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Rethinking Development Strategies After the Financial Crisis, Volume I: Making the Case for Policy Space

Book by Alfredo Calcagno, Sebastian Dullien, Alejandro Márquez-Velázquez, Nicolas Maystre, Jan Priewe (ed), 2015

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The global financial crisis in 2008 marked a starting point for a comprehensive rethinking of economic theories and policies, reinforcing the importance of implementing strategies for development as opposed to leaving the economy to market forces. In this context, this publication explores the nature and consequences of the crisis, as well as the diversity of economic and social development among developing countries, and looks at the reasons behind the recent improvement in developing countries' performances and its potential for continuation after the financial crisis.




Volume I: Making the Case for Policy Space


Volume I: Making the Case for Policy Space

Edited by

Alfredo Calcagno
Sebastian Dullien

Alejandro Márquez-Velázquez
Nicolas Maystre

Jan Priewe

New York and Geneva, 2015



The opinions expressed in this publication are those of the
authors and are not to be taken as the official views of the
UNCTAD secretariat or its member States.

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United Nations concerning the legal status of any country,
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of the publication containing the quotation or reprint to be
sent to the Publications Assistant, Division on Globalization
and Development Strategies, UNCTAD, Palais des Nations,
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This publication has been edited externally.

Copyright © United Nations, 2015
All rights reserved



Sales No. E.15.II.D.9

ISBN 978-92-1-112894-9
eISBN 978-92-1-057556-0


Table of contents


Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

Explanatory notes ....................................................................................................................................................... vi
Abbreviations and acronyms ...................................................................................................................................... vii
About the authors ...................................................................................................................................................... viii

Alfredo Calcagno, Sebastian Dullien, Alejandro Márquez-Velázquez, Nicolas Maystre and Jan Priewe .................. 1

Alfredo Calcagno ......................................................................................................................................................... 9

Abstract ........................................................................................................................................................................ 9
Introduction .................................................................................................................................................................. 9
I. A “big crisis” ..................................................................................................................................................... 10
A. Causes and nature of the crisis .................................................................................................................... 10
B. Inadequate policy responses ........................................................................................................................ 12
II. The case for a reorientation of development policies ....................................................................................... 12
A. The global economic environment after the crisis ...................................................................................... 12
B. A more balanced approach on the demand side .......................................................................................... 15
III. The need for policy space ................................................................................................................................. 19
A. Rediscovering industrial policies ................................................................................................................ 19
B. Foreign capital flows and domestic sources of finance ............................................................................... 20
C. Fiscal space ................................................................................................................................................. 22
IV. Concluding remarks .......................................................................................................................................... 23
Notes ....................................................................................................................................................................... 24
References .................................................................................................................................................................. 24

Jan Priewe ................................................................................................................................................................. 27

Abstract ...................................................................................................................................................................... 27
What is a strategy for development and why do we need one? ................................................................................. 27
I. Traditional strategic concepts ........................................................................................................................... 28
A. Washington Consensus ................................................................................................................................ 28
B. Plain neo­liberalism .................................................................................................................................... 29
C. Good governance ........................................................................................................................................ 30
D. Millennium Development Goals ................................................................................................................ 31
E. Outward development and export­led growth ............................................................................................. 32
F. Structural change: Towards industrialization or commodities and services?.............................................. 33
II. Strategic concepts based on macroeconomic policies ...................................................................................... 34
III. Learning from success and failure – growth performance in the long run ....................................................... 38
IV. Conclusions ....................................................................................................................................................... 41
Notes ....................................................................................................................................................................... 43
References .................................................................................................................................................................. 43


Eric Helleiner ............................................................................................................................................................. 45

Abstract ...................................................................................................................................................................... 45
Introduction ................................................................................................................................................................ 45
I. Growing discontent ........................................................................................................................................... 46
II. American goals for Bretton Woods ................................................................................................................... 48
III. Inclusive multilateralism and North­South dialogue ........................................................................................ 51
IV. The fate of the development content of Bretton Woods ................................................................................... 53
References .................................................................................................................................................................. 54

Veerayooth Kanchoochat ........................................................................................................................................... 55

Abstract ...................................................................................................................................................................... 55
Introduction ................................................................................................................................................................ 55
I. Three approaches to the middle­income trap .................................................................................................... 56
A. Getting education and institutions right ...................................................................................................... 57
B. Changing export composition through comparative advantage .................................................................. 57
C. Industrial upgrading through State intervention ......................................................................................... 57
II. Education and institutions as magic bullets? .................................................................................................... 58
A. Education needs to link with industrial targets .......................................................................................... 58
B. Growth­enhancing governance is more relevant than “good governance” ................................................. 58
III. Structural transformation through comparative advantage? ............................................................................. 59
A. Long­term economic development requires structural transformation ...................................................... 59
B. Changing export compositions usually goes against comparative advantage ............................................ 60
IV. Industrial policy without yardsticks and macroeconomic stability? ................................................................. 60
A. East Asian policies entailed variation in carrot­and­stick incentives .......................................................... 60
B. Macroeconomic stability matters, but in unconventional ways ................................................................. 61
V. The middle­income trap: Future research agenda ............................................................................................ 62
Notes ....................................................................................................................................................................... 64
References .................................................................................................................................................................. 64

Robert H. Wade .......................................................................................................................................................... 67

Abstract ...................................................................................................................................................................... 67
Introduction ................................................................................................................................................................ 67
I. The return of industrial policy? ........................................................................................................................ 69
II. The developmental State Mark II ..................................................................................................................... 71
III. “New structural economics” and industrial policy ........................................................................................... 72
IV. Political and organizational determinants of industrial policy ......................................................................... 74
A. State­society relations ................................................................................................................................. 74
B. Making effective industrial policy bureaucracies ....................................................................................... 75
V. The future of industrial policy .......................................................................................................................... 76
Notes ....................................................................................................................................................................... 78
References .................................................................................................................................................................. 78


Roberto Frenkel and Martín Rapetti .......................................................................................................................... 81

Abstract ...................................................................................................................................................................... 81
Introduction ................................................................................................................................................................ 81
I. SCRER and economic performance ................................................................................................................. 82
A. Empirical evidence ...................................................................................................................................... 82
B. Mechanisms ................................................................................................................................................. 83
II. SCRER management ........................................................................................................................................ 86
A. SCRER and external equilibrium ............................................................................................................... 86
B. SCRER and internal equilibrium ................................................................................................................ 87
III. Conclusions ....................................................................................................................................................... 89
Notes ....................................................................................................................................................................... 90
References .................................................................................................................................................................. 90

Rachel Denae Thrasher and Kevin P. Gallagher ....................................................................................................... 93

Abstract ...................................................................................................................................................................... 93
I. Crisis­era protectionism and the expanding trade regime ................................................................................ 93
II. The soft foundations of soft protectionism ....................................................................................................... 95
III. The threat to financial stability and industrial development policies ............................................................... 98
A. Tariffs .......................................................................................................................................................... 98
B. Import licensing and bans ........................................................................................................................... 99
C. Tax­based export incentives ...................................................................................................................... 100
D. Performance requirements ........................................................................................................................ 100
E. Financial regulation .................................................................................................................................. 101
F. Public welfare and “green” measures ...................................................................................................... 101
G. Public procurement .................................................................................................................................. 102
IV. Alternatives for emerging market and developing countries .......................................................................... 103
Notes ..................................................................................................................................................................... 104
References ................................................................................................................................................................ 104


Explanatory notes

Classification by country or commodity group

The classification of countries in this publication has been adopted solely for the purposes of statistical or
analytical convenience and does not necessarily imply any judgement concerning the stage of development
of a particular country or area.

The terms “country” / “economy” refer, as appropriate, also to territories or areas.

References to “Latin America” in the text or tables include the Caribbean countries unless otherwise indicated.

References to “sub­Saharan Africa” in the text or tables include South Africa unless otherwise indicated.

Other notes

References in the text to TDR are to the Trade and Development Report (of a particular year). For example,
TDR 2014 refers to Trade and Development Report, 2014 (United Nations publication, sales no. E.14.II.D.4).

References in the text to the United States are to the United States of America and those to the United
Kingdom are to the United Kingdom of Great Britain and Northern Ireland.

The term “dollar” ($) refers to United States dollars, unless otherwise stated.

The term “billion” signifies 1,000 million.

The term “tons” refers to metric tons.

Annual rates of growth and change refer to compound rates.

Use of a dash (–) between dates representing years, e.g. 1988–1990, signifies the full period involved,
including the initial and final years.

An oblique stroke (/) between two years, e.g. 2000/01, signifies a fiscal or crop year.

Decimals and percentages do not necessarily add up to totals because of rounding.


Abbreviations and acronyms

ASEAN Association of South-East Asian Nations
ATIGA ASEAN trade in goods agreement
BW Bretton Woods
BRICS Brazil, Russian Federation, India, China and South Africa
CRA Contingent Reserve Arrangement
DAAD German Academic Exchange Service (Deutscher Akademischer

EMDE emerging market and developing economies
FDI foreign direct investment
FEFI Fraser Economic Freedom Index
GATT General Agreement on Tariffs and Trade
GDP gross domestic product
GNI gross national income
GPA government procurement agreement
IAB Inter-American Bank
IBRD International Bank for Reconstruction and Development
ILO International Labour Organization
IMF International Monetary Fund
LMICs low- and middle-income countries
MDG Millennium Development Goal
MERCOSUR Common Market of the South (Mercado Común del Sur)
MIT middle-income trap
NAFTA North American Free Trade Agreement
NDB New Development Bank
NIE newly industrializing economy
OECD Organisation for Economic Co-operation and Development
PPP purchasing power parity
PWT Penn World Table
RER real exchange rate
SCRER stable and competitive real exchange rate
SDRM sovereign debt restructuring mechanism
TDR Trade and Development Report
TNC transnational corporation
TPP Trans-PacificPartnership
TRIMs trade-related investment measures
UNCTAD United Nations Conference on Trade and Development
UNIDO United Nations Industrial Development Organization
WDI World Development Indicators
WTO World Trade Organization


About the authors

• Alfredo Calcagno is Head of the Macroeconomic and Development Policies Branch within the Division
on Globalization and Development Strategies at UNCTAD, and team leader of the Trade and Development
Report (TDR).

• Sebastian Dullien is Professor of International Economics at HTW Berlin – University of Applied
Sciences and Senior Policy Fellow at the European Council on Foreign Relations. From 2009 to 2013, he
was co­director of a DAAD­sponsored network on “Economic Development Studies on Money, Finance
and Trade” between 12 universities in Belarus, Brazil, Chile, China, Germany, Jordan, Mauritius, South
Africa, Uganda and the United Republic of Tanzania that worked in close collaboration with UNCTAD’s
Virtual Institute.

• Roberto Frenkel is a Principal Research Associate at the Center for the Study of the State and Society
(CEDES). He has been Director of the Program of Specialization in Capital Markets (University of Buenos
Aires – Stock Market of Buenos Aires) since 1991 and a Member of the Academic Council of the Master
Degree Program in Economics, School of Economics, University of Buenos Aires since 1993. He was a
consultant to ECLAC, UNPD, ILO, the Colombian Government, OECD Development Centre, UNCTAD,
ONUDI and IADB and director of the Provincial Bank of Argentina. His research has been published in
the Cambridge Journal of Economics, the Journal of Post­Keynesian Economics, the Oxford Handbook
of Latin American Economics, the Journal of Globalization and Development, the International Review
of Applied Economics and the Journal of Iberian and Latin American Economic History, among others.
He studied Mathematics at the Universidad de Buenos Aires. He was awarded the James H. Street Latin
American Scholar for 2013 by the Association of Evolutionary Economics, among others.

• Dr. Kevin P. Gallagher is an associate professor at Boston University’s Frederick S. Pardee School
of Global Studies, where he co­directs the Global Economic Governance Initiative and the Global
Development Policy Program. He is the author or co­author of five books: Ruling Capital: Emerging
Markets and the Reregulation of Cross-Border Finance; The Clash of Globalizations: Essays on Trade and
Development Policy; The Dragon in the Room: China and the Future of Latin American Industrialization
(with Roberto Porzecanski); The Enclave Economy: Foreign Investment and Sustainable Development
in Mexico’s Silicon Valley (with Lyuba Zarsky); and Free Trade and the Environment: Mexico, NAFTA,
and Beyond. Gallagher has edited or co­edited a number of books, including Rethinking Foreign
Investment for Sustainable Development: Lessons from Latin America (with Daniel Chudnovsky) and
Putting Development First: the Importance of Policy Space in the WTO and IFIs. He is the co­chair of
the Task Force on Regulating Capital Flows and has served as an adviser to the Department of State and
the Environmental Protection Agency in the United States, as well as the United Nations Conference
on Trade and Development. Gallagher has been a visiting or adjunct professor at the Fletcher School of
Law and Diplomacy, El Colegio de Mexico in Mexico, Tsinghua University in China and the Center for
State and Society in Argentina. Gallagher is co­editor of the Review of International Political Economy
and writes regular columns in the Financial Times and the Guardian.

• Eric Helleiner is Professor and Faculty of Arts Chair in International Political Economy at the Balsillie
School of International Affairs and the Department of Political Science of the University of Waterloo. His
most recent books include The Forgotten Foundations of Bretton Woods (Cornell University Press, 2014)
and The Status Quo Crisis: Global Financial Governance After the 2008 Meltdown (Oxford University
Press, 2014).


• Veerayooth Kanchoochat has worked as an Assistant Professor of Political Economy at the National
Graduate Institute for Policy Studies (GRIPS, Tokyo) since 2013. He holds an MPhil and a PhD from the
University of Cambridge, United Kingdom. His past research and teaching experience is affiliated with
Chulalongkorn’s Political Economy Centre, Cambridge’s Centre of Development Studies, the Brooks
World Poverty Institute (Manchester) and the Overseas Development Institute (London).

• Alejandro Márquez-Velázquez is Assistant professor at the Institute for Latin American Studies at the Free
University of Berlin. From 2009 to 2013, he was administrative coordinator of the DAAD­sponsored
network on “Economic Development Studies on Money, Finance and Trade”.

• Nicolas Maystre is an Economic Affairs Officer in the Macroeconomic and Development Policies Branch
within the Division on Globalization and Development Strategies at UNCTAD, which is responsible for
the Trade and Development Report (TDR).

• Jan Priewe was Professor of Economics at HTW Berlin – University of Applied Sciences from 1993 until
2014. He was co­director of a cooperation project of the German Ministry for Economic Cooperation
and Development with the People’s Bank of China from 2000 until 2009. From 2009 to 2013, he was
co­director of a network sponsored by the German Academic Exchange Service (DAAD) on “Economic
Development Studies on Money, Finance and Trade” between 12 universities in Germany, Belarus,
Brazil, Chile, China, Jordan, Mauritius, South Africa, Uganda and the United Republic of Tanzania,
which worked in close collaboration with UNCTAD’s Virtual Institute.

• Martin Rapetti is an Associate Researcher at the Center for the Study of the State and Society (CEDES),
an Assistant Researcher at CONICET and Professor at IIEP­BAIRES, University of Buenos Aires,
Argentina. His research has been published in the Cambridge Journal of Economics, Structural Change and
Economic Dynamics, the Oxford Handbook of Latin American Economics, the Journal of Globalization
and Development, the International Review of Applied Economics and the Journal of Iberian and Latin
American Economic History, among others. He holds an undergraduate degree in Economics from the
University of Buenos Aires and a PhD in Economics from the University of Massachusetts, Amherst.

• Rachel Denae Thrasher holds a JD in international law and a master’s degree in international relations,
both from Boston University. She was admitted to practice law in the Commonwealth of Massachusetts.
Ms. Thrasher works on policy issues related to economic relations between developing countries, regional
trade agreements and bilateral investment treaties, multilateral environmental agreements and global
forests governance. Her publications include 21st Century Trade Agreements: Implications for Long-
Run Development and Preferential Trade Agreements: Free Trade at What Cost? She is the co­editor
of a recent book titled The Future of South-South Economic Relations with Adil Najam. At GEGI, she
continues to research areas of trade and investment agreements and their impact on development policy.
She also teaches a course entitled Trade Law and Development Lab at the Pardee School of Global Studies
at Boston University.

• Robert H. Wade is Professor of Political Economy at the London School of Economics. His book Governing
the Market: Economic Theory and the Role of Government in East Asian Industrialization (Princeton
University Press, 1990, 2004) won the American Political Science Association’s Best Book or Article in
Political Economy award in 1992. He won the Leontief Prize in Economics in 2008.


Alfredo Calcagno, Sebastian Dullien,

Alejandro Márquez-Velázquez, Nicolas Maystre and Jan Priewe

The global financial crisis that erupted in 2008
marks the starting point for a comprehensive rethink­
ing of economic theories and policies, particularly
in the field of development strategies. A number of
questions need to be addressed for economic analysis
and policy recommendations to be relevant, including
the assessment of the causes of the crisis, its potential
remedies and the way in which the crisis challenges
our understanding of economic and social processes.

The crisis shed new light on the economic trends
that led to it, including the developments in different
developing and transition economies.1 Moreover, the
crisis may be changing the economic framework in
which developing countries formulate and implement
their development policies; therefore, it is necessary
to assess the extent to which these policies need
to be reformulated. These considerations call for
examining development strategies from a historical
perspective. Indeed, different groups of develop­
ing and transition countries had experienced quite
divergent performances in the decades preceding the
global financial crisis. This has provided a rich set
of experiences from which a very valuable learning
can be extracted.

When looking at the long­term performance
of developing countries from 1980 until 2013, it
is possible to identify three major features. First,
Asian countries perform remarkably better on most
indicators, and especially in terms of per capita gross
domestic product (GDP) growth, compared with
African and Latin American countries. Second, while
the 1980s and 1990s were practically two lost decades
for development in most countries outside Asia,

transition and developing economies have boomed
since the early 2000s; even after the Great Recession
of 2008–2009, output growth has been more buoyant
in developing countries than in developed countries,
despite strong diversity of performances within
the regions. Third, after several decades in which
the share of developing countries in global output
remained virtually constant, it almost doubled in the
decade following 2003.

In the 1980s and 1990s, per capita GDP growth
rates in most developing countries were well below
those of developed countries, and in many cases they
actually contracted (table 1). This trend of develop­
ing countries lagging behind visibly changed in the
period from 2000–2013, when per capita GDP in the
developed countries expanded by a meagre average
annual rate of 0.9 per cent, while developing and
transition economies caught up with a (weighted)
average annual increase in per capita incomes of
4.6 per cent. All developing and transition regions
improved their economic performance: Asian
economies continued their strong dynamic, several
African and Latin American countries reoriented
their economic policies away from the Washington
Consensus and benefited from a commodity boom,
while transition economies in Europe and Central
Asia recovered from the huge output losses from the
economic collapse of the early­1990s. This growth
acceleration was achieved despite the industrialized
countries being in the doldrums for most of this

Rapid output growth was associated with
significant increases in per capita incomes in many

2 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

Table 1


Country group 1981–1990 1991–2000 2001–2013 1991–2013

Developed 2.0 2.1 1.1 1.9
Developing and transition 0.3 1.1 2.8 2.0

Average of the group/region
Developed 2.6 2.0 0.9 1.5
Developing and transition 1.3 2.0 4.6 3.5
of which:

Developing Africa -0.5 0.0 2.4 1.7
Developing America -0.3 1.4 2.3 1.7
Developing Asia 3.2 4.7 6.0 5.2
Transition … -4.8 4.9 2.5

Number of developing and transition with growth…
above 5 per cent 19 14 27 18
above 3 per cent 36 41 77 47
above 0 per cent and below 3 per cent 45 71 67 97
below 0 per cent 66 53 20 19
above average weighted growth of developed 41 63 124 96
below average weighted growth of developed 106 102 40 67

Number of developing and transition with data 147 165 164 163

Source: UNCTAD secretariat calculations, based on United Nations, Department of Economic and Social Affairs (UN-DESA), National
Accounts Main Aggregates database.

Note: GDP per capita is calculated by dividing the corresponding total GDP by the total population of each country group.

developing countries, and particularly those that
are highly populated. Therefore, in terms of the
population that benefited from it, the improvement
was remarkable: in 1990, 52 per cent of the world’s
population lived in low­income countries (defined
here as below the $1,000 level in per capita GDP
in constant prices of 2013); in 2013, that share had
plummeted to 10 per cent (table 2). First, China
left the low­income group, followed after 2000 by
India, among others. Hence, the accelerated income
growth has had real effects for the living conditions
of hundreds of millions of the poor across the world.
Developmental indicators like the reduction of abso­
lute poverty or improvements in health and education
usually go hand in hand with higher average levels of
income. However, the strength of the nexus between
growth and social improvement strongly differs
across countries. Indeed, it may be significantly
reduced if – as has frequently happened – growth is
associated with rising inequality and environmental
damages. Therefore, the drivers and characteristics
of growth hold the utmost importance, not only for

determining the social impacts of growth but also for
its environmental sustainability.

The overall positive developments in the eco­
nomic and social indicators of developing regions
require two major qualifications. First, after the
financial crisis, growth in developing and transition
economies has become more erratic and the pros­
pects gloomier, with uncertainty about the future
growth of the world economy being on the rise. In
many large emerging markets from Brazil to South
Africa and the Russian Federation, there are doubts
about whether the growth spell of the past 15 years
can be continued. Second, even if some catching­up
occurred, the income gap between developed and
developing countries remains large. When using per
capita income at constant 2005 dollars as a yardstick,
developing countries on average only reached 8.3 per
cent of the developed countries level in 2013, and
only marginally improved from 5.5 per cent in 1990.
At current exchange rates, developing countries’
average income reached 11.6 per cent of that of the


developed countries in 2013 (improving from 5.4 per
cent in 2000).

Whatever the measure for proper cross­country
income comparisons, there is no doubt that there
has been a significant change in the relative weight
of developing and developed countries in the world
economy. The share of developing countries in world
output fluctuated between 16 and 23 per cent during
1980–2003 (chart 1). By contrast, from 2003 until
2013 it almost doubled from 20.3 to 36.5 per cent
(when China is excluded, this share rises from around
16.0 to 24.3 per cent). This is due to both accelerat­
ing growth in developing countries and decelerating
growth in developed countries. This structural change
is likely to continue as long as developed countries
maintain their low growth path, as has been the case
– on average – after the financial crisis. However, this
should not be interpreted as a decoupling between
developed and developing countries since global
interdependence is stronger than ever. Nonetheless,
the characteristics of this interaction and the nature of
growth drivers are changing, whereby development
strategies must adapt accordingly.

Furthermore, there has been considerable
diversity in the developing countries’ growth perfor­
mance, both between the different broader regions
of developing countries and to a lesser extent within
the regions. There is no clear and unique formula for
success or failure, no “one size fits all” approach to
development strategies. One of the lessons that can
be extracted from experience is that policies need to
adapt to specific conditions and national goals, which
implies avoiding rigid precepts for both targets and

tools. However, this does not mean that strategies
have to be replaced by ultra­pragmatic and flexible
policies, constantly changing according to short­term
conditions. The adoption of a better combination of
macroeconomic pragmatism and a clear development
orientation is one of the reasons why the perfor­
mance of many developing and transition economies

Table 2


Number of countries in sample Population (per cent)

1990 2000 2013 1990 2000 2013

Below $1,000 51 66 54 53.4 41.2 10.3
$1,000–$5,000 85 60 65 25.8 34.4 37.8
$5,000–$20,000 41 43 43 6.8 10.3 36.9
More than $20,000 29 38 46 14.0 14.0 14.9

Total reported 206 207 208 100.0 100.0 100.0

Source: UNCTAD secretariat calculations, based on UN-DESA, National Accounts Main Aggregates database.
Note: All economies are categorized according to their GDP per capita in current dollars. The World Bank Atlas Method was used

for conversion to dollars and for the benchmarks adjustment. For example, the 2013-benchmark of $1,000 was applied like
$803 in 2000 and $663 in 1990. Population is presented as percentage of the world total population for the country groups.

Chart 1


(Per cent of global GDP in current dollars)

Source: UNCTAD secretariat calculations, based on UN-DESA,
National Accounts Main Aggregates database.










1970 1975 1980 1985 1990 1995 2000 2005 2010

Developing economies

Transition economies

Developing economies,
excluding China


4 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

dramatically improved in the early­2000s. Volume I
of this publication discusses these general issues
that all developing countries need to handle, as well
as highlighting some key policy areas of interest for
most of them.

Theoretical thinking on economic development
largely relies on comparative analysis. In particu­
lar, it explores the reasons why some countries or
regions have performed better than others in the
long run. Essays in Volume II of this publication
contribute to this approach, as well as examining
why the performance in a given country or group of
countries has improved or deteriorated in the long­
term depending on changing development strategies.
From this perspective, poor economic results in vast
developing regions and transition economies in the
1980s and 1990s have to be compared with rapid
output growth and social improvements in the two
preceding decades, as well as the 2000s. Several fac­
tors have contributed to explaining these contrasts. In
particular, the existence of a developmental State that
uses its room for manoeuvre to act on both the supply
and demand side is a common denominator of most
successful experiences. On the contrary, neoliberal
policies that restrained the role of the State in the
economy and dismissed the need to preserve any
policy space prevailed in the slow­growing regions
during the 1980s and 1990s.

The demise of the Washington Consensus owing
to failing empirical tests (Birdsall and Fukuyama,
2011), the failures of neoliberal recipes and the
dramatic consequences of the global financial cri­
sis (after several regional financial crises) have
altogether generated enormous new challenges.
Consequently, old certitudes have to be abandoned.
Development models championed by governments
and academia in developed countries as well as by
several international organizations are increasingly
questioned. Moreover, in parallel to their rising
economic weight, the leading developing economies
have gained increased influence in the debate about
the functioning of the global financial and trading
system, as well as global political issues.

Against this historical background, this publica­
tion intends to explore the nature and consequences
of the crisis, as well as the diversity of economic and
social development among developing countries. It
looks at the reasons behind the recent improvement in
developing countries performances and its potential
for continuation after the financial crisis.

The recent economic trends and the challenges
posed by the global crisis reinforce the importance of
implementing strategies for development as opposed
to leaving the economy to market forces. Countries
need a strategic compass for long­run economic
development, either explicitly or implicitly. Among
other ingredients, this comprises macroeconomic
policies, sectoral policies (including the financial
sector, trade and industrial policies), institution
building in key areas and development­friendly
global governance. Within a chosen medium­ or even
long­term strategy, governments need more policy
space to adjust to the specific (and evolving) social,
historical and institutional context. The experience of
Asia shows that rather than implementing narrow and
rigid general guidelines, experimental approaches –
which require policy space – are a recipe for success.
Furthermore, the slow­growth periods endured by
several countries (the “lost decades”) allowed infer­
ring which policies should be avoided. The authors
of this publication share the notion that developing
countries can and should learn more from each
other, as well as from their own past experience. It is
important to look at comparisons between developing
countries, including both success and failure stories.

A developmental State needs to use a variety
of tools to intervene in several key areas. Most
authors in this book hold the view that more active
macroeconomic management with a stronger focus
on domestic demand is needed. This should replace
export­led growth when associated with entrenched
incomes and austere public spending. More prudent
financial sector development is necessary to enhance
investment with predominantly domestic sources
of finance. Industrialization is a major target of any
development strategy, and this requires industrial
policy. Small countries – even more than larger
ones – need a focus of policies on certain sectors
to shape potential comparative advantages beyond
agricultural or mineral commodities. Boom­bust
cycles of short­term capital flows undermine growth
and development. Cross­border capital flows should
be governed by prudent management, which can
include capital controls. Unregulated capital flows
negatively affect market­driven exchange rates, gen­
erating strong volatility or chronic overvaluation of
exchange rates, both of which are strong hindrances
for development, given that currency­related conflicts
or even currency wars may need to be resolved in the
framework of a new global financial architecture.
Strong and sustainable development requires a devel­
opmental State supported by increased fiscal space


for providing public goods and income redistribution.
Reducing income inequality beyond curtailing abso­
lute poverty can have positive impacts for growth,
employment and structural change (TDR 2012).

Many of the chapters in this publication were
written by authors who collaborated within the
“Partnership on Economic Development Studies”, a
network of 11 universities from the South and HTW
Berlin – University of Applied Sciences, with which
UNCTAD has been cooperating. This network was
funded by the German Academic Exchange Service
(DAAD) from 2009 until 2013.2 We are grateful to
the DAAD for their generous support of this project.
Most of these contributions stem from the workshop
on “Development Strategies: Country Studies and
International Comparisons” held in November
2013 in Shanghai (hosted by the East China Normal
University). Other chapters are from well­known
scholars who work or regularly cooperate with

As already mentioned, this publication is pre­
sented in two volumes with a total of 14 chapters. The
first volume addresses the more general issues, while
the second focuses on country studies and country
comparisons. Due to space limitations, many issues
cannot be addressed here. For instance, environmen­
tal problems as well as the debate on the Sustainable
Development Goals are not included, and in the sec­
ond volume we mainly cover large economies with
significant regional impact, although several lessons
that can be extracted from their experiences also hold
interest for many least developed countries. While
all authors are academic economists, we attempt
to reach a broader readership within and outside
academia, from graduate students to journalists
and policy makers. Therefore, unnecessary techni­
cal presentations are avoided. Lastly, the opinions
expressed are those of the authors and do not neces­
sarily represent those of UNCTAD, HTW Berlin or
the institution to which the authors are affiliated. The
remainder of this introduction provides an overview
of the first volume’s chapters.

Alfredo Calcagno analyses the need to adjust
developing strategies after the global financial crisis
in a context of expected future slow growth in the
North. The global financial crisis that started in 2008
has exposed a number of fundamental flaws in how
the world economy has been functioning under a
“finance­driven globalization” and often export­led
growth, with increasing income inequality and a

diminishing economic role for the State. Calcagno
pleas for a stronger emphasis on domestic demand­
led growth based upon rising incomes rather than
credit and asset bubbles, addressing the role of a
change in income distribution and the establishment
of a developmental State that should also promote
structural change and industrialization.

Jan Priewe analyses seven development
strategies, namely the Washington Consensus, neo­
liberalism, good governance, the UN Millennium
Development Goals, export­led growth, industri­
alization and a heterodox macroeconomic strategy
for development, which is suggested by the author.
Priewe argues that – at least in the case of large devel­
oping countries – a strong focus needs to be placed
upon coherently managed macroeconomic policies
to provide a stable environment that is conducive to
development, namely one that minimizes the risk
of balance­of­payments crisis, promotes domestic
demand and finance for both fixed investment and
human capital formation. He further argues that suc­
cessful countries have pursued industrial policies, a
combination of inward and outward approaches in
the course of industrialization and diversification of

On the occasion of the 70th anniversary of the
Bretton Woods institutions in 2014, Eric Helleiner
argues that remembering the original development
content of Bretton Woods may be politically very
useful for reformers seeking to construct a more
development­friendly global financial system today.
The author recalls that the then­negotiations are
often described as an Anglo­American affair in
which developing countries played little role and
development issues were largely ignored. However,
he underscores that the Bretton Woods architects
included officials from many poorer countries and
international development goals were explicitly
prioritized in the design of the post­war international
financial order. As discontent with Bretton Woods
institutions grows among developing countries
policymakers, the proposed reforms may recover the
original idea of constructing a multilateral economic
order that would support the development aspirations
of poorer countries.

Veerayooth Kanchoochat aims to identify the
main middle­income traps and presents a critical
review of the literature. The author discusses three
strands, which he labels as (i) getting education and
institutions right, (ii) changing export composition

6 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

through comparative advantage and (iii) industrial
upgrading through State interventions. Among the
author’s conclusions is that rather than focusing
only on alphabetization and institutions assuring the
well­functioning of the market, governments should
try to focus on developing institutions (including
education) geared towards the development of
modern industries targeted at changing the export
composition of countries. He criticizes suggestions
of following a country’s traditional comparative
advantage to achieve a structural transformation. Last
but not least, he underscores that while industrial and
technological policies are essential to transform the
economic structure of a country, such policies must
be guided by the carrot­and­stick principle applied in
the first­tier newly industrialized economies within
a stable macroeconomic environment.

Robert Wade discusses the relevance of indus­
trial policy for developing countries, given the rising
interest shown in this type of policy by politicians
and economists in both the developed and developing
world after the 2008 global financial crisis. For this
purpose, he presents examples showing that industrial
policy has regained relevance in the post­2008 world.
At the micro level, he argues that agencies in charge
of industrial policy should be directed by capable
managers who have weak ties with the ruling elite
when appointed and subsequently develop a strong
tie with the president while still maintaining weak
ties with the rest of the elite. He concludes by recom­
mending that policymakers in developing countries
should undertake industrial policy despite the opposi­
tion to this idea shown by mainstream economics and
many international financial institutions.

Concentrating on one of the key macro eco nomic
policies of a development strategy, Roberto Frenkel
and Martin Rapetti make the case for developing
countries targeting a “stable and competitive real

exchange rate” (SCRER) as part of their develop­
ment strategy. For this purpose, the authors review
a sample of the empirical literature reporting a posi­
tive impact of real exchange rate undervaluation on
growth, as well as another strand of the literature
concerned with the possible transmission channels
from SCRER to increased growth. The authors
argue that the main growth transmission channels of
targeting a SCRER are the greater macroeconomic
stability brought about by the reduced risks of balance
of payment crises, the greater availability of foreign
exchange and the stimulus that a higher relative price
of tradeables has on investment in modern tradeable
sectors. Moreover, they argue that targeting a SCRER
is sustainable at the national level since financing
the consumption of other countries can be sustained
across time and that internal equilibrium can be
attained at no or a relatively low cost if the exchange
rate, monetary policy, capital controls, fiscal and
wage policies can be coordinated.

Rachel Denae Thrasher and Kevin P. Gallagher
argue that it is imperative for countries to have the
national­level flexibility to meet global develop­
ment goals. The authors analyse a sample of trade
agreements to show that a new ‘trade’ policy has
evolved seeking to liberalize all perceived impedi­
ments to global commerce, reaching into the realms
of financial regulation, innovation policy, as well as
a range of domestic regulations that promote public
welfare. They argue that there is a fine line between
what may be perceived as ‘protectionism’ by actors
seeking further market access and the legitimate
deployment of domestic regulation for sustainable
and inclusive growth on the part of emerging market
and developing countries. The authors conclude by
stating that global and regional trade rule­making
will need to preserve nation States’ ability to deploy
country­specific policy for development.


1 In our view, there is not a completely satisfactory
classification of countries in “developed”, “develop­
ing” and “transition economies”. In some cases, the
participation in a given group or organization (e.g.
being a member of the OECD or of the “Group of 77
and China” (G77)) is used to distinguish developed
and developing countries. However, this does not
exclude overlapping or paradoxes, such as some G77
countries having per capita GDP higher than some
OECD countries. Some institutions classify countries
in low­, middle­ and high­income groups, using
their per capita income levels as the sole criterion
and setting arbitrary thresholds. For instance, the
World Bank (2014) currently defines low­income
countries as those whose per capita income is
below $1,045, middle­income countries as those
with an income between $1,045 and $12,746 and
high­income countries as those exceeding $12,746
(thresholds are periodically adjusted with inflation).
However, using the income level as the criterion for
dividing countries in “developing” and “developed”
is problematic (Nielsen, 2011). A number of small

oil­exporting countries (e.g. Brunei Darussalam,
Equatorial Guinea, Oman and Qatar) or offshore
financial centres have higher per capita income
levels than countries with a much more developed
and diversified production capacity, higher techno­
logical mastery and better qualified working force
(e.g. Argentina, Brazil, the Republic of Korea, the
Russian Federation and Turkey). In this introduction,
we generally use the United Nations classification
of developed, developing and transition economies.
According to the United Nations Statistical Division
(UNSD, 2013), “there is no established convention
for the designation of ‘developed’ and ‘developing’
countries or areas in the United Nations system. In
common practice, Japan in Asia, Canada and the
United States in northern America, Australia and
New Zealand in Oceania, and Europe are considered
‘developed’ regions or areas.” The group of transition
economies comprises the CIS and the South­East
European countries that are not European Union

2 See http://daadpartnership.htw­berlin.de/.



Birdsall N and Fukuyama F (2011). Post­Washington
consensus­development after the crisis. Foreign
Affairs, 90(2): 45–53.

Nielsen L (2011). Classification of countries based on
their level of development: How it is done and how
it could be done. IMF Working Paper WP/11/13,
International Monetary Fund, Washington, DC.

UNCTAD (TDR 2012). Trade and Development Report,
2012. Policies for Inclusive and Balanced Growth.
United Nations publication, sales no. E.12.II.D.6,
New York and Geneva.

UNCTAD (TDR 2014). Trade and Development Report
2014. Global Governance and Policy Space for

Development. United Nations publication, sales no.
E.14.II.D.4, New York and Geneva.

UNSD (United Nations Statistical Division) (2013). Com­
position of macro geographical (continental) regions,
geographical sub­regions, and selected economic and
other groupings. Available at: http://unstats.un.org/

World Bank (2014). Data. A short history. Available at:

9Rethinking Development Strategies after the Global Financial Crisis

The situation in the global economy has always
provided the framework for development processes,
setting specific configurations of trade, migratory
flows, capital movements and the exchange of
knowledge and technology. These exchanges have
been shaped by the rules established in multilateral,
regional or bilateral spheres; moreover, they are
also affected by the action and policies of influen­
tial actors, including governments, domestic elites,

international banks and transnational corporations
(TNCs). However, the global context has not com­
pletely determined the development path: developing
countries have always had some room for manoeuvre
regarding the way in which they have integrated this
international environment.

All these factors – the international economic
environment, the situation of developing countries


Alfredo Calcagno

* Many of the ideas and most of the statistical evidence presented in this chapter have been elaborated by the team
that has prepared the Trade and Development Report (TDR) of the United Nations Conference on Trade and Develop­
ment (UNCTAD) in the last few years, with the author being a member of that team since 2003, and its coordinator
since 2012. In addition to recognizing this intellectual debt, I wish to specially thank three members of the team, Pilar
Fajarnés, Jörg Mayer and Nicolas Maystre, for their detailed comments on a previous version. However, this text does
not necessarily fully reflect the views of all the TDR team members or those of UNCTAD.


The global financial crisis that erupted in 2008 and its long-standing effects have evidenced a number
of fundamental flaws in the way in which the word economy has been functioning under a “finance-
driven globalization”. This has been characterized by increasing income inequality and a diminishing
role of the State in the economy. The crisis has evidenced a changing structure of the word economy,
with a larger share in global output and trade for developing countries. Development strategies should
thus rely less on export-led growth oriented to developed countries markets and more on domestic
and regional demand, based upon better income distribution.

In this framework, there is an essential role for a developmental State on both the demand and the
supply side. Developing countries need to preserve and creatively use the remaining policy space
within the multilateral rules to implement industrial policies to diversify and upgrade their economies.
They also need to strengthen their domestic sources for financing investment and reinforce the fiscal
space, which is essential for a successful developmental State.


10 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

and the role of relevant actors – have been upset
by the global financial crisis. The perceived nature
and depth of the crisis crucially determines the need
to redefine development policies and how such a
reorientation should be designed.

According to the view that the crisis was an
accident caused by policy mistakes, excessive risk
appetite and regulatory shortcomings, it may be
possible to return to the pre­crisis growth regime
without major changes in the development strate­
gies. From this perspective, some structural reforms
may be helpful – in particular, those aimed at further
trade and capital account opening, labour market
flexibilization and reduced state intervention in the
economy. However, these reforms would reinforce

the features of the pre­crisis economic system rather
than transforming them.

This chapter adopts an alternative approach,
in line with UNCTAD’s analysis of the crisis (see
in particular TDRs 2009 to 2014). It contends that
the global financial crisis that erupted in 2008 has
evidenced a number of fundamental flaws in the way
in which the world economy has been functioning
under a “finance­driven globalization” (UNCTAD,
2011). The crisis thus marks a breaking point, after
which it will be neither possible nor desirable to
return to the pattern of growth that prevailed before
the crisis. Accordingly, developing countries need to
rethink their development strategies in accordance
with the new environment.

I. A “big crisis”

A. Causes and nature of the crisis

The global financial crisis has been extraor­
dinary in several respects. Regarding its severity,
global output contracted for the first time since the
Second World War (2.1 per cent in 2009). It was also
extraordinary for its reach, as it spread to virtually
all regions in the world. Output fell in absolute terms
in developed and transition economies, while in
developing countries, there was a mix of reductions
of gross domestic product (GDP) and significant
growth slowdowns. The strength and speed of the
transmission of the crisis were also remarkable. An
apparently minor shock – the burst of the subprime
bubble in the real estate market of the United States
– severely struck international financial markets and
affected global economic activity and employment, as
well as international trade. The rapidity with which
the crisis spread contrasts with the sluggishness of the
recovery, especially in several developed countries
that continue struggling to restore a sustainable and
employment­creating growth path.

Therefore, this is a “big crisis” regarding its
magnitude, extension and time length. It may also
be characterized as a “big crisis” in the different –
more qualitative – meaning, which was introduced
by Robert Boyer (1979). The history of capitalism
has been punctuated by many crises. Most of them

(the “small crises”) were functional to the endog­
enous adjustment (the “regulation”) of the economy:
they corrected excess expenditure and credit, adjusted
relative prices (including real wages), depreciated
and concentrated the real and financial capital in a
way that re­established the conditions for growth.
These were crises within an economic regime (mode
de régulation). A different case in point is that of a
“big crisis”, i.e. a crisis of the economic regime itself.
This happens when the economic system enters into
a prolonged recession from which it cannot recover
without changing some of its fundamental aspects.
In this situation, market mechanisms and short­term
adjustment measures (e.g. automatic stabilizers)
cannot restart growth on a solid basis because they
do not address the roots of the problem.

An important indication of the nature of the
crisis is the fact that this time its epicentre was in the
most advanced countries in the world. This contrasts
with the financial crises that have recurrently hit
developing or transition economies since the begin­
ning of economic and financial liberalization in the
early­1980s. The global financial crisis originated
in the most sophisticated financial markets from
countries that were leading in all the rankings of
financial efficiency and good governance prepared
by different “market friendly” institutions. The crisis
was not due to imperfect functioning of institutions or

11Rethinking Development Strategies after the Global Financial Crisis

bad implementation of liberalizing policies, but rather
to the very nature of those institutions and policies.

The crisis reveals a number of fundamen­
tal problems of the economic system that have
accumulated tensions and imbalances at both the
national and global level in recent decades. These
went largely unnoticed in the pre­crisis years of
widespread complacency – a period known as the
“Great Moderation”. It was then thought that, thanks
to the wisdom of independent Central Banks, inflation
was definitely under control and that the complete
liberalization of all markets (including financial
markets) would lead to strong and sustained growth
within this framework.

The optimism in a context of positive economic
growth that prevailed during those years masked
rapidly mounting internal and external disequilibria.
Some imbalances were too large to be ignored, such
as the current account deficit of the United States
(6 per cent of its GDP in 2006). However, rather
than being a cause of concern, they were seen as
proof of the United States’ economic strength. It was
contended that the rest of the world was generating a
“savings glut”, which could not find a use as profit­
able as in the United States, a country where the
investment opportunities exceeded its population’s
desired savings (Bernanke, 2005; see also Economic
Report of the President, 2006).

These external imbalances resulted from internal
problems, which were also ignored or underestimated.
If the United States and other developed countries
had rising deficits, it was not only because their
consumption was very high, but also because they
consumed a large proportion of imported goods and
services. Their firms had lost market shares and
capital inflows tended to finance consumption rather
than investment. Furthermore, the rise in households’
expenditure did not primarily reflect the rising income
of wage earners, whose share in total income had
been declining in several countries over the last few
decades; rather, it largely resulted from expanding
consumption and mortgage credit. This evidenced the
rising income and wealth inequality since the 1980s,
following the increasing dominance of globalized
finance, the erosion of the welfare State and the
weakening of workers’ bargaining power (TDR 2012).

Real wage growth lagged behind that of pro­
ductivity, and in some countries they did not increase
at all. Therefore, many households had to resort to

debt, not only for financing housing, but also for
consumption. Their access to credit was boosted by
the rising price of real estate and financial assets,
which were used as collateral. This set in place a
classical financial bubble, whereby expanding credit
supported the rise in the prices of the real estate and
financial assets, which in turn backed new credit to
finance consumption and the continued acquisition
of financial assets.

Firms also had to increase their borrowing, since
their managers were under pressure to increase equity
values and thus used benefits to distribute dividends
rather than reinvesting them. This reflects an increas­
ing hegemony of shareholders in the governance of
firms in developed countries, which contrasts with
the previous dominance of the “techno­structure”,
i.e. corporate management, analysed by John K.
Galbraith (1972).

On the credit­supply side, the financial sys­
tem allowed for the disequilibria to subsist, and
even enlarged them. It benefitted from widespread
de­regulation to extend its business without propor­
tionally increasing its capitalization. In particular, it
introduced financial innovations (e.g. securitization,
financial derivatives) and barely regulated institu­
tions (e.g. hedge funds, investment vehicles). Larger
leverage spurred the return on capital, although it
also augmented the risk of insolvency. In addition,
the banking system relied more on short­term credits
and less on deposits for its funding, which increased
maturity mismatch and liquidity risk. Financial
fragility was further aggravated by incentives that
encouraged risky behaviour among financial agents,
who received bonuses when they generated gains but
suffered no penalties in case of running losses.

These developments led to an extraordinary
expansion of the financial system worldwide, with
financial assets climbing from $12 trillion in 1980
(1.2 times the global output) to $225 trillion in 2012,
which is close to three times the global output.1 The
growing predominance of the financial sector over the
real economy also contributed to income inequality.
Indeed, a significant part of the very high incomes
(those received by the “top 1 per cent”) comprises
interest payments and substantial compensations and
bonuses in the financial system, as well as dividends
distributed by firms. This created a vicious circle in
which the unequal distribution of income pushed
many households and firms to resort to credit rather
than current income to fund their consumption and

12 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

investment. In turn, this increased financial profits
and income concentration.

B. Inadequate policy responses

After a first generalized and short­lasting
response to support the economy, policymakers in
most developed countries focused on recovering
the confidence of financial markets through fiscal
austerity (Ostry et al., 2010; IMF 2011a and 2011b).
They also tried to expand exports with “supply­side”
measures to improve competitiveness, including
wage constraints, although this did not address the
fundamental causes of the crisis. In a situation of
insufficient private demand, these kinds of measures
were particularly detrimental to economic growth,
and to some extent self­defeating: lower growth in
many countries at the same time hampered fiscal
revenues and external demand.

Expansionary monetary policy was the only

tool that remained to support economic growth.
However, this did not translate into larger credit
supply. Potential borrowers (households and firms)
were trying to reduce their indebtedness, and potential
lenders were reducing their leverage. This was an illus­
tration of the well­known debt­deflation situation (or
“balance­sheet recession”) described by Irving Fisher
(1933) and more recently by Richard Koo (2011).

The coexistence of strong monetary expansion
with subdued consumption and investment demand in
developed countries channelled significant amounts
of liquidity to speculative uses and emerging market
economies. This again pushed up the prices for a
number of financial assets and in real estate markets,
contributing to recovering domestic demand in some
countries (e.g. the United Kingdom and the United
States) at the risk of re­creating financial bubbles.
Financial flows also led to an appreciation of a num­
ber of developing­country currencies and an increase
in primary commodity prices. However, such capital
flows tend to be volatile and rather than a sustained
rise, they led to increased instability in those markets.

Summing up, rather than a temporary accident,
this appears to be the crisis of a pattern of growth (a
“big crisis”), whose main features are the dominance
of de­regulated finance over the real economy, the
mounting inequality in the distribution of income
and wealth and the State’s lesser role in the economy,
which have led to rising domestic and external imbal­
ances that can no longer be sustained. Subsequent
policies in developed economies that intended to
handle the crisis have not addressed its roots. On the
contrary, they have somewhat tended to reinforce
some of its causes by accentuating income inequality,
restricting governments spending and generating new
financial bubbles, while the announced re­regulation
of the financial sector is lacking behind.

II. The case for a reorientation of development policies

A. The global economic environment
after the crisis

The crisis has changed the economic landscape,
particularly for development policies. After grow­
ing at an average annual rate close to 4 per cent in
2004–2007, the growth of global output fell to around
2.4 per cent between 2012 and 2014. Economic decel­
eration affected developed, transition and developing
economies alike, although the latter maintained a
growth rate of around 5 per cent (table 1).

Even more remarkable is the slowdown in
international trade, whose annual average growth
rate fell from around 8 per cent in 2004–2007 (twice

as much as global output) to around 2.5 per cent in
2012–2014 (similar to that of global output). This is
mostly due to stagnating trade in developed countries
since 2011 (chart 1). This was a reflection of weak
domestic demand simultaneously affecting most
trade partners.

Developing countries have not been immune to
the slower demand in developed economies. Trade in
developing countries kept growing in volume, albeit
at half the pre­crisis growth rate. Growth in exports
from developing countries decelerated, partly due
to the weaker demand from developed economies,
which put a break to exports of manufactures to final
destinations. Moreover, this affected the trade of

13Rethinking Development Strategies after the Global Financial Crisis

inputs among the developing countries participating
in international production networks. Imports were
relatively less affected due to the more resilient GDP
growth and the gains in the terms of trade that com­
modity exporters benefitted from during most of the
post­crisis period (chart 1).

Development strategies are highly depend­
ent upon the extent to which these differentials in

growth rates of GDP and international trade between
developed and developing countries are a short­term
phenomenon or a long­term trend. This is particularly
the case for developing countries that have engaged
in export­led growth policies, where exports were
mostly oriented to developed country markets. Taking
a long­term perspective, it appears that the growth
differential between developed and developing coun­
tries was not caused by the crisis; rather, the crisis

Table 1

(Annual percentage change)

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

World 4.1 3.6 4.1 4.0 1.6 -2.1 4.1 2.8 2.2 2.3 2.5
Developed countries 3.0 2.5 2.9 2.5 0.1 -3.7 2.7 1.5 1.1 1.3 1.7
Transition economies 7.8 6.6 8.5 8.7 5.4 -6.5 4.8 4.6 3.3 2.0 0.9
Developing countries 7.4 6.8 7.7 8.0 5.3 2.6 7.8 5.9 4.7 4.6 4.3
of which:

Africa 5.7 6.0 5.8 6.1 5.4 2.8 4.9 0.5 5.2 3.2 3.0
Latin America and the Caribbean 5.9 4.5 5.6 5.6 3.7 -1.7 5.8 4.2 3.0 2.6 1.3
West Asia 10.3 7.2 7.6 5.5 4.6 -1.0 6.7 7.5 3.9 4.0 3.4
East, South and South-East Asia 7.9 8.0 9.0 10.0 6.2 5.2 9.3 7.0 5.5 5.7 5.8

Source: UNCTAD secretariat calculations, based on United Nations, Department of Economic and Social Affairs (UN-DESA), National
Accounts Main Aggregates database, and World Economic Situation and Prospects (WESP): Update as of mid-2015; ECLAC,
Preliminary Overview of the Economies of Latin America and the Caribbean 2014; OECD, Economic Outlook No. 96, November
2014; IMF, World Economic Outlook, April 2015; Economist Intelligence Unit, EIU CountryData database; JP Morgan, Global
Data Watch; and national sources.

Chart 1

(Index numbers, 2005=100)

Source: UNCTAD secretariat calculations, based on UNCTADstat.




























Developed economies
Developing economies

Trend developed economies, 2005 Q1–2008 Q1
Trend developing economies, 2005 Q1–2008 Q1











14 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

simply rendered more visible some trends that were
already under way, such as the increasing economic
weight of a number of large developing countries.

From 1970 onwards, it is possible to identify
four major periods (table 2). Between 1970 and
1981, developed countries represented a relatively
stable share of 70 per cent of global output, while
developing countries gradually increased their part
from 17 to 23 per cent, at the expense of the transi­
tion economies.2 The following decade witnessed a
further fall on the part of transition economies, from

8 per cent to 3 per cent of global output between
1980–1981 and 1990–1991 (compared to 13 per cent
in 1970–1971), while developing countries lost their
previous gains. Developed economies increased their
share to almost 80 per cent in 1992. The third period
showed little changes, with the share of developing
countries slowly increasing, the collapse of the Soviet
Union further lowering that of transition economies
and developed countries maintaining their part
slightly below 80 per cent.

These long­term trends sharply changed since
2003. In only ten years, the share of developing
countries jumped from 21 to 37 per cent of world
output, that of transition economies improved from
1.5 to 4 per cent and the part of developed countries
fell from 78 to 59 per cent. Indeed, the trend towards
the increasing share of developing countries and
decline in developed ones has continued during the
crisis and its aftermath.

This evolution in the contribution to total output
was parallel to that of international trade. In 1995,
developed economies accounted for 70 per cent of
total exports and 69 per cent of total imports; in
2003, these shares had declined to 65 and 69 per cent
respectively, and they further fell to 51 and 54 per
cent in 2013. Similarly, the part of developing coun­
tries in total exports rose from 28 per cent in 1995
to 33 per cent in 2003 and 45 per cent in 2013, and
that of imports from 29 per cent in 1995 and 2003 to
42 per cent in 2013 (table 3).

Table 2

COUNTRY GROUPS, 1970–2013 a

(Per cent)

1970 1981 1992 2003 2013

Developing economies 16.8 22.9 18.0 20.9 36.9
Transition economies b 13.4 7.9 2.7 1.6 3.9
Developed economies 69.8 69.2 79.3 77.5 59.2
Total 100.0 100.0 100.0 100.0 100.0

Source: UNCTADstat.
a Calculated using GDP in dollars at current prices and

current exchange rates.
b Comprises Albania, Armenia, Azerbaijan, Belarus,

Bosnia and Herzegovina, Georgia, Kazakhstan,
Kyrgyzstan, Montenegro, Republic of Moldova, the
Russian Federation, Serbia, Tajikistan, the former
Yugoslav Republic of Macedonia, Turkmenistan,
Ukraine and Uzbekistan.

Table 3

(Per cent of world exports)




economies Total

1995 Developed economies 52.2 16.6 0.9 69.7
Developing economies 16.1 11.9 0.3 28.3
Transition economies 1.0 0.3 0.6 2.0
Total 69.3 28.8 1.8 100.0

2003 Developed economies 49.5 14.0 1.1 64.6
Developing economies 17.9 14.5 0.3 32.8
Transition economies 1.5 0.5 0.6 2.6
Total 69.0 29.1 2.0 100.0

2013 Developed economies 34.2 14.9 1.6 50.7
Developing economies 17.8 26.4 0.9 45.0
Transition economies 2.4 1.1 0.8 4.3
Total 54.3 42.4 3.3 100.0

Source: UNCTAD secretariat calculations, based on UNCTADstat.

15Rethinking Development Strategies after the Global Financial Crisis

B. A more balanced approach on
the demand side

Export­led growth, mainly directed towards
developed economies, has long been the preferred
development strategy in many developing countries.
It involved either exporting directly to those markets
or participating in some global value chains, eventu­
ally finishing in developed markets. The main debate
about this strategy concerned the links between the
export­oriented activities and the rest of the economy.
Indeed, it was possible (and quite frequent) that a
country managed to rapidly expand its international
trade without significant improvements in capital
accumulation, productive diversification and GDP
growth. By themselves, neither larger exports nor
foreign direct investment (FDI) inflows necessarily
lead to increasing productive capacities. In fact, they

may simply develop some outward­oriented enclaves
without generating domestic productive linkages or
distributing a significant amount of income to local
agents. This is the case, for instance, in assembly
industries that import most of their inputs, employ
low­qualified working force and benefit from fiscal
incentives. Likewise, the contribution of activities
in extractive industries to domestic growth may be
rather small when they generate little employment,
import most inputs and services rather than creating
linkages with domestic suppliers, export the raw
material, transfer profits abroad and contribute insuf­
ficiently to tax revenues. As a result, increasing trade
openness was not associated with larger fixed capital
formation in most developing countries (chart 2).

Within this export­led approach to growth,
many developing countries sought to accelerate

Chart 2

(Per cent of GDP)

Source: UNCTAD secretariat calculations, based on UNCTADstat.










1970 1975 1980 1985 1990 1995 2000 2005 2010










1970 1975 1980 1985 1990 1995 2000 2005 2010

Latin America and the Caribbean











1970 1975 1980 1985 1990 1995 2000 2005 2010

East and South-East Asia, excl. China








1970 1975 1980 1985 1990 1995 2000 2005 2010


Gross capital formation Exports of goods and services Imports of goods and services





16 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

their integration with developed economies by sign­
ing bilateral free trade and investment agreements.
However, such agreements severely restricted their
ability to apply the accompanying macroeconomic
and industrial policies that were needed to make
this integration conducive to development (TDR
2007). In other words, there seemed to be a trade­
off between market access and policy space. With
the crisis and the subsequent loss of dynamism in
developed country markets, the gains from market
access are more uncertain. Thus, the terms of this
trade­off may have changed: if those markets have
entered into a prolonged period of slow growth, the
export­led strategy directed to them is not viable.
Therefore, there is a need for a more balanced
approach in development strategies, giving a larger
role to domestic and regional markets and, more
generally, to South­South trade.

Some factors of such a reorientation on the
demand side are already visible. As mentioned above,

the composition of global trade is changing, with
a larger participation of South­South trade, which
exceeded 26 per cent of total trade in 2013, compared
to only 11 per cent in 1995. The rapid expansion of
very large countries, and particularly China, India and
Indonesia, has modified the trade geography, as well
as its composition. Strong GDP growth associated
with rapid urbanization and industrialization lead
to an expanding demand for commodities. China
alone has deeply transformed these markets in just
a decade (chart 3).

Given the size already attained by the Chinese
economy, it is likely to continue playing a key role
in global commodity demand in the foreseeable
future, even if it grows at slower rates than before
the crisis. Between 2007 and 2013, China’s GDP in
current dollars increased from $3.5 to $9.6 trillion.
A more moderate growth rate of 11.5 per cent in cur­
rent dollars (and 7.6 per cent at constant prices) in
2013 represented a larger increase in global demand

Chart 3

(Share in global consumption in per cent)

Source: UNCTAD secretariat calculations, based on World Bureau of Metal Statistics Yearbook 2013; BP, Statistical Review of World
Energy 2013; and United States Department of Agriculture (USDA), Production, Supply and Distribution online database.

Copper 2002 Soybeans 2002 Oil 2002

Copper 2012 Soybeans 2012 Oil 2012

Developed countries China Other

17Rethinking Development Strategies after the Global Financial Crisis

($960 billion) than that generated in 2007 ($711 bil­
lion) with a growth rate of 25.5 per cent in current
dollars (and 14.2 per cent in real terms), according
to UNCTADstat data.

However, this does not guarantee that commod­
ity prices will keep growing indefinitely. In response
to the high prices, new supply capacities also came to
the fore, particularly in mining and hydrocarbons. It is
mainly developments on the supply side that explain
the substantial reduction of prices experienced in
2013–2014 (TDR 2014). In addition, in financialized
commodity markets, prices are affected by financial
operators that tend to exacerbate upward and down­
ward movements. Moreover, geopolitical factors
(which play a strong role in hydrocarbon markets)
can also influence commodity prices; therefore, these
prices are very difficult to forecast, especially in the
short run. Taking a long­term perspective, however, it
is important to analyse whether the present downward
movements evidence the declining phase of a “super
cycle”, which would bring back commodity prices
to the early­2000s levels. On the other hand, the new
conditions of demand may have pulled durably com­
modity prices to a higher level, even if they remain
subject to wide oscillations. This is illustrated by the
fact that even after the substantial reduction experi­
enced in 2013–2014, commodity prices remained
well above their 2002–2007 average (chart 4).

UNCTAD has leaned towards the second view
on the prospects for commodity prices. The size
already attained by the economies of China and
India, the evolving consumption pattern of their
population and their persistently large investment
needs are structural factors that provide the basis for
sustained demand for commodities in the coming
years (TDR 2013).3 Nonetheless, this should not lead
to complacency in commodity exporting countries,
as strong price volatility continuously shows. In
particular, they should strengthen their domestic pro­
duction linkages around these activities. They should
also use the revenues generated in export­oriented
primary industries to diversify their economies and
thus reduce their dependence on commodities. The
government’s role is key in this process, as it is the
actor that can capture a significant part of the rent
generated in primary production and apply it in social
and economic investment. Moreover, diversifying
production and generating production and incomes
linkages tends to develop domestic markets, which
are essential to establishing a sustained development

Chart 4


(Index numbers, 2002=100)

Source: UNCTAD secretariat calculations, based on UNCTAD,
Commodity Price Statistics Online database.

Note: Crude petroleum price is the average of Dubai/Brent/
West Texas Intermediate, equally weighted. Index
numbers are based on prices in current dollars, unless
otherwise specified.








All commodities
All commodities (in euros)
Minerals, ores and metals
Crude petroleum






Tropical beverages
Vegetable oilseeds and oils
Agricultural raw materials

2002 2004 2006 2008 2010 2012 2014 2015

2002 2004 2006 2008 2010 2012 2014 2015

18 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

This does not mean that there is an opposition
between domestic and external markets. Much on the
contrary, international trade cannot revive without a
significant recovery of domestic demand in a suf­
ficiently large number of countries. In fact, too many
countries seeking to grow through net exports and
gain competitiveness in ways that depress domestic
demand would necessarily lead to a fallacy of com­
position: weak domestic markets, if generalized, also
weaken global markets.

In addition to recognizing the importance of
domestic demand for a more balanced and sustainable
growth, it is necessary to consider the composition
of that demand, which in turn critically depends
on income distribution. Very unequal distribution
patterns concentrate consumption in high­income
sectors, with a high proportion of imported goods
and services and weak domestic production linkages.

Therefore, this kind of domestic demand has little
impact on domestic growth and employment, nega­
tively affects the trade balance and does not provide
the necessary support for industrialization (Prebisch,
1963; Pinto, 1970). On the contrary, a more equal
income distribution has a positive impact on total
domestic demand (as low­ and middle­income social
groups have a higher propensity to consume than
high­level income groups). It also alters its compo­
sition by increasing the share of goods (including
manufactures) and services that are more likely to
be supplied by domestic and regional producers.
Consequently, a better income distribution not only
supports consumption but also investment.

Governments can use several policy tools
for reducing income inequality and combine them
according to specific situations. They can support
job creation, in particular in the modern and formal
sector; moreover, they can also implement incomes
policies so that wages increase (at least) in line with
the average productivity growth in the economy
plus the targeted inflation rate. With this aim, they
can establish minimum wages, empower unions
with a nation­wide mandate, implement collective
bargaining mechanisms and provide general guid­
ance within these negotiations. However, in many
developing countries (particularly in Africa and
Asia), a large part of workers are self­employed or
employed in the informal sector and thus they do
not benefit from wage policies (chart 5). Therefore,
specific measures aimed at increasing the income of
small peasants (through changes in their production
and commercialization schemes) are also needed.
Public policies for income redistribution also need
to be developed, through progressive taxation and
social transfers. Recent improvements in income
distribution in Latin America largely resulted from
a larger redistributive role of the State (TDR 2012).

Giving a larger place to domestic and regional
demand (especially to low­ and middle­income
groups) is not only important for providing a stronger
and more reliable source of growth, but more impor­
tantly because it leads to a more inclusive kind of

Chart 5


(Per cent)

Source: UNCTAD secretariat calculations, based on ILO
Laborsta database; and national official publications.

Note: Own account workers include contributing family














Africa Latin
and the



Employers Employees
Own account workers Others and not classifiable

19Rethinking Development Strategies after the Global Financial Crisis

A. Rediscovering industrial policies

Strengthening domestic demand, and par­
ticularly that of the low­ and middle­income social
groups, is a necessary yet not a sufficient condition
for economic development. Inadequate production
capacities for responding to rising demand and a
limited possibility of financing increasing imports
with exports may lead to balance of payments
restrictions. As discussed above, the prospects for
expanding exports mainly depend on expanding
domestic demand in a large number of countries.
The involvement of large economies is particularly
relevant. In this sense, current policies aimed at
reorienting the structure of demand in China towards
domestic markets and consumption can help to boost
global demand. Indeed, a number of countries are
incorporating large parts of their population into
a middle class. Demand in this group is not only
increasing in volume, but also diversifying in com­
position, providing new opportunities to domestic
and foreign producers (see TDR 2013, chapter II).

It is also essential that developing countries
expand and adapt their production capacities to
respond to the new demand pattern, although such
adjustments would not take place spontaneously. In
order to increase investment, firms not only need to
have good demand prospects, but also supportive
macroeconomic and industrial policies, basic infra­
structure and long­term finance.

Industrial policies were sidelined for many
years, during which the main strategy involved
liberalizing trade and capital flows (see Robert
Wade’s contribution in this volume). The only
active policies frequently used were providing
incentives and advantages to TNCs. It was expected
that through these means the country would expand
its commodity exports or entry into international
production networks (depending on their static
comparative advantages) and engage in export­led
growth. Since industrial policies no longer seemed
relevant, losing policy space through World Trade
Organization (WTO) disciplines and even more by
signing Bilateral Investment Treaties and Regional
Trade Agreements with developed countries (mostly
in the 1990s) seemed a low price to pay compared to
the promise of larger market access and FDI inflows.
However, subsequent experience has shown that even

in export­led growth schemes, public policies were
essential to avoid the country remaining locked into
low­value added activities or seeing their extractive
industries becoming enclaves with barely any domes­
tic productive linkage and little income (including
taxes and royalties) distributed within the country.

Since the beginning of the financial crisis, many
countries, both developed and developing, have
acknowledged the importance of industrial policy
to sustain or expand their manufacturing sectors and
firms. Both the United States and the European Union
launched economic packages aimed at smoothing
the impact of the crisis, particularly on their manu­
facturing sectors. With a longer­term perspective,
the American Recovery and Reinvestment Act of
2009 allocated an $800 billion package to favour the
structural adjustment of the manufacturing sector,
the repatriation of offshore manufacturing and the
development of clean energies. Furthermore, the
Government of the United States has been supporting
strategic industries and the development of new tech­
nologies by funding very risky research and creating
innovation networks. The European Union seeks to
support research and development, innovation and
competitiveness in the context of the Lisbon Strategy
(adopted in 2000) and the Horizon 2020 Programme
(adopted in 2010) (see TDR 2014: 93–96).

With the Uruguay Round Agreements in 1995,
developing countries have at least partly lost some
of the tools that several East Asian countries used for
their rapid industrialization. Indeed, they now face
restrictions in the use of subsidies, they cannot set
export requirements or domestic content to foreign
firms and are not allowed to reverse engineering
and imitation for technology access.5 However, the
remaining room for manoeuvre is not negligible.
WTO members can use tariff policy when there is a
gap between bound and applied tariffs and modulate
it to support specific industries. They may use certain
flexibilities through export credits or environment­
related subsidies, compulsory licensing and parallel
imports and sector­specific entry conditions on FDI
(see TDR 2014: ix and 84–86). They can also offer
tax incentives, provide long­term credit at moderate
interest rates and use government procurement to
support local providers. Much of these remaining
flexibilities may disappear if developing countries
accept the terms of Free Trade Agreements or

III. The need for policy space4

20 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

Bilateral Investment Treaties that contain more strin­
gent provisions than those included in the multilateral
regime (“WTO­plus”) or go beyond the multilateral
agreements (“WTO­extra” provisions). When
considering the signature of those new agreements,
developing countries should carefully consider their
costs in terms of the loss of policy space (see TDR
2014: 86–89. See also Mayer, 2008).

Any process of structural change is normally
associated with “creative destruction”. Industrial
and macroeconomic policies should aim at ensuring
that creation prevails over destruction. This was not
the case with neoliberal reforms that took place in
many countries of Latin America in the 1980s and
1990s. Growth and employment were greatly affected
because rapid and unilateral opening to trade and
capital movements, regressive income distribution
and dismantling of the developmental State strongly
hit the tradable sectors, particularly those dependent
on domestic markets. The destruction of capital and
human qualification in the affected sectors was not
compensated by expected improvements in other sec­
tors. This was partly because these losses on both the
demand and supply side created a downward spiral
that depressed investment, despite the availability
of foreign capital. Furthermore, openness to capital
movements led to an appreciation of domestic curren­
cies (which undermined exports from the supposedly
competitive sectors), generated debt overhang and
boom­and­bust episodes and led to severe financial
crises (Calcagno, 2008). To be successful, structural
change must be driven by the expansion of new sec­
tors, whereby the decline of other sectors (in relative
or absolute terms) should be the result of that expan­
sion, and not the other way around.

B. Foreign capital flows and domestic
sources of finance

The global financial crisis evidenced the
flaws and risks entailed by a financial globalization
characterized by huge private capital movements
and large foreign­held capital stock without proper
international or national financial governance. In this
framework, access to abundant international finance,
which could have been a blessing for many devel­
oping countries by easing their balance of payment
restriction, became in many cases a problem.

The main issue is that, more often than not, the
amount, use and timing of predominantly private

capital movements do not respond to developing
countries’ needs. Capital flows tend to follow a
global financial cycle, whereby “push factors” in
the developed economies where the main suppliers
of international credit are based have more influence
than country­specific “pull factors” (i.e. countries’
demand for credit; see Akyüz, 2012; Rey, 2013).
Indeed, almost all of the major “waves” of capital
inflows received by developing countries since the
late­1970s have been triggered by expansionary
monetary policies in developed countries. They were
amplified by the leverage cycles of global banks
(chart 6).

The volume of such inflows is frequently too
large for relatively small economies (Haldane,
2011). Much of it is channelled by the domestic
financial system to consumption, real estate and
financial assets, rather than productive equipment
and machinery. Consequently, rather than spurring
investment and growth, they have frequently gener­
ated macroeconomic instability, distorted prices and
created trade imbalances and credit bubbles. When
economic policies changed in developed countries
or any event affected market confidence, a “sudden
stop” or reversal of capital flows triggered financial
crises. Therefore, it is little wonder that empiri­
cal studies have generally failed to find a positive
correlation between openness to capital flows and
development (see for instance Bhagwati, 1998;
Prasad et al., 2003; Prasad et al., 2007; Jeanne et al.,
2012; TDR 2014, chapter VI).

Development strategies should prevent or at
least reduce the macroeconomic instability and
economic fragility caused by international capital
movements. It is increasingly accepted that as long as
multilateral regulation mechanisms are not in place,
governments have to resort to capital management
measures, including capital controls (TDR 2011;
IMF, 2012). Managing the volume of capital inflows
and outflows is essential for prudential reasons, to
avoid financial fragility and conduct macroeconomic
policies. Similarly important is the regulation of their
composition and use (e.g. long­term credits for invest­
ment projects vs. short­term flows for consumption
or speculation). A cautious and selective approach
towards cross­border capital flows would reduce the
vulnerability of developing and transition economies
to external financial shocks, as well as channelling
foreign capital to development­enhancing purposes
(TDR 2013, chapter III).

21Rethinking Development Strategies after the Global Financial Crisis

The management of capital flows should be seen
as a way to make them a complement to domestic
sources of investment. Indeed, domestic sources are
quantitatively the most important for investment
financing, whereby firms’ retained profits6 over­
whelmingly constitute the main source of finance
for investment, followed by bank credit (chart 7).
Economic policies should aim at strengthening the
profit­investment nexus and apply active credit

policies to increase real investment. This would
be more effective in promoting investment than
seeking to increase domestic and foreign savings
through higher interest rates and capital inflows de­
regulation. Furthermore, the usual policy tools aiming
at increasing savings (e.g. increasing real interest
rates, adjusting fiscal spending and increasing income
inequality) may actually discourage investment, as
they tend to reduce expected demand and profits. If

Chart 6


Source: UNCTAD secretariat calculations, based on Institute of International Finance, Capital Flows database; and UNCTADstat.

Chart 7

(Per cent)

Source: UNCTAD secretariat calculations, based on World Bank, Enterprise Survey database.
Note: Developed Europe comprises Germany, Greece, Ireland, Israel, Portugal and Spain. Emerging Europe comprises Bulgaria,

Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia.

- 200






1 000

1 200

1 400

1978 1984 1990 1996 2002 2008 2014

A. Billions of current dollars

Net private inflows Net private inflows, excl. equity outflows

- 1

1978 1984 1990 1996 2002 2008 2014

B. As a percentage of GDP













All countries Developed


Africa Latin America
and the





Equity or stock sales finance

Trade credit

Bank finance

Internal finance

22 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

that is the case, they would be self­defeating since
lower investment would lead to lower growth and
income generation, and thus lower savings.7

C. Fiscal space

The global crisis provided new evidence
concerning the importance of the State’s role in the
economy. Even in the neoliberal view, it was rec­
ognized that public action was essential to avoid a
complete financial implosion and a deeper economic
contraction. Moreover, it was acknowledged that
there was a need for a greater participation of the
State in the economy on a more permanent basis. In
particular, there was certain agreement on the need
for improving public supervision and regulation of
the financial system. In some countries, incomes
policies (including social transfers and employment
programmes) for supporting domestic demand and
improving low revenues gained wide acceptance.
Furthermore – as mentioned above – an increasing
number of countries are implementing industrial poli­
cies and expanding the public provision of essential

Fiscal space is an essential aspect of the policy
space needed by the developmental State (see TDR
2014, chapter VII). Even if governments are allowed
to conduct some development policies within the
multilateral, regional or bilateral frameworks, they
still need to finance them. To that end, strengthening
public domestic revenues is key, given that they are
more sustainable in the long run than relying on aid
or debt, as well as being less subject to restrictions
and conditions that hamper policy space.

Public revenues as a percentage of GDP nor­
mally increase during the development processes.
On the one hand, higher public revenues reflect the
expansion of taxable income, wealth and transac­
tions as economies progress and the informal sector
squeezes. On the other hand, they can cover rising
demands in terms of social services, public invest­
ment and transfers. The specific ways in which
economies raise taxes and other public revenues
critically depend upon country characteristics and
political choices.

However, the globalized economy poses serious
challenges to increasing tax revenues, as it prompts
tax competition among countries (a “race to the

bottom”, mainly on direct taxation) to attract for­
eign capital. This competition has been particularly
damaging in mining and hydrocarbons: an estimate
for a sample of resource­rich developing countries
shows that governments only captured about 17–34
per cent of the rents generated in extractive industries
dominated by private firms between 2004 and 2012.
This share increased to 64–87 per cent when a public
firm had a dominant role in the activity.8

Finance­driven globalization has also seen
the development of a dense network of tax havens,
offshore financial centres and secret jurisdictions
that host them. They provide various means for tax
avoidance to the main potential taxpayers, includ­
ing internationalized firms and wealthy households.
While the magnitude of tax leakages is difficult to
assess, all estimations agree that they are huge (see
TDR 2014: 175–176).

For instance, Henry (2012) calculated that
rich households held between $21 and $32 trillion
in tax havens in 2010. A conservative calculation
of the resulting loss of public revenues amounts to
$190−$290 billion per year, of which $66−$84 billion
is lost from developing countries.9 As for corporates,
their main vehicle for tax avoidance or evasion and
capital flight from developing countries is the misuse
of “transfer pricing” (i.e. when international firms
price the goods and services provided to different
parts of their business to create profit­loss profiles that
minimize tax payments). By this means, developing
countries may be losing over $160 billion annually
(Christian Aid, 2008).

These examples suggest there are significant
potential gains from seriously checking tax avoidance
mechanisms and reversing the “race to the bottom”
behaviour in tax matters, which only benefits some
TNCs. Those gains would not only be important
from an economic perspective, but also by introduc­
ing some fairness in the distribution of the costs of
the crisis. Furthermore, this would represent a true
structural change, as these mechanisms allowing for
tax leakages are part of modern business practices and
are integrated into the trade and financial systems of
many developed economies.

Therefore, the first condition to end these
practices is to have the political will to place limits
upon the globalized financial system, stemming “tax
optimization” strategies by TNCs, reducing inequali­
ties and strengthening governments’ fiscal space.

23Rethinking Development Strategies after the Global Financial Crisis

This is an ambitious programme that would address
the roots of the “big crisis”, as well as contributing

to generate social and political support for the new
development strategy.

This chapter argues that the global financial
crisis has been a “big crisis”, in the sense that it
was not just a temporary disruption that could be
reabsorbed without any fundamental change in the
economic and social framework. Indeed, its resolu­
tion would require a number of structural reforms to
address a number of fundamental flaws in the world
economy. Such reforms cannot result from market
mechanisms; rather, they need to be implemented
through a political process.

Many observers would agree that structural
reforms are needed; however, the content of such
reforms critically depends upon the perceived causes
of the crisis. The view conveyed in this chapter is
that the crisis resulted from a number of long­term
trends that gained momentum since the mid­1970s
and early­1980s. The most important were the domi­
nance of the increasingly unregulated financial sector
over the real economy, the State’s diminishing role in
the economy and the increasing income inequality.
Based upon a different understanding of the causes
and nature of the crisis, many of the proposed or
on­going reforms – mainly in developed countries

– are either too timid in addressing some factors of
the crisis (e.g. insufficient financial re­regulation)
or they actually worsen its very causes, by further
weakening the role of the State in the economy or
increasing income inequality.

Developing countries need to adapt their devel­
opment strategies to the new, less conducive, inter­
national conditions. This would not only require
applying supportive macroeconomic policies, but
more generally reinstating a developmental state
and enlarging its policy space. Public action should
sustain domestic demand through incomes policies
and expand the production capacities, particularly
through public investment and industrial policies.
Reorienting the financial system and mobilizing
resources to finance development policies are chal­
lenging tasks, whose success critically depends upon
the willingness and ability to tame the globalized
financial system and strengthen governments’ fiscal
space. This ambitious programme would address
the roots of the “big crisis” and contribute to gener­
ating social and political support for the new devel­
opment strategy.

IV. Concluding remarks

24 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

1 Financial assets include equities, bonds issued by
the public and private sectors, and loans. See Lund
et al. (2013).

2 The group “transition economies” has significantly
evolved with the incorporation of several former
socialist countries into the European Union, which
were thus included in the “developed countries”
group. For consistency, countries in this group are
those still considered in transition by 2014; see the
complete list in table 2.

3 In China, it is expected that 400 million persons
will move from rural to urban areas in the following
15 to 20 years, which mean building 200 medium­
size cities and the corresponding infrastructure. See
Aglietta (2012).

4 This section largely draws on TDR 2014, chapters V,
VI and VII, whose main authors are Jörg Mayer;
Alfredo Calcagno and Ricardo Gottschalk; and
Diana Barrowclaugh, Pilar Fajarnés and Nicolas
Maystre, respectively.

5 These restrictions are established in the Agreement
on Subsidies and Countervailing Measures (SCM),

the Agreement of Trade­related Investment Measures
(TRIMs) and the Agreement on Trade­related aspects
of Intellectual Property Rights (TRIPS), respectively.

6 Retained profits include reinvested profits by TNCs,
which is a component of FDI flows.

7 This issue refers to the fundamental debate between
the neoclassical view that sees savings as a precondi­
tion for investment and the Keynesian/Schumpeterian
view, which sustains that investment can be financed
by banking credit (created ex-nihilo) and savings is
an endogenous variable resulting from the income
generated in the economic process. See TDR 2008,
chapters III and IV; Dullien, 2009.

8 The study comprised Angola, Colombia, Ecuador
and the Bolivarian Republic of Venezuela for oil,
and Chile, Ghana, Mali, Peru, the United Republic
of Tanzania and Zambia for mining. See TDR 2014,
chapter VII, table 7.1.

9 In Henry’s calculation, this would result from a
30 per cent income tax paid over a hypothetical
return of only 3 per cent per year.


Aglietta M (2012). Chine: Horizon 2030. In: Centre
d’�tudes Prospectives et d’Information Internatio­
nales, eds. L’Économie mondiale 2013.Paris, La
Découverte: 35–54.

Akyüz Y (2012). The boom in capital flows to developing
countries: Will it go bust again? Ekonomi-tek, 1:

Bernanke B (2005). The Global Saving Glut and the U.S.
Current Account Deficit. Sandrige Lecture, Virginia
Association of Economists, 10 March 2005.

Bhagwati J (1998). The capital myth: The difference
between the trade in widgets and dollars. Foreign
Affairs, 77(3): 7–12.

Boyer R (1979). La crise actuelle: une mise en perspective
historique. Quelques réflexions à partir d’une analyse
du capitalisme français en longue période. Critiques
de l’Économie Politique, no. 7–8: 3–113.

Calcagno AF (2008). Reformas estructurales y modali­
dades de desarrollo en América Latina. In: Déniz
J, de León O and Palazuelos A, eds. Realidades
y desafíos del desarrollo económico de América
Latina. Madrid, Los Libros de la Catarata.

Christian Aid (2008). Death and taxes: the true toll of tax
dodging. London; available at: http://www.christia­
naid. org.uk/images/deathandtaxes.pdf.

Dullien S (2009). Central banking, financial institu­
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27Seven Strategies for Development in Comparison

Jan Priewe

In our understanding, a development strategy
is an economic conception that defines the priority
goals, coherently explains how set goals can be
reached, identifies the policy tools and explores
trade­offs and the time frame. It is a kind of vision
with normative goals, balanced against what is fea­
sible. Such a strategy does not necessarily have to
be explicit; rather, it can be implicit in the mind­set
of policymakers or a tacit agenda of governments.
Moreover, it does not need to be comprehensive,
but it must address key issues for the medium to
long term. If such a vision does not exist, it is likely
that the policymakers in charge, including external
advisers, will simply follow the historic track, with a
focus on short­term issues barely related to long­term

goals. Pragmatism without a compass might prevail
with rather low ambitions.

A number of “guidelines” or blueprints for
development are offered in academic economics and
the political economy of development, which we will
discuss and compare in this essay. They are often
general, i.e. not country­specific, recommendations
for economic development that can to some extent be
adapted to the specific needs of a country. After the
demise of guidelines of the one-size-fits-all type, a
backlash occurred as if anything would go and noth­
ing can be said in general. I will argue here that this
is not the case; rather, there are clear success stories
and clear stories of failure or stagnation.

* A longer version of this essay is available online with more empirical details, see Priewe (2015).


Four traditional mainstream development strategies are discussed (Washington Consensus, plain
neo-liberalism, “good governance” and Millennium Development Goals and two long-debated
key strategic issues are reconsidered (inward or outward development, industrialization or growth
with predominant primary goods exports) in this comparison, adding a heterodox approach with
a focus on macroeconomic policies and structural change. The rough empirical comparison finds
that countries and areas with strong emphasis on macroeconomic policies, mainly in Asia, have
performed unambiguously better than the mainstream approaches since 1980. From successful
Asian countries, it can be learnt that a long-run continuous growth and development performance
with more resilience against adverse shocks is key. Almost all larger middle-income countries have
embarked on industrialization, thereby strategies based upon primary commodities or high current
account deficits are unlikely to be successful in the long run. A stronger role of a package of six
macroeconomic policies is advised for the larger economies; for instance, those 21 countries with a
GDP of more than 100 billion in constant 2005 dollars, comprising around 87 per cent of the total
GDP and 72 per cent of the population in the South in 2013.

What is a strategy for development and why do we need one?

28 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

After many of the old ideas for quick develop­
ment success after World War II had failed, such
as the “Big Push” or heavy aid­led development
based upon “saving gap” concepts, or grand­scale
import substitution policies as practised in many
countries of the South until the 1980s, a transition to
more simple recipe­like recommendations emerged.
The (in)famous “Washington Consensus”, often
misunderstood as plain liberalization and market
fundamentalism, was promulgated in 1989, before
later being complemented by cooking recipes for
“good institutions” and “good governance”. The
plea for financial globalization added an important
part to the comprehensive liberalization agenda,
concentrating on free trade, free capital flows, the
privatization of State­owned enterprises and a small

State in contrast to a developmental State (which
is not necessarily large). Seemingly a backlash, the
sudden about­face to the “Millennium Development
Goals” (MDGs) was in part only a complement to
the continuing neo­liberalism.

These concepts will be recapitulated in section I.
The debates on inward or outward development
will also be picked up, while the overdue debate on
industrialization versus commodity­led development
will be addressed. In section II, a macroeconomic
approach to development will be sketched, put for­
ward by ideas stemming from adapted Keynesianism
and dependencia theories. Section III reviews the
stylized facts of developmental success or failure
since 1980, before section IV concludes.

I. Traditional strategic concepts

A. Washington Consensus

As is well­known, John Williamson summarized
in 1989 (Williamson, 1990) what he believed to be
the consensus of four Washington­based institutions
regarding economic policies in Latin America at the
time: the State Department, the Treasury, the World
Bank and the International Monetary Fund (IMF).
Easily understandable, it was used as a set of ten com­
mandments that were more or less applicable to the
rest of the world, including the collapsing countries
of the former Soviet Union and in Eastern Europe.
It was a much­needed makeshift in the absence of
sound and coherent strategies of western nations for
development. The ten guidelines do not truly sound
like a full­fledged neoliberal agenda. In hindsight,
many postulates seem innocuous and not particularly
controversial, yet sufficiently ambiguous for a broad
range of interpretations:

• Reduction of budget deficits to a non­inflationary

• Redirection of public expenditure to areas such
as education, infrastructure, etc. As tax increases
are ruled out, lower marginal tax rates and a
broadened tax base are advised, similar to what
was practised in the United States at the time.

• Domestic financial liberalization towards “mar­
ket­determined interest rates”, with no mention

that interest rates are largely determined by
central banks, and hence tight monetary policy
might be the key idea in disguise. Moreover,
there is no mention that domestically liberalized
interest rates likely also trigger cross­border
liberalization of capital flows. Again, much
discretion for interpretation remains.

• Sufficiently competitive exchange rates that
induce rapid growth in non­traditional exports.
In plain text, avoiding the over­valuation of
exchange rates is demanded, which makes
industrialization difficult. Alternatively, it could
be read as currency under­valuation, as well
as a plea for market­determined flexible rates.
Regarding trade, quantitative restrictions should
be lifted and tariff reductions be instituted.

• The privatization of State­owned enterprises.
One of the few unequivocal quests, similar
to the better protection of property rights and
the liberalization of foreign direct investment

• More competition for start­ups and other

In hindsight, it is stunning how narrow the
range of the consensus was and how much ambigu­
ity can be found in the wording. Williamson, not a
plain neoliberal, used a wording that left sufficient

29Seven Strategies for Development in Comparison

room for interpretation and hence risked strong
misunderstanding. Carefully read, one cannot see
a clear plea for free trade and free international
capital flows or a minimalist state. It is interesting
to see what is not addressed, either due to a missing
consensus or lacking concern: import substitution
or export promotion, poverty reduction or any kind
of social spending, the choice of the exchange rate
regime, external debt and the balance of payments,
let alone environmental issues. Furthermore, time
and sequencing are ignored; accordingly, the agenda
can be seen as a shock therapy or Chinese­type of
gradualism. From the viewpoint of neoclassical or
endogenous growth theories, almost nothing is said
about technological upgrading, while from a struc­
turalist view structural change and industrial policy
are unaddressed, let alone foreign aid. In retrospect,
the most stunning characteristic of the “Washington
Consensus” seems to be the simplicity and naivety, its
selectivity and blindness vis­à­vis so many obvious
economic problems.

B. Plain neo-liberalism

The ambiguity of the Washington Consensus
was often used to interpret it as plain neo­liberalism.
The imperatives would then be to free all goods,
labour and financial markets as much as possible
from regulations, reducing the size of governments,
avoiding counter­cyclical fiscal policies, giving
priority to price stability over growth and employ­
ment objectives and keeping taxation low. The legal
framework of economic systems has to be geared
to securing property rights, including privatising
public enterprises and promoting market­friendly

The implicit rationale of the neoliberal phi­
losophy is the notion that developing countries
suffer from manifold market distortions, similar to
transition economies, whereby the unleashing of the
invisible hands of markets could drive growth and
development. From this perspective, the main drivers
for development are seen in free trade and free cross­
border financial flows, supported by institutional
reforms towards what is considered as “good govern­
ance”. Trade and capital flows follow the comparative
advantage theory in the Heckscher­Ohlin form, where

developing countries can exploit their cheap labour
and natural resources while rich countries provide
capital, technology and knowledge. Openness for
foreign direct investment and all other capital flows
is a key ingredient of this conception (e.g. Mishkin,
2006). The classical view that capital accumulation
and related technical progress are engines of growth
is out of focus, as well as the Keynesian idea of active
macroeconomic management. The notion of public
goods, and particularly education, training, research
and development, which are considered as key for
development by endogenous growth theories, do not
form the centrepiece of this concept. Nonetheless, this
philosophy is sufficiently vague and flexible to adjust
to special needs or combine it with other ingredients,
as long as it remains the backbone for a growth and
development strategy.

Some economists have pondered on the
sequencing of this strategy. John Williamson and
others have advised careful gradualism, with steps
to freer trade such as dismantling quantitative
restrictions as the first step and liberalized capital
accounts for short­term financial flows as the last
stage (Williamson, 1997). Others have called for
quick sequencing or big­bang reforms to pressure
countries into overcoming resistance against reforms
(e.g. Ishii et al., 2002).

Using the Fraser Economic Freedom Index
(FEFI, 2014), a composite indicator of the degree of
economic liberalization for a comparison of the FEFI
of 71 low­ and middle­income countries (LMICs)
with the ranking of per capita gross domestic product
(GDP) shows no clear linkage. The FEFI integrates
more than 50 single indicators concerning the
regulation of markets, protection of property rights,
low inflation, free trade, good governance and small
government, providing a grading from zero to ten
(high liberalization). The change of the FEFI over
the period 1990–2011 does not correlate with per
capita GDP growth, nor does the FEFI level in 2011
correlate with the level of per capita GDP (charts 1
and 2). Advanced countries generally have a higher
score in the FEFI compared with less developed
countries, similar to often­used corruption indices or
“good governance” indices. However, growth rates
of GDP do not correlate with levels or changes of
these indicators.

30 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

C. Good governance

Many mainstream economists argued that the
weak nexus between the liberalization of markets and
development could be rooted in poor “institutions”.
The latter is often interpreted as “good governance”,
measured in six dimensions in the CPIA indicators
of the World Bank (“Country Policy and Institutional
Assessment“). These indicators were often criticized
(being opaque, biased, without conceptual base,
one­size­fits­all approach, etc.). In particular, the
dimensions of “regulatory quality” and “govern­
ment effectiveness” with an emphasis on “sound
policies” are critical and biased (e.g. Langbein and
Knack, 2010; Kaufmann et al., 2007; and Wade in
this volume).

What is more important is that policies are left
out in favour of “governance” or simple neoliberal
policies often return through the backdoor. The
linkage between good governance in this sense and
economic growth and development is weak. As with
the FEFI, high income levels correlate with high
CPIA scores across countries, although the level of
CPIA scores do not correlate with per capita GDP
growth and income growth does not significantly
correlate with score changes. In most LMICs, the
CPIA scores change very slowly, even when growth
and structural change are booming. It seems that
good governance, whatever it is in essence, is quite
diverse and more a long­term result of development
rather than a precondition. Many of the fast growing
emerging economies are not winners of high CPIA
score medals. It took developed countries more than
a century to climb up to the score that they now have
(e.g. Chang 2003).

Some much debated institutionalists like
Acemoglu and Robinson (2012) believe, following
Douglas North, that the fundamental causes of weak
or strong development are rooted in “economic
institutions”, while the proximate causes lie in the
determinants of growth, as analysed in standard
growth theories. It is unclear what development­
friendly economic institutions really are, nor is it
justified to exclude policies from the fundamental
determinants of growth and development. An often­
used broad understanding of institutions may leave
the determinants of development in the darkness
of black boxes. Besides this, basic, long­standing
entrenched institutions are hard to change.

Chart 1

ECONOMIES, 1990–2011

Source: Author's calculations, based on World Bank, World
Development Indicators (WDI) database, and Fraser
Institute (2014), Economic Freedom of the World 2014
Annual Report.

Note: Selected economies refer to the 71 countries classified
by the World Bank as developing for the year 1990 and
with data available in the WDI database. All data refer
to the changes between 1990 and 2011.

Chart 2


Source: Author's calculations, based on World Bank, World
Development Indicators (WDI) database; and Fraser
Institute (2014), Economic Freedom of the World 2014
Annual Report.

Note: Selected economies refer to the 71 countries classified
by the World Bank as developing for the year 1990 and
with data available in the WDI database. All data refer
to the levels of 2011, in constant 2005 dollars.

y = 0.0088x + 1.4696
R² = 0.023









-40 -20 0 20 40 60 80 100 120 140 160




l g



f G




Relative change in economic freedom

y = 1 300.7x-5 362
R² = 0.09

-2 000


2 000

4 000

6 000

8 000

10 000

12 000

14 000

16 000

3 4 5 6 7 8 9

Economic freedom





31Seven Strategies for Development in Comparison

D. Millennium Development Goals

The United Nations turning to the MDGs
in 2000 signified a paradigm shift in the policies of
supranational institutions. Quantitative goals were
set in great detail, with a fixed timeframe, identical
for all developing countries and in conjunction
with the support of developed countries, whereby
income distribution was addressed in part for the
first time. However, the MDGs, translated in poverty
reduction strategy papers as medium­term national
strategies, were confined to goal­setting, although
they missed economic strategies, apart from the
verbal commitment of donor countries to markedly
increase official development aid. Perhaps strategies
had been deliberately left out by the initiators of the
MDGs to find global consent and delegate the choice
of strategy to the respective country. Ironically, the
usual set of policy advice as shown above was not
really changed, with the exception of the IMF’s
initiative to include capital flow management (alias
capital controls) into the official toolbox of the Fund
from 2010. Hence, the MDGs can be considered
as a social policy complement of the mainstream
roadmap for broad­based liberalization of markets
in the “South”. While setting proper goals is an
important part of defining development strategies,
the MDGs miss a production view on development
so that the eradication of absolute poverty and the
related other goals can be achieved sustainably and

eventually self­reliantly. Development has often
been interpreted and reduced to simply overcoming
poverty, predominantly understood as absolute
poverty, as well as reaching the other goals to enable
“capabilities” (Sen, 2001) and open opportunities
for individual freedom for all citizens. Accordingly,
the MDGs can be understood as a reduced substitute
for genuine, broader development as perceived in
traditional development discourses (e.g. Chang,
2010). From this perspective, the advent of the
MDGs was a reduction of developmental ambitions
in disguise.

Nevertheless, the reduction of absolute poverty
advanced towards a key benchmark for development.
As shown in table 1, the results thus far are mixed.
Global poverty, relative to the population, was reduced
remarkably, and other MDGs could be approached
similarly. The share of absolute poverty (conceived
as $1.25 in purchasing power parity (PPP) per day in
2005 prices) fell from 43 per cent of the population in
the “South” in 1990 to 21 per cent in 2010, and from
65 per cent to 41 per cent when the margin for poverty
is taken as $2 per day. If East Asia is excluded, the
absolute number of poor was slightly higher in 2010
than 1990 and increased considerably when using the
$2 margin, mainly due to strong population growth in
Africa and India. Of course, it is questionable whether
the progress made was really driven by MDG­related
policies or owing to other factors.

Table 1

(Per cent of the population, unless otherwise specified)

Below $1.25 a day Below $2 a day

1990 1999 2010 1990 1999 2010

East Asia and the Pacific 56.2 35.6 12.5 81.0 61.7 29.7
Latin America and the Caribbean 12.2 11.9 5.5 22.4 22.0 10.4
Middle East and North Africa 5.8 5.0 2.4 23.5 22.0 12.0
Sub-Saharan Africa 56.5 57.9 48.5 76.0 77.4 69.9
South Asia 53.8 45.1 31.0 83.6 77.8 66.7
All developing countries 43.1 34.1 20.6 64.6 57.4 40.7
All developing countries, excl. East Asia 34.8 33.2 25.0 54.3 54.9 46.6

Memo item:
All developing countries (in million) 1 782 1 642 1 153 2 674 2 767 2 276
All developing countries, excl East Asia (in million) 882 1 004 908 1 378 1 659 1 692

Source: Author’s calculations, based on World Bank, World Development Indicators database.

32 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

E. Outward development and export-led

After the end of Latin American import sub­
stitution strategies, the debate concerning whether
import substitution or export orientation or inward or
outward development is the right strategy approached
an end, with outward orientation alias export promo­
tion seen as the winner. The enormous growth of
world trade, as well as the strong export orientation
of many successful East Asian countries, seemed to
endorse the defeat of the Latin American dependen­
cia theories. However, it was overlooked that many
Asian countries applied both import substitution
and export promotion, mostly first the former and
then the latter, but often concurrently (e.g. Bruton,
1998; Cypher 2014), with the Republic of Korea,
China and Viet Nam being cases in point. In China
and Viet Nam, particularly State­owned enterprises
or even joint ventures with multinational companies
defended domestic market shares, while foreign
funded enterprises and some domestic served the
world market (e.g. Amsden, 2001: 190). With tariff
and non­tariff barriers, the promotion of techno­
logical innovations and energy saving or domestic
energies, developed countries also attempted to
practice import substitution, or at least the defence
and overt or hidden protection of domestic suppli­
ers. Moreover, export promotion was extended into
outright neo­mercantilistic export­surplus oriented
growth in a number of countries, both developed and
developing, at times supported by under­valuation
of the currency and by targeting export promotion
with direct and indirect policies. The pressure to
achieve price competitiveness forced many develop­
ing countries to repress prices and wages and hence
domestic demand, which has contributed to large
current account imbalances. China and Germany,
and to a lesser extent Japan, were the main culprits,
while China turned to domestic demand­led growth
after the great financial crisis and strongly reduced
its current account surplus.

Regarding development strategies, the question
of import substitution versus export promotion was
posed incorrectly, given that neither are both mutually
exclusive nor does development depend on exports
regardless of what is exported or imported. Exports
of low­value commodities with a low income and
price elasticity of world demand and, conversely,
imports with high income elasticity and low price
elasticity contribute little to growth and develop­
ment. Terms of trade, income elasticity of demand

and technological sophistication of traded goods are
key parameters for the nexus of exports and GDP
growth. For instance, sub­Saharan Africa’s share in
world trade is marginal and remained so from 1990
to 2012, although its export to GDP ratio is similar to
East Asia, whose share in world exports grew almost
fourfold during this period, as can be seen in table 2.
However, Africa’s exports were mainly commodities,
while East Asia’s were mainly manufactured goods.
Moreover, South Asia, and predominantly India,
also has a tiny world market share and – like Latin
America – had a lower degree of trade openness than
sub­Saharan Africa during the entire 1990–2012

Even though import substitution is still relevant
and by no means outdated, economies of scale are
extremely important for exporting manufactured
goods. Besides a few huge domestic markets in large
economies, structural change towards manufacturing
compellingly requires exports. Increasing exports is
imperative for importing those goods and services
that are indispensable for technology upgrading if
a current account balance (or a contained deficit)
is envisaged. The feat of a successful development
strategy is to combine export promotion with import
substitution without jeopardising the balance of pay­
ment equilibrium and without restricting necessary
imports of sophisticated goods produced in advanced

Table 2


COUNTRIES , 1990–2012

Per cent of
world exports

Per cent of

1990 2012 1990 2012

East Asia and Pacific 3.7 14.2 20.3 33.5

Europe and
Central Asia 2.6 3.5 20.3 36.2

Latin America
and the Caribbean 3.8 5.0 17.3 23.7

South Asia 0.8 2.3 8.5 22.5

Sub-Saharan Africa 1.8 2.2 26.1 31.9

World 12.7 27.2 19.6 30.3

Source: World Bank, World Development Indicators database.
Note: Data only include low- and middle-income countries,

except for the world. Data for Middle East and North
Africa are not available.

33Seven Strategies for Development in Comparison

F. Structural change: Towards
industrialization or commodities
and services?

Orthodox theories on growth and development
do not care much for structural change and hence
sector­specific policies. Market forces determine
what is produced, whereby market­determined
optimal allocation of resources should be aligned
to static comparative advantage. This would guide
developing countries towards the production of com­
modities and developed ones to manufactures and
knowledge­intensive goods and services. Those who
believe that this might corroborate underdevelopment
will plea for policies for structural change towards
dynamic comparative advantages, overcoming the
confines of nature and the historic role of developing
countries as latecomers.

Amazingly, most mainstream concepts bypass
this issue. In East Asia, industrialization – under­
stood here as manufacturing, excluding mining and
construction – is strongly promoted by governments,
whereas in sub­Saharan Africa it has hardly started,
and in almost all Latin American countries value
added in manufacturing as a share of GDP is shrink­
ing after the high values achieved in the 1970s and
early­1980s. In India, as the core of South Asia, the
level reached by 1980 was maintained until the mid­
1990s and shrank gradually thereafter.1

Despite a trend of deindustrialization in many
developing countries, a quick look at the data shows
that almost all middle­income countries, except oil
exporters, have a higher share of manufacturing
value added than most Organisation for Economic
Co­operation and Development (OECD) high­
income countries, which have a level of 15.7 per cent
of GDP in 2010 (chart 3). In contrast to advanced
OECD countries, the structural change regarding
employment in middle­income countries has usu­
ally led directly from low­income agriculture, often
subsistence farming, to low­income services, often
petty trade and other petty services, with a small share
of the high­value service sector, which is prevalent
in OECD countries. With few exceptions, almost all
rapidly growing economies have de facto embarked
on industrialization. Therefore, calling developed
countries industrialized in contrast to developing
ones has long been outdated.

For a number of reasons, manufacturing has
been key for development in economic history, for

both now developed countries – only a handful of
them developed with primary goods rather than
industrialization, such as Canada, Australia and New
Zealand (e.g. Taft Morris and Adelman, 1989) – and
successful emerging economies after World War II.
Manufacturing used to be the epicentre of applied
technical progress in economic history: while inven­
tions may be made in the service sector, product and
process innovation pertain to mainly manufactured
goods, whereas primary merchandise largely stems

Chart 3

(Per cent of GDP)

Source: Author's calculations, based on World Bank, World
Development Indicators database.

Note: For comparison, the average of the high income OECD
economies is also reported.

0 10 20 30 40





United States
Rep. of Moldova



Venezuela, Boliv. Rep. of

South Africa

Russian Federation
High-income: OECD





Costa Rica
Viet Nam
Sri Lanka




Rep. of Korea


34 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

from nature­made resources, with technical progress
in extraction or land use generated in either the ser­
vice sector or manufacturing. Manufactured goods
are tradables with increasing value added, based
upon productive employment, while primary goods
involve – if profitably sold – rents. Strong demand
surges for primary goods, with supply constraints
due to natural scarcity or long gestation periods,
risk Dutch disease or even resource curse problems,
which hamper manufacturing. The extent to which
services can be rendered tradable is uncertain. For
most LMICs, service exports have not increased
above a ten percent share of total exports, with the
exception of India (see table 3). Future developments

may differ from history, but to date there is very little
evidence that services can substitute manufactured
exports on the road to economic development, apart
from small countries that can live from niches in the
world market.

The share of service exports has been on the rise
in recent decades, having reached 23.5 per cent of
all exports in high­income OECD countries, mainly
driven by the United States. A great portion of these
services pertains to either merchandise goods, such
as transportation, or high­end knowledge, such as
patents, trademarks or similar, where LMICs have a
competitive disadvantage.

Table 3

(Per cent of total group exports)

East Asia South Asia
Latin America and

the Caribbean

High income


Merchandise goods 89.2 68.2 88.0 83.0 77.7
of which:

Manufactured goods 73.7 45.1 45.6 21.4 55.4

Services 10.6 31.4 10.7 11.0 23.5
Errorsa 0.2 0.4 1.3 6.0 -1.2

Source: Author’s calculations, based on World Bank, World Development Indicators database.
a Data errors prevent that merchandise goods and services add to 100. All country groups, but the high-income OECD, only

include low- and middle-income countries.

II. Strategic concepts based on macroeconomic policies

In the strategic concepts sketched above, macro­
economic policies were only marginally mentioned.
In general, the belief prevails that “sound money” for
low inflation requires sovereign independent mon­
etary policy, independent from monetary policy in
advanced countries by having flexible exchange rate
regimes. Strong swings in exchange rates have to be
accepted. Since overly expansionary fiscal policy, and
particularly monetized budget deficits, is seen as the
main culprit for inflation, tight fiscal policy is advis­
able most of the time, since developing countries
generally suffer from greater inflationary pressures
than advanced economies. Free capital flows, espe­
cially for private equity flows, allow the financing of

current account deficits. Structural adjustments are
advised when the current account deficit becomes
too great and if the competitiveness of enterprises
is at risk due to overly high inflation or over­valued
exchange rates. Free capital flows sanction fiscal prof­
ligacy and bad governance and reward the economy
if the opposite prevails. Thus, the policy space for
potential misbehaviour of governments is narrowed
to the benefit of the country. Macroeconomic policy
of this kind, mostly restrictive and geared towards
priority for low inflation and a flexible exchange rate,
is considered quite relevant in this view, although the
long­run growth is determined by the private sector,
first and foremost by the ability to make profits and

35Seven Strategies for Development in Comparison

invest them profitably and innovatively to generate
technical progress in the sense of technology transfer
from more advanced countries. This is by and large
the standard application of neoclassical thinking.

Keynesian thinking, blended with structural­
ist ideas borne in Latin America in the tradition
of dependencia theories, believes that cyclical or
chronic shortage of aggregate demand can influence
medium­ to long­run growth. Abundant labour is
available and skills could be provided by concomitant
policies. Representative for this macroeconomic
view on development is Bresser­Pereira’s “New
Developmentalism” (e.g. Fundação Getulio Vargas,
2014; Bresser­Pereira, 2010) or similar macroeco­
nomic views on development in Priewe and Herr
(2005). Empirical evidence for the characteristics
of the best growth performers in comparison can
be found in the report of the Spence­Commission
(Commission on Growth and Development, 2008),
in line with the reasoning put forward here.

One of the main roots of underdevelopment is
the low ranking of the local currency in the global
currency hierarchy, led by the leading reserve cur­
rencies. Domestic money may not fulfil all of its
functions properly, and particularly not the store of
value and medium of credit function, while the rating
of the currency and the respective domestic financial
sector tends to be poor. Wealth owners have a higher
propensity to hold part of their wealth in other curren­
cies compared with advanced countries. By and large,
the preference to hold financial wealth in liquidity or
short­term assets is higher, which effectuates higher
interest rates, even if the central bank policy rates are
low. Poor collateral and risks of depreciation make
long­term loans impossible or very dear. Hence, the
virtuous cycle of money and credit creation, inducing
investment and employment, aggregate demand and
GDP growth, can be impeded. External credit in for­
eign currency can substitute weak domestic finance,
although it generates “original sin”, i.e. long­term
exchange rate risks that can paralyse the use of the
exchange rate to devalue if necessary for the balance
of payments; hence, a fear of depreciation arises.

Furthermore, countries that wish to catch­up
with advanced economies encounter balance­of­
payments constraints, as they tend to have a faster
growth of imports than exports (e.g. Thirlwall, 2011).
In principle, this predicament can be overcome by
a structural change of exports towards merchandise
that is more income and price elastic and hence more

competitive. However, this is a difficult and long
process of innovation. Devaluations of the local cur­
rency may be contractionary in the short to medium
term (see Krugman and Taylor, 1978; Blecker and
Razmi, 2008). Even worse, not only might devalua­
tions be difficult, but the currency might tend to be
appreciated by natural resource price booms (Dutch
disease) or similar capital inflow surges. As a result,
many developing countries struggle with balance­
of­payments constraints, which require containing
current account deficits by tight fiscal policies.

Achieving competitiveness of trade might sub­
sequently require reducing wages and other incomes
relative to productivity, although this can weaken
domestic demand and may drive people in partial
subsistence or a working poor status with normally
low productivity. Repressed wage increases and
high unemployment or under­employment in the
subsistence or informal sector, which are prevalent
features in many developing countries at all stages
of development, tend to keep domestic demand low.

Finally, in an open economy context, monetary,
fiscal and exchange rate policies are less efficient than
in most developed countries. The notion that expan­
sionary monetary policy can function efficiently
under flexible exchange rates, as stipulated by the
standard Mundell­Fleming model, obfuscates that
strong depreciation with massive capital outflows
might follow, triggering inflation and an increased
burden of external debt. Instead, the truth seems to
be that monetary policy in most developing countries
with an open capital account is strongly dependent
on the policy rates of central banks of the lead­
ing currency areas (e.g. Priewe, 2015); moreover,
specific country risk premiums have to be added
to the external benchmark rates. Furthermore, the
transmission of monetary policy to investment and
aggregate demand might be much looser than in
highly monetized advanced countries. Fiscal policy
is facing a smaller fiscal multiplier in small and very
open economies, as most developing economies are

While macroeconomic policies seem to be less
efficient and have no suitable substitute, develop­
ing countries tend to be more exposed to shocks.
Commodity prices are more volatile, as are real
exchange rates, and a lower degree of diversification
of the economies makes them susceptible to sector­
specific shocks. Last but not least, the push factors for
capital inflows and outflows, depending on the whims

36 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

of risk appetite of global wealth owners, face them
with boom­bust­cycles of external financial flows
(Rey, 2013). Uncertainties seem to be much greater
in developing countries compared to advanced ones,
let alone political instability, poor governance, etc.

While Keynes envisaged the necessity to stabi­
lize the fundamentally unstable advanced capitalist
economies, mainly with monetary, fiscal and exchange
rate polices, predominantly conducted by the cen­
tral banks and the treasuries, besides multilateral
governance, this need might be even more urgent in
developing economies.

In contrast to the problems and disadvantages
of developing countries in this regard, they are also
privileged in many aspects compared to developed
countries. The most important ones are the potential
access to advanced knowledge and technologies –
the “advantage of backwardness”, as Gerschenkron
(1962) christened it long ago. Furthermore, even the
salaries of people with equal skills as in developed
countries are much lower and hence reflect a com­
petitive edge, let alone unskilled workers. Revenues
from abundant natural resources can help, beyond the
shadows of Dutch disease, to kick­start productive
development and finance infrastructure and other
public goods, if used prudently.

The outcome of this brief analysis is that
macroeconomic policies do matter for the short and
long run, and hence for development strategies.
Adverse macroeconomic conditions, especially the
prices with macro impact like wages, interest and
profit rates, exchange rates, as well as taxes, tariffs,
fiscal deficits and public debt, depress growth and
can hardly be offset by the utmost business­friendly
policies as favoured by the neoliberal approaches to

The conclusion from this analysis is a package
of seven policies (e.g. Priewe and Herr, 2005):2

• Monetary and exchange rate policy: to enable
sovereign monetary policy geared to the needs
of the country, a managed exchange rate
regime with either permanent or occasional
use of capital flow controls might be necessary,
whereby the central bank should be committed
to low inflation, as well as supporting growth
with low real interest rates. This implies that
the inflation control has to use either a nomi­
nal wage anchor or an exchange rate anchor.

Occasional exchange rate adjustments must
not be excluded. Low inflation is necessary
for financial stability and contains unexpected
inflation and uncertainty. Overly high inflation
likely induces overshooting currency deprecia­
tions and possibly capital flight, whereby macro
uncertainty rises and triggers interest rate hikes.
A mild under­valuation of the real exchange rate
can support net exports, if embedded in a set
of other policies and multilaterally acceptable.

• Fiscal policy: some degree of counter­cyclical
fiscal policy, including the usage of automatic
stabilizers, would be conducive to support both
inflation control and growth. Nonetheless, debt
sustainability should be accomplished, predomi­
nantly with debt in local currency.

• Balance-of-payments management: the avoid­
ance of current account deficits and ever­
increasing net international debtor position is
necessary. This may require capital inflow and
outflow controls, or general import taxes, apart
from orderly devaluations. Mild exchange rate
under­valuation over a longer period can help
to promote exports.

• Financial sector development: key for avoiding
excessive external finance is the unfolding of
local credit and – with lower priority – equity
markets, preferably credit markets with long­
term maturity for promoting fixed investment.
A bank­based financial system with mildly
repressed finance can be conducive to growth
and structural change. This implies that the
credit to GDP ratio as well as the broad money
to GDP ratio rise in the process of development.

• Industrial policy: for the promotion of non­
traditional tradables and import substitution,
targeted industrial policy bound to the perfor­
mance of enterprises should be conducted with
a broad variety of tools. This should support
structural change and alleviate pressures in the
balance of payments. While industrial policy is
rather of a micro and sector policy nature, since
it is targeting economic growth and balance of
payments equilibrium it is strongly intertwined
with macroeconomic policies, similar to those
regarding financial sector development.

• Labour market policies: wages should rise, on
average, in line with increases in aggregate

37Seven Strategies for Development in Comparison

productivity plus the target inflation rate to
avoid price­wage­spirals. This is easier to
implement with a centralised wage bargaining
system, strongly in contrast to deregulated
labour markets. Dynamic minimum wages and
indexed salaries in the civil service can help to
shape institutions for productivity­led wages.

• Pro-poor income redistribution: In countries
with high income and wealth inequality,
profits and rents are saved abroad to a greater
extent (free capital outflows presumed), thus
dampening domestic financial intermediation
and aggregate demand. Redistribution policies
could curb such leakages and channel purchas­
ing power to lower income groups with a high
propensity to consume; it helps to raise tax
revenues to provide more public goods, and
capital outflow controls could contain leakages
and improve tax collection. This might increase
domestic aggregate demand to a permanently
higher level, thus supporting employment and
growth and thereby changing the Kuznets curve.

As Asian countries have shown, policy space
and an experimental, gradualist approach can help
to optimise the package of policies. Macroeconomic
policies play a stronger role in this concept compared
to developed countries, although they are often more
difficult to implement.

When checking the applicability of macro­
economic policy packages as outlined above, one
has to bear in mind the small size of the majority of
LMICs, measured in terms of both GDP and popula­
tion (see table 4). 87 per cent of the GDP of those
130 LMICs listed by the WDI database for 2013
stems from only 21 countries. For example, rank 21
is held by Hungary with a GDP of 113 billion dollars,
while India is ranked second and has a GDP half of
Germany’s, which ranks behind China; the latter
has a size of one­third of the United States GDP.
All LMICs’ GDP together has the magnitude of the
United States GDP. Regarding population, the size
structure is similar, whereby only 18 LMICs have a
population of 50 million and more, together compris­
ing around 76 per cent of the populace of LMICs.

Table 4



Number of

Aggregate GDP
as percentage of
total developing
countries’ GDP

Aggregate GDP
as percentage of

world GDP

Above $100 billion 21 87.5 22.7
$20–100 billion 27 9.2 2.3
$10–20 billion 19 2.0 0.5
Below $10 billion 63 1.5 0.4
All 130 100.0 25.9

B. Population

Number of



Aggregate population
(Percentage of

developing country

Aggregate population
(Percentage of

world aggregate)

Above 50 million 18 4.452 76.5 62.5
20–50 million 26 0.820 14.1 11.5
10–20 million 24 0.325 5.6 4.6
Below 10 million 71 0.221 3.8 3.1
All 139 5.818 100.0 81.7

Source: Author’s calculations, based on World Bank, World Development Indicators (WDI) database.
Note: Developing countries refer to country with a GNI per capita up to $12,745.

a Data refer only to the numbers of countries for which data are available in the WDI database.

38 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

This size structure poses great differences for the
choice of strategies, as independent macro policies
are more difficult to apply in smaller countries. In

these countries, probably only few macro policies
out of the package are applicable, while industrial
policy for strategic sectors becomes more important.

III. Learning from success and failure – growth performance
in the long run

While per capita GDP growth is certainly not
a synonym for development, many development
indicators such as life expectancy, absolute poverty,
health, etc. require higher per capita GDP and hence
GDP growth as a necessary yet not sufficient pre­
condition. The well­known Human Development
Indicator from the United Nations Development
Programme, comprising GDP growth as well as
other components, shows that the per capita GDP
component and others strongly correlate (Priewe,
2015). Per capita GDP, counted in PPP dollars, might
be, at first glance, the more appropriate measure for
assessing real incomes,3 although the data are not
very reliable due to different consumption baskets;
moreover, PPP­based income data only exist for few
years, meaning that time series cannot sensibly be
used. Therefore, in the following we use constant
2005 dollars to measure and compare incomes. We
only consider rough performance indicators, due to
space limitations. For more detailed analyses, see
Priewe (2015).

Comparing annual per capita GDP growth,
there are stunning differences between the main

regions in the “South”: sub­Saharan Africa grew
on average by only 0.2 per cent per annum during
the 1980–2012 period, with higher growth during
2000–2012 and negative growth in the lost 1980s and
1990s. Latin America accomplished overall 1.0 per
cent growth during 1980–2012, in contrast to South
Asia, mainly India, with 3.9 per cent and East Asia,
driven by China and neighbouring countries, with
7.0 per cent (table 5). Growth acceleration in the
2000s in all regions, especially in Africa, was backed
by improved barter terms of trade in many countries
(e.g. TDR 2013: 50).

Comparing the per capita GDP growth ranking
of 40 medium and large developing countries and
transition economies (defined here as having a popu­
lation above 20 million) shows that 11 countries grew
more slowly from 1990 until 2013 than the OECD
high­income country group, while 29 grew faster,
most prominently China, Viet Nam and India (data
are not available for five countries in this group) (see
chart 4). Ranks 12 and after are occupied by Uganda
and some other African countries, whereas Brazil, the
Russian Federation and South Africa rank low while

Table 5

(Per cent)

1980–1990 1990–2000 2000–2013 1980–2013 1990–2013

East Asia and Pacific 6.0 6.7 7.9 7.0 7.4
Europe and Central Asia 1.9 -0.7 3.8 1.9 1.8
Latin America and the Caribbean -0.7 1.4 1.9 1.0 1.7
Sub-Saharan Africa -1.3 -0.7 2.2 0.2 0.9
South Asia 3.1 3.3 5.1 3.9 4.3
Middle East and North Africa -0.1 1.5 2.2 1.3 1.9

Source: Author’s calculations, based on World Bank, World Development Indicators database.
Note: Data only include low- and middle-income countries, except for the world. Calculations are based on constant 2005 dollars.

39Seven Strategies for Development in Comparison

Mexico, the Bolivarian Republic of Venezuela and
Kenya join the group of poor performers. It becomes
evident that the top runner group mainly comprises
Asian countries that more or less continuously

performed well, whereas a few African countries
only picked up after the turn of the millennium (e.g.
Commission on Growth and Development, 2008).

Looking at the long period from 1980 until
2013 for selected developing economies (chart 5),
we see China’s outstanding growth, clearly beating
the Republic of Korea and all others. However, China
follows a growth track similar to the Republic of
Korea, Taiwan Province of China and Hong Kong
(China), which started 10 to 20 years earlier. From
this perspective, China has a speed similar to the first
“Tiger” generation of catching­up countries in Asia.
By contrast, Brazil, Mexico and South Africa have
not gained so much since 1980. Here, we clearly see
the diversity of growth and development. Success is
not necessarily accomplished by maximising growth,
but rather by continuous growth without severe and
long­lasting setbacks.

Despite high growth in Asia, the level of per
capita GDP achieved in Latin America is almost
twice as high compared to East Asia, as well as six
times higher than in sub­Saharan Africa (chart 6).4

Chart 4


(Per cent of GDP)

Source: Author's calculations, based on World Bank, World
Development Indicators database.

Note: Medium and large developing countries refer to
economies with more than 20 million people in 2013.
The following medium and large developing countries
are not reported because GDP per capita data for 2013
was available: Afghanistan, Argentina, Democratic
Republic of the Congo, Iraq, Democratic People's
Republic of Korea, Myanmar, and Syrian Arab Republic.
For comparison, the average of the high income OECD
economies is also reported.

Chart 5

ECONOMIES, 1980–2013

(Index numbers, 2000 = 100)

Source: Author's calculations, based on World Bank, World
Development Indicators database.

- 200




1 000

1 300

1 600

1 900









1980 1985 1990 1995 2000 2005 2010

India Indonesia

Republic of KoreaMexico
South Africa Thailand
Turkey China (right scale)

-2 0 2 4 6 8 10

Côte d'Ivoire


Venezuela, Boliv. Rep. of

South Africa
Russian Federation


High income OECD

Saudi Arabia


United Rep. of Tanzania

Iran, Islamic Rep. of








Rep. of Korea
Sri Lanka

Viet Nam


40 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

One of the basic reasons for higher growth in
Asia is the degree of monetization of the economies,
measured roughly by the domestic credit to GDP
ratio (see table 6). Broad money and credit largely
grow in tandem. In all regions analysed, credit picked
up relative to GDP. In 2012 East Asia had reached
the level of high­income OECD countries of 1990,
although this may have driven their credit volume
relative to GDP in some countries into an excessive
dimension after 2000. The strong credit growth
within a bank­centred financial system backed the
financing of investment dynamics and thus avoided
dependence on foreign finance.

Credit growth and fixed investment­to­GDP
ratios (see tables 6 and 7) show the same hierarchy
across regions. East Asia invested on average almost
twice as much of GDP in fixed capital compared to
sub­Saharan Africa and Latin America, and South
Asia remarkably more so than the latter. This reflects
the strong role of fixed investment for growth and
embodied technical progress when complemented
with human capital formation (e.g. Commission on
Growth and Development, 2008).

The majority of developing countries, and espe­
cially the smaller and less developed ones, struggle
with high current account deficits. Of the 153 LMICs
listed in the World Economic Outlook Database from
the IMF (2014), 113 faced current account deficits
on average during the 2000–2013 period, whereby
70 countries (46 per cent of all LMICs listed) had
deficits higher than 5 per cent of GDP and 22 up

Chart 6

REGIONS, 1981–2013
(Constant 2005 dollars)

Source: Author's calculations, based on World Bank, World
Development Indicators database.

Table 6


(Per cent of GDP)

1990 2000 2012

East Asia and Pacific 76.3 110.9 141.5
Europe and Central Asia 51.7a 34.1 64.3
Latin America and
the Caribbean 58.0 42.3 71.7
Middle East and North Africa 74.4 61.3 31.5b

Sub-Saharan Africa 55.3 67.8 66.4
South Asia 47.6 48.4 71.1
South Asia 47.6 48.4 71.1
High income OECD 141.3 179.2 213.1

Source: Author’s calculations, based on World Bank, World
Development Indicators database.

Note: Data only include low- and middle-income countries,
except for the high-income OECD group.

a Data refer to 1992.
b Data refer to 2010.

Table 7


(Per cent of GDP)



East Asia and Pacific 36.7 38.9
South Asia 23.1 29.8
Middle East and North Africa 27.0 26.6
Least developed countries 19.4 23.3
Europe and Central Asia 23.7 22.0
Latin America and the Caribbean 19.5 20.2
Sub-Saharan Africa 16.4 18.4

Source: Author’s calculations, based on World Bank, World
Development Indicators database.

Note: Data only refer to the average of 153 low- and middle-
income countries.


1 000

2 000

3 000

4 000

5 000

6 000

1981 1985 1989 1993 1997 2001 2005 2009 2013

East Asia and the Pacific
Europe and Central Asia
Latin America and the Caribbean
Least developed countries
Middle East and North Africa
South Asia
Sub-Saharan Africa

41Seven Strategies for Development in Comparison

to 5 per cent. The median deficit was ­7.0 per cent
of GDP, in most cases far beyond sustainability.
39 countries had surpluses, headed by top oil export­
ers. Despite conspicuously higher growth in the
2000s, the current account deficits were on average
smaller in the 1990s, with a median deficit of 4.9 per
cent and 124 countries in deficit. The reasons for the
increased deficit in the 2000s are, among others, the
increased imports dependent on higher growth, as
well as higher energy prices.

Not all chronic current account deficits had
dragged growth. Some countries still follow the
“growth cum debt” strategy, which largely failed in
so many countries, and especially in Latin America.
A number of African countries have fared quite
well regarding GDP growth in the last decade, with
high inflows of foreign aid, partially spent more
productively than in earlier periods, especially in
Ethiopia and to a lesser extent in Uganda, with a
rising investment­to­GDP ratio. However, their high
growth does not seem sustainable unless they remain
on the drip of donors and remittances from emigrants
for long or even forever.

Our brief overview of a few key economic
indicators unequivocally shows the distinct dif­
ferences between Asian countries, despite all the
differences between China, India and others on the
one hand and sub­Saharan Africa and Latin America

and the Caribbean on the other, and despite the lat­
ter’s marked difference in the level of development.
China is not as unique as it might appear, since the
country sails in the same class as Japan, Hong Kong
(China), Singapore, Taiwan Province of China and
the Republic of Korea previously did. Within Latin
America, Chile, a copper­heavy economy, striving
with little success to overcome its monoculture, is
the spearhead of enduring growth since the 1990s,
while Brazil and Argentina accelerated in the 2000s,
until growth petered out recently. Whether the few
fast growing African economies can sustain their
speed in the future is questionable, not least due to
a huge backlog in industrialization and the fact that
commodity prices will not rise forever.

In the rough picture that we have painted, we
have neglected income distribution, among many
other indicators. The high level of income and wealth
inequality in Latin America has been somewhat
reduced in the 2000s, whereas it strongly increased in
many Asian countries, particularly in China, as well
as in sub­Saharan Africa, facing commodity windfall
profits; however, Asia comes from a much lower
level of inequality than in Latin America whereas
sub­Saharan Africa could reduce inequality until
1990 clearly below Latin America’s level, apart from
South Africa and Namibia (see TDR 2012: 51; data
apply for unweighted averages in personal income

While few governments or policy­making
elites have clear explicit development strategies,
many have explicit or tacit ideas on the proper eco­
nomic rationale for their future development, often
provided by various economic advisers within and
outside the country. Our short review of the original
“Washington Consensus” and even more so the
neoliberal interpretation that followed has shown that
these visions are far too narrow, neglect important
points, especially active macroeconomic policies,
have no sound theoretical base or are rooted in
abstract neoclassical thinking that does not stand up
to the challenges of reality. The successful developing
countries de facto do not follow this line and rank
relatively poorly on the “Fraser Economic Freedom

Index”. Similar applies to the “good governance”
approach to development; even if the indicators were
clear and unbiased, they cannot be achieved quickly
(and could not be in the history of now developed
countries) and thus they are more a result of devel­
opment rather than precondition. Moreover, many
countries develop consummately in many aspects
with low indicator values, even for corruption and
rule of law. Nonetheless, the latter deserve strong
ethical and distributional appreciation.

Regarding the old debates on inward or outward
development, export orientation and import substitu­
tion do not show a black and white divide in either
theory or reality; rather, countries have implemented

IV. Conclusions

42 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

both. Indeed, it is the prudence of the mix that counts
for growth and development. Export promotion in
the often­propelled sense of export­led growth, with
preferences for exporters regardless what is exported,
is neither in line with the experience of advanced
countries that seek systematically new comparative
economic advantages, nor with the reality of suc­
cessful emerging economies. At least for the larger
developing countries, a thorough export orientation
requires a strong commitment to industrialization,
fully in line with the ideas of the pioneers of develop­
ment economics. Almost all middle­income countries
are nowadays more industrialized than high­income
OECD countries; the latter have embarked more
strongly on high­value services as inputs to industrial
exporters or increasingly to direct high­value service
exports. Developmental strategies primarily focusing
on agricultural and mineral commodities may flourish
in times of commodity price hikes, but hardly in the
long run, and they are at risk to infection by Dutch
disease, which over­appreciates the currency and
hampers net exports of goods that are not subject to
price booms. Hence, industrial policies are required to
promote non­traditional exports and prudent import
substitutions; moreover, a focus on few sectors is
unavoidable for small economies, while macroeco­
nomic policies are largely less efficiently applicable.

The orthodox development strategies neglect
macroeconomic policies, as they narrow the latter
to the goal of achieving price stability, mainly with
tight monetary and fiscal policy. Instead, money,
interest and exchange rates are not neutral for the
growth of output and employment, neither in the
short nor the long run. Strong dynamics of domes­
tic aggregate demand matters and can be fired by
growth­enhancing macroeconomic policies, not
only for short­term stimulus to overcome recessions.
Macroeconomic policies comprise a package of seven
policies that can be blended according to the condi­
tions and constraints in specific countries. This not
only requires respective policies, but also focused
institution building, for instance, for the management
of the balance of payments, exchange rate manage­
ment, wage bargaining or income redistribution, aside
from establishing a central bank committed to more
than price stability and capable of cooperating with
other institutions.

The brief overview of basic macroeconomic
performance indicators shows a distinct competitive
advantage for East and South Asian countries, led
by the giant economies of China and India. They

strongly liberalized their economies in select areas
in the past decades, but in a gradualist approach and
in key aspects. They refrained from taking the full­
fledged free­market­road of strong macroeconomic
policies, maintaining capital inflow and outflow
controls to some extent, as well as the usage of some
kind of industrial policies. Financial sector develop­
ment is a backbone for both economies, much more
so in China compared to India, with the former having
maintained State­ownership in commercial banking
and a number of important sectors.

In sub­Saharan Africa and many Latin American
economies, a higher degree of liberalising goods,
labour and financial markets has taken place, with
little success in the 1980s and 1990s but growth
acceleration in the 2000s, mainly caused by com­
modity price booms that reversed the trend of terms
of trade. In Africa, the hesitation to embark on indus­
trialization beyond mining continues, while in Latin
America deindustrialization has occurred since the
early 1980s regarding manufacturing. The challenge
of finding a development pattern with continuous
growth, resilience to inflation and financial crises
and growth enabling macroeconomic conditions,
especially pertaining to competitive exchange rates
and low real interest rates, is still awaiting a sound
policy response.

The lessons that can be learnt from emerg­
ing Asian countries have not found a full echo in
Latin America, let alone Africa. If both China and
India as well as their neighbours embarked on full
liberalization, they would most likely jeopardize the
factors that have led them to where they are now. In
particular, the Indian sub­continent seems to have
reached a critical juncture.

Our tour d’horizon on development strategies
has left out three increasingly important aspects that
lie beyond this analysis, namely: the rising inequal­
ity of income and wealth, as well as the difficulties
in reducing inequalities once they have reached
high levels; environmental issues; and the necessity
of more global governance in the face of rapidly
increasing globalization of trade, finance, labour
and pollution. Limited global governance makes
developing countries very vulnerable to negative
external shocks. They would be forced to limit their
exposure to global markets when their policy space
shrinks to an extent that render governments impotent
in coping with the ensuing problems, while emerging
democracies would be impeded.

43Seven Strategies for Development in Comparison

1 According to the WDI, for the 1960–2012 period,
Argentina reached a peak – in terms of value added
of manufacturing as a share of GDP – of 41 per cent
in 1966, compared to 21.7 per cent in 2012. Brazil
reached 34.0 per cent in 1982 compared to 13.3 per
cent in 2012. Mexico reached 28.8 per cent in 1987,
compared to 18.3 per cent in 2012. Chile reached
29.9 per cent in 1974, compared to 14.1 per cent in
2012. India reached 17.3 per cent in 1979 and stood
at 13.5 per cent in 2012.

2 A similar approach regarding developed countries
is used by Herr and Kazandziska (2011).

3 This notion could be questioned: lower prices of non­
tradable goods and services imply lower income for
their producers, regarding the purchase of tradables.
These households often have to live, mostly partially,
in subsistence.

4 Counted in current dollars, Latin America ranks first
with $9,617, with Chile as the top runner, East Asia
ranks second with $5,690, followed by sub­Saharan
Africa with $1,701 and South Asia bringing up the
rear with only $1,409, and the 49 least developed
countries at $863. All the data refer to 2013 (World
Bank, 2014).


Acemoglu D and Robinson JA (2012). Why Nations Fail.
The Origins of Power, Prosperity, and Poverty. New
York, NY, Crown Business.

Amsden AH (2001). The Rise of “The Rest”: Challenges
to the West from Late-Industrializing Economies.
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Blecker RA and Razmi A (2008). The fallacy of composi­
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tion: Why Some Emergent Countries Succeed
and Others Fall Behind. Cambridge, Cambridge
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sen J, eds. Towards New Developmentalism: Market
as Means rather than Master. Abingdon, Routledge.

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Growth Report. Strategies for Sustained Growth
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Cypher J (2014). The Process of Economic Development.
4th edition. Abingdon, Routledge.

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at: http://www.freetheworld.com/datasets_efw.html.

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developmentalism. Available at: http://www.tenthe­

Gerschenkron A (1962). Economic Backwardness in His-
torical Perspective. A Book of Essays. Cambridge,
MA, Belknap Press.

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Regimes in Western Industrial Countries. Abingdon,

IMF (2014). World Economic Outlook database. Interna­
tional Monetary Fund.

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stability. IMF Occasional Paper No. 211. Washing­
ton, DC, International Monetary Fund.

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worldwide governance indicators: Answering the
critics. World Bank Policy Research Working Paper
No. 4149. Washington, DC, World Bank.

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ernance indicators: Six, one, or none? Journal of
Development Studies, 46(2): 350–370.

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vantaged Nations Can Harness Their Financial Systems
to Get Rich. Princeton, NJ, Princeton University Press.

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(HWR). IPE Working Paper 53/2015. Available at:

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opment and Poverty Reduction: Strategies Beyond
the Washington Consensus. Baden­Baden, NOMOS.

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cycle and monetary policy independence. The Federal


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Reserve Bank of Kansas City. Available at: http://www.
kansascityfed.org/publicat/sympos/ 2013/2013rey.pdf.

Sen A (2001). Development as Freedom. Oxford, New
York, NY, Oxford University Press.

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development experience and lessons for today. World
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New York and Geneva.

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no. E.13.II.D.3, New York and Geneva.

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capital account last. In: Ries CP and Sweeney RJ,
eds. Capital Controls in Emerging Economies.
Boulder, CO, and Oxford, Westview Press.

45Restoring the Development Dimension of Bretton Woods


Eric Helleiner

Many analysts anticipated that the 2008 global
financial crisis would generate very substantial
reforms to global financial governance (see refer­
ences in Helleiner, 2014a). To date, however, reforms
have been more incremental than transformative,
generating growing frustration in many quarters.
Discontent is particularly strong among many
policymakers and analysts in emerging market and
developing economies (EMDEs) who lament the
continuing dominance of the Bretton Woods (BW)
institutions by Northern powers and the inadequate
attention given to their developmental priorities in
multilateral financial reforms. These frustrations are
generating support for initiatives to create alternatives
to the BW institutions, such as the New Development

Bank (NDB) and Contingent Reserve Arrangement
(CRA) between Brazil, the Russian Federation, India,
China and South Africa (referred to as BRICS).

As the future of the BW institutions comes into
question, this chapter argues that it is worthwhile
recalling their original purpose. The BW negotiations
are often described as an Anglo­American affair in
which developing countries played little role and
the development issues were largely ignored. This
portrayal fosters pessimism about the prospects for
reform today by suggesting that the design of the
BW system was development­unfriendly from the
very start. In fact, however, this history story is quite
inaccurate, given that the BW architects included


The slow pace of the post-2008 global financial reform is encouraging growing discontent among
policymakers from emerging market and developing economies who lament the continuing dominance
of the Bretton Woods institutions by Northern powers and the inadequate attention given to their
developmental priorities in multilateral financial reforms. Questions are increasingly raised about
whether their time might be better spent constructing alternative institutional arrangements to the
Bretton Woods system. As the future of the Bretton Woods institutions comes into question, it is
worthwhile recalling their original purpose. The initial Bretton Woods negotiations are often described
as an Anglo-American affair in which developing countries played little role and the development
issues were largely ignored. However, the Bretton Woods architects included officials from many
poorer countries and international development goals were explicitly prioritized in the design of the
post-war international financial order. Remembering this original development content of Bretton
Woods may be politically very useful for reformers seeking to construct a more development-friendly
global financial system today.


46 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

officials from many poorer countries and international
development goals were explicitly prioritized in the
design of the post­war international financial order.
Indeed, the BW negotiations pioneered the idea of
constructing a multilateral economic order to support

the development aspirations of poorer countries.
Resurrecting this original development content of
BW may be politically very useful for those reform­
ers seeking to strengthen international development
goals within global financial governance at present.

Officials from EMDEs have many reasons to
be dissatisfied with the content of post­2008 global
financial reforms to date. One such reason is the slow
pace of efforts to enhance their influence within the
BW institutions. At their first summit in November
2008, the G20 leaders noted that “emerging and
developing economies, including the poorest coun­
tries, should have greater voice and representation”
in the International Monetary Fund (IMF) and World
Bank (quoted in Helleiner, 2014a: 37). Reforms were
agreed two years later, involving a shift in approxi­
mately six per cent of voting shares to EMDEs and
a reduction by two members of European represen­
tation on the IMF Executive Board to make room
for more emerging market and developing country
representatives. However, the Congress of the United
States has since delayed approval of the new reforms
(Helleiner, 2014a: 50–51).

EMDEs have also been frustrated by inadequate
efforts to strengthen a “global financial safety net”
that could address their special needs for short­term
balance of payments support. Indeed, the G20 leaders
dramatically increased the size of the IMF resources
from $250 billion to $750 billion during their April
2009 summit, in order to help countries cope with
balance of payments shocks in the wake of the 2008
financial crisis. Yet, few EMDE countries took
advantage of the IMF enlarged lending capacity to
borrow from the institution in the following months.
A central reason was the ongoing concern about
the IMF record during the 1997–98 Asian crisis,
when its loan conditionality was widely criticized
for being overly intrusive, neoliberal and exces­
sively influenced by the policy goals of the United
States. Since 2008, the IMF has made some efforts
to address the stigma associated with its borrowing
by creating new facilities and streamlining condi­
tionality. Nonetheless, potential borrowers remain
understandably wary, particularly as the shift in the

content of conditionality in IMF crisis lending has
been uneven and the IMF governance reforms remain
stalled (Helleiner, 2014a).

Frustration with the IMF as a source of balance
of payments finance encouraged discussion in 2010
within the G20 of mechanisms to try to institution­
alize and expand the conditionality­free bilateral
swaps arrangements that the Federal Reserve of the
United States (thereafter Fed) had extended during
the financial crisis. Four EMDE countries – Brazil,
Mexico, the Republic of Korea and Singapore –
received Fed swaps of $30 billion in October 2008,
which were important in boosting confidence at the
time, particularly in the Republic of Korea, which
drew extensively on its swap. When the Fed let
its crisis­era swaps expire in February 2010, the
Government of the Republic of Korea – then chair
of the G20 – proposed the creation of a multilateral
swap arrangement that would make permanent the
swap arrangements created in the crisis, as well as
extending them to a wider group of emerging market
countries by embedding them within the G20 frame­
work (Helleiner, 2014a).

However, this proposal was resisted by officials
of the United States, who preferred swaps to be
bilateral and extended on a discretionary basis to
minimize the burdens and responsibilities that might
be placed on the Fed (Helleiner, 2014a: 45–47). As
the now­released minutes of the Federal Open Market
Committee (2008: 11, 16, 29–30, 35) make clear,
the Fed’s resistance to lending to a wider group of
countries had also been apparent at the height of the
crisis, when its officials had explicitly decided that
most Southern countries were not considered deserv­
ing of swaps, even including important G20 members
such as India, Indonesia and South Africa. The reluc­
tance of the United States to institutionalize swaps
with EMDE countries was subsequently confirmed

I. Growing discontent

47Restoring the Development Dimension of Bretton Woods

in October 2013 when the Fed only chose to make
swap arrangements permanent with the central banks
of Canada, England, Europe, Japan and Switzerland.

Such developments have encouraged EMDEs
to search out alternative mechanisms to insulate
themselves from balance of payments crises. In
2014, the BRICS announced the creation of the
CRA, a $100 billion swap arrangement among
themselves (whereby 30 per cent of the funds can be
accessed without an IMF programme). Many EMDE
Governments have also turned to self­insurance by
unilaterally building up national foreign exchange
reserves. In addition, there has been a proliferation of
bilateral swap arrangements among EMDEs, particu­
larly involving China. Regional swap arrangements
have also been strengthened, most notably in East
Asia, where members of the Chiang Mai Initiative
transformed their network of bilateral swaps into
a self­managed multilateral fund that opened in
March 2010 with $120 billion. This Chiang Mai
Initiative Multilateralism was subsequently doubled
to $240 billion in June 2012 and the portion of its
funds available without an IMF programme was
increased from 20 to 30 per cent (rising to 40 per
cent in 2014) (Helleiner, 2014a: 47).

The same centrifugal pressures can be seen
in the world of long­term international develop­
ment finance. In the wake of the 2008 crisis, the
G20 leaders boosted the resources of a number of
multilateral development banks, including that of
the World Bank, which experienced its first general
capital increase in over twenty years. However, many
officials from EMDEs still perceive these initiatives
as quite inadequate to meet their development needs
and they remain frustrated by enduring G7 influence
in the World Bank and other multilateral develop­
ment banks. Reflecting these sentiments, the BRICS
countries committed in 2014 to create a new institu­
tion, the NDB, devoted to long­term development
lending, particularly for infrastructure projects. It
was established with an initial capital of $50 bil­
lion, with the idea that this will rise to $100 billion.
China is also promoting the creation of a large Asian
Infrastructure Investment Bank with initial capital of
$100 billion, not much smaller than the existing Asian
Development Bank (whose capital is $165 billion)
and World Bank ($223 billion) (Leahy and Harding,
2014). The importance of the World Bank lending
role has also been increasingly challenged by the
growing bilateral official lending of countries such
as China and Brazil.

North­South tensions also characterized post­
2008 international discussions about the role that
capital controls could play in preserving national
policy space. These tensions were already on display
at the time of the late­1990s Asian crisis, when a
number of Southern officials expressed concerns
about speculative capital flows while Northern
policymakers – particularly officials of the United
States – strongly defended the virtues of financial
liberalization. In the wake of the financial crisis,
many EMDE Governments became bolder in argu­
ing that controls on excessive capital inflows and
outflows might need to play a larger role in their
policy toolbox. The political salience of the issue
was heightened by the fact that dramatic monetary
easing in the leading economic powers encouraged
large capital outflows to many Southern countries,
threatening to generate financial bubbles and drive up
exchange rates in those countries (Gallagher, 2014).

In October 2011, a compromise was reached
on this issue through an ambiguous statement issued
by G20 financial officials. While the statement noted
that “there is no one­size­fits­all approach or rigid
definition of conditions for the use of capital flow
management measures”, it also outlined the long­
term goal of putting in place conditions “that allow
members to reap the benefits of free capital move­
ments” (quoted in Helleiner, 2014a: 120–121). This
G20 statement subsequently helped to inform a new
“institutional view” of the IMF on the issue, which
was announced in late 2012 to help inform its surveil­
lance activities. The document noted that “there is no
presumption that full liberalization is an appropriate
goal for all countries at all times” and it endorsed
the use of “capital flow management measures” to
contain inflow surges or disruptive outflows. At the
same time, it stressed the need for these measures to
be temporary and noted that “careful liberalization of
capital flows can provide significant benefits, which
countries could usefully work toward realizing over
the long run” (quoted in Helleiner, 2014a: 121).
EMDE officials from countries such as Brazil who
had played a leading role pressing for change were
left dissatisfied, complaining that the IMF position
remained far too cautious and pro­liberalization
(Helleiner, 2014a: 121).

Frustration has also been evident about the lack
of attention in the post­2008 global financial reforms
concerning the need for a sovereign debt restructuring
mechanism (SDRM) at the international level. After
the East Asian crisis and 2001 Argentine default,

48 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

the first deputy managing director of the IMF Anne
Krueger proposed the establishment of a SDRM,
arguing that its absence was a “gaping hole” in the
international financial architecture. While her pro­
posal generated enormous debate, it was ultimately
shelved in the face of opposition, most notably from
the United States (Helleiner, 2009). The importance
of the issue was once again highlighted after 2008 by
sovereign debt crises in the eurozone and elsewhere,
as well as by the continuing efforts of vulture funds to
disrupt existing debt restructuring deals (most notably
in the Argentine case). Reflecting the new interest
in the idea, the United Nations General Assembly
adopted a resolution for the first time in September
2014 that called for a “multilateral legal framework
for sovereign debt restructuring processes”. The reso­
lution was proposed by Argentina and fully backed by

the G77, although it was met with opposition in the
United States and some other G7 countries, whose
support would be important for a substantial initia­
tive of this kind to move forward (Muchhala, 2014).

Such developments have left many EMDE offi­
cials pessimistic about the prospects for substantial
change to the BW system. Questions are increasingly
raised about whether transformative reforms of the
system are possible, as well as whether time may
be better spent constructing alternative institutional
arrangements such as the CRA and NDB. This pes­
simistic perspective about the prospects for reform
is often reinforced by histories of the BW system,
which argue that its design was unfriendly to devel­
oping countries and development issues from the
very start.

Is this pessimism deserved? Its historical
foundations certainly warrant questioning. Many
histories of the BW negotiations depict them as an
Anglo­American affair in which development issues
were largely ignored. However, recent research has
shown that this perspective on the origins of BW is
inaccurate. Far from being development­unfriendly,
the BW system was originally designed with the
promotion of international development as one of
its core goals (Helleiner, 2014b).

Policymakers of the United States were particu­
larly keen on this goal. From the very start of their
planning of the post­war international economic
order, American officials made it very clear that
international development issues would be prior­
itized. Even before the United States entered the war,
the President Franklin Roosevelt committed in his
famous “four freedoms” speech of January 1941 that
the post­war world should provide “freedom from
want” for people “everywhere in the world” (quoted
in Helleiner, 2014b: 120). As historian Elizabeth
Borgwardt (2005) has argued, Roosevelt’s vision was
part of his bold attempt at this time to “international­
ize the New Deal”. Just as his New Deal had promised
greater economic security to Americans, Roosevelt
now saw bolstering the standards of living in poorer
regions of the world as a crucial foundation for

post­war international peace and prosperity. The com­
mitment to promote “freedom from want” worldwide
was subsequently enshrined in the Atlantic Charter
that Roosevelt and British Prime Minister Winston
Churchill announced in August 1941, as a statement
of their combined vision of the post­war world.

When Harry Dexter White – who was an
ardent New Dealer – drew up his initial drafts of
the IMF and International Bank for Reconstruction
and Development (IBRD) in early 1942, he made
explicit reference to these international development
goals. White’s interest in international development
was hardly surprising, given that he had already
been a very strong advocate within the Government
of the United States of initiatives to promote Latin
America development since the late­1930s as part of
the Roosevelt administration’s Good Neighbor policy
towards the region. These initiatives represented
the first­ever foreign assistance programmes of the
United States to promote development and they were
not only driven by New Deal values, but also by the
geopolitical goal of offsetting the German influence
in Latin America. White had been particularly sup­
portive of this new aspect of the Good Neighbor
policy and Latin American industrialization which,
he argued was essential if the region’s standards of
living were to be raised (Helleiner, 2014b).

II. American goals for Bretton Woods

49Restoring the Development Dimension of Bretton Woods

A number of features of White’s initial plans
drew directly upon his Latin American experience.
The first was the IBRD’s mandate to mobilize long­
term development lending. This feature was highly
novel, given that no public international financial
institution had ever been created with the purpose
of supporting long­term development loans to poorer
countries. Interestingly, White’s idea built on a United
States­Latin American initiative of 1939–1940 to
construct an Inter­American Bank (IAB) with this
precise mandate in the Americas. White had taken the
lead role in drafting the IAB, which he had empow­
ered to support Latin American development through
direct lending and by guaranteeing private lending
to the region. While the IAB was never established
(because the Congress of the United States did not
approve it), White imported these features of his IAB
plan into the initial IBRD proposal in early 1942
(Helleiner, 2014b).

White’s proposal to create an international fund
offering short­term lending for balance of payments
purposes also grew directly out of his previous
experience of pioneering bilateral loans of this kind
of the United States to Latin American countries.
On his initiative, the Exchange Stabilization Fund
of the United States had begun to extend these loans
in 1936. These were particularly useful to Latin
American countries whose dependence on com­
modity exports left them vulnerable to unexpected
seasonal fluctuations and price swings. White’s col­
leagues noted that his initial draft of the IMF (which
he initially called a “Stabilization Fund”) simply
multilateralized that policy and they emphasized
how the Fund’s role would be particularly helpful for
Latin American countries addressing these balance of
payments difficulties (Helleiner, 2014b: 110).

White also expressed support in his initial drafts
for efforts to curtail capital flight from poorer coun­
tries (or what he called “the steady drain of capital
from a country that needs the capital but is unable
for one reason or another to offer sufficient mon­
etary return to keep its capital at home”, quoted in
Helleiner, 2014b: 110). Once again, this concern had
emerged out of his work in Latin America. During the
drafting of the IAB and some financial advisory work
in Cuba in 1941–1942, White and other officials of
the United States had become interested in how some
Latin American countries were afflicted by large
volumes of capital flight to New York. In the IAB
discussions, they had explicitly designed the institu­
tion to recycle that flight capital by accepting private

deposits and lending the funds back for development
purposes to the Latin American country from which
they had originated (Helleiner, 2014b: 67–68).

Perhaps because that specific proposal had
generated much opposition in the New York financial
community, White did not resurrect it in his initial
BW plans. Nonetheless, he continued to promote the
idea of a cooperative approach to tackling the problem
of flight capital. Under the proposed Fund’s charter,
White included a provision that all member countries
would undertake commitments to help enforce each
other’s controls by agreeing “(a) not to accept or
permit deposits or investments from any member
country except with the permission of that country,
and (b) to make available to the Government of any
member country at its request all property in form
of deposits, investments, securities, safety deposit
vault contents, of the nationals of member countries”
(quoted in Helleiner, 2014b: 111). In subsequent
drafts, he also added the idea that countries receiving
capital flows would commit to sharing information
about those flows with the sending countries. White
argued – as did Keynes at the time – that countries
experiencing illegal outflows of capital would have
a greater chance of making their controls effective
with these kinds of international assistance.

White’s Latin American experience also encour­
aged him to assign a role for both the Fund and Bank
to help facilitate international debt restructuring.
During the 1930s, many Latin American countries
that had defaulted on external loans and efforts to
settle these loans became a major irritant in United
States­Latin American relations throughout the
decade. Like Roosevelt and other New Dealers,
White had little sympathy for New York creditors
who were seen to have engaged in irresponsible and
fraudulent lending practices to the region during the
1920s. In his initial drafts of the BW plans, White
gave his proposed Fund a formal role in settling
international debts through “compulsory arbitra­
tion”. He also inserted a provision into his proposed
IBRD that allowed it to lend to a country in default
on external debts if that country had accepted the
recommendations of a Bank­appointed committee
for settling the outstanding debts “irrespective of
whether the bondholders did or did not” (quoted in
Helleiner, 2014b: 112).

Finally, in his initial drafts, White also referred
to two trade issues with international development
significance that had emerged from out of the context

50 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

of the United States­Latin American relations. The
first was international commodity price stabilization.
As part of efforts to assist Latin American countries,
the United States had signalled its support in mid­
1940 for the development of commodity agreements
that would help to stabilize prices of major Latin
American exports, with the first such agreement – the
Inter­American Coffee Agreement – established later
that year. In a March 1942 draft of the IBRD, White
reiterated this idea, proposing that the Bank could
“organize and finance an International Commodity
Stabilization Corporation for the purpose of stabiliz­
ing the price of important commodities” (quoted in
Helleiner, 2014b: 112–113).

In his initial drafts of the Fund, White also went
out of his way to signal his support for poorer coun­
tries’ use of infant industry tariffs, a support he had
already expressed in the Latin American context. He
argued that the belief that trade liberalization would
generate rising standards of living in poor countries
made the mistake of assuming “that a country chiefly
agricultural in its economy has as many economic,
political and social advantages as a country whose
economy is chiefly industrial, or a country which has
a balanced economy.” He added: “[i]t assumes that
there are no gains to be achieved by diversification of
output. It grossly underestimates the extent to which
a country can virtually lift itself by its bootstraps in
one generation if it is willing to pay the price. The
view further overlooks the very important fact that
political relationships among countries being what
they are vital considerations exist in the shaping of
the economic structure of a country other than that
of producing goods with the least labor” (quoted in
Helleiner, 2014b: 113).

Taken together, these provisions in White’s
initial drafts outlined a highly innovative vision
for a multilateral economic framework that was
supportive of the economic development of poorer
countries. Never before had a global framework of
this kind been put forward for international negotia­
tion. White’s specific proposals drew directly from
experiments in the regional inter­American context
that had arisen out from the politics of United
States­Latin American relations in the late­1930s and
early­1940s. Inspired by New Deal values, White and
others in the Roosevelt administration now proposed
to expand these experiments on a worldwide scale
as a key foundation of the post­war international
financial order.

As White’s proposals were subsequently
refined in internal discussions in the United States
in 1942–1944, some of his ambitious ideas were
eliminated or watered down, often with an eye to
what might be eventually acceptable to the Congress
(particularly after the Republican gains in the autumn
1942 elections). While the IMF and IBRD’s lending
roles remained, White’s proposals concerning debt
restructuring, commodity price stabilization and
infant industry protection were eliminated (in the
latter case, because the BW negotiations were meant
to focus on finance rather than trade). Mandatory
international cooperation to enforce capital controls
was also replaced with a provision simply permitting
such cooperation among countries (Helleiner, 2014b:
115–117). However, to offset the latter change, White
strengthened the right of all countries to employ
capital controls – even on a permanent basis – without
obtaining permission from the Fund.

Policymakers in the United States considered
the endorsement of the use of both capital controls
and adjustable exchange rates in the Fund’s final
articles of agreement to be important in bolster­
ing the policy space of Southern Governments to
promote their countries’ rapid economic develop­
ment (Helleiner, 2014b). Support for this kind of
“development­oriented” policy space was particu­
larly evident during and in the immediate wake of the
BW negotiations, when American officials advised
countries that had attended BW – such as Ethiopia,
Guatemala, Paraguay and the Philippines – to under­
take domestic monetary reforms that were designed
to strengthen the capacity of public authorities to
pursue development goals. These reforms not only
included the creation of new central banks, national
currencies and mechanisms for public authorities to
finance development objectives, but also domestic
legislation that incorporated the Fund’s provisions for
exchange rate adjustments and capital controls. While
BW established a new multilateral framework that
was supportive of State­led development strategies,
these financial advisers of the United States helped to
build domestic institutional capacity to enable these
strategies to be pursued (Helleiner, 2014b,).

At the BW conference itself, officials of the
United States continued to stress their commitment
to the idea that the post­war international financial
order must be supportive of international develop­
ment. White’s boss, the Treasury Secretary Henry
Morgenthau, used his welcoming address to speak

51Restoring the Development Dimension of Bretton Woods

of the importance of establishing “a satisfactory
standard of living for all the people of all the countries
on this earth”. As he put it, “Prosperity, like peace,
is indivisible. We cannot afford to have it scattered
here or there among the fortunate or to enjoy it at
the expense of others. Poverty, wherever it exists, is
menacing to us all and undermines the well­being
of each of us”. The last sentence was reminiscent
of the wording in a statement that the International
Labour Organization (ILO) had endorsed a meeting
two months earlier, claiming that “poverty anywhere
constitutes a danger to prosperity everywhere”. At the
end of the ILO meeting, Roosevelt went out of his
way to praise that statement, noting that “this prin­
ciple is a guide to all of our international economic
deliberations” and citing his concern to bring greater
prosperity to poor regions of the world that he had
visited, such as the Gambia (quotes from Helleiner,
2014b: 122).

In a high profile article in Foreign Affairs
in early 1945, Morgenthau (1945: 190) reiterated

that the BW framework was designed to serve not
only developed countries’ preferences, but also less
developed countries’ objectives of raising levels of
industrialization and standards of living. As he put it:

Unless some framework which will make the
desires of both sets of countries mutually com­
patible is established, economic and monetary
conflicts between the less and more developed
countries will almost certainly ensue. Nothing
would be more menacing to have than to have
the less developed countries, comprising more
than half the population of the world, ranged
in economic battle against the less populous
but industrially more advanced nations of the
west. The Bretton Woods approach is based
on the realization that it is to the economic
and political advantage of countries such as
India and China, and also of countries such as
England and the United States, that the indus­
trialization and betterment of living conditions
in the former be achieved with the aid and
encouragement of the latter.

One final way in which policymakers of the
United States supported international development
goals was through their backing of a very inclusive
form of multilateralism that gave poorer countries
more of a voice in international financial affairs.
From the very start, Roosevelt and his officials
favoured establishing public international financial
institutions whose membership would be open to all
the United and Associated Nations (“Associated”
nations referred to countries that had broken dip­
lomatic relations with the Axis powers but had not
joined the United Nations). They were also strongly
committed to what John and Richard Toye (2004:
18) call “procedural multilateralism”, in which all
the United and Associated Nations would have an
opportunity to contribute to the design of the post­
war international financial order. White and other
officials of the United States engaged in extensive
consultations with other countries in 1943–1944,
culminating with the BW conference itself, to which
they invited 43 other Governments. Well over half

of those Governments were from poorer regions of
the world, including nineteen from Latin America
alone, while their total delegates outnumbered those
representing rich countries (Helleiner, 2014b: 14).
The fact that the conference operated formally on the
principle of one­government­one­vote reinforced the
influence of poorer countries (although many issues
were settled at the meeting without formal voting).

Officials from Latin America, China (which
brought the second largest delegation to the con­
ference) and India (whose delegation was divided
equally between British and Indian officials, due to its
colonial status at the time) were particularly active in
the conference discussions. All of them very vocally
highlighted how they saw the BW negotiations as
an opportunity to construct a development­friendly
international financial regime that was supportive
of their State­led efforts to raising standards of liv­
ing and levels of industrialization. Unsurprisingly,
they were very supportive of the IBRD’s proposed

III. Inclusive multilateralism and North-South dialogue

52 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

development mandate. They ensured that the Bank’s
formal purposes included “the encouragement of the
development of productive facilities and resources in
less developed countries” (Helleiner, 2014b: 163).
They also successfully lobbied at the conference
to include wording that ensured development loans
would be given equitable consideration vis­à­vis
reconstruction loans in the Bank’s operations. The
Mexican official who led this initiative made the
case in language very similar to that of the officials
of the United States: “development must prevail if we
are to sustain and increase real income everywhere”
(quoted in Helleiner, 2014b: 164).

Southern officials also pressed for the IMF’s
lending provisions to be designed in a manner that
was supportive of their countries’ distinctive bal­
ance of payments challenges. Owing to the frequent
fluctuations in their balances of payments caused by
commodity exports, many Latin American officials
had been very supportive of White’s initial plans for
the Fund. As one Brazilian official had put it, the
proposed Fund would mean that his country no longer
had to hold such large gold reserves, the conservation
of which “has been onerous, since it may be likened to
an insurance maintained exclusively by the insured”
(quoted in Helleiner, 2014b: 166). At the BW confer­
ence, Latin American delegates subsequently played
a key role in backing the inclusion of a “waiver”
clause in the IMF’s articles of agreement that allowed
the Fund to override normal restrictions on its lending
in situations that took into consideration the “peri­
odic or exceptional circumstances” of the countries
requesting the waiver. Latin American officials (and
others) saw this clause as explicitly designed to
serve the interests of commodity­exporting countries
that faced larger balance of payments fluctuations
(Helleiner, 2014b: 166–168).

In discussions before and during the conference,
Southern delegates also highlighted their support for

international provisions such as adjustable exchange
rates and capital controls (including cooperative
controls) on the grounds that these would help to
protect their policy space to pursue activist domestic
policies designed to promote development (Helleiner,
2014b: 170–172, 255–256). Some Southern officials
also tried to resurrect White’s initial proposals for
development­friendly trade provisions. For example,
there were calls at the conference to pay greater
attention to the need for infant industry protection
in poor countries (Helleiner, 2014b: 170, 253). Latin
American proposals at the BW conference also
called for an international conference to be held to
establish a new international organization to promote
commodity price stabilization. Pressure arising from
these latter proposals led to the passage of a resolu­
tion at BW recommending that Governments seek
agreement on ways and means to “bring about the
orderly marketing of staple commodities at prices
fair to the producer and consumer alike” (quoted in
Helleiner, 2014b: 170).

In these ways, the BW negotiations represented
the first substantial North­South multilateral dialogue
on international development issues. At the end of
the conference, Southern policymakers applauded
the fact that the final agreements supported their
development aspirations. As Chintaman Deshmukh,
governor of the Reserve Bank of India, told an audi­
ence in India after the conference: “[w]e all now
apparently subscribe to the belief that poverty and
plenty are infectious, in the international as well as
in the national field, and that we cannot hope to keep
our own side of the garden pretty if our neighbour’s
is full of weeds” (quoted in Helleiner, 2014b: 254).
The commitment to building a development­friendly
international financial regime also found support
among policymakers from other rich countries
involved in the BW negotiations, such as Australia,
Canada, the Netherlands and the United Kingdom
(Helleiner, 2014b).

53Restoring the Development Dimension of Bretton Woods

Given this history, it is striking that so many
scholars and policymakers have overlooked the inter­
national development content of BW. However, such
neglect is more understandable once it is recognized
that this content was dramatically watered down right
after the war by changing priorities of the United
States, particularly with the onset of the Cold War.
This is not the place to analyse how and why officials
of the United States withdrew their backing for the
international development vision of BW so quickly.
Nonetheless, the consequence of the changed policy
of the United States was important, resulting in the
fact that the “actually­existing” BW system was much
less supportive of Southern development aspirations
than the original BW vision had been (Helleiner,
2014b: 260–268).

This undermining of the BW development
framework generated the result ominously predicted
by Morgenthau in 1945: growing conflicts between
North and South in international economic diplomacy.
These conflicts escalated particularly after the wave
of decolonisation in the 1950s and 1960s, and by the
early­1970s Southern policymakers were demanding
an entire New International Economic Order that
would better support their development goals. At
the time, the proposal was generally portrayed as a
challenge to the BW system. Yet, many of its specific
demands simply resurrected – usually unknowingly
– ideas put forward at the time of the construction
of the original BW international development vision,
ranging from proposals for development assistance
to commodity price stabilization schemes (Helleiner,
2014b: 268–276).

The same is true of many of the demands of
EMDEs today. As noted above, officials of EMDEs

are often quite critical of the BW system. However,
the BW architects pioneered specific proposals for
promoting international development that EMDEs
continue to see as crucially important today: public
international long­term development finance, short­
term international lending for balance of payments
support, multilateral support for capital controls
and national policy space, SDRMs, and inclusive
multilateral governance practices. The BW archi­
tects also included many policymakers from today’s
EMDEs. Indeed, some of the key countries’ pushing
for global financial reforms today – such as Brazil,
China, and India – were among the most active of the
poorer countries that helped to shape the international
development content of the original BW agreements.

Recalling the original development content of
BW helps to correct the historical misconception that
the BW system was development­unfriendly from its
very beginnings. This correction may be particularly
useful for those seeking to bolster the prominence of
international development goals within contemporary
global financial governance. Rather than challenging
BW norms, reforms with this goal can be accurately
recast as those that resurrect and more fully realize the
vision of the founders of the post­war international
financial order. Indeed, a very strong case can be
made that the future of the multilateral order estab­
lished in 1944 depends on the fate of such reforms. If
they are embraced, that multilateral order will likely
be rejuvenated in the current context where EMDEs
are gaining global economic influence. On the other
hand, if these reforms fail, Morgenthau’s 1945 predic­
tions are likely to be realized once again, resulting
in an increasingly conflictual and fragmented global
financial system.

IV. The fate of the development content of Bretton Woods

54 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

Borgwardt E (2005). A New Deal for the World; America’s
Vision for Human Rights. Cambridge, MA, Belknap
Press for Harvard University Press.

Federal Open Market Committee (2008). Minutes of the
meeting of the Federal Open Market Committee
on 28–29 October 2008. Washington, DC, Federal
Reserve of the United States. Available at: http://

Gallagher K (2014). Countervailing Monetary Power:
Emerging Markets, New Ideas, and the Re-regulation
of Cross-border Finance. Ithaca, NY, Cornell Uni­
versity Press.

Helleiner E (1994). States and the Reemergence of Global
Finance: From Bretton Woods to the 1990s. Ithaca,
NY, Cornell University Press.

Helleiner E (2009). Filling a hole in global financial
governance? The politics of regulating sovereign
bond restructuring. In: Mattli W and Woods N, eds.
The Politics of Global Regulation. Princeton, NJ,
Princeton, Princeton University Press.

Helleiner E (2014a). The Status Quo Crisis: Global Finan-
cial Governance After the 2008 Meltdown. Oxford,
Oxford University Press.

Helleiner E (2014b). Forgotten Foundations of Bretton
Woods: International Development and the Making
of the Postwar World. Ithaca, NY, Cornell University

Leahy J and Harding R (2014). Shanghai leads race for
Brics bank HQ. Financial Times, 2 July.

Morgenthau H (1945). Bretton Woods and international
cooperation. Foreign Affairs, 23(2): 182–194.

Muchhala B (2014). Historic UN General Assembly vote
on a multilateral sovereign debt mechanism. Third
World Network Info Service on UN Sustainable
Development, 19 September. Available at: http://

Toye J and Toye R (2004). The UN and Global Political
Economy: Trade, Finance and Development. Bloom­
ington, IN, Indiana University Press.


55The Middle-Income Trap and East Asian Miracle Lessons

The term “middle­income trap” (MIT) is a
recent powerful catchword in the international devel­
opment community, becoming widespread shortly
after being coined by Gill and Kharas (2007) in their
East Asian Renaissance report. The status of middle­
income countries is defined by the World Bank as
those who had a GNI per capita between $1,036 and
$12,615 in 2012.1 From 101 middle­income econo­
mies in 1960, only 13 economies managed to reach
the high­income level in 2008, namely Equatorial
Guinea, Greece, Hong Kong (China), Ireland, Israel,
Japan, Mauritius, Portugal, Puerto Rico, the Republic

of Korea, Singapore, Spain and Taiwan Province of
China (World Bank, 2013). Given that the lion’s share
of them has been stuck in the same income category
for over half a century, this has attracted attention
from academics and policymakers to explore whether
there is such a thing as a “trap” that deters these
middle­income countries from moving forward.

However, there is neither apparent nor growing
consensus in the literature. Despite using the same
phrase, the MIT literature considerably varies in the
cases studied, the research methods employed, the


Veerayooth Kanchoochat


The “middle-income trap” has recently become a powerful catchword in the international development
community. Nonetheless, despite using the same phrase, the existing literature considerably varies.
The objective of this chapter is twofold. First, it provides a classification of this burgeoning area of
research. Based upon differences in theoretical underpinnings and policy implications, the literature
is categorized into three groups: (i) getting education and institutions right; (ii) changing export
compositions through comparative advantage; and (iii) industrial upgrading through State intervention.
Second, the chapter examines the validity of these three bodies of literature through the East Asian
development experience. Deduced from the successful catching-up of the Republic of Korea, Singapore
and Taiwan Province of China, structural transformation rather than education and institutions is a key
driver of long-term growth. While changing a country’s productive structure often goes against static
comparative advantage, industrial and technology policies require clear yardsticks and compatible
macroeconomic measures. The chapter also suggests conceptual grounds for future policymaking and
research agendas to make the debate more relevant to today’s developing countries.

* Research for this chapter is supported by the Emerging State Project (Comparative History Approach) under the Grant­
in­Aid research project No. 25101004 of the Japan Society for Promotion of Sciences, for which the author is grateful.


56 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

underlying causes of the trap asserted and the poli­
cies suggested. To make this issue more tractable and
particularly pertinent to today’s developing countries,
this chapter has two objectives: first, it provides one
of the earliest attempts at categorizing this burgeon­
ing area of research; and second, it examines the
validity of each strand of MIT literature through the
catching­up experience of East Asia.

The following discussion is organized into five
sections. Section I elaborates upon the three varia­
tions within the literature. Based upon the differing
theoretical assumptions and solutions provided, the
existing works on the MIT can be categorized into
three groups, labelled by their policy stances: (i) get­
ting education and institutions right; (ii) changing
export composition through comparative advantage;
and (iii) industrial upgrading through State interven­
tion. The three succeeding sections examine each of
these three bodies through the East Asian develop­
ment experience. Section II discusses why the focus
on education and institutions cannot guarantee suc­
cessful catching­up unless it is particularly designed
to support the country’s industrial targets. Section III
examines the role of structural transformation and
export in long­term economic development, enquir­
ing whether East Asia has succeeded by following
its comparative advantage. Section IV revisits the

State­centred approach to the MIT and discusses vari­
ous recipes for industrial and macroeconomic policies
pursued in East Asia. Section V summarizes policy
lessons and suggests certain conceptual grounds for
future policymaking and research agendas.

It is worth noting that by East Asia, this chapter
means the policy lessons learned, mainly – yet not
exclusively – from the first­tier newly industrializing
economies (NIEs), namely the Republic of Korea,
Singapore and Taiwan Province of China.2 These
lessons are based upon their experience during the
catching­up period, approximately between the 1960s
and the 1980s, as this is most relevant to the debate
concerning the transition from middle­ to high­income
levels. While East Asia has usually been at the centre
of the contemporary debate over economic develop­
ment, as symbolized in the World Bank’s East Asian
Miracle report (1993), it has surprisingly been miss­
ing from the current MIT debate. Of course, today’s
middle­income countries differ in their characters
and situations, economically, socially and politically.
Although we cannot make a sweeping generalization,
the lessons from East Asia warrant detailed discus­
sion because among the only 13 countries who could
escape from the MIT as mentioned above, East Asia
comprises the major group of those non­European
countries without natural resource wealth.

Generally speaking, the term MIT refers to the
situation in which countries have failed to grow further
into a high­income level despite attaining middle­
income status for certain periods. Nonetheless, there is
no accepted definition of the MIT. One group of litera­
ture sees the trap as “growth slowdowns”; for example,
Eichengreen et al. (2013) define MIT countries as those
who had undergone average GDP growth of at least
3.5 per cent for several years and subsequently stepped
down by at least 2 per cent between successive seven­
year periods (in the same vein are Felipe et al., 2012;
Aiyar et al., 2013). Another group puts the MIT into
the broader debate concerning the economic “catch­
ing up” of developing countries in relation to such
developed countries as the United States or Japan
(e.g. Lin and Rosenblatt, 2012; Lee, 2013).

The MIT literature is even more diverse when
analysing the causes of the trap and proposing
policy solutions. According to their differences in
the analytical approach to, and the solution for,
the MIT, they can be classified into three groups,
namely: (i) getting education and institutions right;
(ii) changing export composition through compara­
tive advantage; and (iii) industrial upgrading through
State intervention. While none of the existing MIT
studies deny the importance of education, institutions
and exports, each work differs in its emphasis placed
upon the fundamental causes of the MIT, as well as
the extent to which the State should be involved in
remedying the problems (functional, facilitating, or
proactive). Indeed, both are the criteria that I used
for this categorization.

I. Three approaches to the middle-income trap3

57The Middle-Income Trap and East Asian Miracle Lessons

A. Getting education and institutions

The first strand is distinctive in terms of its
principal focus on the causal mechanisms of educa­
tion and institutions. It considers inadequate quality
of education and institutions as the main causes that
impede middle­income countries from sustainable
economic growth. In terms of policy suggestions,
this strand prefers the role of the State to be kept to
a minimum, particularly when comparing with the
other two strands. For example, Aiyar et al. (2013)
conducted a comprehensive study through probit
regressions covering 138 countries from 1955 to
2009. Defined as strong rule of law, small govern­
ment and light regulation, high­quality institutions
are among significant factors that prevent growth
slowdowns in middle­income countries. In terms of
policy suggestions, this and related studies maintain
that the State should concentrate on the so­called
functional intervention by making the right incen­
tive systems for private sectors, investing more in
education and institution building (e.g. Jimenez et al.,
2012; Jitsuchon, 2012; Tran, 2013; Aiyar et al., 2013).

B. Changing export composition through
comparative advantage

Rather than education and institutions, the
second and third strands are more concerned with
the country’s structural transformation. Specifically,
they point to a country’s export composition as
being particularly critical to its catching­up success
and failure. For example, Felipe et al. (2012) argue
that successful catching­up is found in those with a
“diversified, sophisticated, and non­standard level
export basket”. Put differently, while the Republic
of Korea was able to gain comparative advantage
in a significant number of sophisticated products,
Malaysia and the Philippines were only able to gain
comparative advantage in electronics. From their
perspective, countries have fallen into the MIT
because they have inadequate capabilities to produce
and export higher­technology products. The disparity
between these two groups lies in the role the State
should play in solving the exports problem.

The second strand has reservations about State
intervention. While policy suggestions vary within
this group, they generally prefer the State to function
as no more than a facilitator who supports a country’s
transformation towards higher value­added exports.
Whereas some works recommend that developing
countries should pay attention to their export com­
positions, they offer no clear instruction concerning
how the State can achieve this (e.g. Felipe et al.,
2012; Eichengreen et al., 2013). Another work within
this strand goes further and maintains that the State
should play a facilitating role by supporting sectors
in accordance with the country’s current comparative
advantage. For example, Lin and Treichel (2012: 48)
assert that: “To achieve dynamic growth, a develop­
ing country should develop industries according to
its comparative advantage, which is determined by
the country’s endowment structure, and tap into the
potential advantages of backwardness in industrial

C. Industrial upgrading through State

Similar to the second group, the third strand
of MIT literature emphasizes exports and produc­
tion structures. Nevertheless, it explicitly supports
the active role of the State in acquiring indigenous
technology for latecomers, even against the country’s
comparative advantage when necessary. Put otherwise,
for this group, comparative advantage is not a matter
of concern, and especially comparative advantage in
trade determined by initial endowment conditions.
This group makes it clear that the MIT problem is
mostly about the inappropriate or insufficient role of
the State in enhancing the country’s capabilities to
produce and export higher­technology products. As
a result, the State should be proactive, paying close
attention to capability accumulation and industrial
upgrading (e.g. Ohno 2009; Paus, 2012; Lee, 2013).

In summary, those who used the term MIT hold
different underlying assumptions about the trap,
thereby deriving a different set of policy sugges­
tions. In the subsequent sections, we examine each
strand through the catching­up experience of East
Asian NIEs.

58 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

While the first strand of MIT literature considers
education and institutions as holding the key to reach­
ing a higher­income level, the East Asian experience
tells us that neither guarantees successful catching­
up. In order to contribute significantly to economic
growth, education and institutions need to be closely
linked with specific industrial targets.

A. Education needs to link with industrial

In contrast to conventional wisdom, a number
of cross­country studies find that the relationships
between education and economic growth are weak
(Benhabib and Spiegel, 1994; Pritchett, 2001) or
take place in the opposite direction, namely from
economic growth to a higher quality and quantity of
education (Bils and Klenow, 2000). When comparing
East and Southeast Asia, it was found that the literacy
rates and average years of schooling of the first­tier
NIEs were below those of the Philippines in 1960.4
Even as late as 1994, the average years of schooling
of Indonesia, Malaysia and Singapore were still lower
than that of the Philippines (Collins and Bosworth,
1996). However, the Philippines is the least success­
ful catching­up country among them.

Why might this be the case? The reason is that
despite having value on its own, much of the knowl­
edge gained in education is not necessarily relevant
for productivity enhancement, not only because many
subjects have almost no impact on most workers’
productivity (such as literature, history, and philoso­
phy), but also because education tends to promote
individual betterment to a greater extent than national
prosperity (Chang, 2010: 189). The causal link from
(more or higher quality) education to (higher, more
continuous) growth is indirect at best, and requires
many more things in the causal process. To ensure
that education contributes substantially to economic
growth, educational policy has to be tailored to sup­
port the national development strategy, rather than
simply increasing literacy rates, average years of
schooling or even gross tertiary enrolment.

For example, in Singapore, the human resource
system was restructured in 1981 when the country
decided to shift from import­substitution to export­
oriented industrialization. The new system was aimed

at specific industrial goals and not only encompassed
improving formal education, but also upgrading the
abilities of the existing workforce in the industry
through training and vocational education (for the
Skills Development Fund, see Kuruvilla, 1996). By
contrast, while Thailand and the Philippines were
able to create educated workers, their university–
industry linkages have been porous and neglected,
which in turn has impeded the utilization of labour
forces and hampered the economic development of
both countries (Yusuf and Nabeshima, 2010).

B. Growth-enhancing governance is more
relevant than “good governance”

While no one would reject the contribution of
institutions to economic development, the question
about which kind of institutions matter remains
debatable. In this regard, the existing MIT literature
is influenced by the so­called “good governance”
institutions meant for minimizing the role of the State,
as well as rent­seeking activities. According to Aiyar
et al. (2013), better institutional quality is meant to
comprise less government ownership of enterprises,
lower income tax rates, fewer regulatory restrictions
on the sale of real property, as well as fewer trade
taxes and non­tariff trade barriers.

However, methodologically speaking, the argu­
ment for “good governance” institutions is based
upon flawed research methodology, as in fact many
of the explanatory variables in empirical research
are not really institutions (e.g. tax rates and trade
barriers). However, in theory, institutions are sup­
posed to be something more fundamental and deeply
rooted, providing the basic scaffolding for human
interactions, such as constitutions or widely held
norms. Even assuming away the problematic use
of such proxies, cross­country regressions are poor
tools to determine which particular institutions are
necessary for a country to develop, because we still
lack good aggregate measures of complex institutions
or an understanding of how these institutions interact
with specific country characteristics (Shirley, 2008).

More importantly, from an empirical perspec­
tive, the first­tier NIEs were able catch up with
advanced economies despite their institutions being
highly deficient by modern standards, in such areas

II. Education and institutions as magic bullets?

59The Middle-Income Trap and East Asian Miracle Lessons

as democracy, bureaucracy and judiciary, property
rights, western­style corporate governance and finan­
cial institutions (Chang, 2002). In the Republic of
Korea, for example, rent­seeking was rife throughout
the high­growth period under the Park Chung Hee
regime. The assumption that rents and rent­seeking
are always counter­productive and thus should
be eliminated at all costs is problematic because
there are different types of rent. For example, the
Schumpeterian rents, or the above­average profit that

the firm earns due to innovation, are vital to ensure
sustained efficiency and growth. The implication is
that it is the way in which rents have been created
and managed holds greater relevance for consequent
economic performance (see Khan and Jomo, 2000;
Kang, 2002). Specific to the task of escaping from
the MIT, growth­enhancing institutions, namely those
that focus on the country’s structural transformation
and export compositions, are more relevant than good
governance ones.

Beyond education and good governance institu­
tions, the second strand of MIT literature emphasizes
structural transformation, export composition and
comparative advantage. First, it revives the old tradi­
tion of development economics by reaffirming that
structural transformation is the key to sustaining
economic growth. Second, it has shifted the focus
from export expansion to export composition as a
prime indicator of structural transformation. Third,
it renews the concept of comparative advantage as
a guideline for a developing country to follow. The
experience of East Asia is supportive of the first two
statements, yet is at odds with the third one.

A. Long-term economic development
requires structural transformation

To begin with, the definition of “development”
has always been subject to controversial debate.
The current UNDP human development index may
underscore the non­income dimensions of human
welfare, such as health and gender equality. However,
another group of development economists has tried
to draw academic attention back to the “old school”
cannon in the tradition of, inter alia, Arthur Lewis,
Simon Kuznets and Nicholas Kaldor. Before the rise
of neo­liberalism in the 1980s, there was a general
consensus that development is largely about the
transformation of the productive structure. Emphasis
is placed on manufacturing as the source of national
prosperity because it offers greater returns to scale
and spillovers from learning and productivity poten­
tial (e.g. Rodrik, 2007; Cimoli et al., 2009; UNIDO,
2013). In human history, only a few countries have

achieved high­income status without industrializing,
and merely because they were endowed with an
extraordinary abundance of natural resources.

This “productionist” tradition of development
is based upon the world history of industrialization.
Among the catching­up economies, Latin America
remained the most industrialized region until 1975,
while Africa has been the least industrialized region.
However, the most transformative change took place
in Asia, whose manufacturing continuously surged
throughout the last half of the century, particularly
from 1965 to 1980. Moreover, by 2010, the three most
successful economies in East Asia, namely China, the
Republic of Korea and Taiwan Province of China,
together accounted for approximately one­fifth of
world manufacturing’s value­added share and world
manufactures trade (UNIDO, 2013).

In short, since the Industrial Revolution, long­
term growth has required a country’s structural
transformation in which resources are transferred
to higher­value­added sectors (i.e. from agriculture
to industries and services), production is diversified
continuously and labour productivity is significantly
increased. The successful catching­up of first­tier
NIEs also results from such transformation, albeit
in a faster and more intense manner than any other
developing region (Szirmai, 2012).

In addition to reviving the old definition of devel­
opment, the second body of MIT literature brings a
fresh empirical insight by shifting the focus from
export expansion to export composition as the crucial
determinant of sustainable structural transformation.

III. Structural transformation through comparative advantage?

60 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

Export expansion alone is not sufficient for sustaining
growth. What separates export­led industrialization
in Latin America and East Asia is export composi­
tion. The study by Palma (2009) finds that between
the 1960s and the 1990s, Latin American countries’
capacity to move into the “high­tech” products
was much lower than that of the East Asian ones.5
Although Latin American countries managed to reach
East Asian levels of market penetration in OECD
markets (matching export expansion) in the 1990s,
they only did so in their traditional export products,
while NIEs were able to increase remarkably the share
of high­tech products in their exports to the same mar­
kets (different export composition). In sum, exports
can be used as both a development tool and a test of
a country’s success (see also Hausmann et al., 2007).

B. Changing export compositions usually
goes against comparative advantage

However, the extent to which the role of the
State is needed in changing the country’s export
composition remains controversial. Although overly
deviating from comparative advantages might be
damaging, it is almost impossible for a backward
economy to accumulate capabilities in new industries
without defying comparative advantage and actu­
ally entering the industry before it has the “right”

factor endowments. Theoretically speaking, the
concept of comparative advantage, which underlies
Justin Lin’s policy advice, is based upon unrealistic
assumptions, including: (i) the “no” conditions, such
as no externalities; no increasing returns to scale; no
factor mobility between countries; no technological
change; and (ii) the “necessary” conditions, such as
the perfect competition in all markets in both coun­
tries (Fine and Waeyenberge, 2013). Empirically,
high­speed structural transformation in first­tier
NIEs was a result of various mixtures of proactive
State intervention aimed at upgrading their industrial
structures. For example, the Republic of Korea set
up the State­owned steel mill, POSCO, and initiated
the Heavy and Chemical Industrialization (HCI) pro­
gramme, which promoted shipbuilding, automobiles
and machinery in the early 1970s when its per capita
income was only 5.5 per cent that of the United States.
Given that per capita income has been used as a proxy
to compare capital abundance between the United
States and the Republic of Korea, the latter should
have specialized in labour­intensive sectors such as
the apparel industry rather than the HCI programme
(see detailed discussion in Lin and Chang, 2009).
Of course, changing export composition and going
against comparative advantage can do more harm
than good if industrial and technology policies are
not well implemented, which is an issue to which
we now turn.6

The third strand of MIT literature gives strong
weight to industrial and technology policy. Although
the East Asian experience seems to concur with this
view, the Achilles heel of this approach is its lesser
emphasis on the pragmatic guidelines on effective
State intervention and, more importantly, macroeco­
nomic policymaking (e.g. Ohno, 2009; Lee, 2013).
This section discusses the carrot­and­stick ingredients
of industrial policy, as well as the macroeconomic
measurements pursued by the first­tier NIEs.

A. East Asian policies entailed variation
in carrot-and-stick incentives

Despite the East Asian experience always repre­
senting a strong case for the proponents of industrial

policy, detailed analysis of how the first­tier NIEs
succeeded in operation is usually missing. The fruits
of such policy vary considerably across time and
space. In general, the first­tier NIEs used export
performance and the discrepancy between domestic
costs and international prices to guide subsequent
government policies for the targeted industries. The
role of exports is underestimated by both sides of the
industrial policy debate: while its proponents do not
fully appreciate how critical exports are to the success
of industrial policy, its opponents do not recognize
that selective industrial policy is required for local
firms to be capable of competing in global markets
(Chang, 2011).

At the micro level, the Republic of Korea and
Taiwan Province of China ran a tight ship and took

IV. Industrial policy without yardsticks and macroeconomic stability?

61The Middle-Income Trap and East Asian Miracle Lessons

punitive actions whenever necessary. In Taiwan
Province of China, the recipients of policy support
were threatened with a penalty if the prescription
was not followed. Control instruments included
quantitative import restrictions and export licens­
ing, foreign investment screening, approval for
capital goods imports for new plants, no private
borrowing of foreign funds and restrictions on entry
to certain sectors. Likewise, the Republic of Korea
strongly deployed the tight performance monitoring
system, set by industry associations in concert with
the Government. Its punitive measures included the
withdrawal of subsidized credit and import licences,
income tax audits, while even prison sentences could
be put in place for some serious issues. Moreover, the
Korean State usually set up State­owned enterprises
to accomplish the tasks that private firms could not be
forced to undertake. Singapore is less punitive than
the Republic of Korea and Taiwan Province of China,
given its FDI­led strategy. However, firms would
only be granted potential rewards when their activi­
ties matched the country’s specific targets at a given
time (see Amsden, 1989; Wade, 1990; Lall, 2004).

The intensity of the carrot­and­stick measures
outlined above is in marked contrast with the indus­
trial policymaking of other State­led economies.
For example, in Malaysia, technology transfer did
not involve any ex post monitoring and appraisal,
while the ex ante screening was poorly managed,
as exemplified in the case of Proton, the “national
car” project. Despite having been granted substantial
protection through high tariffs and excise duties since
1983, Proton has yet to develop engine­manufactur­
ing capability because the Malaysian Government
has had no rigorous mechanisms to monitor and
improve performance to adjust tariffs downwards
according to levels of efficiency (Doraisami and
Rasiah, 2001). Political factors aside,7 the lack of
effective carrot­and­stick incentives warrants close
attention, as it draws a fine line between successful
and failed catching­up.

B. Macroeconomic stability matters,
but in unconventional ways

Another shortcoming of the proponents of
proactive State intervention is the downplaying
of macroeconomic policy in relation to industrial
upgrading. East Asia reminds us that the stability of
macroeconomy was instrumental in gearing a country

towards successful catching­up. However, it is worth
noting that for the first­tier NIEs, macroeconomic
policies were considered part of, and subordinated
to, the overriding goal of structural transformation
and enhancing export performance.

In the Republic of Korea, fiscal and monetary
policies were employed to sustain a high level of
investment by creating an expansionary environment,
even through inflationary measures if necessary
(Chang, 1993). During the 1960s and 1970s, annual
per capita income in the Republic of Korea was grow­
ing at 9.5 per cent, in parallel with an average inflation
rate of around 15.5 per cent (Jeon, 1995). Overall, the
majority of financial resources were directed towards
targeted sectors. The Republic of Korea ran budget
deficits to finance government investment or re­lend
to private sectors. Fiscal support by the government
to favoured firms and industries was far greater than
officially shown in budget expenditures (Haggard
et al. 1994). One of the most important means was
“policy loans”, which accounted for 57.9 per cent
of total bank loans made approximately between
1962 and 1987 (Heo, 2001). Monetary policies
were also used to manage credit allocation in the
targeted industries and increase household savings.
Real deposit interest rates were increased to raise
the low national saving rate, thus helping to close
the saving gap. To control resource allocation, the
government repossessed a major portion of equity
shares of nationwide commercial banks in 1961 and
exercised tight control over the lending activities of
these institutions until the early 1980s (Dornbusch
et al., 1987).

Macroeconomic policy in Taiwan Province of
China may be more “conventional” than that of the
Republic of Korea. Throughout its catching­up period,
Taiwan Province of China attained surplus budgeting,
high real interest rates, low money supply and stable
foreign exchange rates (Auty, 1997). Nonetheless,
during the high­growth period of 9.7 per cent from
1960 to 1979, Taiwan Province of China still had an
average inflation rate of 7.2 per cent (Jeon, 1995). The
balance of priority between macroeconomic stability
and industrial upgrading was readjusted at times.
When confronting external shocks, the top priority
was placed on macroeconomic stability, although
once the economy was stabilized growth would return
to the top of the agenda. For example, whenever
export growth slowed down, Taiwan Province of
China’s central bank would lower the rediscount rate
on export loans to stimulate investment. Despite a

62 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

relatively restrictive monetary policy, the economy
had a significant informal, unregulated financial
sector, which has been a major supplier of funds for
small­ and medium­sized firms. Private enterprises
in Taiwan Province of China borrowed up to 34 per
cent of annual funds for investment and operations
from the informal financial sector in the 1964–1991
period (Lin et al., 1996).

At a glance, Singapore’s macroeconomic policy
seems the most conservative among these first­tier
NIEs, with low inflation, high savings and invest­
ment and small government expenditures. It had an
inflation rate of only 4.3 per cent between 1965 and
1979, while growing at 10.2 per cent on average
(Jeon, 1995). However, these conventional figures
were only made possible because the island State
engineered the “unconventional” tools to encour­
age industrial investment. For one thing, the use of
government budget surplus is a misleading indica­
tor of Singapore’s fiscal stance as it rules out the
gigantic resources spent by the State­owned enter­
prises, known as the government­linked companies
(GLCs). On the one hand, these GLCs hold majority
shares in a wide range of areas, including Singapore
Airlines, telecommunications, financial services,
energy and natural resources, transport, shipping,
semiconductors, health care, and engineering. As
a result, the public sector share of gross fixed capi­
tal formation in Singapore was 35.6 per cent in the
1960s, 26.7 per cent in the 1970s and 30.3 per cent
in the 1980s, which were even much higher than in
Taiwan Province of China and the Republic of Korea
(Shin, 2005). Singapore often used these GLCs to

pump­prime the economy whenever there was any
sign of economic downturn. Furthermore, profits
from GLCs were used to subsidize deficits in govern­
ment priority areas like housing, which kept up the
effective demand (Chowdhury, 2008).

On the other hand, the major source of Singapore’s
public sector investment stems from the country’s
compulsory social security scheme that forces every
employee to save, named the Central Provident Fund
(CPF). Between 1974 and 1985, government savings
rose from 23 to 67 per cent of gross national savings.
The CPF provided a ready and non­inflationary
source of finance for government spending, including
fiscal incentives for foreign investors, with lower than
market interest rates (Huff, 1999). Together, the use
of GLCs and the CPF functioned as an “automatic
stabilizer for inflation” in Singapore. Meanwhile,
certain monetary policies have been utilized to restrict
short­term capital flows; for example, withholding
tax on interest earned by non­residents and prevent­
ing banks from making Singapore dollar loans to
non­residents or residents for use outside Singapore
(Chowdhury, 2008).

In summary, although macroeconomic stability
was a necessity, it should be defined in a broader way
as part of national development strategy, rather than
a narrow, unfounded focus on single­digit inflation
and budget balancing. To the greatest extent possible,
macroeconomic policy should focus on the variables
of ultimate concern, such as efficiency, growth and
equity, rather than an intermediate variable like infla­
tion (see Herr and Priewe, 2006; Stiglitz et al., 2006).

This chapter has explored the growing body of
literature on the MIT, providing reflections and policy
lessons drawn from the catching­up experience of the
Republic of Korea, Singapore and Taiwan Province
of China, the so­called first­tier NIEs. First, with
some oversimplification, I classified the existing
MIT literature into three groups, labelled by their
policy statements, namely: (i) getting education and
institutions right; (ii) changing export composition
through comparative advantage; and (iii) industrial
upgrading through State intervention. Although the

factors studied and policy suggested overlap across
those works who used the term MIT, they differ in
their emphasis on the factors that engendered the
“trap”, as well as the extent to which the State should
play a role, which are the main benchmarks that
I have used for this classification.

The chapter subsequently examined each of the
above three strands in relation to the East Asian devel­
opment experience. Regarding the first strand, I argued
that education and good governance institutions cannot

V. The middle-income trap: Future research agenda

63The Middle-Income Trap and East Asian Miracle Lessons

guarantee successful catching­up; rather, both have
to be designed to tailor specific industrial targets of
the country at that time, as exemplified in East Asian
economies. If the subject matter is about long­term
economic growth, transforming the productive struc­
ture and export compositions of a country should
be at the centre of policymaking, as the second
MIT strand suggested. If anything, these East Asian
economies have achieved the fastest industrialization
in human history. However, in doing so, the role of the
State rather goes beyond a comparative­advantage­
following strategy, with this theory heavily relying on
unrealistic assumptions. Of course, moving against
comparative advantage demands well­designed
industrial and technology policies. The third strand of
literature, which advocates proactive State interven­
tion, typically underestimates the nitty­gritty details
of incentives needed for industrial upgrading, as well
as the compatible macroeconomic policies required
to maintain economic stability.

To make the future debate on the MIT more
relevant to, and policy advice more realistic for,
today’s developing countries, the chapter ends with
two conceptual grounds for policymaking and one
crucial research agenda.

To begin with, we should have reached a con­
sensus that industrial policy can work – although it
can also fail – before moving on to the productive
debate. In other words, both God and the devil of
industrial policy are in the details. In doing so, two
conceptual points should give grounds for policymak­
ing. First, industrial and technology policymaking
should be posited on the same level as other types
of policymaking, whether education, health or
social policies, in the sense that it will certainly be
confronted with problems and difficulties in terms of
implementation. However, the tasks of policymak­
ers are to minimize such problems and maximize
the benefits through processes of policy evaluation
and refinement. Second, targeting should not imply

an automatic negative connotation. The debate
over “functional” versus “selective” intervention is
almost meaningless at the operational level. Those
who support functional intervention of the State may
draw the line of intervention at education, R&D and
infrastructure that benefits all industries equally.
Nonetheless, almost all interventions in reality
inevitably favour some sectors and actors over others,
and thus have discriminatory effects that amount to
targeting (Rodrik, 2008; Chang 2011).8 Accordingly,
designing a systemic selective policy ex ante should
be a more productive and accountable enterprise than
deploying it with blind prejudice.

Nevertheless, one of the crucial yet under­
researched areas in the field concerns the potential
criteria for effective targeting. Although targeting is
almost inevitable, we still lack a set of well­developed
measures to be employed by developing countries.
Among recent studies in this thread is Lee (2013),
which argues that leapfrogging is more likely to
take place in the sectors characterized by rapid
technological change. Lee argues that the success
of the Republic of Korea and Taiwan Province of
China is largely due to their overarching strategy
towards “short­cycle”, technology­based sectors.9
Short­cycle technologies mean that the sector not
only has less reliance on existing technologies but
also has a greater opportunity for the continued
emergence of new technologies. For example, the
Republic of Korea’s catching­up with Japan in
high­definition TVs would not have been successful
if in the 1980s Korean electronics companies had
not targeted the emerging digital technology­based
products more aggressively than Japanese companies,
which decided to continue manufacturing the then­
dominant analogue products. In summary, to distil
useful policy lessons, an exploration into criteria
for targeting such as Lee’s technological cycle time
should be one of the crucial themes of future MIT
research (also in this vein are Hausmann et al., 2011;
Lin and Treichel 2011).

64 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

1 According to the country’s GNI per capita in 2012,
countries have been classified as follows: low
income, $1,035 or less; lower­middle income,
$1,036–$4,085; upper­middle income, $4,086–
$12,615; and high income, $12,616 or more. Note
that the World Bank measures and categories have
been repeatedly adjusted.

2 Hong Kong (China) is dropped from my discussion,
as it is the only economy in East Asia that has been
prosperous mainly due to free trade and a laissez-
faire industrial policy. However, Hong Kong (China)
had never been an independent State. As a British
colony from the mid­19th century until 1997, it was
used as a platform for Britain’s financial and trading
interests in Asia. It has subsequently become China’s
financial and trading centre.

3 It is worth noting that my review here is limited to
those that explicitly use the term “middle­income
trap”. Seemingly related works, such as those on
middle­income countries or the East Asian devel­
opment, are not included if they have not used that
specific term.

4 In 1960, the Philippines had a literacy rate of 72 per
cent, while it was 71 per cent for the Republic of
Korea, 68 per cent for Thailand, 54 per cent for

Taiwan Province of China and 53 per cent for
Malaysia (Sarel, 1996).

5 High­tech products are defined as products with high
R&D content (see Palma, 2009).

6 How the role of globalization and the changing
patterns of international trade have affected the
path of structural transformation is discussed at
greater length by Yang in the volume Development
Strategies – Country Studies in Comparison.

7 Nonetheless, the deeper causes of second­tier NIEs’
mediocre catching­up lie in their political and insti­
tutional deficiencies; for example, the Philippines’
oligarchic structure (see Hamilton­Hart and Jomo,

8 For example, granting R&D subsidies implicitly
favours R&D­intensive high­tech sectors. Building
railways (rather than roads) implicitly favours the
steel industry (over the auto industry). Among a few
policies that could be regarded as “general” are basic
education and health care (Chang, 2011).

9 Lee (2013) measures the cycle time of technologies
by the mean citation lag, which is the time difference
between the application year of the citing patent and
that of the cited patents.


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67The Role of Industrial Policy in Developing Countries

The voices gathered against “industrial policy”
in the economics profession have long achieved a
choral force. For Nobel laureate Gary Becker, “the
best industrial policy is none at all” (1985). For
John Williamson, crystallizer of the Washington
Consensus about appropriate development policy,
“little in the record of industrial policy suggests
that the state is very good at ‘picking winners’”
(2012: 10). For Lawrence Summers, former chief
economist of the World Bank, Treasury Secretary of
the United States, presently professor of economics at
Harvard, government “is a crappy VC [venture capi­
talist]” (quoted in Nocera 2011). For The Economist
magazine, “the government has a terrible record of
picking winners” (2011).

For William Easterly, ex­World Bank economist
and currently professor of economics at New York
University, “[t]he track record of dictators picking
winners is very poor, so why are we so sure that this
factor contributed to the success of the Gang of Four
[East Asian tigers]?” (2009: 129). An interviewer
pressed him on how he reconciled his faith in free
markets with evidence that the typical developing
country had better economic performance in the
1960s and 1970s, when governments intervened
more, compared to later, when governments inter­
vened less: “It is a bit of a mystery why they did well
... the growth had a lot of mystery for me ... It is mys-
terious to those who advocate hands­off markets.”
(Easterly, 2002: 91, emphasis added).


Robert H. Wade


The voices raised against “industrial policy” in the economics profession have long achieved a choral
force. However, historical evidence suggests that the public authorities of virtually all of the small
number of non-western economies that achieved “developed” economic status in the past two centuries
have used industrial policy to impart directional thrust aimed at catching up with western economies.
Since the 2007–2008 financial crash and ensuing long slump, minds have become somewhat more
open to this evidence as the realization dawns that western countries themselves have to restructure
their production structure beyond the limits of “let the market decide”.

This chapter argues that the classic developmental State is only viable today for a very small number
of countries with large domestic markets. However, a variant of the developmental State can still be
viable. The chapter spells out necessary features of the encompassing political settlement and the
industrial policy agency itself. It ends on the note that developing country policy makers should be
cautious about accepting mainstream economists’ blanket negatives about industrial policy.


68 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

By this time, Easterly had been analysing
development issues for 21 years, most of them in
the World Bank.

In short, the choral force says that “industrial
policy” is “government picking winners”; and eve­
ryone knows that governments cannot pick winners.

However, since the Great Western Recession
starting in 2007–2008, industrial policy has enjoyed
something of a renaissance. Prominent development
economists (including Ha­Joon Chang, Ricardo
Hausmann, Justin Yifu Lin, Mariana Mazzucato,
Dani Rodrik and Joseph Stiglitz) write about it in at
least partly positive terms, with their arguments elicit­
ing a more respectful response within policy circles
than before. Lin’s advocacy is significant, because
he was chief economist and senior vice president at
the World Bank from 2008 to 2012, which gave him
an institutional platform for disseminating ideas.
The Organisation for Economic Co­operation and
Development (OECD) published a flagship report
with “industrial policies” in the title, Perspectives on
Global Development 2013: Industrial Policies in a
Changing World (2013). UNCTAD and the ILO pub­
lished Transforming Economies: Making Industrial
Policy Work for Growth, Jobs and Development (2014,
edited by Salazar­Xirinachs et al.). The United Nations
Industrial Development Organization (UNIDO) now
makes “inclusive and sustainable industrial develop­
ment” its banner headline and organizes industrial
policy promotion events. Mariana Mazzucato’s The
Entrepreneurial State: Debunking Public vs. Private
Sector Myths (2013) became a widely reviewed best­
seller, translated into six European languages so far
and top of Amazon’s “economic policy” list for six
months, with sales of around 10 000 (as of mid­2014).

This chapter begins by summarising reasons for
the recent – apparent – re­legitimation of industrial
policy in section one. Section two discusses the scope
today for a developmental State à la France, Japan,
the Republic of Korea, Taiwan Province of China and
Brazil of the post­war decades. Section three outlines
a recent debate about how a government should
identify priority industries or products, particularly
concerning the extent to which it should only target
activities within the economy’s current comparative
advantage. Section four turns to organizational issues:
the political and organizational features that make
for high capacity to implement industrial policy at
the level of State­society relations and the level of
particular agencies. Section five concludes on the

future of industrial policy, with some suggestions
and cautions for developing country policymakers.

Before proceeding, it is necessary to raise three
points about the larger context of industrial policy.
First, the past two centuries since the Industrial
Revolution show, on the one hand, a dramatic Great
Escape from lives that were “nasty, brutish and
short”, borrowing Thomas Hobbes’ phrase (Deaton,
2013). On the other hand, the number of non-western
economies that have become developed in the two
centuries since the Industrial Revolution is less
than ten, even stretching the categories of “non­
western”, “economies” and “developed”. The list
plausibly includes Japan, the Russian Federation,
Taiwan Province of China, the Republic of Korea,
Hong Kong (China), Singapore, Israel and maybe
Mauritius. Such a low total suggests that strong forces
operating at the level of the world economy hold
“developing” countries back, analogous to gravity,
and that the vast “development industry” created
since the Second World War can hardly be classed
a success. The non­western success stories had or
have two conditions in common: first, external State
enemies capable of conquering the territory; and
second, a public authority imparting more directional
thrust than is consistent with neoclassical develop­
ment prescriptions (with Hong Kong (China) being
a partial exception to the second condition).

This finding should induce caution about accept­
ing the Washington Consensus agenda for developing
countries (privatize­free trade­deregulate­no industrial
policy), even though, according to John Williamson,
it reflects the beliefs of “all serious economists”.

Second, industrial policy – understood as tar­
geted efforts to change the production structure of an
economy in order to accelerate economic development,
so it should more accurately be called “production
transformation policy” – is an “inner wheel” whose
effects depend on “outer wheels” of macroeconomic
conditions and underlying political settlements.

Macroeconomic conditions refer especially to
the exchange rate. Standard comparative advantage
theory assumes that when economies specialize and
trade on the basis of comparative advantage (produce
and export products whose opportunity costs are
lower compared to other products that might be pro­
duced in the same economy and import the rest of the
consumption bundle), welfare will be maximized and
trading economies will all gain from trade. The freer

69The Role of Industrial Policy in Developing Countries

the trade, the greater the welfare gains, compared to
no trade. The theory assumes that trade is balanced,
with no payments surpluses or deficits, although the
mechanisms of balance are unclear. A cousin of the
standard theory (the purchasing power parity theory
of exchange rates) says that the balance comes from
the exchange rate moving to ensure that the price of
a good in two countries is the same when expressed
in a common currency. This means that producers in
the relatively most efficient country will specialize
in the good and others will import it. Accordingly,
the exchange rate adjusts to reflect relative cost dif­
ferences, which signal the appropriate specialization.

However, this is a fanciful picture of how ex­
change rates move in the real world. They not only
move in response to trade flows but also in response
to (often much greater) volatile capital flows, and
can go in quite the wrong direction for balancing
trade flows – and for helping a country’s emerging
industries to compete internationally (see Frenkel
and Rapetti chapter, this volume). The exchange
rate is commonly as important a determinant of
growth and the structure of production and trade as
the dense array of international trade and investment
rules. However, the literature on how to do industrial
policy tends – wrongly – to treat the exchange rate
as belonging to another policy realm.

Political settlements, the second kind of “outer
wheel”, refer to institutional balances between the
State, business and labour, as well as between rival
parties or groups contending for control of the State.
Political settlements affect the extent to which “busi­
ness”, “politicians”, “police”, “judges” and “Church”
are unconstrained in their (collusive) control over
society, the extent of “rule by law” rather than “rule
of law”, the extent to which labour movements limit
the power of business and the extent to which the
State ties industrial policy assistance to performance
conditions. Political settlements affect wages, income
distribution and domestic demand, as well as the
State’s ability to raise broad­based taxes and use the
revenues for financing public goods, as distinct from
private goods or goods with which to keep others
out of power.

The third contextual factor is limits to growth,
especially environmental limits. Any discussion of
the economic growth and catch­up of developing
countries has to acknowledge that endless growth on
a finite planet is impossible – short of revolutionary
changes in technology.

For the most part, this essay takes these points
as given and focuses on debates around industrial
policy more narrowly construed.

Let us consider why industrial policy is currently
receiving attention in the spirit of how to do it better
rather than how to do it less. There are several reasons.

First, the Great Recession and median income
stagnation in the western world (more than six years
old at the time of writing) has dented the widespread
confidence in the idea that “free markets” and “small
States” are best for all.

Second, recent research shows that – contrary
to widespread understanding – the Government of
the United States has been vigorously undertaking
a form of selective industrial policy for several
decades, especially since the 1990s. Agencies such
as the Defence Advanced Research Project Agency,

National Institutes of Health, National Institute
of Standards and Technology and the Central
Intelligence Agency have taken the initiative to cre­
ate and steer knowledge­pooling networks, linking
(a) firms that otherwise compete with each other,
(b) sources of finance and (c) universities, public labs
and private labs. This form of industrial policy of the
United States has escaped public attention, partly
because there is no superordinate “industrial policy
agency” akin to Japan’s Ministry of International
Trade and Industry (MITI) in the post­war decades, as
well as because the agencies have tried to keep their
network­building and direction­setting programmes
below the radar of conservative public attention
(Wade, 2014b; Mazzucato, 2013; Lind, 2012; Block
and Keller, 2011; Schrank and Whitford, 2009).

I. The return of industrial policy?

70 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

The contradiction between the fact of vigorous
industrial policy in the United States – where State
agencies are active in helping to pick (or more accu­
rately, make) winners – and the general understanding
that the United States does not do industrial policy
prompts the quip that the most successful United
States industrial policy is to persuade the world that
the United States does not do industrial policy.

A third reason for the recent attention to indus­
trial policy is the dramatic fall in the growth rates of
“emerging economies” after 2010, which dented con­
fidence that their high growth rates from 2003 to 2010
would be sustained long into the future, powering a
catch­up to developed countries. The fall in emerg­
ing economy growth rates is another fact that helps
to open minds to the potential for industrial policy
to spur production diversification and upgrading. In
the new situation, people devote more attention to the
previously little noticed trend: in the period from 1980
to the early­2000s, the majority of middle­income
countries in Latin America, sub­Saharan Africa,
Middle East and North Africa and South Asia fell
behind the West in relative average income, whereas
more of them had raised their per capita incomes
relative to the capitalist core in 1960–1980, during
the era of supposedly bad “import­substituting indus­
trialization” (Wade, 2003a; 2014a). The later falling
behind occurred while many of these economies were
under “structural adjustment programmes” of the
World Bank and similar organizations, whose content
derives from the Washington Consensus. After the
2008 Crash, people became more willing to notice
evidence that structural adjustment and Lawrence
Summers’ “three ­ations” (privatization, stabilization,
liberalization) were not so favourable a foundation for
development as they had been led to believe.

Fourth, there is accumulating evidence that
many upper middle­income countries that might be
first in line to graduate to developed economy status
are stuck in a “middle­income trap” (see Kanchoochat
chapter, this volume). While this has become a popu­
lar phrase, it hides an important distinction between
a middle­income trap and a middle capabilities trap.
Even when a middle­income country converges
upwards in income (thanks to high prices for com­
modity exports), it may be stuck in a capabilities trap.
For example, its non­natural­resource­based firms
may find that – with the exchange rate buoyed up by
the commodity exports – they cannot compete with
firms producing standardized products in lower­wage
countries, as well as being unable to compete with

firms producing more technology­intensive goods and
services in higher­wage countries (Paus, 2012; 2014).

The notion that much of Latin America might
be stuck in the capabilities trap is suggested by the
dramatic fall in the region’s ratio of regional manu­
facturing value­added to regional GDP, from 26 per
cent in 1980 to 16 per cent in 2009 (East Asia’s
equivalent figure is over 30 per cent) (World Bank,
2014). Chinese­ and German­made intermediate and
final goods were in evidence everywhere at Brazil’s
World Cup venues in June–July 2014.

Some evidence suggests that even the South­
East Asian economies are no longer advancing in
high value­added manufacturing activities. True,
Malaysia, Thailand, and Indonesia experienced
deep structural change out of natural resources and
into manufacturing after the mid­1970s, especially
in electronics, electrical engineering, textiles and
autos, building up production and management skills
to match the productivity levels of developed coun­
tries in standardized products. No other developing
countries beyond North­East Asia have experienced
such growth of manufacturing capacities.

Nonetheless, in contrast to Taiwan Province of
China and the Republic of Korea at the equivalent
stage of development, not even the wealthiest –
Malaysia − has built an indigenous capacity to design,
innovate and commercialize into new and more
profitable sectors, while few firms have created even
regional brand names. All of them remain heavily
dependent on subsidiaries of multinational corpora­
tions (TNCs) for their higher­tech manufacturing
exports. Most importantly, backward links from TNC
operations into the domestic economy are thin, with
the result that domestic value­added in manufacturing
remains low.

Indeed, as China advances − dense backward
links from TNC operations to domestically­owned
firms, including firms operating in lower­wage
western China − it is leap­frogging the South­East
Asian economies, putting them under even stronger
competitive pressure (see Yang in volume 2 of this

A recent study of Malaysia finds that real wages
declined in 2002–2008, while the average skill
intensity of production also declined. It concludes:

Malaysian industry appears to be sliding down
the technological slope, and the incentives for

71The Role of Industrial Policy in Developing Countries

workers to improve their skills are weaken­
ing… technological capabilities are relatively
static (and may even be declining)… industrial
competitiveness is marking time (Yusuf and
Nabeshima, 2009: 26, emphasis added).

Worried about being caught in the middle­
income or capabilities trap, Governments of middle­

income countries have become more willing to
challenge the long­standing argument of mainstream
economics and the World Bank, namely that “the best
industrial policy is none at all.”

The above circumstances and evidence have
helped to make discussion of industrial policy par­
tially respectable.

The classic developmental State focused on
developing the capacities of indigenous firms across
a broad range of major global industries, capable
of acting as first­tier suppliers to TNCs and even
competing head­to­head with them. Today, only a few
economies with very large internal markets − China,
India and Brazil most obviously – have this as an
option. High entry barriers in the face of existing
TNC dominance and neoclassically­inspired trade
and investment rules make such an objective non­
viable for most (Pirie, 2013).

However, if the developmental State Mark I
(where the capitalist State leads the creation of a
diversified and autonomous industrial base) is now
only viable for very large developing countries, this
is not the end of the story; rather, there is scope for
developmental State Mark II.

First, World Trade Organization (WTO) rules
are more constraining for some policy instruments
than for others: more constraining for tariffs, quantita­
tive restrictions, local content requirements; medium
constraining for government procurement, intellec­
tual property, export subsidies in agriculture; and least
constraining for devaluations, investment incentives,
trade finance and export taxes, for example.

Second, the State can act more − or less − strate­
gically in attracting selected portions of global value
chains into its territory. It can bargain hard with a
TNC to maximize the transfer of skills into the heads
of citizens, or it can let the corporation decide by
itself how many citizens to employ in which stages
of which operations. Throughout the fast catch­up
phase, the public authorities of the Republic of Korea
and Taiwan Province of China bargained hard with

incoming TNCs, in a way that public authorities in
many other developing countries (Chile and Hong
Kong (China), for two) did not.1 Indeed, some stud­
ies argue that policymakers in the Republic of Korea
and Taiwan Province of China continue to practice
activist industrial policy, even as they keep their
interventions much more covert than in the past.2

In other words, the leaders of a State may buy
into the prevailing liberal ideology that they can best
promote development by improving the institutional
and physical framework for markets, in the hope
that, having made a level playing field in line with
the World Bank’s criteria (as in its Doing Business
reports), the players will turn up to play. Accordingly,
private profit­seeking investors − domestic and for­
eign − responding to incremental price signals, will
diversify and upgrade production sufficiently to keep
incomes rising. Alternatively, the leaders of the State
can use the remaining room for policy manoeuvre to
promote non­incremental jumps in the product and
technology space, in the spirit of developmental State
Mark II. In countries as varied as Argentina, Nigeria,
Thailand and the United Kingdom, State leaders
could still today undertake entrepreneurial roles,3
even accepting that anything like the developmental
States of East Asia of the post­war decades – building
up indigenously­controlled major industrial sectors in
cars, chemicals, petrochemicals and electronics – is
unlikely (Wade, 1990; 2003a; 2003b).

Indeed, new evidence suggests that since 2008
and the long slump, many developed and developing
country States – whatever they say – have moved
further away from “level playing field” policies and
intensified policy selectivity by sector, location and
ownership. This is the finding of Vinod Aggarwal and

II. The developmental State Mark II

72 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

Simon Evenett (2010), who draw upon the Global
Trade Alert data set for the United States, major EU
countries, Argentina, Brazil China, India and others.
Much of the resulting “industrial policy” (although
generally not called that) is directed at “green”
products and processes, which softens neoclassical
censure (albeit not as much as “military” does).
States have generally avoided tariffs and quantita­
tive restrictions (which, as noted, are in the “more
constrained” category of WTO rules). They have
employed modes subject to “medium” or “low” WTO
restraint, such as public procurement, discriminatory
subsidies and bailouts (“murky protection”).

In short, the quantum of industrial policy has
gone up since 2008, especially for green invest­
ments. WTO rules have affected the composition
of industrial policy instruments, rather than curbing
the quantum.

The developmental State Mark II is all the more
important for the many middle­income countries

that find themselves in the squeeze described ear­
lier, where their producers cannot compete with
low­wage countries in standard goods and do not
have capabilities to compete in exports of skill­ and
knowledge­intensive goods and services. China’s
position as the workshop of the world across a wide
range of manufactured products (more accurately,
the assembly workshop of the world, drawing upon
parts and components produced elsewhere, par­
ticularly in regional value chains spanning East and
South­East Asia) intensifies the squeeze on others.
Across swathes of manufacturing, China has enjoyed
absolute – not just relative − cost advantages over
producers elsewhere, while its exports have been
knocking out manufacturing employment in both
middle­ and high­income countries. The idea that
governments should hew to neoclassical principles
in response to this competitive squeeze and limit
themselves to investing in the basic ingredients of
State fiscal and legal capacity, as well as leaving the
outcome to the Invisible Hand mechanism, is – to
put it politely − debatable.

Justin Yifu Lin, chief economist at the World
Bank from 2008 to 2012, is a leading proponent of
“new structural economics”. He argues, first, that
market prices give signals for incremental change,
but can block larger economic diversification and
innovation. Second, governments can usefully push
or incentivize firms to diversify and upgrade their
production, giving more encouragement to some
activities ahead of others. Third, government efforts
should remain within the economy’s existing com­
parative advantage, because firms operating within
existing comparative advantage are more likely
to attain and sustain private profitability (and not
depend on continued government support). Fourth,
comparative advantage itself will evolve over time as
endowments change. Accordingly, investing in line
with today’s comparative advantage alters tomor­
row’s endowment structure, which alters tomorrow’s
comparative advantage and permits sustainable
(because privately profitable) production diversifica­
tion and upgrading relative to today.

The underlying image is of a vast, continuously
improving Toyota­style production system in which
different products have different growth potential
and opportunities and constraints are identified as
they emerge over time. Learning and self­discovery
by actors − private and public − are central.

Lin calls his approach the “comparative­
advantage­following” strategy, in contrast to the
“comparative­advantage­defying” strategy. He spells
out five operational steps for a specific country (Lin,
2010; 2012):

(1) Government identifies a list of goods and ser­
vices produced over the previous two decades
in dynamically growing countries with similar
endowment structures and average GDP 100 per
cent higher.

(2) Among the resulting list, government gives
priority to those products that some domestic

III. “New structural economics” and industrial policy

73The Role of Industrial Policy in Developing Countries

private firms have already started to produce,
and helps remove obstacles to their growth and
upgrading. For products not locally produced,
government could adopt specific measures to
attract firms in higher­income countries to invest
in these industries.

(3) Government should pay attention to private en­
terprises’ independent discoveries of successful
products that are not included in the list, as well
as providing support to scale up those industries.

(4) In developing countries with poor infrastructure
and unfriendly business environment, govern­
ment can invest in industrial parks or export
processing zones and make improvements to
attract domestic private firms and/or foreign
firms willing to invest in the targeted industries.

(5) Government should give limited incentives for
domestic firms or foreign investors that work
within the list of products in step (1) to com­
pensate them for the public knowledge created
by their private investments.

Lin stresses that targeted public support must
be confined to activities within the economy’s exist­
ing comparative advantage. This is a useful defence
against the standard accusation that any sectorally
targeted support amounts to “government picking
winners”. However, he has been reluctant to identify
criteria for distinguishing investments within and with­
out the economy’s existing comparative advantage.

For example, the Cambridge University­based
economist Ha­Joon Chang, born in the Republic
of Korea, emphasizes more than Lin that what an
economy produces today determines the skill and
comparative advantage of tomorrow – an effect that
is external to private decision making and “undersup­
plied” if resource allocation is left to private agents.

Chang argues that Japan’s push into steel, autos,
ships and the like in the late­1950s and early­1960s,
when its per capita income was only 19 per cent that
of the United States (1961, at market exchange rates),
was beyond its existing comparative advantage. The
same applies for the Republic of Korea’s push into
heavy and chemical industries in the late­1960s, when
its per capita income was only 6 per cent that of the
United States, as well as its push into semiconductors
in 1983, when its per capita income was still only
14 per cent that of the United States.

On the face of it, these combinations of products
and relative average income suggest that Japan and
the Republic of Korea invested heavily in products
far above their existing comparative advantage (for
example, far above the products being produced in
countries with average income twice theirs at the
time, in line with Lin’s step one).

Lin replied that these moves were indeed within
the country’s comparative advantage at the time.
In the Republic of Korea, POSCO, the giant State­
owned steel company established in 1968 against
strong World Bank advice, which soon became the
most efficient maker of basic steel products in the
world: “[B]uilt upon the success of development in
garments, wigs, footwear, and other labour­intensive
industries…, [the Republic of] Korea accumulated
capital and the capital intensity of its endowment
structure increased. From the perspective of the
comparative­advantage­following strategy, the
upgrading of a few firms into more capital­intensive
industries became a necessity”.

Lin continued: “Industries such as steel produc­
tion and shipbuilding were among the most advanced
industries globally in the nineteenth century, but by
the mid­twentieth century they no longer held this
leading­edge position… Investments in these mature
industries required a large amount of capital, com­
pared with traditional labour­intensive industries, but
their capital intensities were much lower than in the
emergent industries. It is therefore not surprising that,
with some government support for overcoming the
difficulty of mobilising a large amount of capital in
an economy with an underdeveloped financial sector,
these industries are viable in an economy that have
achieved or are approaching lower­middle­income
status” (Lin and Chang, 2009: 499).

However, Lin’s argument smacks of tautol­
ogy: the fact that Japan and the Republic of Korea
succeeded in the given industries means that those
industries with those technologies must have been
within their existing comparative advantage. More
generally, the principle that industrial policy should
remain within existing comparative advantage
seems to advise a Stone­Age economy trading with
an information and communication technology
economy to continue specialising in the production
of stone­intensive products as though this is the
optimal equilibrium (Salazar­Xirinachs and Nubler,
2010; Wade 2014c).

74 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

The debate between Lin and Chang leaves
unmentioned a surprising fact: we know little about
how East Asian industrial policymakers – in Japan
and Taiwan Province of China from the 1950s, the
Republic of Korea from the 1960s – went about
identifying priority sectors or priority firms and
changing support for the targeted industries and
firms over time.

My own research on East Asian industrial policy
identified two modes of targeted public support
(Wade, 1990; 2003a): first, “government leadership”,
where the government allocates public resources to
industries where the private sector is not willing to
invest on its own; and second, “government follower­
ship”, where the government comes in to underwrite
some of the bets that the private sector has already
made or would be prepared to make on its own.
An example of followership is the work of Taiwan
Province of China’s Industrial Development Bureau
in its role as an industrial extension service (parallel
to an agricultural extension service). Its employees
(about 150 by the early­1980s, mostly engineers)
visited factories up and down the country at frequent
intervals, and among other things kept nudging
owners and managers to rearrange the production
line, buy a new kind of machine tool, upgrade qual­
ity, diversify products, link up with subsidiaries of
TNCs producing in Taiwan Province of China and
hunt out export markets. They kept a close eye on
parts and components being imported by big foreign
firms or firms of Taiwan Province of China, and
looked for promising opportunities to “persuade” big
firms to switch their sources of supply from imports

to domestic producers, without having to take too
great a hit in price or quality. They regarded import
replacement and export promotion as “two wings of
the same bird”. Of course, the same bureau was also
involved in promoting the “big lump” investments
in upstream sectors, as were apex bodies like the
Council for Economic Planning and Development
and the Science and Technology Advisory Board.

Over time in any one sector, one can trace
periods of “leadership” and “followership” in various
sequences, as well as the default mode of no targeted
support at all. In terms of this distinction, “follow­
ership” is close to Lin’s advocacy of government
support for activities within the economy’s current
comparative advantage, while “leadership” is close to
Chang’s advocacy of public support for investments
beyond current comparative advantage. We can think
of government “leadership” as like “stretching”
comparative advantage, in an analogy with a rubber

What is missing from their arguments is the
point just made, namely that over time in any one
sector one should see movement between the three
modes; for example, an initial period of “government
leadership” in one sector may give way to more
limited support for private sector initiatives (“follow­
ership”) and then to no targeted support. Moreover,
what is missing from Lin, but not from Chang, is the
recognition that trade protection may be a justified
instrument of followership and leadership, especially
where State fiscal capacity to raise broad­based taxes
is relatively low.

The literature tends to concentrate on what the
State should do, using which instruments, whereas it
tends to leave unexamined the determinants of State
effectiveness (Devlin and Moguillansky, 2011, is a
useful exception). We can think of these at two levels:
first, the macro level of State­society relations and the
political settlements behind them referred to earlier;
and second, the more micro level of State agencies,
in particular, industrial policy agencies.

A. State-society relations

In terms of the first, a State executive has a broad
choice between (a) building generic State capacity
(fiscal, legal, bureaucratic, military) or (b) build­
ing specific State capacity to redistribute resources
to itself and its group at the expense of would­be
incumbents, using legal subterfuge, repression or
violence to exclude opponents. Where the State lacks

IV. Political and organizational determinants of industrial policy

75The Role of Industrial Policy in Developing Countries

experience of constitutional constraints and demo­
cratic accountability, electoral victors are more likely
to follow the second route and adopt winners­take­all
strategies, shutting out the opposition and governing
as they see fit. Few States of this kind have been
able to mount effective industrial policies. Most of
the exceptions (China is one) have sustained enough
State discipline to provide public goods (as well as
redistributive goods) because they see themselves
facing powerful external enemies, whose existence
induces internal solidarity and acquiescence. On the
other hand, where the State operates in conjunction
with a cohesive capitalist class, the prospects for
effective industrial policy are considerably improved.

The short answer to why the East Asian capital­
ist developmental States took the form they did is that
(a) their societies faced external State­based enemies
capable of overwhelming the whole society, and
(b) the owners and managers of capital faced episodes
of labour militancy early on. The famed “embedded
autonomy” of the East Asian developmental State
came out of co­determination between external
military threats, State fiscal, legal and bureaucratic
capacity, as well as State constraints on capital and
especially labour (Evans, 1995).

B. Making effective industrial policy

The Politics of Public Sector Performance:
Pockets of Excellence in Developing Countries,
edited by Michael Roll (2014), uses an inductive
approach to identify characteristics of State agencies
that distinguish themselves from the surrounding
bureaucratic swamp by being effective in carrying
out their mission. The case studies range across
Brazil (the National Development Bank), Nigeria
(National Agency for Food and Drug Administration
and Control), Surinam (State Oil Company),
mainland China before 1949 (Sino­Foreign Salt
Inspectorate), Taiwan Province of China after 1949
(Joint Commission for Rural Reconstruction) and
State­owned enterprises in rentier States. From these
case studies, Roll induces several necessary (but not
sufficient) conditions for “pockets of effectiveness”.

The first condition is a strong head of govern­
ment (or a small, coherent elite), which has strong
commitment to particular tasks – like industrial diver­
sification and upgrading – being done effectively.

His or her motives may be defence against external
enemies, national prestige or international prestige.

Second, the head of government breaks with
normal – patronage – appointment criteria, possibly
against a lot of elite opposition. Instead, criteria for
appointment to top positions in the agency empha­
size technical qualifications, proven leadership
and proven incorruptibility. The agency director or
chief executive officer (CEO) comes from outside
the inner elite and is connected to it through “weak
ties”. This makes the CEO less vulnerable to the
insider’s dilemma: the insider head of an agency
is under pressure to allocate jobs, contracts and
other public resources to other members of the elite
network, or risk their own career and effectiveness
from insider attacks; but stuffing the agency with
officials recruited on patronage networks is likely
to render the agency ineffective, which can also risk
the CEO’s career.

Therefore, prior to the appointment, the tie
between the CEO­to­be and the president is a weak
one; they usually do not know each other well,
because the candidate comes from outside the inner
elite. However, once selected, the third necessary
condition − the link between the CEO and the
president − must become a strong one, because the
CEO heavily depends on the president’s support to
defend him/her against the established elite’s attacks.
However, the link to the rest of the elite remains weak.

Fourth, the strong tie to the head of government
helps to secure the necessary bureaucratic autonomy
– necessary because the agency will often conflict
with politicians and firms with contrary interests
(e.g. firms wanting continued protection despite
non­performance). However, autonomy does not
mean separation or no contact, and it is not fixed
and based on law. Paradoxically, autonomy depends
on political connections and is inherently relational.
Agency managers must constantly manipulate their
external environment to secure their autonomy, using
connections to politicians, corporations, unions and
other powerful entities.

Fifth, the director must be free to appoint mem­
bers to the management teams and select staff who
are committed to the mission (“principled agents”),
most of whom come from outside political elite net­
works (some from private companies or overseas).
Salaries and benefits are higher than in the regular
civil service. However, the ethos of the agency is such

76 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

that performance does not mainly depend on extrinsic
incentives (money); rather, staff work conscientiously
mainly due to intrinsic incentives, because they see
their job as meaningful for national development.
Intrinsic motivation helps agency effectiveness
because it reduces the director’s costs of controlling
staff. In the language of principal­agent analysis, it
reduces the principal’s cost of controlling agents.

Sixth, an agency that aims to be a “pocket of
effectiveness” in a bureaucratic swamp must change

internal and external expectations of the agency’s
modus operandi. The key instruments are (1) stand­
ardization of procedures (for example, procedures
for project appraisals and project decisions) and
(2) regular evaluations of agency performance. In
relations with the outside, the standardization of
procedures enhances predictability for clients and
reduces the incentives for bribes. In relations within
the agency, standardization raises staff confidence in
the information they receive from others, rendering
it unnecessary for them to check it for themselves.

Many advanced and developing countries are
worried about the erosion of manufacturing in the
face of Chinese competition, many middle­income
countries are worried about being stuck in the middle­
income trap, many lower­income countries are
worried about being stuck as commodity exporters,
running faster to stand still, while many governments
− developed and developing − are trying to target
investment in “green” industries.

These trends have helped to rekindle a broad
interest in industrial policy, and national strategy
more generally, in developing countries. The arrival
of China as a major “aid” donor and foreign inves­
tor in Africa, Latin America, and other parts of the
developing world has forced recognition in host
governments that if they are not to repeat their earlier
failure to set the terms of engagement with western
“aid” and foreign investment, they must formulate
national development strategies and ensure that
Chinese investment meets their own development
agenda, rather than just China’s.

Several prominent development economists
have started to make the academic field bubble.
Some of the recent writing suggests flaws in the
earlier evidence used to discredit sectoral industrial
policy, drawing attention to previously neglected soft­
meso forms of industrial policy (such as the United
States form described earlier). Other development
specialists have focused on the important question of
how to constrain politicians and officials to provide
services (including industrial policy) that meet a
national interest test rather than a sectarian interest
test (Besley and Persson, 2011).

Some middle­income countries’ governments
draw inspiration from East Asian experience and have
been trying to use their growing voice in multilateral
development banks to change norms in favour of
doing industrial policy better, rather than simply less
(Wade, 2011).

It is often said that the rules of the international
economic order constitute a significant constraint on
effective industrial policy; indeed, it is true that WTO
rules make a large part of East Asia’s earlier devel­
opment interventions actionable or illegal (Wade,
2003b). Here, however, the neglected distinction
between hard and soft industrial policy − or leader­
ship and followership − is important, because most of
what the WTO makes actionable or illegal is towards
the hard end of the spectrum (protection, subsidies,
quantitative import restrictions and the like).

Developing country governments should exploit
this policy space, even as they try to modify the
larger framework of rules to allow more use of harder
measures. They should recognize that although the
East Asian, French and Brazilian developmental State
of the post­war decades is not a viable option today
(except perhaps in a few of the largest developing
countries), this is not the end of the story; rather,
scope remains for the developmental State Mark II.

However, we should not underestimate the
forces arranged against any more positive role of
government. Economics as a discipline has failed to
produce positive theories that match the pervasive
role of the State in most economies, as distinct from
theories (such as those of James Buchanan and

V. The future of industrial policy

77The Role of Industrial Policy in Developing Countries

George Stigler) that show the State as self­serving and
predatory, while the same theories give private firms
a largely free pass. The failure reflects an ideological
idea of the good society embedded in the DNA of the
neoclassical discipline, in which the government’s
appropriate role is to protect free markets and “fix”
occasional market failure when the Invisible Hand
does not produce satisfactory results. The operat­
ing procedures and loan conditions of western­run
organizations like the World Bank institutionalize
the idea of the free market as the optimal resource
allocation mechanism.

Indeed, efforts to promote the idea of industrial
policy in international organizations have encoun­
tered strong resistance from within the staff, as well
as from member States. When Justin Yifu Lin was
chief economist of the World Bank, only one vice
president showed an interest in trying to put his ideas
on industrial policy into modest practice, in the form
of several pilot projects under the name “Competitive
Industries program”. For all that Lin insisted on the
orthodoxy of his approach (industrial policy should
only assist activities within the economy’s existing
comparative advantage, not stretch it), Lin himself
admits that during his time as chief economist less
than 10 per cent of World Bank economists were
sympathetic to his arguments (personal commu­
nication, 2010). Under Lin’s successor, the chief
economist’s complex “is mainly run these days
by a Director of Development Policy who strongly
opposes any form of active government strategy”
(personal communication, July 2014). In the opera­
tions complex, the new Senior Director most relevant
to continuing the Competitive Industries programme
closed it down on the grounds that “she understands
industrial policy only as the failed import­substitution

policies implemented in Latin America in the 1960s”.
Therefore, post­Lin, the World Bank has played little
part in the new interest in industrial policy.

In the case of the OECD and its Perspectives
on Global Development 2013: Industrial Policies
in a Changing World, several of the staff of seven
delegated to produce the report made it clear that
they doubted the wisdom of industrial policy. Senior
OECD managers kept asking, “are we really sure the
OECD should endorse industrial policy?” (personal
communication, 2013).

As for UNIDO, its big push for Inclusive and
Sustainable Industrial Development is a kind of
gamble for resurrection. As big western States have
terminated or are terminating their membership of
UNIDO, it faces a budget crisis and appointed a
Chinese national as director­general in 2013 in the
hope that China will be able to elicit more buy­in
from developing countries and avoid staff cuts
(such as those in UNDP, where about 20 per cent of
its 5,000 staff have recently been made redundant).
Industrial policy is the substance around which the
organization is trying to elicit this buy­in from devel­
oping countries, even at the risk of further alienating
western States that continue to say that industrial
policy is a bad idea.

In short, developing country policymakers
should be cautious about accepting economists’
negative judgements about industrial policy, and
doubly cautious about accepting politicians’ negative
judgements of the kind made by the former German
Chancellor Helmut Schmidt, referring to national
exercises in foresight, “people who have visions
should see a doctor”.

78 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

Aggarwal V and Evenett S (2010). Financial crisis, “new”
industrial policy, and the bite of multilateral trade
rules. Asian Economic Policy Review, 5(2): 221–244.

Becker G (1985). The best industrial policy is none at all.
Business Week, 26 August.

Besley T and Persson T (2011). Pillars of Prosperity:
The Political Economics of Development Clusters.
Princeton, NJ, Princeton University Press.

Block F and Keller M (eds.) (2011). State of Innovation:
The U.S. Government’s Role in Technology Develop-
ment. Boulder, CO, Paradigm Publishers.

Chu Y (2009). Eclipse or reconfigured? South Korea’s
developmental state and challenges of the global
knowledge economy. Economy and Society, 38(2):

Deaton A (2013). The Great Escape: Health, Wealth and
the Origins of Inequality. Princeton, NJ, Princeton
University Press.

Devlin R and Moguillansky G (2011). Breeding Latin
American Tigers: Operational Principles for
Rehabilitating Industrial Policies. Santiago and
Washington, DC, ECLAC and World Bank.

Easterly W (2002). The failure of economic development,
interview. Challenge, 45(1): 88–103.

Easterly W (2009). The indomitable in pursuit of the inex­
plicable: The World Development Reports’ failure
to comprehend economic growth despite determined
attempts, 1978–2008. In: Yusuf S, ed. Development
Economics Through the Decades: A Critical Look
at 30 Years of The World Development Report,
121–130. Washington, DC, World Bank: 121–130.

The Economist (2011). Angst in the United States: What’s
wrong with America’s economy. 28 April.

The Economist (2012). The Third Industrial Revolution.
21 April.

Enos J and Park WH (1988). The Adoption and Diffusion
of Imported Technology. London, Croom Helm Ltd.

Evans P (1995). Embedded Autonomy: States and Indus-
trial Transformation. Princeton, NJ, Princeton
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Fine B, Saraswati J, Tavasci D (eds.) (2013). Beyond the
Developmental State: Industrial Policy into the
Twenty-first Century. London, Pluto Press.

Fourcade M (2009). Economists and Societies: Discipline
and Profession in the United States, Britain, and
France, 1890s to 1990s. Princeton, NJ, Princeton
University Press.

Halimi S (2013). Tyranny of the one percent. Le Monde
Diplomatique. (English version), May.

Jenkins B (2013). We Can’t Go on Like This – it is Time
to Reform the Civil Service. Financial Times.
12 December.

Klein N (2009). Why We Should Banish Larry Summers
From Public Life. Washington Post. 19 April.

Kohli A (2004). State-Directed Development: Political
Power and Industrialization in the Global Periphery.
Cambridge and New York, Cambridge University

Leunig T (2010). Economy Class. Prospect Magazine.

Kohli A (2004). State-directed Development: Political
Power and Industrialization in the Global Periphery.
Cambridge, Cambridge University Press.

Lin JY (2010). Six steps for strategic government interven­
tion. Global Policy, 1(3): 330–331.

Lin JY (2012). The Quest for Prosperity: How Developing
Economies Can Take Off. Princeton, NJ, Princeton
University Press.

Lin JY and Chang HJ (2009). Should industrial policy
in developing countries conform to comparative
advantage or defy it? Development Policy Review,
27(5): 483–502.

Lind M (2012). Land of Promise: An Economic History
of the United States. New York, NY, Harper Collins.



1 Enos and Park (1988) report that in the 1970s, when
the public authorities of the Republic of Korea, Chile
and Hong Kong (China) ordered the same ethylene
plant from Dow Chemicals, the Republic of Korea
pressed Dow much harder to employ nationals across
the several stages of the project; and the ratio of
nationals to regular Dow employees increased in
each of the two subsequent plants the Republic of
Korea ordered from Dow. This case fits a motto heard
in the Republic of Korea “we never learn anything
twice” (Wade, 1982).

2 See Chu (2009), who argues: “In seeking to attain
its development goals, the Korean state articulates
visions and deploys public resources to structure the
market and shape innovation”.

3 While even a State like the United Kingdom could
undertake an entrepreneurial role, the December
2013 report of its House of Commons liaison com­
mittee about the future of the civil service identified
a fundamental problem in the pervasive “belief
in incremental change versus long­term vision”
(Jenkins, 2013).

79The Role of Industrial Policy in Developing Countries

Madrick J (2014). Seven Bad Ideas: How Mainstream
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ing Public vs. Private Sector Myths. London, Anthem

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Creating Policy Norms in the IMF and the World
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the United States: A neo­polanyian interpretation.
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Wyman D, eds. Manufacturing Miracles. Princeton,
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Industrialization. Princeton, NJ, Princeton Univer­
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81The Real Exchange Rate as a Target of Macroeconomic Policy

Roberto Frenkel and Martín Rapetti*

In recent years, the idea that a stable and
competitive real exchange rate (SCRER) can foster
economic growth in developing countries has gained
much attention, with a growing body of research
having provided persuasive evidence indicating
that undervaluation of the currency – a high real
exchange rate (RER) level – is positively associated
with higher economic growth. Moreover, research
has also documented that RER volatility negatively
affects growth. Based on this and other more episodic
evidence, some economists and analysts have started
to advocate that developing countries should target a
SCRER as part of their development strategy.

The aim of this chapter is to take stock of the
work – including ours – that has addressed different

aspects of the SCRER strategy for development,
focusing on what we consider the three main issues.
First, we review in section I the empirical literature
finding evidence that SCRER is positively associated
with economic growth. Second, we discuss the mech­
anisms that could explain such an association and
their supporting evidence or lack of it. In section II,
we explore the theoretical and practical aspects of
macroeconomic management in a framework that
targets a SCRER while attaining full employment,
low inflation and balance of payments sustainability.
We conclude the chapter in section III with some
final remarks.

Before moving on, some definitions are in order.
We define the exchange rate as the domestic price of


In recent years, several authors have argued that developing countries should aim to target a stable
and competitive real exchange rate (SCRER) to foster economic growth. A growing body of empirical
research gives support to this claim. Although more theoretical work is needed, some ideas from
development theory can help to explain the empirical findings. For instance, if modern tradable
activities display some form of increasing returns to scale, market forces alone would deliver a set of
relative prices to render capital accumulation in these activities suboptimal. This chapter supports the
view that developing countries could target SCRER as part of a development strategy that promotes
the expansion of modern tradable activities. We review the empirical findings, discuss the channels
through which a SCRER can stimulate economic growth and describe the policies needed to pursue
a strategy based on a SCRER.


* The authors thank Emiliano Libman for his comments on the chapter.

82 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

a foreign currency. Consequently, a rise (fall) in the
nominal/real exchange rate implies a nominal/real
depreciation (appreciation) of the domestic currency.
The RER is the relative price between tradables and
non­tradables. A competitive RER level is one that
is above its equilibrium level.1 We generally refer

to a competitive RER level as the level at which the
modern tradable sector of a developing economy
reaches a risk­adjusted profit rate equal to that of
the same sector in a developed economy.2 We use
competitive or high RER and undervalued domestic
currency indistinctively throughout this chapter.

I. SCRER and economic performance3

The relationship between the RER, real wages
and output usually generates some confusion. On
the one hand, it is commonly accepted that real
currency depreciation has a negative impact on
output level in the short run. A standard Keynesian/
Structuralist interpretation is that real depreciation
redistributes income against wage earners, who have
a large propensity to spend, and thus it contracts
aggregate demand and output levels. Another com­
mon mechanism is the negative balance sheet effect
of devaluation when debts are issued in foreign
currency. On the other hand, the proposition that
we develop in this chapter claims that a stable and
competitive level of the RER – through mechanisms
discussed below – has a positive effect on the rate of
growth of output and real wages in the medium run.4

The two propositions are not contradictory: the
former refers to the short-run effects of a change
in the RER on output level, and the latter to the
medium-run effects of the level (and stability) of the
RER on the rate of change of output (i.e., economic
growth). While there is a good deal of evidence
supporting the first proposition,5 the second one is
more controversial. Below, we review a recent body
of research that supports the second proposition and
the mechanisms involved.

A. Empirical evidence

Most empirical work analysing the associa­
tion between RER levels and economic growth has
been conducted through growth regressions, finding
substantial evidence that competitive and stable RER
levels tend to be associated with higher GDP per
capita growth rates. The association appears robust
to changes in the estimation technique – cross­section
OLS, panel data (fixed and random effects), dynamic

panel data (GMM), non­linear panels and panel
cointegration techniques –, the number of control
variables and the data sources for both the dependent
and independent variables.

An interesting result is that the RER­growth
association seems to be especially strong in develop­
ing countries. Rodrik (2008) tests whether there is any
significant difference between developed and devel­
oping countries. He uses a fixed­effects model for a
panel of up to 184 countries between 1950 and 2004
and defines developing countries as those with a GDP
per capita less than $6,000 in constant dollars of 2005.
He finds that the positive relationship between RER
competitiveness and economic growth is stronger and
more significant for developing than developed coun­
tries. Rapetti et al. (2012) replicate Rodrik’s work and
show that if the threshold is selected from anywhere
in the $9,000–$15,000 range, the estimated effect of
RER competitiveness on developed countries’ growth
is similar to that estimated for developing countries.
Given the fragility of Rodrik’s result, they investigate
the issue in more detail by developing a series of
alternative developed/developing countries splits and
conducting different empirical strategies, finding that
the effect of currency undervaluation on growth is
indeed larger and more robust for developing econo­
mies. Extending the analysis for a substantially longer
period, Di Nino et al. (2011) also find supporting
evidence that the relationship is strong for developing
countries and weak for advanced countries in both the
pre­ and post­World War II period (1861–1939 vs.
1950–2009). Other studies, like Cottani et al. (1990),
Dollar (1992) and Gala (2008), focus exclusively on
developing countries and find similar evidence of the
positive effect of RER competitiveness on growth.

Since most of studies have used RER misalign­
ment indexes as measures of RER levels, a valid

83The Real Exchange Rate as a Target of Macroeconomic Policy

concern is whether the results are driven by cases of
RER overvaluation decelerating economic growth.
Put differently, the positive relationship between
RER levels and growth rates may result from low
RER levels decelerating growth, which also implies a
positive association between RER levels and growth
rates. Nonetheless, several studies have explicitly
addressed this concern.

Razin and Collins (1999) use a pooled sample
of 93 developed and developing countries over 16 to
18 year periods since 1975, finding that currency
overvaluation hurts and undervaluation favours
growth, although the effect of overvaluation appears
stronger. Aguirre and Calderón (2005) find that the
estimated coefficients of their RER misalignment
indexes are larger for cases of overvaluation than
those of undervaluation; but here, again, the positive
effect of undervaluation on growth is both statistically
and economically significant. Rodrik (2008) finds
that overvaluation hurts growth and undervaluation
favours growth and reports no significant difference
in terms of the size of each effect. Rapetti et al. (2012)
find similar results to Rodrik’s, although the effect
of overvaluation is slightly higher in absolute terms
than that of undervaluation. Bereau et al. (2012) use
panel non­linear techniques – i.e. a Panel Smooth
Transition Regression model – to capture whether
there are asymmetries between RER undervalua­
tion and overvaluation. They find robust evidence
that undervaluation accelerates and overvaluation
decelerates growth, with a similar strength.

Other studies have tested whether the RER­
growth association is robust to measurement errors in
the dependent and independent variable. MacDonald
and Vieira (2010) construct seven different indexes
of RER misalignment and use them alternatively on
the right­hand side of the growth regressions. They
find a significant and positive correlation between
RER competitiveness and economic growth, which
is stronger for developing and emerging countries.
Razmi et al. (2012) use the rate of investment growth
as the dependent variable, finding a strong positive
association with RER levels.

Many empirical studies have used Penn World
Tables (PWT) data for the dependent variable (i.e. GDP
per capita growth). Johnson et al. (2009) show that GDP
estimates vary substantially across different versions of
the PWT and that the results of many published studies
employing PWT growth rates – especially those using
higher frequency – are fragile when changing from

older to newer versions of the PWT. Libman (2014)
address this issue by using growth rates from data
sources other than the PWT, such as International
Financial Statistics, World Development Indicators
and Madisson Historical Statistics and finds that the
positive RER­growth association holds.

Other studies have used different empirical
strategies, like case and episode studies or historical
analyses and also found supporting evidence that
SCRERs favour economic growth. Hausmann et
al. (2005) identify and analyse determinants of
‘growth episodes’ in the latter half of the twentieth
century, finding that adjustments of RER towards
more competitive levels tend to precede sustained
growth spurts. Frenkel and Rapetti (2012) carry out
a historical analysis of exchange rate regimes and
economic performance in Latin America and find
that countries have tended to growth faster when
macroeconomic policies aimed to maintain SCRERs.
Regarding the role of RER stability, Cottani et al
(1990), Eichengreen (2008) and Rapetti et al. (2012)
have found supportive evidence that RER volatility
is negatively associated with GDP growth.

B. Mechanisms

Research has established a robust positive asso­
ciation between RER levels and economic growth.
Although there might be some room for debate,
it seems widely accepted that the causality runs
from RER levels to economic growth. Every­day
experience shows that governments use a variety of
instruments – including exchange rate, monetary,
fiscal, incomes and capital management policies – to
manage the level and stability of the RER with real
objectives. Thus, the relevant question is not about
causality but rather the mechanism explaining why
undervalued (overvalued) RER levels would favour
(hurt) economic growth. Below, we discuss the
mechanisms that we consider more plausible.

One such mechanism focuses on the effects of
capital movements on the RER and the probability of
crisis. An extreme form of this mechanism arises as
a result of currency overvaluation caused by massive
capital inflows, which eventually leads to currency,
financial and debt crises with a long­lasting negative
impact on growth. Indeed, a number of developing
countries – mostly in Latin America – have experi­
enced this type of boom­and­bust episodes.6 Many
of these episodes began with the implementation of

84 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

macroeconomic programmes that combined fixed or
semi­fixed exchange rates, liberalized current and
capital accounts and the deregulation of domestic
financial markets. In a first phase, the combination
of these elements stimulated capital inflows that
appreciated the domestic currency in real terms,
expanded economic activity and induced current
account deficits. In many cases, a consumption
boom ensued without a rise in the investment rate.
Even when investment increased, the overvaluation
of the currency favoured investment in non­tradable
activities with little increase in the export capacity
required to repay foreign debt.

In a second phase, the excessive external bor­
rowing raised concerns about the sustainability of the
fixed exchange rate regimes and triggered speculative
attacks against the domestic currencies, whereby the
effect of capital outflows was typically contraction­
ary. The domestic banking systems – which had
currency mismatch between dollarized liabilities and
assets in domestic currency – faced liquidity prob­
lems and went bankrupt in many cases, exacerbating
the negative impact on economic activity. In cases in
which the collapse of the financial system was severe
and the foreign (private and public) debt burden
was very high, the crises had long­lasting effects on
economic growth. Clear examples of these dynam­
ics are the stabilization programmes based on active
crawling pegs (the so­called tablitas) in Argentina,
Chile and Uruguay during the late­1970s, which
ended up in severe debt crises that crippled growth
during the ‘lost decade’ of the 1980s. Other stabiliza­
tion programmes leading to crises occurred during the
1990s in Mexico (1994–1995), Brazil (1998–1999),
Argentina (2001–2002) and Uruguay (2002). Taylor
(1998) suggests that this kind of cyclical dynamics
was also observed in the South East Asian crises of
1997–1998, while Bagnai (2012), Cesaratto (2012)
and Frenkel (2013) argue similarly concerning the
current crisis in the southern European countries.

Historical records are supportive of this mecha­
nism for the case of currency overvaluation and low
or negative growth via the effects of crises, with more
recent experience in emerging market accounting for
the positive association observed between high/com­
petitive RERs and faster growth. Several authors have
indicated that undervalued currency help to stabilize
long­term growth by limiting external debt accumula­
tion and avoiding contractionary effects of sudden
stops (Prasad et al., 2007). Competitive RERs typi­
cally generate current account surpluses and facilitate

foreign exchange (FX) reserve accumulation, which
in turn operate as an insurance against international
financial instability and sudden stops. Recent
research supports this view, with Aizenman and Lee
(2007) finding evidence suggesting that international
reserve accumulation in emerging markets has been
carried out as a self­insurance strategy to protect the
economy from sudden stops. Polterovich and Popov
(2003) and Levi Yeyati et al. (2013) find a positive
correlation between FX reserve accumulation and
RER levels, as well as between reserve accumula­
tion and economic growth. Similarly, Prasad et al.
(2007) find that current account balances are highly
and positively associated with both undervalued
currencies and economic growth.

The mechanism discussed above highlights
that international capital markets operate with
many imperfections that can jeopardize long­term
economic performance, particularly in developing
countries. Consequently, these countries need to
establish safe linkages with international markets to
minimize their reliance on foreign savings and the
probability of crises. It is important to note that this
refers to the composition of savings. A higher RER
helps to reduce the domestic absorption of tradables
while promoting the domestic production of trada­
bles, thus lowering foreign saving. At the same time,
a higher RER level implies a transfer of income from
workers to firms via the decline in real wages gener­
ated by the rise in tradable prices. If workers have a
lower propensity to save than firms, the redistribution
would result in higher domestic savings. The effect of
a higher RER level on aggregate savings would be
determined by the effect of these two. While evidence
concerning the complete effect is not entirely clear,
it seems to suggest that RER levels and aggregate
saving rates are positively associated.

In our view, the strongest mechanism is one that
rests on the key role that “modern” tradable activi­
ties play in the process of economic development.
Essentially, this mechanism perceives economic
development as a process characterized by a rapid
and intense structural transformation from low­
productivity to high­productivity activities that are
largely tradable. While “modern” tradables have
traditionally been associated with manufactures,
there is now recognition that some services (e.g.,
software) and knowledge­intensive agricultural
activities (e.g., seed production) are also part of this
group. The tradable­led growth channel can be seen
as comprising three broad elements:

85The Real Exchange Rate as a Target of Macroeconomic Policy

(i) Modern tradable activities are intrinsically
more productive or operate under some sort of
increasing returns to scale.7

(ii) Given this trait, the reallocation of (current
and future) resources to these activities – i.e.
structural change – accelerates GDP per capita

(iii) Accumulation in these activities depends on
their profitability, which in turn depends on the
level of the RER. Rapid capital accumulation
requires a sufficiently competitive (high) RER
to compensate for the market failures caused
by the increasing returns.

A large number of specific mechanisms have
been advanced with this general logic. In an influ­
ential article, Rodrik (2008) indicates that modern
tradable activities are disproportionally affected by
market and institutional failures. Using an endog­
enous growth model, he shows that the resulting
misallocation of resources towards non­tradables
leads to slower economic growth, whereby a high
RER can be a second­best policy that compensates
for the market and institutional failures, improves
tradable profitability and accelerates economic

Of course, Rodrik is not the first to emphasise
the important interplay between RER levels and
market failures in economic development. Learning
externalities, for instance, imply that infant industries
in the tradable sector can benefit from temporary
protection against foreign competition via a transitory
trade policy or currency undervaluation (Ros, 2013).
Similarly, temporary currency overvaluation can lead
to de­industrialization and lower growth – as in the
Dutch disease case – when tradable firms’ production
is subject to some form of increasing returns to scale
(e.g. Krugman, 1987, and Ros and Skott, 1998). The
opposite case – transitory currency undervaluation
– can spur a virtuous dynamics of structural change
and economic development (Rapetti, 2013). Models
of export­led growth and modern trade theory have
emphasized positive externalities that are not equally
prevalent in non­export activities; therefore, policies
reallocating resources to export industries – like a
SCRER policy – promote higher growth (e.g. de
Melo and Robinson, 1992).

Another mechanism emphasizes that the
lack of FX may constrain economic growth in

developing countries. This idea has a long tradition in
the United Nations Economic Commission for Latin
America and the Caribbean (CEPAL) structuralist
economics (Ocampo, 2014) and the balance­of­
payments­constrained growth literature initiated by
Thirwall (1979). However, it remains a matter of
debate whether the RER can help to alleviate the FX
constrain and favour growth. Under the “elasticity
pessimism” view of the old structuralists, the level
of the RER was unimportant. A similar view emerges
from the Thirwall­type of models. In such settings,
long­run growth is demand constrained, i.e. con­
strained by foreign demand of domestic tradables (i.e.
exports). The level of the RER is neutral on growth
dynamics because only a continuous real depreciation
can foster growth via substitution effects on a given
rate of foreign demand growth.

These pessimistic views overlook the possibil­
ity that the FX constraint on growth may depend on
supply­side factors. As emphasized above, the RER
is a key determinant of tradable profitability and thus
capital accumulation: in other words, the level of
RER is a key determinant of the long­run supply of
domestic tradables. If foreign demand for (at least)
some tradables is large at a given international price
(i.e., highly or perfectly elastic), then a higher RER
level would increase exports, relax the FX constraint
and accelerate growth. Thus, the point under dispute
is to what extent export growth depends on foreign
demand growth vis-à-vis domestic tradable firms’
ability to profitably expand their supply at the given
international prices. Indeed, this has recently become
an area of intense debate in certain circles.8 Evidence
seems to side with the view that the level of the RER
does play an important role in the behaviour of trad­
able supply and thus in relaxing the FX constraint
on growth.

For instance, Freund and Pierola (2012) detect
92 episodes of sustained manufacturing export
growth and show that they tend to be preceded by
real currency undervaluations. Their findings sug­
gest that high RERs help entry into new exports
products and new markets (i.e. extensive margin)
in developing countries. Colacelli (2010) also finds
strong evidence that the extensive margin of trade is
very responsive to RER changes. Cimoli et al. (2013)
work with a panel of 111 countries over 1962–2008,
finding that higher RERs favour export diversifica­
tion. In turn, exports diversification is associated
with an upgrading in the technological intensity
of exports and higher economic growth. McMillan

86 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

and Rodrik (2011) use a panel data of nine sectors
in 38 countries over the period 1990–2005 and find
that level of the RER favours structural change in
favour of modern tradables and the flow of labour
from low­productivity to high­productivity tradable
activities. Similarly, Eichengreen (2008) works with
a panel of 28 industries for 40 emerging market
countries covering the period 1985–2003, finding that
higher and more stable RER levels favour tradable
employment growth.

To summarize, there are both sensible expla­
nations and a significant amount of evidence to
believe that stable and competitive RER levels
favour economic growth in developing countries.
A SCRER appears to be growth­enhancing because
it: (a) minimizes the risks of currency and financial
crises and sudden stops; (b) relaxes the FX constraint
on sustained economic growth; and more importantly,
(c) stimulates modern tradable activities that are key
for economic development.

II. SCRER management

From the strict perspective of conventional
economic theory, managing a relative price – like the
RER – sounds like a heresy. Because speeds of price
adjustment vary from market to market and therefore
some prices are stickier than others, conventional
economic theory could concede that managing a
relative price would only be possible in the short
run. However, if deviations from equilibrium are
only transitory, what would the purpose of such an
objective be?

Economists know that the real world is substan­
tially more complex than any abstract representation
of it and that policy making requires some degree of
eclecticism. This pervades the conduct of macroeco­
nomic policy. For instance, it is widely recognized
that nominal exchange rates – like the price of
any other financial asset – are highly volatile and
frequently follow long swings. Thus, conventional
wisdom on macroeconomic policy suggests that cen­
tral banks should curb RER movements that are not
associated with changes in economic fundamentals.
Most central banks in developing countries – where
exchange rate volatility is high – follow this recipe.
They conduct sui generis inflation­targeting regimes
in which exchange rates are managed through inter­
ventions in the FX market that seek to avoid this kind
of non­fundamental volatility.9

A SCRER strategy challenges this view because
its goal is not to manage the RER to avoid short­run
misalignments, but rather to keep it competitive in
the medium run. As discussed in the previous sec­
tion, a central assumption is that modern tradables
operate under some form of increasing returns, thus
making their expansion favourable for economic

growth. Economic theory establishes that multiple
equilibria arise in the presence of increasing returns to
scale. Targeting a SCRER can thus be conceived as a
strategy seeking to move the economy from one equi­
librium to another. Because some of the gains from
investing are difficult to internalize by the firms under
normal conditions, an RER higher than equilibrium
gives proper incentives to invest. Sustained capital
accumulation in the modern tradable sector puts the
economy on a trajectory towards a better equilibrium,
in which the size of this sector is significantly larger.
However, if incentives are weak and volatile, capital
accumulation may not follow. RER competitiveness
thus has to be sufficiently stable and durable to induce
investment, which may likely require managing the
RER beyond the short run.

Targeting a SCRER beyond the short run is a
strategy that has a long­run goal – i.e. to accelerate
growth – but needs to be compatible with the con­
ventional short­run goals of macroeconomic policy.
In other words, macroeconomic policy under this
regime needs to keep the RER stable and competi­
tive while achieving full employment, low inflation
(i.e. internal equilibrium) and current account sustain­
ability (i.e. external balance). Addressing all these
issues simultaneously is not an easy task; rather, it
requires the coordination of several policies.

A. SCRER and external equilibrium

Attaining external equilibrium under a SCRER
regime is probably the least controversial aspect. As
discussed in section I, a SCRER strategy tends to
be associated with current account surpluses or low

87The Real Exchange Rate as a Target of Macroeconomic Policy

deficits and the accumulation of international reserves
by the central bank, because it stimulates the supply
of and limits the demand for tradables. Countries are
in a stronger position to deal with negative external
shocks and reduce the chances of sudden stops of
capital inflows. Moreover, a SCRER strategy makes it
very unlikely that the economy follows unsustainable
trajectories regarding its international assets position.
The most likely case is that the country would reduce
its net foreign debt or increase its net asset position.

If anything, the concerns relate to whether accu­
mulating foreign assets is optimal. While textbook
treatments consider sustained current account deficits
and surpluses as cases of external imbalances, this
characterization misses an important distinction. A
sustained current account deficit implies that domes­
tic agents are continuously issuing foreign debt. In
turn, a sustained current account surplus implies that
domestic agents are postponing spending indefinitely.
In the first case, the behaviour is probably desirable
but unsustainable. One would like to consume beyond
their means, but the problem is to find someone will­
ing to finance such behaviour. In the second case, the
behaviour is sustainable but arguably suboptimal.
One can sustainably finance someone else’s spending;
rather, the issue is whether there is a reason to do so.

In the case of a country following a SCRER
strategy, it may be desirable to accumulate foreign
assets – and therefore finance other countries’ spend­
ing – if the country manages to reach a higher level
of development by doing so. The discussions about
the “global imbalance” have never pointed to China’s
inability to maintain its current account surplus, but
rather whether the United States could keep running
current account deficits or the potential bubbles that
such financing could cause on the United States and
European financial markets. These considerations
relate to the important issue of the global conse­
quences of conducting a SCRER strategy, but are
unrelated to specifics concerning how such a strategy
is conducted at the national level.

B. SCRER and internal equilibrium10

Internal equilibrium – full employment with
low inflation – is usually tackled through monetary
policy. In the case of a SCRER strategy, the central
bank needs to manage the nominal exchange rate to
achieve the targeted SCRER, as well as the interest
rate to regulate the liquidity and influence the pace

of aggregate demand. This immediately brings in
the well­known policy trilemma, establishing that
it is impossible for a central bank to simultaneously
control the exchange rate and the interest rate in an
economy open to capital flows.

One way to avoid such difficulties is to use
controls on capital inflows. Several countries have
successfully used this instrument. Evidence appears
to suggest that capital controls reduce the share of
short­term inflows and lower exchange rate volatil­
ity. Many scholars highlight the benefits of capital
management techniques for macroeconomic manage­
ment, especially in developing countries (Gallagher
et al., 2012). Even the IMF, who had fiercely opposed
them in the past, now perceives a role for them in the
macroeconomic policy toolkit (IMF, 2010). Despite
their increasing acceptance within the profession,
it seems uncontroversial that they constitute an
imperfect instrument to isolate domestic financial
markets from the international capital market. If a
central bank wants to use monetary and exchange
rate policies simultaneously, it would surely need
additional instruments.

Sterilized FX interventions can be useful in this
regard. In a situation of excess supply of FX at the
targeted exchange rate – a likely scenario in a coun­
try following a SCRER strategy that runs a current
account surplus or a small deficit – the central bank
can control both the prevailing exchange and the
interest rate. It can purchase all the excess supply of
international currency in the FX market and sterilize
the monetary effect of such an intervention through
issuing bonds in the money market. The central
bank has two instruments available to achieve its
two targets: intervention in the FX market to control
the exchange rate and the sterilization in the money
market to control the interest rate. Accordingly,
Tinbergen’s maxim is fulfilled.

A fully sterilized intervention in a situation
of excess supply of international currency at the
targeted exchange rate can be considered a policy
implemented in two steps. First, the central bank’s
intervention in the FX market generates a monetary
expansion. The resulting situation would show a
higher amount of monetary base, the same amount
of domestic bonds and an interest rate lower than the
initial one. In the second step, the sterilization fully
compensates for the change in the private portfolio
that took place in the first step, whereby the central
bank absorbs the increment of the monetary base

88 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

and issues an amount of domestic assets equal to
the initial excess demand for domestic assets (the
excess supply of international currency), returning
the domestic interest rate to its previous level.

Note that the excess supply of international
currency at the targeted exchange rate is tantamount
to an excess demand of domestic assets. If the central
bank can supply such an asset, the trilemma would be
invalid.11 Certainly, in a situation of excess demand
of FX at the targeted exchange rate, the predictions of
the trilemma continue to be valid. The central bank’s
capacity to intervene in such a situation is limited by
its stock of international reserves. However, there is
no symmetry between situations of excess demand
and excess supply of FX: while the trilemma is
valid in the first case, it is not true in the second.
The asymmetry lies in the fact that in the first case,
sterilization is constrained by a fixed stock (i.e. FX
reserves), while in the second, sterilization may be
carried out indefinitely due to an accommodating
stock (i.e. the central bank’s bonds). The central
bank’s ability to issue bonds but not FX reserves is
the key difference. It seems that this conclusion is not
generally acknowledged because the literature dis­
cussing monetary autonomy and exchange regimes
rarely considers situations of excess supply of FX.

Even if circumventing the trilemma is feasible
in cases of excess supply of foreign currency, one may
wonder about the sustainability of such a strategy.
This depends on the potential cost that the central
bank faces when performing these operations. At a
given targeted exchange rate, a sustained policy of
fully sterilized interventions implies no change in the
central bank’s net worth. The asset side of its balance
sheet increases by the increment of FX reserves and
the liability side by the bonds issued to sterilize, with
both magnitudes initially of equal value. The cost
depends on the yield of the FX reserves compared
to the interest rate that the sterilising bonds pay.
Since FX reserves are typically allocated in low
risk assets – e.g. United States bonds – the yield of
FX reserves are likely to be lower than the bonds
interest rate (Rodrik, 2006). However, note that the
full cost of the operation also depends on the capital
gains or losses associated with the variation of the
exchange rate in time: if it depreciates (appreciates),
the yield of FX reserves increases (diminishes) by
the rate of depreciation. Note that if the central bank
follows some sort of uncovered interest parity rule12

to manage the exchange rate – devaluing by a rate
equal to the difference between the interest rate that

the central bank’s bonds pay and the one paid for the
international reserves – the marginal cost of sterili­
zation would be nil (Bofinger and Wollmershäuser,
2003). However, even if the marginal cost is positive,
the policy may be financially sustainable. This would
depend on the whole asset and liability structure of
the central bank’s balance sheet and the correspond­
ing yields. Frenkel (2008) analyses sustainability
conditions for sterilized FX interventions consider­
ing reasonable balance sheet structures, concluding
that they are sustainable as long as the interest rate
of monetary policy is “moderate”, which critically
depends on sovereign and currency risk premia.

Sterilized FX intervention may be sustainable
even if it generates a net positive cost to the central
bank. This would imply that the Treasury has to
finance the central bank’s deficit, whereby this deci­
sion would depend on a cost­benefit analysis of the
strategy. If the costs of the sterilized interventions on
which the SCRER strategy is based are low compared
to the benefits in terms of structural change and devel­
opment, then it may worth financing them. As John
Williamson (1996: 30) pointed out regarding the cost
of sterilization in Chile’s SCRER policy during the
1990s: “[if paying 1­1.5 per cent of GDP] is the price
of preserving a model that works, it would be cheap”.

Despite the arguments developed thus far, it
is possible that under certain conditions the interest
rate required to attain internal equilibrium would be
too high to make sterilization financially sustainable.
Capital regulations could help in this scenario, but
it is also imaginable that inflows would find ways
to at least partially circumvent them. These consid­
erations highlight the fact that financial integration
with international markets makes monetary policy
not completely independent. For this reason, fiscal
policy also needs to play a role in the management
of aggregate demand under a SCRER framework.
Given that most public spending items and taxes are
rigid and their modification typically requires legis­
lative treatment, authorities need to develop some
fiscal instrument that is sufficiently flexible to help
monetary policy to conduct counter­cyclical policy.
Indeed, some countries have successfully developed
counter­cyclical fiscal funds that play such a role.

Managing aggregate demand under a SCRER
strategy thus requires the coordination of policies,
including exchange rate, monetary, capital account
and fiscal policies. If correctly coordinated, macro­
economic policy can properly respond to shocks and

89The Real Exchange Rate as a Target of Macroeconomic Policy

manage aggregate demand to attain internal equilib­
rium. However, it is important to bear in mind that a
SCRER strategy can have an inflationary bias even
if macroeconomic policy is adequately coordinated.
A competitive or high RER implies that real wages
– or more specifically, wages in terms of tradable
prices – are lower than they could be if the RER
were at equilibrium. Thus, even if aggregate demand
is not generating inflationary pressures in the goods
markets, inflation may still accelerate due to wage
inflation pressures arising from workers’ perception
that wages are too low. Wage aspirations are not
only influenced by the degree of unemployment,
but also by history, social norms and institutions.

Thus, keeping a RER competitive beyond the short
run may ultimately depend on developing some
mechanism that makes workers’ wage aspirations
compatible with modern tradable sector’s profitabil­
ity. Authorities would need to convince workers and
their leaders that their cooperation in terms of prudent
wage aspirations are not only beneficial for modern
tradable activities, but also workers themselves,
because under cooperation real wages would be
higher in the medium run. Social agreements between
governments, firms and workers linking real wages
to productivity in key tradable activities may thus
be an important element in a successful competitive
RER strategy for development.13

Today’s mainstream approach to macroeconomic
policy is to conduct inflation­targeting regimes with
the dominant goal of a low and stable inflation rate.
Additionally, exchange rates are managed through FX
interventions seeking to avoid short­run volatility that
is unassociated with economic fundamentals. A com­
mon result of this kind of approach has been RERs
that are volatile and domestic currency is overvalued,
which may represent an obstacle for long­run growth.

In this chapter, we have made the case for an alter­
native approach, suggesting that attaining standard

macro­policy objectives while targeting a SCRER
is viable. The proposed scheme is certainly more
complex than a standard inflation­targeting frame­
work because it adds an additional target to
macro economic policy, namely the RER. However,
evidence persuasively suggests that SCRERs tend to
foster economic growth and development. Therefore,
developing countries should evaluate the possibility
of adopting this development­friendly approach to
macroeconomic policy.

III. Conclusions

90 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

1 Equilibrium RER is a concept that generates no
few confusions and debates. For simplicity, we
define it here as the one at which the economy is at
macroeconomic equilibrium (i.e. full employment
with low inflation and external balance). It depends
on deep economic fundamentals (e.g. productivity),
exogenous variables (e.g. international interest rate)
and policy variables (e.g. public spending).

2 See Bresser­Pereira (2010) for a similar definition.
3 This part draws on Rapetti (2014).
4 While we do not discuss the association between

RER levels and employment here, there is evidence
suggesting that SCRERs tend to make growth more
labour­intensive. See Frenkel and Ros (2006) and
Damill and Frenkel (2012).

5 See, for instance, Razmi (2007) for a theoretical and
empirical discussion and the references therein.

6 Frenkel (1983) analyses and formalizes this kind of
dynamics. English readers can check Frenkel (2003)
and Frenkel and Rapetti (2009).

7 This is a main characteristic emphasized by the pio­
neers of development economics such as Rosenstein­
Rodan (1943) and Hirschman (1958).

8 See, for instance, Razmi (2013), Cimoli et al. (2013)
and Marques Ribeiro et al. (2014).

9 See, for instance, the analysis of Chang (2008) for
the case of Latin American inflation targeters.

10 This section draws on Frenkel (2007), Frenkel (2008),
Frenkel and Rapetti (2008) and Rapetti (2013).

11 Except for special circumstances, public debt instru­
ments – including those issued by the central bank
– are the least risky assets in a developing economy.
The interest rate of such instruments set the floor of
the other interest rates in the economy. In fact, this
is the very basis for conducting monetary policy via
an interest rate set by the central bank. Thus, unless
there is an institutional constraint, central banks
should be able to offer such an asset and perform
sterilization operations.

12 UIP stands for uncovered interest parity, which states
that portfolio decisions should lead to domestic inter­
est rate being equal to the sum of foreign interest rate
and the expected rate of exchange rate variation.

13 In commodity­exporting countries, such an agree­
ment could be complemented with special taxes on
rents, whereby the proceeds are used to finance social
transfers that function as indirect wages.


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Marques Ribeiro R, Tadeu­Lima G and McCombie J
(2014). Exchange Rate, Income Distribution and
Technical Change in a Balance­of­Payments Con­
strained Growth Model. Mimeo.

McMillan M and Rodrik D (2011). Globalization, Struc­
tural Change and Productivity Growth. NBER
Working Paper 17143, National Bureau of Economic
Research, Cambridge, MA.

Ocampo JA (2014). Balance of Payments Dominances: Its
Implications for Macroeconomic Policy. In: Damill
M, Rapetti M and Rozenwurcel G, eds. Macro-
economics and Development: Essays in Honor of
Roberto Frenkel. Forthcoming.

Polterovich V and Popov V (2003). Accumulation of
Foreign Exchange Reserves and Long Term Growth.
MPRA Paper 20069, University Library of Munich,

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Capital and Economic Growth. Brookings Papers on
Economic Activity, 1: 153–209.

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in a competitive real exchange rate strategy for
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93Defending Development Sovereignty: The Case for Industrial Policy and Financial Regulation in the Trading Regime

Following the Great Depression and World War
II, the global economic consensus reflected the need
for countries to direct and stimulate their economies,
while also drastically lowering traditional barriers to
trade in goods. The Bretton Woods regime, referring
to the triad of the International Monetary Fund (IMF),
the World Bank and the General Agreement on Tariffs
and Trade (GATT), aimed at globalizing trade while
leaving “plenty of space for governments to respond
to social and economic needs at home” (Rodrik, 2011:
69). Where the two aims – globalization and domestic
policy needs – clashed, national interests dominated.

Out of the success of the Bretton Woods regime
came an even greater push for global trade liberaliza­
tion. Tariffs had been brought low and global trade

flows had exploded. As a result, the gains from
liberalizing trade in goods slowed down. Indeed, full
global trade liberalization in goods is now estimated
to yield a one­time increase in GDP of less than one
per cent (Ackerman and Gallagher, 2008). Thus,
market actors now seek increased market access
in other areas – including services, investment and
intellectual property – in an effort expand exports and
market share. Combined with the desire for greater
market access, a philosophical shift toward suspicion
of government intervention in the market led to a set
of beliefs now called the Washington Consensus. The
creation of the World Trade Organization (WTO),
with its increased market access commitments and
more enforceable dispute settlement procedures,
reflected and reinforced the prevailing view that


Rachel Denae Thrasher and Kevin P. Gallagher


As nation States and development experts contemplate renewing commitments for global development
goals, it is imperative that countries have the national-level flexibility to meet those goals. It is equally
imperative that emerging market and developing economies pursuing sustainable and inclusive growth
are able to meet their global economic governance commitments. This chapter focuses on the expanding
trade regime. While the benefits and economic rationale for gradual liberalization of trade in goods
is well-founded, global barriers to goods trade are at an all-time low. Therefore, a new “trade”
policy has evolved, seeking to liberalize all perceived impediments to global commerce – reaching
into the realms of financial regulation, innovation policy and a range of domestic regulations that
promote public welfare. This chapter argues that there is a fine line between what may be perceived
as “protectionism” by actors seeking further market access and the legitimate deployment of domestic
regulation for sustainable and inclusive growth on the part of emerging market and developing
economies. Global and regional trade rulemaking will need to preserve nation States’ ability to deploy
country-specific policy for development.

I. Crisis-era protectionism and the expanding trade regime

94 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

broader and deeper liberalization beyond tariffs and
quotas in goods was the best way to promote growth

Circumstances changed again in the wake of
the Global Financial Crisis and the resulting Great
Recession. The Washington Consensus view of the
1990s is becoming a minority view in many capitals
across the world, as well as the halls of academia. The
growth success stories of China and other East Asian
nations on the one hand, and the fact that the global
financial crisis was due to problems in the West on
the other, have generated a widespread questioning
of the Washington Consensus (Moreno­Brid, 2013).

In terms of financial stability, many countries
across the world – regardless of their income level
– have been re­regulating the financial sector in an
attempt to prevent and mitigate the next financial
crisis. In emerging market and developing economies
(EMDE), there has been a renewed effort to regulate
foreign financial flows that can be de­stabilizing
for long­run development prospects. Moreover, to
the surprise of many, the IMF has endorsed the use
of such cross­border financial regulations in some
circumstances (IMF, 2013). This thinking has also
permeated the World Bank (Ju et al., 2011; Lin and
Treichel, 2012).

Perhaps more stark than the IMF and World
Bank endorsement of regulating the capital account
is the embracing of industrial policy in the advanced
countries. David Cameron, Prime Minister of the
United Kingdom, urged the staff of the Foreign
Office to “develop [their] global comparative advan­
tage” and create a “modern industrial strategy”.1 In
response to what was perceived as the “increasingly
aggressive industrial policies of America, Britain,
China and France”,2 Japan has promised similar
policies to support domestic manufacturing (Moreno­
Brid, 2013). Indeed, the majority of all such measures
introduced in the past five years have come from
already­industrialized countries and emerging econo­
mies in the Group of Twenty (G20) (Evenett, 2013a).
Of course, EMDE have been pioneers of industrial
policy over the past decade and many – such as those
discussed below – are at the forefront in current times.3

Dani Rodrik posits a “political trilemma”
in which nations are divided between pursuits of
democracy, national self­determination and economic
globalization. He argues that a nation “cannot simul­
taneously pursue” all three at once (Rodrik, 2011).

In practice, one of the three gives way to the others.
Furthermore, choosing which interests should prevail
is not always a straightforward decision. Thus, despite
a growing consensus in favour of domestic policy
interests, some market actors have pushed against this,
electing to favour economic globalization instead.

There is a growing concern, for example, that
policies introduced at the onset of the Financial
Crisis may have “morphed into another, potentially
longer­lasting, form of discrimination against for­
eign commercial interests” (Evenett, 2013b: 148).
Simon Evenett argues that despite the importance
of prioritizing economic growth, employment and
financial sector management, “the harm done by
beggar­thy­neighbor policies should not be over­
looked” (Evenett, 2013a: 1). Evenett and others are
rightly concerned that a rise in protectionist policies
like those during the Great Depression could slow a
global economic recovery and at considerable cost
(Kindleberger, 1986). Globally, governments have
pledged not to repeat such mistakes in their public
commitments at global bodies such as the G20.
Nevertheless, there remains a concern that market
distortions could act to cover up domestic competitive
deficiencies rather than forcing governments and the
markets to fix them (Evenett, 2013a).

Evenett argues that WTO disciplines have not
done much to keep countries from resorting to protec­
tionism; rather, it has only “altered the composition”
of that protectionism (Evenett, 2013a: 7). Since the
crisis, global growth has continued at a slow and
uneven pace. If these unregulated measures are used
as substitutions for – or disguised versions of – older
forms of protectionism, Evenett and others argue that
the global trade regime should at least have a method
for phasing these policies out over time. Otherwise,
the policies initially introduced for legitimate reasons
may be used in the long term to “discriminate against
foreign goods, companies, workers and investors”
(Baldwin and Evenett, 2009: 4).

“Murky” or “soft” protectionism are the most
commonly used terms for these technically legal
measures that are not yet directly governed by the
WTO or other trade rules. Attempts to measure this
type of “protectionism” suggest that 60 per cent of
the trade­distorting measures put in place since 2012
are non­traditional, i.e. not tariffs or trade defence
mechanisms (Evenett, 2013c). Such measures have
included health and safety regulations, stimulus pack­
ages that direct spending domestically, government

95Defending Development Sovereignty: The Case for Industrial Policy and Financial Regulation in the Trading Regime

subsidies limited to local manufacturers, bank bail­
outs, industrial and innovation policies, as well as
many other ways to boost the domestic market while
not running afoul of the international trade laws.

There is an additional concern about investment­
related protectionism that specifically targets policy
related to foreign direct investment as well as cross­
border financial regulations. In an article published
shortly after the crisis, Claude Barfield made a plea
that measures blocking foreign investment are just
as significant as trade measures and called on United
States of America President Barack Obama to lead
an effort to prevent such protectionism (Barfield,
2009). Between 2009 and 2012, the Organisation for
Economic Co­operation and Development (OECD)
– long a supporter of the deregulation of invest­
ment markets – and the United Nations Conference
on Trade and Development (UNCTAD) issued
nine reports to the G20, calling for a restraint on
investment­related measures restricting the flow of
capital and companies across borders, and continue
to do so (OECD, 2013a).

Some proponents of this view uphold the
WTO as the best option for creating and enforcing
global economic commitments to keep this kind of
protectionism at bay (OECD, 2013a). Others argue
that the WTO is not structured to place these kinds
of restraints on member nations, but rather that
the initiative to continue global commercial liber­
alization should come from the individual nations
(Evenett, 2013b). Reflecting the latter argument to
some degree, governments worldwide are pushing
for additional market access commitments outside
of the purview of the WTO. The Transatlantic Trade
and Investment Partnership (TTIP) on one side and
the Trans­Pacific Partnership (TPP) on the other are
each attempting to secure commitments in services,
investment, intellectual property and financial ser­
vices worldwide. Plurilateral negotiations for the
Trade in Services Agreement (TISA) have begun
between governments in favour of further liberaliza­
tion in services sectors. Therefore, the global trend
in trade and investment agreements seems to reflect
the concern over crisis­era protectionism, pushing
for ever­broader and deeper economic globalization.

The emerging narrative around “soft” and
“murky” protectionism rests on relatively weak
foundations and thus it should be examined with
scrutiny. The economic case for expanding the
trade and investment regime to include measures
that regulate for financial stability and industrial
diversification is fairly limited. Economic theory
surrounding the liberalization of investment flows is
quite weak, likewise the empirical evidence. Those
nations that liberalize the free flow of capital (both
foreign direct investment (FDI) and financial flows)
have not been correlated with strong growth and have
been more susceptible to financial crises. Moreover,
those nations that regulate foreign capital flows have
done so in an effective manner. In addition, economic
theory has long shown that EMDE should deploy
certain regulations on trade to correct for market
failures and generate long­run dynamic comparative
advantages. The empirical evidence shows that those
nations that steer trade in this manner have developed
more than those that have not. Furthermore, almost
all conventional models of trade liberalization have

shown that the benefits of further liberalization are
relatively small.

Jeanne et al. (2012) conduct a sweeping “meta­
regression” of the entire literature, including 2,340
regression results, finding little correlation between
capital account liberalization and economic growth.
They conclude: “the international community should
not seek to promote totally free trade in assets – even
over the long run – because (as we show in this book)
free capital mobility seems to have little benefit in
terms of long run growth and because there is a good
case to be made for prudential and non­distortive
capital controls” (Jeanne et al., 2012: 5). There is also
considerable work demonstrating that capital account
liberalization is associated with a higher probability
of financial crises. Reinhart and Rogoff (2010) show
that, since 1800, capital mobility has been associated
with banking crises. Indeed, the most recent research
has shown that capital market liberalization is only
associated with growth in nations that have reached
a certain institutional threshold: a threshold that

II. The soft foundations of soft protectionism

96 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

most developing nations are yet to achieve (Kose et
al., 2009; Jeanne et al., 2012). This is partly due to
the fact that the need for external investment is not
the binding constraint for some developing country
growth trajectories, but rather the lack of investment
demand. This constraint can be accentuated through
foreign capital flows because such flows appreciate
the real exchange rate, thus reducing the competitive­
ness of goods and reducing private sector willingness
to invest (Rodrik and Subramanian, 2009).

There is an even older and deeper tradition in
economics that industrial policy can also be optimal
(see Wade, 1990; Amsden, 2001; Chang, 2002;
Rodrik, 2007). For EMDE, what matters most in the
longer run is not static comparative advantage at any
one moment in time, but rather the ongoing pattern
of dynamic comparative advantage: the ability to
follow one success with another, to repeatedly build
on one industry by launching another. Since the pro­
cess of technology development is characterized by
increasing returns, many models will have multiple
equilibria. It is easy to specify a model in which the
choice between multiple equilibria is not uniquely
determined by history; rather, it becomes possible
for public policy to determine which equilibrium will
occur (Krugman, 1991). If the multiple equilibria in
such a model include high­tech, high­growth paths
as well as traditional, low­growth futures, then public
policy may make all the difference in development.
Four key market failures plague nations seeking to
catch up to the developed world: coordination exter­
nalities, information externalities, dynamism and
technological change and human capital formation.
By definition, diversification can mean the creation
of whole new industries in an economy and some­
times may require linking new industry to necessary
intermediate goods markets, labour markets, roads
and ports and final product markets (Rodrik, 2007).

Of course, many policies to provide public
goods for the welfare of the public stand on the
strongest economic grounds. Pigou (1920) long
established that in cases where private and social
costs diverge, taxes or subsidies that internalize
externalities can lead to significant welfare gains.
Regulations on food safety and security, environmen­
tal policy, alternative energy and beyond all fall into
this category. Most economists prefer price­based
interventions to correct for market failures such as
taxes or subsidies. However, under conditions of
significant uncertainty and high damage costs (such
as in climate change and chemical substances with

lethal impacts) at the tails of a distribution there is a
stronger justification for outright bans and quantita­
tive restrictions (Weitzman, 1974).

With the right accountability policy in place, it
has been shown that those nations that have deployed
capital account regulations and industrial policies
have been among the best growth performers of the
past centuries: Europe, the United States, Japan,
the Republic of Korea, Taiwan Province of China
and, more recently, China. Moreover, it has been
shown that trade liberalization is not correlated with
economic growth in ex­post econometric analyses
(Rodrik, 2007). Even in the theoretically­driven
computable general equilibrium models, a high
estimate for full global trade liberalization would
give a one­time boost in global output of 0.27 per
cent (Ackerman and Gallagher, 2008).

Juxtaposed with the relatively minor benefits of
the further liberalization of trade and investment, the
costs of further deregulating the global economy in
the name of “murky protectionism” are significant.
Moreover, while many countries pay lip service to
the expanding and deepening trade regime, their
domestic policy tells a different story. Opponents of
“murky protectionism” are gathering extensive data
on policies employed all over the world that place
restraints on trade. While many of the measures that
are seen as impediments to trade have some justifica­
tion, a number of measures that are well justified and
key to an effective development strategy have been
targeted as soft or murky protectionism. As table 1
demonstrates, many of the measures targeted aim
at financial stability, industrial development and
public welfare. Some involve domestic regulations,
like United States of America and European Union
environmental regimes, some involve direct govern­
ment subsidies to support certain industries, while
others use government procurement policy for the
same purpose.

Nations must have the policy space to put
measures such as these in place under the right condi­
tions. Table 1 lays out important policies for financial
stability, industrial development and public welfare
that have been singled out as protectionist. The jus­
tification for such policies is much stronger than the
justification to de­regulate for private gain. However,
new proposals at the WTO as well as under regional
and bilateral arrangements from industrialized coun­
tries are increasingly critical of such measures in the
name of soft protectionism. This is very concerning

97Defending Development Sovereignty: The Case for Industrial Policy and Financial Regulation in the Trading Regime

for those EMDE working to “catch up” and stimulate
sustainable and inclusive growth in their economies.
In the following section, we compare bilateral and
regional trade agreements with disciplines under the

WTO to determine the extent to which the various
regimes constrain policy space for member nations,
as well as what this means for countries negotiating
new agreements.

Table 1


Purpose of measure Country examples

Financial stability India: Reserve Bank of India prohibits Indian banks from engaging in proprietary
trading in currency futures

Australia: 2013–2014 budget specifies new “thin-capitalization” ratios for non-resident
multinational corporations

Brazil: Extends programme for sustaining investment to capital goods in 2014,
including local content requirements for subsidized credits from the Brazilian
Development Bank (BNDES)

Brazil: Tax on financial operations (IOF tax) – allowing the Government to raise and
lower taxes on capital flows to stabilise the economy

Republic of Korea: Lowered the ratio of banks foreign exchange derivatives to equity

Industrial development Canada: Government subsidies for R&D provided through a new technology
demonstration programme

Viet Nam: Restricted bidding by foreign firms on public procurement tenders except
where domestic bidders cannot provide the necessary services

Brazil: Preferential treatment of local construction products in public procurement

Viet Nam: Increased import duties for certain mineral resources (from 30 to 40 per

Russian Federation: State guarantees export sales for companies with 30 per cent
local sourcing/content

Indonesia: Franchise law requiring 80 per cent of inputs to be sourced locally

India: Local content requirements extended to private telecommunications firms

Ghana: Local content requirements in the petrol industry

Public health and welfare European Union: Fuel quality directive; maximum residue levels of pesticides

United States: Denial of entry to goods not complying with energy conservation and
labeling standards

China and Japan: import restrictions on beef due to bovine spongiform
encephalopathy (BSE)

China: Financial aid provided for purchasing new energy vehicles (including electric
and hybrid vehicles)

Source: Global Trade Alert (2014) and OECD (2013a).

98 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

As we have discussed above, developing and
developed countries alike have historically had a wide
range of policy tools available to respond to market
failures and direct their economies. Today, the variety
and number of those tools are shrinking. This section
focuses on specific policy tools that remain in use
under the current global trade regime.

We find that while the WTO permits a fair
amount of flexibility outside of traditional trade
policy, other agreements making up the global trade
regime are not so open to government “creativity”
in guiding trade and investment for development.
Bilateral and regional agreements widely vary in the
policy space that they permit, depending on which
countries are involved, their geographic proximity
and whether there is a large development gap between
them, among other factors. Bilateral agreements
between developing nations (South­South agree­
ments) tend to provide ample space to all parties to
promote development and rarely delve deep enough
to bind a country’s “behind the border” activities
(regulation, taxation, environmental measures).

By contrast, bilateral agreements between the
European Union or the United States of America and
a developing country tend to restrict policy space
both more broadly and deeply. As we discuss in
more detail below, trade and investment agreements
in which the United States of America is a partner
attempt to keep countries from imposing any new
restriction that could interfere with trade or invest­
ment flows. United States of America agreements
prohibit export incentives, forbid local labour,
technology transfer and research and development
requirements for foreign investors and have mecha­
nisms in which foreign companies (private sector)
can sue the host country if regulations interfere
with their investment. The United States of America
model reflects the current global trend to broaden
and deepen global commerce commitments through
bilateral and regional agreements.

Table 2 provides an illustrative list of policy
tools that countries have employed (and still do!)
in an effort to promote financial stability, industrial
development and public welfare. The table indicates
whether these measures are prohibited under the
indicated trade regimes. In the next pages, we explore
how differences in agreement breadth and depth

affect the policy flexibility that countries enjoy within
the global trading system.

There are a few things to note about the chart
above. First, where provisions are prohibited under
both the WTO and bilateral regimes, differences in
enforcement and exceptions leave room under the
former that is not there under the latter. Second,
South­South agreements are far from uniform with
respect to these measures. Furthermore, the arrange­
ments may act as special protection from developed
world competition by keeping tariffs among members
low while keeping external tariffs high. Likewise,
even North­South agreements are not all the same
(despite being considerably more uniform). For
example, European Union agreements tend to vary
based upon the treaty partner, leaving more policy
space available to lesser developed countries.

III. The threat to financial stability and industrial development policies

Table 2


Measure Types WTO

South trade

South trade

Tariff rate flexibility • •

Import bans, licensing • •

Tax-based export incentives •

Performance requirements • •

Capital controls •

Domestic environmental/
health regulations

Public procurement
preferences •

Source: Thrasher and Gallagher (2010).

A. Tariffs

Tariffs have long been the preferred trade bar­
riers under the global trade regime because they are
easy to measure, transparent to apply and straightfor­
ward to liberalize progressively over time. Employed
carefully, countries can raise and lower tariffs to
protect nascent industries until they are ready to
face global competition. Under the WTO, countries

99Defending Development Sovereignty: The Case for Industrial Policy and Financial Regulation in the Trading Regime

often bind their tariff rates far above their applied
rates, leaving room for such measures. By contrast,
bilateral and regional agreements have tended to
demand lower tariff bindings.

Many countries have taken advantage of the
WTO flexibilities and with some success. In Viet
Nam, this method has been used to great effect
to stabilize energy prices and protect various key
industries, even as a member of the ASEAN trade in
goods agreement (ATIGA). The chart below indicates
that Malaysia has reserved an entire classification of
goods from WTO binding, presumably as a way of
protecting the automotive industry. Likewise, Brazil
has leaned on tariff rate flexibilities to protect indus­
tries facing impossible competition from Asia. Table 3
provides an example of one particular line of goods,
comparing bound and applied rates for iron and non­
alloy steel bars and rods (WTO Current Schedules).

This chart highlights some interesting trends.
First, in every instance, whether North­South or
South­South, the regional or bilateral tariffs are much
lower than the bound tariff levels at the WTO. Also in
every instance, the countries in question have average
rates above their bilateral bindings, indicating that
they take advantage of tariff rate flexibilities with
respect to trade partners outside of their bilateral
arrangements. Second, as mentioned above, low or
non­existent tariffs in the South­South arrangements
may actually protect industries from competition
rather than exposing them. This is the case in both

MERCOSUR4 (with a common external tariff) and
ATIGA (without one). They allow developing nations
to work together to build up nascent industries within
the region without competition from the developed
world. Finally, it is important to note that the 0.0 per
cent applied tariffs represent all kinds of different
arrangements. Where the European Union and United
States of America might provide 12–14 years for
the elimination of some tariffs, other product duties
were eliminated immediately (compare European
Union­South Africa5 and NAFTA6 with European

B. Import licensing and bans

Despite being disfavoured except under dire
circumstances, import licensing and bans have been
historically used to protect domestic industry and
stabilize economies. Actual quantitative restrictions
(quotas) and import bans are generally prohibited
under the WTO, except to address food shortages and
balance of payments difficulties or enforce certain
local standards and regulations (GATT Arts. XI,
XII). Import licensing programmes are more widely
used, although they are heavily regulated in the
WTO Import Licensing Agreement to promote

Outside of the WTO, the availability of these
measures widely varies. Treaties with the European
Union generally mimic WTO exceptions but can vary

Table 3

(Per cent))

Country/agreement WTO binding

applied tariff
MFN applied rate (avg)


Brazil (MERCOSUR) 35.0 0.0 12.0

Chile (European Union-Chile) 25.0 0.0 6.0 (2011)

Mexico (NAFTA) 35.0 0.0 11.5

Guatemala (DR-CAFTA) 20.0 4.5a 15.0

Malaysia (ATIGA) Unbound 0.0 5.0

South Africa (European Union-South Africa) 15.0 0.0 5.0 (2013)

Viet Nam (ATIGA) 21.7 5.0 15.0

Source: WTO Current Schedules.
a Guatemalan tariffs were scheduled to be eliminated as of 1 January 2014. Since the latest data available was from 2012, it

is possible that the 4.5 per cent duty has now been eliminated.

100 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

with the treaty partner; for instance, European Union­
Chile prohibits both quotas and import licensing,
while European Union­South Africa only mentions
quotas (European Union­Chile Art. 76, European
Union­South Africa Art. 19). Both agreements leave
some space for exceptional circumstances (European
Union­Chile Art. 93 (shortages), European Union­
South Africa Art. 24 (safeguards)). Treaties where
the United States of America is a partner increas­
ingly shrink the same kind of room for exceptional
circumstances. Only one of six treaty partners under
the Dominican Republic­Central American Free
Trade Agreement8 (DR­CAFTA) retained a short­
ages exception, while most recent agreements have
eliminated the exception for balance of payments
(see United States of America agreements with
Colombia,9 Peru10 and Singapore;11 DR­CAFTA
Annex 3.2(F)). If the United States of America model
carries the day in the current TPP negotiations, it
could have very real consequences for the develop­
ing countries involved. For example, both Viet Nam
and Malaysia have ongoing programmes of import
licensing to control imports in certain sectors. Viet
Nam’s automatic licensing programme is limited to
steel products as of 2012 (WTO, 2013). Malaysia, on
the other hand, maintains an extensive set of border
measures including import permitting and quotas to
protect its highly prized auto industry (United States
Trade Representative, 2013).

C. Tax-based export incentives

Tax­based export incentives have also played
a key role in making global trade work for develop­
ment. In fact, this may be an area where there remains
the most flexibility in promoting development locally.
Taking the form of duty drawbacks, tax deferrals,
exemptions and deductions, these measures can
promote a healthy trade balance and enable local
industry to compete globally (Mai, 2004). Under
the WTO’s Agreement on Trade­Related Investment
Measures (TRIMs), tax­based advantages limiting
import purchases to a value related to exports of local
products would violate the general pillar of national
treatment under the WTO. However, as exports have
long been considered a key vehicle for economic
growth, broad­based tax incentives that encourage
exports are generally accepted. This sharply contrasts
more direct subsidy programmes prohibited by the
Subsidies and Countervailing Measures (SCM)

While most bilateral regimes follow the
example of the WTO in this respect, certain United
States of America agreements almost universally
prohibit such incentives. Under NAFTA and United
States­Chile,12 for example, member States may not
provide drawbacks or tax deferrals on condition that
goods are exported or used as material for another
exported good (Art. 303; Art. 3.8). Once again, if the
TPP reflects this approach, it could directly affect
developing country members.

Viet Nam has moved away from explicit export
performance­based tax incentives since entering the
WTO. However, it continues to indirectly support
domestic industry through tax incentives for corpo­
rate or land use taxes (WTO, 2013). Malaysia relies
on a complex tariff, tax, quota and credit system to
support its national car companies. The National
Automotive Policy gives tax exemptions to exporters
based upon a percentage of domestic value­added.
Concurrently, taxes on primary goods export have
increased linkages within the auto industry and
the economy more generally (United States Trade
Representative, 2013). Following a United States of
America model, these countries will face far more
restrictions on their domestic tax laws.

D. Performance requirements

Performance requirements are highly scruti­
nized under the global trade regime. The TRIMs of
the WTO prohibits any measures that violate national
treatment (Article III) or the general obligation to
eliminate quantitative restrictions (Article XI). It
subsequently lays out an illustrative list of prohibited
measures in its annex. Under TRIMs, countries may
not require that foreign investors achieve a certain
level of domestic content in their goods or prefer
domestic producers or products in their produc­
tion process. They may not limit foreign investors’
imports in relation to their local production or export
levels. Moreover, they may not require investors to
acquire foreign exchange only through export and
they may not demand that investors sell a certain
amount of their product within the domestic market.
Furthermore, WTO members may not create incen­
tives by requiring any of the above as a condition for
receiving economic advantages.

Once again, United States of America agree­
ments tack on several “plus” provisions that place

101Defending Development Sovereignty: The Case for Industrial Policy and Financial Regulation in the Trading Regime

additional limits on government policymakers.
In addition to WTO disciplines, United States
of America agreements forbid technology and
knowledge transfer requirements and manage­
ment nationality pre­requisites (NAFTA Art. 1106,
DR­CAFTA 10.9). Nonetheless, even members of
United States of America agreements may continue
to provide advantages to companies that “locate
production, supply a service, train or employ workers,
construct or expand particular facilities, or carry out
research and development, in its territory” (NAFTA
Art. 1106, DR­CAFTA 10.9). Certain other measures
such as local infrastructure investment, directed
credit and administrative guidance for multinational
corporations lay beyond the scope of these investment
provisions, making them available to all countries
that have the capacity to impose and enforce them.

Despite their high level of scrutiny today, per­
formance requirements have commonly been used
with tax incentives to funnel FDI into favoured or
essential industries for economic development. Both
Malaysia and Viet Nam openly used local content,
labour and capital, as well and domestic location
and export performance requirements to promote
industrial development (WTO, 2013, Fuangkajonsak,
2006). Malaysia has had to eliminate explicit perfor­
mance requirements since joining the WTO, although
it retains some more subtle measures connecting
financial benefits to local value­added and local
content (United States Trade Representative, 2013).

A key difference between the multilateral trade
and investment regime and the United States of
America model of investment provisions appears
in the dispute resolution process. Unlike the WTO
State­to­State dispute settlement (or other State­to­
State arbitration processes in most trade agreements,
both North and South), investment disputes under
the United States of America model allow private
investors to sue States in a private arbitration
forum. Although the TPP has yet to agree on a full
draft of the proposed agreement, leaked drafts of
the investment chapter indicate that investor­State
dispute resolution may be included (Citizens Trade
Campaign, 2012). NAFTA is the only agreement
in force long enough to have a history of investor­
State disputes and since then a few agreements have
attempted to clarify certain treaty standards (Van
Harten, 2009). Nonetheless, countries like Malaysia
and Viet Nam could likely experience regulatory chill
due to NAFTA’s arbitration history and the threat of
expensive lawsuits.

E. Financial regulation

Financial regulation is another tool that coun­
tries have used to promote development and stabilize
their financial environment. Brazil’s Tax on Financial
Operations (IOF tax) introduced at the outset of the
2008 financial crisis provides one example, as does
tax of the Republic of Korea on foreign exchange
derivatives. Indeed, similar regulations have been
put in place by India, Indonesia, Taiwan Province
of China, Uruguay and numerous other nations in
the wake of the crisis (Global Trade Alert, 2014;
OECD, 2013a).

However, restrictions on foreign capital flows
are generally disfavoured within modern trade agree­
ment models. The WTO as well as all North­South
trade agreements prohibit international transfer and
payment restrictions presumptively. Nonetheless,
under the WTO, capital flows are treated under the
General Agreement on Trade in Services, which
employs a positive­list approach to binding measures,
whereby countries select which sectors and industries
they want to bind under the agreement. By contrast,
United States of America trade agreements – as
well as more recent European Union agreements
(European Union­CARIFORUM)13 – apply a nega­
tive list approach to investment protection, where
liberalization is the rule rather than the exception.

The WTO rules provide an exception in the
case of “serious balance of payments and external
financial difficulties” (General Agreement on Trade
in Services Art. XII). This exception is mirrored in
most – if not all – bilateral and regional agreements.
While this protects in emergency situations, it would
be better if countries could employ capital controls
preemptively to avoid financial instability and crisis.

F. Public welfare and “green” measures

Public welfare and “green” measures may be
directed at the quality of certain products or the
effects of their production. While these measures
have been used less frequently in the developing
world, with increasing awareness of the cross­border
effects of health and environmental problems, they
are becoming more prevalent. The European Union
restricts the pesticide residue level on imported agri­
culture, based upon a concern that such pesticides will
cause harmful health effects. Both China and Japan
placed restrictions on imported beef due to fear of

102 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

the bovine spongiform encephalopathy, which can
be fatal to humans. As carbon­based energy sources
start to dwindle, many countries are realizing the
importance of developing national green energy
projects. Thus, environmental measures are used to
protect the environment as well as domestic industry.
Feed­in tariffs in Europe and targeted subsidies in
China have helped countries like Germany, Spain and
China itself to gain global comparative advantages
in low carbon­renewable energy while increasing up
the value chain.

The somewhat conflicting relationship between
trade and the environment is far from new, whereby
all modern global, regional and bilateral agree­
ments make some mention of promoting sustainable
resource development and environmental protection.
NAFTA was the first trade agreement to include
environmental provisions as a part of the agreement,
and the trend continues to date (Gallagher, 2009).
At the WTO, the Commission on Trade and the
Environment has the ongoing concern of considering
questions of environmental protection in global trade.
Nonetheless, those concerned with “murky” protec­
tionism identify environmental measures as suspect
alongside policies protecting domestic industries
and firms (Global Trade Alert, 2014). Under NAFTA
investor­State disputes, all three countries’ foreign
firms have challenged environmental laws in their
host States as measures “tantamount to expropria­
tion” (Gallagher, 2009). Environmental protection is
quickly becoming a widely accepted global norm that
may eclipse the concern for fully free trade. However,
it seems important to recognize the tension between
trade and environmental interests, as the expanded
trade regime blurs the lines between domestic and
global regulation.

G. Public procurement

Public procurement remains an area in which
most countries retain plenty of flexibility to promote
their domestic policy goals. Procurement measures
have been used historically – as well as recently – to
protect vulnerable people groups, favour domestic
industries and show support for environmental
and social concerns. In much of Europe, public

procurement is an accepted tool for reaching public
welfare and environmental goals. Through pro­
curement policies, Viet Nam actively prefers local
suppliers and discourages imports where domestic
inputs can be produced (WTO, 2013). Malaysia
public procurement in favour of its indigenous
people group continues to respond to the historical
race tensions that exist in the country (United States
Trade Representative, 2013). Brazil, alongside its
MERCOSUR partners, stands out as having initiated
a pilot programme of sustainable public procurement,
promoting environmental sustainability through their
tender policies (Instituto Argentino de Desarrollo
Sostenible, 2008).

Such measures currently remain beyond the
scope of the global trade rules, at least as they apply
to all members. The Government Procurement
Agreement (GPA) in the WTO only has 15 members,
whereas most countries are reluctant to subject their
government spending to global scrutiny. As with
many types of measures, European Union treatment
of public procurement depends on the treaty partner.
European Union­South Africa simply mentions liber­
alization as a future goal and European Union­Chile
contains a comprehensive chapter governing procure­
ment within the parties. United States of America
agreements are more uniform, as with many other
areas, containing chapters that put in place rules for
the valuation and awarding of government contracts
(NAFTA Ch. 10, DR­CAFTA Ch. 9). Interestingly,
even some South­South agreements have begun to
incorporate public procurement provisions.

MERCOSUR countries signed the Protocol
of Mercosur Public Bids for Tender in 2006, under
which countries commit to non­discrimination on a
sector­by­sector basis in goods, services and public
works. As noted above, each of our case studies has
extensively relied on public procurement for national
development aims. Within the newest negotiations,
it is unclear whether the United States of America
and the European Union will push for greater market
access in government procurement. Both are signato­
ries to the GPA of the WTO, although its membership
remains limited. However, it is clear that broader and
deeper trade rules in this area could bind government
hands more tightly than most of the world would like.

103Defending Development Sovereignty: The Case for Industrial Policy and Financial Regulation in the Trading Regime

The terms “soft”, “murky” and “investment
protectionism” emerge from the view that trade lib­
eralization should extend beyond trade in goods into
areas traditionally not seen as part of trade policy. The
intellectual foundations of these concepts, as well as
the empirical record of what happens when regula­
tions in these areas are stripped, are weak. Targeted
government regulation has been part and parcel of
growth and inclusive development for over a century.
Nevertheless, powerful interests in the West have
been expanding the mandates of trade and investment
treaties to include measures on financial stability and
industrial policy in particular.

By examining some key policies employed by
developing and developed countries alike, we show
that the United States of America model of trade
agreements (and to some degree also European Union
agreements) more severely constrain nations from
deploying adequate industrial strategies. Drawing
on this analysis, it appears that North­South free trade
agreements should be considered with great caution
for nations looking to expand or devise industrial
development strategies. EMDE are also urged to
develop new model treaties (as Brazil and South Africa
are) that steer closer to the South­South model prior­
itizing development­oriented trade and investment.

Many countries are already working to this end,
albeit in different ways. At the WTO, a coalition of
EMDE has been successful in resisting industrial­
ized country proposals to expand the mandate of the
WTO. During the early days of the Doha Round,
there was a push by the advanced countries to include
(further) investment measures, government pro­
curement, competition policies and other measures
now repackaged as “protectionist”, although these
coalitions were able to hold the debate to look at
distortions in agricultural and manufacturing markets.
On a more proactive level, EMDE have proposed a
“product basket approach” to manufacturing tariff
reductions, although movement on such proposals

has stalled as the Doha Round is at a near standstill.
Somewhat analogous to the “box” approach in the
WTO Agreement on Agriculture, nations could put
certain sectors in a “basket” that could have higher
tariffs as long as they are balanced by further reduc­
tions in other baskets of countries.

Some countries have simply avoided new trea­
ties that may further restrict their existing policies,
with Brazil being one example here. The country
underwent a major inter­governmental assessment
and concluded that the most beneficial approach
would be to focus on multilateral trade negotiations
at the WTO. It has not ratified bilateral investment
treaties or trade agreements beyond the MERCOSUR
agreement. Other countries are working on South­
South trade or investment agreements that have a
starkly different model. For instance, the ASEAN +6
treaty only deals with goods trade and some ser­
vices; itincludes FDI but not other financial flows,
has special and differentiated treatment for poorer
nations and does not feature investor­State dispute
resolution. A group of countries is trying to come
up with new language and rules for North­South
treaties. Chile and other nations are proposing safe­
guards for financial stability in the TPP Agreement.
Other countries, such as South Africa, are carefully
withdrawing from their bilateral investment treaties
and offering to re­negotiate them to balance them
with national development priorities (Haftel and
Thompson, 2014). Finally, other countries are simply
walking away from their existing commitments, such
as Argentina, the Bolivarian Republic of Venezuela
and the Plurinational State of Bolivia (Gaillard, 2008;
Lavopa et al., 2013).

The path taken will need to cater to each coun­
try’s specific circumstances. Given that we live in one
of the most open periods in global economic history,
rather than searching for new barriers to deregulate,
nations need to work to design the appropriate
national policies to thrive in a globalizing world.

IV. Alternatives for emerging market and developing countries

104 Rethinking Development Strategies after the Financial Crisis – Volume I: Making the Case for Policy Space

1 The Telegraph, Speech by David Cameron at Lord
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2 The Economist, The global revival of industrial
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3 For more on the role of industrial policies for devel­
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