of the continent in their New Partnership for Africa’s Development (NEPAD), which they endorsed at the Organization of African Unity summit in July 2001. NEPAD is vast in scope, but it identifies four areas for immediate action from an impressively broad range of recommendations: communicable diseases, information and communications technology (ICT), debt reduction, and market access. Even tackling these issues will be a major challenge for many cash-strapped African governments, however, and the three spheres development framework highlights the need to find strategic entry points, where actions in one area can trigger gains in others. Many African countries face unique challenges but, as the leaders responsible for NEPAD have noted, some consistent requirements and actions to promote virtuous spirals can be identified: 1 The need for regional cohesion. Africa’s integration into the global economy should be built on intra-regional integration. The NEPAD plan suggests a “discretionary preferential trade system for intra-

Sub-Saharan Africa

213

African trade”,122 which would help to promote the development of fledgling African industries while shielding them from the worst of the global currents. Intra-regional cooperation can also help African countries to improve their skills and knowledge in advance of global integration.123 Previous attempts at regional integration have had mixed results, and at present, regional trade barriers exclude rather than encourage African exporters. Cooperation should go beyond liberalization, however, with governments working together to tackle cross-border issues such as AIDS and war. If Africa can begin to solve some of its own problems, its negotiators will have more clout in the international arena and the continent’s image will be strengthened in the eyes of foreign investors. Links with other developing regions may also have beneficial effects for trade and investment, and successful economies such as those in South-East Asia may provide valuable lessons for Africa. 2 The need for infrastructure improvements. Intra-regional cooperation could also give an impetus to lowering the costs of transport, energy and communications. Globalization has been driven by dramatic innovations in these areas, but many parts of Africa still suffer from the constraints of state ownership. Even small steps can produce big results, with the UK Government reporting that the improved access to markets created by a programme to build dirt roads in Mozambique led to increased agricultural production.124 3 The need to tap into the African diaspora. Africans living abroad offer a pool of knowledge and skills not yet available to domestic populations. Communications technology can help governments build networks designed to capitalize on diaspora groups’ resources. The Colombian Government, as we have seen, has focused on research projects in biotechnology and other fields specifically relevant to Colombia’s development. Governments and universities in Africa might follow this example, with benefits for agricultural productivity (Africa has benefited little from the “green revolution” that transformed agriculture in much of Asia) and pharmaceutical development. 4 The need to develop tourism. Africa’s natural resources give the continent many competitive advantages, but the region’s image is more often coloured by poverty, violence and disease than spectacular scenery and rich wildlife. Skilful marketing such as Kenya and South Africa’s online travel websites will have little effect if Western news stories are dominated by humanitarian disasters and crime. As well as threats, however, current events can also offer opportunities – the August 2002 World Summit on Sustainable Development in Johannesburg, for example, provided a strong platform for Africa to demonstrate its commitment to tackling its human development problems at the same time as preserving its environment.

214 Bloom et al. 5 The need for export diversification. Tourism is just one example of the wide-scale diversification of exports that is required if Africa is not to remain “stuck as an exporter of a narrow range of primary commodities, most of which are suffering long-term declines in their international terms of trade”.125 As we have seen, the quantity of Africa’s exports is already slightly above the world average – it is quality improvements that are now required. Diversification away from primary goods will increase regional stability. And upgrading into more dynamic and profitable sectors – textiles instead of cotton, for example, and branded coffee instead of coffee beans – will help exporters to circumvent high tariff barriers on agriculture.126 Kenya’s successful cut-flower exporters are an example of how farmers can diversify within the agricultural field, and the growing Western market for exotic fruits and alternative medicines gives Africa further opportunities to exploit and develop existing resources. At present, however, much of the continent lacks the human resources, technology and capital required to develop a manufacturing base, and foreign investment, along with well-channelled aid, will be required to provide the technologies and skills needed for diversification. Strategic targeting of foreign firms that possess the required technology will both speed up diversification and give domestic firms the chance to complement, rather than be swallowed up by, overseas producers. 6 The need for governments to facilitate foreign investment. If governments are to promote their countries as destinations for FDI, they need to cut red tape for investors. This requires policy coordination across many departments, including customs, immigration and tax authorities. Structural changes can also be made to investment promotion agencies to include members of the private sector on their governing boards. Businessmen should have the opportunity to communicate online with investment agencies so that they can receive swift assistance when problems arise. Furthermore, strategic targeting of foreign firms that possess technology useful to the economy will both speed up diversification and give domestic firms the chance to complement, rather than be swallowed up by, overseas producers. 7 The need for ICT. Many have suggested that Africa should attempt to leapfrog existing technologies and move directly to wireless communications. Clearly, the continent will not be able to take full advantage of the communications revolution while nearly half of its people are unable to read, but there are large potential benefits if Africa can get connected. Landlocked states would be better able to integrate with the world economy, the costs of doing business in many fields would be reduced, and the increase in access to information may have strong effects on democracy and the strength of civil society. If African coun-

Sub-Saharan Africa

215

tries are to make gains in ICT, educational improvements are essential – India has benefited from a strong higher education system, and a tertiary-level focus on science and technology can provide broad benefits in the global knowledge economy.127 Communications and energy infrastructures in Africa, too, must be improved if the region is to compete in global ICT markets. Privatization of energy and telecommunications sectors is needed to help foster the competition and foreign investment required for their modernization. Regional groupings like SADC and ECOWAS can work to facilitate the rollout of networks across borders. And the advantages of a micro-level approach have been demonstrated in Bangladesh, where poor people have received loans from foreign donors to buy mobile phones and set up successful mini-telephone centres.128 8 The need for micro-finance to encourage small businesses. The informal sector, dominated largely by agriculture, accounts for three-quarters of employment in Africa,129 but many are deterred from investing in improving productivity or moving into new areas of production by the difficulty of accessing finance. Peter Cornelius has found that “the cost of borrowing is widely regarded as the single most important obstacle to the operation and growth of private sector firms”,130 and there are therefore few incentives for people to move into the formal sector. Micro-finance programmes offering credit to registered small businesses or individuals might be combined with lower corporate tax rates to attract businesses into the formal sector, potentially increasing government revenues at the same time as giving small enterprises the opportunity to grow. Micro-finance programmes in other areas, such as the Grameen Bank’s programme in Bangladesh, have had a particularly strong response from women. In Africa, women are prominent in low-value areas such as agriculture, and access to finance can give them a tool for investing in their own and their families’ development. 9 The need for a focus on women. Girls’ education is a vital development instrument. The World Bank, recognizing the importance of promoting gender equity, has recommended support for farming and micro-enterprise as a key to empowering women.131 Gender inequality in Africa has broad-ranging effects and creates many vicious spirals. Inadequate female education, for example, underlies the continuation of higher fertility rates and has negative impacts on family health. Women’s lack of status compared to men makes it more difficult for them to refuse unprotected sex. The risk of AIDS is therefore increased, and Africa is the only continent where HIV infections among women outnumber those among men.132 Conversely, an improvement in women’s status via improved education can, merely by increasing the proportion of a population available for productive work, boost economic growth. If Africa’s human development

216 Bloom et al. indicators are to improve to the extent that they have an impact on economic growth, efforts by policy-makers, donors and NGOs to target women are likely to trigger increasing benefits. 10 The need to tackle AIDS. AIDS is cutting life expectancies across Africa, with only Senegal and Uganda having made sustained inroads against its spread. Other African governments have so far failed to make an impact, and partnership with the private sector may now be needed to counter HIV’s effects. Radio, whether publicly or privately run, is widely listened to across sub-Saharan Africa, and offers an obvious vehicle for the transmission of information on the virus. And, to take a more specific example of the potential benefits of public–private partnership, the pharmaceutical company Boehringer Ingelheim is offering its drug Nevirapine, which is simple to administer and dramatically reduces the rates of mother-to-child HIV transmission, free to African governments for the next five years. Governments therefore have a strong incentive to improve medical distribution networks (possibly again with the help of private firms with existing distribution networks that are looking to demonstrate their social responsibility), with huge collateral benefits. The availability of a drug to stop HIV transmission to their children is likely to encourage many pregnant women to present for testing. At the testing centre, those who test positive can be advised on treatment methods and on measures to stop them passing on the infection; those who test negative can be informed about prevention methods; and all women who are tested can be given information on other health issues. Moreover, by empowering women to take control over an aspect their health, Nevirapine is likely to increase interest in health issues in general, with consequent positive impacts on family health. 11 The need for tailored education. African governments have already made progress in increasing access to education at all levels. Quality of education, however, is uneven, and curricula in many countries do not address Africa’s specific needs.133 According to UNCTAD, Africa’s current “skill-per-worker” endowment is similar to that of Thailand, Malaysia and Indonesia thirty years ago.134 In order to connect to the global knowledge economy, Africa needs to develop its skills in science and technology. To redress the human development balance, it needs to generate new knowledge specific to local conditions – for example, on the ecology of disease. Working with its diaspora will contribute to this, as will connecting to the Internet. The latter also offers opportunities for distance training of teachers. Private sector communications companies Cisco, Marconi and Virgin have recently teamed up with the UK Department for International Development to use ICT to support teacher training. The initiative sets up district resource centres to which teachers can travel, providing Internet access and the chance to exchange information and materials with their peers and their tutors.135

Sub-Saharan Africa

217

12 The need to tackle corruption. Progress on economic and human development will inevitably be hampered by corruption. Donors and civil society can play a role in monitoring government activity, and the strengthening of democracy will also encourage greater openness. If Africa’s reputation with domestic and foreign investors, tourists and the international community is to be improved, its leaders need to work to shed the continent of its corrupt image. Africa’s own people, too, are more likely to be spurred to greater productivity if the fruits of their labour are seen to be fairly distributed. 13 The need for international cooperation. The NEPAD strategy paper suggests that structural adjustment, whose benefits the World Bank and IMF have for so long preached to Africa, is now required of developed countries. Lowering trade barriers and migration controls and relieving Africa of its debt will greatly facilitate the region’s development. Political pressures in the West are likely to make standing still on these issues increasingly difficult, with the HIPC debt relief programme already highlighting the power of NGO networks to enforce change. International donors, by focusing their aid on those countries genuinely committed to reform, can act as a catalyst for improvements across the region.

V. Conclusion In recent years some parts of Africa have made steps on the road to recovery. Others, however, have faltered. Gains in terms of liberalization and economic growth have been undermined by human development setbacks such as AIDS and civil strife. In some countries liberalization appears to have come too soon, while in others export diversification has led to unprecedented growth. Regional integration may help to distribute the benefits of globalization while strengthening the response to its threats, and it is in the political interests of the international community’s globalizers to ensure that Africa begins to close the economic gap with the rest of the world. Liberalization in much of Africa has not yet led to sustained and sufficient improvements in the quality of life of the continent’s people. Policies need to move beyond liberalization, therefore, and focus on boosting the supply-side of Africa’s economy. Growth-oriented strategies should be based on encouragement to domestic businesses and measures to attract beneficial foreign investment. Growth is unlikely to be sustainable, however, without a renewed focus on the region’s human capital. Poor health, insecurity and corruption bedevil the lives of many Africans and mar the region’s standing in the eyes of the rest of the world. The three spheres approach to development recommends a balanced focus on liberalization, economic growth, and human and social capital development. Hitherto, however, Africa and its international partners’

218 Bloom et al. policies have been tilted towards the liberalization sphere. Continued opening up of Africa’s markets, while important to the region’s integration into the global economy, is unlikely to be sufficient to improve Africans’ prospects without significantly improved progress in the human development and economic growth spheres. Going forward, these last should be the main focus of domestic and international policy-makers’ attention. Human development is particularly crucial. Long-term economic growth is unlikely to be sustainable if Africa’s governments fail to invest in the education of their people. Progress in access to primary education now needs a renewed push to achieve universal enrolment. Secondary education should also be a key focus of investment and ideas, with curricula tailored to national needs. And the traditional neglect of tertiary education is no longer a viable option in today’s economy, where countries without strong higher education systems are likely to lack the skills needed for successful integration into knowledge and communication-driven global markets. Investment in a country’s health is equally essential. AIDS is devastating large parts of Africa, and the infectious disease burden continues to severely hamper poverty reduction efforts. Foreign aid can play a part in improving health systems, and private sector involvement will further help ease capacity and financial pressures on governments. Action to prevent AIDS via condom provision and information campaigns can have collateral impacts on population growth. Tackling the virus, which has left Africa with over thirteen million orphans, will also contribute to the social cohesion needed for sustained development. A focus on its people is vital to Africa’s development. As the NEPAD planners recognize, only when Africans are given the tools to “extricate themselves from the malaise of underdevelopment and exclusion in a globalising world” will their continent begin to reverse its long-term drift.

Notes 1 The authors are grateful to Larry Rosenberg for a thorough set of thoughtful comments and suggestions. We would also like to thank Ajit Bhalla, Romilly Greenhill, Khalil Hamdani, Kamran Kousari and Jane Morley for their helpful comments and contributions. 2 World Bank (2001a), World Development Report 2000/01, World Bank, Washington, DC. 3 World Bank (2001b), Global Economic Prospects and the Developing Countries 2002, World Bank, Washington, DC, p. 205; Population Reference Bureau (2001), 2001 World Population Data Sheet, PRB, Washington, DC. 4 UNDP (2001), Human Development Report 2001, Oxford University Press, New York. 5 Financial Times (2002), “Democracy in Africa”, 4 January. 6 For simplicity, we will refer to sub-Saharan Africa more simply as Africa. 7 UNCTAD (1998), African Development in a Comparative Perspective, UNCTAD, Geneva, pp. 69, 106.

Sub-Saharan Africa

219

8 D. E. Bloom and J. Sachs (1998), “Geography, demography, and economic growth in Africa”. Brookings Papers on Economic Activity, 2: 207–95. 9 UNDP (2001), ibid. 10 UNCTAD (2001), Economic Development in Africa: Performance, Prospects and Policy Issues, UNCTAD, Geneva, p. 27. 11 UNCTAD (2001), ibid, p. 28. 12 World Bank (2001b), ibid, p. 126. 13 The Economist (2001), ibid. 14 World Bank (2002a), Globalization, Growth and Poverty, World Bank/Oxford University Press, p. 55. 15 World Bank (2005) World Development Indicators. 16 UNDP (2001), ibid. 17 World Bank (2005), ibid. 18 UNCTAD (1998), ibid, p. 71. 19 UNCTAD (1999), Investment Policy Review: Uganda, UNCTAD, Geneva. 20 UNCTAD (1999), ibid. 21 World Trade Organization (2001), Uganda Trade Policy Review, WTO, Geneva. 22 D. Dollar and A. Kraay (2002), “Spreading the Wealth”, Foreign Affairs, January/February. 23 World Trade Organization (2001), Mozambique Trade Policy Review, WTO, Geneva. 24 A. S. Bhalla (2002), Globalization and sustainable development: a Southern African perspective. In Technology Management and Sustainable Development (forthcoming). 25 UNCTAD LDCs website: www.unctad.org/en/subsites/ldcs/country/profiles/malawi.htm. 26 World Trade Organization (2002), Malawi Trade Policy Review, WTO, Geneva. 27 C. Chipeta, M. Mkandawire and H. Taye (2002), Malawi: Globalization, Liberalization and Sustainable Human Development. Available at: magnet.undp.org/new/ pdf/PDFscomplete/Malawi%20(draft).pdf. 28 World Bank (2000a), Country Brief: Uganda, World Bank, Washington, DC. 29 Chipeta et al. (2002), ibid. 30 World Trade Organization (2001), Mauritius Trade Policy Review, WTO, Geneva. 31 Bhalla (2002), ibid, p. 15. 32 A. Maddison (1996), Monitoring the World Economy: 1820–1992, OECD, Paris. 33 UNCTAD (2001), ibid, p. 7; World Bank (2002a), ibid. 34 World Bank (2000b), Can Africa claim the 21st Century? World Bank, Washington, DC, p. 8. 35 UNCTAD (2001), ibid, p. 44. 36 UNCTAD (2000), Capital Flows and Growth in Africa, UNCTAD, Geneva, p. 22. 37 The African countries listed in the AT Kearney/Foreign Policy Magazine Globalization Index (2002) are, on average, ranked higher than the Asian and Latin American countries listed. 38 M. Weisbrot (2002), “The mirage of progress”, The American Prospect, 13(1): 1–14; D. Rodrik (2002), “Globalization, growth and poverty: is the World Bank beginning to get it?”, The Straits Times, 12 February. 39 World Bank (2000b), ibid, p. 20. 40 World Bank (2002a), ibid, pp. 5, 13. 41 Defined as the percentage of people living on less than $1 a day. 42 World Bank (2001a), ibid. 43 Bloom and Sachs (1998), ibid, p. 34. 44 UNCTAD (2001), ibid, p. 10. 45 UNCTAD (2001), ibid, p. 36.

220 Bloom et al. 46 UNCTAD (2001), ibid, p. 42. 47 UNCTAD (1998), Trade and Development Report, 1998, UNCTAD, Geneva, p. 190. 48 UNCTAD (2001), ibid, p. 13. 49 P. Cornelius (2000), Financial Development and the Liberalization of Financial Services Trade. The Africa Competitiveness Report 2000/2001, World Economic Forum, OUP, New York. 50 Sachs (1996), ibid. 51 UNDP (2001), ibid, p. 65. 52 UNCTAD (1998), ibid, p. 99. 53 R. Kanbur, T. Sandler with K. M. Morrison (1999), “The Future of Development Assistance: Common Pools and International Public Goods”, Policy Essay 25 – ODC Books in Brief, ODC. 54 UNDP (2001), ibid, p. 65. 55 A. Amjadi and A. Yeats (1995), “Have transport costs contributed to the relative decline of African exports? Some preliminary evidence”, World Bank Working Paper, Washington, DC. 56 World Bank (2000b), ibid, p. 143. 57 UNDP (2001), ibid, pp. 48–63. 58 World Bank (2000b), ibid, p. 208. 59 UNCTAD (1998), ibid, p. 194. 60 A. Sen (1999), Development as Freedom, Oxford University Press, Oxford, pp. 42–3. 61 See D. E. Bloom and D. Canning (2001), “The health and poverty of nations: from theory to practice”, Development, 44: 36–43, 10, 14. 62 UNDP (2001), ibid. 63 UNDP (2001), ibid, World Bank (2000), ibid. 64 Bloom and Sachs (1998), ibid, p. 3. 65 See The Task Force on Higher Education and Society (2000), Higher Education in Developing Countries: Peril and Promise, World Bank, Washington, DC. 66 UNDP (2001), ibid, p. 169. 67 D. Bloom, D. Canning and J. Sevilla (2001), Economic Growth and the Demographic Transition, RAND, Santa Monica. 68 The Task Force on Higher Education and Society (2000), ibid. 69 United Nations Population Division (1998), World Population Estimates and Projections, The 1998 Revision, datasets on diskettes, United Nations, New York. 70 UNDP (2001), ibid. p. 15. 71 UNICEF, EFA (2000), Assessment Statistical Document, pp. 29, 33. 72 D. Bloom, River Path Associates and J. Sevilla (2002b), Health, Wealth, AIDS and Poverty – the case of Cambodia, Asian Development Bank, Manila. 73 Bloom and Sachs (1998), ibid, p. 18. 74 S. Myers (2001), South Africa: The Destructive Impact of AIDS on the Automotive Sector, World Markets Research Centre. Available at www.worldmarketsanalysis.com/InFocus2002/articles/africa_HIV_safrica.htm. 75 UNCTAD (2002), Investment and Innovation Policy Review of Ethiopia, UNCTAD, Geneva, p. 102. 76 Sen (1999), ibid, p. 41. 77 Bloom and Sachs (1998), ibid, pp. 4, 32. 78 Bloom and Sachs (1998), ibid, p. 13. 79 World Bank (2000c), Global Economic Prospects and the Developing Countries 2001, World Bank, Washington, DC. 80 A. Smith (1776), The Wealth of Nations, Penguin Books, London, p. 122. 81 Bloom and Sachs (1998), ibid, p. 9. 82 Bloom and Sachs (1998), ibid.

Sub-Saharan Africa

221

83 D. S. Shepard, M. B. Ettling, U. Brinkmann and R. Sauerborn (1991), “The economic cost of malaria in Africa”, Tropical Medicine and Parasitology, 42: 199–203. 84 D. E. Bloom, A. Mahal, J. Sevilla and River Path Associates (2001), “AIDS & Economics”, Paper prepared for Working Group 1 of the Global Commission on Macroeconomics and Health. 85 UK Government (2000), “Eliminating World Poverty: Making Globalization work for the Poor”, White Paper on International Development. 86 UNDP (2001), ibid, p. 50. 87 BBC News (2002), Timeline: Democratic Republic of Congo. BBC News online, 22 February. 88 CIA World Factbook 2001. Available at www.cia.gov/cia/publications/factbook/ index.html. 89 World Bank (2001b), ibid, p. 203. 90 BBC News (2001), “UN alleges DR Congo exploitation”, 16 April. 91 Media Institute of Southern Africa (2000), So this is Democracy – State of the Media in Southern Africa 2000, MISA, Windhoek. 92 In one of the most prominent scandals, French oil company Elf Aquitaine is being investigated for bribery of top officials in Gabon and CongoBrazzaville. BBC News (2001), “A potential political earthquake”, BBC News online, 30 May. 93 Transparency International (2001a), Corruption Perceptions Index 2001, Transparency International, Berlin. 94 J. G. Lambsdorff and P. Cornelius (2000), Corruption, Foreign Investment and Growth. The Africa Competitiveness Report 2000/2001. World Economic Forum, OUP, New York; World Bank (2002a), ibid, pp. 43, 102. 95 Transparency International (2001a), ibid, p. 62. 96 Transparency International (2001a), ibid, p. 62. 97 World Bank (2000a), ibid; The Economist (2002), “The worm that never dies”, The Economist, 2 March. 98 Transparency International (2001a), ibid, p. 75. 99 J. Sachs (1996), “It can be done”, The Economist, 29 June. 100 ibid. 101 UNCTAD (2001), “From rhetoric to reality of African development: UNCTAD calls for major policy shift”, UNCTAD, press release, 11 September. 102 The Economist (2001), ibid. 103 E. Supper (2001), Is There Effectively a Level Playing Field for Developing Country Exports?, UNCTAD, Policy Issues in International Trade and Commodities Study Series, No. 1, United Nations, New York and Geneva, p. 5. 104 According to the World Bank, agricultural subsidies in high-income countries total more than six times all development assistance. 105 World Bank (2001b), ibid, p. 40. 106 ibid, p. 35. 107 See D. E. Bloom, A. S. Mahal, D. King, F. Mugione, A. Henry-Lee, D. Alleyne, P. Castillo and River Path Associates (2002), Jamaica: Globalization, Liberalization and Sustainable Human Development (online at www.unctad.org/en/docs/ poedmm176.en.pdf). 108 Bloom and Sachs (1998), ibid, p. 36. 109 The Economist (1997), “Out of Africa”, The Economist, 13 March. 110 W. Easterly (2001), “The failure of development”, Financial Times. 7 September. 111 UNCTAD (1998), ibid, p. 15. 112 UNCTAD (2001), ibid, p. 25. 113 World Bank (2005), ibid.

222 Bloom et al. 114 Figures taken from statistical appendix of International Monetary Fund (2001), World Economic Outlook, IMF, Washington, DC; and Population Reference Bureau (2001), World Population Data Sheet, PRB, Washington, DC. 115 UNCTAD (2001), ibid, p. 24. 116 J. D. Sachs, M. Cuchra and S. E. Sievers (2000), The Case for Increased Debt Forgiveness. The Africa Competitiveness Report 2000/2001. World Economic Forum, OUP, New York. 117 The Economist (1999), “Right on debt”, The Economist, 10 June. 118 R. Greenhill, Jubilee Research, personal communications. 119 Timothy Hatton and Jeffrey Williamson find that emigration powerfully raises the wages of remaining unskilled workers. T. J. Hatton and J. G. Williamson (2001), “Demographic and Economic Pressure on Emigration Out of Africa”, Working Paper No. w8124, February, National Bureau of Economic Research; and T. J. Hatton and J. G. Williamson, Paper presented to the conference on Globalization: Trade, Financial and Political Economy Aspects, Greece, May 2000. 120 Dollar and Kraay (2002), “Spreading the wealth”, Foreign Affairs, 81(1). 121 The Economist (2002), “Making the most of an exodus”, The Economist, 21 February. 122 The New Partnership for Africa’s Development. Available at www.dfa.gov.za/events/ nepad.pdf. October 2001, p. 48. 123 UNCTAD (1998), ibid, p. 89. 124 UK Government (2000), ibid. 125 Bloom and Sachs (1998), ibid, p. 4. 126 As UNCTAD’s 1996 Trade and Development Report showed, countries increasing their market share in products in which trade is growing faster than the average for all products – “dynamic” products – can strengthen their competitive position. East Asia’s economies benefited greatly from dynamic products. UNCTAD (1996), Trade and Development Report, 1996, UNCTAD, Geneva. Africa’s trade negotiators at the WTO have a role to play in supporting this diversification. Effective training in commercial diplomacy will ensure that they have a firm command of the issues. This will give them a stronger hand in negotiations and allow them to respond better to the needs of domestic producers, thereby ensuring their economies benefit from the international trading system. 127 The Task Force on Higher Education and Society (2000), ibid. 128 UK Government (2000), ibid, p. 123. 129 Global Labour Institute (2000), Notes on Trade Unions and the Informal Sector. Available at www.global-labour.org/trade_unions_and_the_informal_sector_ wiego.htm. 130 P. Cornelius (2000), Financial Development and the Liberalization of Financial Services Trade. The Africa Competitiveness Report 2000/2001. World Economic Forum, OUP, New York. 131 World Bank (2001), “Attacking poverty with a three-pronged strategy”, World Bank Policy and Research Bulletin, 12(1). 132 UNAIDS (2000), Report on the Global HIV/AIDS Epidemic, UNAIDS, Geneva. 133 D. E. Bloom and J. Cohen (2002), The Unfinished Revolution: Universal Basic and Secondary Education, Daedalus, Summer, pp. 84–95. 134 UNCTAD (1998), ibid, p. 74. 135 UK Government (2000), ibid, p. 112.

9

Economic growth, liberalization and human development in Asia Learning from the miracle workers David E. Bloom, Larry Rosenberg, Mark Weston and David Steven

I. Introduction Many parts of Asia have benefited greatly from globalization. The “East Asian Miracle” is the development success story to which all other developing nations aspire, and the region’s trade links with the industrialized nations have helped to propel it faster than anyone imagined possible. Where Japan, Korea, Hong Kong and Singapore and Taiwan led, the rest of East Asia soon followed, with export-based development strategies in Indonesia, Malaysia, Thailand and, to a lesser extent, the Philippines having similarly dramatic effects on incomes and quality of life.1 The 1997 financial crisis and subsequent recessions across the region took some of the gloss off the story, with some questioning even before then whether the “miracle” is sustainable,2 but the speed of the region’s transformation from agricultural backwater to thriving economic powerhouse is nevertheless a phenomenon that has yet to be matched. East Asia’s policy-makers were extremely successful at finding strategic points of entry into the three spheres development framework. A strong emphasis on human development was complemented by consistent and effective pro-growth policies, which were in turn backed up by trade liberalization. East Asia’s success has not been replicated across the whole continent, however. In Vietnam, Lao People’s Democratic Republic, Cambodia and China, development has often been held back by political constraints, while the diversity of the continent is highlighted by South Asia, which, notwithstanding India’s progress in recent years, is still plagued by poverty, corruption, civil strife and disturbingly poor human development indicators. This chapter provides a broad summary of Asia’s development in terms of the liberalization, economic growth and human and social development framework. Section II assesses East Asia’s progress, asking how far a balance of the three spheres has contributed to the region’s rapid growth and where the focus should lie going forward. Section III looks at the rest of Asia (South-East Asia, South Asia and China), focusing in particular on the emergence of China and India and the lessons these economies can learn from East Asia’s success.

224 Bloom et al.

II. East Asia The right foundations Many of the foundations for economic development were in place in East Asia before the drive for growth began. Geography, a favourable global political and economic climate, stable governments, strong human development achievements and demography all gave East Asia advantages that other areas, and in particular South Asia and Africa, lacked. This subsection will assess the importance of these underlying factors in creating the conditions necessary for growth. The following subsection will look at the measures taken to promote growth in the region via proactive policies, and the third subsection will address efforts to facilitate growth via liberalization. The final subsection will ask which policy measures are needed for renewed development in the wake of the late-1990s financial and economic crisis. East Asia’s geography makes it well suited to an export-based growth strategy. All the East Asian “miracle” economies are either islands or have long coastlines relative to their total land mass. As Chapter 8, on Africa, shows, landlocked countries wishing to increase trade face major obstacles in terms of transport costs. East Asia’s economies, on the other hand, were able both to access trade routes and, as the region developed, to benefit from their geographical proximity to one another.3 East Asia’s geography was also important from a political viewpoint – the second of the region’s strong fundamentals. The US, keen to stop the spread of communism in the region during the Cold War, promoted political stability by giving its developing, non-communist economies preferential access to world markets.4 Unlike Africa, East Asia remained largely untouched by war throughout the post-war period and, apart from the Vietnam War, those conflicts that did occur were largely confined within national borders, so the impact on regional stability was limited. The region’s leaders also saw economic growth as the key to stability. Many East Asian governments have been intolerant of dissent and the spread of western-style democracy has been slow – often following rather than preceding economic growth. Their leaders focused on growth as a deterrent to political unrest, establishing strong legal and political institutions to provide an enabling framework for trade. Even where changes of leadership have been common, such as in Thailand, economic policy was generally set by economic technicians who were independent of the rest of government and insulated from the political pressures tough decisions might provoke. The third of the key foundations for economic development – the strong human capital that gave East Asia such a solid platform from which to enter the global economy – was a focus of pro-growth government policy from an early stage. Until the East Asian miracle began, human development had long been perceived as an add-on to growth. Economic

Asia 225 development, it was thought, had to precede significant advances in human development because the capital needed to promote health, education and social welfare would not become available until incomes rose. Although it is true that economic progress can and usually does spur improvements in these areas, East Asia showed how the link works in the other direction, too. An educated population was a vital precondition for the gradual technological upgrading that spurred the region’s development. Education has for long been a key policy goal. Even in the mid-nineteenth century Japan had a higher literacy rate than Europe,5 and by 1965 88 per cent of East Asia’s children attended primary school.6 As Amartya Sen has written: “These economies went comparatively early for massive expansion of education . . . and this they did, in many cases, before they broke the restraints of general poverty. And they have reaped as they have sown.”7 Educational improvements have continued throughout the growth period. Primary enrolment is now almost universal in East Asia, and class sizes have come down from thirty-three pupils per teacher in the mid1960s to around twenty-three per teacher in 1992.8 Healthy populations, too, were important, particularly as health improvements created demographic conditions that were favourable to growth. Medical developments after the Second World War were channelled through East Asia’s effective public health systems to promote dramatic mortality reductions. The development of antibiotics and antimicrobials such as penicillin, the use of DDT to combat malaria, and improved access to water and sanitation cut infant mortality rates by nearly two-thirds from 1965 to 1990. At the same time, life expectancy rose from under fifty years to seventy years.9 Active policies to promote health led to much larger health gains in East Asia than in the rest of the developing world. These improvements in turn triggered a demographic transition, whereby declines in mortality were eventually followed by declines in fertility to replacement level as parents realized they needed fewer children to attain their desired family sizes. Government family planning programmes hastened fertility declines.10 The demographic transition in East Asia was the most rapid in history. The crude birth rate fell by more than half from 1950 to 2000, and fertility fell from six children per woman in 1950 to two per woman (replacement level) in 2000. In the lag between declines in mortality and fertility, the youth cohort swelled, creating a “baby boom” generation. When this cohort reached working age it boosted the size of the workforce, increasing the proportion of workers to non-workers in the population. The working-age population grew nearly four times faster (an average of 2.4 per cent per year) than the non-working population between 1965 and 1990.11 The health improvements that eventually led to lower fertility also had an impact on education. Parents, seeing that their children were likely to

226 Bloom et al. lead longer, healthier lives, invested more in their education. With fewer children to invest in, a higher-quality education was affordable, and children emerged from school better able to make productive contributions to the economy.12 With the benefit of a good education and an economic environment that enabled them to find productive work, the baby boomers had a major impact on the region’s economic production – providing East Asia with a “demographic dividend”. Bloom and Williamson (1998), Bloom et al. (2000) and Mason (2001) have suggested that demography was perhaps the single biggest factor behind East Asia’s “economic miracle”, and it is estimated that the demographic dividend accounted for between one-fourth and two-fifths of East Asia’s growth.13 Health can therefore be seen as one of the pillars supporting East Asia’s rapid growth. A virtuous spiral from health to lower fertility to education to economic productivity was created, and the prevailing economic conditions enabled the absorption of the baby boomers into the workforce. Growth-promotion policies – the subject of the next subsection – sped up this absorption. Growth promotion The speed and endurance of East Asian growth over the past five decades is unprecedented. After the devastation of the Second World War, Japan has rejoined the ranks of developed countries. GDP per capita in Hong Kong, Singapore, Taiwan and Korea has almost reached developed world levels; Malaysia, Thailand, and Indonesia have also outsped all other developing regions in graduating from agriculture to industry-based economies. Where it took the United Kingdom fifty-eight years to double its income (starting from 1780) and the US forty-seven years (from 1839), Korea’s income doubled in just eleven years (from 1966).14 Progress on human development has been no less impressive. From the poverty of the post-war years, four East Asian countries – Japan, Hong Kong, Singapore and Korea – now figure in the top thirty of the 162 countries listed on the UNDP Human Development Index; Malaysia, Thailand and the Philippines are ranked in the top seventy; and only Indonesia is ranked outside the top 100, although it is still considered a “medium human development” nation.15 Sustained economic growth has helped lift millions of East Asians out of poverty. The percentage of those living in absolute poverty (on less than $1 a day) fell from 58 per cent in 1975 to 21 per cent twenty years later – a faster decline than any other developing region.16 Anti-poverty policies in the region helped to distribute the benefits of growth more equally than in other developing regions,17 and many parts of East Asia have succeeded in combining high income growth with declining inequality. Growth over the next decade is likely to slow somewhat, as a consequence of the financial crisis and regional and global recessions, but the region’s transformation is nevertheless remarkable.18

Asia 227 East Asia’s efforts to promote economic growth benefited from a virtuous spiral whereby profits from exports of primary commodities were reinvested in the development of manufacturing industries. Profits from exports of the latter were, in turn, re-invested in progressively higher technology production. This “profit-investment nexus” was pushed by proactive government policies.19 Realizing that continued exports of resource- and labour-intensive goods could eventually precipitate price declines and evoke competitive sources of supply, the region’s policymakers focused on maximizing savings and creating a strong investment climate to encourage diversification into higher-value goods. This virtuous spiral was driven by exports. Governments encouraged exports through a series of mechanisms. Bonded manufacturing warehouses allowed large firms a fast-track route through customs; duty drawbacks on tariffs on imported materials reimbursed exporters once products were sold abroad; subsidized credit promoted the development of domestic firms attempting to penetrate export markets; and export processing zones (EPZs) were established across the region, where tax concessions, infrastructure and customs administration were geared towards reducing transaction costs for multinational firms.20 These incentives were conditional on export performance, and governments complemented them by assisting exporters with information-gathering and marketing activities.21 East Asia began its export drive with agricultural products. In the 1960s, much of East Asia was reliant on agriculture, and growing populations had made food security a major concern. However, high-yield crop varieties introduced to the region in the 1960s sparked a massive and sudden increase in agricultural productivity known as the “Green Revolution”. Technological improvements were driven by government policies. Most governments invested in agriculture research and rural infrastructure,22 and taxes on the rural economy were kept low. In Korea and Taiwan, land reform helped to further spread the benefits, and import restrictions on consumer goods protected rural producers.23 As a consequence, agricultural productivity grew faster in East Asia than the rest of the developing world.24 Cereal production, for example, increased by 118 per cent from 1970 to 1995, while using only 4 per cent more land. Per capita calorie supply rose from 2,004 to 2,675 calories per day.25 The success of the Green Revolution allowed the region to become an exporter of food, and profits from exports increased foreign exchange earnings and boosted savings rates.26 Although not especially high in the 1960s, savings rates in the region rose to well over 20 per cent in the 1970s – in Hong Kong they climbed above 30 per cent and in Singapore above 40 per cent.27 Both central government and private saving rates were higher in Asia than in the rest of the world. Governments encouraged the re-investment of these savings in the

228 Bloom et al. development of manufacturing industries. Policies including tax breaks, subsidizing interest rates for corporate investment and limiting risk for private investors ensured that the profits from agriculture were put into capacity improvements.28 Investment was further boosted by development banks, which directed credit to fledgling industries. Between 1960 and 1990 rates of investment were very high, in both historical and comparative perspectives; in Singapore, they exceeded 40 per cent. The consequent upgrading of technology and infrastructure, as well as continued heavy investment in education, provided the crucial stimulus to the region’s diversification-led growth.29 Promoting manufacturing-led export growth has been a profitable strategy in recent decades. Global demand for manufactured products grew much more quickly than demand for primary goods between 1980 and 1996, and the terms of trade for primary commodities declined.30 The type of goods promoted by East Asia was equally important. According to UNCTAD, “the East Asian economies have been singularly successful in increasing their exports of products that are growing in importance in international trade”.31 Products in which trade was growing faster than the average for all products – so-called “dynamic” products – were at the centre of the region’s diversification into manufacturing, and by 1990 around 75 per cent of exports were in sectors whose share of OECD imports had grown consistently since 1960.32 The region’s exporters, in short, moved into the right sectors at the right time. Beginning with basic manufactures such as textiles and toys, they gradually moved up the value chain into products such as household appliances, cars, electronics and semiconductors. A good example of both the farsightedness and the proactivity of East Asia’s governments is provided by Malaysia’s move from rubber and tin production to palm oil production. Realizing that rubber prices were declining and tin deposits running out, the Government of Malaysia encouraged diversification into palm oil. In the 1960s and 1970s, global demand for palm oil was growing (and has continued to grow rapidly since33), and the Government encouraged producers to move into processing and refining the product by increasing duties on crude palm oil exports and relaxing those on processed products. This forced producers to invest in processing capacity, and the ensuing competition between them pushed Malaysia to the forefront of the world palm oil industry. Tax instruments were supported by the establishment of research partnerships between government and industry, and Malaysian palm oil products now account for 75 per cent of the world trade.34 The profit–investment nexus therefore provided the spark needed for growth within national economies. Linkages between economies were also vital to East Asia’s development. In what has been described as a “flying geese development paradigm”,35 exports of goods from the most advanced countries in a region (in this case, initially, Japan) to less advanced economies (such as Hong Kong, Korea and Taiwan) transferred new tech-

Asia 229 nologies and new capital goods to the latter. Eventually, the less advanced economies began to produce and export these goods themselves, and Japan lost competitiveness in them. In the meantime, Japan, by ploughing the profits from its exports into upgrading its production, had diversified into higher technology products where it had a comparative advantage, so it began to phase out production of the primary goods and import them from the “follower” countries. The pattern subsequently trickled down to the later developers such as Thailand and Indonesia.36 In the flying geese paradigm, the follower countries benefit by importing the technology they need to develop their own industries and, later, from access to advanced-country export markets. The leader countries benefit initially from export earnings and later from cheaper imports from the follower countries. According to UNCTAD, the outcome of this pattern is a “constantly evolving regional division of labour within a group of economies all striving for the common goal of industrialization”. “Countries”, it adds, “can move up the industrial hierarchy through accelerated capital accumulation and the adaptation of advanced technology in such a way that shifts competitiveness to the mutual advantage of all countries.”37 As with the profit–investment nexus, the flying geese pattern was pushed by government policy. Japan’s government, for example, worked with other regional governments to promote both Japanese exports and export industries in the follower countries (through official development assistance (ODA) aimed at infrastructure development and promotion of foreign direct investment (FDI), for example). Host governments, too, have worked to encourage the FDI required for technological development and the imports needed for capital goods manufacturing. One of the tools used for this was trade liberalization. Growth facilitation Strong governments with a vision of growth based on exports were instrumental in triggering East Asia’s economic development. Governments also used liberalization to facilitate exports and growth, with reductions on tariffs and import restrictions, openness to FDI and privatization all employed to varying degrees. Policy on tariffs has varied. While Hong Kong has favoured a near-zero tariff on imports throughout the past four decades, Korea and Taiwan, and later Indonesia, Thailand and Malaysia pursued an import substitution strategy for consumer goods.38 Policy on the intermediate and capital goods needed for the production of manufactured exports was more consistent, however, with tariffs reduced or removed across the region. By 1985, the average tariff rate on these goods was 12 per cent (in the four most advanced economies – Hong Kong, Korea, Singapore and Taiwan – they averaged 5.7 per cent). Tariffs on intermediate and capital goods in

230 Bloom et al. South Asia, on the other hand, were over 50 per cent, in Latin America 20 per cent and in sub-Saharan Africa 23 per cent. The share of imports covered by quantitative restrictions was also significantly lower in East Asia than in other developing regions.39 Low import tariffs encouraged firms to import machinery and equipment. This gave them the technology they needed to upgrade production.40 As early as 1970, capital goods imports accounted for a three-times higher share of total investment than in South Asia.41 And in the early 1990s, nearly three-quarters of Korea’s investment in equipment was in imported goods.42 The region’s move into electronic goods exports provides a good example of the benefits from tariff liberalization. In 1974, the costs of producing electronic goods in East Asia were substantially lower than in Africa, partly because African governments charged their firms 20 per cent average duties on imported inputs while East Asia charged nothing. These costs negated the advantage of Africa’s cheaper labour. East Asia’s low labour costs in turn meant that production in the region was significantly cheaper than in Western Europe. This confluence of low tariffs and low labour costs helped East Asia to corner the global electronic goods market.43 Between 1970 and 1994 the share of electronics in exports rose from 5 to 26 per cent in Korea, from 0 to 33 per cent in Malaysia, from 0 to 18 per cent in the Philippines and from 4 to 28 per cent in Singapore.44 Tariffs and import restrictions have become steadily less important over time. As countries have reaped the benefits of manufactured exports, tariffs and quotas have been reduced. In many cases a spiral resulted, whereby the growth in revenues from exports, which was facilitated by lower tariffs, encouraged countries to remove other barriers to trade. This in turn gave neighbouring economies greater access to their markets, and the chance to achieve growth themselves.45 As well as a low-tariff policy, Hong Kong and Singapore also acted to remove restrictions against foreign direct investment. Later-developing economies such as Thailand, Malaysia and the Philippines have also welcomed FDI, partly to offset their deficits in education compared to more advanced nations. Korea and Taiwan, on the other hand, discouraged FDI until the 1980s.46 Even in Korea, however, the extent of foreign investment has varied between sectors – encouragement of FDI in manufactured exports sectors has meant that foreign affiliates make up over 70 per cent of the crucial electronics and electrical machinery industries.47 FDI has grown in recent years. The region overtook Latin America as a recipient of foreign investment in the late 1980s, and investment in Korea in particular has increased dramatically since the early 1990s as its economy has opened up to investment from abroad. In the region as a whole, FDI as a percentage of GDP rose from 1.5 per cent in 1990 to 3.9 per cent in 2000.48 Although most investment in the region has come from the US and Europe, FDI is also an important driver of the flying geese paradigm.

Asia 231 Investment by advanced-country firms in follower countries transfers capital and speeds up the process of technology adoption, thereby hastening the growth of host-country export industries. In recent years, FDI in East Asia from Japan has been matched by within-region investment from Hong Kong, Korea, Singapore and Taiwan. In all cases, initial investments in primary commodities industries have been superseded by higher technology investments as both the investing and host economies have developed.49 So far, FDI has been concentrated in export manufacturing sectors. There is scope for it to have an impact on services, but privatization of state-owned entities in the region has so far been limited – thus keeping FDI rates down. Service provision and investment in infrastructure improvements have hitherto been largely government-led. Results have been impressive, with high investment in power, transport, water and telecommunications paying off by driving higher growth.50 However, with services increasing in importance as an economy grows (the US and UK economies, for example, are dominated by services), central planning may no longer be the optimal strategy for continued dynamism in fast-growing sectors such as energy, telecommunications and transport. Privatizing these sectors is likely to yield benefits similar to those received by countries in receipt of FDI – technology and knowledge transfers should upgrade capacity and increase competitiveness. There are, of course, risks associated with privatization, and careful management of the process should be combined with strict rules on fair competition and pricing. But provided governments maintain a role in regulation, competition among providers has the potential to improve efficiency and maintain fair prices. Liberalization in East Asia, therefore, was uneven. Hong Kong adopted an essentially free trade approach from the start, but other economies liberalized only gradually, as they began to grow. Tariff reductions were comprehensive in export-related industries but more limited in consumer goods sectors. FDI was welcomed by several East Asian economies, with efforts to attract it in others largely concentrated in the export sectors that drove the region’s growth. And privatization has to this day made only limited inroads, although some governments have begun to sell off their assets since the 1997 financial crisis. Selective and gradual liberalization clearly helped East Asia’s industries to prepare themselves for opening up to the global economy. Early liberalization of export industries provided a vital stimulus to growth, while protection of domestic industries gave investors in the latter the space to redirect resources into more profitable, outward-facing sectors. Workers, too, benefited from the safety net that protection provided – investment of the profits from exports in education and training programmes allowed many to move into export industries without the upheaval that sudden comprehensive liberalization would have created. The political path to change was thereby smoothed.

232 Bloom et al. As we shall see, however, the 1997 financial crisis highlighted the problems caused by a failure to liberalize sufficiently, and the final subsection of Section II will look at the impact of the crisis and the potential for renewed growth in the region. The financial crisis – where next for East Asia? Many commentators have attributed East Asia’s miracle to investment in capital. Bloom and Williamson (1998) and Bloom et al. (2000) suggest that capital accumulation in the form of labour accounts for much of the region’s economic growth.51 Young (1995) also found that productivity improvements were unexceptional, accounting for very little of the growth.52 And Krugman states that outside Japan, “There is startlingly little evidence of improvements in efficiency”, as heavy investment in physical capital has driven East Asia’s rapid development.53 Kim and Lau (1994) support this theory, concluding that “The hypothesis that there has been no technical progress during the post-war period cannot be rejected for the four East Asian newly industrialized countries.”54 Efficiency gains have been unspectacular as investment in infrastructure and machinery has combined with mobilization of labour and improvements in skills and education to promote growth. This highlights a major risk factor facing the region – investment in capital is inevitably subject to diminishing returns, and greater productivity improvements are essential for sustained growth. Outside Japan, therefore, East Asia’s growth is unlikely to be sustainable at such high levels without strong increases in productivity. Japan’s recent troubles highlight a second risk factor facing East Asia’s economies: as a country moves towards the top of the flying geese pattern into high-value manufactured products, the scope for innovation and the exploitation of comparative advantage becomes more limited. Growth in Japan, although based, unlike growth in the rest of the region, on productivity improvements as well as investment, began to slow in the 1970s and has stagnated over the past decade. Innovation is clearly needed, but many of Japan’s large industries have been unable to show the flexibility required. A lack of openness to foreign competition, manifested through either high tariffs on competing imports or government discouragement of FDI, has combined with a lack of the dynamism commonly found in smaller enterprises to exacerbate the region’s difficulties in finding new areas of comparative advantage. Japan has suffered from a lack of small and medium enterprises (SMEs), particularly in the computer and other high-technology sectors. Most of the country’s productivity gains and innovation have hitherto come from larger corporations, and many of those small firms that do exist are locked into a partnership with a larger firm – a so-called keiretsu relationship.55 The flexibility, creativity and innovation of small firms have therefore been lacking.

Asia 233 Although Taiwan is heavily reliant on the SME sector, in the region as a whole there is only one SME per 100 people – in the developed countries, the ratio is one SME for every 20 people.56 The banking sector has played a large role in the suppression of SMEs in the region. Encouraged by their governments, East Asia’s banks have traditionally supported big corporations at the expense of smaller firms. Bank loans to Korea’s chaebol, for example – the large, family-run conglomerates that dominate the country’s economy – have effectively been guaranteed by the Government, enabling banks to make loans without careful consideration of the likely returns.57 Inevitably, therefore, banks were keener to invest in these firms than in smaller, more risky propositions. Inefficient bank lending also had an impact on larger firms’ productivity. Close connections with politicians, who had close connections with banks, enabled conglomerates to obtain financing without having to prove where the money was going. In his book, Against the Dead Hand: The Uncertain Struggle for Global Capitalism, Brink Lindsey cites Tom Horton, who represented US investment fund Newbridge Capital in its purchase of Korea First, a leading Korean bank that had collapsed after lending heavily to several large conglomerates that all went bankrupt during the 1997 financial crisis. Horton asked the bank’s credit committee how many loans they had ever denied: They all looked at each other, and after a pause they said their rejection rate was about 1 per cent . . . That’s because at Korea First about 90 per cent of the loans were to 10 chaebol. And a $100 million loan would be just two pieces of paper – the loan itself and a security agreement with cross-guarantees from the rest of the chaebol.58 Such lax banking practices bred inefficiency and corruption.59 They also allowed conglomerates to run up massive debt burdens. The opening up of the region’s financial markets in the period before the crisis allowed corporations and banks to increase their risk still further by borrowing foreign currency, so when demand for East Asia’s exports slowed in the mid-1990s and local currencies were devalued in response, the debt burdens became unsustainable. As late as 2000, the debt-equity ratio in four of Korea’s largest chaebol was over 190 per cent, and Daewoo had gone bankrupt.60 The vulnerability of export-based economies to global currents was the third risk factor facing the region. Japan, as we have seen, moved into recession at the beginning of the 1990s, but declines in global demand for the rest of the region’s products saw export growth drop sharply in 1996 and 1997.61 In Malaysia and Thailand, for example, the growth rate of export earnings dropped by over fifteen percentage points in 1996.62 As foreign investors in the region’s newly-liberalized financial markets perceived that growth was slowing, they reduced their exposure. Short-term

234 Bloom et al. investors, too, withdrew their interests, and the close links between the region’s economies meant that a domino effect, beginning in Thailand and quickly spreading throughout the region, ensued. The combination of three major risk factors – the diminishing returns on capital investments, the difficulty of identifying new patterns of comparative advantage and making appropriate adjustments as a country moves up the flying geese pattern, and the vulnerability of export-based economies to global currents – combined to provoke the 1997 financial crisis and the subsequent region-wide recession. All three factors were related to a failure to continue to innovate, linked in particular to the inflexibility and lack of transparency engendered by the close relationship between governments, banks and large conglomerates. Several commentators have attributed East Asia’s woes in the last few years to the opening up of their financial and capital markets in the face of IMF and US Treasury Department pressure. They argue that, since savings have traditionally been so high in the region, it did not need the funds portfolio that investment in securities markets would bring.63 As we have seen, the region’s vulnerability to the sudden withdrawal of foreign funds played a part in the economic crisis, but the weak fundamentals of the banking sector provided the major stimulus for the contagion effect that resulted.64 On the other hand, with SMEs starved of credit by the relationship between banks and large firms, capital markets are a means for them to access the funds they need to develop and innovate. By way of market signals, capital markets also provide a key source of information for those considering moving into new sectors or developing new products. Large firms, too, can benefit from the transparency and accountability capital markets encourage, as well as from the instant information market signals provide. Liberalization of East Asia’s financial markets came too quickly for the region’s inflexible banking sectors and large industries, however. As UNCTAD’s Trade and Development Report 1998 explains, governments did too little to ensure a smooth transition to open capital markets. The Report lists a lack of risk controls, poor classification standards and provision for non-performing loans, weak collateralization of property loans and inadequate controls over currency risks as the key weaknesses in the regulatory regime.65 Governments did both too much, by liberalizing financial markets too quickly, and too little, by not regulating them sufficiently. The links between banks and governments allowed the former (and their conglomerate clients) free rein to borrow and invest recklessly. Many East Asian governments have realized since the financial crisis that financial markets can benefit both large and small enterprises, and there is a growing awareness that strong institutions are needed for them to function efficiently. Many East Asian economies have responded to the crisis with further liberalization. The Korean and Thai governments have sold off many of

Asia 235 their banks to foreign investors; the Korean government has encouraged banks to lend to smaller firms while forcing chaebol to restructure and cut their debts; Singapore’s government is reducing its stake in Singapore Telecom; and Japan has created two new stock markets aimed at entrepreneurial businesses – the “Market of the High-growth and Emerging Stocks” and Nasdaq Japan.66 Regulatory processes have also been strengthened in some areas, with Malaysia, for example, tightening the rules on non-performing loans and increasing banks’ capital ratios.67 Many of East Asia’s problems point to a need for increased productivity based on renewed dynamism. Large firms have stagnated due to a lack of competition and new ideas combined with the cosseting by banks that has allowed them to make inefficient use of funds. Smaller firms have been starved of credit and access to information and have faced high set-up costs and an excess of red tape. And banks have suffered from a lack of regulation and from the moral hazard created by government guaranteeing of their loan policies. The dynamism required to confront the risk factors facing the region should be based on a new government vision. The region’s leaders have been particularly good at finding strategic points of entry over the past fifty years, in each of the three development spheres – investment in agriculture research, low tariffs on imports for manufacturing, the establishment of export processing zones, and the universalization of primary education, for example, have had far-reaching collateral effects leading to good health, economic growth and poverty reduction. Having made such enormous gains, however, East Asia now needs to take the next step, with a focus on four key areas that are likely to trigger sustainable virtuous spirals: 1

2

Banking reform. If East Asia’s high savings rates are to be allocated more efficiently, liberalization of the banking sector is clearly essential. Competition from foreign firms is needed to increase transparency and make the sector more accountable for its investment decisions, and governments should distance themselves from lending decisions while ensuring the establishment of a facilitative regulatory environment. Without reform, funds will continue to be directed to unproductive firms and the strengthening of capital markets will be hampered, with collateral impacts on both large and small firms. Reform of big business. Banking reform will have strong effects on the efficiency and transparency of large firms if financing decisions can be made on the basis of merit rather than personal relationships. Strong banks and capital markets will also provide conglomerates with the signals that can help them determine whether new investments are likely to prove profitable. However, in order to respond to market signals, firms will need to become more flexible and more entrepreneurial themselves. In the earlier stages of development, large

236 Bloom et al.

3

4

companies were successful in penetrating international markets, but as they have grown they have become more cumbersome, and in a world where technological change is both rapid and quickly dispersed, greater flexibility is now required. Until now, those firms that have faced foreign competition – that is, those in the export sector – have been far more innovative than domestic industries (Japan in particular has suffered from a “dual” economy, with world-leading export firms contrasting sharply with stagnant domestic sectors). Protection of domestic producers now needs to give way to an emphasis on competition. As firms such as Malaysia’s palm oil processors are forced to compete, they become more innovative and productivity grows. Efforts to attract FDI, therefore, such as those made by Korea in recent years, should now be built on and extended across the region. Promotion of SMEs. Encouraging large firms to be more entrepreneurial and dynamic will be made easier if smaller firms are allowed to provide them with an example. The dynamism found in SMEs – 20 per cent of Japan’s small and medium-sized manufacturers, for example, developed new patentable products in 199968 – is vital for both further diversification of export industries and improved productivity in the service sector. Continued poverty reduction, too, depends largely on the success of smaller firms. Many governments have attempted to boost the SME sector in recent years. Taiwan, much of whose success has been driven by small businesses, promotes its small businesses via a series of measures, including an information management system, a credit guarantee fund, EPZs, an SME development fund and funding for research and development (Japan’s SMEs, on the other hand, find it harder to access funding for research and development than capital investment69). Thailand encourages its entrepreneurs to establish SME Associations for knowledge-sharing, marketing and funding activities. Singapore, too, has recognized the importance of small firms in the knowledge economy.70 Governments have an important role to play here – not only by encouraging SME development by loosening the links between banks and large firms and reducing red tape, but by facilitating information-sharing and marketing activities in a similar way to their earlier assistance to large firms attempting to penetrate export markets. A drive for knowledge. Economies can grow either by using more resources or by using resources more effectively. East Asia’s success was based on the former strategy – the region made full use of resources that had previously been languishing. Now, however, the scope for increased capital accumulation is limited, so economies need to squeeze more out of the resources accrued. Knowledge and technology are essential for this, and for the region to make new leaps forward it will need to advance its knowledge and use technology in

Asia 237 more sophisticated ways.71 As well as learning from foreign governments and industries, East Asia’s governments need to promote tertiary education. In 1995, tertiary enrolment rates across the region (at 7 per cent) were less than half those in high-income countries – only in Korea, where enrolment rates were 52 per cent, did they approach the high-income average of 58 per cent.72 In 1994, the average East Asian worker had received seven years of education – in developed countries, workers receive over ten years of schooling.73 Increased access should be complemented by improved quality, with governments working with civil society, business and higher-education institutions to create a vision for a tertiary education system. A systems approach allows for the effective differentiation of higher-education institutions, with each type of institution, from technical college to university, having a clearly defined purpose. In this way the whole higher-education sector can contribute to national goals. Growth in East Asia is likely to recover once the global economy moves out of recession, and economies such as Korea and Taiwan have already begun to show encouraging signs. But for the region to once again become a “tiger”, its policy-makers, in finding new strategic entry points in the growth, liberalization and human and social development spheres, need to both continue the good work of recent decades and become even more open to new ideas.

III. Catching tigers This section will assess the development process in the rest of Asia and examine the potential for matching East Asia’s achievements. In recent years, China, India and smaller economies such as Vietnam and Cambodia have emerged from long periods of state control and begun to integrate into the global economy. In some of these cases, growth has been spectacular. Economies such as Nepal and Pakistan, on the other hand, have continued to struggle. The section will attempt to answer three questions. First, is following the East Asian model desirable? Second, is it possible? And third, how successful have the rest of Asia’s efforts to catch up with the tiger economies been? The final subsection of the chapter will look at the region’s future prospects and the challenges it faces in promoting virtuous spirals towards sustainable human development. Why follow East Asia? East Asia reaped huge rewards from establishing strong linkages between export earnings, savings and investment. The “profit–investment nexus” allowed the region to develop its human capital and upgrade its

238 Bloom et al. infrastructure and industrial base, and with the consequent economic growth came dramatic improvements in quality of life. An export-based strategy was particularly appropriate for East Asia. Many of its countries consist of islands with relatively small populations, so exports, by broadening markets, allowed firms to benefit from economies of scale which would not have been available had they been limited to producing for domestic markets. Competing in export markets also made firms more efficient. Since the region began its development with limited resources in terms of the capital and intermediate goods needed for the development of a manufacturing base, it had to import these goods, paying for them with export earnings. Much of the rest of Asia is in a similar situation. Small economies such as Nepal, Vietnam, Cambodia and Bangladesh have neither the market size nor depth to sustain rapid industrial upgrading. And although China and India have huge populations, and thus the potential for economies of scale within domestic industries, those populations are largely poor and rural, so market development has so far been limited. At least in the early stages of development, therefore, both large and small economies are likely to require exports to pay for imports of capital goods.74 At the same time as attempting to follow its export-based growth strategy, developing Asian economies would do well to avoid the pitfalls of East Asia’s recent history. China, for example, is already exhibiting signs of a “dual” economy similar to that in Japan, with GDP per capita in outwardfacing coastal regions more than double that of the inland provinces that are home to two-thirds of China’s population.75 And the problems of Korea’s chaebol are mirrored in the troubles of protected large industries across the region. Banking sectors too exhibit the fragility that has so damaged the East Asian economy in the past five years – pouring funds into failing state-owned enterprises had left China’s four biggest banks insolvent by 1997.76 As we have seen in East Asia, a lack of competition in industrial and banking sectors can severely hamper the growth process. The rest of Asia has the opportunity to learn from its Eastern pathfinders. Growth of the type seen in Korea, Singapore and Hong Kong over the past four decades would pull millions out of poverty and give economies such as China and India a position on the world stage more commensurate with the size of their populations. The next subsection will assess whether such growth is possible today. The potential for growth Favourable internal and external conditions were vital to East Asia’s development. Geography, international politics, international trading conditions and strong human capital all facilitated growth. Such factors are likely to be equally important to the success of the rest of Asia’s efforts to catch up.

Asia 239 As we have seen, East Asia’s geography contributed to its growth. Long coastlines, proximity to trade routes and the geopolitical climate of the Cold War greatly facilitated its export-based growth strategy. As the development process took off, the tigers’ proximity to each other came to constitute a further geographical advantage, as the region’s economies were able to benefit from the “flying geese” pattern. Physical geography in much of the rest of Asia is less favourable. Landlocked countries like Nepal and Lao PDR face major barriers in terms of access to trade routes and transport costs. The vast and densely populated inland regions of India and China are also cut off from trade arteries, either by geographical barriers such as mountains and deserts or by poor infrastructure. And climatic conditions imperil growth in Bangladesh, with many other areas also heavily reliant on weather conditions for their survival. The geopolitical situation facing Asia’s most recent developing nations is also different. Whereas East Asia’s economies grew in a climate of peace, tensions between Taiwan and China, India and Pakistan, and internal strife in Myanmar, Nepal, North Korea and Sri Lanka have hampered economic progress in the rest of the region. Unstable states like Afghanistan and North Korea, moreover, threaten their neighbours as well as their own people. However, as with East Asia, global political conditions have increased the strategic importance of many states in the region. The “War Against Terrorism” prompted the US to lift sanctions on Pakistan, for example, and the Bush Administration has taken steps towards establishing friendly relations with China as the latter opens up to the global economy. As in the 1960s, Asia remains crucial to global stability. Trading conditions have also changed since the 1960s. World Trade Organization (WTO) rules and IMF and World Bank loan conditions reduce the scope for protecting domestic industries, through either high tariffs or quantitative restrictions on imports.77 The increased competition from abroad faced by domestic producers is likely to make the transition more disruptive than that in East Asia. UNCTAD has noted that there is still scope under WTO rules to apply quantitative restrictions on imports in “infant industries”, and for “selective government intervention” in the agriculture and textiles sectors that are so important to developing economies,78 but there will nevertheless be pressure on governments to quickly find alternatives to uncompetitive local industries, so that laid-off workers can be absorbed. As well as difficulties posed by the international trading system, there are many potential benefits that were not available to East Asia. WTO rules, if they were to be applied uniformly, would partially level the playing field for developing countries; rich Western economies, in theory at least, are also prohibited from protecting their industries and farmers, so the rest of Asia should have greater access to these vital markets.79

240 Bloom et al. At present, many European Union (EU) and US industries remain protected by high tariff barriers – a continuation of this situation, however, will make it difficult for the latter to insist that Asian economies lower their own barriers. Asia’s newly developing economies can derive further benefits from the emergence of East Asia as an economic power. East Asia’s economies provide a huge market for those neighbours attempting to replicate their success, and there is clear potential for countries such as Vietnam, Bangladesh and Cambodia to be the next entrants into the flying geese pattern. China has already reaped rewards from this paradigm – East Asia’s tiger economies are more important to its exports than Japan, the EU or the US.80 More formal regional integration might help support this process, and would be particularly beneficial to smaller economies such as Nepal. The recent strengthening of the links between the world’s economies has been largely driven by improvements in communications and transport based on technological advances. Although this potentially poses a threat to those economies that have lagged in terms of technological takeup, it also represents an opportunity for speedier growth once the profit–investment nexus begins to function. China, for example, has already begun to export some high-technology products, and some parts of India have leapfrogged production of labour-intensive exports and moved directly into services and high-value computer goods. Transport and communication improvements, moreover, increase the efficiency of the export process, giving developing economies more time and money to invest in productivity increments. If Asia’s people are to make the most of technology, a good education is essential. East Asia benefited from a well-educated population at an early stage of its development, but educational standards across the rest of the continent vary widely. Amartya Sen has shown how China’s strong education system gave it a head start on India when the two countries turned to market-led policies. While India had invested heavily in tertiary education at the expense of primary and secondary schooling, China had a population with a strong basic education – this enabled the majority of the population to participate in productive work.81 This disparity is further highlighted by patterns of gender inequity. In 1993, male adult literacy in South Asia was 62 per cent, while among women it was just 35 per cent.82 Women’s potential for contributing to the economy, therefore, is not being fully realized, which is reflected in the fact that men earn three times more than women. Gender inequality is likely to prove a major hindrance to Asia’s development. Mobilizing labour was a key driver behind East Asia’s growth, but elsewhere in the region economies are failing to make optimal use of half of their human resources. Women’s development, moreover, can trigger numerous virtuous development spirals. Women’s education and health

Asia 241 improves family health; malnutrition among women has effects on the birth weight of their children – this in turn has been shown to be associated with increased cardiovascular disease prevalence in later life;83 and empowering women contributes to lowering birth rates which, as we have seen, can provide a demographic dividend to developing nations. One oftcited example of women’s empowerment is provided by Bangladesh’s Grameen Bank and the Bangladesh Rural Advancement Committee. These organizations have directed micro-credit towards women with great success – women have been able to use funds to invest in the health and education of their children and to set up small businesses: partly as a consequence, fertility rates in Bangladesh declined from 6.1 to 3 children per woman in just two decades.84 Women’s education has also been shown to be an effective tool in the battle against HIV/AIDS, which constitutes a major threat to the region’s development.85 Health in the region has improved in the past thirty years, albeit at a slower rate than in East Asia, but AIDS threatens to reverse these gains. China’s government has recently acknowledged that at least six million people will be infected with HIV by 2010, with the number of reported cases growing by 67 per cent in the first half of 2001. In some villages in Henan province, a scheme whereby poor farmers sold their blood for medical purposes resulted in 80 per cent HIV infection rates as they were re-injected from a contaminated blood pool.86 India, too, has almost four million infections. HIV rates across Asia have generally remained low relative to sub-Saharan Africa, but if the virus continues to cross from vulnerable populations – such as drug users, and sex workers and their clients – into the mainstream, far more explosive epidemics could be the result. As well as the human tragedy involved, the spread of AIDS also threatens to reverse poverty reduction efforts. Bloom, River Path Associates and Sevilla have presented evidence from Bangladesh, Cambodia, Nepal and Vietnam that suggests that the poor and least educated are at greatest risk of HIV infection. Their knowledge of transmission factors and the preventative benefits of condoms is much weaker than that of wealthier and better educated groups, and they are more likely to be sexually active at a young age and to use condoms less frequently.87 Prevention and treatment campaigns targeted at the poor represent a major challenge for the region’s health systems. Many of the fundamental conditions for growth, therefore, are different from those faced by East Asia at the start of its development. Health, education and internal political problems present threats to development in some areas. Since protection of domestic industries is no longer a sustainable option, moreover, social welfare systems will be severely tested, and if they fail the test then human development will be further threatened and political tensions exacerbated. However, the region also faces many advantages compared to East Asia. The emergence of the latter provides a ready-made export market as well as a source of FDI; WTO rules

242 Bloom et al. may give economies greater access to rich-world markets; and technology improvements mean the catch-up process can be rapid. Whether Asia’s economies will take advantage of the opportunities or be cowed by the threats depends largely on its policy decisions, and, importantly, on the actions of developed countries and international financial institutions. The story so far In East Asia, the development process proceeded very roughly as follows: investment in agriculture produced rapid growth in productivity, which eased food shortages and reduced rural poverty; exports of agricultural goods were promoted, and the earnings from exports were reinvested in upgrading into manufacturing; many former agricultural workers moved into industry, and promotion of manufacturing exports was facilitated by liberalization of the imports needed for upgrading; East Asia’s economies continued to move up the value chain and rapid growth in manufacturing further reduced poverty and greatly improved quality of life. This process was enhanced by the flying geese pattern, whereby follower countries imported goods from more advanced economies and used them to develop their own industries. These industries eventually exported to the advanced countries in the pattern, as the latter developed comparative advantages in higher-value areas which enabled them to move away from goods that the follower countries were now exporting. Like their East Asian predecessors, many other Asian countries started from a position of a high dependence on agriculture, and widespread poverty. The Indian food crisis of the 1960s and the 1959 famine in China that killed over twenty-five million people highlighted the region’s vulnerability and its dependence on food aid. As in East Asia, the Green Revolution made an enormous impact. Cereal production in South Asia increased by 93 per cent from 1970 to 1995, using just 4 per cent more land. Daily per capita food supply rose by 12 per cent,88 and India became a net exporter of food as annual incomes rose from $241 to $439.89 China, too, saw large benefits, with the new high-yield crops reducing its dependence on food aid and freeing up rural workers for the massive expansion of industry that marked the liberalization period (nearly a quarter of China’s rural labour force is now employed in non-farm sectors90). China has quickly re-invested the profits from agricultural exports in the production of higher-value goods, beginning with toys and textiles but now also producing electrical and electronic goods (computers and telecoms equipment currently account for one-quarter of China’s exports91). Bangladesh, Pakistan and Sri Lanka have also reduced their reliance on primary goods, although most of their exports are in labour-intensive, rather than skill- and technology-intensive, commodities.92 Other economies, however, such as Myanmar and India, remain heavily dependent on agriculture, which still employs nearly three-quarters of the latter’s population.93

Asia 243 China and Vietnam have led the way in investing heavily in export promotion in recent decades. The establishment of EPZs (known as “special economic zones” in China) has allowed exporting firms to benefit from tax and regulatory concessions as well as zero tariffs on the imported inputs required for manufacturing exports. Labour markets, too, have been liberalized, providing greater flexibility to employers; and foreign direct investment, particularly in the special economic zones, has been encouraged.94 Liberalization has further boosted exports, with average tariffs in China falling from over 25 per cent in 1985 to 15 per cent in 2002.95 These rates are comparable with East Asia’s, and well below those of South Asia. As a result of such measures, exports have boomed. Annual export growth in the 1990s averaged 16 per cent in China and 23 per cent in Vietnam,96 and the ratio of trade to GDP in China rose from 10 per cent in 1978 to 36 per cent in the late 1990s.97 FDI in China also grew, multiplying more than twelve-fold from 1990 to 1998.98 High savings and investment rates have spurred China’s move away from primary commodities. Manufactured goods now make up 90 per cent of the country’s exports,99 as high corporate savings comparable to those in East Asia have been re-invested in upgrading China’s industrial base.100 South Asia, on the other hand, has suffered from low savings and investment rates,101 which have hampered the development of a profit–investment nexus. The region has a large informal sector, which in India, for example, accounts for 91 per cent of employment,102 and therefore a narrow tax base that limits the funds available for investment. Informal workers rarely have bank accounts, so governments do not have access to personal savings. In economies such as Bangladesh, Nepal and Pakistan, moreover, high levels of debt tie governments’ hands, and, as in East Asia, unstable and opaque banking sectors both discourage savers and fail to allocate funds efficiently. Much of South Asia has therefore been unable to invest in diversification into dynamic products. While small pockets, such as Bangalore in India, have managed to move into high-technology production, these areas remain the exception rather than the rule. As well as a lack of funds for investment, South Asia’s exporters are constrained by high tariff barriers on imported goods. Tariffs in the region are among the highest in the world, and Radelet et al. have found that this lack of openness has made a significant dent in its aspirations to match East Asia’s growth.103 Exports make up less than 10 per cent of South Asia’s GDP – a much smaller share than in East Asia and Latin America.104 Despite the sluggishness of liberalization, however, some progress has been made. India’s service sector has flourished since liberalization began, and accounted for 51 per cent of GDP in 2002. The sector doubled in size the decade after liberalization, and foreign direct investment rose

244 Bloom et al. from almost nothing to nearly $4 billion a year in 2002.105 Moreover, import tariffs, although still exceptionally high at over 30 per cent, halved since 1991, and exports grew at a rate of 9.8 per cent a year in the 1990s.106 Economies such as China and Vietnam, therefore, have more closely followed the East Asian model of export promotion than South Asia’s developing economies. Growth rates show similar variation. Annual per capita GDP growth in China averaged nearly 10 per cent between 1989 and 2000,107 and the doubling of its income in the ten years from 1987 outpaced even South Korea’s rapid growth.108 Vietnam saw per capita growth of over 6 per cent over the same period.109 India, meanwhile, grew at just under 4 per cent per year and Pakistan’s growth from 1990 to 1999 was slower than in the preceding fifteen years.110 Poverty reduction has also been more significant in China and Vietnam than in South Asia, although both regions have seen declines. The number of rural poor in China fell from 250 million in 1978 to 34 million twenty years later.111 Vietnam, which opened up its economy in the late 1980s, saw poverty rates halve over the ensuing decade. Poverty rates in South Asia are also expected to more than halve by 2015, although half of Indians still live in poverty.112 Quality of life, too, has improved. As Bloom et al. have shown, although quality of life is lower in rural than urban Asia, it did not decline in the period from 1970 to 1995, despite the population increasing by nearly 40 per cent.113 Life expectancy has risen from fifty to sixty-two years in South Asia, and sixty-three to seventy years in China since the early 1970s; infant mortality has fallen from 128 and 85 per 1,000 live births to sixty-nine and thirty-three per 1,000 respectively; and primary and secondary enrolment in South Asia have risen from 68 to 94 per cent and 24 to 39 per cent respectively.114 Virtuous spirals Much progress has been made by Asia’s economies in following East Asia’s lead, but a focus on five areas in particular may speed up the process by promoting virtuous development spirals: 1

Opening up to the global economy has provided large benefits to many Asian economies, but, along with more investment in human development, further liberalization of industry is likely to be required if high growth rates are to be sustained. Much of India’s heavy industry and many of its banks remain publicly owned and, while China has liberalized many state-owned enterprises (SOEs), the state’s share of industrial output is still high relative to other economies. The close relationship between the state and industry has contributed to East Asia’s recent problems, and Asia’s other large economies are now facing similar difficulties. Industrial growth in India has been sluggish, and by the mid-1990s the ratio of liabilities to assets in China’s state

Asia 245

2

3

4

5

sector was a perilous 85 per cent. The consequent propping up of SOEs by state-owned banks has left 40 per cent of outstanding loans non-performing.115 Safety nets are needed to counter the negative impacts of liberalization. The troubles faced by SOEs have forced China to restructure the state sector. Entry into the WTO is likely to further increase the pressure for reform. In 1998 and 1999 twenty million state sector workers were laid off,116 and the country’s social services have been severely tested. Safety nets for those displaced are vital if laid-off workers are to avoid poverty and engage in a productive search for new jobs. Political pressures, as well as the need to reabsorb the unemployed, will require an emphasis on training, perhaps in tandem with welfare benefits, to help equip workers for the changing economic conditions. A focus on equality is likely to pay dividends for the region as a whole. Vietnam has grown without significant changes in inequality, but in China both rural–urban and inter-provincial inequality have mushroomed since 1985.117 Restructuring of state enterprises is exacerbating unemployment problems in the poorer, inland regions, which is likely to lead to increased urbanization. It has been estimated that migration to cities will mean that eight to ten million more jobs will need to be created each year – in an economy where job creation has slowed of late.118 China has already taken steps to reduce income differentials between coastal and inland regions.119 In India, too, where the caste system has institutionalized inequality, disparities in education and health standards mean that the poor will be both less likely to enjoy the benefits of economic growth and less able to contribute to it. Poverty reduction efforts will be strengthened by small business promotion – the fourth potential trigger of virtuous development spirals. Since liberalization of state-owned industries began, much of China’s manufacturing growth has been produced by small-scale, rural enterprises, whose share in exports tripled to over 44 per cent between 1980 and 1993,120 so there is clearly scope for liberalization to have significant impacts on small enterprises. The industrialized world also has a vital role in promoting pro-poor growth by liberalizing its own tariff and subsidy regimes on the agricultural and industrial goods that are so important to countries beginning their development process. Finally, bringing the region’s large informal sector into the formal economy is likely to further contribute to SME development, but red tape and civil service corruption currently deter many informal entrepreneurs. On Transparency International’s Corruption Perceptions Index, China ranks 57th of the ninety-one countries studied, India 71st, Vietnam 75th, Pakistan 79th and Bangladesh last.121 Morgan Stanley

246 Bloom et al. Dean Witter has estimated that corruption costs China’s economy 2–3 per cent of GDP per year.122 China has taken some steps to counter corruption by increasing public sector wages. It also investigated 15 per cent more corruption cases in 2000 than in 1999. Accession to the WTO will bring further pressure for transparency.123 Singapore, which ranks an impressive 4th in Transparency International’s list, has shown the benefits of high civil servant salaries and the personal commitment of its Prime Minister to wiping out corruption.124 Increased openness to foreign investment has the potential to reduce corruption in the business sphere – many transnational corporations are listed on their domestic stock markets, where a lack of transparency is often punished. They also fall under the spotlight of domestic and international NGOs, which further limits their scope for behaving badly and associating with dubious partners. The effects of corruption fall heaviest on the poor, and increased transparency in both government and industry is likely to have strong impacts on poverty reduction. To conclude, therefore, although growth in the rest of Asia has not yet matched East Asian levels over a sustained period of time, progress in many areas has nevertheless been encouraging. Growth rates in some countries have been solid, poverty rates have fallen and the region’s share in world trade has risen. A profit–investment nexus has been established in the most successful economies, which are also beginning to benefit from a new flying geese paradigm involving the newly industrialized economies of East Asia. Several economies have not yet derived benefits from globalization, however, with progress in Nepal and many rural parts of India and China particularly slow. If India and China are to realize the potential of their huge populations to provide economies of scale so that domestic industries do not need exports for growth, they will first need imported technologies to develop their manufacturing base. India in particular, which has been slower to develop an export sector than China, will benefit from further liberalization of imports (especially those imports required for manufactured exports) combined with a drive to strengthen the institutions needed for savings rates to grow. Formalizing regional relations may help smaller economies to profit from their neighbours’ development. And a focus on reducing inequality – between rich and poor as well as male and female – will have impacts on human development and poverty reduction. Interventions in these areas will help to trigger the virtuous spirals from which East Asia, with its balanced approach to development, reaped such great rewards.

Asia 247

Notes 1 For the purposes of this chapter, East Asia refers to Hong Kong, Indonesia, Japan, the Republic of Korea, Malaysia, Philippines, Singapore, Taiwan (China) and Thailand. South-East Asia includes Burma, Cambodia, Lao People’s Democratic Republic and Vietnam. South Asia refers to Bangladesh, India, Nepal, Pakistan and Sri Lanka. This chapter will not cover Western and Central Asia. China is addressed separately. 2 P. Krugman (1994), “The myth of Asia’s miracle”, Foreign Affairs, 73(6). 3 D. Bloom and J. Sachs (1998), “Geography, demography, and economic growth in Africa”, Brookings Papers on Economic Activity, 2: 207–73. 4 UNCTAD (2000), Trade and Development Report, 2000, UNCTAD, Geneva, p. 70. 5 A. Sen (1999), Development as Freedom, OUP, Oxford, p. 41. 6 ADB (1997), Emerging Asia: Changes and Challenges, Asian Development Bank, Manila, p. 273. 7 Sen (1999), ibid, p. 41. 8 ADB (1997), ibid, p. 273. 9 ADB (1997), ibid. 10 A. Mason (ed.) (2001), Population Change and Economic Development in East Asia: Challenges Met, Opportunities Seized, Stanford University Press, Stanford. 11 D. E. Bloom and J. Williamson (1998), “Demographic transitions and economic miracles in emerging Asia”, World Bank Economic Review, 12(3): 419–55. 12 With economic growth, parents no longer needed their children to earn money for the family, so the children had more time to attend school. Moreover, even sending fewer children to public schools (which were generally free) reduced the considerable out-of-pocket expenses incurred by parents even with a “free” education. 13 D. Bloom and J. Sachs (1998), ibid; D. Bloom and J. Williamson (1998), ibid; D. Bloom, D. Canning and P. Malaney (2000), “Demographic change and economic growth in Asia”, Population and Development Review, 26(Suppl.): 257–90; Mason (2001), ibid. 14 J. A. Frankel (1998), “The Asian Model, the Miracle, the Crisis and the Fund”, Speech delivered at the US International Trade Commission, 16 April. 15 UNDP (2001), Human Development Report 2001, Oxford University Press, New York. 16 D. E. Bloom, P. H. Craig and P. N. Malaney (2001), The Quality of Life in Rural Asia, Asian Development Bank, OUP, Oxford, p. 37. 17 J. Stiglitz (2001), To a Third Way Consensus, Project Syndicate (online at www.project-syndicate.org/commentary/stiglitz1). 18 UNCTAD (2002), Trade and Development Report, 2002, UNCTAD, Geneva, p. 16. 19 UNCTAD (1997), Trade and Development Report, 1997 Overview, UNCTAD, Geneva, p. 9. 20 EPZs provided 74 per cent of Malaysia’s exports, for example, in 1980. ADB (1997), ibid, p. 99. 21 UNCTAD (1996), Trade and Development Report, 1996, UNCTAD, Geneva, p. 132. 22 J. McNeill (2000), Something New Under the Sun, Penguin, London, p. 221. 23 S. Radelet, J. Sachs and J.-W. Lee (1997), “Economic Growth in Asia”, HIID Development, Discussion Paper #609, 23 November, p. 22.

248 Bloom et al. 24 ADB (1997), ibid, p. 17. 25 M. W. Rosegrant and P. B. R. Hazell (2000), Transforming the Rural Asian Economy: The Unfinished Revolution, Asian Development Bank, OUP, New York. 26 ibid, pp. 27–8. 27 ADB (1997), ibid, p. 107. 28 UNCTAD (1997), ibid, pp. 75–6. 29 Paul Krugman (1996), Pop Internationalism, MIT Press, Cambridge, MA, p. 175. 30 Bloom and Sachs (1998), ibid, p. 34. 31 UNCTAD (1996), ibid, p. 124. 32 ibid. 33 Financial Times (1998), “Palm oil gives Malaysia helping hand”, Financial Times, 12 June. 34 UNCTAD (1998), Trade and Development Report, 1998, UNCTAD, Geneva, p. 194; K. S. Jomo and M. Rock (1998), “Economic Diversification And Primary Commodity Processing In The Second-Tier South-East Asian Newly Industrializing Countries”, UNCTAD Discussion Paper No. 136. 35 The paradigm was formulated by K. Akamatsu in 1932. UNCTAD (1996), ibid, p. 75. 36 Labour market integration also contributed to the region’s growth. Bloom and Noor find that the sharp increase in intra-regional trade in the 1970s and 1980s led to a near doubling of the proportion of the region’s labour force participating in cross-national labour market transactions between 1980 and 1991, with governments relatively open to immigration. D. Bloom and W. Noor (1997), “Is an integrated regional labour market emerging in East and South-East Asia?”, in Regionalization and Labour Market Interdependence in East and Southeast Asia, edited by D. Campbell, A. Parisotto, A. Verma and A. Lateef, St. Martin’s Press, New York. 37 UNCTAD (1996), ibid, pp. 75, 78. 38 Radelet et al. (1997), ibid, p. 33. 39 R. Barro and J. W. Lee (1994), “Sources of economic growth”, CarnegieRochester Conference Series on Public Policy, 40(2): 1–46. 40 M. G. Quibria (2002), Growth and Poverty: Lessons from the East Asian Miracle Revisited, Asian Development Bank Institute, 8 January, p. 5. 41 ADB (1997), ibid, p. 89. 42 IMF (1995), Korea: Statistical Tables, IMF Staff Country Report No 95/137, IMF, Washington, DC. 43 ADB (1997), ibid, pp. 94–5. 44 Ibid. 45 D. Rodrik (2001), “The Developing Countries’ Hazardous Obsession with Global Integration”, The South Centre, 8 January (online at www.south centre.org/papers/nonsouthcentre/toc.htm). 46 UNCTAD (1996), ibid, p. 121. 47 Ibid, p. 122. 48 World Bank (2002), World Development Indicators, 2002, World Bank, Washington, DC. 49 UNCTAD (1996), ibid, p. 75. 50 A. Mody and M. Walton (1998), “Building on East Asia’s infrastructure foundations”, Finance & Development, 35(2). 51 D. Bloom and J. Williamson (1998), ibid; D. Bloom, D. Canning and P. Malaney (2000), ibid.

Asia 249 52 A. Young (1995), “The tyranny of numbers: confronting the statistical realities of the East Asian growth experience”, Quarterly Journal of Economics, 110(3): 641–80. 53 Krugman (1996), ibid, p. 176. 54 J. Kim and L. J. Lau (1994), “The sources of economic growth of the East Asian newly industrialised countries”, Journal of the Japanese and International Economies, 8(3): 235–71. 55 F. Fukuyama (1995), Trust, Penguin Books, London, p. 164. 56 C. Harvie and B. Chye-Lee (2002), “East Asian SMEs: contemporary issues and developments – an overview”, Globalization and Small and Medium Enterprises in East Asia, edited by C. Harvie and B. Chye Lee, University of Wollongong. Edward Elgar, Cheltenham. 57 The Economist (1999), Economics: Making Sense of the Modern Economy, The Economist Publishing Group, London, p. 202; Lindsey (2002), Against the Dead Hand: The Uncertain Struggle for Global Capitalism, John Wiley & Sons, New York, pp. 138–9. 58 Lindsey (2002), ibid, p. 139. 59 In Transparency International’s Corruption Perceptions Index, which measures corruption as perceived by businesses, academics and risk analysts in 91 countries, South Korea ranks 42nd, behind South Africa and Mauritius; Thailand ranks 61st along with Malawi; the Philippines ranks 65th and Indonesia 88th, ahead only of Nigeria and Bangladesh. Only Singapore (9th) and Hong Kong (14th), the two most open economies in the region, rank in the top twenty. Transparency International (2001), Corruption Perceptions Index, Berlin. 60 Lindsey (2002), ibid, p. 148. 61 UNCTAD (2000), ibid, p. 70. 62 UNCTAD (1998), ibid, p. 59. 63 D. Rodrik (2001), ibid; J. Stiglitz (2000), “What I learned at the World Economic Crisis”, The New Republic Online, 17 April. 64 UNCTAD (1998), ibid, pp. 67–8. 65 UNCTAD (1998), ibid, p. 64. 66 The Economist (2001), “State-owned stockpiles”, The Economist, 29 March; The Economist (2002), “Plastic bubble”, The Economist, 20 April; Lindsey (2002), ibid, p. 157. 67 UNCTAD (1998), ibid, p. 64. 68 Small and Medium Enterprise Agency (1999), “1999 White Paper on Small and Medium Enterprises in Japan”, Ministry of International Trade and Industry, Japan. 69 ibid; Chapter 2, section 4. 70 Harvie and Chye-Lee (2002), ibid, p. 19. 71 The impact of resource efficiency on global environmental problems is also increasing in importance, and there are likely to be regulatory pressures and market mechanisms in the future that reward a country that is able to squeeze a lot out of, for example, every unit of energy expended. 72 The Task Force on Higher Education and Society (2000), Higher Education in Developing Countries: Peril and Promise, World Bank, Washington, DC, pp. 104–7. 73 The Economist (1999), ibid. 74 UNCTAD (2002), ibid, p. 166. 75 UNCTAD (2000), ibid, p. 18. 76 Lindsey (2002), ibid, p. 154. 77 D. Rodrik (2001), ibid, p. 11. 78 UNCTAD (1996), ibid, p. 157.

250 Bloom et al. 79 Recent US moves to impose higher tariffs on steel imports and to further subsidize its agricultural producers cast doubt on the extent to which developing countries will be able to benefit from a nominally levelled playing field. 80 UNCTAD (2000), ibid, p. 32. 81 Sen (1999), ibid, p. 42. 82 ADB (1997), ibid, p. 280. 83 ibid. 84 ibid. 85 D. Bloom, River Path Associates and J. Sevilla (2002), Health, Wealth, AIDS and Poverty, ADB/UNAIDS. 86 G. Bates, J. Change and S. Palmer (2002), “China’s HIV crisis”, Foreign Affairs, 81(2). 87 Bloom et al. (2002), ibid. 88 Rosegrant and Hazell (2000), ibid. 89 McNeill (2000), ibid, p. 225. 90 The Economist (2001), “Country briefing: China – economic structure”, The Economist, 5 September. 91 UNCTAD (2002), ibid, p. 141. 92 ADB (1997), ibid, p. 92. 93 UNCTAD (1997), ibid, p. 169; Radelet et al. (1997), ibid, Table 5b. 94 ADB (1997), ibid. 95 Barro and Lee (1994), ibid; China Daily (2000), “China to cut its overall tariff rates”, China Daily, 30 December. 96 World Bank (2002), Global Economic Prospects and the Developing Countries, World Bank, Washington, DC, p. 238. 97 Lindsey (2002), ibid, p. 125. 98 World Bank (2000), ibid, p. 314. 99 UNCTAD (2002), ibid, p. 141. 100 UNCTAD (1997), ibid, p. 169. 101 Radelet et al. (1997), ibid. 102 Lindsey (2002), ibid, p. 164. 103 Radelet et al. (1997), ibid, Table 4. 104 World Bank (2002), ibid, p. 239. 105 World Bank, World Development Indicators, 2005. 106 World Bank (2002), ibid, p. 238. 107 G. Gilboy and E. Heginbotham (2001), “China’s coming transformation”, Foreign Affairs, 80(4): 26–39. 108 Frankel (1998), ibid. 109 World Bank (2002a), Global Economic Prospects and the Developing Countries, World Bank, Washington, DC. 110 World Bank (2002), ibid, p. 180. 111 World Bank (2002a), ibid, p. 6. 112 World Bank (2002), ibid, p. 30; Quibria (2002), ibid, p. 1. 113 Bloom et al. (2002), ibid, p. 91. 114 UNDP (2001), ibid; ADB (1997), ibid, p. 273. 115 N. R. Lardy (1998), China’s Unfinished Economic Revolution, Brookings Institution Press, Washington, DC, pp. 39–43; World Bank (2001), Special Focus: Financial & Corporate Restructuring, World Bank East Asia Update, Washington, DC, p. 3. 116 ibid. 117 World Bank (2002a), ibid, p. 49. 118 The Economist (2000), “Now comes the hard part”, The Economist, 6 April. 119 UNCTAD (2000), ibid, p. 18. 120 ADB (1997), ibid, p. 117.

Asia 251 121 Transparency International (2001), ibid. 122 Transparency International (2001a), East Asia and the Pacific Regional Report, Transparency International, Berlin. 123 Ibid. 124 Transparency International (2001b), Southeast Asia Regional Report, Transparency International, Berlin.

10 Gendered labour markets and globalization in Asia Gita Sen

I. Introduction This chapter argues that processes of economic globalization have significantly transformed labour markets in Asia during the last three decades. A central feature of this transformation is the growing importance of female labour at the core of economic processes. This feature has been extensively discussed by feminist economists and anthropologists but has received relatively little attention in macro-policy debates. At best, policies towards women workers are viewed as welfare measures of primary interest to the women themselves. The chapter argues that such a view is shortsighted and its limitations are becoming evident in the context of the recent economic crisis. Gender-biased or “gendered” labour markets, as we call them, are not only a problem for women workers. They also trap economies on the socalled low road of labour-intensive growth, making it difficult to garner the full fruits of growth, or to ensure its sustainability. Sustainable human development focused on the conditions of women’s participation in labour markets can lay a firmer grounding for sustained increases in income per capita. Sustainability is viewed as having three dimensions – human development, the gains from trade and integration with the global economy, and resilience in the face of economic shocks such as the recent crisis. The chapter is divided into three main sections: • • •

The implications of globalization for the transformation of labour markets The micro and macro implications of gendered labour markets The policy implications of gendered labour markets under globalization.

II. Globalization and the transformation of labour markets in Asia The past three decades have witnessed major changes in Asian labour markets associated with globalization processes, and the liberalization and

Gendered labour markets and globalization in Asia 253 integration of national economies into the international economy. Asia is, of course, a vast region with considerable differences and divergent trends in its sub-regions and also within the countries of the various sub-regions. This chapter does not attempt a comprehensive analysis of these differences, but rather focuses on those aspects of labour market change most closely linked to economic globalization.1 The earliest country in the region to globalize was clearly Japan, whose post-War emergence as the “classic” export-oriented fast-growth economy dates back to around the mid-1960s (Carney and O’Kelley, 1990). Japan’s lead was followed rapidly by the Republic of Korea, Hong Kong Special Economic Zone and Taiwan Province of China, and in the 1970s by Singapore, Malaysia, Thailand and Indonesia. Although the economic growth and labour market experiences of these first three rounds of Asian countries to globalize had their specific features, they shared common characteristics: unprecedented high growth rates, export orientation, significant investments and achievements in health and education, and a striking reliance on female labour in new and fast-growing manufacturing and services (World Bank, 1993; Joekes, 1995). Not all of these features are to be found in the relative late-comers to globalization in the region such as Sri Lanka, Bangladesh, Vietnam, China and, most recently, India. Despite this, newer segments of the labour market in these countries also show a higher employment (and in some cases a preponderance) of women workers (Mitter and Rowbotham, 1995; Pearson and Mitter, 1993). This regional “feminization” of the labour market has been commented on and analysed almost since its inception by economists and anthropologists working on women and development (Elson and Pearson, 1981), and later by labour analysts at the ILO (Standing, 1989) and elsewhere. With a few exceptions, however (Amsden and van der Hoeven, 1996; Joekes, 1999), analysis of this feminization process has been poorly linked to the discussion of macroeconomic issues including trade policies and globalization. Yet, the phenomenon of feminization has been significant enough in the region to make this a major lacuna in both analysis and policy discussions. This section of the chapter provides an analysis of the dimensions of this labour market transformation by examining both demand and supply sides. Changes in the supply of labour Two aspects of labour supply have been important – quantity, as represented by population growth rates, rising female labour force participation rates, and migration; and quality, as represented by education levels and health status. Table 10.1 shows that while official labour force participation rates for women are still significantly below those for men (except for the socialist economies), the share of women in the adult labour force has grown in all countries (with the exception of India) between 1970 and

254 Gita Sen 1997. These increases have been particularly significant in countries such as Indonesia, South Korea, Malaysia, Singapore and Sri Lanka, ranging between six and twelve percentage points. Other countries have experienced smaller but still significant percentage increases. When combined with the fact that, for the period 1965–95, annual growth rates for the total labour force have been over 2 per cent in almost all the countries under consideration, this points to a significant increase in the absolute and relative importance of women workers in the region.2 Women workers have risen from around one-third to over two-fifths of the adult labour force in many of the countries considered. This increase in the female labour force has two components to it – the increase in the total labour force consequent on population growth and change in the age structure, and the increase in women’s labour force participation growing faster than that of men. The proportion of women in work-related migration has also been increasing (Hugo, 2000). Although large-scale migration data comparable across countries are difficult to come by, Hugo (2000) argues plausibly that the “migration of women both within and between countries has increased exponentially over the last two decades . . . In considering migration of women we are no longer focusing on a small minority.” Traditionally, female migration has tended to be heavily marriage-related and associational (with families), but recent decades have seen women migrating in larger numbers for work and by themselves, both domestically and internationally. These migrants (more often young and single than before) are employed in new factories and workshops associated with the global assembly line, as well as in informal sector work such as petty trade and services, domestic service, sex work and the entertainment industry (Hugo, 1993). Many international migrant workers are undocumented, and there has been an increase in trafficking of women migrants in the region. Table 10.2 provides some surrogate indicators for labour force quality in these countries. The indicators provided include recent data on female literacy, infant and maternal mortality, and female life expectancy, as well as the human and gender development indices. It is well known that such indicators are considerably better in the East and South-East Asian countries than in South Asia (excepting Sri Lanka). Throughout the subregions, there were already disparities in these indicators of the region’s labour markets at the start of incorporation into the global economy (Table 10.3) and they continue to exist today. Some have argued (Bagchi, 1999) that these differences account for the much faster growth of GNP per capita in East and South-East Asia. Be that as it may, one may hypothesize that labour force quality, as embodied in workers’ health and education levels, will influence the sustainability of labour intensive growth as discussed in Section IV of this chapter.

84 96 86 90 85 76 91 85 84 82 86 92 – – – –

8* 80 50 31 38 41 52 38 53 30 67 77 – – – –

Women 2.57 2.60 2.55 2.09 2.48 2.48 3.49 2.85 1.82 1.93 2.66 2.53 – – – –

Avg. annual LF growth rate 1965–95a (%) 40 42 35 34 30 32 31 33 26 25 48 48 – – – –

1970b (%)

Note *The LFPR for Bangladesh is inconsistent with women’s share in the adult labour force.

42 43 34 34 35 39 34 35 35 27 47 48 42 34 28 42

1980c (%) 42 45 37 31 39 39 36 37 38 34 47 50 – – – –

1990b (%)

Women’s share of adult (15–64) labour force (%)

Sources: a World Bank, 1995: Table A-1; bUNDP, 1997: Table 16: cWorld Bank, 1998/99: Table 3.

Bangladesh China Hong Kong India Indonesia S. Korea Malaysia Philippines Singapore Sri Lanka Thailand Vietnam E. Asia Pacific S. Asia Latin America & Caribbean Sub-Saharan Africa

Men

LFPR (1995) (%)

Table 10.1 Indicators of female labour supply

42 45 38 32 40 41 37 37 38 36 46 49 44 33 34 42

1997c (%)

144 108 22 138 99 32 60 98 26 91 59 121

128 90 28 118 86 35 45 81 27 70 39 101

GDI 1994

Source: UNDP, 1997 : Tables 1, 2, 12.

Bangladesh China Hong Kong India Indonesia S. Korea Malaysia Philippines Singapore Sri Lanka Thailand Vietnam

HDI 1994

Table 10.2 Indicators of labour force quality

24 71 89 36 77 97 76 94 87 87 91 90

Female adult literacy rate (%) 85 43 5 74 53 10 12 36 5 16 29 41

IMR 1994 (per 1,000 live births) 57 71 82 61 65 75 74 69 79 75 72 68

Female life expectancy at birth 1994

850 95 7 570 650 130 80 280 10 140 200 160

MMR 1990 (per 100,000 live births

Gendered labour markets and globalization in Asia 257 Table 10.3 Indicators of labour force quality, c.1965

Bangladesh China Hong Kong India Indonesia S. Korea Malaysia Philippines Singapore Sri Lanka Thailand Vietnam

Female enrolment in primary school (%)

Infant mortality rate

Female life expectancy at birth

31 NA 99 57 65 99 84 111 100 86 74 NA

153 90 28 151 138 64 57 73 28 63 90 89

44 59 71 44 45 58 59 57 68 64 58 50

Source: World Bank, 1986: Tables 27, 29.

The demand for female labour The phenomenon of high growth rates in the East and South-East Asian regions prior to the recent financial crisis is too well known to require repetition here. An examination of the changes in the structural composition of GDP during the period reveals some interesting ways in which the countries of the region have bucked global trends. As is well known, the global trend has been a decline in the proportion of agriculture and manufacturing, and an increase in the share of services. These patterns, of course, are different in high-income economies as compared to others. This is true particularly in the distribution within the service sector between corporate services and personal, informal-sector services. Table 10.4 reveals, however, that the average pattern of sectoral change for both low- and middle-income economies does not hold for a number of countries in our group. For low-income economies in the world, on average the share of agriculture declined, that of industry remained stagnant, while the share of services increased. For the low-income economies in our group, however, while the share of agriculture also declined, the share of industry actually increased (except for Sri Lanka, where it increased between 1970 and 1980 and declined thereafter). For middle-income economies in the world, on average there was a smaller decline in agriculture, a significant decline in industry and a corresponding increase in services. This pattern is similar to the well-known pattern of recent structural change for high-income economies. Indeed, distinguishing between lower middle- and higher middle-income economies shows this change to be even more similar to that of the high-income economies. In our group, by contrast, while the share of

258 Gita Sen Table 10.4 Structure of GDP – value added as per cent of GDP Agriculture

Industries

Services

1970 1980 1997 1970 1980 1997 1970 1980 1997 Bangladesh China Hong Kong India Indonesia S. Korea Malaysia Philippines Singapore Sri Lanka Thailand Vietnam Low-income Middle-income Low middle-income Upper middle-income

55 34 2 45 45 25 29 30 2 28 26 29 37 NA NA NA

50 30 1 38 24 15 22 25 1 28 23 NA 35 15 18 9

30 20 0 27 16 6 13 20 0 22 11 27 31 12 14 10

9 38 36 22 19 29 25 32 30 24 25 28 28 NA NA NA

16 49 32 26 42 40 38 39 38 30 29 NA 26 45 45 46

17 51 15 30 42 43 46 32 36 26 40 31 27 38 40 34

37 28 62 33 36 46 46 39 68 48 49 42 33 NA NA NA

34 21 67 36 34 45 40 36 61 43 48 NA 38 40 37 45

53 29 84 43 41 51 41 48 64 52 50 42 42 50 46 56

Source: World Bank, 1998/99.

agriculture fell and that of services rose, the share of industry increased significantly for each country with the exception of the Philippines, where it rose between 1970 and 1980 and fell thereafter. Furthermore, the percentage increase in the share of industry was significantly higher than that for the share of services in many countries. In addition to the growth in services, these data point to the importance of industrial growth in the performance of both the low- and high-income economies of the region, which is in contrast to the average pattern for the rest of the world. Table 10.5, which shows the sectoral distribution of the labour force during the mid-1980s to mid-1990s, indicates, however, that there has not been an equivalent structural shift in the distribution of employment. In a number of countries agriculture remains the repository of well over half of the total labour force, implying that the distribution of total GDP and income has shifted in favour of those in industry and services. A striking example of this is Thailand, where agriculture still had 66 per cent of the labour force in 1989, while its share in value added was only 23 per cent in 1980 falling further to 11 per cent by 1997. Similarly, 50 per cent of Indonesia’s labour force was in agriculture in 1993 while only 16 per cent of GDP was produced by agriculture in 1997. A similar pattern is true for India as well as other countries. While anti-poverty programmes and social safety-nets might counter these effects, there is an inherent structural vulnerability here which is important to bear in mind, particularly in the context of the current crisis.

Gendered labour markets and globalization in Asia 259 Table 10.5 Labour force distribution (per cent)

Bangladesh China Hong Kong India Indonesia S. Korea Malaysia Philippines Singapore Sri Lanka Thailand Vietnam

Year

Agriculture

Industry

Services

1989 1993 1991 1991 1993 1991 1988 1991 1991 1986 1989 NA

66 61 1 63 50 17 31 45 0 49 66 NA

16 18 35 14 16 36 23 16 35 18 12 NA

20 21 64 23 34 48 47 39 65 33 22 NA

Source: World Bank, 1995: Table A-2.

Returning to our discussion of the importance of industry in the growth performance of these countries, Table 10.6 shows that the share of women in the category of production workers, and more specifically among manufacturing workers, held its own or increased in most countries. The exceptions to this appear to have been the high-income countries in the group – Singapore, Hong Kong and South Korea. Given our earlier point about the importance of industry to the growth of GDP in these countries, it is clear that the labour market has been distinctly feminized in Standing’s (1989) sense. Even more striking is the share of women in EPZ industries, as shown in Table 10.7. In all the countries in the table, the work force in EPZs has been overwhelmingly female. Table 10.6 Share of women among manufacturing workers and non-agricultural employment

China Hong Kong India Indonesia S. Korea Malaysia Philippines Singapore Sri Lanka Thailand

Proportion of women among manufacturing workers (%)

Proportion share of women in non-agricultural employment (%)

1975

1980

1994

1975

1980

1994

NA 52 9 NA 45 NA NA 41 32 41

40 50 10 NA NA NA NA 47 31 42

45 44 NA NA 38 NA NA 44 (1993) 61 (1992) 50 (1991)

NA 40 10 37 33 NA 47 30 18 42

NA 39 11 34 35 30 46 35 18 42

NA 42 NA 38 (1992) 38 (1993) 35 (1993) 46 40 29 45 (1991)

Source: Standing (1999): Tables 3, 4.

260 Gita Sen Table 10.7 Share of women in EPZ industries (per cent) Early 1980s Singapore S. Korea Hong Kong Malaysia Philippines Sri Lanka India Indonesia

60 75 60 85 74 88 80 90

Source: Joekes (1995): Table 5.

The so-called global assembly line uses women workers in developing countries to produce exports in at least three distinct ways. The first and best-known of these is in EPZs, as mentioned above. The second of these is labour outside of EPZs. Bhattacharya (1997) discusses the case of Bangladesh in the 1980s and 1990s. The number of garment factories grew from four in 1978 to 2,400 by 1995, when 1.2 million workers were employed, of whom 90 per cent were young women under the age of twenty-five. The garment industry accounts for almost three-quarters of female wage employment in Bangladesh. Other countries have had similar experiences. The third way women workers in developing countries produce exports is through sub-contracted piece-work in the home. Homework is used for finishing operations in garments, and is also used to supplement labour needs during peak seasons. Chen and colleagues (1999) estimate that the percentage of home-workers in garments ranges from 30 to 60 per cent in different Latin American and Asian countries. The ultimate employers in all three cases may be multinationals or domestic firms of varying sizes; sub-contracting in particular often involves a whole chain of intermediaries between the multinational buyer and the woman producer. Some believe, however, that women workers are being pushed out of their dominant position in export production (Bagchi, 1999; Joekes, 1999). This phenomenon has been observed in countries as distant as Mexico, Mauritius and Malaysia, and may indicate that this phase of the global assembly line, which depends so heavily on female labour, is drawing to a close. It may be the case that the global assembly line is now dispersing more and higher-skilled jobs rather than only low-end, labourintensive assembly, and men are therefore being drawn in. An alternative hypothesis is that, given the growing rates of male unemployment in many regions during the last two decades, men are beginning to compete on comparable terms for women’s jobs. The evidence is insufficient to know how deep or widespread such a reversal is or where its causes may lie. But this phenomenon would be in line with Standing’s (1999) thesis about feminization: that it represents a convergence downwards between men’s

Gendered labour markets and globalization in Asia 261 and women’s work through processes of “flexibilization” and “casualization” of labour. Services have also seen an increase in importance as absorbers of female labour in a number of countries. Four types of growth of jobs in services have been documented, although aggregate data or distributions among these types are not available. Women with higher levels of education in countries such as Singapore have found employment as professionals in banks, finance and insurance firms, and other corporate service providers. Most similar to the global assembly line in manufacturing is data-entry work for service multinationals such as insurance firms, airlines, mail-order houses and credit card companies, as well as for health management organizations, police departments, etc. (Pearson and Mitter, 1993). Taking advantage of time differences, the global management of data-dependent services is taking on the characteristics of a “24 hour economy” (Presser, 1999). While South-East Asian countries such as Malaysia have had such labour for quite some time, cheaper sources such as India are now coming onto the market.3 A third form of service sector work for women is the growth of service work as a result of growth in tourism and related services – maids, attendants, entertainers – in a number of countries. A fourth is the growth of similar jobs abroad, in a number of high-income countries both within and outside the region, which are increasingly serviced by young women migrants. Although the growth of high-value horticulture has been slower in the region than in others, women workers are to be found here as well (in India for instance) in the labour-intensive jobs, especially harvesting of fruits, vegetables and flowers produced for international and domestic markets. Women workers are also to be found in South Asia and elsewhere in the processing of shrimp for the international market. Labour markets in Asia have been significantly transformed by the processes of globalization and integration of national economies into the international market.4 These processes have turned out to be significant employers of young (and often unmarried) women workers, even in countries such as Bangladesh where systems of purdah and restrictions on the physical mobility of women have traditionally been prevalent. Women workers have been in the vanguard of the export production that has fuelled rapid growth in the region. Such exports go far beyond manufactures into services at home and abroad, and agriculture. The next section will examine the micro and macro implications of these gendered labour markets.

III. Gendered labour markets – micro and macro implications Labour markets may be thought of as being gendered in two senses. The first relates to the sex-based division of labour, by which men and women

262 Gita Sen not only do different kinds and amounts of paid and unpaid work; occupations are also segregated by gender, male–female earnings differentials are significant, and overall there is a distinct hierarchy between women and men in relation to work. The second sense of “gendering” is the way in which gender roles, ideologies and norms shape the above sex-based division of labour, assigning multiple work burdens and responsibilities to women, and determining workers’ vulnerability and bargaining strength. This second sense in which we use the concept of “gendering” may be seen to underpin the first, thereby determining both the division and the hierarchy of female and male labour. Gendered labour markets typically exhibit significant sex-based differences in earnings and working conditions, in work burdens and in the returns to labour that accrue to the individual worker. As such, they have crucial implications for human development and its sustainability. Gendered labour markets also have important macroeconomic implications for the sustainability of export growth and aggregate growth rates, which have thus far been poorly understood by policy. In the current phase of globalization, cheap female labour has too often been viewed by policy-makers as a costless public resource. It is believed that the benefits of this resource will continue indefinitely to accrue publicly in the form of export growth and increased competitiveness for the national economy in the international market, while its costs will be borne privately by individual women workers. This section subjects this belief to scrutiny, and thereby lays the basis for policy action. Occupational segregation The Asian labour markets we are examining in this chapter are gendered in both the senses used above. There is a significant amount of sex-based occupational segregation as well as differentials in earnings between women and men in both high- and low-income economies (Anker, 1998). The picture for Asia when compared with the other regions appears better in terms of the extent of segregation.5 Table 10.8 presents data on the Duncan Index of Dissimilarity6 (ID) at 1-digit and 2-digit occupational classification levels, as well as representation ratios for the six major occupational groups. While ID at 1- and 2-digit levels was on average 0.37 and 0.58 for all countries, it was only 0.22 and 0.45, respectively, for the AsiaPacific group. Anker (1998) suggests that this lower level of “horizontal” segregation may not be picking up a different kind of “vertical” segregation, i.e. men and women may be in the same occupational group but women may be in grades with less pay, status or promotion opportunities (Anker, 1998: 184–5). An indication of this kind of segregation is obtained by comparing some typical female and male occupations (see Table 10.9). Even a cursory glance at the table brings to light the striking differences between typically male and typically female occupations.

– – – – –

Averages: Asia-Pacific All countries OECD LAC Africa

4

5

6

1.35 – 1.25 1.21 1.15

1.07 1.20 1.69 0.89 1.35 1.40 1.16

Notes 1 Professional and technical. 2 Administration and managerial. 3 Clerical. 4 Sales. 5 Services. 6 Production.

0.34 – 0.47 0.58 0.39

0.29 0.71 0.19 0.08 0.29 0.61 0.26 0.95 – 1.62 1.37 1.31

0.69 1.68 0.53 1.04 1.53 1.20 1.00 1.02 – 1.15 1.25 1.47

1.28 0.97 0.55 1.30 0.88 1.44 1.38 1.42 – 1.45 1.53 1.13

1.34 1.13 1.48 1.70 1.13 1.28 1.22 0.74 – 0.42 0.43 0.51

0.99 0.62 1.06 0.66 0.76 0.44 0.80 0.22 0.37 NA NA NA

0.09 NA 0.17 0.23 0.19 NA NA

For six occupational groups

3

1

2

(1-digit)

Occupational groups

0.45 0.58 NA NA NA

0.29 NA 0.46 0.40 0.49 NA NA

(2-digit)

Index of dissimilarity

Representation ratios

Source: Anker (1998): Tables 6.3, 8.2.

1982 1991 1981 1983 1980 1990 1980

China Hong Kong India S. Korea Malaysia Philippines Thailand

Year

Table 10.8 Occupational segregation

(83 occupations (56 occupations) (76 occupations)

(38 occupations)

264 Gita Sen Table 10.9 Typical female and male occupations in the Asia-Pacific region Female

Percentage female workers

Nurses Teachers (all) Stenos, typists Book-keepers, cashiers and related workers Sales persons, etc. Cooks, waiters, bartenders, etc. Maids, etc. Hairdressers, beauticians, etc. Tailors, dressmakers, sewers, etc. Non-agricultural labour force

93.4 43.8 80.4 52.6 42.4 42.3 86.3 40.9 65.2 30.1

Male

Percentage male workers

Architects, engineers, etc. Legislators, govt. administrators Managers Sales supervisors, buyers Protective services Production supervisors and general foremen Blacksmiths, toolmakers, etc. Bricklayers, carpenters and other construction workers Non-agricultural labour force

94.3 87.4 89.8 82.3 96.8 92.5 88.9 95.8 69.9

Source: Anker (1998): Tables 11.3A, 11.3B.

The latter are clearly lower-status jobs. Furthermore, the male occupations have hardly any women workers, unlike a number of the occupations that are important for women and also hire large numbers of men. Representation ratios for the six major occupational groups reveal some other differences between Asia and the other regions. In the other regions (OECD, Latin America and Africa), women workers tend to be over-represented in the categories of Professional & Technical, Clerical, Sales, and Services, and significantly under-represented in Administrative & Managerial, and Production workers. By contrast, in the Asia-Pacific countries considered by Anker (1998), the representation ratio is close to 1 for both Clerical and Sales workers. Furthermore, although women are under-represented among Production workers in Asia, the ratio is about 50 per cent higher than for other regions. Unlike other regions, a relatively high proportion of the largest female-dominated occupations in Asia are in the Production group, especially in the textile sector. These include jobs such as spinners, weavers and knitters, fibre-preparation workers, tailors and sewers, embroidery workers, textile machine operators and sewing machine operators (p. 283). In many regions including Asia, some occupational groups became even more feminized during this period, particularly in small export-oriented countries – for example, in Hong Kong the percentage of women in the category tailors, dressmakers, sewers etc. rose from 64 per cent to 73 per cent between 1971 and 1981. On a positive note, over the past two decades Anker (1998) found that occupational segregation decreased for the world as a whole, particularly in the OECD countries and a number of small developing countries. However, this did not happen in large East Asian countries; in particular, occupational segregation actually increased in China between 1982 and 1990, and in Hong Kong between 1971 and 19917 (Anker, 1998: 412).

Gendered labour markets and globalization in Asia 265 Moreover, men were able to keep their privileged position in the labour market by maintaining their hold over traditional male-dominated occupations in these same countries (p. 414). Overall, therefore, one may conclude that, in the countries of the region, female, labour-intensive, export-oriented integration with globalization has increased women’s representation among production workers above world averages, and also kept “horizontal” occupational segregation lower than average. However, in absolute terms segregation is still high and what is worse, shows little sign of decreasing, unlike elsewhere in the world. Women workers are still crowded into a fairly narrow range of occupations even within the export sector, and at the lower end of occupational hierarchies based on pay, status or advancement possibilities. Earnings differentials This crowding is partly responsible for significant earnings differentials between women and men workers in the region. Consistent and comparable data on earnings are not available for all the countries in our group. Table 10.10 puts together data for five countries. Although it is difficult to see any clear trends in the female–male wage ratios in manufacturing between 1980 and 1994, the most important characteristic is that, in some of the fastest-growing economies of the region, women earn less than twothirds of what men earn.8 This is true despite the fact that women’s education levels have risen considerably in these countries and are sometimes greater than for men. Few studies have actually decomposed the factors behind earnings ratios. One of the few (Terrell, 1992) found that discrimination against women workers explained more than two-thirds of the differential in the countries studied, while human capital endowments (including education) explained less than one-third. In Malaysia in 1979, 86 per cent of the differential was due to discrimination and only 14 per cent to human capital. Gendered ideologies and norms are often used to justify both occupational segregation and pay discrimination. Anker (1998) identifies a number of common stereotypes about women and shows how they are Table 10.10 Female–male wage ratios in manufacturing (per cent)

Hong Kong S. Korea Malaysia Singapore Sri Lanka

1980

1990

1994

NA 45 NA 62 81

69 50 50 55 66

68 NA NA 57 86

Sources: Anker (1998): Table 2.2; Joekes (1999): Table 2.

266 Gita Sen used to keep women in low-paying and low-status jobs. Women are believed to have a more caring nature; to be more skilled at householdrelated work; to have “nimble fingers”; to be more honest, more docile and more willing to take orders; to be more willing to accept lower wages; to have less need for income; to be more interested in working at home; to have less physical strength and endurance; to dislike supervising others; to be less able to do science or mathematics; and to be less willing to travel, face physical danger or use physical force. When willingness to do boring, repetitive jobs on an assembly line is added to this list, the combination translates into the places that women workers occupy in the new international division of labour. This is poignantly captured in the words of a Malaysian woman worker retrenched during the 1985 recession (Ravazi, 1999): After eleven years of working, I realize that I have learnt nothing that is of any use to me. The government has told me to find another job, not to be choosy. How can I be choosy? I have nothing anyone wants. Working conditions and work burdens It is often argued that, when compared to the conditions faced by women workers in the informal sector (which is the major repository of female labour), work in the global assembly line is better. However, while earnings may be higher, working conditions on the global assembly line leave a great deal to be desired. Because the trend was set by EPZs where there are restrictions on freedom of association, workers are rarely able to complain or win redressal of grievances. Women work long hours in cramped, noisy and unsafe conditions, with few breaks; face sexual harassment and violence from male supervisors and co-workers; and are exposed to a range of hazards. Women in microelectronics are exposed to dangerous chemicals with possible carcinogenic effects, while occupational safety standards are implemented in the breach in many units. Under the pressure of cost-cutting, speed and intensification of work, long hours and forced overtime are the norm. Maternity is generally frowned upon, and virginity tests and forced contraception/abortion are not unknown. Ponniah and van Heerden (1998) analysed the factors that influence working conditions in EPZs, and found that tightness of the labour market, origin of the foreign investment, government policies towards setting and enforcing standards, as well as the sector of manufacturing, size of the unit and consumer pressure can all have an influence. As is obvious, when it comes to sub-contracted work in smaller units, or to home-work, many of the positive conditions are even less present. However, in the case of home-work, control and work-intensity are usually ensured through the payment of piece-rates rather than through the direct physical control of the factory or sweatshop. The desperation, vul-

Gendered labour markets and globalization in Asia 267 nerability and fragmentation of home-based workers is usually greater even than of the young women in the factories, and ensures docility and compliance. Home-work does allow somewhat greater flexibility in combining domestic responsibilities and work with contracted labour, but the cost in terms of reduced earnings and risk of job loss is great. Migrant workers, and especially international migrants, probably face the greatest risks and vulnerability, although the promise of reward is also greater. Although migrants usually depend on social networks, they are extremely vulnerable to exploitation in terms of both broken promises regarding pay and conditions, and also sexual and other violence and abuse (Hugo, 2000). Trafficking in women, as mentioned earlier, is a major problem in the region, and a serious violation of women’s human rights. Macro implications Few authors have seriously considered the implications of the gendered labour market under globalization for the returns from trade or the sustainability of growth. Joekes (1999) distinguishes between the potential effects of the so-called low and high roads to industrialization. The low road depends on competition on the basis of cheap labour without the significant investment in productivity increases which characterize the high road. Low wages and low value added in exports can keep export prices low and weaken the terms of trade, resulting in a form of immiserizing growth. The Singer–Prebisch thesis explaining the weak terms of trade for primary products may thus hold for manufacturing as well. Thus, to the extent that gender inequalities and biases are allowed to keep wages perennially low, these can reinforce structural inequalities in global trade between South and North. This is an important hypothesis, given the fact that the terms of trade appear to have turned against manufactured goods from low-income countries in recent years. Much more analytical and empirical work needs to be done to explore these ideas further. The implication of this argument is that the way forward is to make a transition from the low road (based only on cheap labour) to the high road (based on increased worker productivity). This was beginning to happen in some countries in the region prior to the recent economic crisis. However, the effects of the crisis are still not clear in this aspect. Real wages have fallen dramatically, and if restructuring of the economies hardest hit by the crisis begins from these levels, the incentive to move to the high road may be lost. Other implications of making such a transition will be discussed further in Section IV.

268 Gita Sen Key questions We end this section by posing three key questions as a transition to discussing policy issues and interventions. The first is, has globalization of labour markets worked to empower women workers by breaking traditional roles and ideologies affecting women’s work and in this sense, has it supported sustainable human development? Almost from the beginning, there has been a serious debate among scholars and policy activists about how empowering such work is, and how the workers themselves view their situation (Beneria and Roldan, 1987; Lim, 1990; Tiano and Fiala, 1991; Kabeer, 1995; Sainsbury, 1997). While early writers drew attention to the exploitative nature of working conditions and wages, others argued that, given limited options for female employment and access to income, these jobs (especially under multinational firms) not only provided alternatives but also often paid higher wage rates. Despite the difficulties of the work, it has been argued, women, and especially young girls, come to be seen by their families as assets rather than liabilities, and the workers themselves appreciate the improvement in their status and expanded options. Drawing together the evidence and arguments to date, some tentative conclusions can be reached as to whether or not the kinds of work we have been discussing are empowering or not for women. This depends on a number of factors: the worker’s own characteristics (age, marital status, educational level, number of dependants); the rigidity of gender norms and practices in the community from which the worker comes; the conditions of the work itself (pay, working conditions, possibility of skill development and promotion); and gender norms and practices in the workplace and in the community in which the worker lives. It is obvious from this set of factors that there can be no simple answer to the question of empowerment, and there may well be contradictory tendencies. A young woman working in a garment factory in Bangladesh may find the work back-breaking and onerous, but may welcome the possibility it provides to support her and to make contributions to the family. Despite increased risks of abuse and violence, an additional and often important, if not critical, factor is the freedom from traditional gender norms of seclusion and restricted mobility these contributions can provide. From the viewpoint of sustainable human development, the important question to ask therefore is not whether this work empowers women or not, but what policy interventions (positive and preventive) need to be undertaken to ensure that it does so in all its different dimensions. Our second question is, can the processes we have been discussing improve the gains from trade and provide sustained competitive strength to low-income countries in the global economy? As discussed earlier, Joekes (1999) points to the way in which the gendered structure of labour markets, while supporting the low road to growth based on cheap labour, may act as a constraint to the sustainability of growth. Clearly the answer is not to do away with female

Gendered labour markets and globalization in Asia 269 labour(!) but to remove the gender biases and barriers to an increase in labour productivity. Without a clear vision in this area, countries will be condemned to perennial competition against cheaper and cheaper sources of female labour. The major beneficiaries from this competition will not, in the end, be the countries of the South.9 The third question (related to the previous two) is, has the recent economic crisis affected the structure of labour markets and in particular their gendered features and, if so, how? There has been much excitement recently that the economic crisis is over in the region (with the possible exception of Indonesia), and that a new growth spurt is already beginning. Certainly, foreign investors’ confidence in the region (justifiably or not) has been growing. But one of the problems with the debate among economists that followed the crisis was its excessive focus on the financial sector and its need for reform. This is not to minimize the importance of financial regulation, although this chapter does not enter into the debate around what and how much was needed. The point is rather that discussion about the deeper vulnerability of the real economies in the Southeast region has been quite weak. If indeed it was competition from China in recent years that was responsible for the stagnation in exports of some countries, which then was transmitted to the financial sector, then the critical question is how the renewed basis for growth will be laid.10 One way would be to attempt to out-compete China, and this may indeed be possible for a time because of the decline in real wages. But this may trigger an even deeper crisis by making China more vulnerable, and may set off the kind of cut-throat competition from which none of the countries can benefit in the end. The alternative is to try to make a transition to the high road. However, whether this will be possible is not clear. Assuming it is (at least for some countries), this has immediate implications for gender policy, labour conditions and regulatory frameworks for labour, rather than for just financial institutions.

IV. Policy implications of gendered labour markets under globalization One way of viewing different economies in the Asian region is as a spectrum between the low and high roads to growth and poverty removal. Countries in South Asia (with the possible exception of Sri Lanka) may be seen as located nearer the low end of the road, still largely dependent on cheap, low-skilled and low-productivity labour. Many South-East Asian economies such as Thailand and Malaysia are further along, having successfully ensured improved labour quality through investments in education and health, but they have not yet made the transition to the high road of high-productivity labour. Countries like Singapore, Hong Kong and South Korea have made the transition to the high road, and one might risk arguing (despite the effect of the recent crisis on South Korea)

270 Gita Sen that they are now at the other end of the spectrum.11 However, South Korea’s labour market is still deeply gendered (like Japan’s) and structurally dependent on the flexibility of its female labour force, which bears the bulk of the costs of economic adjustment. Given this enormous variability in conditions, no single set of policy prescriptions will be applicable to all countries. The suggestions made below should therefore be considered as appropriate to the particular country. All of them are based on the recognition that countries cannot remain stuck at the low end of the growth spectrum (or even in the middle) if growth is to be sustainable in itself and to support human development. This requires a change in the mindset of policy-makers away from the belief that the cheap labour of women can be relied upon to forever sustain rapid growth of exports at favourable terms of trade. Strengthening women’s “capabilities” 12 and improving labour quality As was seen in Table 10.2 and discussed in Section II, there is enormous variability in women’s capabilities in terms of basic requirements of health and education in the region. The South Asian sub-region in particular (with the exception of Sri Lanka) is seriously constrained by the consequent poor quality of its labour force. Female labour may be drawn nonetheless into new types of jobs, but this is largely because of the absolute size of the labour market and the extreme cheapness of labour. These processes are unlikely to spread more widely, as has happened in China, unless a serious decision is taken at the highest level of government to do more than pay lip-service to the need to empower women and improve their capabilities. While the South-East Asian region is better than South Asia in this regard, many problems still remain. The infant mortality rate in Sri Lanka, a much poorer country, is lower than in Thailand or the Philippines. The maternal mortality rate is still high in Indonesia, and not only in Thailand but also in South Korea it is higher than warranted by the level of per capita income.13 Tackling the problem of maternal mortality with the same political commitment that governments and agencies have brought to bear on infant mortality in the last two decades is the critical need. So far as education is concerned, it is true that the problem of basic female literacy, while urgent in South Asia, has largely been resolved in other sub-regions. However, upgrading their skills and technical abilities across a wider range is essential in the other regions as well if the crowding of women into a few (relatively poorly paid) occupations is to end. As we have discussed, however, gender biases deny women workers higherend jobs with better pay and authority even when they are educationally qualified. A systematic tackling of gender bias at the highest policy level is needed, as well as through well-defined programmes for educating boys and men in communities, in bureaucracies and in private firms. All too

Gendered labour markets and globalization in Asia 271 often, political and policy pronouncements stress the sacrifices that women must make and the responsibilities they must bear (especially during crises), but say little about women’s rights or the responsibilities that men and societies have towards women. One such social responsibility is that associated with the so-called “care economy”.14 A prevalent myth in Asian societies is that joint family systems distribute the responsibilities and labour, including responsibilities for child care. However, these systems are working less and less, not only in urban areas but also among the rural poor where the opportunity cost in terms of women’s income earnings is great. The repeated experience of organizations such as SEWA (the Self Employed Women’s Association) in India is that affordable child care is high on women’s stated priorities for policy, as well as access to clean water and cheap fuel, all of which often consume a great deal of women’s time and labour. These, together with adequate sanitation, are necessary ingredients of sustainable human development that recognizes women’s needs as well as the contribution that such improvements in capabilities can make to the macroeconomy. One area where there has been considerable discussion is that of maternity benefits. Discrimination against married women workers in both hiring practices and pay is often justified on this score. The current understanding among scholars appears to be that these benefits need to be paid for either through general public revenues or through social insurance in order to avoid the disincentive effects to individual employers. In the constrained circumstances that many public exchequers face currently, this appears unfeasible. However, current discussions of healthsector reform and sector-wide approaches (SWAPs) in health urgently need to consider this. Improving working conditions and productivity Switching from the low to the high road of labour intensive growth requires, as we have seen, a shift from taking advantage of cheap labour through intensified exploitation to undertaking the investments needed to increase labour productivity. World-wide, the experience with industrialization has shown that intensified exploitation of cheap labour provides only a temporary competitive edge. Sustained advance requires ongoing investment in productivity improvement. Such improvements come in two ways – embodied in new equipment, production methods, etc., on one side, and better working conditions that enhance a worker’s job satisfaction and creativity on the other. A great deal needs to be done in this regard in both the EPZ and the non-EPZ production units. Effective regulation of hours of work (including compulsory overtime), the provision of adequate breaks from work,15 clean and safe work environments and reduced noise levels have long been recognized as contributing positively to worker productivity. For women workers, in addition, freedom from the

272 Gita Sen fear of sexual harassment by male co-workers or supervisors can be an essential requirement for effective production. The problem is the difficulties of enforcing standards in the large numbers of exporting units in the informal sector. However, the first step is to tackle conditions in Export Processing Zones, which are far from satisfactory in this regard, often because governments are bending over backward to promise minimal regulation to potential investors. However, authorities need to recognize that investors are often willing to allow better regulations in this regard, particularly in the face of pressure from consumer movements and labour organizations in the buying countries. For smaller units, certification systems arranged through trade organizations may work better than those directly managed by the state, which are often open to petty corruption. In the face of consumer and union pressure, a number of multinational firms have begun voluntary processes of certification – but these are often merely public relations exercises. The state can play a role in encouraging the development of independent certification bodies with credibility, i.e. do for working conditions what has long ago been done for ensuring product quality and standards. Manufacturing workers are, however, only one type of worker drawn into the globalization process. Particularly for migrant workers in each category, agricultural workers (horticulture, fisheries) and service workers face some of the most difficult and hazardous working conditions. The problems encountered in improving working conditions in informal sector manufacturing are often compounded in these types of work by widespread physical dispersion and illegality. Despite this, the last decade has seen a significant increase in women’s organizations focusing on ensuring the rights of migrant workers, particularly across international boundaries. International trafficking in migrants for work and sexual slavery is a major human rights problem in the region, requiring effective and sensitive tackling by governments. Ensuring open information about work opportunities, having clear agreements between sending and receiving governments to minimize abuse, and requiring that women’s organizations and migrants’ representatives be present on policy-making bodies are some useful suggestions that have been made in this regard. Broad regulatory instruments Our argument in this chapter is that one important lesson of the recent economic crisis is the necessity of effective regulatory frameworks not only for financial institutions and markets but also for labour and women’s rights. Two important international instruments that countries would do well to ratify and implement are the 1979 Convention on the Elimination of All Forms of Discrimination Against Women, and the 1996 ILO Convention on Home Work. The former is still the most encompassing

Gendered labour markets and globalization in Asia 273 umbrella for the rights of women workers at all levels. A number of countries have signed it with significant reservations, often unrelated to work as such. However, few countries in the region have seriously implemented this Convention, even if they have signed and ratified it. To an extent, this is due to the weakness of the national institutions given the responsibility for promoting and protecting women’s rights, which clearly points to the direction that needs to be taken.16 The 1996 ILO Convention on Home Work is a landmark in recognizing home-based workers as workers entitled to fair pay, and also setting standards for minimum payment and working conditions. As the first international convention for the informal sector, it is to be hoped that this Convention may also begin reversal of a trend noted by Standing (1989) of countries de-ratifying previously signed ILO conventions in order to appear attractive to potential investors. Greater recognition of the importance of making the transition from the low to the high road, growing consumer movements in the North, and pressure from labour organizations are all be pointing in the same direction – sustainable human development, far from being antithetical to rapid economic growth, may be its sine qua non.

Notes 1 Accordingly, the data and analysis in this chapter refer mainly to those countries that have been significantly affected by these processes. See Table 10.1 for a list of these countries. 2 Sharp increases in the share of women workers in the total labour force have also occurred in other developing countries, e.g. Latin America. 3 According to a personal communication from a software professional, traffic citations in New York City are now processed overnight in a town in Western India. 4 Given its absolute size, India’s labour market has not been transformed as comprehensively as in some of the smaller countries. However, the experience of China points to the fact that the potential for change can be quite significant. 5 Anker’s (1998) study examines occupational segregation in depth for forty-one countries of which six were in Asia – China, Fiji, India, Japan, S. Korea and Malaysia. Thus four of the countries in our group are included in his data. 6 The Duncan Index of Dissimilarity (ID) is defined as    Fi/F – Mi/M , where Fi and Mi are the number of female and male workers respectively in occupation i, and F and M are the total number of female and male workers in all occupations. ID ranges between 0 (no segregation) and 1 (total segregation). It may be interpreted as “the sum of the minimum proportion of women plus the minimum of proportion of men who would have to change their occupation in order for the female proportion to be identical in all occupations” (Anker, 1998: 75). The representation ratio is defined as the percentage female in the occupational group divided by the percentage female of the nonagricultural labour force as a whole (p. 162). 7 Occupational segregation did not improve in Japan during the 1980s and 1990s.

274 Gita Sen 8 A recent study by Tzannatos (1998) found that economy-wide earnings ratios improved for women during the 1970s and 1980s in Philippines, Thailand, Indonesia, Malaysia, and S. Korea. 9 To the extent that an important real cause of the recent economic crisis in the region was the relative stagnation of exports in recent years consequent on competition from China (Rakshit, 1997), this point becomes all the more crucial to address. 10 The temptation of making women the principal adjusters was one to which leaders across the region succumbed, calling on women to make disproportionate sacrifices in jobs and incomes, and referring to so-called “Asian values” to shore up patriarchal gender relations and norms. 11 For a discussion of S. Korea’s economic recovery, see Bagchi (1999). 12 The term “capabilities” is used in the sense of Sen (1985). 13 Maternal mortality rate data are of course sometimes of dubious quality, and this must be kept in mind. 14 The term “care economy” refers to all the usually unpaid labour that women typically undertake in order to ensure that household members can survive and even live well. Domestic work, including the care of children, is predominantly the responsibility of women in most societies, and women are not only not paid for it, but it also constrains their participation in labour markets and entrepreneurship. 15 In many export units, the shortness of toilet breaks (sometimes as brief as three minutes a break or five minutes as a total of all breaks in a day!) is a major complaint of women workers. 16 A recent example of how CEDAW can work is the recent landmark judgment on sexual harassment in the workplace given by the Supreme Court of India, in which CEDAW was explicitly cited.

References Amsden, A. and R. van der Hoeven (1996), “Manufacturing output, employment and real wages in the 1980s: labour’s loss until the century’s end”, Journal of Development Studies, 32(4). Anker, R. (1998), Gender and Jobs – Sex Segregation of Occupations in the World, ILO, Geneva. Bagchi, A. (1999), “A turnaround in South Korea”, Frontline, 30 July: 62–5. Beneria, L. and M. Roldan (1987), The Crossroads of Class and Gender: Industrial Homework, Subcontracting, and Household Dynamics in Mexico City, Chicago University Press, Chicago. Bhattacharya, D. (1997), “Gender dimensions of labour market dynamics in the era of globalisation: Bangladesh’s experience in the apparel sector”, Paper presented at the International Workshop on Gender Sensitisation, UNCTAD, Geneva, 9–10 December. Carney, L. and C. G. O’Kelley (1990), “Women’s work and women’s place in the Japanese economic miracle”, in K. Ward (ed.), Women Workers and Global Restructuring, ILR Press, Cornell University, Ithaca. Chen, M., J. Sebstad and L. O’Connell (1999), “Counting the invisible workforce: the case of homebased workers”, World Development, 27(3): 603–10. Elson, D. and R. Pearson (1981), “Nimble fingers make cheap workers: an analysis of women’s employment in Third World export manufacturing”, Feminist Review, Spring: 87–107.

Gendered labour markets and globalization in Asia 275 Hugo, G. (1993), “Migrant women in developing countries”, in Department of Economic and Social Information and Policy Analysis, Internal Migration of Women in Developing Countries: Proceedings of the UN Expert Meeting on the Feminization of Internal Migration, Aguascalientes, Mexico, 22–25 October 1991, United Nations, New York. Hugo, G. (2000), “Migration and women’s empowerment”, in H. Presser and G. Sen (eds), Women’s Empowerment and Demographics – Moving Beyond Cairo, Oxford University Press, London. Joekes, S. (1995), “Trade-related Employment for Women in Industry and Services in Developing Countries”, United Nations Fourth World Conference on Women Occasional Paper No 5, UNRISD, Geneva. Joekes, S. (1999), “The Demographics of Female Labour Supply and Immiserisation in Developing Countries under Globalization”, Paper presented at the IUSSP Seminar on Women in the Labour Market in Changing Economies: Demographic Issues, Rome, 22–24 September. Kabeer, N. (1995), “Necessary, Sufficient or Irrelevant? Women, Wages and Intrahousehold Power Relations in Urban Bangladesh”, IDS Working Paper No 25, IDS, Brighton, Sussex. Lim, L. (1990), “Women’s work in export factories: the politics of a cause”, in I. Tinker (ed.), Persistent Inequalities: Women and World Development, Oxford University Press, New York, pp. 101–19. Mitter, S. and S. Rowbotham (1995), Women Encounter Technology: Changing Patterns of Employment in the Third World, UN University, Institute for New Technologies, Routledge, London. Pearson, R. and S. Mitter (1993), “Employment and working conditions of lowskilled information processing workers in less developed countries”, International Labour Review, 132(1). Ponniah, G. and A. van Heerden (1998), The Forgotten Worker: Women workers’ concerns in Export Processing Zones, ILO, Geneva. Presser, H. (1999), “The 24-hour economy”, Science, 284: 1778–9. Rakshit, M. (1997), “Crisis, contagion and crash: Asian currency turmoil”, ICRA Bulletin: Money and Finance, 4. Razavi, S. (1999), “Export-oriented employment, poverty and gender: contested accounts”, Development and Change, 30(3): 653–83. Sainsbury, J. (1997), “The new inequality: women workers’ lives in Thailand and the Philippines”, CIIR Briefing, Catholic Institute for International Relations, London. Sen, A. K. (1985), Commodities and Capabilities, Elsevier Science Publishers, Amsterdam. Standing, G. (1989), “Global feminization through flexible labour”, World Development, 17(7): 1077–96. Standing, G. (1999), “Global feminization through flexible labour: a theme revisited”, World Development, 27(3): 583–602. Terrell, K. (1992), “Female–male earnings differentials and earnings structure”, International Labour Review, 131(4–5). Tiano, S. and R. Fiala (1991), “The world view of export processing workers in northern Mexico: a study of women, consciousness, and the new international division of labour”, Studies in Comparative International Development, 26(3). Tzannatos, Z. (1998), “Women and Labour Market Changes in the Global

276 Gita Sen Economy: Growth Helps, Inequalities Hurt and Public Policy Matters”, Social Protection Discussion Paper No. 9808, The World Bank, Washington, DC. UNDP (1997), Human Development Report 1997, Oxford University Press, New York. World Bank (1993), The East Asian Miracle – Economic Growth and Public Policy, Oxford University Press, New York. World Bank (1986), World Development Report 1986, World Bank, Washington, DC. World Bank (1995), World Development Report 1995, World Bank, Washington, DC. World Bank (1996), World Development Report 1996, World Bank, Washington, DC. World Bank (1998/99), World Development Report 1998/99, World Bank, Washington, DC.

11 The three spheres Experiences from Latin America, Africa and Asia David E. Bloom, Larry Rosenberg and Mark Weston

I. Introduction The success of East Asia in recent decades highlights the critical importance of the three spheres framework to improving quality of life in developing countries. East Asia’s policy-makers pursued development on all three fronts – they invested in human resources, promoted economic growth and carefully opened up their economies. Progress in attaining sustainable human development in the region has been unprecedented. Other parts of the developing world have attempted to follow East Asia, but in many cases liberalization of economies has taken precedence over policies to promote economic growth and strengthen human and social capital. This chapter looks at the experiences of six developing countries – Botswana, Brazil, Jamaica, Malawi, Nepal and Zimbabwe – that have liberalized their economies in recent decades, and assesses how far reform has contributed to economic and human development. The chapter will first present brief snapshots of the extent and effects of reform in each country. It will deliberately focus more on the internal policy environment than external factors – most of the countries studied suffered from exploitation in the colonial period and high debt burdens in more recent years, but their management of these circumstances differed. The chapter will then look at all six in the context of the three spheres framework, asking how far a mix of policy actions contributed to the success, or otherwise, of reforms. This chapter draws and builds on work carried out for the following papers prepared for the UNCTAD/UNDP Programme on Globalization, Liberalization, and Sustainable Human Development: • •

Sequencing Trade and Capital Account Liberalization: The Experience of Brazil in the 1990s (R. Gottschalk, 2000) Globalization and Sustainable Human Development: Progress and Challenges for Zimbabwe (Ajit Bhalla, Rob Davies, Margaret Chitiga Mabugu, and Ramos Mabugu, 1999)

278 Bloom et al. •

• •

•

Globalization and Sustainable Human Development: Progress and Challenges for Malawi (Ajit Bhalla, Chinyamata Chipeta, Haile Taye and Mjedo Mkandawire, 2000) Globalization and SHD in Nepal (A. R. Khan, 2000) Jamaica: Globalization, Liberalization and Sustainable Human Development (David E. Bloom, Ajay S. Mahal, Damien King, Fiorina Mugione, Aldrie Henry-Lee, Dillon Alleyne, Philip Castillo and River Path Associates, 2001) Botswana: Globalization, Liberalization and Sustainable Human Development (Charles Harvey, Happy Siphambe and Eagilwe Segosebe, 2000).

The chapter is not intended to be a comprehensive review of development performance in each country, but instead highlights particular policy initiatives aimed at promoting improvements in the three spheres of the development framework.

II. Country studies Brazil 1 Brazil undertook reform of its economy in the early 1990s. Previously, the country had protected its industries with import substitution policies. This had left the country with a largely inefficient industrial base and a large debt burden. It was hoped that liberalization would enable Brazil to stabilize its economy, streamline and upgrade production, and strengthen its exporters’ capacity and competitiveness. The 1980s saw a consensus emerge on the optimal order of structural adjustment programmes, with broad agreement that capital account liberalization should be the last stage in the process. This consensus was challenged in the late 1980s, however, by continued economic instability in Latin America and pressure from the international community for countries to undertake stabilization and liberalization reforms simultaneously. Brazil went along with this new theory, and embarked on liberalization of its capital account before the economy was fully stabilized. This strategy helped attract the foreign exchange reserves necessary for the subsequent stabilization plan. It also helped control inflation – Brazil’s economy had long been plagued by hyperinflation, and there was strong political pressure to control price rises. Brazil also began to implement further liberalization measures, eliminating subsidies, laying off public sector workers as part of an administrative reform programme and privatizing state-owned industries. The foreign trade regime was also opened up – non-tariff barriers were removed, import tariffs gradually reduced and the exchange rate allowed to depreciate.

The three spheres 279 Liberalization had three main consequences. First, liberalization meant that external prices began to influence manufacturing costs and prices. Imported raw materials and intermediate goods reduced costs, and external competition put downward pressure on prices. In Brazil, this led to increased manufacturing efficiency at the same time as declines in profits and market share.2 Second, tariff reductions and the opening of the capital account contributed to price stabilization. Increased investor confidence then combined with high interest rates to attract large inflows of foreign capital, which helped the country to build substantial foreign reserves. This, in turn, further anchored the price stabilization process. Third, Brazil’s current account deficit grew. Although imports increased immediately, exports took time to adjust. This would not have been a problem for Brazil had foreign investors been confident that the export sector would recover and begin to benefit from the efficiency gains. However, when this did not happen, the negative balance of payments situation, which led investors to doubt the country’s ability to meet its external obligations, appears to have contributed to the capital flight that caused the 1999 currency crisis. R. Gottschalk (2000) has described trade reforms as a two-stage process: In the first phase, the current account of the balance of payments tends to go into a larger deficit, due to import liberalization and service payments associated with the new foreign-owned stock of assets arising from net capital inflows. In the second phase, the trade account is expected to generate an increasing surplus, thereby offsetting the deficit in the factor services account. Higher exports would reflect the maturation of (partly externally) financed investments in the tradable sector.3 Although Brazil passed through the first phase, the second phase proved more problematic. Imports increased at an average of 15.5 per cent per year between 1991 and 1998, while exports grew by just 7.1 per cent per year.4 Although this may have been a reflection of the first phase of reform, there is evidence to suggest that export growth did not achieve its full potential during this period. Brazil’s share of world exports, which had increased by 50 per cent from 1970 to 1985, fell back to the 1970 level in the 1990s. Therefore, although liberalization had the potential to increase exports by raising the quality and lowering the cost of goods, this potential was not realized. There are two main reasons for the poor performance of exports. First, few Brazilian companies invested in expanding export capabilities. Second, much of the foreign investment in Brazil has been channelled into non-tradable sectors, and has therefore failed to help break the cyclical pattern of the country’s exports by changing the structure of export

280 Bloom et al. industries. As Gottschalk (2000) has argued, “external capital was used to support microeconomic reforms, investment and modernization, [but] this process was not deep or wide enough to cause an effective change in the country’s export pattern or to expand export capacity.”5 Whereas East Asia’s governments consistently identified and channelled funds into sectors that offered a potential comparative advantage, allowing their industries to continually upgrade into more lucrative areas, Brazil’s government failed to seize the opportunity to invest in export capacity and diversify into areas with greater value added. Liberalization in Brazil was therefore carried out without sufficient attention being paid to growth promotion measures. Proactive efforts to support existing exporters and create opportunities for new firms to move into export-based activities would have enabled the country to continue to move up the value chain into more dynamic sectors. Instead, Brazil’s economy has grown at an average of just 1.75 per cent per year since 1998.6 Unemployment has risen, with under-employment higher still. Poverty remains rife.7 Government debt has soared, reaching a record 62 per cent of GDP in July 2002. With regard to the three spheres framework, then, it appears that liberalization came too quickly for Brazil’s exporters. As Gottschalk suggests, “a gradual approach would have . . . given time to build the institutions needed to channel external capital to productive activities.”8 Proactive measures to combine liberalization with growth promotion are likely to have more positive results than those focusing on just one of the spheres. Zimbabwe9 Like Brazil, Zimbabwe embarked on a liberalization programme before macroeconomic stability had been achieved. A large debt burden and a failure to control the budget deficit has led to declining investment in human and physical capital. The lack of investment has contributed to stagnant productivity, and the recent political crisis poses a further serious threat to the country’s future prosperity. Vicious spirals proliferate. Zimbabwe moved from strict regulation to liberalization in a short period of time. In the pre-independence period before 1980, the economy was relatively closed and government regulation dominated economic policy. By the end of the 1980s, however, the large social spending programme implemented after independence was becoming increasingly difficult to sustain, and in 1990 the country began a structural adjustment programme.10 Gradual trade liberalization, opening up of the capital account and reform of domestic agriculture were expected to increase trade and improve competitiveness. However, macroeconomic management throughout the reform period was mixed. Trade liberalization was implemented, and exports increased. Measures to attract foreign direct investment, such as capital account lib-

The three spheres 281 eralization and export processing zones, were put in place. However, the budget deficit remained high, standing at over 10 per cent of GDP in the mid-1990s,11 and government borrowing to finance the deficit pushed up interest rates and deterred investment and growth. High inflation, which has soared dramatically in recent years (reaching 123 per cent in 200212), further deterred investors. The balance of trade, foreign exchange reserves and foreign debt are all now worse than they were before the economy was opened up. Debt has been a continuing problem for Zimbabwe. As in Brazil, trade liberalization led to a faster increase in imports than exports and a trade imbalance ensued. The government was forced to borrow to finance its fiscal deficit, and when donors such as the World Bank failed to disburse funds on time13 the government had to increase its expensive short-term commercial borrowing. Total external debt doubled between 1985 and 1996, thus further hampering investment-led growth. Although the liberalization process was set in motion, growth promotion, partly for the reasons outlined above, has been weak. Zimbabwe has failed to modernize its industries and add value to its exports. Agricultural output has stagnated, and productivity improvements have been modest. SME development has also been very limited. Political governance has also had a major negative impact on growth. According to Bhalla et al. (1999), “Much of the poor performance of Zimbabwe during the past decade’s attempts to globalize extensively have arisen because of poor domestic management. The problem is not the lack of sensible policies but rather the failure to implement them.” Corruption, repression of political opposition and misguided decisions such as the 1997 handout of US$450 million to war veterans have all contributed to the country’s plight.14 Economic contraction – per capita growth averaged 0.5 per cent per year in the 1990s – led, of course, to declining living standards. Liberalization led to retrenchments in the public sector as well as the closure of many uncompetitive private firms, but the government was not able to create opportunities in other areas to compensate those who had been displaced. Foreign investors, discouraged by both the hostile political climate and macroeconomic instability, have not stepped in to fill the gap. Unemployment therefore increased, and poverty has spread. More than 60 per cent of Zimbabweans are now unemployed,15 and famine, according to the World Food Programme, is imminent.16 Modernization of the economy has been further stifled by weak human development. In Brazil, liberalization was accompanied by actions to improve human resources. Efforts to tackle HIV/AIDS and infant mortality were broadly successful, and educational enrolment rates improved. In Zimbabwe, spending on education has declined over the past decade and HIV/AIDS has been allowed to spread rapidly. According to Bhalla et al. (1999), the Zimbabwe Government has never given a high priority to

282 Bloom et al. poverty reduction,17 and the country’s debt burden has further hindered investment in improving the lives of the poor. Social capital has also weakened. HIV/AIDS is tearing apart poor families, leaving behind large numbers of orphans, many of whom are either forced to turn to crime in order to survive or are easy prey for the armies fighting Africa’s many wars. The government’s land reform programme, which aims to redistribute white farmers’ land, has been violent and chaotic. And high inflation has led to increasing protests against government policies. A teachers’ strike in November 2002 was stopped when the government sacked hundreds of strikers, and a law was recently passed giving President Robert Mugabe the power to declare strikes illegal.18 Failure to enhance human and social capital, therefore, and to tackle poverty and create employment-generating growth has compounded Zimbabwe’s problems. Although the economy is now more open than before liberalization, it has fallen into a vicious spiral where macroeconomic and political instability have prevented the improvements in human and social capital that are essential for the country to upgrade its technologies and benefit from globalization. Without political and macroeconomic stability, investment in Zimbabwe’s people and businesses will become ever more difficult. The country is likely to fall further behind and become more isolated. Poor economic performance has led the government to reverse some of its liberalization policies – for example, narrow and distortionary financial incentives for exports, which were abolished in 1994, were reinstated in 1998. A lack of attention to the growth and human development spheres, therefore, has had negative impacts on the liberalization section of the development framework. Malawi 19 Malawi undertook economic reform in the late 1980s. Liberalization of goods markets was followed by liberalization of foreign trade. As in Zimbabwe, however, things have worsened for Malawians since reform began. The supply side of Malawi’s economy remains extremely weak, and the productivity of its industries and agriculture has proved no match for foreign competition. Increased poverty and the famine of 2002 have resulted. Liberalization was implemented in Malawi before measures were put in place to help the country’s firms and farmers benefit from it. The country’s economy is largely agricultural, with no dynamic manufacturing sector that could immediately gain from liberalized trade. Rather, privatization and competition from imports meant companies and the public sector were forced to lay off large numbers of workers. Structural adjustment in the agricultural and manufacturing sectors had little impact on productivity. Food production remains stagnant, and recent droughts

The three spheres 283 have made matters worse. Total manufactured output, too, is now lower than in 1991 and, despite liberalization, some major foreign firms have withdrawn from the country. The high costs of production in Malawi are a major factor behind its failure to benefit from liberalization. The country’s infrastructure (roads, the power and water supply, and telecommunications in particular) is weak, and transport costs are extremely high. Economic governance is poor – corruption among poorly paid public sector workers raises costs for businesses, and excessive regulation of the economy has contributed to the exodus of foreign direct investment. As well as failing to bring down costs, the government also failed to invest in growth promotion activities. Schemes to retrain and re-employ displaced staff in alternative income-generating pursuits were lacking, so unemployment increased. Credit facilities to businesses and farms were inadequate. The country’s uncompetitive exports, moreover, remain concentrated in low-value primary products such as tobacco and groundnuts. Instead of diversifying, in fact, the concentration of the country’s exports has increased since liberalization. As in Zimbabwe, then, Malawi’s budget deficit has grown (to over 10 per cent of GDP in the 1990s20). This, coupled with the dearth of foreign direct investment, has forced the government to borrow, from both foreign and domestic financial institutions, thereby increasing an already high debt-burden. Domestic borrowing has meant that investment in productive activities has been severely restricted – and a vicious spiral has resulted. As Bhalla et al. (2000) have argued, “With such huge debt service payments, Malawi’s ability to invest in infrastructure to become globally competitive will remain very limited.” As well as making investment in the growth sphere of the development framework difficult, debt has also restricted efforts to strengthen Malawi’s human and social capital. Health and education have been neglected, leaving workers poorly equipped for the technological upgrading policymakers hoped for. Low educational quality, low life expectancy, HIV/AIDS, and poor sanitation and water quality mean very few of the country’s people are fit and educated enough to set up businesses, use new technologies and develop new products for export. In another vicious spiral, poor economic performance since liberalization – growth has slowed considerably since liberalization began – has further undermined human capital, as well as increasing poverty and contributing to the disastrous 2002 famine. Crime, too, is on the increase, as social structures have broken down. In order to combat these weaknesses and enable future growth, investment in people (particularly via actions to combat AIDS, modernize school curricula and attack poverty) and efforts to reduce the costs of doing business and to promote small and medium enterprise development will need to be combined with better governance. In 2000, Malawi

284 Bloom et al. was approved for debt relief under the Heavily Indebted Poor Countries (HIPC) programme. The money saved as a result of HIPC should be invested in the hitherto neglected growth and human and social capital spheres of the development framework. Without a renewed focus on these areas, Malawi will continue to struggle against the globalization tide. Nepal 21 For small, poor countries with limited domestic markets, exports offer a vital conduit for economic growth. East Asia’s economies, whose focus on exports led to dramatic quality of life improvements, are the clearest example of the benefits of an export-led growth strategy. Nepal undertook liberalization of its economy in the late 1980s with the aim of expanding its markets and upgrading production. Liberalization was comprehensive. Tariffs were significantly reduced, quantitative restrictions on imports eliminated, domestic industries privatized and full convertibility of the currency introduced. The import substitution policy that had prevailed in the 1970s and 1980s was completely reversed. Like Malawi, however, Nepal liberalized on the back of poor productivity and weak human capital. Reform of the trade regime has therefore failed to make an impact on quality of life, or even on trade performance. Exports have become less diversified – reliance on the carpet and garment industries has increased since liberalization and, although the ratio of trade to gross domestic product has risen, it remains low relative to other small countries. Largely as a consequence, economic growth declined sharply after the reforms were concluded in 1995. Many of the factors behind Nepal’s failure to benefit from globalization are similar to those encountered in Malawi. Nepal’s human development levels are low compared to other developing countries, with life expectancy, literacy and the status of women particularly poor. Progress in recent decades has been mixed – while primary school enrolment increases have been impressive and life expectancy has improved, income inequality and poverty have grown. As in Malawi, debt has prevented significant investment in Nepal’s human resources, which has limited the prospects for technological upgrading, diversification of production and improved productivity. Growth promotion measures, too, have been lacking in Nepal. An immature industrial base has suffered from weak and corrupt institutions, a lack of infrastructure and extremely high transport costs – Nepal is a landlocked nation, with limited and expensive access to distant ports and bad relations with many of its neighbours. Costs of production are therefore extremely high, and industrial growth has declined in recent years. For Nepal to benefit from liberalization, proactive policies to promote growth are urgently needed. Negotiations with neighbouring countries to secure freer access to ports will be vital for reducing exporters’ costs.

The three spheres 285 Investment in infrastructure will be needed if the country is to take advantage of more open borders. Nepal is heavily reliant on India for access to trade routes, and the country has traditionally been closely integrated with its larger neighbour in an economic sense too. The trade treaty signed between the two countries in 1996, which gives investors access to the huge, and growing, Indian market, offers hope for increasing foreign investment in Nepal. Tourism, already a leading source of income for Nepal, should also be attractive to foreign investors, and can be a strong driver of employment growth. As with exports, however, developing and promoting tourism will also require infrastructure development and improved training of those involved in the industry. Nepal also needs to diversify its export base and perhaps learn from the experience of the East Asian tigers. As Khan (2000) has suggested, this may require the “creation of comparative advantage in specifically targeted goods and services”. The East Asian countries used research and consultation with businesses and financial institutions to identify promising industries, and funds and expertise were then channelled into these areas with great success. The jute industry, in particular, which declined with the advent of polythene bags, is a promising new area, in the light of recent and anticipated further actions to ban the use of polythene in many countries. Growth will also be strengthened if Nepal makes better use of its human capital. Finding and developing new areas of comparative advantage will help to create employment opportunities and reduce poverty. Micro-finance schemes to boost small enterprises and satisfy poor people’s need for credit offer another potential avenue for poverty reduction. Land reform to ensure wider and more equitable distribution of assets offers another, albeit complicated, possibility. As in Malawi and Zimbabwe, the human and social development and, in particular, the economic growth promotion spheres of the development framework must be the focus for Nepal’s policy-makers going forward. Jamaica22 Compared to Malawi and Nepal, Jamaica began its economic reform process from a position of relative strength. Trade has typically dominated the economy, and human development has been strong. Jamaica’s geography is also favourable – the country is close to large markets such as the US and Latin America, and foreign exchange receipts from tourism almost match those from merchandize exports. Finally, the English language offers further advantages to Jamaica, particularly in the fast-growing fields of science and information technology. Despite these advantages, however, economic growth has been disappointing. Following a boom in the 1950s and 1960s, Jamaica’s economy

286 Bloom et al. has stagnated. Protection of industry has contributed to decades of poor productivity in manufacturing and services, and per capita incomes fell between 1970 and 2000. The Jamaican Government attempted to address the lack of growth by liberalizing its economy. Tariff reductions and the dismantling of quantitative restrictions on imports have formed the basis of structural adjustment programmes, although agriculture and some industries remain protected. Jamaica has also stepped up its involvement in the Caribbean Community and Common Market (CARICOM), and the proposed Free Trade Area of the Americas (FTAA) offers potential for access to new markets. Liberalization has had little positive effect, however. Jamaica’s producers are unprepared for foreign competition, and a failure to grow may soon begin to threaten human development and possibly lead to political pressure to reverse the liberalization process. Macroeconomic pressures exacerbate the country’s plight. Jamaica’s macroeconomic policy has focused on achieving low inflation, but a large fiscal deficit and a huge debt burden have kept real interest rates high, while the exchange rate has tended to appreciate. The result is an economic environment that has encouraged imports and discouraged exports, making it hard for Jamaican business to take advantage of the opportunities liberalization offers. High levels of debt continue to act as a block on economic and human development. Economically, they are responsible for keeping interest rates high and starving many businesses of access to investment. Socially, they will inevitably lead to cuts in government expenditure, which will have an impact on education, health and other priority expenditure areas. Job cuts will be another consequence. Since few opportunities for those displaced have been created, unemployment and poverty are likely to spread. Crime levels, already a deterrent to foreign investment, are likely to rise further unless suitable safety-nets for displaced workers are put in place. Responses to the challenges facing Jamaica must be founded on a carefully thought-out vision for the country’s future. The weakness in the growth sphere suggests that achieving growth needs to be an over-riding policy, in order to release the benefits of globalization (and dampen attempts to reverse liberalization) and deliver investment in human development. Policy-makers need to tread a particularly complex path, as they try to deliver growth, improve Jamaica’s competitiveness, help displaced workers to find new jobs in more productive sectors, and provide some kind of security for those who lose out. Politically, the job will be exceptionally difficult and will challenge a political system that enjoys low levels of trust from business, civil society and ordinary people. Jamaica needs to approach the growth promotion sphere on several fronts. First, the country needs to confront a general institutional weak-

The three spheres 287 ness. That the private sector has been unable to respond to new opportunities is, in part, due to bad management. And the low levels of trust in government are a reflection of the failure of successive administrations to make – and fulfil – achievable promises. At its broadest, general institutional weakness is reflected in a crisis of trust within Jamaican society. Within and between organizations, as well as within communities, the country has run down its stock of social capital – and many of its problems (crime in particular) are the result. Second, Jamaica needs to harness the energies of its vigorous informal sector. Informal businesses do not pay taxes, and many have low productivity and offer only subsistence wages. An initiative to pull all government services aimed at small businesses into a single, semi-autonomous organization may help in this regard. This could provide a comprehensive programme of business development, offering basic training in book-keeping, financial planning, and marketing and recruitment issues. It could also work to remove regulation and red-tape issues that inhibit growing informal businesses from making the transition to the formal sector. Third, issues of Jamaica’s brand and identity should be addressed. Domestically, identity is vital if a fragmented people are to be united in pursuit of a shared vision. Externally, stronger branding will be vital to the marketing of Jamaican exports and of Jamaica itself as a destination for foreign investment. Jamaican tourism has expanded rapidly in recent years, but has still underperformed the world market, while Jamaican music has retreated from the high water-mark of crossover artists like Bob Marley. These are key indications of a decline in Jamaica’s brand equity, reflecting the corrosive effect of crime and social breakdown, as well as a failure of organizations to engage in consistent marketing. In a global economy the perception of a country’s prospects is of huge importance, and efforts to increase the prominence of Jamaica’s brand should be given a high priority. Actions to promote human and social capital development will also contribute to growth. Jamaica faces serious issues with the quality of its education system. Although many children attend school, levels of achievement are low compared to other countries within the region and the region’s performance is poor when compared to the world’s leading countries. The value of education is rising rapidly, and the divide of the future is likely to be between the knowledge-rich and the knowledge-poor. In addition, Jamaica faces the problem of brain drain, as the country’s most successful graduates are lured abroad. As countries such as Ireland have found, brain drain can be positive, if émigrés return home with new skills and experience. This, however, relies on policies to attract émigrés back and, with a stagnant economy and high levels of crime, Jamaica is currently poorly positioned to appeal even to those who long to return. Investment in education will only deliver returns in the medium term, however. Workplace training delivers short-term benefits, both through

288 Bloom et al. increased productivity in the individual trained and by its effects on the “culture” of an organization. Social capital also needs to be strengthened. Crime, in particular, continues to be a pressing problem. As always, the fear of crime is as serious a problem as crime itself. Although tourists and foreign business people are relatively seldom the victims of violent crime, the association of Jamaica with crime is strong and undoubtedly deters some tourists. The effect of violent crime on foreign investment may not be so pronounced, but crime is a cost for business in other ways – for example, the opportunity cost of investment in security, the cost of corruption, absenteeism due to violent crime, etc. The greatest impact from crime is, of course, felt domestically – and, within Jamaica, the burden is disproportionately borne by those businesses and individuals who occupy the most marginal position in society. Crime therefore has a significant downward effect on standards of human development, especially when some areas become “no go” areas for outsiders. The experience of Jamaica therefore supports the theory that all three spheres of the development framework – liberalization, consistent economic growth, and human and social capital development – need to be addressed simultaneously if progress is to be made. Jamaica had strong human development indicators and undertook fairly comprehensive liberalization, yet it lacked policies to foster growth. Weak growth, in turn, has weakened social capital and threatens to impact negatively on human development. Going forward, a focus on the second sphere is essential if the country is to halt the vicious spirals that are beginning to develop. Botswana23 Of the six countries studied, Botswana has been the most successful. It has also been the country that has adopted the most balanced approach to development. The country has gone from being one of the poorest in the world in the colonial period to a middle-income nation in a very short time – indeed, no World Bank member country with more than a million inhabitants has grown faster over the last three decades. Unlike the other five countries, Botswana has not had to undertake an economic reform process. Much of Botswana’s success has been based on diamonds. However, liberal economic policies, a consistent policy of developing human resources through education, and effective growth promotion activities have ensured that the country has been able to both maximize the diamond bounty and move into new industries. Manufacturing has grown rapidly, and the export base has been successfully diversified. This has occurred despite the fact that the country is landlocked. Unlike the other five countries studied, Botswana has adopted a consistently liberal economic policy. The government has provided a steering

The three spheres 289 rather than a driving role, providing infrastructure, educating the labour force, maintaining strong institutions and negotiating, when possible, favourable international terms for its exporters. It has not, moreover, restricted imports, which has allowed the country’s producers access to the imported inputs needed to continually upgrade industry. Botswana’s continued success is not inevitable, however. The benefits of economic growth have not been equally distributed, and over a third of Botswanan households still live in poverty. Unemployment is also relatively high. Moreover, Botswana has hitherto been protected from some of the pitfalls of globalization by its membership in the Southern African Customs Union (SACU). This has meant Botswana has traded freely with other SACU members, but has been protected from global competition by the SACU common external tariff. South Africa dominates SACU and, as Harvey et al. (2000) suggest, “Botswana is therefore affected only by a second hand globalization of trade, to the extent that South Africa has liberalized its trade policy and, therefore, that of SACU.”24 Like Nepal, then, Botswana’s scope for independent economic policy is constrained to some extent by its dependence on its larger neighbour. In recent years, South Africa has sped up its integration into the global economy, joining the World Trade Organization and negotiating a free trade agreement with the European Union. As the SACU common external tariff is lowered, it is uncertain whether Botswana’s firms will be able to compete in more competitive global markets. Continued investment in improving productivity will be required to strengthen vulnerable industries. Further diversification of industry will also be necessary if Botswana is to maintain its momentum. Diamond mining, whose growth in the longterm will inevitably slow down, employs relatively few people. A focus on new industries as well as the development of tourism, which is very labourintensive, can contribute to both increased competitiveness and employment creation. Foreign investment may be pivotal to the country’s success in diversifying into new export markets. Harvey et al. (2000) argue that “Botswana needs the management, the technical skills and the knowledge of export markets that comes with FDI. Botswana also needs future sources of foreign exchange earnings, since diamond export growth will eventually end.”25 The country is an attractive destination for investment, with its strong political and macroeconomic fundamentals and its well-educated population, but transport costs are high and international border controls slow. Foreign investors may also be deterred by Botswana’s rampant HIV/AIDS epidemic, which poses the greatest threat to the country’s future prosperity and is undoing much of the good work of the past four decades. Human development has traditionally been a key priority for Botswana’s policy-makers, but HIV/AIDS has shattered the lives of almost

290 Bloom et al. half the country’s labour force. The virus threatens to drastically undermine Botswana’s human capital base and push many households into poverty. High growth rates are likely to be unsustainable in the long term – even if radical action is taken now, this will be too late to avert many of the negative impacts. The country’s large numbers of poor people are particularly vulnerable to the disease, and escaping from poverty will prove much more difficult for households affected by AIDS. Social capital will also be weakened, as large numbers of orphans are plunged deeper into poverty, with crime one of very few escape routes. Action to combat AIDS will need to focus on both prevention and treatment. Countries with smaller epidemics have benefited from investing most heavily in prevention, but Botswana’s epidemic is at too advanced a stage for this to have a huge effect. Keeping those infected with AIDS alive should be a major priority, not only for humanitarian reasons but also for economic and social ones – prolonging the cohesiveness of families and communities will, at least temporarily, fend off social breakdown. Renewed emphasis on helping the poor to cope with infection will also help put a brake on the vicious spirals that are developing. In the past four decades, Botswana’s policy-makers have reaped great rewards from the adoption of the three spheres approach to development. Virtuous spirals (whereby investment in education, for example, triggered productivity gains, and a liberal economic policy spurred industrial modernization) sparked dramatic improvements in the country’s standard of living. However, in recent years, the government has taken its eye off the human development sphere, and vicious spirals are taking over. A continued focus on the growth and liberalization spheres will be necessary for Botswana to maintain its progress, but urgent attention now needs to be given to halting the collapse of human resources. Tragically for Botswana’s people, setting the development wheels in motion is insufficient for success – countries must constantly attend to all three spheres if hard-earned gains are to endure.

III. Lessons from the country studies A simplified taxonomy of the six countries’ approaches to globalization can be summed up as in Table 11.1. All countries undertook fairly comprehensive and rapid liberalization. Only Botswana invested heavily in growth promotion measures, and only Jamaica, Botswana and Brazil attempted, to varying degrees, to develop their human capital. As the “Success” column shows, those countries that undertook liberalization without paying sufficient attention to either of the other two spheres performed poorly in the ensuing years. Only Botswana, which consistently balanced actions to promote all three spheres, can be said to have been a success, although even there, as we

The three spheres 291 Table 11.1 A simplified taxonomy of the six countries’ approaches to globalization

Brazil Zimbabwe Malawi Nepal Jamaica Botswana

Liberalization

Growth promotion

Development of human and social capital

Success

✓ ✓ ✓ ✓ ✓ ✓

✗ ✗ ✗ ✗ ✗ ✓

✓ ✗ ✗ ✗ ✓ ✓?

– ✗ ✗ ✗ – ✓

have seen, recent developments have taken the shine off the country’s impressive progress. The first five countries in the table – Brazil, Zimbabwe, Malawi, Nepal and Jamaica – undertook liberalization after many years of protectionism (Botswana had been a colony immediately before liberalization of its economy). In some cases, pressure from donors and international financial institutions encouraged this opening up. In others, liberalization was undertaken because integration with world markets was thought to be essential for economic growth and industrial modernization. As the East Asia chapter in this book shows, a more gradual approach to liberalization can help weak economies to manage their integration into global markets. Reducing tariffs first on imported inputs needed for strengthening domestic production may give producers time to equip themselves for global competition. Efforts to promote productivity improvements and help industries find new areas of comparative advantage were also instrumental. Consistent investment in education and health further strengthened East Asia’s industries in advance of liberalization. Brazil, Zimbabwe, Malawi, Nepal and Jamaica, however, all had severe debt burdens to contend with – in most cases a hangover from protectionist times – which would have limited their investment prospects even if they had liberalized more slowly. Liberalization generally increased the volume of imports, but a lack of investment in export production and human capital improvements created a vicious spiral whereby the imbalance between imports and exports meant countries had less money to invest. As foreign investors became concerned that productivity improvements would not correct this imbalance, many of them pulled out, and the imbalance tilted further. Debt relief is clearly critical for developing countries attempting to integrate with global markets. With debt service payments exceeding export receipts in many countries, investment in improving productivity and strengthening human resources will be greatly hindered unless debt burdens are eased. Where debt relief is underway, governments should look for cost-effective ways to trigger movement in the growth and human development spheres of the framework. Finding strategic entry points is

292 Bloom et al. crucial for maximizing the use of scant resources. Actions should be identified that are likely to trigger virtuous spirals across all three spheres. HIV/AIDS awareness programmes, for example, have been shown to be extremely cost-effective – Thailand’s actions to prevent AIDS provided a high rate of return on a fairly limited investment, with beneficial effects on GDP and poverty reduction.26 The three spheres approach to development need not be prohibitively expensive for poor countries, and the rewards are likely to heavily outweigh the costs. The countries studied for this book highlight the dangers of a policy focused mainly on liberalization. The tendency for many countries in recent years has been to prioritize that sphere of the development framework. Unfortunately, this has made many people worse off than they were before their economies opened up. Liberalization, as East Asia’s economies showed and as India and China’s success is currently re-emphasizing, is clearly desirable for undeveloped, isolated economies that need access to global markets in order to upgrade production and market their exports. But if liberalization is undertaken in the absence of strong human capital and productive workforces, countries are more likely to suffer than thrive.

Notes 1 This summary of Brazil’s reform process draws heavily on R. Gottschalk (2000), “Sequencing Trade and Capital Account Liberalization: The Experience of Brazil in the 1990s”, UNCTAD/UNDP Occasional Paper, Geneva. 2 Gottschalk (2000), ibid, pp. 13–14. 3 ibid, p. 18. 4 ibid. 5 ibid, p. 24. 6 The Economist (2002), “The meaning of Lula”, The Economist, 3 October. 7 The Economist (2002), “Can Lula finish the job?”, The Economist, 3 October. 8 Gottschalk (2000), ibid, p. 24. 9 The summary of reform in Zimbabwe draws extensively on A. Bhalla, R. Davies, M. C. Mabugu and R. Mabugu (1999), “Globalization and Sustainable Human Development: Progress and Challenges for Zimbabwe”, UNCTAD/UNDP Occasional Paper, Geneva. 10 BBC News (2000), “Mugabe: Freedom Fighter Turned Autocrat”, BBC News, 10 May. 11 Bhalla et al. (1999), ibid, p. 22. 12 Economist Intelligence Unit (2002), “Rearranging the deckchairs on the Titanic”, EIU Viewswire, 28 August. 13 Bhalla et al. (1999), ibid, p. 22. 14 EIU (2002), ibid. 15 CIA (2002), “Country profile: Zimbabwe”, The World Factbook, CIA. 16 IRINNEWS.ORG (2002), “Zimbabwe: famine ‘very close’, WFP warns”, 4 December. 17 ibid. 18 IRINNEWS.ORG (2002), “Zimbabwe: focus on rising dissent as cost of living soars”, 4 December.

The three spheres 293 19 This summary draws on A. Bhalla, C. Chipeta, H. Taye and M. Mkandawire (2000), “Globalization and Sustainable Human Development: Progress and Challenges for Malawi”, UNCTAD/UNDP Occasional Paper, Geneva. 20 Bhalla et al. (2000), p. 4. 21 This summary draws on A. R. Khan (2000), “Globalization and SHD in Nepal”, UNCTAD/UNDP Occasional Paper, Geneva. 22 This section draws on D. E. Bloom, A. S. Mahal, D. King, F. Mugione, A. HenryLee, D. Alleyne, P. Castillo and River Path Associates (2001), “Jamaica: Globalization, Liberalization and Sustainable Human Development”, The UNCTAD/UNDP Programme on Globalization, Liberalization, and Sustainable Human Development, Geneva. 23 This summary draws on C. Harvey, H. Siphambe and E. Segosebe (2000), “Botswana: Globalization, Liberalization and Sustainable Human Development”, UNCTAD/UNDP Country Assessment Study, Geneva. 24 Harvey et al. (2000), ibid, p. 1. 25 ibid, p. 13. 26 D. Bloom, D. Canning and J. Sevilla (2002), The Demographic Dividend: A New Perspective on the Economic Consequences of Population Change, RAND, MR-1274, Santa Monica.

Index

action points: SHD 32–6 active policies 1, 20, 63, 174 Africa 85, 108, 118, 119, 264; see also subSaharan Africa; individual countries African diaspora 213, 216 age dependency ratios 153–4 Agreement on Trade-related Investment Measures 94 agricultural subsidies 20, 209 agriculture 165, 193, 204–5, 209, 227, 242, 257–8 aid organisations 21 AIDS see HIV/AIDS analytical framework 1–2 Anand, S. 116 Angola 72, 206 Anker, R. 262, 263 antidumping procedures 50 Argentina 4, 43, 60, 180, 185, 187 Asian countries 23, 26; see also South Asia; South-East Asia; individual countries asset distribution 43 authoritarian regimes 206–7 “baby booms” 28, 225–6 balance of payments 75 Banco Sol 35, 190 Bangladesh 241, 260 banking reform 235 bank loans 233 Bank Rakyat 35 Bhattacharya, D. 260 Bill and Melinda Gates Foundation 3 birth rates 151–4, 225 Blair, Tony 193 Blomström, M. 78 Bolivia 35, 140, 180, 186, 187, 188, 190 Botswana 42, 288–91 Brazil 185, 278–80, 291 bribery see corruption “brown agenda” 90 budget deficits: Central America 131–2 CACM (Central American Common Market) 127, 133, 134–5, 170 Campos, N. F. 180

Cancun, Mexico, talks 4 capital: nature of 177 capital account liberalization 53–61 capital interaction 181–3 capital markets 234 “care economy” 271 Caribbean Basin Trade Partnership Act (CBTPA) 146 Caribbean Community and Common Market (CARICOM) 286 CCL (Contingency Credit Lines) 60–1 CDF (Comprehensive Development Framework) 21, 183 CEDAW (Convention on the Elimination of All Forms of Discrimination Against Women) 272–3 Central America: budget deficits 131–2; CACM 127, 133, 134–5, 170; civil conflicts 129–30; civil society groups 131; crime rates 130; customs unions 134; debt problems 149–50; democracy 130; demographic transition 151–4; economic performance 139–42; education 128, 157–61; exchange rates 135–8; export incentives 138–9; exports 127–8, 142–8; FDI 127, 139, 148–9; future policies 169–71; governance 131; HDI 151; health 154–7; health indicators 128; human development 150–1; human rights violations 130; inflation rates 131–2; infrastructure 128; intraregional trade 133–5; labour mobility 137; land seizures 130–1; living conditions 161–2; macroeconomic adjustment 127, 131–2; micro-enterprise sector 164–9; military expenditure 130; peace process 130; poverty 162; tariffs 133; see also individual countries Central American Common Market (CACM) 127, 133, 134–5, 170 Central American Import Tariff 133–4 CET (common external tariff) 127, 133–4 CFF (Compensatory Financing Facility) 60 Chen, M. 260 child care 271 child labour 189

Index 295 children 86 Chile 60, 185, 186 China: education 240, 245; exports 238, 242, 243, 244; HIV 241; human development 201; inequality 245; political conditions 239; World Bank on 176 civil conflicts 34, 127, 129–30, 206, 224 civil society groups 131 closed economies 40 coastal zones 204–5, 209 collateral 52–3 Colombia 185, 212, 213 common external tariff (CET) 127, 133–4 Common Market of Eastern and Southern Africa (COMESA) 195 comparative advantages 49 compensatory depreciation 67 Compensatory Financing Facility (CFF) 60 competition: for FDI 93–5 Comprehensive Development Framework (CDF) 21, 183 conditionality 60–1 Congo 206 contagion 60 Contingency Credit Lines (CCL) 60–1 Convention on the Elimination of All Forms of Discrimination Against Women (CEDAW) 272–3 cooperation: developed and developing countries 33 corruption 11, 131, 180, 207–8, 217, 245–6, 281 Costa Rica 42, 62, 130, 147, 151 credit markets 52–3 crime 27, 130, 181, 213, 288 customs delays 199–200 customs unions 134 death rates 28, 151; see also infant mortality; maternal mortality debt burdens 233, 281, 286, 291 debt relief 149–50, 196, 210–11, 284, 291 debt suspensions 61 deforestation 91 de-linking 39 democracies 28–9 democracy 130, 206 demographic dividend 28, 30–1, 179, 182–3, 187, 202, 226 demographic transitions 27–8, 105–6, 114, 151–4, 179–80, 182, 186–7, 225 demography 106, 186–7 dependency 34, 189 depreciation 47 developed countries 33, 36 developing countries 1, 22–3, 33, 36 development: analytical framework 1–2; conventional approach 31–2; of human and social capital 41–4; SHD approach 31–2 development banks 53, 58 Development Goals: United Nations xvii, 3, 8, 119

diaspora: African 213, 216; Colombian 212 Díaz-Alejandro, C. F. 53 division of labour 177 Doha Round of World Trade Organization negotiations xvii, 4, 20, 36 Dollar, David 4 dollarization 137–8 domestic entrepreneurship 96 domestic financial markets 52–3 domestic labour markets 51–2 domestic saving 24–5 drawback schemes 138 Duncan Index of Dissimilarity (ID) 262 Dunning, J. 74 earnings differentials 265–6 East Asia: agriculture 227; authoritarian regimes 206–7; banking reform 235; business reform 235–6; definition 247n; development process 242; economic policies 224, 227–9; education 178, 225–6, 236–7; exports 199, 227; FDI 93–4, 230–1; financial crisis 23–4, 232–5; foundations for economic growth 224–6; geography of 224; health 225–6; human development 224–6; liberalization 229–31; manufacturing 228; saving rates 24, 227; SMEs 236; tariff barriers 4; tariffs 229–30; see also individual countries East Asian financial crisis 23–4, 232–5 “East Asian Miracle” 108, 178, 179, 223, 226, 232 Easterly, W. 210 Eastern Europe 36, 118, 119 Economic Community of Western African States (ECOWAS) 195 economic growth: Africa 197–201; determinants of 113–16; expected rates of 19; foundations for 224–6; promotion of 24–5; three spheres 1–2, 3; vs. human development 33 economic policies: active 174; Botswana 288; East Asia 227–9; Latin America 11, 190 economic reform: and democracy 28–9 ECOWAS (Economic Community of Western African States) 195 Ecuador 180, 187 education: access to 3; Africa 202–3, 216, 218; benefits of 26; Central America 128, 157–61; as a determinant of growth 178; East Asia 225–6, 236–7; and economic growth 114; and health 106, 182; higher 35; Jamaica 287; Latin America 184–6; and opportunity 119; provision of 154; women 34, 182; Zimbabwe 281 elderly people 188–9 electronic goods market 230 El Salvador: civil war 129; demographic transition 151–4; economic performance 139–42; education 157–61; exchange rates 135–7; export subsidies 138; FDI 148; HDI 151; health 154–6; inflation rates 132; living conditions 161–2;

296 Index El Salvador continued micro-enterprises 165–6; micro-finance 167–8; tariffs 134; tax revenues 132 employment: Central America 165; Latin America 189–90; structure of 44; TNCs 83–6 empowerment 268 entrepreneurs 35, 96, 200 entrepreneurship 181 environmental management 87–92, 177 environmental preservation 44 environmental regulations 87–92 EPZs (export processing zones) 85, 138–9, 146, 147, 209–10, 227, 243, 259–60, 266, 271–2 equality 2, 174, 245; see also gender equality; inequality equality of opportunity 29, 131 Eritrea 206 exchange rates 23, 47–8, 54, 135–8 exploitation 75, 85–6, 89, 90, 189 export diversification 48–50 export incentives 138–9, 282 export processing zones (EPZs) see EPZs export promotion 227 export subsidies 48, 51, 62 exports: Africa 194; Brazil 279; Central America 127–8, 142–8 factor accumulation 24–5 families 27, 181 family policies 188–9 famines 242, 281, 282 FDI (foreign direct investment): Africa 195, 199–200, 214; analysis of 95–6; benefits and costs 73–6; Central America 148–9; competition for 92–3; and developing countries 72–3; and employment 83–6; and the environment 87–92; and human and social development 96–101; and human resources 23; and income distribution 86–7; liberalization 22, 39–40, 55, 58–9, 61–3, 139; policy approaches 93–5; policy changes 19; and protectionism 39; and technology 76–83 female labour supply: data entry work 261; demand 257–61; earnings differentials 265–6; effect of financial crisis 269; empowerment 268; export production 259–61; migration 254; occupational segregation 262–5; participation rates 44, 253–5, 259–60; policy implications 269–73; quality 254, 256, 257; service sector 261; tourism 261; working conditions 266–7, 271–2 “feminization”: of labour market 253, 260–1 fertility rates 151–4, 179, 187, 202, 209, 225, 241 financial capital flows 47–8 financial crises 4, 23–4, 37, 60, 232–5, 269 financial institutions 35 financial markets 52–3 financial resources 50

Financiera Calpiá 35, 167–8, 190 “flying geese development paradigm” 228–9 foreign direct investment (FDI) see FDI forestry sector 91 free trade see trade liberalization Free Trade Area of the Americas (FTAA) 286 Fukuyama, F. F. 29, 180 G8 Summit (2005) 3 “G77” countries 195 Gabon 42, 91 Gallup, J. 116 GDI (Gender-related Development Index) 96 gendered labour markets: concept of 261–2; disadvantages 246; earnings differentials 265–6; effect of financial crisis 269; empowerment 268; macro implications 267; occupational segregation 262–5; policy implications 269–73; sustainability of growth 267, 268–9; working conditions 266–7, 271–2 gender equality 28, 32, 44, 85–6, 188–9, 215–16, 240–1 Gender-related Development Index (GDI) 96 geographical handicaps: Africa 204–5; Asia 239 geography: and economic growth 114 Ghana 193 global assembly line 260, 266 global stability 239 GNP: per capita 42–3 Gottschalk, R. 279, 280 governance: good 180; new forms of 36–7 government intervention 21 government reform: Uganda 196 governments: tasks of 32–3 Grameen Bank 35, 52, 241 Greenhill, Romilly 211 Green Revolution 227, 242 growth: equation 115–16; and trade liberalization 40 growth rates 113–16 Guatemala: budget deficit 132; civil war 129; contraceptive prevalence 152; customs union 134; demographic transition 151–4; economic performance 140–2; education 128, 157–61; exchange rates 135–6; FDI 148; HDI 43, 151; health 128, 154–7, 186; human rights violations 130; indigenous people 131; inflation rates 132; living conditions 161–2; micro-enterprises 165; tariffs 134 Guinea 206 Harvey, C. 289 HDI (Human Development Index) 28, 42–3, 76, 96, 201 health: access to 3; action on 35–6; Africa 205, 218; Central America 154–7; East Asia 225–6; effects of 182; importance of 26–7; and inequality 116–18; policies 186–7; and wealth 105–8, 119, 178–9

Index 297 Heavily Indebted Poor Countries (HIPC) initiative 149, 150, 170, 196, 210, 217, 284 higher education 35, 160–1, 184–6, 237 HIV/AIDS 27, 31, 36, 119, 182, 186, 198, 202, 203, 205, 215, 216, 241, 281–2, 283, 289–90 home-working 260, 266–7 Honduras: agriculture 165; civil conflicts 130; customs union 134; debt problem 128, 149–50, 170; demographic transition 151–4; economic performance 139–42; education 157–61; exchange rates 136; FDI 148; HDI 151; health 154–7; inflation rates 132; land seizures 130; living conditions 161–2; maternal mortality rates 187; tariffs 134; tax revenues 132; wages 165 Hong Kong: EPZs 209; FDI 230, 231; financial crises 60; flying geese paradigm 228; GDP per capita 226; globalization 253; HDI 43; high-productivity labour 270; labour force 259; liberalization 231; occupational segregation 264–5; saving rates 227; tariffs 229; technological capabilities 77 Hong Kong talks 4 Horton, Tom 233 human and social capital 1–2, 3, 25–30 human and social capital development: and FDI 96–101; FDI and employment 83–6; FDI and income distribution 86–7; FDI and technology 76–83; FDI and the environment 87–92; meaning of 41–4 human capital 20, 26–8, 178–80 human development: Africa 201–3; East Asia 224–6 Human Development Index (HDI) 28, 42–3, 76, 96, 201 Human Development Report 25–6 human rights violations 130, 267 human welfare indicators 42–3 ICT: Africa 214–15 ID (Duncan Index of Dissimilarity) 262 IFC (International Finance Corporation) 58 ILO (International Labour Organization) 85 ILO Convention on Home Work 272–3 IMF (International Monetary Fund) 58, 59–61, 73, 210 immunization 156 import duty drawbacks 48 import substitution 4, 45 incentive-led competition 93–4 income distribution 43, 86–7, 106, 109–13, 116–18, 176 India: corruption 245; education 201, 215, 240; equality 245; exports 246; FDI 79; food exports 242; geographical barriers 239; growth rates 244; HIV 241; income poverty 108; industrial growth 244–5; inequality 245; labour force distribution 258–9; market development 238; poverty rates 113, 118; poverty reduction 119, 244;

service sector 239, 243–4; women workers 253, 261, 271 indicators: of human and social development 43–4 Indonesia 209, 226, 229 industries 257–8 inequality 3, 27, 34, 116–18, 245 “infant exporters” 51 infant mortality 42–3, 154–5, 202, 225, 244, 270 inflation rates 22, 131–2 information gathering 50 infrastructure 200, 213 infrastructure funds 58 institution building 94 institutional biases 3 institutional reform 180 institutional renewal 36–7 institutions 114 integration schemes, regional 51, 93, 130, 135, 139, 170, 212–13 intellectual property (TRIPS) 51 International Finance Corporation (IFC) 58 international finance flows 55 international finance system 37 International Labour Organization (ILO) 85 International Monetary Fund (IMF) 58, 59–61 international policies 50–1 intra-regional integration 212–13 investment rates 24–5 Ireland 93, 96, 287 Jamaica 285–8, 291 Japan 208, 225, 226, 228–9, 232, 235, 236, 253 Joekes, S. 267 Jubilee Research 211 Kanbur, S. 116 Katz, J. 82 Kay, J. 181 Kenya 193, 213, 214 Kim, Jong-Il 232 knowledge economy 189 knowledge revolution 177–8 Kokko, A. 78 Korea, Republic of 23, 60, 79, 209, 226–31, 233, 234–5, 237 Kraay, Aart 4 Krugman, Paul 232 Kuznets curve 116 labour costs 230 labour flows 211–12 labour-intensive rural employment 33 labour markets 51–2, 85–6, 106, 243, 252–61; see also female labour supply; gendered labour markets labour mobility 137 land reform programme 282 land tenure reform 3

298 Index Latin America: corruption 180; demography 186–7; education 178, 184–6; employment 189–90; families 181; family policies 188–9; health policies 186–7; homeworkers 260; income growth 179, 197; inequality 176; liberalization 4, 5; openness 175; pensions 187–8; population growth 180; savings 24, 187–8; tariffs 230; women 188–9, 264; see also individual countries Lau, Laurence 232 lending: to private sector 54 liberalization: active policies 20; Africa 194–7, 217–18; analytical framework 3–5; Botswana 288–91; Brazil 278–80; capital account 54; East Asia 229–31; and FDI 22, 39–40, 55, 58–9, 61–3, 139; Hong Kong 231; of industry 244–5; Jamaica 285–8; Latin America 4, 5; Malawi 282–4; market 29; Nepal 284–5; passive policy 20; traditional implementation 1; Zimbabwe 280–2; see also trade liberalization Liberia 206 LIDCs (low-income developing countries) 72, 81–2, 84–5, 89–90, 94, 97, 99 life expectancy 42–3, 105–7, 114, 119, 155, 202, 244 Lindsey, Brink 233 living conditions 161–2 logging 91 long-term growth 43 low-income developing countries (LIDCs) see LIDCs macroeconomic adjustment 22 macroeconomic policies 34 MAI (Multilateral Agreement of Investment) 3, 54, 58–9 malaria 203, 205 Malawi 196, 197, 282–4, 291 Malaysia 200–1, 228 malnutrition 155–6 Malthus, Thomas 179 Mansoob Murshed, S. 176 manufacturing 209, 228 maquila regimes 138 maquiladora industry 144–7, 170 market failure 49–50 market liberalization 29; see also trade liberalization maternal mortality 187, 254, 270 Mauritius 5, 195, 196–7, 198, 199, 207, 209, 210, 260 mergers 59 Mexico 146, 149, 181, 185, 186, 260 micro-enterprise sector 35, 164–9, 189–90, 215 micro-finance 35, 52, 165–9, 189–90, 215 Middle East 4, 118 MIGA (Multilateral Investment Guarantee Agreement) 139 migration 130, 139, 198, 245, 254, 267, 272 migration controls 208, 211–12

military expenditure 130, 206 Millennium Development Goals xvii, 104, 118, 119 mining sector 90–1 models: of development 33 mortality rates 28, 151; see also infant mortality; maternal mortality Mozambique 195, 198, 210, 213 Multilateral Agreement of Investment (MAI) 3, 54, 58–9 Multilateral Investment Guarantee Agreement (MIGA) 139 multiple models: of development 33 NAFTA (North American Free Trade Agreement) 146 national innovation system (NIS) 80 natural resources 75, 89, 90 NEPAD (New Partnership for Africa’s Development) 212–17 Nepal 284–5, 291 New Partnership for Africa’s Development (NEPAD) 212–17 NGOs 20, 167, 180, 189, 208, 216, 217, 246 Nicaragua: debt problem 149–50, 170; debt relief 128; demographic transition 151–4; economic performance 139–42; education 157–61; education spending 151; exchange rates 135–6; export subsidies 138; FDI 148; fiscal reforms 132; foreign assistance 136; foreign investors 139; HDI 151; health 154–6; inflation rates 132; living conditions 161–2; microfinance 168; property rights 131; sanitation 129; tariff surcharges 134; under-employment 165; wage remittances 136 Nigeria 200, 206, 207 NIS (national innovation system) 80 non-FDI capital flows 22 North Africa 4 North American Free Trade Agreement (NAFTA) 146 Nugent, J. B. 180 Nur University 186 occupational segregation 262–5 ODA (official development assistance) 62–3, 149 OECD 3, 54, 58, 264 official development assistance (ODA) 62–3, 149 older people 188–9 openness 22–3, 30, 114, 175, 194 outmigration 211–12 output gap 19 Oxfam International 20 palm oil industry 200–1, 228 Paraguay 185 passive policies 52, 174 peace process 130 pensions 187–8, 212

Index 299 Peru 180, 187, 190 pharmaceuticals 36 physical capital 24–5 piece-work 260, 266–7 policies: active 1, 20, 63, 174; affecting women 28; Central America 169–71; conditionality 61; East Asia 224, 227–9; economic 11, 190, 227–9, 288; family 188–9; FDI 93–5; financial 41; health 186–7; international 50–1; international trade 39–40; macroeconomic 34; nontrade 48–50; passive 52, 174; TNCs 40, 73–4; trade 45–8; Uganda 195 policy frameworks: analysis of 95 policy portfolios 21, 30 policy spheres: analytical framework 1–5; economic growth 24–5; general 20–1; human capital 25–8; integration into the global economy 22–4; interactions 30–2; social capital 25, 28–30 pollution havens 87 pollution prevention 88–9, 92, 177 Ponniah, G. 266 population growth 151–4, 179–80 portfolio investments 54–5, 57–8, 59, 75 poverty: Africa 209; Botswana 289, 290; Brazil 280; effect of 27; extreme 108; and health 108–9; and income distribution 109–13; Jamaica 286; Malawi 282; measurements 162; model of 109–10; Nepal 284; as a term 105; Zimbabwe 281–2 poverty rates 118–19, 198, 201 poverty reduction 20, 34, 43, 86–7, 104–5, 118–20, 176, 198, 244, 245, 282 press freedom 207 primary commodities 198–9 private investment 25 privatization 231 profit–investment nexus 227–8 property rights 131 pro-poor growth strategies 3, 34, 119 protectionism 36, 39, 50, 194 public investment 25 public–private partnerships 20 quality of life indicators 43 Ramos, J. 52 R&D (research and development) 78–9 reforms: banking 235; business 235–6; economic 28–9; and FDI 73–6; fiscal 132; government 196; institutional 180; land 3, 282 refugees 130, 206 regional integration schemes 51, 93, 130, 135, 139, 170 rehabilitation: mining sites 91 rent-seeking 39 research and development (R&D) 78–9 Rodrik, Dani 4 rules-based competition 93–4 rural employment 33

rural families 27 Russia 4, 29, 119, 149, 176, 183 Rwanda 206 Sachs, Jeffrey 4, 208 SACU (Southern African Customs Union) 289 SADC (Southern African Development Community) 195 safety nets 34, 245 S&D (special and differential treatment) 50–1 Sandinistas 129 saving rates 24–5, 106, 187 savings 187–8 security 206 Self Employed Women’s Association (SEWA) 271 self-employment 165 Sen, Amartya 37n, 201, 225, 240 Senegal 205 service provision 231 service sector 243–4, 257–8, 261 SEWA (Self Employed Women’s Association) 271 Sierra Leone 206 Singapore: corruption 246; domestic technological capabilities 77, 79, 96; electronic goods market 230; EPZs 209; FDI 93, 230, 231; financial crises 60; GDP per capita 226; HDI 43, 226; saving rates 226; SMEs 236; tariff rates 229; women workers 254, 259, 261, 269 Singapore Telecom 235 Smadja, Claude 19–20 small and medium enterprises (SMEs) 53, 94, 232–3, 236, 287; see also microenterprise sector Smith, Adam 205 social capital 28–30, 180–1; see also human and social capital social exclusion 27, 34, 184 SOEs (state-owned enterprises) 244–5 South Africa 181, 207, 213, 289 South Asia 198, 202, 223, 230, 242, 243–4, 247n; see also individual countries South Korea see Korea, Republic of South-East Asia 4, 209, 247n, 254, 261, 269, 270; see also individual countries Southern African Customs Union (SACU) 289 Southern African Development Community (SADC) 195 special and differential treatment (S&D) 50–1 special economic zones 243 spillovers: TNCs 77–8, 90, 96 spirals 182–3, 183 Sri Lanka 34, 42, 239, 242 Standing, G. 260, 273 state-owned enterprises (SOEs) 244–5 structural change: economic 43–4 structural reforms 73–6

300 Index sub-Saharan Africa: corruption 207–8, 217; debt 210–11; economic growth 197–201; education 202–3, 216, 218; export diversification 214; FDI 195; financial crises 4; geographical handicaps 204–5; health 203, 205, 218; HIV/AIDS 31, 119, 182; human development 201–3; liberalization 5, 194–7; migration controls 211–12; NEPAD 212–17; poverty reduction 198; tariffs 197; technological development 200; trade barriers 208–10; transport costs 204–5; war 199, 201, 206; see also individual countries subsidies 4, 20, 49–50, 138, 208–9, 278 Supplemental Reserve Facility 60 sustained development 21 Taiwan: domestic technological capabilities 77; economic growth 237; EPZs 209; exchange rates 23; FDI 79, 93–4, 96, 230, 231; GDP per capita 226; geopolitical situation 239; imports 229; land reform 227; SMEs 233, 236 tariff barriers 4, 194, 196–7, 240 tariff rates 46–7 tariffs 229–30, 286 tax evasion 11, 180, 199 teacher training 216 technological development 200 technological inputs: TNCs 77–83 technology: upgrading 44 tertiary education 184–6, 203, 237 textiles 209 TFP (total factor productivity) 24–5 Thailand: AIDS prevention 36, 205, 292; development strategies 223; economic growth 226; EPZs 209; exports 233–4; flying geese paradigm 229; imports 230; labour force 258; labour quality 269; mortality rates 270; SMEs 236 Third World governments 20 Third World Network 20 Timmer, C. P. 117 TNCs (transnational corporations): effects of 73–4; policies towards 40, 73–4; technological inputs 77–83; see also FDI (foreign direct investment) total factor productivity (TFP) 24–5 tourism 213–14, 285 trade barriers 22, 46, 73, 194, 208–10, 213, 217 trade credits 55–6 trade disputes 20 trade liberalization 3–5, 22, 23, 39–40, 45–8, 208, 280 trade negotiations 3 trade policies 45–8 trade rules 36 trafficking 254, 267, 272 training 44, 78, 81–2 transnational corporations (TNCs) see TNCs (transnational corporations) transport costs 204–5

TRIPS (intellectual property) 51 tuberculosis 203 Tutu, Desmond 190 Uganda: AIDS 36, 205; and conflicts 206; corruption 208; debt relief 210, 211; FDI 72; government reform 196; growth rates 198; liberalization policies 195–7 Uganda Debt Network 208 UNCTAD (United Nations Conference on Trade and Development) xvii–xviii; inequality 40 UNCTAD–UNDP Programme on Liberalization and Sustainable Human Development xix, 1 under-employment 165 UNDP (United Nations Development Programme) xvii–xviii, 25–6, 40, 42 unemployment 161, 165, 189, 281 United Kingdom (UK) 104–5, 226 United Nations Conference on Trade and Development (UNCTAD) xvii–xviii United Nations Development Programme (UNDP) xvii–xviii, 25–6, 42 United Nations Millennium Development Goals xvii, 3, 8, 119 unskilled labour 85–6 USA (United States of America) 146, 147, 224 USSR see Russia van Heerden, A. 266 Venezuela 5, 182, 188 vicious spirals 20, 31, 182–3, 202 Vietnam 243, 244 virtuous spirals 20, 31, 108, 182–3, 199, 227, 244–6 wages 86–7 Warner, Andrew 4 wars 199, 206; see also civil conflicts wealth: and health 105–8, 178–9; sources of 175 welfare indicators 64–6 women: in Africa 215–16; in Asia 240–1; education 34, 153, 158, 182, 203; employment 44, 85–6; entrepreneurs 165; Guatemala 131; in Latin America 188–9; maternal mortality rates 187; policies affecting 28; role of 27–8, 181; status raising 34; see also female labour supply working conditions 266–7, 271–2 World Bank 19, 21, 73, 183, 210, 215 World Economic Forum (2006) 3 World Summit on Sustainable Development (2002) 20 WTO (World Trade Organisation) 19, 50, 51, 58–9, 73, 239 Young, A. 232 Zambia 193 Zimbabwe 128, 193, 197, 198, 206, 280–2, 291