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Rethinking Development Strategies After the Financial Crisis, Volume Ii: Countries Studies and International Comparisons

Report by Alfredo Calcagno, Sebastian Dullien, Alejandro Márquez-Velázquez, Nicolas Maystre, Jan Priewe (ed), 2016

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Theoretical thinking on economic development largely relies on comparative analysis. In particular, 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.



Volume II: Country Studies and International Comparisons



Volume II: Country Studies and
International Comparisons

Edited by

Alfredo Calcagno
Sebastian Dullien

Alejandro Márquez-Velázquez
Nicolas Maystre

Jan Priewe

New York and Geneva, 2016



The opinions expressed in this publication are those of the
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Table of contents


Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

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

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

Sebastian Dullien ......................................................................................................................................................... 9

Abstract ........................................................................................................................................................................ 9
Introduction .................................................................................................................................................................. 9
I. Determinants of growth and development: The literature ................................................................................ 10
II. An alternative approach: Characteristics of top performers ............................................................................. 12
III. Why do top performers outperform the rest? .................................................................................................... 16
IV. What can we learn about development strategies? ........................................................................................... 17
Notes ....................................................................................................................................................................... 19
References .................................................................................................................................................................. 19

C.P. Chandrasekhar ................................................................................................................................................... 21

Abstract ...................................................................................................................................................................... 21
Introduction ................................................................................................................................................................ 21
I. Capital requirements ......................................................................................................................................... 21
II. A lesson from history ........................................................................................................................................ 22
III. Development banking ....................................................................................................................................... 23
IV. Policy banks ...................................................................................................................................................... 23
V. The BNDES in Brazil ....................................................................................................................................... 24
VI. The Indian experience ....................................................................................................................................... 25
VII. Comparing two experiences .............................................................................................................................. 26
VIII. The Republic of Korea: The State and development finance ........................................................................... 27
IX. China: A different trajectory ............................................................................................................................. 28
X. Conclusion ........................................................................................................................................................ 30
Notes ....................................................................................................................................................................... 30
References .................................................................................................................................................................. 30


Amit S. Ray ................................................................................................................................................................. 31

Abstract ...................................................................................................................................................................... 31
I. The context ....................................................................................................................................................... 31
II. Evolution of development policymaking in India ............................................................................................ 32
A. Policy planning driven by ideology: 1950s and 1960s ............................................................................... 32
B. Deeper penetration of self-reliance: 1970–1985 ......................................................................................... 33
C. Policy ambivalence and sporadic reforms: 1985–1990 .............................................................................. 34
D. Paradigm shift: 1991 onwards ..................................................................................................................... 35
III. India’s development trajectory .......................................................................................................................... 36
IV. The Indian model of development – promises and pitfalls ............................................................................... 38
Notes ....................................................................................................................................................................... 39
References .................................................................................................................................................................. 40

Liqing Zhang and Qin Gou ........................................................................................................................................ 41

Abstract ...................................................................................................................................................................... 41
Introduction ................................................................................................................................................................ 41
I. China’s economic growth performance: Retrospect ......................................................................................... 42
A. China’s economic growth performance ...................................................................................................... 42
B. Interpretation of China’s rapid economic growth ....................................................................................... 44
C. Underlying driving forces ........................................................................................................................... 44
II. Prospect of China’s economic growth: Challenges .......................................................................................... 47
A. Growth slowdown after the global crisis ...........................................................................................................47
B. Challenging factors ..................................................................................................................................... 48
III. Policy implications ........................................................................................................................................... 52
A. Deepening reforms ...................................................................................................................................... 52
B. Structural rebalancing ................................................................................................................................. 53
C. Taking mini-stimulus policies ..................................................................................................................... 54
IV. Concluding remarks .......................................................................................................................................... 54
Notes ....................................................................................................................................................................... 54
References .................................................................................................................................................................. 55

Laike Yang .................................................................................................................................................................. 57

Abstract ...................................................................................................................................................................... 57
Introduction ................................................................................................................................................................ 57
I. Literature review ............................................................................................................................................... 58
II. EastAsiaproductionnetwork:Fromtheflyinggeesemodeltoproductionsharing ........................................ 59
III. The impact on China’s technological upgrading .............................................................................................. 64
IV. Conclusion ........................................................................................................................................................ 68
Notes ....................................................................................................................................................................... 69
References .................................................................................................................................................................. 69


Pedro Rossi and André Biancarelli ............................................................................................................................ 71

Abstract ...................................................................................................................................................................... 71
Introduction ................................................................................................................................................................ 71
I. Deepening and renewing the social emphasis of the Brazilian development ................................................... 72
II. Brazilian macroeconomic regime: A critical assessment .................................................................................. 73
A. Exchange rate policy and the need for greater control ................................................................................ 74
B. Fiscal policy, anti-cyclical action and the search for room for investment ................................................. 76
C. Inflation targeting and the flexibility needed ............................................................................................... 77
III. Final remarks .................................................................................................................................................... 78
Notes ....................................................................................................................................................................... 79
References .................................................................................................................................................................. 80

Ricardo Ffrench-Davis ............................................................................................................................................... 81

Abstract ...................................................................................................................................................................... 81
Introduction ................................................................................................................................................................ 81
I. An overview of four decades ............................................................................................................................ 82
II. Three quite diverse experiences ........................................................................................................................ 84
A. The neo-liberal revolution, 1973–1981 ....................................................................................................... 84
B. Counter-cyclical regulation of the capital account: 1990–1995 .................................................................. 86
C. Contagion, counter-cyclical response and recovery in 2008–2013 ............................................................. 88
III. Closing remarks ................................................................................................................................................ 91
Notes ....................................................................................................................................................................... 91
References .................................................................................................................................................................. 92


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 “sub-Saharan 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
BNDES Banco Nacional de Desenvolvimento Econômico e Social

(National Bank for Economic and Social Development)

DAAD German Academic Exchange Service
(Deutscher Akademischer Austauschdienst)

DB development bank

DFI development finance institution

EU European Union
FDI foreign direct investment

FFE foreign-funded enterprise

FIE foreign-invested enterprise

GDP gross domestic product

IFIs international financial institutions

IMF International Monetary Fund

IPR intellectual property rights
ISIC International Standard Industrial Classification of All Economic Activities

IT information technology
ITES IT enabled services

n.e.s. not elsewhere specified

NIE newly industrialized economy

OECD Organisation of Economic Cooperation and Development

P&C parts and components
S&T science and technology
SELIC Sistema Especial de Liquidação e Custódia

(Special System for Settlement and Custody)
SITC Standard International Trade Classification

SME small- and medium-sized enterprise

SOE State-owned enterprise

TDR Trade and Development Report

TFP total factor productivity

UNCTAD United Nations Conference on Trade and Development

WTO World Trade Organization


About the authors

• André Biancareli is PhD Professor at the Institute of Economics of the State University of Campinas
(Unicamp), researcher at the Center for Studies of Current Trend and Economic Policy (Cecon) and
coordinator of the Developmentalist Network (RedeD).

• 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).

• C. P. Chandrasekhar is Professor at the Centre for Economic Studies and Planning, Jawaharlal Nehru
University. His areas of interest include the role of finance and industry in development and the experience
with fiscal, financial and industrial policy reform in developing countries. He has co-authored (with
Jayati Ghosh) Crisis as Conquest: Learning from East Asia (Orient Longman), The Market that Failed:
Neo-Liberal Economic Reforms in India (Leftword Books) and (with Simran Kumar and Kiran Karnik)
Promoting ICT for Human Development: India (Elsevier). He is a regular columnist for Frontline (titled
Economic Perspectives), Business Line (titled Macroscan), and The Hindu web edition (titled Economy
Watch). He is an Executive Committee member of IDEAs (International Development Economics
Associates), an international network of economists engaged in the promotion of teaching and research
using heterodox approaches to economic issues.

• 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 co-director of a DAAD-sponsored 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.

• Ricardo Ffrench-Davis is Professor of Economics at the University of Chile. He holds a PhD in Economics
from the University of Chicago and has been awarded the Chilean National Prize for the Social Sciences
and Humanities. He is former Principal Regional Adviser of ECLAC, 1992–2005, Chief Economist at the
Central Bank of Chile, 1964–1970 and 1990–1992, co-founder of the Center for Economic Research on
Latin America (CIEPLAN), 1975–1989, and Chairperson of the Committee for Development Policy of
the United Nations in 2007–2010. He has published 21 books and about 150 articles on trade and finance,
development and Latin American economies and is the author of Reforming Latin America’s Economies
after Market Fundamentalism (2006) and Economic Reforms in Chile: from Dictatorship to Democracy


• Qin Gou is Assistant Professor at the School of Finance of the Central University of Finance and
Economics, Beijing, China.

• 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 DAAD-sponsored
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 co-director 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
co-director 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.

• Amit S. Ray is Director, Centre for Development Studies, Trivandrum, India, on deputation leave from
Centre for International Trade and Development, Jawaharlal Nehru University, New Delhi, where he has
been a Professor since 2000.

• Pedro Rossi is PhD Professor at the Institute of Economics of the State University of Campinas (Unicamp),
researcher at the Center for Studies of Current Trend and Economic Policy (Cecon) and associated
researcher at the Developmentalist Network (RedeD).

• Laike Yang is Professor at the East China Normal University and currently the Dean of the Department
of International Trade. He holds a PhD in Economics from Xiamen University. He conducted his post-
doctoral research at the Chinese Academy of Social Science (CASS). His research fields are trade and
environment, Asian economic integration and China’s foreign trade.

• Liqing Zhang is Professor of International Finance, Dean of the School of Finance and Director of
International Finance Studies at the Central University of Finance and Economics, Beijing, China.


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 long-term 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 early-1990s. 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 II: Country Studies and International Comparisons

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 low-income 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 low-income 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 catching-up
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 cross-country
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 ultra-pragmatic and flexible
policies, constantly changing according to short-term
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 II: Country Studies and International Comparisons

dramatically improved in the early-2000s. 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 slow-growing 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 long-run 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 development-friendly
global governance. Within a chosen medium- or even
long-term 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 slow-growth 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
export-led 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. Boom-bust
cycles of short-term capital flows undermine growth
and development. Cross-border capital flows should
be governed by prudent management, which can
include capital controls. Unregulated capital flows
negatively affect market-driven exchange rates, gen-
erating strong volatility or chronic overvaluation of
exchange rates, both of which are strong hindrances
for development, given that currency-related 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. 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 well-known
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 second volume’s chapters.

In this (second) volume, four countries are
selected based upon the role that they play in the
developing world and the current discourses on devel-
opment: Brazil, Chile, China and India. To a certain
extent, they all represent development success stories,
at least for a considerable spell of time. Brazil, China
and India account for a large proportion of the world
population and their corresponding regional GDP.

The continental size of these economies plays a role
in their development conditions, particularly regard-
ing their domestic markets. By contrast, Chile is a
special case as a small country that is among the most
developed in Latin America and often considered a
role model, yet it remains many miles off the levels
achieved by the first generation of Asian tigers like
Taiwan Province of China or the Republic of Korea,
especially regarding its industrial development.

China and India have experienced very rapid
growth and a remarkable structural transformation in
recent decades, strongly contributing to the changing
landscape of the world economy. These trends, which
are based upon fast industrialization and urbanization
processes, are likely to continue in the foreseeable

Brazil and Chile share a number of common
features with most other countries in Latin America,
such as semi-industrialization, dependence on com-
modities, high income and wealth inequality and a
relatively high per capita income (in current dollars)
among developing countries ($11,200 and $15,700,
respectively, in 2013, compared to $1,600 and $6,600
in India and China in the same year). All these coun-
tries are very peculiar cases embedded in their history
and incorporating their idiosyncratic heritages.

It is not possible to identify single countries
that are completely representative of the more than
160 countries identified as developing countries by
the United Nations. Indeed, developing countries
have become increasingly heterogeneous as a group.
Nevertheless, some of the development strategies
analysed here may be relevant for the cases of least
developed countries and middle-income countries.
Aside from the detailed analysis of selected country
cases, this publication includes two overarching and
comparative studies. The remainder of this introduc-
tion provides an overview of the seven chapters of
this volume.

Sebastian Dullien looks at the characteristics of
countries that performed best in terms of real GDP per
capita growth between 1980 and 2013. He finds three
types of countries in this group: a few tiny economies
that have found a specific niche in the world mar-
ket, some petroleum exporters that have exploited
new fuel sources, and a relatively large number of
countries that had an undervalued exchange rate and
a deliberate development strategy, often including
explicit industrial policy. Interestingly, institutional

6 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

quality as generally measured by standard indicators
does not seem to play a decisive role in terms of being
a top performer; rather, this group comprises both
countries with good rule of law and low degrees of
corruption as well as those with poor scores for these
two indicators.

C.P. Chandrasekhar analyses the important role
of development banks as a major component of the
financial policies that a development strategy should
envision. However, development banks are being
challenged by neoliberal financial liberalization on
the grounds that equity and bond markets could sub-
stitute them. The author argues that the disappearance
of development banking would lead to a shortfall
in finance for long-term investments, especially
for medium and small enterprises. Accordingly, he
points to a number of successful development banks
in several countries.

Amit S. Ray observes an enigma of the “Indian
model” of development, which he attempts to unveil.
After discussing the evolution of India’s development
policies over the last six decades, he describes India’s
development trajectory over the long haul. He shows
how the country has finally emerged a global player in
the last couple of decades, despite India’s lost oppor-
tunity to be a part of the Asian Miracle during the
1960s, 1970s and 1980s. However, the Indian model
of development, principally driven by rapid expan-
sion of high-end knowledge-intensive sectors, comes
with a tragic neglect of low-end labour-intensive
mass manufactures. From an agriculture-dominated
economy, India straight away jumped to an economic
structure, albeit with a transition period of three or
four decades, during which services and high-end
manufacturing assumed the lead role. He argues that
this development model is not only inequitable in
the extreme, but it is also a prescription for political
volatility and is definitely not a sustainable develop-
ment model, especially in a democracy.

Liqing Zhang and Qin Gou provide a retrospect
of China’s economic growth since 1978, as well as
a prospect for the years to come. They start with a
review of China’s economic spurt in the past reform
period. They hold that this success had been driven
by the demographic dividend, high saving rates,
an outward-oriented development strategy as well
as growing technical progress. Subsequently, the
authors analyse the challenges from the diminishing
demographic dividend, growing structural imbal-
ances, macro instability and financial risks. Lastly,

they suggest some reform policies to maintain sus-
tainable economic growth and avoid middle-income
traps, including deepening financial sector reforms,
reforms of the household registration system and
the education system, structural rebalancing and the
phasing-out of the massive stimulus policy applied
during and after the financial crisis.

Laike Yang analyses China’s production sharing
within East Asia and the respective changes in the
trade pattern. International production sharing has
been a key feature of East Asian economic develop-
ment in recent decades, with firms in advanced Asian
economies relocating their production to China, using
it as an assembly base before exporting the final
products to the United States and Europe. China has
taken advantage of this process and transformed into
a global manufacture centre, with the country’s emer-
gence having reshaped the Asian production network
and trade pattern. Yang analyses the economic model
and the development strategies in East Asia, China’s
position in East Asia’s production network, as well
as its impact on China’s technological upgrading.
He finds that China has moved to the centre of East
Asia’s production network, thanks to its export-led
development strategy. It has significantly upgraded
its technology and narrowed its technology gap with
South East Asia, although the gap between China and
Asian advanced economies remains large.

The term “social developmentalism” in the
sense of a social-oriented development strategy is a
source of heated debate among Brazilian economists.
Pedro Rossi and André Biancarelli analyse this model
for the case of Brazil. In the recent debate on the
Brazilian growth model, the economic tripod, i.e.
the combination of inflation targeting, targeting the
primary fiscal deficit and the floating exchange rate
regime, was identified as being responsible for low-
ering economic growth and hindering development
in Brazil. However, the macro regime has proved
flexible over time, allowing changes in the form of
management of policies within the same institutional
framework, especially after the 2008 crisis. Within
this context, the authors aim to discuss the relation-
ships between these macroeconomic policy fronts
and a social-oriented development strategy for the
Brazilian economy. The background question is
whether the actual macroeconomic regime, inherited
from an orthodox perspective, is compatible with the
deepening of social development, which depends
upon a strong role of the State, changes in income dis-
tribution and the expansion of social infrastructure.


Ricardo Ffrench-Davis analyses the perfor-
mance of the Chilean economy over the last four
decades. In terms of GDP per capita, Chile is the
most advanced country in Latin America and is often
considered a role model for development, not only in
this continent. Its economy is usually highly praised
as having been successful since the imposition of
neoliberal reforms under the dictatorship of general
Pinochet in 1973. However, the four decades that
have elapsed include sub-periods with quite different
policy approaches and notably diverse outcomes;



thus, there is neither one unique model nor only one
outcome. The four decades’ growth is moderate,
averaging 4.2 per cent per year, comprising meagre
growth of 2.9 per cent during the 16 years of dictator-
ship and a much better performance of 5.1 per cent
during a quarter-century of democracy, albeit with a
vigorous 7.1 per cent in the initial years (1990–1998)
and a more modest 3.9 per cent in the last 15 years.
Focusing on three episodes (1973–1981, 1990–1995
and 2008–2013), French-Davis explores lessons for
building “a model 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 high-income groups, using their
per capita income levels as the sole criterion and
setting arbitrary thresholds. For instance, the World
Bank (2014) currently defines low-income countries
as those whose per capita income is below $1,045,
middle-income countries as those with an income
between $1,045 and $12,746 and high-income
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 oil-exporting
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 technological 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, develop-
ing 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 South-East European countries that are not
European Union members.

Birdsall N and Fukuyama F (2011). Post-Washington
consensus-development 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 sub-regions, and selected economic and
other groupings. Available at: http://unstats.un.org/

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

9A Question of Strategy: What Characterizes Top Growth Performers?


Sebastian Dullien

For decades, economists have tried to find
the holy grail of economic development. Since the
advent of the New Growth Theory in the early-
1990s, research on the determinants of economic
growth has grown exponentially. After a first wave
of cross-country studies, a second wave with panel
regressions followed, making use of the fact that
panel regressions allow working with information
concerning within-country variation as well as
cross-country variations. While pre-1990s studies
often tried to confirm or reject income convergence
between initially more and less developed countries,
the new wave of contributions tried to identify fac-
tors that could explain differences in growth in gross
domestic product (GDP) per capita, with the implicit
aim of also providing policymakers some guidelines
concerning how to design economic reforms for
development and growth.

At least quantitatively, this research was very
productive. Sala-i-Martin (1997) already counts
60 variables that have been proven significant in at

least one specification and it is safe to assume that
this number has more than doubled in the subsequent
decade-and-a-half. As the development economist
Romain Wacziarg (2002: 907) puts it in his review
of William Easterly’s The Elusive Quest for Growth:
“All-encompassing hypotheses concerning the
sources of economic growth periodically surface, and
with the support of adequately chosen cross-country
correlations, enjoy their fifteen minutes of fame. Over
the last few decades, the list of proposed panaceas
for growth in per capita income has included high
rates of physical-capital investment, rapid human
capital accumulation, low income inequality, low
fertility, being located far from the equator, a low
incidence of tropical diseases, access to the sea,
favourable weather patterns, hands-off governments,
trade-policy openness, capital-markets develop-
ment, political freedom, economic freedom, ethnic
homogeneity, British colonial origins, a common-law
legal system, the protection of property rights and
the rule of law, good governance, political stability,
infrastructure, market-determined prices (including


This contribution looks at the characteristics of countries that have performed best in terms of real
GDP per capita growth between 1980 and 2013. It is found that three types of countries can be found
among this group: a few tiny economies that have found a specific niche in the world market; some
petroleum exporters that have found new fuel sources; and a relatively large number of countries that
had an undervalued exchange rate and a deliberate development strategy, often including explicit
industrial policy. Interestingly, institutional quality as generally measured by standard indicators
does not seem to play a decisive role in terms of being a top performer; rather, this group comprises
both countries with good rule of law and low degrees of corruption as well as those with bad scores
for the two indicators.


10 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

exchange rates), foreign direct investment, and suit-
ably conditioned foreign aid. This is a growing and
non-exhaustive list.”

From the perspective of policymakers who want
to increase the growth prospects of their own country,
the issue is further complicated by lingering debates
about the robustness of the findings for both cross-
country and panel regressions. A number of issues
such as the endogeneity of variables and the robust-
ness of estimated coefficients are being discussed,
with some studies concluding that essentially none of
the more elaborated factors proclaimed by the litera-
ture to explain economic growth can truly be robustly
seen as an explanatory factor for development.

Therefore, this chapter adopts a different ap-
proach by considering the top performers among
developing countries and emerging markets over the
past three decades, trying to identify what they have
in common. While this exercise naturally is not as

statistically rigorous as econometric cross-country
or panel regressions, given the methodological
problems that burden the latter, this approach might
nonetheless prove informative. While the vast body
of cross-country and panel regression literature has
yet to present a list of priorities for development, one
can argue that the common factors of the “top growth
performers” are good candidates for necessary and
possibly even sufficient conditions for a sustained
catch-up growth and hence convergence towards the
living standards of high-income countries.

The remainder of this chapter is structured as
follows. First, section I will look at the lessons that
we can draw from standard growth and convergence
literature, before section II considers international
growth experiences. In this section, some character-
istics of the top growth performers over the period
from 1980 to 2013 will be extracted and presented.
Section III subsequently tries to explain the factors
that are found to be relevant for economic growth.

There is definitely no shortage of literature on
the determinants of economic growth, yet unfortu-
nately there is also no lack of dispute about what
are the main explanatory factors for a rapid GDP
per capita growth rate. While the initial contribu-
tion focused on applying the Solow (1956) growth
model and sought to find evidence for the conditional
convergence hypothesis (according to which each
country would converge to its own equilibrium out-
put, determined by the national investment ratio1 and
population growth, and according to which countries
further from this steady state grow more quickly), the
contributions of the New Growth Theory added prox-
ies for variables such as human capital, institutional
quality, democratic governments, economic openness
and stock of knowledge.

The next step was a shift towards using panel
regressions rather than simple cross-country regres-
sions, which offered the advantage of providing
a much larger number of data points and hence
increased the validity of econometrics methods.
Consequently, the majority of recent research on
the determinants of economic growth uses panel

Unfortunately, despite hundreds of papers
having been published using both cross-country and
panel regressions, the results have been far from
clear. Most of the variables have been found to be
significant in some contributions yet not significant in
other specifications or with slightly altered samples.

Some authors have recently tried to use tech-
niques for meta-analysis of existing studies to solve
these questions. For example, summarizing more than
80 studies and almost 500 estimates, Doucouliagos
and Ulubasoglu (2008) find that democracy has no
direct effect on economic growth, but an indirect one
through human capital accumulation, lower inflation
and lower political instability. De Dominicis et al.
(2008) conduct a similar exercise on the relationship
between inequality and growth yet find that the results
critically depend on the estimation methodology
applied in the underlying studies, concluding that
more targeted research is needed. Ugur and Dasgupta
(2011) find that the vast number of studies support the
claim that corruption overall hurts economic growth.

However, a number of unresolved statistical
is sues seem to remain in the underlying studies,

I. Determinants of growth and development: The literature

11A Question of Strategy: What Characterizes Top Growth Performers?

which clearly cannot be addressed by meta-analyses
merely summarizing the findings of other studies.
The first issue is the measurement problem. GDP
measured in purchasing power parity (which is
often used for these cross-country and panel regres-
sions) is highly unreliable, especially for developing
countries, with repeated large revisions dating back
over decades. Measurement issues are even worse
for some of the institutional variables. A number of
these proxies, e.g. for the degree of rule of law or the
prevalence of corruption, are based upon surveys and
hence carry a large degree of subjectivity.2 Moreover,
many indicators are not always reported each year
and hence are averaged over a multi-year period.
Together, the data quality clearly calls into question
the results of most studies.

The second problem is endogeneity. For many
variables routinely included in growth regressions as
explanatory variables, it is unclear whether they are
really exogenous. For example, the share of children
enrolled in school is often used as a proxy for human
capital and hence an exogenous variable explain-
ing GDP per capita. Nonetheless, it is theoretically
plausible that school enrolment itself is a function of
the general income level of an economy and hence
endogenous to GDP. Another example is the open-
ness of an economy, which is generally measured as
the share of imports and exports among GDP. While
this measure of openness is often used as a proxy
for the absence of tariffs and trade barriers, it can be
well argued that this measure of openness itself is
endogenous to the level of economic development in
an economy. A population with very low real GDP
levels can be expected to spend a larger share of
disposable income on locally grown food and local
services, whereas a country with a more diversified
(and hence developed) manufacturing sector can be
expected to have a larger share of exports to GDP.

The third hitherto unresolved question concerns
model uncertainty and robustness. The problem of
model uncertainty is that there is no clear single
theoretical model telling researchers which variables
to include and how to choose between alternative
specifications. Practically, this problem has been
solved by something akin to data mining. Economists
with a certain (theoretical) idea about the relationship

between one factor (e.g. schooling) and GDP per
capita look for adequate indicators for schooling
(e.g. primary school enrolment, spending on primary
educations or average years in school) and add them
on a trial-and-error basis to a standard dataset until
they find a statistically significant variable that
remains robust to slight changes in the specification.
As is nicely demonstrated in Charemza and Deadman
(1997), such procedures lead to the conclusion that
some variables are statistically significant in explain-
ing the dependent variable (here GDP per capita)
despite having no underlying economic relationship
to it.

The question of robustness of significance in
cross-country estimations was first prominently
raised by Levine and Renelt (1992) and was rebutted
by Sala-i-Martin (1997), claiming that the former had
used an excessively harsh criterion of robustness.

However, how valid the question of robustness
remains has recently been demonstrated by Westling’s
(2011) paper, which attracted significant attention in
mainstream media, such as the Economist. In a clear
attempt to underline the statistical fragility of much
of the cross-country growth literature, Westling
added the average national human penis size to the
well-known Mankiw et al. (1992) dataset, showing
that, according to standard methodology, penis size is
not only highly significant (with an inverse U-shaped
relationship) in explaining the GDP per capita level
in 1985, but also in explaining (with a linear nega-
tive relationship) GDP per capita growth from 1960
to 1985. Moreover, according to Westling, taken
at face value, his results would indicate that penis
size contributes more towards explaining GDP than
standard proxy variables used for describing political
institution, further underlining that variables without
an obvious connection to underlying economic
growth dynamics can emerge as highly significant
in cross-country regressions.

In a more serious paper, Moral-Benito (2012)
claims that when properly taking account of the
issues of endogeneity and model uncertainty, both
the conditional convergence hypothesis as well as the
significance of the most routinely included explana-
tory variables for output growth disappear.

12 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

These unresolved issues call for complementing
the standard regression approaches with other meth-
odologies, especially mixed-methods that combine
the initial large-sample empirical analysis with a
more qualitative analysis of a smaller sample. Indeed,
this is what this contribution is trying to achieve: it
will look at the group of top growth performers and
try to infer from their experiences which elements are
central for starting and sustaining a vibrant economic
development process over an extended period.

Therefore, what can we learn if we look instead
at those countries that have performed best in recent
decades? In order to answer this question, we first
need to define what “perform best” means. In line
with the existing literature, the best point of refer-
ence is the growth in per capita real GDP. A second
question now would concern the extent to which a
certain GDP per capita growth rate by low-income
countries should be seen as a similar performance
as the same growth rate for a middle-income coun-
try. According to the Solow model, a low-income
country could expect higher growth rates than a
middle-income country. However, the literature is
unclear about whether there is actually any trend
towards convergence (Moral-Benito, 2012), while
casual inspection of the correlation between initial
levels in 1980 and subsequent GDP growth rates
indicates that there is no clear negative correlation.
Hence, simply looking at plain average annual GDP
per capita growth rates seems adequate as a yardstick
for economic performance.

Regarding the time period used, the years
from 1980 to 2013 have been chosen. The macro-
economic data for this exercise has been taken from
the International Monetary Fund (IMF) 2013 World
Economic Outlook database and data up to and
including 2013 has been used.3 For institutional and
structural variables, the dataset used by Rodrik (2008)
(and provided on his personal website) has been used.

There are some pragmatic and conceptual
considerations behind the choices for the period
and dataset used. Pragmatically, the dataset from
1980 onwards is much more complete in both
scope and width than the commonly used dataset
from 1960s onwards. Conceptually, we ideally
want to draw relevant policy lessons for developing
countries. As the global environment was very dif-
ferent in the 1960s and 1970s from today, with the

Bretton-Woods-System of fixed exchange rates in
place in the 1960s and early-1970s, it seems that more
can be learned from successful growth experiences in
the 1980s and 1990s than the 1960s or 1970s. The use
of Rodrik’s dataset is justified as his work is widely
cited and he has collected the data from sources
already widely used prior to his publication; hence,
any difference in the outcome of the analysis cannot
be attributed to the use of different data sources.

When we now look at the global distribution
of average growth rates of GDP per capita over
these 33 years (chart 1), we find that roughly half
of the countries and territories covered by the IMF
for the entire period have experienced higher GDP
per capita growth than the United States of America
(and hence can be seen as catching up if we define
the United States as the frontier), while about half
have experienced slower GDP growth and hence
have been falling behind. Moreover, as marginal
upward deviations from the United States growth
rates means very long periods of convergence of
several centuries, we are interested in countries that
have performed spectacularly better than the United
States. The original sample includes all developed
and developing economies covered by the IMF World
Economic Outlook.

A question now is how many of the top per-
formers to include in a closer analysis. Again, there
is no objective guideline to follow. Looking at the
distribution of growth rates, it is interesting to note
that within the overall distribution of average per
capita GDP growth rates, there is a noticeable drop
between slightly less than 4 per cent and around
3.5 per cent. While selecting only 10 or 15 top per-
formers would exclude some of the countries that still
almost reached an annual per capita growth rate of
4 per cent, increasing this sample to 20 includes all of
the countries that reached almost 4 per cent. Hence,
the top 20 growth performers have been selected for
closer scrutiny in this chapter.

Selecting countries with a particular growth
experience and looking at them as a methodol-
ogy is not new. The Commission on Growth and
Development (2008) also looks at 13 “success
stories”, namely periods in countries with sustained
high rates of growth. This chapter differs from the
Commission’s approach as it uses a common time
period (1980 to 2013), while the Commission looks

II. An alternative approach: Characteristics of top performers

13A Question of Strategy: What Characterizes Top Growth Performers?

at success stories that might have started in the 1960s
and compares them to countries that were successful
in the 1990s. Given that the global macroeconomic
environment and institutions have significantly
changed between these periods, looking at the imme-
diate past seems more appropriate in terms of how to
achieve a sustained catch-up growth today.

Now, if we take a look at the top 20 growth
performers over this more than a quarter century, we
obtain a diverse group comprising: China, Bhutan,
the Republic of Korea, Viet Nam, Taiwan Province of
China, Maldives, Sudan, India, Botswana, Thailand,
the Lao People’s Democratic Republic, Singapore, Sri
Lanka, Cape Verde, Mauritius, Hong Kong (China),
Malaysia, Indonesia, St. Vincent and the Grenadines
and Oman. All of these economies averaged annual

GDP per capita growth rates of at least 3.2 per cent
over the entire period, with China at the top with
average annual growth rates of 8.8 per cent. Given the
dynamics of compound growth, this means that each
of these economies at least roughly tripled its GDP
per capita since 1980, while China increased its GDP
per capita 16 times. Interestingly, this list is rather
robust, given that 17 out of the 20 top performers
from 1980 to 2013 would have also been on this list
had we started the period of examination in 1985.4

The first interesting point is that the size of the
economies on the list widely differs. While the two
most populous countries in the world, China and
India, have made it onto the list, some of the small-
est countries in the World can also be found, such as
St. Vincent and the Grenadines (initial population in

Chart 1

(Per cent)

Source: Author’s calculations, based on IMF, World Economic Outlook database.
a These economies are in descending order: Finland, Sweden, Rwanda, Spain, Austria, Islamic Republic of Iran, Angola,

Germany, the Netherlands, Guyana, El Salvador, Argentina, Belgium, Iceland, Peru, Denmark, Canada, Bulgaria, New
Zealand, Hungary, Romania, Fiji, France, the Philippines, Papua New Guinea, Ecuador, the Congo, Italy, Brazil, Switzerland,
Jordan, Bahrain, Lebanon, Honduras, Mali, Mexico, Paraguay, Algeria, Jamaica, Kenya, South Africa, Barbados, Greece,
Senegal, Bahamas, Malawi, Plurinational State of Bolivia, Benin, Vanuatu, the Gambia, Cameroon, Guatemala, Solomon
Islands, Venezuela, Burundi, Comoros, Gabon, Guinea-Bissau, Zambia, Sao Tome and Principe, Saudi Arabia, Qatar, Kiribati,
Niger, Sierra Leone, Kuwait, Central African Republic, Côte d’Ivoire, Madagascar, Haiti, Togo, Democratic Republic of the
Congo, Libya, United Arab Emirates.

b These economies are in ascending order: Nigeria, United Republic of Tanzania, Japan, Portugal, Norway, Australia, Ethiopia,
Colombia, Israel, Albania, Uruguay, the United Kingdom, Cyprus, Morocco, Antigua and Barbuda, Seychelles, Ghana,
Poland, Uganda, Burkina Faso, Egypt, Tunisia, Swaziland, Dominican Republic, Turkey, Pakistan, Nepal, Chad, Saint Lucia,
Luxembourg, Lesotho, Belize, Panama, Grenada, Bangladesh, Ireland, Saint Kitts and Nevis, Mozambique, Chile, Tonga,
Oman, Saint Vincent and the Grenadines, Indonesia, Malaysia, Hong Kong (China), Mauritius, Cape Verde, Sri Lanka,
Singapore, the Lao People’s Democratic Republic, Thailand, Botswana, India, the Sudan, Maldives, Taiwan Province of
China, Viet Nam, the Republic of Korea, Bhutan, China.









United States:
1.7 per cent

Economies falling behinda Economies catching upb

14 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

1980: 110,000) and the Maldives (initial population:
340,000). Hence, the notion that significant econo-
mies of scale allow larger countries to grow more
quickly is not supported in the data, at least not to the
extent that being a large country is a prerequisite for a
top growth performance. The share of tiny economies
among the top performing group is roughly the same
as in the overall database.

For further analysis, very small economies
with an initial population of less than two million
inhabitants over the average of the period have been
excluded,5 although we will return to those small
country cases later. This exclusion can be justified
given that the economics of development in tiny
economies might be very different from those for
large countries. Moreover, if the goal is to improve
living conditions for a large share of the world’s
population, the fate of tiny economies holds rather
secondary importance: in 1980, out of the roughly
4.4 billion people on the planet, according to the IMF
World Economic Outlook data, not even 20 million
(0.5 per cent of GDP) lived in the almost 40 countries
with a population of less than 2 million.

Interestingly, two of the top performers are
countries that have discovered or developed large
fuel deposits in the past decades. Sudan started to
export crude oil in the late-1990s, which led to more
than a quadrupling of GDP per capita after decades of
stagnation. Oman made major oil discoveries around
1980, many of which went online in the first half
of the 1980s, thus strongly increasing the country’s
oil production and oil exports (Mohamedi, 1994).
Moreover, Oman started to export liquefied natural
gas in the early-2000s with the inauguration of the
country’s two facilities in 2000 and 2005, again
giving a strong push to the country’s GDP (United
States Energy Information Administration, 2014).
Thus, two findings here are interesting: first, of the
many countries depending on petroleum exports, only
two made it into the group of the top performers; and
second, this also does not necessarily give support
to the hypothesis of an unavoidable resource curse,
given that these two countries obviously managed to
at least partly escape problems related to the inflow
of natural resource revenue.

Now moving on from tiny economies and petro-
leum economies, what do the larger countries among
the top growth performers have in common?6 If one
follows the literature on endogenous growth and the
recommendations of the Washington Consensus, one

would think that good governance and rule of law
should be one of the preconditions for sustained eco-
nomic growth. If these issues are so important, surely
no country without these preconditions should have
made it into the top 20. However, this notion seems
to be false. As can be seen in charts 2 and 3 (which
show the average indexes for the rule of law and the
absence of corruption over the period discussed, as
used by the Rodrik (2008) dataset, separating the top
performers into oil economies, tiny countries and
the rest), there does not seem to be any discernible
relationship between rule of law and the absence of
corruption and being among the top 20 performers.
By contrast, there seems to be a wide variation, with
some economies in this group (such as Indonesia or
the Lao People’s Democratic Republic) performing
terribly in terms of these institutional variables,
whereas some others (such as Hong Kong (China)
or Singapore) do quite well. Indeed, the same holds
for the government regulation index.

What about net capital inflows? Textbook mod-
els recommend that developing economies open up
their capital account and allow for net capital inflows,
which is expected to result in higher domestic invest-
ment and should be seen in a deficit in the current
account. By contrast, Prasad et al. (2007) found that
economies with a current account surplus actually
tended to grow faster over the period from 1970
to 2000. Interestingly, among the group of the top
performers, we can find all kinds of current account
experiences: economies with large current account
surpluses (such as Hong Kong (China), Singapore or
Taiwan Province of China), as well as those with large
deficits (as the Lao People’s Democratic Republic, Sri
Lanka or Viet Nam) and those with almost balanced
current accounts (chart 4).

Certainly, trade openness must then be impor-
tant. Again, this cannot be confirmed by the data. The
group of top performers include economies with trade
(average of import and export) to GDP ratios of only
slightly more than 10 per cent, such as India, as well
as those with trade-to-GDP ratios of almost 40 per
cent (such as Viet Nam).

We get closer to common factors if we look
at possible undervaluation of the national cur-
rency. Using Rodrik’s (2008) definition and index
for undervaluation and computing the average for
the entire period from 1980 to 2007,7 we see that
the economies in the top performing group share
something in common, at least if we abstract from

15A Question of Strategy: What Characterizes Top Growth Performers?

Chart 2

IN TOP 20 PERFORMERS, 1996–2004

Source: Author’s calculations, based on Rodrik (2008) data.
Note: Data refer to the average of the period. Top 20

performers refer to economies that registered the
highest compound annual growth rates of GDP per
capita during the 1980–2013 period (cf. chart 1).

Chart 3

IN TOP 20 PERFORMERS, 1996–2004

Source: Author’s calculations, based on Rodrik (2008) data.
Note: See chart 2.

Chart 4

IN TOP 20 PERFORMERS, 1980–2013

(Per cent of GDP)

Source: Author’s calculations, based on IMF, World Economic
Outlook database.

Note: See chart 2.

Chart 5

IN TOP 20 PERFORMERS, 1980–2004

Source: Author’s calculations, based on Rodrik (2008) data.
Note: See chart 2.

-2 -1 0 1 2




Republic of Korea

Viet Nam

Taiwan Prov. of China



Lao People's Dem. Rep.


Sri Lanka

Hong Kong (China)






Cape Verde


St. Vincent and
the Grenadines

Tiny economies

Oil economies

-2 -1 0 1 2 3




Republic of Korea

Viet Nam

Taiwan Prov. of China



Lao People's Dem. Rep.


Sri Lanka

Hong Kong (China)






Cape Verde


St. Vincent and
the Grenadines

Tiny economies

Oil economies

-20 -15 -10 -5 0 5 10 15 20




Republic of Korea

Viet Nam

Taiwan Prov. of China



Lao People's Dem. Rep.


Sri Lanka

Hong Kong (China)






Cape Verde


St. Vincent and
the Grenadines

Oil economies

Tiny economies

-1.0 -0.5 0.0 0.5 1.0




Republic of Korea

Viet Nam

Taiwan Prov. of China



Lao People's Dem. Rep.


Sri Lanka

Hong Kong (China)






Cape Verde


St. Vincent and
the Grenadines

Oil economies

Tiny economies

16 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

oil exporters and tiny economies (chart 5): none
of the economies had a significantly overvalued
exchange rate over the period in question. Moreover,
most of the economies in this group had a strongly
undervalued exchange rate. Economies that had a
slightly overvalued exchange rate on average often
had a clearly undervalued one at the beginning of
their development process. For example, according
to Rodrik’s data, Singapore had an undervalued
exchange rate in all but one year between 1960 and
1980, while the Republic of Korea had a strongly
undervalued currency until the late-1980s. All this

points towards the conclusion that it is very difficult
to truly get into the group of top growth performers
without a competitively valued exchange rate, at least
at the start of a development process.

There is one further observation worth noting,
namely that all but two of the larger top performers
are what are usually classified as Asian economies.
Indeed, the two exceptions are Oman and Sudan, two
petroleum exporting countries with rather specific
characteristics and relatively late development of
some fuel sources.8

III. Why do top performers outperform the rest?

So, why can all top performers be found in
Asia, once tiny and oil exporting countries have
been excluded? One possible explanation is naturally
that specific Asian values are more conducive to
economic growth than African, Central and Eastern
European or Latin American values. However, the
problem with this hypothesis is that the group of the
top performers includes culturally and politically
extremely different Asian countries. For example,
India is historically, ethnically and from its institu-
tion extremely different from China or the Republic
of Korea, probably at least as different as Thailand
is from some Latin American countries.

Another possible explanation is the high popula-
tion density and easy access to easily navigable ocean
shipping lanes of most countries has helped the Asian
region to experience economies of scale in the growth
process. In some of the larger countries, the sheer size
and density of the population might mean that any
type of innovation produces large improvements in
productivity as they can be used by a large number of
people and quickly spread among them. In some of
the smaller countries, growing trade integration might
have helped the spillover of technological progress
and innovation, thus creating a similar mechanism
even if the national population is rather small.
Support for this argument can be found in the fact
that (unlike in other regions such as Africa and Latin
America) trade integration and cross-border produc-
tive networks in South-East Asia have now reached
levels that almost mirror those in the European Union
(Athukorala and Kohpaiboon, 2010).

The second explanation is the existence of a
deliberate development strategy. All of the larger,

non-petroleum exporting countries among the top
performer group have in common heavy State involve-
ment in the development process, often with a clear
vision of which sectors to promote and how to imple-
ment this support, as well as having feedback loops in
place to correct the course if some policies fail.

This is not initially visible in the macroeco-
nomic data or the institutional indicators. Again, the
top performer group includes economies that have a
very large public sector (India), as well as those with
a relatively slim public sector, such as Hong Kong
(China) and Singapore. However, the share of gov-
ernment expenditure in GDP, which is most widely
used to measure the degree of government involve-
ment in the economy, does not tell the whole story. In
addition, there is always the question of regulations
and other government interference in the business
sector, including cases of moral suasion that might
not show up in any of the widely used indicators.

For some economies, the role of (in some
cases) far-reaching industrial policies spanning over
a wide number of policy fields in a broader develop-
ment strategy is well documented. For example, for
economies such as China, Indonesia, the Republic
of Korea, Taiwan Province of China and Thailand,
industrial policies have been widely described and
analysed,9 as has been the example of industrial
policy in India, which is generally seen as less suc-
cessful. As is evidenced by the above-presented data
on undervaluation, macroeconomic variables such
as the exchange rate have been used as one element
of industrial policy in these economies, namely by
providing additional price incentives for exports and
import substitution.

17A Question of Strategy: What Characterizes Top Growth Performers?

However, less obvious members of the group
of top performers such as Singapore also support
this point. While Singapore often scores among the
highest in terms of institutional measures such as the
Fraser Institute’s index of economic freedom, as well
as having a rather low share of government revenue
and government expenditure to GDP, the Government
has played a decisive role in its economic develop-
ment since the 1960s, actually defining and fostering
priority sectors. Wong (2001) nicely summarizes the
various interventions of Singapore’s Government
in a number of important markets such as those for
labour, land and capital to achieve strategic goals in
the industrialization process.

The only exception to this observation might
be Hong Kong (China), which has long been seen as
a champion of the free-market approach. However,
while the Government did not “pick winners” in
certain industrial sectors, it was heavily involved in
the planning of transport infrastructure, such as the
port and domestic transport routes. Moreover, the
policy of fixing the exchange rate through a currency

board system together with liberalized labour markets
can also be seen as an attempt to achieve a competi-
tive exchange rate. Here, one could say that being
extremely open to international trade was also a
deliberate strategy based upon the specific strength
of the territory, namely its close connection to both
the Chinese mainland and Britain at the same time.

This also links back to the tiny country cases in
our group of top growth performers. As previously
mentioned, there are a number of small economies
on our list that we have not yet explored in detail,
such as Maldives, Mauritius and St. Vincent and the
Grenadines. If one looks into the economies of the
more successful small countries, it soon becomes
evident that these countries have managed to move
into a specific niche of the world market in which
they have prospered. For example, the Maldives has
managed to establish itself as a high-price tourist
destination. By contrast, Mauritius has created a
financial sector that is used as an FDI holding location
for Indian investment (Joseph and Troester, 2013),
while also promoting high-value tourism.

If we now look back at the different cases again,
we can summarize that there seem to be three differ-
ent strategies that can lead to successful development:

1. Find oil and limit the negative effects from the
resource curse;

2. Find a niche in the world market; or

3. Produce cheaply and use this price advantage
for technological upgrading, supported by
industrial policy.

The question is now why some countries have
managed to employ a strategy bringing them onto
the path of successful development while many other
countries have not.

From the arguments above, there are some
important lessons for the design and implementation
of successful development strategies. First, one size
clearly does not fit all when it comes to development
approaches. Especially when we talk about niches in
the world market, it is imperative that not all develop-
ing countries try to fill the same niche, as a niche does
not provide sufficient space for all. A country that has

found oil does not need to worry about which markets
to serve, but rather how to manage the oil windfall in
a way that does not hinder development beyond the
single sector. It is also striking that the strategy of big-
bang liberalization of as many markets as possible
and government retrenchment is not a strategy that
seems to be empirically promising when one wants
to belong among the top growth performers. With the
possible (and disputable) exception of Hong Kong
(China), none of the top performers has managed a
leading position with such a strategy.

The second point is that a comprehensive strat-
egy is needed. While many countries have passed
documents that supposedly define a “development
strategy” or an “industrial strategy”, many do not
implement them beyond the creation of an investment
promotion agency. However, what all of the Asian
economies depicted above share in common is that
a wide range of instruments has been applied with
the goal of reaching the targets set in their develop-
ment strategy, including capital controls, exchange
rate and wage policies to sustain a competitive real
exchange rate and create domestic savings, which
could subsequently be funnelled as credit supply

IV. What can we learn about development strategies?

18 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

to certain sectors. Furthermore, industrial policies
have been widely used with selective protectionism
and preferential treatment for potential export indus-
tries.10 These instruments need to be well coordinated
and there must not be conflicts with other policy goals
holding potentially higher priority.11

The third point is that a strategy requires more
than simply being called “a strategy”. To understand
this point, one needs to briefly think about what
a “development strategy” is. Given that countries
have been pushed by the IMF, the World Bank and
the Organisation for Economic Co-operation and
Development into formulating their own poverty
reduction and development strategies and including
them in “poverty reduction strategy papers”, many
countries have formally adopted such strategies by
now. However, these strategies are often not very far
reaching when it comes to the economic part. Even
though most of these papers feature an explicit sec-
tion on a “growth strategy”, the discussion of many
policy fields, including the macroeconomic variables
in the different countries’ strategies, are extremely
similar and not necessarily specific to a country’s
problems or conditions.

The macroeconomic discussion usually only
covers a few pages of documents of several hundred
pages and thus lack depth. A good example here is
Cameroon’s poverty reduction strategy paper (IMF,
2003: 33), which states (and continues in a similar
tone): “Macroeconomic stability fosters growth and
welfare improvement in the medium term. It allevi-
ates the burdens of debt, inflation, and high interest
rates that penalize all economic actors and more par-
ticularly the poorest households. It reduces the level
of uncertainty and country risks and hence decreases
the cost of capital. It contributes to maintaining a
stable real exchange rate. The latter three factors help
improve overall economic competitiveness and foster
investment, production, and export diversification,
thereby accelerating growth, reducing the volatility
of the economy, and maximizing welfare.” Another
example is the discussion of monetary policy in the
Republic of Bolivia’s (2001: 195) strategy paper:
“The low inflation rates anticipated in the BPRS
[Bolivian Poverty Reduction Strategy] are an impor-
tant factor in avoiding distortions in the allocation
of resources; they also reduce redistribution effects
harmful to society’s poorest members given that most
of them have neither the information they need nor
the ability to shield themselves against inflation by
allocating their limited resources to financial instru-
ments that are indexed or maintain their value.”

Hence, macroeconomic recommendations hard-
ly ever go beyond the goal of guaranteeing stable
prices, low budget deficits and stable exchange rates.
Country specifics here are usually limited to the
description of recent inflation trends and expected
reactions of the central bank, or a description of the
overall fiscal deficit and instruments to reduce it.

When it comes to the external sector and
tariffs, the poverty reduction strategy papers usu-
ally proclaim the goal of further liberalizing the
external sector, but they hardly ever spell out which
sequencing of liberalization might be most sensible
to promote domestic industrial development.

If one compares this to the approach chosen and
applied by the top growth performers, the difference
quickly becomes clear: it is not sufficient to broadly
identify that a country wants economic growth and
poverty reduction. Instead, a proper strategy needs a
vision of where a country wants to go. A successful
strategy might include “picking winners” in the sense
that the government might decide to prioritize certain
sectors or devises a business model for the whole
country in the case of a small country. Moreover, a
successful strategy clearly requires the employment
of all available instruments, including the most pow-
erful macroeconomic instruments influencing credit
availability, interest rates and real exchange rates.

Finally, one clearly important result from this
simple exercise is to observe that becoming one of
the top growth performers seems possible with a
wide variety of institutional structures and features.
Any development strategy here needs to be country-
specific, looking at not only existing comparative
advantages but also the specific institutions that exist,
as well as asking the question of how far comparative
advantages can be changed for the advantage of the
country in question. In such a strategy, priorities need
to be set. Accordingly, it is possible that bringing
institutions to a Western standard reaching high index
values in widely used measurements for democracy
and rule of law does not need to be the first priority.

Further research is clearly needed, which needs
to go beyond employing cross-country or panel
regressions at a global level. Instead, carefully crafted
case studies or comparative country studies could
prove very useful towards better understanding what
are the crucial elements of a successful development

19A Question of Strategy: What Characterizes Top Growth Performers?

1 While many textbooks speak about the “savings
ratio”, Solow (1956) himself refers to this variable
as “investment”.

2 For example, in some countries, there is a huge dif-
ference between the share of respondents who think
that their country is corrupt and those who admit to
ever having paid or accepted a bribe, while in other
countries this difference is rather small, hinting at a
high level of subjectivity in the first indicator.

3 While the growth rates for 2013 are still estimates for
all countries in the sample and the growth rates for
earlier years are estimates at least for some countries,
this should not affect the analysis as the estimates
for the recent past (for which no final data has been
published) are usually reasonably reliable and this
contribution looks at averages over several decades
in which small estimation errors in very recent years
should not have much influence on the final value.

4 Starting in 1985, Indonesia, Oman and St. Vincent
and Grenadines would not have made it on the list.

5 This sub-group includes Bhutan, Cape Verde,
Maldives, Mauritius, St. Vincent and Grenadines.

6 When working on this paper, a large number of typi-
cally used indicators have been checked. For reasons
of space constraints and for better readability, only
a small selection has been presented here.

7 Note: Rodrik’s data set ends in 2007.
8 Geographically, Oman is part of Western Asia of

course, but it is usually grouped with Middle Eastern

9 See e.g. Weiss (2005) or Kuchiki (2007).
10 For an in-depth discussion on the issue of industrial

policy, see UNCTAD (TDR 2006).
11 On these issues, see also the contributions by Roberto

Frenkel and Martín Rapetti on the exchange rate, or
Robert Wade on the role of industrial policy.


Athukorala PC and Kohpaiboon A (2010). China and
East Asian trade: The decoupling fallacy, crisis and
policy challenges. In: Garnaut R, Golley J and Song
L, eds. China: The Next Twenty Years of Reform and
Development. Canberra, ANU E Press: 193–220.

Charemza WW and Deadman DF (1997). New Directions
in Econometric Practice, Second edition. Chelten-
ham et al., Edward Elgar.

Commission on Growth and Development (2008). The
Growth Report: Strategies for Sustained Growth
and Inclusive Development. Washington, DC. World
Bank Publications.

De Dominicis L, Florax RJGM and de Groot HLF (2008).
A meta-analysis on the relationship between income
inequality and economic growth. Scottish Journal of
Political Economy, 55(5): 654–682.

Doucouliagos H and Ulubasoglu M (2008). Democracy
and economic growth: A meta-analysis. American
Journal of Political Science, 52(1): 61–83.

IMF (2003). Cameroon: Poverty Reduction Strategy
Paper. IMF Country Report No. 03/240. International
Monetary Fund. Washington, DC.

Joseph A and Troester B (2013). Can the Mauritian miracle
continue? The role of financial and ICT services as
prospective growth drivers. Berlin Working Papers
on Money, Finance, Trade and Development, No.
01/2013, Berlin.

Kuchiki A (2007). Industrial policy in Asia. Discussion Paper
No. 128, Institute of Developing Economies, Chiba.

Levine R and Renelt D (1992). A sensitivity analysis of
cross-country growth regressions. American Eco-
nomic Review, 82(4): 942–963.

Mohamedi F (1994). Oman. In: Metz HC, ed., Persian Gulf
States: Country Studies. Washington, DC, Library
of Congress: 251–318.

Moral-Benito E (2012). Growth empirics in panel data
under model uncertainty and weak exogeneity, Work-
ing Papers No. 1243, Banco de España, Madrid.

Prasad ES, Rajan RG and Subramanian A (2007). Foreign
capital and economic growth. Brookings Papers on
Economic Activity, 38(1): 153–230.

Republic of Bolivia (2001). Poverty Reduction Strategy
Paper. La Paz.

Rodrik D (2008). The real exchange rate and economic
growth. Brookings Papers on Economic Activity,
39(2): 365–439.

Sala-i-Martin XX (1997). I just ran two million regres-
sions. American Economic Review Papers and
Proceedings, 87(2): 178–183.

Solow RM (1956). A contribution to the theory of eco-
nomic growth. The Quarterly Journal of Economics,
70(1): 65–94.

Ugur M and Dasgupta N (2011). Corruption and economic
growth: A meta-analysis of the evidence on low-
income countries and beyond. MPRA Paper No.
31226. University Library, Munich.

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2006. Global Partnership and National Policies
for Development. United Nations publication. Sales
No.E.06.II.D.6, New York and Geneva.

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able at: http://www.eia.gov/beta/international/


20 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

Wacziarg R (2002). Review of Easterly’s The Elusive
Quest for Growth. Journal of Economic Literature,
40(3): 907–918.

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Institute Discussion Paper No. 26. Asian Develop-
ment Bank Institute, Tokyo.

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Singapore, Singapore University Press: 503–579.

21National Development Banks in a Comparative Perspective


C.P. Chandrasekhar

A feature of most countries in the less devel-
oped regions in the period after the Second World
War was the emergence and consolidation of a set
of specialized institutions referred to as develop-
ment finance institutions (DFIs) or development

banks (DBs). The principal factor motivating
the creation of these institutions was the need to
channel large sums of capital for investment in
capital-intensive enterprises in industry and the
infrastructural sector.


A feature characteristic of countries that were late industrializers was their reliance on financial
institutions geared to the task of financing capital-intensive investments with direct and indirect
support from the State. While in Germany the universal banks served this purpose in the 19th century,
developing late industrializers after the Second World War established specialized development banking
institutions to play this role, as well as reach credit to sections that were otherwise excluded from the
banking network. Despite differences in the evolution of the development banking infrastructure across
these countries, there are striking similarities in terms of what they were mandated to do and how they
were financed. However, with the turn to financial liberalization, the transformation of development
banking across countries has been very different, with seemingly significant consequences.


As Gerschenkron (1962) emphasized, a feature
of late industrialization that is (by definition) charac-
teristic of developing countries was the quantum jump
in investment needed for industrial take-off. Not only
was each industry more capital-intensive than it was in
earlier times, but increased interdependence meant that
countries had to make simultaneous investments in a
larger number of industries. In addition, investment in
infrastructural projects characterized by economy-wide
externalities (such as power, communications, roads and
ports) was crucial to supporting such industrial growth.

The large capital required for such a combina-
tion of lumpy investments is unlikely to have been
accumulated by many potential private investors in
backward economies. Even to the extent that such
accumulation had occurred, many of those wealth-
holders would be wary of investing large volumes of
their own capital in one or a few such projects, with
long gestation lags and high risks. These investments
had to be either made by the State or supported with
external finance on reasonable terms provided to
willing private investors.

I. Capital requirements

22 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

However, the problem is that in developing
economies the financial sector is not sufficiently
developed and diversified to undertake such
activity. The financial sector tends to be bank
dominated. While there are active markets for
government bonds, markets for corporate bonds are
most often absent. On the other hand, the typical
commercial bank is most unsuited to financing such
projects. They attract deposits from small savers
who have a strong preference for liquidity and

short lock-in periods and would like to abjure any
income or capital risk. Drawing on capital of this
kind, banks would be reticent to expose themselves
in any substantial measure to loans that are rela-
tively illiquid and of long maturity, as required by
infrastructural projects, for example. An absence
of adequate sources of long-term finance is typical
of backwardness. Therefore, finding the capital to
finance the industrial take-off represents a major

What is noteworthy is that some of the first-
tier late industrializers such as France, Germany
and Japan managed to overcome this problem.
Alexander Gerschenkron (1962) underlined the
important role played by special and unusual kinds
of credit institutions in late industrializers in Europe
such as France and Germany in the late-nineteenth
century. Examples of such institutions were the
Crédit Mobilier established by the Pereire brothers in
France and the “universal banks” in Germany. They
were unique in the sense that they were “financial
organizations designed to build thousands of miles
of railroads, drill mines, erect factories, pierce canals,
construct ports and modernize cities” (Gerschenkron,
1962: 12). Gerschenkron believed that they served
as institutional substitutes for crucial “prerequisites”
for the industrial take-off, such as the prior accu-
mulation of capital or the availability of adequate
entrepreneurial skills and technological expertise.
As Gerschenkron (1962: 13) argued: “The differ-
ence between banks of the crédit mobilier type and
commercial banks in the advanced industrial country
of the time (England) was absolute. Between the
English bank essentially designed to serve as a source
of short-term capital and a bank designed to finance
the long-run investment needs of the economy there
was a complete gulf.”

This historical evidence is intriguing, since
– as argued above – commercial banks typically
do not engage in such lending activity, given the
maturity and liquidity mismatches involved. In a
set of lectures on continental banking delivered in
Cambridge, Piero Sraffa (De Cecco, 2005) attempted
to explain what made this possible. According to
him, what was experimented with on the continent
by the Crédit Mobilier and the German universal

banks (Kreditbanken) was a form of “active banking”
involving close interaction of banks and industry with
an element of domination of the latter by the former
owing to “the superior information banks could
gather on industry, being at the crucial node of the
economic system” (De Cecco, 2005: 352).1

A liquidity mismatch only arises if an institution
exposed to capital-intensive projects is unable to
access cash to meet demands from some of its deposi-
tors. Therefore, the issue is not that banks would not
be able to call in their long-term credits, but rather
that the assets they hold in the form of the securities
associated with those credits may not be easily sold
and converted to cash to meet demands to pay back
deposits. This problem can be resolved if – as hap-
pened in Germany – the central bank (Reichsbank)
stands by willing to exploit the elasticity of its right of
note issue to provide lines of credit to banks engaged
in long-term lending to industry when the latter are
unable to obtain liquidity from elsewhere. In France,
however, the Banque de France not only refused to
support the Crédit Mobilier with liquidity as and
when required, but also prevented it from issuing
long-term bonds. Faced with this problem, Sraffa
reportedly argued that while the Crédit Mobilier
began with a wise policy of matching maturities
of assets and liabilities, it later made the mistake
of turning towards financing long-term investment
with short-term deposits, which ultimately led to its

Learning from the experience of the Crédit
Mobilier, the German State – through the backing
of the Reichsbank – successfully used the universal
banks to finance German industrialization. De Cecco
(2005: 355) summarizes Sraffa’s perception of the

II. A lesson from history

23National Development Banks in a Comparative Perspective

system as follows: “German Grossbanken, which
were heavily involved in maturity transformation,
were likely to find themselves periodically stuck in
illiquidity situations, and required reliable access to
last-resort lending by the Reichsbank. In fact, the
whole concept of last-resort lending, which had
been developed in the English context, had to be
adapted, indeed drastically transformed, to be used

in the German one.” According to De Cecco (2005:
354) in Sraffa’s perception, “the German experi-
ence represented a clear case of planned institution
building”, to realize the task at hand. The universal
banks were private, limited liability, joint stock
banks, although they were also instruments of the
State, acting on its behalf in return for large-scale
liquidity support.

DBs as institutions were clearly inspired by that
experience and the subsequent direction that it took
in the form of the main-bank system in Japan, which
financed export-led industrial expansion with sup-
port from and direction by the Bank of Japan and the
Japanese Government. Nonetheless, there were two
important differences: first, rather than combining the
activities of pre-existing commercial banks with the
industrial financing function, most developing countries
chose to establish stand-alone DFIs expressly geared
to realizing specified financing objectives; and second,
these institutions were not autonomous creations of the
private sector, which subsequently came under govern-
ment influence, but rather were established by the State
and were in many cases State-owned institutions.

DBs are generally mandated to provide credit
at terms that render industrial and infrastructure
investment viable. They provide working capital
and finance long-term investment, including in the
form of equity. To safeguard their investments, they
closely monitor the activities of the firms they lend
to, often nominating directors on the boards of com-
panies. This allows for corrective action as soon as
any deficiencies are detected. DBs are also involved
in early stage decisions such as choice of technol-
ogy, scale and location, requiring the acquisition of
technical, financial and managerial expertise. They
also sometimes provide merchant banking services,
taking firms to market, underwriting equity issues and
supporting firms with their own reputation.

III. Development banking

Since DBs serve to finance activities that may
not otherwise be supported by the financial sector,
they are sometimes given specific mandates to deliver
credit to specified sectors such as marginal farmers
and the small-scale sector. Providing credit in small
volumes to dispersed and often remotely located
borrowers substantially increases transaction costs.
If these transaction costs are to be reflected in interest
rates charged on loans, the rates could be so high that
the loans concerned cannot be used for productive
purposes. Accordingly, a subsidy or subvention of
some kind would be needed to keep interest rates
reasonable. Only specially created banks are likely
to undertake such policy lending. Most countries
have found that it is best to create separate DBs to
provide long-term capital at near-commercial rates
and “policy banks” to provide credit to special areas
such as agriculture or the small-scale sector, where

interest rates have to be subsidized and grace periods
have to be longer.

What is surprising is the degree to which gov-
ernments have relied on the development banking
instrument. A 1998 study by Nicholas Bruck identi-
fied over 550 DBs worldwide, of which around 520
were national DBs (NDBs) and 32 international,
regional and sub-regional DBs. These were located
in 185 countries, with developing countries in par-
ticular hosting an average of three or more DBs. Latin
America and the Caribbean had the largest number
of NDBs (152), followed by Africa (147), Asia and
the Pacific (121), Europe (49) and West Asia (47).

As expected, these banks varied significantly
in terms of their size and scope of operations. A
sample of 90 DFIs studied by de Luna-Martinez and

IV. Policy banks

24 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

Vicente (2012) in 2009 found that although almost
half of them (49 per cent) were established during
the import-substitution years between 1946 and 1989,
nearly two-fifths (39 per cent) came into existence
during the globalization years between 1990 and
2011. One implication is that irrespective of policy
orientation, the failure of private financial markets
to deliver adequate long-term finance forces govern-
ments to rely on development banking institutions.
The de Luna-Martinez and Vicente study defined a
DFI as being an institution with “at least 30 per cent
State-owned equity” and “an explicit legal mandate
to reach socioeconomic goals in a region, sector or
particular market segment”. It emerges that 74 per
cent of these institutions were entirely government
owned and controlled and a further 21 per cent had
less than 50 per cent of private equity ownership.

Reflecting the fact these were specially estab-
lished stand-alone institutions – unlike the universal
banks of Germany – the DFIs largely depended on
non-depository sources of finance. More than half
of them (53 per cent) had specific policy mandates,
having been “established to support the agriculture
sector (13% of all DBs), SMEs [small and medium

enterprises] through their lending, guarantee or
advisory services (12%), export and import activities
(9%), housing (6%), infrastructure projects (4%),
local governments (3%), and other sectors (6%).” (de
Luna-Martinez and Vicente, 2012: 12). This require-
ment meant that they could not finance their activities
solely with finance from the market. Nearly 90 per
cent of the DFIs surveyed borrowed resources from
other financial institutions or issued debt instruments
in domestic markets and 64 per cent had the benefit
of government guarantees for debt issued by them.
However, 40 per cent of them received budgetary
transfers from the government. This backing allowed
around half of these DBs to offer credit at subsidized
interest rates, and two-thirds of those institutions
reported financing those subsidies with the transfers
that they received from the government.2

Of course, the evolution of development bank-
ing and DFI behaviour varied across nations. In what
follows, we consider a few experiences with the
evolution and operation of DFIs to identify common
elements as well as differences in a policy phenom-
enon captured in a common phrase yet varying in
content across countries.

A classic case of a country that has relied on
one large development banking institution is Brazil,
which established the Brazilian Development Bank,
also known as National Bank for Economic and
Social Development (BNDES – the acronym for its
Portuguese name) in 1952. At the end of 2011, the
bank’s assets amounted to 15 per cent of Brazil’s
GDP, of which 10 percentage points were accounted
for by loans and another 3 comprised investments in
corporate equity and debt securities. The first phase
of the BNDES’s activities stretched to the mid-
1960s, during which period (besides investments in
developing a new capital at Brasilia) the focus of its
activity was the financing of public sector projects
in infrastructural sectors like transport and power.
During these years, between 80 and 90 per cent of its
financing was directed at the public sector (Armijo,
2013: 3).

A transition occurred in the mid-1960s involv-
ing three major changes. First, there was a significant
step up in BNDES financing. In 1965, BNDES’s

outlays rose from 3 per cent of capital formation to
6.6 per cent and continued at that enhanced level.
Second, more of the institution’s financing now
went to the private sector, with the public sector’s
share falling to 44 per cent during 1967–1971 and
between 20 and 30 per cent subsequently. This shift
in favour of the private sector was accompanied by
a change in the sectoral composition of BNDES
funding, which was now also directed to sectors such
as nonferrous metals, chemicals, petrochemicals,
paper, machinery and other industries. Since the
1970s, the bank has also supported Brazilian firms
to target foreign markets or go global, by financing
the modernization of potential export sectors such
as textiles, footwear and apparel and funding efforts
by firms such as meat major JBS Friboi to acquire
rivals abroad and enhance its presence in international
markets. Finally, after the financial crisis of 2008
and the recession that followed, the BNDES was
used by the Brazilian Government as the medium
for its stimulus aimed at reversing the downturn.
As compared with annual loan disbursements of

V. The BNDES in Brazil

25National Development Banks in a Comparative Perspective

just R$23.4 billion in 2000, the figure stood at to
R$168.4 billion in 2010. Subsequently, disburse-
ments came down to R$139.7 billion in 2011 and
R$156 billion in 2012 (Armijo, 2013). This was an
unusual role for a DFI. At its peak in 2010, annual
BNDES lending amounted to around 70 per cent of
long-term credit in the country.

When compared with DBs in other contexts,
the sources of finance for the BNDES have been
unusual. Besides bond issues, resources from
multilateral organizations, transfers from the treas-
ury and deposits from the Government of funds
from privatization, the institution benefited from
resources garnered through a special cess. In the
early-1970s, the Brazilian Government instituted the
Social Integration Programme (PIS) and the Public
Employment Savings Programme (PASEP), which
were to be financed with payroll taxes imposed on
company profits. Under President Ernesto Geisel
(1974–1979), the administration of these funds was
transferred to BNDES. Subsequently, under the 1988
Constitution, changes were made in the management
of PIS-PASEP, which led to the creation of a Workers
Assistance Fund, whereby 40 per cent of accruals had
to be mandatorily routed to BNDES for investments
in employment-generating projects. In addition,
the Government has used various measures such
as special taxes and cesses, levies on insurance and
investment companies and the reallocation of pen-
sion fund capital to direct resources to the industrial
financing activities of the BNDES (Baer and Villela,
1980). In 2007, 10 per cent of BNDES funds came
from the Government’s investment in its equity,
and 75 per cent from obligatory investments of FAT
(Workers’ Support Fund) resources and special pro-
grammes such as the Accelerated Growth Programme
(PAC - the acronym for its Portuguese name) and the
Sustainable Investment Programme.

A consequence of this is that through BNDES,
the Brazilian Federal Government has been an
important source of long-term credit to the country’s
corporate sector. Implicit in that process has been the
delivery of a subsidy to the private sector through
BNDES. The rate of interest at which the Government
borrows from the market, which is the benchmark
SELIC (Sistema Especial de Liquidação e Custódia
or Special System for Settlement and Custody) rate
set by the central bank, is higher than the TJLP (Taxa
de Juros de Longo Prazo or Long-Term Interest
Rate), the rate at which it lends to the BNDES. This
amounts to subsidized lending to the BNDES at
the cost of the taxpayer. To the extent that BNDES
offers credit to its borrowers at a rate lower than the
SELIC, there is also a transfer to the latter. Indeed, the
BNDES lends at rates close to the TJLP. According
to Lazzarini et al. (2011), if the BNDES had obtained
funds at the SELIC rate, then its net interest margin
would have been negative in many years. BNDES
is clearly being used by the Federal Government as
a means to make implicit transfers to a select set of
firms that it supports.

This holds considerable relevance because there
is evidence of concentration in BNDES lending.
In 2012, close to two-fifths of BNDES outstand-
ing loans were with the five top borrowers. It also
holds large chunks of equity in private firms such as
Fibria (30.4 per cent), Klabin (20.3 per cent), JBS
Friboi (17.3 per cent), Marfrig (13.9 per cent) and
America Latina Logistica (12.2 per cent). During the
2008–2010 period when BNDES lending accelerated,
$16 billion was advanced to the food industry and
$30 billion to Petrobas. Together, this amounted to
50 per cent of BNDES lending to the manufacturing
sector. To the extent that this reflects the Government’s
new growth priorities, BNDES as a DFI is clearly an
instrument of State capitalist development in Brazil.

The other country that conducted a remarkable
experiment with development banking was India. A
distinguishing feature of the experience was the crea-
tion of a large number of DFIs, including numerous
industrial financing institutions, a number of policy
banks and a set of special purpose vehicles to finance
investments in sectors like power and shipping.
This deviation from the Brazilian path – where the

industrial financing function was largely concentrated
in the BNDES - was the result of a number of factors.
First, a decision to segment financing for large and
small industry so that the latter is not deprived of
finance. Second, the creation of special institutions to
channel funds received from foreign donors. Finally,
the creation of policy banks aimed at providing
finance to targeted groups, sectors and industries.

VI. The Indian experience

26 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

The industrial finance infrastructure comprised
the Industrial Finance Corporation of India (IFCI),
established in 1948, the State Financial Institutions
set up under an Act which came into effect in
August 1952, the Industrial Credit and Investment
Corporation of India (ICICI), the first DFI in the
private sector, established in January 1955 with a
long-term foreign exchange loan from the World
Bank, the Refinance Corporation for Industry (1958)
established to channel counterpart funds of the
United States Agricultural Trade Development and
Assistance Act of 1954 (Public Law 480) earmarked
for lending to the private sector, and the Industrial
Development Bank of India (IDBI) established in
1964 as an apex DB. Thus, by the end of the 1980s,
the industrial development banking infrastructure in
India comprised three all-India DBs (IFCI, ICICI and
IDBI) and 18 State Financial Corporations (SFC).
In 1990, the Government established the Small
Industries Development Bank of India (SIDBI) as
an all-India financial institution for the financing of
micro, small and medium enterprises.

Despite this elaborate infrastructure, dis-
bursements by all financial institutions (including
“investment institutions” such as the Life Insurance
Corporation, Unit Trust of India and General
Insurance Corporation) amounted to just 2.2 per
cent of gross capital formation by the financial
year 1970/71. With a view to supporting various
term-financing institutions, the Reserve Bank of
India (RBI) set up the National Industrial Credit
(Long-Term Operations) Fund from 1964/65. The
post-1972 period witnessed a phenomenal rise in

financial assistance provided by these institutions
(including investment institutions), and the assistance
disbursed by them rose to 10.3 per cent of gross
capital formation in 1990/91 and 15.2 per cent in
1993/94. Given the nature of and the role envisaged
for the DFIs, the Government and the RBI had an
important role in providing them resources. In addi-
tion, public banks and the Life Insurance Corporation
and General Insurance Corporation also played a role
(Kumar, 2013).

However, with the balance of payments crisis
of 1991 triggering a major financial liberalization
effort, a decline in development banking followed.
Domestic and foreign private institutions that were
now given greater scope objected to the provision
of concessional finance to the DFIs as a source of
unfair competition, which kept them out of areas
that they were now looking to enter. The result-
ing pressure to create a “level playing field”, to
which the Government succumbed as reflected in
the Narasimham Committee reports of the 1990s
(especially Narasimham, 1998), triggered a process
through which the leading DFIs were transformed
into commercial banks, starting with the ICICI in
2002 and the IDBI in 2004. By 2011/12, assistance
disbursed by the DFIs amounted to just 3.2 per cent
of gross capital formation (Kumar, 2013).3 By 2012,
there were only two all-India development banking
institutions: the National Bank for Agricultural and
Rural Development (established in 1982) and the
Small Industries Development Bank of India. Only
these two policy banks have expanded their opera-
tions substantially in recent years.

VII. Comparing two experiences

An interesting feature of the experiences of
Brazil and India discussed above is the trajectory
that development banking took in the years after
these two countries opted for internal and external
liberalization during the period of globalization. In
Brazil, reform notwithstanding, the BNDES has
grown in strength, as noted above, which has served
Brazil well. The bank’s role significantly increased
when private activity slackened in the aftermath of
the financial crisis. This countercyclical role helped
Brazil to face the crisis much better than many other
developing countries. The BNDES had stepped in to
keep business credit going when private sector loans
dried up in 2008 (Bevins, 2010).

On the other hand, liberalization led to a decline
in development banking and the demise of the major
DFIs in India. In 1993, the IFCI Act was amended
to convert the IFCI – established as a statutory
corporation – into a public limited company. The
stated intention was to do away with the institution’s
dependence on funding from the central bank and the
Government, requiring it to access capital from the
open market. Since this would involve borrowing at
market rates, the role played by the IFCI has been
substantially transformed. In the case of the ICICI,
which was allowed to set up a banking subsidiary
in 1994, the parent ICICI was integrated with ICICI
Bank (its recently established subsidiary) through a

27National Development Banks in a Comparative Perspective

reverse merger in 2002, to create what was essen-
tially a pure commercial bank. Similar moves were
undertaken to transform the IDBI. In 2003, the IDBI
Act was repealed and a company in the name of IDBI
Ltd was established, which in turn set up IDBI Bank
as a subsidiary. Subsequently, IDBI was merged with
IDBI Bank, marking the end of industrial develop-
ment banking in India.

The absence of these specialized institutions
is bound to limit access to long-term capital for
the manufacturing sector. One result is that the
Government has had to use the publicly-owned com-
mercial banks as a means of financing infrastructural
investment. The share of infrastructure in lending to
industry by scheduled commercial banks in India

has risen from less than 5 per cent in 1998 to 32 per
cent in 2012, when aggregate credit provided by
scheduled commercial banks rose from 21 to 56 per
cent of GDP, with the share of advances to industry
falling from around 50 to 40 per cent. Absolute lend-
ing to industry and thus infrastructure was extremely
high. Given the reliance of banks on shorter maturity
deposits that are extremely liquid, this exposure to
infrastructure implied large maturity and liquidity
mismatches. Unsurprisingly, defaults have been on
the rise and non-performing assets have shot up,
leading to balance sheet fragility.

As the Brazilian trajectory shows, this was not
the inevitable direction that policy and outcomes had
to take, even under liberalization.

Brazil and India are similar in the sense that
they both pursued industrialization strategies in
which the principal source of demand was the
domestic market. This raises the question of whether
developing market economies that pursue export-
oriented or export-led industrialization strategies
also rely on development banking. A useful case
to consider here is the Republic of Korea. Among
the factors responsible for the Republic of Korea’s
success – with its mercantilist, outward-oriented
industrialization strategy of growth based upon rapid
acquisition of larger shares in segments of the world
market for manufactures – was the role of the State
in guiding industry to the segments of the global
market that were dynamic. For this to work, the
State must through its financial policies ensure an
adequate flow of credit at favourable interest rates to
firms investing in these sectors, so that they can not
only make investments in frontline technologies and
internationally competitive scales of production, but
also have the means to sustain themselves during the
long period when they acquire and expand market
share. These financial policies would include interest
rate differentials and favoured financing of private
investment. Indeed, development banking was an
important component of this process.

As Cole and Park (1983) note, at the end of the
Second World War when the South part of Korea was
first occupied by the United States and then just after
the Government of Korea was elected, “[the Republic

of] Korea had the shell of a modern financial system”
(Cole and Park, 1983: 48). In the words of Bloomfield
and Jensen (as quoted by Cole and Park), who were
sent in 1950 from the United States Federal Reserve
to help Korean officials reform the Korean financial
system: “All the existing banking institutions are
engaged predominantly in a regular commercial
banking business consisting essentially of accepting
demand deposits and of making short-term loans and
advances to primary producers, to businessmen and
to Government Agencies.” (Cole and Park, 1983: 49)
Thus, in the case of the Republic of Korea, there was
also a major gap to be filled with respect to long-term

Therefore, the Government decided to set up the
Korea Development Bank (KDB) in 1954, with the
primary objective of granting medium- and long-term
loans to industry. Wholly owned by the Government
and built on the assets and facilities of the Industrial
Bank, the KDB came to account for over 40 per cent
of total bank lending by the end of 1955. At one
point, it accounted for 70 per cent of the equipment
loans and 10 per cent of working capital loans made
by all financial institutions (Sakong and Koh, 2010).
These loans were not based upon deposits — about a
third of the loans were supported by aid counterpart
funds and two-thirds with financing from the Bank
of Korea and the Government. In the 1950s, 50 per
cent of the funds came from the Government fiscal
loans programme and another 30 per cent raised by

VIII. The Republic of Korea: The State and development finance

28 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

issuing bonds. Development banking had become an
important instrument of policy.

Third, the KDB’s charter was revised to allow it
to borrow funds from abroad and guarantee foreign
borrowing by Korean enterprises. In fact, an interest-
ing feature of industrial finance in the Republic of
Korea was the guarantee system, largely created to
privilege borrowing abroad over attracting foreign
investment, to keep Japanese capital at bay. Firms
wishing to borrow from abroad obtained approval
from the Economic Planning Board, which was
ratified by the National Assembly. Once that was
achieved, the Bank of Korea (BOK) (or later the
Korea Exchange Bank) issued a guarantee to the
foreign lender and the KDB issued one to the Bank of
Korea. Therefore, while the borrower was committed
to repaying the loan and carrying the exchange risk,
that commitment was underwritten by the KDB and
BOK, which by guaranteeing against default were
ensuring access to foreign borrowing. Between 1960
and 1978, foreign loan guarantees by the KDB rose
from 0.2 billion won to 3,898.3 billion won.

Besides the KDB, the other DFIs established
in the Republic of Korea included the National
Investment Fund, the Korea Development Finance
Corporation and the Export-Import Bank of Korea.
The Korea Development Finance Corporation, estab-
lished in 1967 with support from the World Bank,
was mandated “to assist in the development and
creation of private enterprises by providing medium
and long-term financing and equity participation, as
well as technical and managerial consulting services”

(quoted in Cole and Park, 1983: 73). It took on the
underwriting of equity shares and debentures as a
major activity.

With the launch of the Heavy and Chemical
Industries strategy, the National Investment Fund
(NIF) was set up in 1974 to direct savings to these
industries. The NIF mobilized its resources through
the sale of bonds, obtaining loans from the deposit
money banks and other savings and investment insti-
tutions and transfers from the Government’s budget.
The role of the State was visible in the fact that the
deposit money banks were required to provide the
NIF with 15 per cent of their incremental deposits
and non-life insurance companies as much as 50 per
cent of their insurance premiums and other receipts
(Cole and Park, 1983: 77). While the Ministry of
Finance was responsible for administering the NIF,
its management was entrusted to the BOK. The NIFs
lending often included an implicit subsidy reflected
in lending rates lower than deposit or borrowing
rates, although these were covered with funds from
the Government.

Clearly then, the Republic of Korea was also
a late industrializer in which development finance
(supported by the State through the budget and the
central bank) played an extremely important role
and contributed in no small measure to the success
of its late industrialization. However, the DB’s role
here included support for borrowing from abroad to
acquire foreign technology, which was subsequently
leveraged to launch a successful export-oriented

IX. China: A different trajectory

Among the DBs that are spoken of today, one
that receives special attention due to its large size and
asset base as well as its growing global presence is
the China Development Bank (CDB). Development
banking came late to China, and was the product of
two trends. The first was China’s economic reform
that created an environment in which firms and agents
large and small had to find resources for investment
from sources other than the central Government or
the local one. The second was the decision of the
party and Government in the Deng Xiao Ping era in
the early-1990s to accelerate investment and growth
in China.

In the years prior to 1993, it was difficult to
separate development banking from “normal” or
commercial banking in China. Long-term invest-
ments were financed either directly from the State
budget or through directing credit to the enterprise
sector. In fact, until the 1980s, the only bank of
relevance was the People’s Bank of China, which
subsumed all kinds of financial activities through
its head office, branches across the country and
subsidiary units such as the Bank of China. In this
environment, financial policy in China involved the
direct allocation of resources from the Government’s
budget or the use of directed credit in the form of

29National Development Banks in a Comparative Perspective

mandatory credit quotas for the State-owned banks
that mobilized public savings (Xu, 1998).

This system was put to the test when China’s
Government decided to accelerate growth within the
framework of an increasingly liberalized economy
in the early-1990s. With the mandate to raise invest-
ment and a promise of rewards if they did, provincial
leaders went on a spending spree. They were helped
by the fact that provincial governments substantially
influenced appointments to and the operations of
regional bank branches, including branches of the
central bank. The result was a borrowing and spend-
ing spree, not only to finance infrastructure but also
large “prestige projects”, which were not revenue
earning. The inflationary spiral that followed and the
evidence that provincial governments were finding
it difficult to service the debts they had accumulated
to finance these projects led the central Government
to ban borrowing by provincial governments in 1994
(Xu, 1998).

Measures were undertaken to recapitalize the
commercial banks and remove non-performing assets
from their accounts. Furthermore, asset liability and
risk management procedures were introduced and
the State-owned commercial banks were required to
reduce bad loans over time. They were also issued
guidelines to lend against collateral, take account of
borrower creditworthiness when lending and limit
their exposure to any single borrower to 10 per cent
of their capital (Xu, 1998).

The CDB was established as part of this process
in 1994. Therefore, unlike in India, it was a product
of reform rather than a victim of the same. However,
three factors gave CDB a privileged position. First,
it was established at a time when banks were being
restrained from lending to projects that were either
capital-intensive in nature, with long gestation lags,
or were in the infrastructural area. This gave CDB a
niche that it could seek to occupy, during a time when
China was pursuing a high-investment growth strat-
egy. Second, this was the phase of rapid urbanization
in China, resulting in huge demands for infrastruc-
ture. Third, much of the investment in infrastructure
was being undertaken by provincial governments
that did not have the tax revenues needed to finance
those expenditures and could not borrow to finance
the same due to the 1994 ban. To circumvent the ban,
they established special local government financing
vehicles (LGFVs), which became important clients
of CDB (Sanderson and Forsythe, 2013).

CDB mobilized resources by issuing bonds that
were subscribed to by banks that saw these instru-
ments as being safe despite yielding higher returns.
After a lacklustre initial innings, CDB registered a
dramatic expansion of its asset base. That process
was accelerated in 2008-2009, when CDB became a
leading vehicle to finance the Government’s gigantic
stimulus package adopted in response to the global
financial crisis. By 2011, the assets of CDB were esti-
mated at $991 billion, as compared with $545 billion
for the World Bank group,4 $306 billion for BNDES
(2010) and $132 billion for the KDB (Sanderson and
Forsythe, 2013).

Four areas accounted for CDB’s huge asset base.
The first was lending that was part of its original
mandate, involving replacing the Government and
the commercial banks as lender to the State-owned
enterprises. The second was lending to the LGFVs
to finance the huge infrastructural investments being
undertaken by the provincial governments. According
to Sanderson and Forsythe (2013), as much as half
of CDB’s loan book could comprise lending to local
governments, and the bank may account for as much
as one-third of all LGFV loans, making it a bigger
lender than all of the four commercial banks put
together. The third, which has been visible since the
last decade, is financing China’s “going out” policy
or spread abroad, partly as a manufacturing investor
in low cost locations in Africa and Latin America
but more importantly as an acquirer of mineral and
oil resources across the globe. Finally, as a major
investor in China’s wind, solar and telecommunica-
tions companies, with Huawei Technologies being
the largest beneficiary.

It is to be expected that many of these projects
would not be profit-making, stretching from some
infrastructural projects to ventures in the solar and
wind area. Nonetheless, CDB is considered an
extremely well-managed financial institution with
the lowest ratio of non-performing loans among
China’s lenders (Sanderson and Forsythe, 2013).
This must be because the central Government and
the provincial ones ensure that there are no defaults
on payments to the institution. The role of the
State is crucial in ensuring the stability of a system
where one gigantic DB stands at the centre of an
investment-led growth strategy. The transition away
from the era of “planning” to one with a socialist
market economy may not mean much in terms of
explaining how China is financing its high growth

30 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

Thus, over a significantly long period of time,
countries embarking on a process of development
within the framework of mixed, capitalist economies
have sought to use the developing banking function
– embedded in available or specially created institu-
tions – to promote their development goals. The role
of these institutions in the development trajectories
of late industrializing, developing market economies

cannot be overemphasized. They have played a role
independent of the kind of industrialization strategies
pursued and irrespective of the extent of industrial
and financial regulation. Therefore, it is surprising
that under financial liberalization India has chosen
to do away with specialized development banking
institutions on the grounds that equity and bond
markets would do the job.

X. Conclusion


1 Hilferding (1910) argued that the close relation-
ship between banks and industry allowed capital to
assume the form of “finance capital”, which was the
most abstract form of capital.

2 Eighteen per cent of the institutions that received
transfers declared that if transfers were withdrawn,
they would not be able to operate.

3 Figures computed from information provided in
tables 13 and 83 of Reserve Bank of India (2013).

4 Comprising the International Bank for Reconstruc-
tion and Development (IBRD), the International
Development Association and the International
Finance Corporation.


Armijo LE (2013). The public bank trilemma: Brazil’s new
developmentalism and the BNDES. In: Kingstone P
and Power T, eds. Democratic Brazil Ascendant. Pitts-
burgh, University of Pittsburgh Press (forthcoming).

Baer W and Villela AV (1980). The changing nature of
development banks in Brazil. Journal of Interameri-
can Studies and World Affairs, 22(4): 423–440.

Bevins V (2010). BNDES: Climate for casting a wider
net. Financial Times. 6 May.

Bruck N (1998). The role of development banks in the
twenty-first century. Journal of Emerging Mar-
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Basingstoke, Macmillan.

31The Enigma of the “Indian Model” of Development

After a long journey of developmental strug-
gle, negotiated through meticulous planning and
policy initiatives spanning over nearly six decades,
India finally emerged as a major player in the world
economy and polity. India’s journey began as a newly
independent poor underdeveloped nation in 1947, the
year of its independence from the British rule. At that
time, India was one of the poorest nations in the world
in terms of per capita income, wealth and material
capacity. However, it had an illustrious history of an
ancient civilization dating back to 5000 BC, with
periods of high prosperity and a rich cultural herit-
age, intellectual capacity and enlightened leadership.1
With these assets, India embarked on its path of
post-colonial economic development. The original
architects of India’s development planning and policy
were perhaps chasing a goal of bringing back India’s
past glory to re-establish its lost position in the world
after a prolonged (two centuries of) colonial rule.
Over the next six decades, the trajectory of India’s
development policies evolved through the ups and
downs of its development performance.

India’s development experience has attracted
significant attention in the economic development
literature.2 Much of this literature focuses on the
failure of India’s initial approach of “State-directed”
development with a strong inward-looking bias in its
development strategy. It has been well demonstrated
how India’s prolonged strategy of import substitution
was followed by a paradigm shift towards a more
liberalized open economy model of development in
the 1990s. India’s successful emergence in the world
economy has often been attributed to this liberalized
trade and industrial policy regime. Essentially, the
existing literature on India’s development experience
analyses its economic performance in an attempt to
link it with the broad theoretical contours of out-
ward versus inward-looking industrialization and

However, we believe that this approach is
too simplistic to understand the complexities of
the so-called “Indian model” of development.
Accordingly, the present paper has a very different

Amit S. Ray


The present chapter is an attempt to unveil the enigma of the “Indian model” of development. After
discussing the evolution of India’s development policies over the last six decades, the paper attempts
to unfold India’s development trajectory. It shows how, despite India’s lost opportunity to be a part
of the Asian Miracle of the 1960s, 1970s and 1980s, the country finally emerged as a global player
in the last couple of decades. However, the Indian model of development, principally driven by rapid
expansion of high-end knowledge-intensive sectors, comes with a tragic neglect of low-end labour-
intensive mass manufactures. From an agriculture-dominated economy, India straight away jumped
to an economic structure, albeit with a transition period of three or four decades, in which services
and high-end manufacturing assumed the lead role. This development model is not only inequitable
in the extreme, but it is also a prescription for political volatility and is definitely not a sustainable
development model, especially in a democracy.

I. The context

32 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

flavour: rather than focusing on the broad contours
of overall development strategies, we argue that
specific policy elements are formulated within such
an overall strategy framework to achieve narrow
and targeted goals of development. Each and every
policy element may not necessarily be an integral
component of a particular development strategy
package, as theoretically understood in the develop-
ment economics literature. While many of the policy
elements might have played complementary roles
in achieving desired developmental goals, some of
the others might have been conflicting. Moreover,
new policy elements have been added over time,
while older ones have been modified and sometimes
discarded. In this chapter, we consider India’s quest
for development as a composite of a multitude of
policy initiatives addressing specific aspects of a
multi-dimensional conceptualization of development.
Indeed, this approach towards understanding India’s
development policies will also enable us to address
a frequently raised yet less understood question:

Is there indeed an “Indian model” of development
within such a diversity of policy initiatives? The
present paper marks an attempt to unveil the enigma
of this “Indian model” of development.

The chapter begins with a discussion of the
evolution of development policymaking in India in
section II. We demarcate the first couple of decades
as a period during which policies were driven by
ideology and idealism, followed by deeper penetra-
tion of self-reliance during 1970–1985. The second
half of the 1980s was a period of policy ambivalence
with sporadic reforms and opening up, while 1991
marked the beginning of a paradigm shift in India’s
policymaking. Section III presents India’s develop-
ment trajectory, showing how India finally emerged
a global player in the last couple of decades, despite
its lost opportunity to be a part of the Asian Miracle
of the 1960s, 1970s and 1980s. Section IV highlights
the foundations of India’s success story and discusses
its promises and pitfalls.

II. Evolution of development policymaking in India

As already indicated, the conventional discourse
presents India’s development policy largely within
the paradigm of inward- versus outward-looking
strategies, dividing it into two distinct regimes –
import substituting industrialization extending until
the 1980s, followed by a paradigm shift in 1991
towards a liberalized trade and industrial policy
regime. Here, we refrain from such a broad-brush
depiction of India’s development policy evolution.
Accordingly, we demarcate four distinct phases of
India’s development policy, distinguished by their
guiding philosophies and compulsions.

A. Policy planning driven by ideology:
1950s and 1960s

India remained a virtually closed economy for
nearly four decades after its independence in 1947,
following an inward-looking development strategy.
The key goal was to achieve self-reliance in all pos-
sible dimensions of economic activities of the nation.
The immediate aspiration of independent India was
perhaps to mimic the development trajectories of
the “advanced” industrialized nations, albeit very
much within the framework of import substitution

and self-reliance. It was perhaps important for Indian
policymakers to signal to the rest of the world that
India could do whatever the advanced nations could
(Ray, 2006). Accordingly, a diversified industrial
production base was meticulously planned out for
India, ranging from simple consumer items to sophis-
ticated capital goods and heavy machinery. This drive
towards self-reliance also prompted India to engage
in highly-complex and resource-intensive activities
such as space research and nuclear technology. The
notion of natural comparative advantage took a back
seat in this planning process. This policy approach
was perhaps a result of the hangover of the prolonged
colonial rule that fostered a process of “drain of
wealth” through tripartite and unequal trading rela-
tions dictated by the colonial rulers. This hangover
was reinforced by the contemporary scholarship
on dependency theories3 pioneered by the Latin
American School of thought, highlighting notions of
elasticity pessimism and in-equalizing trade. All this
led to deep cynicism about trade and openness among
the founding fathers of India’s development policy.
Therefore, the goal was to achieve “self-reliance”
by doing away with all elements of dependence
on the western world. Indeed, the notion of self-
reliance played a major role in defining the norm

33The Enigma of the “Indian Model” of Development

of development in post-colonial India. However,
the idea of self-reliance itself has gone through a
metamorphosis in India’s development policy.

The architecture of India’s post-colonial devel-
opment policy framework was inspired by the soviet
model of development. Indeed, the foundations of
India’s second Five Year Plan model (Mahalanobis,
1953) closely resembled Feldman’s (1964 [1928])
model developed in the Soviet Union in the 1920s,
arguing for a larger share of investment in the capital
goods sector, which may slow down growth in the
short run but would result in a much higher growth
rate in the long run, accompanied with higher
levels of consumption. India’s first Prime Minister
Jawaharlal Nehru, with his Cambridge exposure,
had a strong faith in socialist ideals, which left a
significant imprint on India’s post-colonial develop-
ment model. If we consider the Nehruvian era, which
extends probably until the mid-1960s, we note that
socialist sentiments went a long way towards defining
India’s own understanding of development, in terms
of both its means and ends. Indeed, there are several
pointers to substantiate this claim.

Soviet style Central Economic Planning was
the cornerstone of India’s initial development strat-
egy, aimed at a “socialistic pattern of development”.
There was lack of faith in the market and the role of
the State was emphatically highlighted. Although a
mixed economy was envisaged, there was a clearly
assigned role earmarked for the private sector, pri-
marily restricted to the consumer goods segment,
and even that was subject to pervasive regulatory
control by the State. The public sector was expected
to reach the “commanding heights” of the economy
with clearly demarcated priority sector industries
reserved for the public sector, progressively expand-
ing its ambit during the Nehruvian era.

Trade received very little attention in the foun-
dation of India’s post-colonial development strategy.
India’s trade policy was characterized by pervasive
import and exchange control, primarily relying on
quantitative restrictions. From 1962 onwards, these
restrictions were supplemented by the increasing use of
import duties. There was initially a pessimistic neglect
of exports, although the Third Plan (1961–1966)
included some piecemeal and ad hoc attempts towards
export promotion through export incentives (subsidies,
fiscal incentives, and import entitlements). Of course,
there was a temporary and short-lived trade-liberali-
zation attempt during the devaluation of 1966, with

an announced goal of eliminating/rationalizing export
subsidies and liberalizing import licensing and reduced
import duties, albeit only to be followed by a reversal
to the protectionist policy framework (Wolf, 1982).

Socialist ideals were also reflected in the
deliberate policy attempts on several other fronts:
(i) the reduction of monopoly and concentration of
economic power; (ii) the promotion of a small-scale
sector that generates income and livelihood for the
common man through a policy of industrial reserva-
tion; (iii) ensuring balanced regional development
through freight equalization policy to eliminate
regional disparities in growth and development; and
(iv) price controls aimed at ensuring the availability
of certain “essential” (“crucial”) products at “reason-
able” prices, namely fertilizer, cement, iron, steel and

Another area that warrants special attention in
India’s development policy during the Nehruvian era
is its concerted focus on social sector policies, driven
by the ideals of the so-called Nehruvian Socialism.
The need for a proactive role of the Government in
the provision of merit goods like health and education
was clearly highlighted. An elaborate public health
care system and infrastructure was envisaged and
created during this period. Likewise, government-
funded higher education and research, especially in
the fields of science and technology, was emphasized
with the creation of an elaborate network of public-
funded colleges and universities, as well as other
institutions of higher learning in sciences, technology
and management.

B. Deeper penetration of self-reliance:

The decade of the 1960s witnessed several
changes in the global political economy scenario.
Two neighbourhood conflicts (1962 China and 1965
Pakistan) exposed the ground realities of India’s
limited military capabilities and the consequent
vulnerabilities against global forces and alliances.
Moreover, the acute food crisis of 1966 revealed
India’s economic vulnerability vis-à-vis the United
States, when it withdrew its food aid to India under
public law 480.4 This was followed by an acute cur-
rency crisis and a major devaluation of the rupee.

Despite being one of original founders of the
non-aligned movement in a bipolar world, India

34 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

slowly started aligning with the Soviet Union, on both
a strategic and economic front. There was urgency to
rapidly march towards the goal of self-reliance, both
economically and strategically. India’s achievement
of nuclear capability in 1974 was a clear step in this
direction. This was also a period during which the pri-
vate capitalists were emerging as a powerful class in
India, as an outcome of its original vision of a mixed
economy. This class had a vested interest in protect-
ing their business from international competition
and a policy of self-reliance and import substitution
was in perfect harmony with their narrow interests.
The policy of licence-raj had already created a rent-
seeking vested interest among bureaucracy. Against
this backdrop, India’s development policy framework
tilted towards deeper penetration of self-reliance
in every sense of the term. However, the original
policy goal, whereby the public sector was expected
to reach the commanding heights of the economy,
seemed to have been substantially diluted by now
and the private capitalist class was being rolled out
a larger space to operate. In the re-classification of
the industrial sectors, greater access was accorded
to private capitalists. The public sector was also
mentioned, although it was no longer expected to
reach the “commanding heights” of the economy.5
Industrial licensing continued in full steam. There
was an announced intention to relax licensing poli-
cies with a change in the political regime in 1977,
although it never quite materialized and was promptly
reversed in 1980.

This period also witnessed a passage of sev-
eral legislative acts that have a direct bearing on
India’s development model. The Foreign Exchange
Regulation Act (FERA) of 1973 was introduced to
restrict and regulate the operations of foreign (mul-
tinational) companies in India to protect and develop
indigenous industrial and technological capability. A
40 per cent ceiling was imposed on foreign equity
share, with the exception of some “core” sectors like
pharmaceuticals, where up to 74 per cent foreign
equity was allowed to high technology bulk and for-
mulation producers, with the proviso that 50 per cent
of the bulk was supplied to non-associated formula-
tors and the share of own bulk in their formulation
should not exceed one fifth. The Monopolies and
Restrictive Trade Practices Act of 1970 was enacted
to ensure that industrialization did not result in the
concentration of economic power in hands of a few
rich. The Patent Act of 1970 was a radical departure
from the earlier patent law inherited from the British
period. This Act only granted process patent for

chemical substances including pharmaceuticals,
reduced the duration of patents to seven years from
the date of filing or five years from the date of sealing
whichever is lower, excluded all imported substances
from the domain of patent protection (i.e. only new
substances manufactured in India were entitled to
patent protection) and placed the burden of proof on
the plaintiff in case of infringement.

All these acts introduced in the 1970s, in con-
junction with several other policy initiatives towards
the active promotion of indigenous technology crea-
tion and adoption, resulted in a policy framework that
took the goal of self-reliance beyond mere manu-
facturing capabilities to technological self-reliance.
Given the protectionist environment, considerations
of costs and quality as per global standards were not
considered to hold much relevance during this phase
of India’s development model.

Another important dimension of this deepen-
ing of self-reliance during this era was evident in
India’s strive towards attaining self-sufficiency in
food grains production. India’s green revolution was
made possible through the Government’s concerted
effort and investment in agricultural research and
extension services.

C. Policy ambivalence and sporadic
reforms: 1985–1990

The flipside of this protectionist policy regime
soon revealed itself in the form of inefficiencies of
various kinds. For one thing, there was no incentive
to keep pace with the fast changing global technology
frontier in many of the manufacturing sectors, which
resulted in Indian industry becoming technologically
backward and inefficient with respect to global
standards of cost and quality. India’s industrial sector
was characterized by very high effective rates of pro-
tection and associated domestic resource costs. The
concept of natural comparative advantage appeared
to have taken a back seat in India’s development
trajectory. The country settled at a “Hindu” rate of
growth of 2–3 per cent per year and was branded
by development scholars as a growth laggard in the
world (see e.g. Lal, 1988 and 1989).

From the mid-1980s, with Rajiv Gandhi taking
over as prime minister with a young and dynamic
appeal along with his team of technocrat advisers like
Sam Pitroda, a technological view of development was

35The Enigma of the “Indian Model” of Development

gaining momentum in India’s development policy. It
was realized that being able to produce everything
could not be the end-all goal; rather, it is also very
important to be able to do things “efficiently”. This
may require opening up the doors to the latest techno-
logical development on the global frontier, marking
quite a departure from its earlier inward-looking
policy regime. At the same time, global scholarship
on development strategy was also undergoing a
metamorphosis, fuelled by the trumpeting of the suc-
cess of outward-oriented industrialization strategies
adopted by East Asian economies. There was some
serious re-thinking about India’s development path
among Indian scholars and policymakers, albeit with
significant scepticism and hesitation.

In a sense, this marked the beginning of India’s
policy of liberalization. However, the policy response
beginning in the mid-1980s was feeble and sporadic,
given that it was limited to liberalizing particular
aspects of the control system, without any major
change affecting the system itself in any fundamen-
tal way. These attempts of liberalization have been
arguably piecemeal and somewhat ad hoc without
a comprehensive programme of reforms that some
of the other inward-looking economies had already
adopted (including China since 1978).

D. Paradigm shift: 1991 onwards

1991 marked a radical departure from the past,
when, faced with an exceptionally severe balance of
payments crisis, India launched a massive economic
reforms package comprising short-term stabiliza-
tion measures along with a longer-term programme
of comprehensive structural reforms. Indeed, the
reforms initiated in 1991 were much wider and
deeper than earlier piecemeal attempts. It ushered
in a complete paradigm shift in policymaking that
now emphasized the liberalization of government
controls, a larger role for the private sector as the
engine of growth, freer operation of the market and
competitive forces to boost efficiency, as well as
greater integration with the world economy.

Interestingly, the balance of payments crisis
of 1991 that precipitated India’s massive economic
reforms package coincided with the Uruguay Round
of negotiations culminating in the establishment of
the World Trade Organization (WTO), thus heralding
the beginning of a new world order of globalization.
Hence, a better perspective on the Indian reforms

process may be gained by viewing it against the
backdrop of the evolution of the WTO-driven new
world order, rather than regarding it merely as an
isolated occurrence.

In terms of outcomes, the reforms process put
in place a trade regime compatible with the diktats
of the WTO over a period of time, with the removal
of all quantitative restrictions on trade, reduction
of tariff rates, market-aligned foreign exchange
rates with full current account and limited capital
account convertibility and a liberal, transparent,
investor-friendly foreign direct investment policy
in place. In the industrial sector, the reforms led to
the virtual elimination of industrial licensing and
de-reservation. The number of sectors reserved for
small-scale enterprises was drastically reduced. Most
significantly, the role of public sector was re-defined
with the Stated objective of disinvesting and privat-
izing public sector units. Finally, the establishment
of bodies like the Investment Commission and the
National Manufacturing Competitiveness Council
clearly highlight a major shift in the government’s
role from “control” to “regulation” as far as the
industrial sector is concerned.

On the fiscal front, the Fiscal Responsibility and
Budget Management Act was passed to achieve fiscal
consolidation and stabilization. This act enjoined
the central government to eliminate its fiscal and
revenue deficits in a phased manner in the medium
term. In another significant move, a uniform system
of value-added tax was adopted and services sector
(contributing to more than 50 per cent of GDP) was
brought under the tax net in a comprehensive manner.
Finally, subsidies on petroleum products were pro-
gressively dismantled by linking the domestic retail
prices to international prices, which considerably
reduced government expenditure on the petroleum

Financial sector reforms entailed the deregula-
tion of the banking sector, which has significantly
expanded the size of the sector in terms of the num-
ber of new private banks and branches, as well as
enhanced the scale of operations, particularly in new
businesses like merchant banking, mutual funds, etc.
The capital market has also been liberalized with the
gradual removal of controls on various transactions
in the capital account. The Securities and Exchange
Board of India was set up in 1995 to regulate the
primary and secondary stock markets along with
the stock exchanges and market intermediaries. The

36 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

Insurance Regulatory and Development Act was
introduced in 1999, opening up the insurance sector
to private participation.

Agriculture had received scant attention dur-
ing the initial phases of India’s economic reforms
process, largely due to the absence of a political

consensus. Although such a consensus remains
somewhat elusive, a growing realization regarding
the urgency of removing various inefficiencies in
the farming sector has resulted in the introduction
of some reform measures, essentially in three areas:
subsidies, procurement and the public distribution

III. India’s development trajectory

In this section, we attempt to portray India’s
development trajectory with the objective of unveil-
ing the process of its emergence as a major player in
the world economy. India had to wait for five long
decades before it could make its presence felt in the
world economy. Despite its rich heritage and endow-
ment of intellectual and scientific capacities, India
remained a poor underdeveloped nation with very low
material capacity for more than half a century after
independence. It is needless to mention that India
had significant ideational influence on global politics
and international relations during the Nehruvian era
(1950s). However, over time, even this influence
became eroded, perhaps due to its failure to match
its global diplomatic presence with commensurate
economic and/or military presence in the world. It is
rather intriguing to note that much of labour-surplus
Asia (East and South-East, in particular) forged ahead
with economic prosperity from the 1960s and 1970s,
despite starting from a much lower base compared
to India. Over the last forty years, some of the
economies in East and South-East Asia have grown
at rates unprecedented in human history, whereas
India remained stuck at low levels and growth rates
of per capita income.

Popularly known as the Asian Miracle, this
spectacular economic development and prosperity
in Asia was not as an isolated, regional phenom-
enon; rather, it reflected an unfolding pattern of
international specialization, integrating the labour
surpluses of Asia into the mainstream of world trade.
“Within [labour-surplus] East Asia, the development
of different national economies followed an orderly
sequence – the so-called “flying geese” pattern
(Akamatsu, 1962). The initial leader Japan was fol-
lowed by the Four Tigers (Korea, Taiwan, Hong Kong
and Singapore), then by the three Cubs (Indonesia,
Malaysia and Thailand) and finally by China and
Vietnam. At each stage, rapid economic growth in the

current leaders [driven by labour-intensive manufac-
tured exports produced a Stolper-Samuelson effect
and] set off a wage-explosion. This drove labour-
intensive industries out to the next tier of low-wage
economies while the current leaders graduated to
more sophisticated activities that were not however at
the cutting edge of technology. The final destination
of this migration of labour-intensive manufacturing
was of course China. In part, this was due to its vast
surplus of low-wage labour [generating a Lewis
effect].” (Guha and Ray, 2004: 301).

Despite its bulging population, where was
labour-surplus India in this Asian Miracle? Given
its autarkic trade policy regime that created strong
anti-export bias in the relative incentive structures
(Bhagwati and Srinivasan, 1975; Wolf, 1982), India
could never experience the Asian Miracle driven by
rapid expansion of labour-intensive manufactured
exports. However, if the inward-looking trade policy
regime was indeed the only reason for India’s inabil-
ity to join the miraculous growth experience of its
East Asian neighbours, one would naturally expect
India, with its low labour costs, to surge ahead in
flooding the global markets for labour-intensive mass
manufactures after it opened up its trade in 1991.
Nonetheless, this never happened. By the time that
India’s policy shift took place, competition in the
global mass market in labour-intensive manufactures
had intensified and India had already lost out in the
race against the East and South-East Asia. This was
perpetuated by India’s obsolete industrial policies,
and especially the policy of product reservation for
small-scale enterprises. It was supposedly in the
interests of equity and employment, which spectacu-
larly succeeded in crippling the textile industry, the
spearhead of labour-intensive export expansion in the
rest of the developing world (Guha and Ray, 2004).
Effectively, India almost voluntarily opted out of the
world’s mass market for traditional labour-intensive

37The Enigma of the “Indian Model” of Development

goods; indeed, it was the conquest of this market that
propelled China’s boom of the 1990s.

However, this did not prevent India from
charting out its own trajectory of emergence in the
world economy that transgressed simple labour cost
advantage. Fortunately, the advantage conferred
by low labour costs is pervasive and extends well
beyond the realm of traditional labour-intensive
goods into new industries and services, like soft-
ware, information technology (IT) and IT enabled
services (ITES), biotechnology and pharmaceuticals,
where knowledge inputs prove the key source of
comparative advantage. India’s opening up in the
1990s coincided with a new era, during which these
knowledge-intensive sectors began to dominate the
world economy. India’s advantage in these activities
arises from a strong university-educated middle class
(translating labour abundance into skill abundance)
and its public investment in science and technology
science and technology (S&T) research. We must
underline here the role of idealism and ideology in
shaping India’s development policy in the immediate
post-independence era. The policy thrust on higher
education and research, especially in S&T, has cre-
ated a knowledge base, skilled labour force and S&T
capacity that are well-equipped to capitalize on the
IT and biotechnology booms.

Apart from knowledge, skills and S&T capacity,
another key source of India’s strength has been its
knowledge of English language, inherited from its
colonial past. This has proved an asset of incalcu-
lable value for India in an age of instant worldwide
communication, essentially in the English language.
Thus, while China continues to dominate the vast
world market for traditional labour-intensive manu-
factures, new vistas have opened up for India, where
knowledge resources – as opposed to simple labour
abundance – prove the key source of comparative

Given that India’s emergence has centred on a
limited number of specific sectors, an obvious ques-
tion that arises is whether (and to what extent) it has
been ignited by sector-specific policies. We find quite
a divergence among sectors in this regard. India’s
success in IT and ITES has largely been self-driven,
taking off on its own in response to the new global
economic opportunities created by an IT driven global
production structure in a globalized world. Of course,
India’s advantages in terms of skilled (university-
educated) manpower and English language naturally

led to the flourishing of IT and ITES in India, even
without any specific government policies towards IT
during the initial phases. It is interesting to note that
the National Policy on Information Technology was
only announced in 2011, long after the successful
emergence of India’s IT sector.

However, the story is somewhat different in
the case of the pharmaceutical sector. Here, India
created a unique policy space for itself that fos-
tered the technological capability of the domestic
pharmaceutical industry (Ray and Bhaduri, 2014).
Carefully designed and targeted policy framework
adopted in the 1970s helped this industry to become
self-reliant, not only in manufacturing but also in
technology, eventually competing successfully in
global markets through technological capability.
In the first two decades after independence, India’s
overall development strategy of import substituting
industrialization – supplemented by an active role
played by public sector enterprises – acted as the key
driving force behind the growth and expansion of
the pharmaceutical industry. However, the industry
continued to remain largely dominated by foreign
firms and drug prices were among the highest in the
world (Kefauver Committee Report, 1961). Simply
trade policy alone is perhaps inadequate to foster self-
reliance, especially in a process-driven sector where
learning and technological capability building has to
be actively nurtured through complementary policy
instruments, and particularly intellectual property
rights (IPR). This policy reinforcement towards
technological self-reliance started in the 1970s with
the passage of several government directives directly
shaping the growth path of this sector, including the
Drug Price Control Orders of 1970 and 1979, the
Foreign Exchange Regulation Act of 1973, the New
Drug Policy of 1978 and, of course, the Patent Act
of 1970. Within this favourable policy environment,
the pharmaceutical industry in India embarked upon a
new trajectory of technological learning and acquired
substantial technological capability of process devel-
opment through reverse engineering both infringing
processes for off-patented molecules and non-infring-
ing processes for patented molecules. Through the
1970s and 1980s, the Indian pharmaceutical industry
reached new heights of process capabilities to “knock
off” any new drug with a non-infringing process and
market them at low prices. This phenomenon has
often been referred to as the “process revolution”
in the Indian pharmaceutical sector, whereby India
was now poised to make a major dent in the global
generics market (Ray, 2008).

38 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

The story of India’s economic emergence,
coupled with the diversity of its experiences in the
IT and pharmaceutical sectors, makes it evident that
the Indian model of development cannot be fully
comprehended with a broad-brush analysis of its
transition from an inward-looking policy regime to a
more open and liberalized economic environment in
line with the neoliberal traditions. We have analysed

how finer elements of development policies – ranging
from higher education and S&T research to product
reservations and IPR – have played a role in India’s
economic emergence in one way or another. In some
cases, non-targeted general policy elements have
produced desired results for specific sectors, while
in others targeted and sector-specific policies have
yielded positive sectoral outcomes.

As we have explained above, the Indian model
of development, as it has unfolded in the last couple
of decades, is based upon a foundation of knowl-
edge resources. The importance of knowledge as
a principal driving force behind economic growth
and development is now well recognized, given
that there are unlimited opportunities that can be
tapped by nurturing and augmenting knowledge
resources. Indeed, India has enormous potential and
unprecedented opportunities to make effective use of
its knowledge resources to enhance productivity in
all fields and make a successful transition towards a
knowledge economy.6

However, India’s assets and advantages on this
count (namely its educated workforce, technological
capability and knowledge of English) are far from
being permanent in character; rather, they can be
replicated in other countries with some effort. Indeed,
some of the other emerging economies like Brazil and
China are quickly catching up with India in terms
of these assets. More seriously, these assets created
by India’s colonial history and post-colonial policy
effort can be irreparably damaged, if not destroyed,
by unimaginative policy. For instance, the language
policy (shunting English) adopted by some of the
State governments as well as the union government
(at times) or the lack of a consistent higher education
policy to bring India to newer heights of intellectual
achievements could prove serious impediments to
nurturing these invaluable assets that have propelled
India’s economic emergence in the world.

The Indian model of development – prin-
cipally driven by rapid expansion of high-end
knowledge-intensive sectors (IT, biotech, business/
knowledge process outsourcing and other similar
services) – comes with a tragic neglect of low-end
labour-intensive mass manufactures. Even with all

the rhetoric about India’s high-end capabilities, one
must confront a fundamental question: how high is
India’s high end? Ironically, India’s high end is not
quite so “high”. Ray (2009) shows that although
India has demonstrated significant competitive
strength in routine (though skill intensive) tasks like
coding (in software) or process development (in
pharmaceuticals), it has been lacking creativity and
innovativeness to reach the global frontiers of tech-
nological advancement. India is yet to make a mark
in cutting-edge global technologies. For instance, it is
noteworthy that despite India’s global presence in the
generic market and its declared effort to reach newer
heights in pharmaceutical research and development
(R&D), we are yet to see a new chemical entity (drug)
from India hitting the global market. Effectively
then, India cannot compete with advanced nations
in the truly high-tech segments in terms of creating
new technologies and ideas. While India has created
a niche for itself in the so-called lower-end activi-
ties of the high-end sectors (like customized IT and
ITES and generic medicines) requiring skills and
technological capability that India has acquired, it is
yet to reach the levels of the league of technologically
advanced nations.

In the framework of the conventional structural
transformation paradigm (Chenery and Syrquin,
1975), the Indian model of development seems to
have skipped the middle phase of an expanding sec-
ondary sector, in which manufacturing is supposed
to account for the lion’s share of the GDP. From
an agriculture-dominated economy, India straight
away jumped to an economic structure, albeit with
a transition period of three or four decades during
which services assumed the lead role. However, in the
process, India completely lost out to other emerging
economies (mainly China) in the low-end segment
of mass manufactures. At the same time, it has been

IV. The Indian model of development – promises and pitfalls

39The Enigma of the “Indian Model” of Development

unable to compete with the technologically advanced
nations in the truly high-tech segment.

India’s remarkable success in lower-end activi-
ties of the high-end knowledge-intensive sectors has
undoubtedly created unprecedented opportunities
for a limited segment (creamy layer) of the society,
mainly for the English-speaking, college/university-
educated urban elite. It might have also created
incentives for upward mobility and opportunities
for the less fortunate to ascend the social ladder and
be absorbed in what has been described as the Great
Indian Middle Class. Nonetheless, it can hardly
be called a truly inclusive strategy of economic
development. It emphasizes services performed by
an educated middle class as the leading sector in
growth, in the midst of an ocean of illiteracy and
poverty. Of course, arguably the incomes generated
in the leading high-end sector may eventually trickle
down to the poor through increased demand for food
and manufacture, although this is a process that raises
the aspirations of the masses for a better life and then
fulfils them – if at all – at an excruciatingly slow pace.
It is not only inequitable in the extreme, but also a
prescription for political volatility. This is surely
not a sustainable development model, especially in
a democracy. The political economy of neglecting
the bottom quarter billion people, who lack health,
nutrition, education and shelter, must be clearly
understood.7 We believe that it is simply unviable to
sustain such a growth process in a democratic setup.

To employ the billion strong population pro-
ductively, one cannot rely on a policy of picking
winners and supporting a narrow set of sectors,
whether capital-intensive import substitutes (as dur-
ing the pre-1991 regime) or knowledge-based IT,
pharmaceuticals, biotech, etc. (as pursued now). It

is essential to tap the potentials for labour-intensive
“low-end” sectors (mass products) that create job
opportunities for the masses. This cannot necessar-
ily be achieved through counter-productive policies
of reservation and prolonged protection, but rather
through a proactive policy framework to resolve
infrastructure deficits on the one hand and improve
labour productivity through health, primary educa-
tion and appropriate technology policy on the other.

The new global economic order that has emerged
during the last couple of decades has ushered in a
process of globalization that entails greater integration
of the global economy, following the principles of free
trade and laissez-faire. While opening up new and
exciting opportunities for India’s economic growth
and development in the 21st century, globalization has
also posed serious challenges, especially regarding the
social sectors. The architecture of this new world order,
principally designed by the WTO agreement and sup-
plemented by the prescriptions of structural adjustment
offered to developing nations by the IMF/World Bank,
has an immediate consequence of retreat of the State
from active engagement in economic activities. Fiscal
reforms initiated everywhere (India being no exception)
have clearly mandated for public expenditure compres-
sion, whereby the soft targets for public expenditure
compression – as always – happen to be the social sector
allocations, in particular education, health and poverty
reduction. This directly affects the poor in a material
sense. It is somewhat ironic that while the primary
threats of globalization in India are directed towards the
underprivileged masses of its enormous population, it is
this same pool of human resources – if properly nurtured
– that will prove to be its greatest strength and source
of opportunity to embrace globalization positively and
productively to become a global economic power in
every sense of the term.


1 By 1947, India had already produced two Nobel lau-
reates (CV Raman in Physics and Sir Rabindranath
Tagore in Literature, who also happened to be the
first to receive a Nobel prize in Literature outside
the English speaking world), several civil servants,
barristers, professors and scientists of global repute.

2 See, for instance, Bhagwati and Desai (1970),
Bhagwati and Srinivasan (1975), Chakravarty
(1987), Little and Joshi (1994), Ahluwalia and Little
(1998), Panagariya (2008).

3 See, for instance, Prebisch (1950).
4 The Agricultural Trade Development and Assistance

Act of 1954, commonly known as public law 480,
allowed the Government of the United States to
export surplus agricultural commodities (food) to
“friendly” nations, on concessional or grant terms.
The initial objective was to eliminate agricultural
surpluses of the United States, but later it became
a foreign policy instrument of the country when it

40 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

was re-energized as a Food for Peace programme by

5 This may appear somewhat ironic, given that India’s
political alignment with the Soviet Union was becom-
ing stronger in this period, while private capitalists
were also becoming increasingly influential.

6 A knowledge economy is one that creates, dissemi-
nates and uses knowledge to enhance its growth and
development. See Dahlman and Utz (2005).

7 This figure is based upon a conservative estimate of
the poverty line. A more liberal poverty line at US$2
a day PPP will inflate this number substantially.


Ahluwalia IJ and Little IMD, eds. (1998). India’s Economic
Reforms and Development: Essays for Manmohan
Shingh. Delhi, Oxford University Press.

Akamatsu K (1962). A historical pattern of economic
growth in developing countries. The Developing
Economies, 1(s1): 3–25.

Bhagwati JN and Desai P (1970). India: Planning for
Industrialization: Industrialization and Trade Poli-
cies since 1951. London, Oxford University Press.

Bhagwati JN and Srinivasan TN (1975). Foreign Trade
Regimes and Economic Development: India. New
York, NY, Columbia University Press.

Chakravarty S (1987). Development Planning: The Indian
Experience. Oxford, Clarendon Press.

Chenery HB and Syrquin M (1975). Patterns of Development,
1950–1970. New York, NY, Oxford University Press.

Dahlman CJ and Utz A (2005). India and the Knowledge
Economy: Leveraging Strengths and Opportunities.
Washington, DC, World Bank.

Feldman GA (1964) [1928]. On the theory of growth rates
of national income. In: Spulber N, ed. Foundations of
Soviet Strategy for Economic Growth: Selected Soviet
Essays, 1924–1930 (translated version). Bloomington,
IN, Indiana University Press.

Guha A and Ray AS (2004). India and Asia in the world
economy: The role of human capital and technology.
International Studies, 41(3): 299–311.

Kefauver Committee Report (1961). Study of Administered
Prices in the Drug Industry. Washington, DC, United
States Government Printing Office.

Lal D (1988, 1989). The Hindu Equilibrium, Vols. I and II.
Oxford, Oxford University Press.

Little IMD and Joshi V (1994). India: Macroeconomics
and Political Economy 1964-1991. Delhi, Oxford
University Press.

Mahalanobis PC (1953). Some observations on the process
of growth of national income. Sankhya: The Indian
Journal of Statistics, 12(4): 307–312.

Panagariya A (2008). India: The Emerging Giant. Oxford,
Oxford University Press.

Prebisch R (1950). The Economic Development of Latin
America and Its Principal Problems. Lake Success,
NY, United Nations Economic Commission for
Latin America.

Ray AS and Bhaduri S (2014). India’s Pharmaceutical
Industry: Policy Space that Fosters Technological
Capability. In: Drache D and Jacobs LA, eds. Linking
Global Trade and Human Rights: New Policy Space
in Hard Economic Times. New York, NY, Cambridge
University Press.

Ray AS (2006). India’s economic reforms: Opportunities,
challenges and political economy perspectives.
In: White L, ed. Is there an Economic Orthodoxy?
Growth and Reform in Africa, Asia and Latin America.
Johannesburg, South African Institute of International

Ray AS (2008). Learning and innovation in the Indian
pharmaceutical industry: The role of IPR and other
policy interventions. RECIIS Electronic Journal
of Communication, Information and Innovation in
Health (Brazil), 2(2): 71–77.

Ray AS (2009). Emerging through technological capabil-
ity: An overview of India’s technological trajectory.
In: M Agarwal, ed. India’s Economic Future: Edu-
cation, Technology, Energy and Environment. New
Delhi, Social Science Press: 40–70.

Wolf MH (1982). India’s Exports. New York, NY, Oxford
University Press.

41Demystifying China’s Economic Growth: Retrospect and Prospect

Since the economic reforms and opening up
policy launched in 1978, China has experienced a
massive, protracted and unprecedented economic
upsurge, which is sometimes described as the
“China miracle” (Lin et al., 1996). Thereby, China
has been transformed from a remarkably closed and
poor agrarian society into an open global economy
within the past three decades. The average 10 per
cent growth rate of gross domestic production (GDP)
has lifted China’s GDP per capita (in constant 2005
dollars) from less than $200 in 1978 to more than
$3,500 in 2013(World Bank, 2013), promoting China
from the low-income group into the upper-middle
income group, as well as dramatically reducing the
proportion of absolute poverty (Ravallion and Chen,
2004). China has already grown to become the second
largest economy in the world, representing the engine
of growth in the Asian area and the top contributor to
global growth (Huang, 2011; Lin, 2011).

Despite consensus on the extraordinary eco-
nomic success, its sources remain open for inter-
pretation. Various analytical frameworks have been
developed by economists to explain the key to this

success, such as the demographic dividend – e.g. the
rising share of working-age population – (Cai, 2010;
Cai and Lu, 2013), the transition to comparative-
advantage-oriented development strategy (Lin et al.,
1996), allowing incremental growth of the private
sector activities while maintaining support to State-
owned enterprises (SOEs) (Naughton, 1995), the
“dual track strategy” (transform to market-oriented
while also supporting planned activities) (Brandt and
Rawski, 2008), taking over the growth model of East
Asia (Sachs and Woo, 2000), as well as asymmetric
product and factor market liberalization (Huang,

Most recently, the steady deceleration of
economic growth, the growing structural imbal-
ance, macro instability and financial risks have led
to expectations of a downward growth potential.
Economic growth slowed down after the 2008
financial crisis, decreasing to 7.7 per cent in 2013.
The Chinese Government adjusted the target growth
rate from above 8 per cent to around 7.5 per cent in
2011 for the first time and has maintained this target
rate ever since. In addition, many think tanks and


Liqing Zhang and Qin Gou


This chapter provides both a retrospective and prospective view of China’s economic growth since
1978. It starts with a review of China’s economic spurt from the reforms of the late 1970s, before
investigating how this success has been driven by the demographic dividend, high savings rate, outward-
oriented development strategy, as well as rising total factor productivity. The chapter then studies the
challenges arising from a diminishing demographic dividend, growing structural imbalance, as well
as macro instability and financial risk, which threaten the sustainability of China’s economic growth.
Finally, the chapter suggests some pillars to maintain sustainable economic growth and avoid the
middle-income trap, including deepening reforms in the financial, household registration and education
systems; accelerating structural rebalancing; and replacing massive stimulus with mini-stimulus.


42 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

economists gauge China’s expected growth potential
to be around 7 per cent in the late-2010s and less
than 7 per cent in the 2020s (World Bank and the
Development Research Center of the State Council,
2012; Eichengreen et al., 2012; Zhuang et al., 2012).
China’s economy is believed to be turning to a new
model of growth and development, whose most
basic features are growth rate slowdown, structural
rebalancing and industrial upgrading (Garnaut et
al., 2013). However, it remains subject to debate
whether China can maintain a robust growth rate.
Lin (2011) believes that China can still potentially
achieve a dynamically rapid growth rate of 8 per
cent for another 20 years or more by relying on the

advantage of backwardness, which is also supported
by Perkins and Rawski (2008).

What contributed to China’s economic spurt in
the past reform period? How was the rapid growth
pace maintained? Moreover, what factors challenge
the sustainability of China’s current and further eco-
nomic growth? How should the Chinese Government
move forward its transition? In this chapter, we will
address these questions by looking back at China’s
past economic performance and the corresponding
driving forces, as well as exploring the present and
future challenges that threaten the sustainability of
China’s economic growth.

I. China’s economic growth performance: Retrospect

A. China’s economic growth performance

Although the industrialization process started
ever since the establishment of People’s Republic of
China, which initiated China’s economic recovery,
the economic performances before and after 1978
significantly differ, with the post-1978 growth model
outperforming the one established after the Second
World War in many respects.

To start with, the real GDP growth rate reports a
remarkable 10 per cent on average between 1980 and
2010, compared to 6.7 per cent during the previous
post-war period (chart 1). As a result, the gap between
China and the United States in terms of GDP reduced,
with China’s GDP relative to the one of the United
States increasing from less than 10 per cent in 1980
to more than 75 per cent in 2013. Indeed, China now
is the second largest economy in the world.

As a result of its extraordinary economic per-
formance, China’s share of global GDP has increased
from less than 1 per cent to more than 9 per cent
during the last three decades (World Bank, 2013),
with China having jumped from the fifth strongest
contributor to global growth to being ranked first
(Lin, 2011). In addition to China’s outstanding eco-
nomic performance in calm periods, China withstood
the shocks and maintained rapid growth during both
the East Asian financial crisis in 1997-1998 and the
current global crises starting in 2008. Moreover,
China’s dynamic growth in the current global crises
was a main driving force for the global recovery.

In respect to GDP per capita, the story is much
more significant. Prior to 1978, China reaped a
3.6 per cent real GDP per capita growth rate, which
slightly outperformed the United States and India yet
left China far behind some of its Asian neighbours
(chart 2). After 1978, the whole picture changed
tremendously, with China’s relative economic size
expanding. Since 1978, China has achieved remark-
ably rapid economic growth, with real per capita
GDP growing at more than 8.5 per cent annually
on average (World Bank, 2013). The high growth
rate has significantly closed China’s income gap
with the United States, with China’s GDP per capita
having increased from 2 per cent to 17 per cent of
that of the United States (chart 2). China’s dramatic
economic success has also obviously reverted its
lagging-behind State into a rapid catching-up trend
with Japan and the Republic of Korea, greatly short-
ening its economic distance to them. Furthermore,
China’s output rose much more quickly than that of
India, pushing China’s GDP per capita from less than
50 per cent of India’s in 1978 to more than its double
in 2010 (chart 2).

Alongside buoyant GDP per capita growth, a
huge decrease in the poverty ratio has been achieved
in the past three decades. The proportion of the
population whose income is less than $1.25 per day
declined to 11.8 per cent by 2009, compared to 84 per
cent in 1981 (World Bank, 2013). 678 million people
were lifted out of poverty during this period, benefit-
ting from China’s dramatic economic development
(World Bank, 2013).

43Demystifying China’s Economic Growth: Retrospect and Prospect

Besides the economic gain, China has achieved
a marked increase in its world market shares in both
trade and international capital flows. China has
experienced rapid growth in both imports and exports
during the past three decades, especially since China
joined the World Trade Organization (WTO) in 2001
(chart 3). China’s exports and imports have both
expanded more than 140 times their value since the
beginning of the economic reform. Its export share in
the world market, i.e. China’s exports to other coun-
tries in the world as a percentage of world exports,
increased from below 1 per cent in 1980 to 10 per cent
in 2013, while its import share in the world market
increased from below 1 per cent in 1980 to 9 per
cent in 2013. The trade surging has lifted China to
become the largest exporter, second largest importer
and second largest trade country in the world.

China’s opening up also provides the country
access to much-needed advanced technology. Foreign
direct investment (FDI) inflow to China rapidly
increased and China has been the top FDI destination
among developing countries since the mid-1990s. In

Chart 1

UNITED STATES, 1953–2013

(Per cent)

Source: Authors’ calculations, based on National Bureau of
Statistics of China; and Wind database.

Note: Relative GDP measure uses purchasing power parity
conversion. GDP growth rates in this chart are not
necessarily consistent with the data that appear in
table 1, in particular for the early years, which present
more conservative GDP growth rate estimates.

Chart 2


(Per cent)

Source: Authors’ calculations, based on Penn World Table 7.1

Note: Relative GDP per capita measures use purchasing
power parity conversion.

Chart 3

MARKET, 1982–2013

Source: Authors’ calculations, based on World Bank, WDI data-





















1953 1963 1973 1983 1993 2003 2013

China’s real GDP growth rate
China’s GDP relative to the United States (right scale)

Reform period




Pre-reform period















1952 1962 1972 1982 1992 2002

Relative to
the Rep. of Korea

Relative to India
(right scale)

Reform periodPre-reform period

Relative to
the United States

Relative to




1 000

1 500

2 000

2 500

3 000

3 500













1982 1987 1992 1997 2002 2007 2013



f c


t 2







China’s import (right scale)
China’s export (right scale)

China’s export share
China’s import share
China’s trade share

44 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

2012, China’s FDI accounted for almost 40 per cent
of total FDI inflows to low- and middle-income coun-
tries (World Bank, 2013). In addition, owing to the
“going out” strategy implemented at the beginning of
the 2000s, China’s outward direct investment (ODI)
has also surged. During the past decades, China’s ODI
flow has raised from $2.9 billion to $109.7 billion
in 2012 (chart 4), ranking China as the third largest
source of ODI in the world at present, according to
the Ministry of Commerce of China (2012).

B. Interpretation of China’s rapid
economic growth

How has China achieved such remarkable
economic success in the post-reform period? To
investigate this question, we first examine the sources
of GDP growth from the supply side. China’s growth
is commonly considered to be primarily driven by
capital accumulation. Therefore, serious doubts have
been raised about the role of productivity progress in
this kind of growth model, as well as the sustainabil-
ity of growth (Kim and Lau, 1994; Krugman, 1994;
Young, 1994). However, this view has more recently
been challenged, given that total factor productivity
(TFP) has also been found to play an important role
in China’s sustained growth, especially in the years
before the 2008 crisis (Kuijs, 2009; Park and Park,
2010; Perkins and Rawski, 2008; Wu, 2011 and

A growth accounting exercise briefly delineates
the diverse patterns of China’s economic growth
before and after the reform. While the pre-1978
growth was mainly led by capital investment rather
than productivity improvements, growth thereafter
has been derived from both (table 1). After 1978,
physical capital grew at a higher growth rate than
other inputs and TFP; indeed, it remains the first con-
tributor to the rapid economic growth. TFP has grown
at more than 3 per cent annually, which evidences
productivity enhancement. Moreover, China’s TFP
growth rate also outperformed its Asian neighbours
from the 1990s onwards (table 2). Although there
remains a heated debate about the role of TFP in
China’s growth, which reaches hardly any consen-
sus, Wu (2011) obtained a 3.7 per cent annual TFP
growth rate on average in the post-reform period
after surveying 74 studies by employing the method
of meta-analysis.

C. Underlying driving forces

In the last three decades, China’s sustained eco-
nomic growth has stemmed from two major sources:
capital accumulation and productivity growth.
Whether China can maintain that growth model
depends on the sustainability of these two major
driving forces. Therefore, explaining the fundamental
factors that drive them is crucial to look forward. No
single factor can explain the whole story of China’s
economic model. The most important underlying
forces are the demographic dividend, high savings
rate, outward-oriented development strategy and
improvement in productivity.

1. Demographic dividend

Since the very beginning of the economic
reform in the late-1970s, the growth of the working
age population has accelerated and the proportion
of working age population in the total population
increased until 2010. This increase not only directly
guarantees abundant labour supply and low wages,
but has also reduced the dependence ratio (the ratio
of the dependent population to the working age
population) from a high level of almost 80 per cent
in the 1970s to below 40 per cent in 2010 (chart 5).
The low dependence ratio contributes to maintaining
a high savings rate, which forms the condition for a
high growth rate of capital accumulation (Cai, 2010).
In addition, the unlimited labour input ensures that the
heavy capital accumulation can support a prolonged

Chart 4


(Billions of dollars)

Source: Authors’ calculations, based on State Administration of
Foreign Exchange of China.









1982 1987 1992 1997 2002 2007 2013


45Demystifying China’s Economic Growth: Retrospect and Prospect

GDP growth, as it prevents marginal return on capital
from diminishing (Bai et al., 2006; Cai and Zhao,
2012; Cai and Lu, 2013).

Moreover, increasing labour mobility will
further strengthen the contribution of the unlimited
labour supply, as mobility ensures the industrial

transition from agriculture to manufacturing and ser-
vices, as well as from rural to urban areas (Brandt and
Rawski, 2008). Factor reallocation across industries

Table 1

(Percentage points)

Periods GDP Labour


Total factor

Perkins and Rawski (2008) 1952–1978 4.4 1.9 5.8 2.5 0.5
1995–2000 8.6 0.9 10.5 1.6 3.2
2000–2005 9.5 1.0 12.6 1.8 3.1
1978–2005 9.5 1.9 9.6 2.7 3.8

Wu (2014) 1952–1977 4.3 1.0 3.3 0.5 -0.5
1991–2001 10.4 0.2 5.7 0.5 3.7
2001–2007 11.3 -0.5 6.1 0.5 4.8
2007–2012 9.3 -0.2 7.7 0.4 1.3
1978–2012 9.8 0.3 5.5 0.5 3.2

Kuijs (2009) 1978–1994 9.9 3.3 2.9 0.5 3.0
1995–2009 9.6 1.0 5.5 0.3 2.7

Source: Authors’ calculations, based on Perkins and Rawski (2008); Kuijs (2009); and Wu (2014).
Note: The growth rate of GDP equals to the factor-share-weighted sum of its four components: labour, physical capital, human

capital and TFP. For comparability, the accounting results are based upon the official data from Wu (2014). The accounting
exercise of GDP growth rate is under the assumption of Cobb-Douglas production function. GDP growth rates in this table
are not necessarily consistent with the official data that appear for instance in chart 1, in particular for the early years, which
are usually believed to overestimate the GDP growth rate.

Table 2


(Percentage points)

G5 Japan NIEs China ADEs

1992–1997 0.20 -0.99 1.71 3.1 -0.05
1997–2002 0.17 -1.04 -0.94 2.5 -1.08
2002–2007 0.31 0.98 2.35 6.6 1.93

Source: Authors’ calculation, based on Park and Park (2010).
Note: Non-Asian G5 refers to France, Germany, the United

Kingdom and the United States.
NIEs refers to Hong Kong (China), the Republic of

Korea, Singapore and Taiwan Province of China.
ADEs stands for Asian developing economies and refers

India, Indonesia, Malaysia, Pakistan, the Philippines,
Thailand and Viet Nam.

Chart 5


Source: Authors’ calculations, based on United Nations, Depart-
ment of Economic and Social Affairs (UN/DESA), World
Population Prospects, the 2012 Revision; and Cai and
Lu (2013).













1 000

1 200

1 400

1 600

1950 1960 1970 1980 1990 2000 2010 2020 2030 2050 2100






65+ 15–64 0–14
Dependence ratio (right scale)

The Chinese
Lewis turning

46 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

and regions thereby promotes total productivity
(Brandt et al., 2008; Brandt and Zhu, 2010; Zhu,
2012). Finally, low labour costs owing to the (tempo-
rarily) unlimited supply of labour emerged as China’s
comparative advantage in the global markets, driving
China into the typical export-led growth model.

2. High savings rate

China maintains a high domestic savings rate,
which is used to fund its unusual investment ratio.
To understand the role of investment in the growth
model, explaining the high savings rate behaviour
is crucial. In the early-2000s, the main contribu-
tor of the increasing savings rate was the high and
rising household savings rate, which is believed to
have been promoted by several factors: firstly, the
demographic structural change that we discussed
above; secondly, the underdeveloped social welfare
system, which promotes high precautionary savings;
moreover, the low interest rate on savings deposits
under financial repression policies, which hinders
household interest income and thus induces house-
hold to save more to compensate for the income loss
(Lardy, 2008 and 2012). Finally, an imbalanced sex
ratio leads families with sons to raise savings to be
more competitive and attractive for marriage (Du and
Wei, 2010; Wei and Zhang, 2011).

Between 2004 and the crisis, corporate savings
largely expanded, accounting for approximately half
of China’s national savings by 2007 (Bayoumi et al.,
2010). According to Hofman and Kuijs (2006), it is
the high corporate savings that make China stand out
in terms of its savings rate in the mid-2000s. Several
factors are behind the high savings by enterprises:
on the one hand, within an underdeveloped financial
system, firms increase retained earnings to fund their
investment, which thus raises the corporate savings
rate (Allen et al., 2005; Guariglia et al., 2011); and
on the other hand, a dividend policy that prevents
households from sharing enterprises’ retained earn-
ings, especially low dividend payments by SOEs
due to large-scale agency problems, further drives
up corporate savings (Hofman and Kuijs, 2006;
Bayoumi et al., 2010).

3. Outward-oriented development strategy

China might be one of the most impressive
cases of outward-oriented development strategy in
terms of economic growth. Prior to 1978, China
was essentially isolated from the rest of the world,

with domestic demand, and particularly domestic
investment, representing the main source of eco-
nomic growth. The economic reform and opening
up policy launched at the end of the 1970s made
China’s economy gradually open to the rest of the
world. In 1988, China switched its typical import
substitute strategy in the early reform period to an
export-oriented development strategy by applying
the “big import and big export” model (Lin et al.,
1996). Since China’s access into WTO in 2001, its
export share in GDP and trade share in the world
market have both substantially surged (chart 3).
The export-oriented strategy has provided China
with a good opportunity to utilize its comparative
advantages and the advantages of backwardness to
gain more economic efficiency, create employment
opportunities and eventually bring about better
economic welfare.

As one of the most important pillars of the
outward-oriented development strategy, FDI inflows
have been greatly encouraged since the early-1990s,
giving an impetus to exports and representing a
source of technological progress. To create more
employment opportunities given an inefficient
domestic financial market, many local governments
tend to rely on FDI. In order to attract more FDI, they
usually offered foreign-funded enterprises (FFEs)
preferential tax treatment, enthusiastically supplied
FFEs cheap or even provided free land for factory
building and other stimulating facilities (Branstetter
and Lardy, 2006). As a result of these encouragement
policies, China became the largest FDI destination
country in the emerging market world from the
mid-1990s. It is noted that by facilitating processing
exports, which account for more than 50 per cent of
the total export in China in recent years (Koopman
et al., 2012; Xing, 2014), the huge FDI inflows have
become one of the main propellants to export growth
in the country. Moreover, it also improves technology
progress through spillover effects.

4. Sources of growing TFP

The increase in TFP during the entire reform
period before the global crisis is attributable to
the technology progress and the improvements in
resource allocation efficiency. First of all, techno-
logical progress enhances productivity. China’s
progress in manufacturing technology mainly stems
from either the learning effect with the advantages of
backwardness (Lin et al., 1996) or spillover effects of
FDI (Tian, 2007) in the early decades. More recently,

47Demystifying China’s Economic Growth: Retrospect and Prospect

innovation and human capital improvement resulting
from enhanced education have also begun to play an
important role (Fleisher, et al., 2010). Meanwhile,
China’s agricultural production efficiency has been
greatly improved as a result of the rural economic
reform, providing incentives for peasants by reinstat-
ing the link between effort and reward (Lin, 1992).

Second, improvements in factor allocation
efficiency due to reallocation across regions and sec-
tors have facilitated TFP growth (Brandt et al., 2008;
Brandt and Zhu, 2010; Cai, 2010). By promoting and

expanding the activities of market-oriented private
sector and strengthening market competitiveness,
the State sector reform has improved the resource
allocation efficiency and productivity. Moreover,
market-oriented pricing reform ensures more efficient
resource allocation, especially in the markets for
products. On the other hand, the partial liberalization
in the factor markets provides incentives for entities
and sometimes overcomes market failure (Huang,
2010). However, some authors observe that factor
misallocation remains, constraining China’s TFP
gains (Hsieh and Klenow, 2009).

II. Prospect of China’s economic growth: Challenges

A. Growth slowdown after the global crisis

The 2008 global crisis was like a watershed for
China’s economic growth, whereby the GDP growth
rate fell from a high of 14.2 per cent in 2007 to below
10 per cent in 2008 and 2009. Although the govern-
ment stimulus policy pushed the growth rate back
to above 10 per cent in 2010, this was not sustained
and it glided down again in 2012 and 2013 to below
7.7 per cent. The GDP growth rate has declined by

1.8 percentage points on average from the pre-crisis
to post-crisis period (table 3). This slowdown trend
has prompted concerns about the prospect of China’s
economic growth. What are the causes of the recent
growth slowdown? Is this deceleration a cyclical
phenomenon? We will analyse the GDP performance
from both the demand and supply side.

Firstly, from the demand side, through decom-
posing the expenditure of GDP, we find that the GDP

Table 3

(Per cent)

growth rate

of GDP

Contributors to GDP growth

growth rate
of export

Contributors to export growth

consumption Investment Net export

World total

China’s export
share in the
world total


(1) (2) (3) (4) (5) (6) (7)

2001–2007 10.81 4.41 5.16 1.24 25.42 12.05 11.94

2008–2013 8.98 4.45 5.05 -0.5 11.48 6.09 5.07

Change -1.83 0.04 -0.11 -1.74 -13.94 -5.96 -6.87

Contribution share
of the change 100 -1.95 5.85 95.19 100 42.79 49.29

Source: Authors’ calculations, based on National Bureau of Statistics of China.
Note: Total consumption refers to private and public consumption. Figures in column 2 to 4 measures the average contributions

of consumption, investment and net export to GDP growth rate and to the change of GDP growth rate from the period of
2001–2007 to 2008–2013. Figures in columns 6 and 7 measure the average contributions of the world total exports and of
changes in China’s export market share to China’s export growth rate and to the change of China’s export growth rate from
the period of 2001–2007 to 2008–2013. Figures in the last row measure the shares of consumption, investment and net
export in contributing to the GDP growth rate decrease from the period of 2001–2007 to 2008–2013, as well as the shares
of the world total exports and China’s export market share in the world in contributing to the decrease of export growth from
the period of 2001–2007 to 2008–2013.

48 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

slowdown is chiefly led by the falling contribution
of net exports, which accounts for 95 per cent of the
decline in the average GDP growth rate (table 3).
Therefore, understanding the net export behaviour
is crucial to explain the recent GDP slowdown. The
decrease in the growth rate of net exports is mainly
because growth rate of exports decreased more than

that of imports. Further decomposing the export
growth rate depicts a different picture from what
is commonly viewed. Accordingly, the decreasing
rate in exports growth is not only explained by the
cyclical external demand (measured as the world total
export) shock after the crisis, but is also led by slower
gains in the market share. Put simply, if we roughly
view China’s export share in the world as China’s
export competitiveness, then the export growth rate
slowdown is not just a cyclical adjustment, but might
also challenge the sustainability of export-oriented
model in the long run.

Although the investment growth rate has de-
creased on average to a rather small degree, its share
in GDP sharply increased from an average of 40.4 per
cent before the crisis to as high as 48.3 per cent in
2011 (chart 6). The Government’s massive stimulus
after the crisis can well explain this trend of switching
from falling to rising. During the same period, the
consumption growth rate slightly increased.

Secondly, from the supply side, the main change
emerges in the growth rate of capital accumulation
and TFP. While the former plays a more important
role in the post-crisis rather than the pre-crisis period,
the latter sharply declines (table 1). After adjusting
the official data, Wu (2014) even obtained a negative
TFP growth rate in the post-crisis period.

The increase in the capital accumulation growth
rate is also attributed to the Government’s stimulus
policy and the acceleration in infrastructure invest-
ment. However, the reason for the declining TFP
growth rate is not so clear. After the crisis, a fall
in the share of the industry sector is mirrored by
a rise in the share of the service sector (chart 7).
Together with the fact that the manufacturing sector
outperforms the service sector in terms of the TFP
growth rate (Wu, 2011), this might provide a pos-
sible answer to the TFP slowdown. In addition, the
investment inefficiency after the stimulus package
and the diminishing of the dividends of opening up
could offer further explanations.

B. Challenging factors

As we have discussed above, the slowdown
of GDP growth after the crisis is not only driven by
cyclical factors or the by-product of the stimulus
policy, but also by structural factors that cause a
reduced export competitiveness and productivity

Chart 6

WORLD ECONOMY, 1978–2013

(Per cent of GDP)

Source: Authors’ calculations, based on National Bureau of
Statistics of China; and Wind database.

Chart 7

(Per cent of GDP)

Source: Authors’ calculations, based on National Bureau of
Statistics of China; and World Bank, WDI database.








1978 1983 1988 1993 1998 2003 2008 2013

Consumption China Investment China
Investment world Consumption world












1978 1983 1988 1993 1998 2003 2008 2013

Primary Industry
Construction Service

49Demystifying China’s Economic Growth: Retrospect and Prospect

growth rate. Therefore, can China sustain its previous
miracle growth pattern from the long-run perspec-
tive? We will explore this by investigating the factors
that challenge China’s economic prospects.

1. Diminishing demographic dividend

Firstly, the demographic dividend has been
diminishing following the decline of the fertility rate
and the ageing of the population. Chart 5 indicates
that as the growth rate of the working age population
decreases, the dependence ratio reached the lowest
point in 2010 and has subsequently switched to
increasing. Therefore, as previously discussed, the
contributions of the demographic dividend to China’s
economic growth have been diminishing.

As the working age population stops grow-
ing, all three supply factors of GDP are negatively
affected. First, the increase in the dependence ratio
pulls back the high savings rate. In addition, the
limited supply of labour can no longer prevent the
diminishing capital return. Without labour realloca-
tion, the productivity growth rate is also affected.
Moreover, labour shortages might push up wages, and
thereby manufacturing costs, which impairs China’s
comparative advantage in the world export market
and hinders investments.

In fact, as China passed the Lewis turning
point or the Lewis turning period (from 2004, when
labour shortages first appeared and migrants’ wages
started to increase, to 2010-2015, when the number
of the working age population peaked), all the trends
described above have been evident in China, i.e.
labour shortages, diminishing returns on capital,
and a declining savings rate (Cai and Lu, 2013).
Demographic structural change will lead to a slow-
down of the potential growth rate (Cai, 2010; Cai and
Lu, 2013). The potential growth rate will fall to an
average of 7.2 per cent during the 2011–2015, before
gliding again to 6.1 per cent during 2016–2020,
according to the estimate by Cai and Lu (2013).

2. Growing structural imbalances

Behind the economic performance achievement,
significant structural imbalances have prevailed in
China over the past thirty years; in particular, a con-
tinuously increasing high investment ratio, decreas-
ing consumption ratio, over-dependence on external
demand, a prolonged weakness of the service sector,

worsening income inequality and severe environmen-
tal degradation, which have resulted as by-products
of the past growth model. Indeed, these structural
imbalance problems have threatened the sustain-
ability of economic growth.

First, the investment share of GDP is already
unusually high, whereas the consumption share is
very low. The investment share has been steadily
rising from less than 30 per cent before the reform
to almost 50 per cent after the crisis (chart 6). This
share is much higher than the world average (around
20 per cent), as well as the average of Asian econo-
mies at around 25 per cent (Huang and Wang, 2010).
Contrary to the sharp rise in the investment ratio, the
consumption (private and public) share has fallen
from more than 60 per cent at the beginning of the
reform to less than 50 per cent recently, which is
below the world average level of around 75 per cent
(chart 6), as well as that of Asian and newly industri-
alized economies (NIEs) (Huang and Wang, 2010).
This declining consumption share is particularly led
by the declining private consumption from around
50 per cent to around 36 per cent, which is much
less than the average of 60 per cent among emerging
market economies (Dorrucci et al., 2013).

Such a high investment share and a low con-
sumption share could dim the GDP outlook in several
ways. First, high investment shares often increase
risks of overheating, bubbles and over-capacity.
The experiences of some East Asian economies with
investment share higher than 40 per cent and strong
economic growth, such as Singapore in the 1980s,
Malaysia and Thailand in the 1990s, increased the
likelihood of financial crisis years later (Huang and
Wang, 2010). Secondly, a too low consumption
ratio might cause social and political problems as
households cannot sufficiently benefit from the
economic development. Lastly, the investment-led
growth model is not sustainable, driven by several
factors. For instance, the diminishing return of capital
cannot support high capital accumulation speed as
before. “One-off windfalls” from both the Chinese
corporate restructuring and WTO entry could fade,
while the per capita capital stock has been rising (Ma
et al., 2012). The obvious natural upper bound on the
investment share also prevents it from continuing
to grow. Moreover, in an international comparison,
Dorrucci et al. (2013) found that although Japan,
the Republic of Korea, and other NIEs had enjoyed
a prolonged increase in investment since their
economy took off, without exception all of them

50 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

had experienced declining investment shares after
reaching a peak of almost 40 per cent.

Second, the external imbalance influences
China’s growth prospects. China’s reliance on net
exports has led to a huge current account surplus,
reaching its highest point (9.7 per cent of GDP)
in 2007 (chart 8). The high dependence on export
exposes China’s economic growth sustainability to
external demand shocks. A huge current account
surplus led to an accumulation of a huge amount
of foreign reserves under a rigid exchange rate
regime. Notably, partly due to the American financial
crisis and partly due to the internal structural adjust-
ment, China’s current account surplus has steadily
decreased since 2009, having already fallen to 2.0 per
cent in 2013. The pressure from excessive depend-
ence on external demand has been reduced.

Third, the sectoral structure is imbalanced in
two ways. Firstly, the development of the service
sector has been significant, but still lags behind. The
share of the industrial sector has remained steadily
around 40 per cent since the mid-1990s, while the
share of the service sector witnessed a rapid growth
and steadily increased from less than 25 per cent at
the early reform period to around 40 per cent in the
2000s before the crisis and 46.1 per cent in 2013.
However, it still lagged behind its average share in
low and middle economies, let alone the high-income
economies (chart 9). In particular, services such as
finance, logistics, information technology, education,

health care and pensions industries remain in short
supply. Secondly, the structure is also imbalanced
within manufacturing. While there is generally
over-capacity within the traditional manufacturing
industries such as the heavy chemical industry, steel,
equipment manufacturing and the coal and solar
industry (Anderlini, 2013), high-end manufactur-
ing, new energy and environment friendly products
remain in short supply (Zhang, 2013).

Fourth, income inequality in both dimensions
among households and regions has deteriorated. The
urban-rural income ratio increased from a low of 1.82
in 1983 to 3.3 in 2009 and the Gini coefficient has also
come close to 0.5 in recent years, according to official
data (chart 10), although it is even higher according
to some other estimates. Rising inequality is emerg-
ing as one of the primary concerns of the Chinese
Government. The good news is that the latest reading
shows a reduction in income inequality in terms of
both the urban-rural gap and the Gini coefficient.

Income inequality in China is also embodied
among regions. While the eastern coast provinces,
especially the big cities, have stepped into high-
income level, the western and middle provinces
remain underdeveloped, especially the rural areas.
Geographical disparity among provinces, measured
as the coefficient of variation of real per capita

Chart 8


Source: Authors’ calculations, based on National Bureau of
Statistics of China.

Chart 9


(Per cent of GDP)

Source: Authors’ calculations, based on National Bureau of
Statistics of China; and World Bank, WDI database.






















1994 1996 1998 2000 2002 2004 2006 2008 2010 2013


t o

f G




f d



Absolute terms
Relative terms (right scale)











1991 1996 2001 2006 2011



Low-income countries

Middle-income countries

High-income countries


51Demystifying China’s Economic Growth: Retrospect and Prospect

income, shows a trend worsening from the early-
1980s (Song, 2013). Moreover, intra-provincial
inequality has also increased, contributing about
63 per cent of the overall increase in regional inequal-
ity during 1997–2007 (Cheong and Wu, 2012).

Last but not least, China is facing unprecedented
challenges of high resource consumption and severe
environmental degradation (Zhang, 2013). Scarcely
restrained by the environmental protection institu-
tions, the spectacular economic development over the
past two decades has dramatically depleted China’s
natural resources and produced skyrocketing rates
of pollution, in particular in the air and water. For
example, along with China’s rapid growing export,
the CO2 emissions embodied in the exports have rap-
idly risen. For example, the CO2 emissions embodied
in China’s exports to the European Union increased
fourfold from 1995 to 532.35 Mt in 2006, accounting
for 8.85 per cent of China’s CO2 emissions (Yan et
al., 2011). The environmental degradation has caused
significant public health problems, mass migration,
economic loss and social unrest (Economy, 2011).
Therefore, China now faces great challenges in
balancing its economic goals with environmental
sustainability (Zhang, 2013).

3. Macroinstabilityandfinancialrisk

Macroeconomic instability and rising financial
risk have increased the burden on the transition. First,
the recent rapid development of local government

financing platforms (LGFPs) has increased the vul-
nerability of the macro-economy and the financial
system, aside from prompting great concerns. After
the 2008–09 global financial crisis, the Chinese
Government introduced a fiscal stimulus package
comprising 4 trillion Renminbi (RMB), in response
to the enormous negative external shock. A large
number of infrastructure projects represented by
railways, highways, airports and subways were
approved. In order to ensure that these projects
remain on schedule, monetary authorities released
a large amount of money and banking regulators
loosened credit standards. Therefore, broad money
(M2) and credit surged in 2009 and 2010 (chart 11).

The credit expansion triggered a rapid prolif-
eration of LGFPs, as the central Government only
contributed RMB 1.18 trillion, with the rest being
provided by local governments (Shih, 2010; Lu and
Sun, 2013). At the end of 2010, the stock of local
government debt reached RMB 10.7 trillion, marking
the equivalent of 27 per cent of GDP in 2010, among
which LGFP debt was around RMB 4.97 trillion,
according to the National Audit Office of the People’s
Republic of China (2011). By the end of 2012, out-
standing LGFPs loans amounted to RMB 9.2 trillion,
accounting for 13.8 per cent of the total outstanding
loans in the banking industry, as estimated by the
China Banking Regulatory Commission. The recent
rapid development of LGFPs has increased the fiscal
and financial risks and prompted great concerns. On

Chart 10

CHINA, 1978–2013

Source: Authors’ calculations, based on State Administration of
Foreign Exchange of China.

Chart 11

JANUARY 2004–JUNE 2014

(Per cent)

Source: Authors’ calculations, based on State Administration of
Foreign Exchange of China.

Note: Data refer to year-on-year change.















1978 1982 1986 1990 1994 1998 2002 2006 2010

income gap

(right scale)

2013 0








01/2004 01/2006 01/2008 01/2010 01/2012 01/2014

52 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

the one hand, LGFPs loans are exposed to the mis-
match between the revenue and expenditure of local
governments, with the fiscal gap being exacerbated
by the fiscal stimulus (Lu and Sun, 2013). On the
other hand, it has also rendered local governments,
banks and the economy vulnerable to the volatility
of the real estate market, as sale of land use rights
constitutes the principal source of LGFPs’ future debt
payment (Lu and Sun, 2013).

Another concern about financial risk emanates
from the real estate sector and shadow banking. The
property price booms have recently been cooling off,
suggesting that real estate investment might collapse.
Broadly described as “credit intermediation involving
entities and activities (fully or partially) outside the
regular banking system” according to the Financial
Stability Board (2013), shadow banking has been
rapidly rising in China at an annualized rate of
34 per cent since the end of 2010, as estimated by
Standard & Poor’s (2013). The total shadowy loans
was estimated to amount to RMB 2.29 trillion at the
end of 2012, equivalent to 44 per cent of GDP and
34 per cent of the total outstanding loans in the bank-
ing industry in 2012 (Standard & Poor’s, 2013). The

rapid development of informal finance, which would
be hazardous, has also prompted significant concerns.

Although the stimulus policy brought an
economic rebound in 2010, it produced large after-
effects. The slowdown of investment growth rate
itself placed pressure upon the GDP growth rate,
while over-capacity and the debt risk stimulated
by these policies further hindered new investment.
Moreover, to maintain their projects, LGFP and
those large firms with over-capacity further finance
themselves at a high interest rate, which drives up
the capital cost and thereby reduces the profits and
investment of private and small firms.

In sum, from the demand side, given that
the investment and export-led growth models are
unsustainable, the way out is to rebalance to domes-
tic demand and improve investment efficiency.
From the supply side, potential output growth rate
is declining due to the diminishing demographic
dividend and investment inefficiency, whereby pro-
ductivity improvement represents the chief remedy.
Furthermore, any reform policy should take consid-
eration of current macroeconomic and financial risks.

III. Policy implications

Although China’s past growth model is not sus-
tainable and the previous rapid growth rate is unlikely
to be maintained, it does not necessarily signify a
crash of the Chinese economy. International experi-
ence indicates that when a fast growing economy
reaches a certain income level, it will transit to a
slowly growing development stage (Eichengreen
et al., 2012);1 therefore, transition to a new growth
model is normal. The key challenge is how to trans-
form the economy successfully to that sustainable and
lower growth model and avoid growth stagnation.
Historically, despite having enjoyed high growth
rates when taking off, most of the middle-income
economies suffer from growth stagnation and become
trapped at the level of middle-income countries (Gill
and Kharas, 2007; World Bank, 2012). How could
China transit its past growth model to the new norm
and avoid the middle-income trap?

A. Deepening reforms

In order to successfully transit China’s past
growth model to the new norm and avoid economic
stagnation, the country requires deepening reforms
in various areas, whose importance has been broadly
realized. In late 2013, the Third Plenum of the
18th Party Congress authorized a comprehensive
economic reform programme and established the
decisive role of the markets in the allocation of
resources. The programme mainly involves reforms
in the government functions, State ownership, and
the financial, fiscal, service and urbanization areas.2

In early 2014, Premier Li Keqiang’s Work Report
to the National People’s Congress outlined policies
to deepen these reforms and accelerate progress
towards a new model, which considers an increase
in consumption and service’s shares in the economy

53Demystifying China’s Economic Growth: Retrospect and Prospect

and the relative incomes of the poorer, as well as a
decrease in environmental damage.

Given its current economic challenges, China
should find new ways to increase its labour supply
and improve TFP. First, it is crucial to deepen the
reforms in the household registration system. Given
the labour shortage resulting from the diminishing
demographic dividend, the household registration
system would promote labour participation by
accelerating mobility between rural and urban areas.
Second, it is key to further liberalize the financial
system, which involves the areas of the banking
sector, interest rate, direct financing, exchange rate
formation and capital account convertibility. This
liberalization is beneficial in terms of eliminating
capital distortions, improving investment efficiency
and thereby improving TFP, although it should not be
made at the expense of prudential regulation. Thirdly,
China should accelerate industrial restructuring.
Given the large disparities in productivity among
industries and subsectors within industries, restruc-
turing would improve TFP as a whole. In addition,
China should also focus on technology progress by
encouraging innovation and strengthening intel-
lectual property protection. Finally, China should
speed up reforms in the education system, including
improving vocational education, which would help
to optimize the employment and industrial structures.
Besides, there are also some other reforms author-
ized in the area of legal and administrative systems,
social welfare, democracy and ecological civilization.
Indeed, it is important to deepen all these reforms.

However, the challenge is how to maintain
macro and financial stability. Although these reforms
would help the sustainability of economic growth and
stability in the long run, they might create short-term
instability; for instance, interest rate liberalization
might push up capital costs and increase inflation
pressure, while capital account opening might
expose China more to global economic and financial
shocks. When further deepening these reforms, both
the sequence and timing are important. First, the
sequence of reforming should be focused on ensur-
ing that all such reforms are coordinated with each
other. For example, to further liberalize the financial
sector, the order of liberalization of interest, the
banking sector, exchange rate and then the capital
account should be well followed (McKinnon, 1993),

otherwise China may be exposed to huge financial
risks or even crisis. In addition, timing is important,
as there are always preconditions for further reforms.
Take capital account liberalization as an example,
for which stable macroeconomic conditions, a sound
fiscal system and a developed financial system are
all important preconditions. Therefore, only with
these conditions in place should China put forward
the reforms in capital account opening.

B. Structural rebalancing

Structural rebalancing is crucial. First, rebalanc-
ing between investment and consumption is crucial,
given that the over-dependence on external demand
has been greatly improved since the crisis; neverthe-
less, this rebalancing will not be as rapid as expected.
On the one hand, consumption promotion strongly
depends on improvements in the reforms in the social
security system, education, housing and the reduction
in inequality, which would take time to realize. On
the other hand, it is inevitable for China to maintain
its high investment share in the short run (Ma et al.,
2012). Therefore, the only remedy is to enhance
investment efficiency.

Secondly, to develop the service sector and
accelerate industry restructuring, the key solution is
to deepen the domestic marketization reform, and
especially the factor markets reform. Marketization
reform is helpful to speed up the restructuring, as well
as solving the over-capacity problem by optimizing
resources allocation. Again, further opening up of
the service sector would facilitate its development,
especially based upon the previous successful prac-
tice in opening up manufacturing. In addition, some
industrial policy for emerging industries would be
beneficial to foster their development, although such
type of policy really needs to reduce government
intervention after some period.

However, it is arduous to promote industrial
restructuring in China. Restructuring might be thorny
in the short term as business failures, bankruptcies
and unemployment may increase. Therefore, main-
taining macroeconomic stability is crucial to create
the conditions for deepening reforms and restructur-
ing. Finally, some other rebalancing policies, such as
urbanization and rural construction to reduce income
inequality, are also important.

54 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

C. Taking mini-stimulus policies

China’s growth rate has been lowering since
early 2010, partly due to the European debt crisis. In
2014, according to the National Bureau of Statistics
of China, GDP growth rate reached 7.4 per cent, the
slowest since 1989. In order to avoid further slow-
down, Chinese authorities announced a mini-stimulus
package, including cutting down tax for small- and
medium-size enterprises, increasing government
investment in the railway network and low-income
housing construction. In the short run, such mini-
stimulus policies are important: on the one hand,

they are capable of balancing the multiple targets of
maintaining economic growth, adjusting structure,
promoting reforms and improving livelihood; while
on the other hand, as mini-stimulus policy is difficult
to be expected and observed, it reduces the potential
disturbing impact of speculative activities of investors
on the economy. In addition, mini-stimulus policy is
less likely to influence the stability of economic growth
when it phases out, thus creating limited negative after-
effects. Moreover, it helps to maintain the stability of
monetary and fiscal policy. In the near future, prudent
monetary policy with moderate liquidity and relatively
loose fiscal policy should be the basic policy mix.

IV. Concluding remarks

China has achieved remarkable economic
performance for more than three decades since the
initiation of the reform in the late-1970s. This mira-
cle has been led by investment and export from the
demand side, as well as capital formation and TFP
improvements from the supply side. The demographic
dividend, high savings rate, the outward-oriented
development strategy, technological progress and
improved resource allocation efficiency have been
the main underlining driven forces.

However, the diminishing demographic divi-
dend, structural imbalances, as well as the macro-
economic instability and financial risk created by the
stimulus policy after the recent global crisis have all
challenged China’s economic growth prospects. In
fact, the recent growth slowdown is not only caused
by the external cyclical shock, but it also reflects
structural problems in the Chinese economy.

Several pillars are needed to maintain a sustain-
able economic growth and avoid the middle-income

trap. First, further deepening of the reforms is needed
in the household registration system, financial system,
industrial structure, education system and some other
reforms in law, politics, social welfare, democracy
and ecological civilization. Second, the continuation
of structural rebalancing is necessary, which mainly
involves rebalancing towards domestic demand and
industrial restructuring. However, as consumption
increasingly depends on other economic and social
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ments and consumption is slow. Therefore, promoting
investment efficiency is the main remedy. Sectoral
rebalancing should focus on both the development
of the service sector and reducing imbalances within
the industry sector. Finally, rather than a massive
stimulus policy as implemented in China in 2009
and 2010, mini-stimuli policies that create fewer
after-effects should be implemented in the near future.
When executing such reforms polices, the sequencing
of the reforms and the relationship between long-
term growth, structural rebalancing and short-term
macroe conomic stability should be well focused.


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57Production Sharing in East Asia: China’s Position, Trade Pattern and Technology Upgrading

East Asia has followed a so-called “flying geese”
development model since around the 1950s. The main
driver of the model is the leader’s imperative for
internal restructuring due to increasing labour costs.
As the evolving comparative advantages of Japan
caused it to shift increasingly further away from
labour-intensive production to more capital-intensive
activities, the country shed its low-productivity pro-
duction to nations further down in the hierarchy in a
pattern that subsequently reproduced itself between
the countries in the lower tiers (Kasahara, 2004).
Under this model, the gross domestic product (GDP)
of many economies in this region has more than
tripled in three decades. Led by Japan, followed by
Asia’s newly industrialized economies (NIEs), later
joined by ASEAN-4 (i.e. the four major economies

in the Association of South-East Asian Nations
(ASEAN), namely Indonesia, Thailand, Malaysia
and the Philippines) and finally China, Viet Nam
and Cambodia, the Asian economies took off one
after another across half a century. During the same
period, East Asia experienced an unprecedented
change in its industrial relationship and international
trade patterns. Prior to the 1970s, East Asian trade
was dominated by a typical North-South vertical
division of labour, whereby trade between Japan
and developing Asia was characterized as typical
inter-industry trade. The developing Asian econo-
mies exported resource-based and labour-intensive
products to Japan, while Japan exported a wide
range of final manufactured goods to its Asian neigh-
bours. Subsequently, Japan shifted from labour- to


Laike Yang

* This chapter was presented at the DAAD Workshop on Development Strategies: Country Studies and International
Comparisons in Shanghai, 11–16 November 2013. The author is grateful to the financial support provided by China
National Social Science Fund (Grant No. 11BGJ036), Research Project of Ministry of Education of China (Grant
No. 10YJA790221) and Research Project of Shanghai Municipal Government (Grant No. 2010BGJ001).


International production sharing has been a key feature of East Asian economic development in
recent decades, with firms in advanced Asian economies relocating their production to China, using
it as an assembly base and exporting the final products to the United States and Europe. China has
taken advantage of this process and transformed into a global manufacture centre, with the country’s
emergence having reshaped the Asian production network and trade pattern. This chapter analyses
the economic model and development strategy in East Asia, China’s position in East Asia’s production
network, as well as its impact on China’s technological upgrading. We find that China has moved
to the centre of East Asia’s production network, thanks to its export-led development strategy. It has
significantly upgraded its technology and narrowed its technology gap with ASEAN-4, although the
gap between China and Asian more-advanced economies remains fairly large and noticeable.


58 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

capital-intensive industries in the 1970s due to the ris-
ing labour costs, while the Asian Tigers (Hong Kong
(China), the Republic of Korea, Taiwan Province of
China and Singapore) took over the labour-intensive
manufactures. In the 1980s, Japan shifted further to
high-technology industry, whereas the Asian NIEs
took over some of the capital-intensive sectors and
passed the labour-intensive sectors to the ASEAN-4
newcomers. Therefore, we observed a kind of three-
layer inter-industry trade between Asian countries,
in a trade pattern well explained by classical trade
theory (Ando, 2006).

However, in the last two decades, and particu-
larly the last 10–15 years, two important changes
have emerged in East Asia. First, international
production sharing1 has become a unique feature of
the region’s economic landscape. Trade in parts and
components (trade fragmentation) has not only grown
faster than in any other part of the world, but also
faster than Asia’s trade in final goods. The produc-
tion process is vertically sliced within one industry
shared between East Asian economies, with each
country/economy specialized in a particular stage
of production. The consequence of this production
sharing is the increased inter-dependency between
more-developed and developing Asia nations. More-
developed Asian countries and NIEs depend on
developing Asia’s cheap labour, rich resources and
lucrative markets, while developing Asian countries
depend on the importation of high-technology parts
and components from Japan, the Republic of Korea
and Taiwan Province of China. Secondly, China has
moved from a periphery country to the centre of
the Asian production network, transforming from
a primary good supplier to a major manufacturing

and assembly centre within the regional production
network. Indeed, many questions have arisen from
these changes: What are the new trends of trade
and production in East Asia? What is the impact of
the production sharing on the trade balance in East
Asian countries? Has China successfully upgraded
its technology level by moving upward in the value
chain? What is the impact of the production sharing
on China’s export competitiveness?

This chapter analyses the development and
trends of production sharing and the trade pattern in
East Asia, China’s participation and its role in this
network, as well as the impact of production sharing
on China’s technology upgrading and trade competi-
tiveness. The study focuses on trade in “machinery
and transport equipment”, category 7 of the Standard
International Trade Classification (SITC), and “mis-
cellaneous manufactured articles” (SITC, category 8),
given that these two categories account for more than
70 per cent of China’s exports and around 50 per cent
of China’s imports. Moreover, these two categories
are the most integrated industries in East Asia and the
best examples of production sharing in the region. The
data that we use is mostly from the United Nations
Commodity Trade Statistics (Comtrade) database,
while some is from national trade statistics. The
remainder of this chapter is structured as follows.
Section I reviews existing literature on this issue
and related topics. Section II analyses the evolution
and current situation of production sharing and trade
fragmentation in East Asia, as well as China’s role
in the network and how it has changed. Section III
discusses the impact of this phenomenon on China’s
trade balance and technology upgrading. Section IV
presents the key conclusions and policy implications.

I. Literature review

International production sharing, namely the
cross-border splitting of the production process
within vertically integrated manufacturing industries,
has been a key facet of economic integration over
recent decades, particularly in East Asia. The associ-
ated spatial diversification of production activities
has been the main driver of the rapid growth of trade
in parts and components between developed and
developing countries, largely motivated by taking
advantage of cheap production costs in developing
countries. Many alternative names have been coined
for such a phenomenon, including “slicing the value

chain” (Krugman, 1995), “vertical specialization”
(Hummels et al., 2001), “international production
sharing” (Ng and Yeats, 1999 and 2001) and “out-
sourcing” (Hanson et al., 2001).

There is a sizeable body of theoretical literature
examining the causes and modalities of international
product sharing, as well as its implications for trade
flows and policies (Cantwell, 1994; Venables, 1999;
Jones, 2000; Jones and Kierzkowski, 2001; Jones
et al., 2005; Baldwin, 2001; Deardorff, 2001). This
literature assumes that intra-industry trade is much

59Production Sharing in East Asia: China’s Position, Trade Pattern and Technology Upgrading

more sensitive to inter-country differences in technol-
ogy, labour supply, logistic efficiency and the overall
production costs than inter-industry trade. Therefore,
globally intra-industry trade has been growing faster
than inter-industry trade due to the differences in
processing technology production costs. Vertical
intra-industry trade is growing faster than the hori-
zontal intra-industry trade, particularly in East Asia.

Although trade in parts and components has
generally grown faster than total world trade in
manufacturing goods, the degree of East Asia’s
dependence on this new form of international spe-
cialization is proportionately larger than in North
America and Europe. Accordingly, literature on the
Asian production network and trade fragmentation
have mushroomed since the early-2000s (Athukorala,
2003, 2011 and 2012; Ng and Yeats, 2001 and 2003;
Athukorala and Yamashita, 2006 and 2008).

Most of the literature focuses on four areas:
(a) the evolution and features of the East Asia produc-
tion network (Ando, 2006; Kimura and Ando, 2005;
Kimura et al., 2007; Athukorala, 2012; Athukorala
and Yamashita, 2006; Ando and Kimura, 2003 and
2010); (b) the causes of East Asian production shar-
ing and trade fragmentation (Ando and Kimura,
2003; Kimura, 2009); (c) the determinants of East
Asian trade in parts and components (Athukorala
and Yamashita, 2006; Kimura et al., 2007); and
(d) China’s role and impact upon East Asian produc-
tion networks (Haddad, 2007; Yu and Xu, 2010; Yu
and Wang, 2012).

Although the topic has been intensively explored
in last ten years, the conclusions and opinions remain
strongly divergent, particularly concerning China.
This country is a relative newcomer in the Asia
economic network. It has a different economic and
political system and industrial structure and is far
larger than other East Asian developing economies

in terms of size of land, population and resources
endowment. Moreover, China began its integration
as an extremely poor country with low education and
technology levels.

From a methodology perspective, three main
methods have been applied to analyse the interna-
tional production sharing. The first such method
involves measuring vertical specialization using
input-output data, as developed by Hummels et al.,
1998 and 2001; Ishii and Yi, 1997). The second
method is to analyse trade in parts and components
flow, identifying the vertical inter-industry trade
relationship between countries and economies (Ando,
2006; Athukorala and Yamashita, 2006 and 2009;
Ando and Kimura, 2008; Falguni, 2012). Finally,
the third method is to analyse the intra-firm trade of
multinational enterprises, identifying its impact on
economic integration (Hanson et al., 2005; Miroudot
et al., 2009).

Although the first method has been widely used
in many analyses, it has some drawbacks in terms of
identifying a country’s position in the international
production network, particularly in developing
countries where the data quality is not good. This
method requires data for measuring foreign input
or intermediary products among the total exports of
a specific industry in one country. In China, there
are different ways to calculate foreign inputs.2 This
causes vast differences in terms of estimating a
vertical specialization index. The third methodol-
ogy relates more to the enterprise level and could
potentially better identify the technology level of one
country in a certain production network, although
enterprise-level data in China is not easy to obtain.
Furthermore, China has a majority of State-owned
enterprises in the so-called scaled enterprises, whose
data does not always fit with the international statisti-
cal system. Therefore, this chapter follows the second
method, using the Comtrade database.

From the 1950s to the 1990s, East Asia fol-
lowed a so-called “flying geese model” in which
one country leads others towards industrialization
step-by-step with a V-shaped formation. The leader
of the region passes its older industries (normally

low-value-added, lower-technology based industries)
down to the followers as its own production cost rises
and it moves into newer industries (higher-value-
added, high-technology-based industries). From
labour-intensive manufacture to capital-intensive

II. East Asia production network: From the flying geese
model to production sharing

60 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

manufacture and subsequently high-technology-
intensive manufacture, the leader passes down its
obsoleted industries to its close followers while
upgrading its own industrial technologies.

The flying geese model started soon after
the Second World War, led by Japan, immediately
followed by the NIEs and subsequently by the
ASEAN-4 economies. China followed in the 1980s,
as well as more recently Viet Nam and Cambodia.
As the changes in comparative advantages of the
“leading goose” oblige it to shift further away from
low value-added production to more value-added
and technology-intensive activities, it relocates the
labour-intensive production to the followers through
foreign direct investment (FDI). The cornerstone of
the flying geese model is the waterfall technological
hierarchy and differences of labour costs between
East Asian countries, which allows vertical inter-
industry division of labour in the region.

However, by the end of the 1990s, some new
factors shook the foundation of the flying geese
model, calling into question its ability to keep
explaining Asian trade flows. One such factor is the
slowing down of the Japanese economy (as shown

in chart 1). As the leader, the Japanese economy
was the fastest among Organisation of Economic
Cooperation and Development (OECD) countries
during the 1960s, 1970s and most of the 1980s,
although it stagnated for about 20 years thereafter.
The annual GDP growth rate in Japan dropped from
almost 10 per cent in 1960–1973 to only 1.7 per cent
from 1989 to 1999. Japan’s GDP growth rates were
not only lower than its Asian followers, but also
slower than the United States, the European Union
(EU) and the OECD average.

Secondly, the technology gap between Japan
and the Asian NIEs was significantly narrowed,
particularly with the Republic of Korea. From
chart 2, we can see that the country’s firm’s total
factor productivity (TFP) had caught up with that of
the Japanese firms by the 1990s. In some industries
like lumber and wood, furniture and fixture, food
and kindred products, the TFP of the Republic of
Korea’s firms has even surpassed that of the Japanese
firms (Jung et al., 2008) (table 1). Therefore, the
Asian NIEs are no longer receivers of the production
activities shifted from Japan, but rather competitors
of Japan in markets of high-technology products.
Trade between Japan and Asian NIEs transformed
from inter-industry trade into intra-industry trade.

Chart 1


(Per cent)

Source: Author’s calculations, based on OECD database.

Chart 2


OF KOREA, 1985–2004

Source: Jung, Lee and Fukao (2008).
Note: The TFP level of all Japanese listed firms in each year

was set at 100. The difference can be regarded as
the percentage gap of TFP between the two countries
because the values are natural log value of TFP. Data
refer to the firm size-weighted mean of all manufacturing
listed firms.












1960–1973 1973–1979 1979–1989 1989–1999

OECD European Union
United States Japan
Germany France
United Kingdom








1985 1990 1995 2000 2004

61Production Sharing in East Asia: China’s Position, Trade Pattern and Technology Upgrading

It can be evidenced by the export similarity between
Japan and the Asian NIEs. As we can see from chart 3,
Japan’s export similarities with the Republic of Korea
and Taiwan Province of China consistently increased
from the 1960s to the 1990s. By the end of the 1990s,
the Republic of Korea and Taiwan Province of China
were competing with Japan in the export market of
more than 50 per cent of the latter’s exports.

Thirdly, the rise of China in the 1980s and 1990s
further reshaped the regional industry landscape.
China’s manufacture technology and labour produc-
tivity dramatically improved thanks to the technology
spillover from foreign-invested enterprises (FIEs)
and the improved education and training system.
In some sectors, the processing technology caught
up or even overtook the ASEAN countries. China’s
role changed from being a follower of ASEAN-4 to
a competitor in labour-intensive and medium-low-
technology products, which led to a strong similarity
in export products between China and the ASEAN

Chart 3



Source: Xu and Song (2002).

Table 1



Industry name 1985 1990 1995 2000 2004 Catch-up pattern

Food and kindred products 81.7 110.3 116.7 111.2 110.9 Over catch-up
Lumber and wood 124.5 141.1 131.8 137.9 150.9 Over catch-up
Furniture and fixtures 87.0 99.6 119.2 125.0 129.1 Over catch-up
Stone clay glass 80.0 92.2 108.9 108.6 112.6 Over catch-up
Petroleum and coal products 73.7 163.7 195.3 114.0 102.7 Just catch-up
Leather 108.5 104.3 128.0 121.1 104.2 Just catch-up
Fabricated metal 90.7 100.0 128.5 110.0 96.3 Just catch-up
Machinery non-electrical 91.8 92.5 122.0 110.2 108.5 Just catch-up
Electrical machinery 24.0 30.8 75.0 73.1 96.6 Just catch-up
Transportation equipment and ordnance 74.8 84.0 103.8 92.5 97.0 Just catch-up
Textile mill products 48.8 57.1 81.3 87.8 82.4 Under catch-up
Apparel 7.7 19.4 53.2 57.5 59.6 Under catch-up
Paper and allied 72.5 75.6 92.2 74.0 86.6 Under catch-up
Motor Vehicles 38.6 54.5 75.1 78.8 88.0 Under catch-up
Instruments 33.9 40.7 73.1 60.2 61.0 Under catch-up
Printing publishing and allied 81.6 98.4 106.4 111.1 88.3 Reverse catch-up
Chemicals 72.7 78.7 91.0 90.0 80.9 Reverse catch-up
Primary metal 67.2 70.0 89.2 78.8 61.3 Reverse catch-up
Rubber and misc. plastics 55.6 61.6 80.5 81.7 76.0 Reverse catch-up

Total 61.6 69.5 92.1 86.5 91.2

Source: Jung, Lee and Fukao (2008).
Note: Data correspond to the average of the TFP gap of firms of the Republic of Korea from the TFP of Japanese industry. The

values also refer to the percentage differences of TFP because they are natural log differences. Reverse catch-up refers to
the industries the Republic of Korea had first caught up with Japan, later on been caught up again by Japan.

0 10 20 30 40 50 60












Republic of Korea
Taiwan Province of China

62 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

Chart 4 illustrates the interesting trends in
the export similarity index between China and its
East Asian neighbours. As we can see, China’s
export similarity with Japan and the Republic of
Korea has been continuously increasing, although
it remains relatively low. China’s export similarity
with Indonesia, the Philippines and Thailand initially
increased between the 1980s and the early-1990s but
decreased in the 2000s, and particularly after 2005.
With Malaysia, the export similarity has continu-
ously increased, reaching a similar level to Thailand
in 2008. Export similarity with Hong Kong (China)
is the highest, although it has not changed since the
mid-1990s. This might be because China’s industry
technology has surpassed the ASEAN countries since
the mid-2000s, becoming a competitor to Hong Kong
(China), the Republic of Korea, Taiwan Province of
China and Singapore.

Apart from changes in technology relationship,
there have also been convergences of labour costs
in Japan and the NIES, as well as between China
and ASEAN-4, resulting in a change of the interna-
tional division of labour in East Asia. The vertical

intra-industry labour division, or production sharing,
has replaced the inter-industry division. Within one
industry, China, Japan, the Republic of Korea and
Taiwan Province of China are focused on different
production stages representing different levels of
technology. The trade pattern in the region has also
transformed from inter-industry trade to vertical
intra-industry trade, which can be measured by the
growing proportion of trade in parts and components
in the total trade value. As illustrated by table 2, Asian
trade of part and components as a share of trade in
all manufacture products was growing considerably
faster than in OECD Europe, North America and
any other part of the world. By 2010, East Asian
countries accounted for more than 40 per cent of
the world’s export in parts and components, as well
as more than 35 per cent of the world’s imports in
parts and components. Within East Asia, exports in
parts and components account for about one-third of
the regional trade. It is particularly high in sectors
such as electronics and telecommunication equip-
ment. Almost three-quarters of all Asian imports
of telecommunication equipment now comprise
components for further assembly.

These trends were mainly driven by multina-
tional enterprises (MNEs) relocating their production
factories and reorganizing their business activities
across different countries to reduce costs and improve
their productivity. In East Asia, regional FDI roughly
followed the technology hierarchy from Japan and
the NIEs to China and ASEAN, helping the host
countries to improve their labour productivity and

Another noticeable change in East Asia is that
China has moved from a peripheral country to being
the centre of the East Asia production network. Due
to the massive FDI flow from Hong Kong (China),
Japan, the Republic of Korea, Taiwan Province of
China and Singapore into China, East Asian MNEs
have relocated a large percentage of their manu-
facturing bases to China, thus marking it as a new
world factory by the end of the 2000s. As shown in
table 3, China’s share in world non-oil exports was
merely 0.8 per cent in the early-1970s, whereas it had
increased to 12.7 per cent by the end of the 2000s.
During the same period, China’s share in world
manufacturing export also dramatically increased
from 0.5 per cent to 14.9 per cent. Not only has
the importance of China in Asia and global trade
improved, but also the trade products structure of
China has greatly improved, whereby manufacturing

Chart 4


Source: Xu and Song (2002) and Loke (2009).
Note: Data for the 1980s are from Xu and Song (2002), those

from 1990s and 2000s are sourced from Loke (2009).
Since Xu and Song calculate the gross export similarity
whilst Loke’s calculates the net export similarity, there
is some inconsistency with the numbers.








1980 1985 1993 1996 1999 2002 2005 2008

Malaysia Indonesia
Philippines Thailand
Japan Republic of Korea
Hong Kong (China)

63Production Sharing in East Asia: China’s Position, Trade Pattern and Technology Upgrading

Table 2

(Per cent)

Exports Imports

1992 1996 2000 2005 2010 1992 1996 2000 2005 2010

East Asia 34.5 38.3 39.5 40.8 42.1 33.5 32.8 33.1 34.1 35.3

NAFTA 28.2 24.0 23.9 23.4 22.8 33.5 25.8 27.5 27.0 26.3

European Union 32.8 38.0 30.9 30.3 28.3 35.1 33.8 31.5 30.3 29.1

Latin America 0.6 0.6 2.1 3.8 4.6 1.3 2.2 3.7 4.2 4.5

South Asia 0.2 0.2 0.1 0.2 0.3 0.7 0.4 0.5 0.5 0.5

Africa 0.1 0.2 0.1 0.1 0.2 0.4 0.9 0.4 0.4 0.5

Source: Author’s calculations, based on United Nations, Comtrade database.

Table 3

(Per cent)

Total non-oil Manufacturing
Manufacturing share

in total exports/imports











China 0.8 2.9 12.7 0.5 3.0 14.9 45.1 83.6 93.4
Japan 6.3 10.4 4.6 8.9 12.7 7.4 93.4 98.0 93.2
Republic of Korea 0.3 2.2 3.0 0.3 2.6 3.5 75.4 93.6 87.6
Taiwan Province of China 0.6 2.7 2.0 0.6 3.1 2.4 71.5 91.9 91.8
Indonesia 0.3 0.5 0.9 0.0 0.4 0.6 3.8 55.6 41.5
Malaysia 0.8 1.0 1.6 0.1 0.7 1.6 7.2 60.4 70.9
Philippines 0.5 0.3 0.6 0.1 0.3 0.6 10.3 62.8 83.8
Thailand 0.3 0.8 1.3 .. 0.6 1.3 7.7 59.6 76.5
East Asia 11.0 23.8 30.7 12.0 26.7 34.8 72.5 90.3 86.6

World 66.5 80.6 68.3


China 0.6 2.3 7.8 0.3 2.3 7.7 48.6 81.0 70.0
Japan 6.5 7.0 0.6 3.0 5.0 3.6 30.4 57.7 49.3
Republic of Korea 0.9 2.3 2.2 0.8 2.2 2.2 59.9 74.8 59.2
Taiwan Province of China 0.6 1.7 1.4 0.6 1.7 1.4 69.7 80.1 76.2
Indonesia 0.4 0.7 0.6 0.5 0.8 0.6 80.7 83.0 57.7
Malaysia 0.5 1.0 1.1 0.5 1.0 1.1 63.9 85.6 72.3
Philippines 0.5 0.4 0.4 0.6 0.3 0.4 77.3 76.4 65.3
Thailand 0.5 1.1 1.1 0.7 1.1 1.1 85.9 84.1 68.5
East Asia 11.6 19.9 24.4 8.3 18.3 24.6 47.6 74.1 67.0

World 66.5 80.6 67.8

Source: Athukorala (2011a).

64 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

products now account for 93 to 95 per cent of China’s
total exports.

Meanwhile, China has also replaced Japan as
Asia’s largest economy and largest trader. From the
end of the 1960s to the end of the 2000s, China’s

share in East Asia’s non-oil trade increased from
7 to 41 per cent, whereas Japan’s share dropped from
57 to 15 per cent. In the manufacturing sector, China’s
share of East Asia’s trade also vastly increased from
4 to 43 per cent, while Japan’s share decreased from
74 to 21 per cent during the same period (see table 4).

Table 4

(Per cent)

1969–1970 1989–1990 2007–2008

China in East Asia’s non-oil trade 7 12 41
Japan in East Asia’s non-oil trade 57 44 15

China in East Asia’s manufacturing trade 4 11 43
Japan in East Asia’s manufacturing trade 74 48 21

Source: Author’s calculations, based on United Nations, Comtrade database.

In the transition from the flying geese model
to production sharing, China has moved from being
a peripheral country to the centre of the East Asia
production network, overtaking Japan as Asia’s larg-
est economy and the most important trade partner for
Asian countries. This prompts the question of how
much has China moved upwards on the value chain
in East Asia. Can this transformation be explained by
the improvement of China’s industrial technology or
is it simply the consequence of its export-led develop-
ment strategy, which has focused on labour-intensive
products? In this section, the chapter analyses the
technology embodied in China’s foreign trade.

There are a few methods for measuring a
country’s technology level of traded products.
Lall (2000) developed a classification system in
which manufacturing products were grouped by
their technology intensiveness. According to Lall’s
classification, there are four types of manufactures:
natural resource-based manufactures, low-tech manu-
factures, medium-tech manufactures and high-tech
manufactures (see table 5). This system is based upon
the SITC (Revision 2), in which 18 out of 161 three-
digit coded products are marked as high-technology
manufactures based upon available indicators of
technological activity in manufacturing (Lall, 2000).

OECD has a different yet broader classifica-
tion system based upon the third revision of the
International Standard Industrial Classification of
All Economic Activities (ISIC). In this system,
manufacturing industries are grouped by their R&D
intensities in production. High-technology industries
include pharmaceuticals, aircraft and spacecraft,
medical, precision and optical instruments, communi-
cation equipment, office, accounting and computing
machinery, etc. (see table 6).

The third method is to measure a country’s
technology level by computing the share of parts and
components (P&C) among total exports, based upon
the assumption that they have higher technology con-
tents and research and development (R&D) intensity.
Aside from these three methods, some scholars have
also developed a so-called export sophistication index
to assess the technology level of traded products
(Hausmann et al. 2006; Gang et al., 2006).

The major drawback of the OECD classification
is that it does not reflect the R&D intensities in devel-
oping countries, since the calculation is based upon
12 OECD countries. Many scholars have questioned
the export production sophistication index because
it links technology to GDP per capita, whereby it

III. The impact on China’s technological upgrading

65Production Sharing in East Asia: China’s Position, Trade Pattern and Technology Upgrading

Table 5


Category Examples SITC, rev. 2

Natural resource-
based manufactures

Prepared meats/fruits, beverages,
wood products, vegetable oils, base
metals (except steel), petroleum
products, cement, gems, glass.

012, 014, 023, 024, 035, 037, 046, 047, 048, 056,
058, 061, 062, 073, 098, 111, 112, 122, 233, 247,
248, 251, 264, 265, 269,423, 424, 431, 621, 625,
628, 633, 634, 635, 641, 282, 288, 323, 334, 335,
411, 511, 514, 515, 516, 522, 523, 531, 532, 551,
592, 661, 662, 663, 664, 667, 681, 682, 683, 684,
685, 686, 687, 688, 689.


Textile fabrics, clothing, footwear,
leather manufactures, travel goods
pottery, simple metal structures,
furniture, jewelry, toys, plastic

611, 612, 613, 651, 652, 653, 654, 655, 656, 657,
658, 659, 831, 842, 843, 844, 845, 846, 847, 848,
851, 642, 665, 666, 673, 674, 675, 676, 677, 679,
691, 692, 693, 694, 695, 696, 697, 699, 821, 893,
894, 895, 896, 897, 898, 899.


Passenger vehicles and parts,
commercial vehicles, motorcycles
and parts, synthetic fibers, chemicals
and paints, fertilisers, plastics, iron
and steel, pipes and tubes, engines,
motors, industrial machinery, pumps,
ships, watches.

781, 782, 783, 784, 785, 266, 267, 512, 513, 533,
553, 554, 562, 572, 582, 583, 584, 585, 591, 598,
653, 671, 672, 678, 786, 791, 882, 711, 713, 714,
721, 722, 723, 724, 725, 726, 727, 728, 726, 727,
741, 742, 743, 744, 745, 749, 762, 763, 772, 773,
775, 793, 812, 872, 873, 884, 885, 951.


Data processing and
telecommunications equipment,
television sets, transistors, turbines,
power generating equipment,
pharmaceuticals, aerospace, optical
and instruments, cameras

716, 718 751, 752, 759, 761, 764, 771, 774, 776,
778, 524, 541, 712, 792, 871, 874, 881.

Source: Lall (2000).

assumes that rich countries always have higher export
sophistication than poor countries. Therefore, in this
chapter, we use the first and third methods to assess
China’s technology structure of export products.

Generally speaking, China’s industrial technol-
ogy has quickly improved during the Asian economic
transformation. As shown in chart 5, the share of
exports in natural resource-based manufactures
maintained a relatively constant proportion from
1994 to 2011. Moreover, the share of low-technology
manufactured exports decreased from 58 to 31 per
cent. By contrast, the share of high-technology
manufactures increased from 12 to 34 per cent and
medium-technology manufactures increased from
18 to 25 per cent.

Given that natural resource-based industries do
not reflect technology intensiveness and only reflect
a very small part of China’s exports, we can derive
a clearer picture of China’s technology embodied in
exports when we omit such industries from our study.
As shown in chart 6, the share of exports in both
high and low-technology industries decreased from

1994 to 2011, while the share of exports in medium-
technology industries significantly increased.

The second approach to assess China’s technol-
ogy upgrade and its position in East Asia’s production
network is to consider the trade in parts, components
and accessories. Upon first glance, we find that
China’s importance in East Asia’s trade of intermedi-
ate products has become increasingly significant. Its
share of parts, components and accessories in total
exports has caught up with Indonesia and Thailand,
although it remains behind Malaysia, the Philippines,
the Republic of Korea and Singapore (see table 7).3

When exploring the details of the region’s trade
in P&C, it is evident that China’s trade with its neigh-
bours is highly imbalanced. China reports large trade
deficits with Japan, the Republic of Korea and Taiwan
Province of China in the P&C trade. This shows that
China is an assembly centre that heavily depends
upon the import of P&C from more-developed Asian
economies to support its massive exports in final
goods. Chart 7 illustrates the trade balance between
China and Japan, the Republic of Korea and Taiwan

66 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

Table 6


(Per cent)

Industry name

Rev. 3

intensity by

High-technology industries

Pharmaceuticals 2 423 10.5

Aircraft and spacecraft 353 10.3

Medical, precision and optical
instruments 33 9.7

Radio, television and
communication equipment 32 7.5

Office, accounting and
computing machinery 30 7.2


Electrical machinery and
apparatus, not elsewhere
specified (n.e.s.) 31 3.6

Motor vehicles, trailers and
semi-trailers 34 3.5

Railroad and transport
equipment, n.e.s.

359 3.1

Chemical and chemical

24 (excl.
2423) 2.9

Machinery and equipment,
n.e.s. 29 2.2


Building and repairing of ships
and boats 351 1.0

Rubber and plastics products 25 1.0

Other non-metallic mineral
products 26 0.8

Basic metals and fabricated
metal products 27–28 0.6

Coke. Refined petroleum
products and nuclear fuel 23 0.4

Low-technology industries

Manufacturing, n.e.s.; recycling 36–37 0.4–0.5

Wood, pulp, paper products,
printing and publishing 20–22 0.4

Food products, beverages
and tobacco 25–16 0.3

Textiles, textile products,
leather and footwear 17–18 0.3

Source: Author’s calculations, based on OECD, ANBERD and
STAN databases.

Chart 5



(Per cent)

Source: Author’s calculations, based on United Nations, Comtrade

Chart 6


(Per cent)

Source: Author’s calculations, based on United Nations, Comtrade

Note: Selected manufactured exports exclude natural resource-
based industry.












1994 1997 2000 2003 2006 2009

Natural resource based industry
Low-tech industry
Medium-tech industry
High-tech industry













1994 1999 2003 2007 2011

Low-tech industry
Low-medium-tech industry
High-medium-tech industry
High-tech industry

67Production Sharing in East Asia: China’s Position, Trade Pattern and Technology Upgrading

Province of China, showing that China holds trade
deficits with all of these countries.

Regarding China’s technological upgrading,
one important factor that should not be neglected
is foreign content in exportation. Indeed, more than
50 per cent of China’s foreign trade involves pro-
cessing trade and more than 60 per cent of China’s
exports are conducted by FIEs. Foreign companies
not only dominate China’s export but also play a
much more important role in high-tech sectors than
in the European Union, Japan and the United States.
As we can see from table 8, foreign content accounted

Table 7


(Per cent)

1994 1998 2002 2006 2009 2013

China 4.8 7.8 12.8 14.2 9.9 10.8
India 2.4 2.4 3.4 3.7 3.2 3.5
Indonesia 2.4 3.7 6.3 4.6 3.9 4.8
Malaysia 28.0 32.5 35.9 28.8 16.1 13.2
Philippines 11.2 55.3 54.6 50.3 41.9 41.8
Republic of Korea 19.9 19.5 21.6 22.4 11.4 18.3
Singapore 29.1 34.5 38.8 40.3 16.1 20.3
Thailand 13.1 25.2 20.5 17.5 9.8 9.6
Argentina 3.5 2.6 2.8 2.4 1.9 1.7
Brazil 5.7 6.3 5.4 5.1 3.5 3.3
Mexico 14.7 15.4 16.5 15.1 11.0 10.3

Source: Author’s calculations, based on United Nations, Comtrade database.

Chart 7

WITH EAST ASIA, 2006–2011

(Billions of dollars)

Source: Author’s calculations, based on United Nations, Comtrade

Note: Data refer to SITC 7 classification. “Other Asia, n.e.s.”
refers to other East Asian economies but a large
proportion is from Taiwan Province of China.

Table 8


(Per cent)

In gross

In high-tech

China 1995 15.5 20.1
2005 27.4 48.5

Japan 1995 8.2 10.0
2005 15.2 21.5

United States 1995 9.5 16.6
2005 12.3 17.4

European Union 1995 20.8 24.1
2005 27.8 31.4

Source: Author’s calculations, based on IMF database.

-100 -50 0 50 100 150 200


Republic of Korea

Other Asia, n.e.s.


Republic of Korea

Other Asia, n.e.s.


Republic of Korea

Other Asia, n.e.s.


Republic of Korea

Other Asia, n.e.s.


Republic of Korea

Other Asia, n.e.s.


Republic of Korea

Other Asia, n.e.s.







Export Import Balance

68 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

for 48.5 per cent of China’s high-tech export in 2005.
Although China’s high-technology product exports
have generally increased, the extent to which this
reflects Chinese innovation and technology remains
uncertain. If we look more closely at the domestic
content in China’s export, we can see that FIEs
operating in China created almost 45 per cent of the
domestic content in Chinese exports, whereas pro-
cessing Chinese-owned enterprises only contributed
by less than 5 per cent (Ma et al., 2014).

Trade between China and ASEAN-4 in high-
technology products is more diversified, whereby
China holds a trade surplus in P&C of office
equipment, telecommunications and transport
equipment, but trade deficits in semi-conductors.
Within ASEAN-4, China holds a trade surplus
with Indonesia and Viet Nam, but has a deficit with
Malaysia, the Philippines and Thailand in P&C (see
chart 8). Accordingly, China has caught up with some
of the ASEAN countries, although its innovation
capability and manufacturing technology remain
far behind Japan and Asian NIEs, and even behind
Malaysia and the Philippines in some industries.

Chart 8


(Millions of dollars)

Source: Author’s calculations, based on United Nations, Comtrade

Note: Since the trade value of SITC 77689 is too small, it is
taken off of the chart.

In recent decades, production sharing has become
the new feature of East Asia’s production network.
Manufacture sectors in East Asian economies are
highly integrated according to the vertical intra-industry
division of labour, whereby regional trade is also
fragmented and characterized as intra-industry trade.
Compared to other parts of the world, trade in parts and
component accounts for a much larger share of East
Asia’s total trade, particularly in manufacturing sectors.
Accordingly, this chapter analyses China’s position in
East Asia’s production network and how it influences
China’s industrial and technological upgrading.

This chapter has found that China has moved
from being a peripheral country to the centre of the
East Asia’s production network. China has replaced
Japan as the largest economy and most important
trade partner of the region. China is now the largest
market for almost all East Asian economies, with
the share of China’s export of manufacturing goods
in East Asia having increased from 4 to 43 per cent,
while Japan’s share dropped from 74 to 21 per cent.
A great proportion of the Republic of Korea, Japan

and Taiwan Province of China’s high-technology
P&C are exported to China, while a large percentage
of their consumer goods are imported from China.
For developing East and Southeast Asian countries,
China is a major importer for raw materials and a
major exporter for final products.

China has improved its technology of manufac-
turing products thanks to a massive inflow of Asian
FDI. The shares of high-tech and medium-high-
technology exports in China’s total exports have
constantly increased, while the share of exports in
low-technology and medium-low-technology prod-
ucts has steadily declined since 1990s. According
to Chinese statistics, the export of high-technology
products accounts for more than one-third of China’s
total export value.

While there is a technology convergence between
China and ASEAN-4, the gaps between China and
more-developed Asian countries remain fairly large
and noticeable. Considering that 50 to 60 per cent of
China’s foreign trade is conducted by FIEs, we can

IV. Conclusion

-1 000 - 500 0 500 1 000 1 500 2 000

Viet Nam


Viet Nam


Viet Nam






Export Import Balance

69Production Sharing in East Asia: China’s Position, Trade Pattern and Technology Upgrading

conclude that China is still at the lower end of the
Asian value chain. In high-technology sectors, China
depends upon the import of P&C from Japan, the

Republic of Korea and Taiwan Province of China.
Despite its large trade value, China is still not a
technology supplier but rather a demander.

1 International production sharing is defined here as
the internationalization of a manufacturing process in
which several countries/economies participate in differ-
ent stages of a specific good’s production. The process
holds considerable economic importance since it allows
stages of production to be located where they can be
undertaken most efficiently. If production sharing is
increasing in relative importance, this implies that coun-
tries are becoming more economically interdependent.

2 Many scholars estimate this by calculating the pro-
portion of so-called processing trade in total export
without a clear definition of what is processing trade.

3 Table 7 also shows that the Philippines’ trade in parts
and components is fairly high, even higher than the
Republic of Korea and Singapore. This is possible
because the Philippines has the well-educated,
English-speaking skilled workers, which attract
many high-technology companies of Japan and the
Republic of Korea relocating their manufacture for
parts, components and accessories to the Philippines.
The difference between China and the Philippines is
that China imports vast quantities of P&C, whereas
the Philippines exports most of the parts and com-
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71Macroeconomic Policy for a Social-Oriented Development Strategy – The Brazilian Case

According to any of the several possible
definitions, economic development is a medium- and
long-term process. Moreover, it is always a set of
structural changes, which are not to be confused with
the short-term fluctuations in the macroeconomic
variables that generally attract more attention in the
economic news, namely the exchange rate, interest
rates, inflation, unemployment and public deficit.
From the perspective of governmental actions, devel-
opment is oriented by issues such as the role of the
government in the economy, industrial policy, regula-
tion, infrastructure, financing and income distribution
policies and other social action fronts, among many
other policies. Accordingly, it takes much more
than macroeconomic management (understood

here as the handling of the monetary, exchange rate
and fiscal policies) to characterize a development
strategy, although there are several points of contact
between the two dimensions. The former president
Lula’s administration is a clear example of gradual
and important changes in the development strategy,
with an activist view of the role of the State, which
occurred despite the visible continuities in the man-
agement of a very orthodox macroeconomic regime.

Using an expression to the liking of econo-
mists, the macro regime is thus a necessary yet
non-sufficient condition for development. However,
it seems a necessary condition, mainly due to the
negative influences and barriers that it can impose

* A preliminary version of this chapter was presented at the workshop “Development Strategies: Country Studies and
International Comparisons” in Shanghai on 12–14 November 2013, organized by the East China Normal University
(ECNU) and HTW Berlin – University of Applied Sciences within the context of the DAAD Partnership on Economic
Development Studies.


Pedro Rossi and André Biancarelli


In the recent debate on the Brazilian growth model, the accuracy of the economic tripod (inflation
targeting, primary fiscal target and floating exchange rate regimes) was pointed out as being responsible
for lowering Brazilian economic growth and hindering its development. However, over time the macro
regime has proved flexible, allowing changes in the form of management of policies within the same
institutional framework, especially after the 2008 crisis. Within this context, the present chapter
aims to discuss the relationships between these macroeconomic policy fronts and a social-oriented
development strategy for the Brazilian economy. The background question is whether the actual
macroeconomic regime, inherited from an orthodox perspective is compatible with the deepening of
a social-oriented development, which depends on a strong role of the State, income distribution and
the expansion of social infrastructure.


72 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

on the conduct of procedures defined by the broader
strategy. Again, the process under way in the
Brazilian economy over the past few years reflects a
clear example of these restrictions.

Thus, the present chapter deals with these rela-
tionships between the macroeconomic policy fronts
themselves (exchange rate, monetary and fiscal) and a
development strategy whose constituent elements were
presented, in part, over the past presidential terms, but
whose contents need to be revisited, deepened and
complemented. The background question is whether
the actual Brazilian macroeconomic regime, derived

from an orthodox perspective, is compatible with the
deepening of a social-oriented development, which
depends on a strong role of the State, income distribu-
tion and the expansion of social infrastructure.

The social component of this strategy, termed
here as “social-developmentalist”, is contextualized
and summarized in the first section.1 The second
section focuses on the institutional framework of
each of the three macroeconomic policy fronts and
assesses their recent conduct in Brazil in the light
of the preceding considerations. Finally, some brief
conclusions complete the text.

In conceptual terms, very distinct development
ideas, practices of economic policy or even “recipes”
can be reunited under the label of “developmental-
ism”. According to Fonseca (2004), developmentalism
is the ideology that preaches government intervention,
nationalism and industrialization for development. In
this conceptual framework, developmentalism can
assume various strategies such as those observed in
the 1960s and 1970s, when the rapid economic growth
that transformed the productive structures was accom-
panied by a deterioration in income distribution. This
is certainly not the best-suited style of development
considering Brazil’s current needs and conditions.

Therefore, we must qualify the “developmental-
ism” that is defended here, as well as differentiating
it from other proposals and strategies of the past
and present. Starting from the recent Brazilian
experience, this qualification specifically comprises
incorporating and emphasizing the social dimen-
sion as a central and guiding development element.
Resuming the argument, we understand that it is pos-
sible to be developmentalist only in economic terms.
In other words, there are theoretical formulations and
policy propositions, and there were several relevant
historical experiences, in which the defence of the
national interest, government intervention and search
for a more sophisticated production structure were
associated with a worsening in income distribution
and/or other dimensions of the social differences that
are characteristic of capitalism.

In Brazil, the economic and social dimensions
have been reconciled, or reinforced, in a virtuous

way in recent years. It is impossible to separate the
growth cycle in the second half of the 2000s from
the expansion of domestic demand, with the latter
greatly influenced by the accelerated personal income
distribution process during this period. In practice,
there has been an expansion of the mass consumer
market as a dynamic engine of economic activity
– a relationship that was already in the theoretical
formulations of progressive economists for some
decades and happened diametrically opposed to that
seen in the 1960s and 1970s, when the concentration
was functional to growth.

In addition to the favourable international
framework, four major tools have been instrumen-
tal in this recent process, not all of which are duly
recognized in the Brazilian public debate. The most
famous were the policies of income transfer to poorer
layers of the population – led by the “Bolsa Família”
programme – which have been heavily enhanced
and expanded.2 In addition to these more focused
actions, the other instruments of the Brazilian social
security system that have a wide scope and very
important impact, despite many problems, deserve
being highlighted.3 The policy of the real appre-
ciation of the minimum wage is the third element
of this explanation, involving a direct expansion
of purchasing power of a broader layer of society
than those directly affected by the focused actions.
Finally, and related to the previous three, there is the
favourable behaviour of the labour market over the
last decade, which is marked by major transforma-
tions still to be better explained, but has resulted in
an intense process of formalization and a gradual

I. Deepening and renewing the social emphasis of
the Brazilian development

73Macroeconomic Policy for a Social-Oriented Development Strategy – The Brazilian Case

reduction in the unemployment rates to historical low
levels.4 As an additional impulse to the dynamism of
the economy in recent years, the expansion of bank
credit has positively influenced the purchasing power
of the population and played an important role in the
expansion of the domestic market.

Looking forward, a developmentalism separated
from the reduction of the huge social inequalities that
mark the Brazilian society does not seem very suitable
– or very promising in practical terms – in the current
context. The social dimension must be at the centre
of the development strategy, and hence the name
“social-developmentalism”. However, this emphasis
should not only serve to explain or praise the recent
trajectory, much less to consider sufficient or secured
the changes. On the contrary, the social character of
the Brazilian development is justified more by the
challenges (and, in the virtuous sense proposed here,
opportunities) than the progress achieved.

The concentration of income in Brazil remains
among the highest in the world. Furthermore, the
positive results in recent years have occurred in one
of the dimensions of inequality: personal income
concentration (and not least in the indices of misery
and poverty). Indicators of inequality with other
approaches (living conditions and consumption, with
an emphasis on the access to sanitation, education
and health) have shown more timid improvements in
recent years, or the differences have even increased.5

Another more important motivation to the social
emphasis is the fact that the progress achieved thus
far has largely been of a personal and private nature,
strongly associated with the power of consumption.

As previously mentioned, this had positive impacts
on the economy, but little explored another venue
of economic dynamism and reduction of inequality,
namely the social infrastructure, or the commonly
termed collective or public goods, such as educa-
tion, health, transportation and conditions of urban
life, sanitation, etc. By contrast, there was a “private
solution” for the social services in several of these
dimensions that expanded them and increased access
while commodifying social relations without ensur-
ing their quality.

Therefore, the way forward is to go beyond the
expansion of the mass consumer market, advancing
in the social rights dimension (incidentally provided
for in the Constitution of 1988). Moreover, this is not
only a goal in itself; rather, the progress in this direc-
tion is also one of the motors for the future growth
of the country. In addition to those effects that have
already been verified (and have not depleted) about
income distribution on the consumer market, the
expansion of social infrastructure also has a great
economic impact in sensitive areas. In the short-term,
this means the expansion of investment, whereas in
the long-term, it influences the competitiveness of
the productive sector by improving the educational,
health and quality of life levels of the workforce.

In this way, next to the strengthening and
efficiency gain of the government, as well as the
reversal of troubling processes underway in the
production structure, the renewal and deepening of
social progress is one of the pillars of the “social-
developmentalist” strategy held here.6 In relation to
this aspect, the macroeconomic policy considerations
are detailed in the following sections.

II. Brazilian macroeconomic regime: A critical assessment

The institutionality of the Brazilian macroeco-
nomic regime currently in force dates back to 1999,
when the tripod floating exchange rate, inflation
targeting and primary fiscal target was set. The
elaboration of this institutional architecture involved
the assumption of a liberal conception about the
role of the government and follows the Washington
Consensus headlines. In this perspective, develop-
ment is an emptied concept delivered to a commonly
called natural character of the capitalist system,
whose operation free from government interference

would lead to an efficient resource allocation. Thus,
the architecture of this regime sought to limit the
government’s discretion in the handling of macro
policies. It was advocated that the macroeconomic
instrument should be mobilized for the – almost
exclusive – search of price stability, identified as a
primordial condition for the development.

This restriction to the government role lies at
the root of the discussion concerning the macroeco-
nomic regimes (Lopreato, 2013). To the new classical

74 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

theory, the macro regime must submit the government
to an “inter-temporal restriction” to avoid spoiling the
economic dynamics that works harmoniously under
the reins of market. In a stylized manner, the goals of
a macroeconomic regime in a neo-liberal project must
focus on the exclusively price stability and solvency
of the public sector in the long run, preferably with
reduced public spending over time, to reduce the size
of the government and thus increase the efficiency in
resources allocation.

For a social-developmentalist project as envis-
aged here, development is assumed as a political
intention and not as spontaneity from the automatisms
of the market. In this way, the macroeconomic regime
must be compatible with the government’s active
role in search of an economic dynamism capable of
ensuring the deepening of the income distribution
process and the expansion of social infrastructure.
For this purpose, the government should enjoy a
higher degree of discretion in the handling of macro
policy, although this does not necessarily mean that
rules and boundaries should not be established. These
are essential so that the management is not restricted
to the short-term horizon and can be reconciled with
the long-term goals.

In the recent debate about the Brazilian growth
model, several critics have pointed to the accuracy of
the economic tripod as being responsible for the low
growth of the Brazilian economy and as a hindrance
to its development. However, the macro regime has
proved flexible over time, allowing changes in the
form of management of policies, within the same
institutional framework. Especially since the 2008
crisis, the foreign exchange policy now includes the
capital controls among the instruments, the monetary
policy now considers the supply-side shocks for its
decisions and the fiscal regime has incorporated, at
least in terms of intentions, an anti-cyclical concern.7
This prompts the question of whether this flexibility
is enough to admit, among other things, a more active
role of the government in the economy, the sustained
growth and structural changes inherent to the process
of economic development.

In the following subsections, we engage in
critical discussion concerning the institutionality
and management of the regime of macroeconomic
policy in force in Brazil, characterized by the floating
exchange rate, fiscal targets and inflation targeting.

A. Exchange rate policy and the need for
greater control

Despite the redundancy, it is worth mention-
ing that the main virtue of the floating exchange
rate regime is its flexibility. In the face of the cur-
rent international context, involving a high degree
of uncertainty associated with the high volatility
of financial variables and commodity prices, the
exchange rate flexibility allows absorbing external
shocks that could otherwise have a strong impact
on the domestic economy. For example, the abrupt
changes in relative prices, when not quickly absorbed
by the exchange rate, can generate inflationary
pressures and thus overburden the monetary policy.
Therefore, the institutionalization of an exchange
regime with some reference rate (goals, foreign
exchange bands, etc.) can generate important mac-
roeconomic imbalances.8

If some degree of flexibility is welcome, an
excessive flexibility can lead to distortions of vari-
ous natures, as the exchange rate determined by the
market is not necessarily best suited to the process
of economic development. For analytical purposes,
we present below four reasons that justify an active
exchange rate policy. These are divided into two
groups, namely those linked to the trade account
of the balance of payments and those linked to the
financial account.

The first reason for an active exchange rate
policy is the cycle of commodity prices. Considering
the system of Hicks (1974), which differentiates
the markets between fix-price and flex-price based
upon the nature of the production process (product
cycle, idle capacity, etc.), the sectors that produce
industrial goods tend to adjust the quantities produced
given the demand shocks, while those that produce
commodities tend to adjust prices. Thus, the export
revenue of the country producer of commodity tends
to be more volatile than that of a country exporter of
industrial goods, meaning that the supply of foreign
currencies arising from external trade will depend on
the price cycle of basic products. This instability is
transmitted to the exchange rate, which affects the
rest of the economy. Thus, in countries with an export
agenda heavily based upon commodities, the foreign
exchange policy is important to lessen the impact of
this price fluctuation in the exchange rate.

75Macroeconomic Policy for a Social-Oriented Development Strategy – The Brazilian Case

The existence of a high competitive com-
modities exporter sector leads to the second argument
linked to current account, which justifies the use of
an active exchange policy. As explored by Bresser-
Pereira (2008), the role of this sector in a national
economy is subjected to the risks of the commonly
termed “Dutch disease”, which is manifested as a
chronic tendency to currency appreciation. One of
the relevant points of approach is the identification of
an equilibrium exchange rate for the current account,
whose level is more appreciated than that required for
the development of a competitive industrial sector.9
In this case, the role of the foreign exchange policy is
to prevent an excessive appreciation of the exchange
rate and a specialization of the domestic economy in
the production of primary goods. Even if the concept
of “equilibrium rate” and the “chronic” character of
the appreciation tendency are questionable, they are
important thoughts for economies such as Brazil.

Specific exchange policies can be designed to
meet these distortions, such as taxes on the exports
of commodities, which are causes of Dutch disease,
or the constitution of stabilization funds, such as
those established by oil exporting economies (the
Islamic Republic of Iran, Kuwait, Norway, the
Russian Federation, the United Arab Emirates and
the Bolivarian Republic of Venezuela) or other com-
modities, such as Chile (Cagnin et al., 2008).

The third reason for the exchange rate policy
is the need to neutralize the temporary or cyclical
distortions caused by the financial sector. This is
because the financial market does not necessarily lead
the exchange rate to an alleged equilibrium and thus
the exchange rate policy has the role of containing
the excesses, avoiding overshootings and exagger-
ated volatility. This volatility is particularly harmful
to countries such as Brazil, with high pass-through
between the exchange rate and inflation. For this
purpose, it is appropriate to use capital controls on
short-term financial flows that are inherently vola-
tile, as well as regulatory measures on the foreign
exchange derivatives market.

However, in the Brazilian case, the financial dis-
tortions go beyond volatility and cause long processes
of exchange rate appreciation interspersed with short
and sharp depreciation periods, such as that experi-
enced in June 2013. This pattern of exchange rate
behaviour is pronounced in the Brazilian economy

due to the high profitability of financial investments
and mainly the high interest rates practised in the
country. Carry trade operations have been a constant
pressure on the Brazilian currency appreciation in the
recent period (Rossi, 2012). This operation is one of
the main transmission mechanisms of international
liquidity cycle to exchange rates and comprises an
inter-currency investment involving the formation of
a liability (or a short position) in the currency of low
interest rates and an asset (or a long position) in the
currency of higher interest rates.10

In a pendulum motion, carry trade operations
tend to appreciate currencies with high interest rates
during the ascending phase of the liquidity cycle and
undervalue them in the reversal phase. The important
detail is that this movement tends to happen asym-
metrically: the process of optimism that characterizes
the international liquidity expansion occurs more
gradually, while the mood reversals are usually more
abrupt. As shown by McCauley and McGuire (2009),
as well as Kohler (2010), the most depreciated curren-
cies during the more acute period of the 2008 financial
crisis were the target of carry trade, while the funding
currencies served as a safe haven of financial flows
and consequently appreciated during the crisis.11

In those terms, the reasons related to the
financial account justify adopting foreign exchange
policies to avoid excessive volatility in the exchange
rate, as well as an excessive appreciation of the
domestic currency. In this context, the architecture of
exchange rate policy must be assembled to neutral-
ize financial distortions, given that the subjection of
the national currency to the speculative cycles from
the financial sector is incompatible with long-term
economic development.

Since the 2008 international crisis, Brazil has
advanced in the direction of a more active exchange
policy. The accumulation of foreign exchange
reserves was complemented with measures of control
of financial flows (taxes on investments in equities,
fixed income and loans), market regulation measures
of interbank exchange (encumbrance of excessive
short positions of banks in the cash market) and the
foreign exchange derivatives market (tax on short
positions in dollar). These measures implemented and
partly withdrawn between 2008 and 2013 proved effi-
cient for both the qualitative improvement of capital
flows and a lower volatility of the exchange rate.12

76 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

B. Fiscal policy, anti-cyclical action and
the search for room for investment

An important task of the macroeconomic regime
is to avoid sharp movements in the pace of activity,
called the anti-cyclical role. This action must be
guided by the goal of sustaining economic growth,
and particularly the rate of investment, to enable
the advancement of structural changes inherent
to the development project. To this end, the guid-
ance of public spending is strategic because it is an
autonomous source of aggregate demand. In addi-
tion, the entire emphasis on the social infrastructure
and public services defended here as a guide for a
“social-developmentalism” require significant fiscal
resources for their implementation.

According to these criteria, the conduct of the
fiscal policy as presented in Brazil – guided by annual
fiscal targets – can and should be improved. This
is because not only is the fiscal result pro-cyclical
within this regime, but also the search for the ful-
filment of the goal throughout the year reinforces
this pro-cyclical character. Therefore, there is an
inadequacy in the establishment of annual targets
that have the purpose of long-term debt sustainability
yet disregard the economic cycle and the endogenous
relationship between public spending and growth.

By definition, the government has control over
its decision to spend, although its revenue depends
on income generation, or economic growth. Thus, the
establishment of an annual goal implies that the gov-
ernment undertakes a fiscal result at the beginning of
the year based upon an expectation of revenues, con-
sidering the estimated economic growth. However,
the growth might not perform as planned during the
year, resulting in a smaller tax revenue than expected,
thus undermining the fiscal result.13 Given this, the
government can: (a) announce that it will not fulfil
the goal and be accountable to society; (b) announce
nothing and fulfil the accounting of the primary goal
through rebates and the anticipation of dividends; or
(c) take additional measures to raise taxes or reduce
spending to ensure the fiscal goal of the period.

Of these three options, the first two are bad for
the government’s credibility and the latter is more
adjusted to the prevailing tax regime. However, it is
the worst among them, given that the search to fulfil
the goal through an emergency and contractionary
fiscal policy removes stimuli to the aggregate demand
of an already sluggish economy and further reduces

economic growth. Added to this, the most common
output for this type of adjustment is the curtailment
or postponement of investment projects, given that
a large part of public expenditure is bound and thus
tax increases or expenditure cutting are not always
politically feasible. In other words, the search for
fiscal goal adds an anti-investment bias to this tax
regime in the short-term.

Similarly, the annual target for the primary
surplus is inappropriate when economic growth
is greater than that projected by the government.
In this case, there is an incentive for the excess
revenues to be materialized in the expansion of the
public spending. By influencing the already heated
economy, this additional spending can generate an
excess aggregate demand and place pressure on the
price level. Thus, the conduct of fiscal policy does
not cooperate with the regime of inflation targeting,
given that it potentially increases demand inflation
and imposes the need for a contractionary monetary
policy to control prices.

In summary, in the regime of annual fiscal tar-
gets, not only is the fiscal result pro-cyclical, but also
the search to fulfil the fiscal goal throughout the year
reinforces this pro-cyclical character and accentuates
the economic cycle. As addressed here, surplus goals
are established for annual periods through a model
that estimates the long-term debt sustainability. The
criticism that arises is the inadequacy of establishing
annual goals in the long-term model, disregarding
the economic cycle and the endogenous relationship
between public spending and growth.

However, there are two ways to neutralize this
problem and reconcile the targeting regime with the
anti-cyclical management of the fiscal policy. The
first one refers to lengthening the periodicity of the
target to encompass the economic cycle. A medium-
term goal would give more flexibility to the fiscal
policy to have expansionary and contractionary
moments, ensuring the expected surplus on average
for the period. The drawback of this proposal is
that it assumes a conjecture about the nature of the
economic cycle and its periodicity, which does not
always follow a pre-determined pattern.14

The second proposition is to establish an insti-
tutional mechanism with clear rules, allowing the
public spending to be expansionary in times of low
growth and contractionary in times of high growth,
thus preserving the continuity of a surplus goal with

77Macroeconomic Policy for a Social-Oriented Development Strategy – The Brazilian Case

annual periodicity. This might be feasible through a
budgetary fund with public resources reserves, which,
when used, must have the specific purpose of public
investment. Thus, there would be a legal apparatus
that allows the expansion of public investment in
the low economic cycle and obliges the government
to save the excess revenues in the high economic

An anti-cyclical policy that guarantees the
sustainability of the growth process also opens up
fiscal space to expand public investment, as already
pointed out as an economic expansion engine and
one of the main axes of the development strategy
defended here. Larger investments in social infra-
structure would have important multiplier effects
in terms of employment, income and boosting local
economies. Moreover, as the coverage and quality
of public services (of education, health, transport,
etc.) are expanded, the increasing portion of fam-
ily income committed to these expenses would be
released for other uses. This second effect is greater
for poorer layers of the population. The expansion of
disposable income seems a more powerful (and fair)
instrument of income distribution than the extension
of subsidies to the private providers of social services
of these social rights, which are often of poor qual-
ity, thus only reinforcing the need for a new public
pro-investment fiscal policy.

C. Inflation targeting and the flexibility

The regime of inflation targeting has the advan-
tage of establishing a public commitment to price
stability and a reference framework for the monetary
policy. This regime is flexible when compared
with the alternatives of monetary targeting regime
and nominal anchor exchange rate policies,16 and
comprises different forms of institutionalization of
the regime and its management. The analysis of the
Brazilian case points to a need for greater flexibility
of the inflation targeting system, given the structural
transformation processes of the economy.

According to the recipe of the commonly called
“new macroeconomic consensus”, the management
of the targets system must rely on using the interest
rate instrument with the aim of affecting aggregate
demand. However, the causes of inflation are not
restricted to a problem of demand; moreover,

structural issues associated with the development
process are sources of price increases on the supply

For example, the process of reducing income
inequality can cause a configuration drift between
wage growth and productivity. In a first moment,
real wage increase generates increased pressure
on production costs. In a second moment, the re-
composition of the profit margin of entrepreneurs
generates a new round of price increase, which in
turn reduces real wages.17 Additionally, the process
of income redistribution also results in changes on the
demand side, given that the entry of new consumer
classes widens the market and requires adjustments
in the supply conditions, which can take time.18

The fluctuation of commodity prices is another
important source of cost inflation. In the recent past,
the exchange rate has been an important channel of
monetary policy transmission and the absorption of
supply shocks from commodity prices. However, the
use of the exchange rate for this purpose is extremely
problematic due to the volatility pattern of commod-
ity prices. Insofar as the exchange rate reproduces
this volatility pattern, the industrial exports and
productive investment are undermined.

As an alternative instrument, we can highlight
the management of import and export tariffs as an
aid to the regime of inflation targeting. In the case
of predominantly imported products such as wheat,
the reduction of import tariffs can be used in times
of this product’s increasing price in the international
market. In the case of the increasing price of Brazilian
export products that have a major impact on the infla-
tion index, export tax represents an alternative. This
increase will prompt the redirection of the production
for export to the internal market, thus boosting supply
and lowering prices.

In the case of commodities and other cases in
which inflation stems from supply problems, the
effectiveness of using the interest rate as an instru-
ment of monetary policy is extremely limited, given
that the increase in interest rates tends to inhibit
investment and retract the offer, thus reinforcing the
causes of inflation.19 Accordingly, the monetary con-
traction might affect the aggregate demand, thereby
reducing the growth without affecting the original
cause of inflation.20 Thus, instruments that are alter-
native and auxiliary to the monetary policy under
the inflation targeting regime should be considered.

78 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

Put briefly, the regime of inflation targeting
might be appropriate for the developmentalism pro-
ject defended here, given that it is flexible. However,
its management must consider three important points:
(1) that inflation targeting is not an exclusive goal
of the monetary policy; (2) that inflation targeting
is flexible enough to accommodate price pressures
arising from structural changes inherent to the devel-
opment process and other supply shocks; and (3) that
the interest rate is not the only instrument to achieve
the goal of inflation and that other instruments are
used depending on the origin of the phenomenon and
the nature of the inflationary impulse.

In addition to these issues, the regime of infla-
tion targeting should be compatible with the Brazilian
economy’s transition to a pattern of lower interest
rates. This transition is absolutely necessary to create
a macroeconomic environment that is more suited to
productive investment and enables the development
of a credit system of long-term financing and the
improved competitiveness of the productive sector.
This transition will be responsible for profound

structural changes in the economy, since the fall of
the basic interest rate must be accompanied by the
fall of the other profitability rates of the system.

The management of the regime of inflation
targeting in Brazil has shown some progress in recent
years. In particular, we highlight the concern about
economic growth that was manifested in recurrent
speeches of the monetary authorities, as well as the
use of macro-prudential policies as an alternative
instrument to the interest rate in terms of controlling
inflation. The Central Bank’s significant reduction in
the levels of the SELIC rate (short-term interest rate)
over the course of 2011 and 2012 was an explicit dem-
onstration of the intent to reduce this anomaly of the
Brazilian economy, taking advantage of the favourable
conjunctures and even facing the powerful resistance
against the reduction in the cost of money in Brazil.
However, this key price has subsequently increased
since April 2013, in a movement that actually responds
to a rise in inflation but should not mean a return to the
levels – and the rigidity of the objectives and instru-
ments – verified on the economic policy until 2011.

In light of the recent Brazilian experience and
its future possibilities, this chapter has sought to
reflect upon the relations between two dimensions of
economic reality and the economic policies that are
usually analysed separately, namely macroeconomic
management and the development strategy. The final
message is that despite the necessary separations
between these two perspectives, they need to be tuned,
especially when it is believed that the task of develop-
ment cannot be solely undertaken by market forces.

In more accurate terms, we need the exchange
rate, fiscal and monetary policies, which alone are
not a sufficient condition for development, to create
minimum conditions (and the least possible con-
straints) for the longer-term objectives of the country,
namely defending the national interest, a relevant
role for government action, the modernization of
the production structure and, in the point highlighted
here, the reduction of the social inequalities that have
historically characterized Brazil.

This last aspect, which justifies the “social-
developmentalist” label, must mean an advance

in relation to the undeniable achievements of the
last decade, mostly in the form of the expansion
and improvement in the supply of public goods.
Investment in social infrastructure and the living
conditions of the population, especially in urban
centres, is a necessary and urgent complement to the
improvements in personal income distribution, which
should continue, given the long path until acceptable
levels are attained. To justify such choices, we not
only have the political and moral imperatives, but
also the positive economic impacts that the social
improvements have caused and continue to cause
in the country, especially in the light of a number of
external constraints that show the domestic market as
a large (and perhaps the only) source of dynamism.

The macroeconomic regime is a necessary
condition to account for this renewal and deepening
of the social character of the Brazilian development.
Therefore, it must be part of the strategic planning
and reinforce the articulation with other development
policies, such as social, industrial, technological,
public investment, infrastructure, wage and other

III. Final remarks

79Macroeconomic Policy for a Social-Oriented Development Strategy – The Brazilian Case

The analysis of the floating exchange, annual
primary fiscal target and inflation targeting regimes
shows that the theoretical assumptions that give
substrate to them do not converge with the social-
developmentalist project. This macroeconomic
regime was originally designed to impose limits on
the discretion of the government’s action and submit
the political authorities to the principles of a liberal
vision of development, within which the market is
the main protagonist. However, a direct correspond-
ence cannot be established between these theoretical
principles and the operationalization of the macro
regime, which has been shown to be flexible.

In this sense, we have assessed that the current
macroeconomic institutional framework can be flex-
ible enough to accommodate a development project
in which the government has an inducer role and the
social is the central focus of its activities. As pointed
out, it is clear that we must move forward in this

direction to increase the control over the functioning
of the foreign exchange market, turn the fiscal policy
effectively into anti-cyclical and with more room for
public investment, as well as ensuring that the flex-
ibility allowed by inflation targeting translates into
sustainable reductions in interest rates in the country.

Nonetheless, this analysis is ultimately opti-
mistic about the compatibility between the two
dimensions addressed. Perhaps better phrased, it
does not consider that the debate concerning the
possible abandonment (or not) of the so-called
macroeconomic “tripod” should be the focus when
the goal is to deepen and renew the virtuous traits
of a development style that has made advances in
recent years. Considering some enhancements and
more appropriate management, the institutionality
of the floating exchange, primary fiscal target and
inflation targeting regimes can accommodate the
social-developmentalist project.


1 The discussion around social developmentalism is
recent and much broader than the space given in this
paper. In relation to this topic, we recommended
reading Carneiro (2012), Biancarelli (2013), Bastos
(2012) and Bielschowsky (2012), although the latter
does not make use of this term.

2 The “Bolsa Família” is a social programme that
provides a benefit to families with less than R$ 70 per
capita monthly income (around $ 30). According to
ANFIP (2014), in 2013 the Bolsa Família programme
benefited 14.1 million families with a basic income
of around $ 70 per family per month.

3 According to ANFIP (2014), the Benefits of
Continuous Support (BPC) amounted to R$ 32.1 bil-
lion in 2013 and were distributed to 4.1 million
elderly and disabled persons.

4 Concerning the social protection system and its
relations with the recent process of the Brazilian
development, see the panoramic analysis of Castro
(2012). In relation to the transformations underway
in the Brazilian labour market, see Baltar (2015). In
addition to the novelty in the Brazilian history, the
virtuous relationship between growth and income
distribution is a very rare feature in today’s world
(by contrast to other times, mostly in Western Europe
during the post-war period).

5 A multisectoral approach to the issue of inequality
is presented by Dedecca (2015).

6 For further details about these other pillars, as well
as the ideas presented in this and the next section,
see Biancarelli (2013).

7 This article does not aim to discuss whether or not the
economic policy carried out from 2008 was correct,

but rather to assess the possibilities of changes and
ways of managing the macroeconomic regime.

8 Additionally, the definition of an exchange rate target
implies an institutional commitment and allows
failures in the conduct of the exchange rate policy.
Faced with a large financial openness, the definition
of an exchange rate target also exposes the regime
to speculative attacks such as those that occurred
in emerging countries in the 1990s, as described in
Prates (2002).

9 “The Dutch disease or the curse of natural resources
can be defined as the chronicle overvaluation of
the exchange rate of a country caused by Ricardian
rents that the country gets when exploiting abundant
and cheap resources, whose commercial production
compatible with an exchange rate of current balance
is clearly more appreciated than the industrial equi-
librium exchange rate” (Bresser-Pereira and Gala:
2010: 671).

10 “It is therefore a leveraged investment that implies
currency mismatch. The generalization of this type
of operation gives specific features to the dynamics
of exchange rates. It follows that, the way that the
financial wealth allocation is promoted by the carry
trade is not restricted to an allocation process of
financial asset, but also to the formation of liabilities”
(Rossi, 2012: 26).

11 It is interesting to note that, at the peak of the flight-
to-liquidity of the 2008 crisis, the Japanese currency
was the only one that appreciated against the United
States dollar. According to McCauley and McGuire
(2009) and Kohler (2010), the explanation for this
lies in its role as the carry trade funding currency.

80 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

12 However, despite the expansion of foreign exchange
policy instruments, some structural aspects have not
been modified. In particular, the Brazilian exchange
market permeability to financial speculation is a critical
element that needs to be addressed. The speculative
nature of the Brazilian exchange market is mainly due
to the interest rate differential of the Brazilian currency
in relation to the others, as well as the liquidity asym-
metry existing between the market of derivatives and
the foreign exchange cash market, as discussed in Rossi
(2012). Therefore, for an exchange rate that is less
subject to financial distortion, a reform in the Brazilian
exchange market is necessary to increase liquidity in
the cash market and reduce the activities of speculators,
whose work primarily focuses on the future market.

13 One way to measure the impact of the cycle in the
primary result is by estimating the structural primary
result. Concerning this measure, see Gobetti et al.

14 Another form of addressing the same problem is by
assuming a “structural fiscal target”, which is a measure
with cyclical adjustment. In the case of Chile, it consid-
ers economic activity and the price of copper among
other variables, as shown in Marcel et al. (2001).

15 It is worth noting that the recovery of the Brazilian
government’s capacity to plan and execute public

investment is necessary for a more efficient use of
the anti-cyclical fiscal policy.

16 Evidently, it is less flexible than a purely discretion-
ary monetary regime.

17 In turn, the transfer of the high production costs
to prices depends on the structure of the produc-
tive sectors. “It is reasonable to consider that, in
general, oligopolistic sectors (with greater market
power) tend to create more inflation for at least two
reasons: (i) have a greater ability to pass-through to
prices increases in costs, and (ii) may be relatively
immune to monetary policy contraction, since it does
not necessarily compete via prices” (Modenesi et al.,
2012: 204).

18 This process is associated with the expanding of
the internal market of mass consumption proposed
by Bielschowsky (2012) and already commented in
section I.

19 In addition, nominal interest should be considered as
a cost component for businesses, as both a financial
cost for indebted companies and an opportunity cost
of capital for all firms (Serrano, 2010).

20 Depending on the combination of factors, the interest
increase might even lead to a rise in inflation, since
it reduces the supply ability.

ANFIP (2014). Análise da Seguridade Social 2013. Asso-
ciacão Nacional dos Auditores Fiscais da Receita
Federal do Brasil (ANFIP) e Fundação ANFIP de
Estudos da Seguridade Social, Brasilia, DF.

Baltar P (2015 ). Crescimento da economia e mercado de
trabalho no Brasil. Texto para discussão No. 2036.
Instituto de Pesquisa Econômica Aplicada, Brasilia, DF.

Bastos PP (2012). A economia política do novo-desen-
volvimentismo e do social desenvolvimentismo.
Economia e Sociedade, 21(Nº Especial):779–810.

Biancarelli AM (2013). Por uma agenda social-desenvolvi-
mentista para o Brasil. In: Fundação Perseu Abramo,
ed. FPA Discute: Desenvolvimento. FPA, São Paulo,
SP: 49–66.Bielschowsky R (2012). Estratégia de
desenvolvimento e as três frentes de expansão no
Brasil: Um desenho conceitual. Economia e Socie-
dade, 21 (No. Especial): 729–747.

Bresser-Pereira LC (2008). The Dutch disease and its
neutralization: A Ricardian approach. Revista de
Economia Política, 28(1): 47–71.

Bresser-Pereira LC and Gala P (2010). Macroeconomia
estruturalista do desenvolvimento. Revista de Eco-
nomia Política, 30(4): 663–686.

Cagnin R, Cintra MA, Farhi M and Almeida JS (2008). O
debate em torno dos fundos cambiais: Experiências
internacionais. Texto para Discussão, No. 150, Univer-
sidad Estatual de Campinas, Campinas, SP, November.

Carneiro RM (2012). Velhos e novos desenvolvimentismos.
Economia e Sociedade 21 (No. Especial):749–778.

Castro JA (2012). Política social e desenvolvimento no Brasil.
Economia e Sociedade, 21 (No Especial): 1011–1042.

Dedecca CS (2015). A redução da desigualdade e seus
desafios. Texto para discussão No. 2031. Instituto de
Pesquisa Econômica Aplicada, Brasilia, DF.

Fonseca PCD (2004). Gênese e precursores do desen-
volvimentismo no Brasil. Revista Pesquisa e Debate,
15(2): 225–256.

Gobetti SW, Gouvêa RR and Schettini BP (2010). Resultado
fiscal estrutural: Um passo para a institucionalização
de politicas anticíclicas no Brasil. Texto para dis-
cussão, No. 1515, Instituto de Pesquisa Econômica
Aplicada, Brasilia, DF.

Hicks J (1974). The Crisis in Keynesian Economics. New
York, Basic Books.

Kohler M (2010). Exchange rates during financial crises.
BIS Quarterly Review, March: 39–50.

Lopreato FL (2013). Caminhos da Política Fiscal do
Brasil. São Paulo SP, Editora UNESP.

Marcel M, Tokman M, Valdés R and Benavides P (2001).
Balance estructural: La base de la nueva regla fiscal
chilena. Journal Economía Chilena, 4(3): 5–27.

McCauley RN and McGuire P (2009). Dollar appreciation
in 2008: Safe haven, carry trades, dollar shortage and
overhedging. BIS Quarterly Review, December: 85–93.

Modenesi A. de M., Alves CCP and Martins NM (2012).
Mecanismo de transmissão da política monetária: a
importância dos fatores microeconômicos. Oikos,
11(2): 203–216.

Prates DM (2002). Crises financeiras dos países “emer-
gentes”: Uma interpretação heterodoxa. Tese de
Doutoramento, Universidad Estadual de Campinas,
Campinas, SP.

Rossi P (2012). Taxa de câmbio no Brasil: Dinâmicas da
especulação e da arbitragem. Tese de Doutorado,
Universidad Estadual de Campinas, Campinas, SP.

Serrano F (2010). O conflito distributivo e a teoria da
inflação inercial. Revista de Economia Contem-
porânea, 14(2): 395–421.


81Is Chile a Role Model for Development?

The Chilean economy is usually highly praised
by some international financial institutions (IFIs),
diverse political authorities and international ana-
lysts. A generalized view prevails that there has been
“one” successful Chilean model since the imposition
of neo-liberal reforms under the dictatorship of
general Pinochet in 1973. However, the four decades
that have subsequently elapsed include several sub-
periods with different policy approaches and external
environments, as well as notably diverse economic
and social outcomes. Accordingly, there is neither
one unique model nor only one outcome. Sometimes,
Chile has performed closer to become a “model”
for development, and at other times the opposite or
something in between.

Economic development at least includes the
production of goods and services and its distribution
among citizens. Accordingly, we will explore how both
have evolved along the four decades, given that a role
model case should be consistently achieving success
in terms of both economic growth and its distribution.

In section I, a summary evaluation is presented
of policies and outcomes during the four decades.
Section II focuses on three episodes: one corresponds
to the first half of the dictatorship, in 1973–1981; a
second one during the first years of return to democ-
racy, namely 1990–1995; and finally the period
since the contagion of the global crisis, 2008–2013.
Section III concludes.

Ricardo Ffrench-Davis

* This chapter is based on material developed in Ffrench-Davis (2010, 2014). Most figures cited come from these
publications, based on Central Bank, Ministry of Finance and National Institute of Statistics. I appreciate the support
of CIEPLAN and the assistance of Simón Ballesteros and Nicolás Fernández.


The Chilean economy is usually highly praised as having been successful since the imposition of
neo-liberal reforms under the dictatorship of general Pinochet in 1973. However, the four decades
that have elapsed include sub-periods with quite different policy approaches and notably diverse
outcomes; thus, there is neither one unique model nor only one outcome. The four decades’ growth is
moderate, averaging 4.2 per cent per year: it averaged 2.9 per cent (meagre) during the 16 years of
dictatorship and a good performance of 5.1 per cent during a quarter-century of democracy, albeit
with a vigorous 7.1 per cent in the initial years (1990–1998) and a modest 3.9 per cent in the last
15 years. Hence, sometimes, Chile has performed closer to becoming a “model” for development,
and at other times the opposite or something in between. Focusing on three episodes (1973–1981,
1990–1995 and 2008–2013), we explore the underlying explanatory variables and some lessons for
building “a model for development”.


82 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

In the five Governments under democracy
(1990–2013), industrial or productive development
policies have been largely absent, as they had been
under the dictatorship; the Pinochet dictatorship
had eliminated most of them in the early years of
his regime. On the contrary, macroeconomic and
social policies have undergone significant changes;
in particular, the macroeconomic regime experienced
notable contrasts among and within the periods
1973–1981, 1982–1989, 1990–1998, 1999–2007
and 2008–2013.

The first deep reforms were launched in 1973.
This stage of the reforms (1973–1981) was character-
ized by the implementation of a neo-liberal model in
its purest and ideological form. Trade and financial
liberalization practically free from prudential regula-
tion, as well as the adoption of “neutral” economic
policies – under the view that “always the market
knows better” – were accompanied by massive
privatizations. By 1981, success had been generally
achieved in reducing inflation and eliminating the
fiscal deficit inherited, albeit at the expense of the
external balance, a highly appreciated exchange rate
and huge external debt, while recording climbing
financial savings yet a low investment ratio. The
outcome was a banking and foreign exchange crisis
with huge economic and social impacts in 1982,
including a gross domestic product (GDP) drop of
14 per cent, high unemployment exceeding 30 per
cent of the labour force and a significant increase in
poverty, with a worsening income distribution.

The second stage of the dictatorship (1982–
1989) implied moves toward more pragmatic policies
to overcome the effects of the deep crisis. It involved
a series of foreign debt renegotiations, several policy
interventions aimed at balancing the external defi-
cit – such as tariff increases and “selective” export
incentives – and the Government’s direct take-over
of the collapsed financial system, before subsequently
privatizing it again when their balance sheets were
in order, thanks to heavy public subsidies to banks
and debtors, costing the Treasury some 35 per
cent of annual GDP. At the end of this period, the
economy had recovered, while income distribution
had worsened even further than in the 1970s. During
recovery, actual GDP grew vigorously, but after due
consideration of the 1982 recession it emerges that
average annual growth was 3 per cent or under in
both halves of the Pinochet regime.

A third variant of the economic model began
in 1990, during the return to democracy, when the
Chilean economy faced the challenges of achieving
a sustained high average GDP growth and serving
the great social debt accumulated in the years of
dictatorship. The formal slogan of the Concertación
Democrática, a centre-left coalition of socialists and
Christian democrats, was “change with stability” for
achieving growth with equity in the socio-economic
dimension of the programme of the new Government.

There were significant reforms of the market
model, strengthening the social component and
correcting severe pro-cyclical failures of economic
policies, including labour and tax reforms to improve
social expenditure. In addition, substantive counter-
cyclical changes in fiscal, monetary, capital markets,
exchange rate and regulatory policies were imple-
mented, aiming at a sustainable real macroeconomic
environment (beyond inflation and fiscal balance
under control, an aggregate demand consistent with
potential GDP and sustainable external balance and
exchange rate).1

The new authorities considered these balances
of the real economy crucial for development (meant
as GDP growth with reduced inequality). One out-
standing feature of this period was the regulation of
the capital account, with a flexible reserve require-
ment (encaje), which was quite active in these years
of large supply of financial flows to the emerging
economies. The counter-cyclical active regulation
helped to control the volume of inflows, shifting its
composition to the long term and their allocation in
productive investment; moreover, it provided space
for monetary policy and avoided undue exchange rate
appreciation and instability. The economy benefited
from comprehensive real macroeconomic stability,
which is meant to be development-friendly, although
there was practically no room for direct industrial or
productive development policies nor for direct sup-
port to small- and medium-sized enterprises (SMEs).
The constitution inherited from Pinochet and the
strong ideological fashion against selective develop-
ment policies represented two particular obstacles.

Owing to the reformed macroeconomic policies,
most of the period’s economic activity was close to
potential GDP, which had only been the case in 1974,
1981 and 1989 during the dictatorship. It was in this
reformed macro-environment that Chile expanded its

I. An overview of four decades

83Is Chile a Role Model for Development?

productive capacity in a sustainable manner between
1990 and 1998, with actual and potential GDP grow-
ing in parallel at annual rates averaging 7.1 per cent,
while also improving social indicators (table 1).

After the mid-1990s, Chile (actually the autono-
mous Central Bank) gradually moved towards the
neo-liberal fashion of capital account and exchange
rate liberalization. The Treasury and the Ministry
for the Economy were initially critical of the move,
although some years later the Treasury also joined
the fashion. Consequently, the exchange rate and
domestic demand came to be led by financial flows
and fell victim to their volatility. Thus, Chile became
vulnerable to the turbulences originated by the Asian
crisis in 1998, since it had allowed the exchange
rate to appreciate “too much” and external deficit to
double in 1996–1997 in comparison with 1990–1995.
This was in acute contrast with the situation when
Chile was immune to the Mexican financial crisis
in 1995.

Vulnerability was aggravated with the full
liberalization of the exchange rate in 1999 and the
capital account in 2001. Subsequently, the economy
exhibited a stagnating actual output and a drop in
the growth of potential GDP during 1999–2003,
when unemployment increased, while the richer/
poorer quintiles ratio rose (back to 16 times). After
a partial recovery in 2004–2008, led by a sharp
improvement in the terms of trade, it suffered the
arrival of the contagion of the global crisis in late
2008 and 2009. Export volumes and prices fell and
capital inflows were reversed. Thanks to a sharply
improved domestic macroeconomic management,
with strong counter-cyclical fiscal policy and a pro-
gressive bias (subsidies to youth employment and the
unemployed), as well as the fortunate help of a rapid
recovery of export prices, there was a solid revival
of economic activity by late 2009.

Recovery was undeterred by a great earthquake
in 2010, pushing actual GDP near its potential output
by 2012. The average increase in GDP was 3.9 per
cent between its peaks in 1998 and 2013.2 While
this figure was greater than the 2.9 per cent of the
dictatorship, it remained far weaker than the 7.1 per
cent recorded during the first nine years of democratic

The fluctuating growth dynamism implies a vari-
able development gap with the developed economies.
Indeed, table 2 shows that the gap with developed

countries increased during the dictatorship. On the
contrary, the rather good average performance in the
two and half decades of democracy implied that Chile
had reduced the distance with the developed world
and left behind most of Latin America, as depicted
in table 2. Nevertheless, this performance was not
continuous. As shown in table 1, only the first half of
the 1990s involved a vigorous GDP per capita growth
(tripling the speed of the one of the United States),
with a strong development convergence with the
developed countries (the per capita income gap fell by
one percentage point per year), including a significant
reduction in income inequality with improvements in

Table 1



(Per cent)

Per capita
GDP growth
(Per cent)



(1) (2) (3) (4)

1974–1981 3.0 1.5 15.1 51.9
1982–1989 2.9 1.2 20.2 56.7
1990–1995 7.9 6.0 15.3 52.7
1996–1998 5.8 4.3 16.0 53.2
1999–2007 3.9 2.8 15.4 52.7
2008–2013 3.9 2.9 12.3 49.2
1990–2013 5.1 3.8 14.7 51.9

Source: Ffrench-Davis (2014).
Note: Data refer to annual averages. For the 1992–1995

subperiod, the Q5/Q1 ratio is 13.7 and the Gini
coefficient is 50.9.

Table 2

BENCHMARKS, 1973–2013

(Per cent)

United States G-7 Latin America

1973 23 29 82
1989 21 25 91
1997 29 34 128
2013 37 44 148

Source: Author’s calculations, based on IMF, World Economic
Outlook database; World Bank, World Development
Indicators database; ECLAC database; and Central
Bank of Chile data.

Note: Data refer to PPP dollars.

84 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

income distribution (to a richer/poorer quintiles ratio
of 13.7). This shortening distance continued in the
long second half (1999–2013), although per capita
GDP growth trend halved and the strong development

convergence exhibited in 1990–1998 was weakened
(to only one half percentage point per year), as well
as previous improvements in income distribution and
the intensity of poverty reduction.

A. The neo-liberal revolution, 1973–1981

Launched after the military coup of 11 September
1973, the first stage of the economic reforms
(1973–1981) represented an extreme case due to the
amplitude of the role granted to the market, the inten-
sive privatization of the means of production, sharp
liberalization of imports and the domestic financial
markets, as well as the regressive changes imposed
on social organizations. There was a determinant
emphasis on the “neutrality” of economic policies,
disregarding the high existing inequality, under the
belief that the “market always knows better” and
provides equitable outcomes.

The initial concerns of Pinochet’s Government
lay with controlling the acute macroeconomic
disequilibria inherited, particularly a 700 per cent
hyper-inflation recorded in 1973, with the reduction
of a huge fiscal deficit assuming top priority.

In 1973–1974, the Government benefited from
a very high copper price (by far the main export, by
a public firm – CODELCO), which increased public
revenue and the availability of foreign currency.
While it was evident to independent observers that
the price was unsustainably high, the revenue from
copper exports was fully spent by the Government
pari passu with its collection. Economic activity
significantly recovered in 1974, making use of
installed capacity underutilized during the previous
year. However, the price of copper sharply declined in
late 1974, prompting the Government to introduce a
tougher adjustment programme in 1975, led by fiscal
and monetary contraction and significant exchange
rate devaluation.

The acute monetary restrictions had a great
impact on economic activity: during 1975, industrial
output fell by 28 per cent, GDP declined by 17 per
cent and total unemployment peaked at 20 per cent
of the labour force. Since productive capacity was
not destroyed but heavily underutilized – reflecting

a main real macroeconomic disequilibrium – a sig-
nificant output gap between actual GDP and potential
GDP emerged, whereby about 21 per cent of GDP
was underutilized in 1975 (chart 1).

In 1975, the domestic capital market was fully
liberalized under weak regulations (the “market
knows”), import policy was moving toward free trade
and taxes on profits had been drastically reduced, as
well as public investment and real wages. Shortly
after the fiscal budget shifted to a surplus.

In the meantime, international capital markets
had become highly liquid, seeking newer destinations
for their supply, including several Latin American
nations. By 1977, Chile had started to receive huge
capital inflows, mostly bank loans. Indeed, given that
the public budget was then in surplus, they reached
the private sector. A passive or neutral public policy
allowed inflows, which appreciated the exchange
rate and increased domestic demand.3 Naturally, the
deepening exchange rate appreciation significantly
contributed to the drastic decline in inflation by the
early 1980s.

However, in parallel, trade liberalization plus
exchange rate appreciation encouraged imports,
which increased faster than exports, in a trend that
continued for five years. Unavoidably, foreign debt
of the private sector was accumulating.

In parallel, actual GDP was increasing fast, even
though output capacity was rising quite slowly. In
fact, the difference was made by the reutilization of
the large output gap – as said, of about 21 per cent
between actual and potential GDP – generated in the
recession of 1975. Investment in new capacity was
low, with the gross investment ratio averaging 16 per
cent of GDP in 1974–1981, much lower than the
20 per cent recorded in the 1960s. Foreign loans were
overwhelmingly used in imports of consumer goods,
with limited imports of equipment and machinery. In
the process, debt amortization and interest payments

II. Three quite diverse experiences

85Is Chile a Role Model for Development?

rose quickly and the deficit on current account was
climbing, reaching an unsustainable 21 per cent of
GDP in 1981.4

Why did the investment ratio average merely
16 per cent of GDP? First, after the large output
gap generated in 1975, actual GDP only became
close again to potential GDP in 1981. Thus, the
macroeconomic environment involved high rates of
underutilization of productive capacity for several
years. This persistent output or recessive gap was
a main factor discouraging gross capital formation
(Agosin, 1998; Ffrench-Davis, 2006). Naturally,
when entrepreneurs are not using a significant
part of their capacity, profits are lower and thus
entrepreneurs have less liquid funds, all of which
evidently discourage expanding their capacity. As a
typical feature of financial crises, abrupt recessions
being followed by gradual recoveries clearly have a
significant negative impact on productive investment,
thus pressing downward the trend of GDP growth and
the quality of employment.

Second, the financial reform (mostly imple-
mented in 1975) gave way to a short-term-oriented
market with very high real interest rates on domestic
loans. In fact, the most common loan held a 30-day
term, while the activities of public investment banks
were curtailed and annual real lending interest rates of
the banking system averaged 38 per cent (reflecting
a macro-price “outlier”) in 1975–1982.

Third, trade liberalization-cum-exchange rate
appreciation reduced the cost of imports, principally
of consumer goods, with their domestic output being
crowded-out. Liberalization attracted investors in
the production of exports with a much weaker force
than the discouragement of domestic firms competing
with imports, with an unexpected drop in the share of
tradables in GDP.5 Additionally, large shares of bank
lending were used by economic groups to purchase
public firms being privatized (fewer in creating
new activities), as well as by households purchas-
ing imported consumer goods. Finally, financing
productive investment through increased inflows
was notably scarce. It is crucial who intermediates
capital inflows, and those intermediated by foreign
direct investors represented a minority.

By 1981, success had been achieved in elimi-
nating inflation, exhibiting a large fiscal surplus
(implying that the external deficit was completely
from the private sector) and a rapid GDP growth.

There was euphoria among the Government, IFIs and
large business firms, holding the view that Chile was
experiencing “an economic miracle”.6 However, vul-
nerability to the changing moods of financial markets
had been created. Foreign borrowing had given rise
to a domestic lending boom in an atmosphere of lax
prudential regulation and supervision. Related-party
auto lending rose rapidly, often with fictitious guar-
antees. The banks renewed loans (often on a 30-day
term) and financed interest payments with new loans.
Non-performing loans appeared low and the banks’
profits high. Many loans were backed by stock and
real estate, although the prices of such collateral
were inflated owing to the financial boom, as well as
the mistaken belief that the Chilean economy would
continue to grow at around 8 per cent a year (the actual
trend of potential GDP was closer to 3 per cent).

Underlying these disequilibria, there was a
severely mistaken diagnosis, led by the belief in mar-
ket spontaneous self-regulating adjustments. Since it
had achieved a fiscal surplus and external borrowing
was being decided by private debtors and lenders, the
Government assumed that a foreign exchange crisis
would never occur. Indeed, the Government was
reassured in this false assumption by the explicit and
strong support of the International Monetary Fund
(IMF) (Robishek, 1981), ignoring that an unsustain-
able external deficit could be generated in the private
sector (Marfán, 2005).

Chart 1

(Trillions of Chilean pesos)

Source: Author’s calculations, based on Ffrench-Davis (2010).
Note: Data refer to constant 2008 Chilean pesos.

1975 1979 1983 1987






Actual GDP Potential GDP

Gap 1975
21 per cent of GDP

Gap 1983
22 per cent of GDP


86 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

By 1981, bank debt per capita almost doubled
the Latin America average. The current account
deficit had risen to 21 per cent of GDP, with domestic
savings having collapsed. Chile required growing net
financial inflows quarter after quarter, which becomes
increasingly difficult when the debt stock has been
rising so much faster than wealth and income. It is
evident that the probability of flows reversal sharply
rises with an increase in the debt stock, size of amor-
tizations and deficit on current account, as well as
the consequent need for exchange rate devaluation.

The macro-adjustment started to take place in
the first semester of 1982, well before the explosion
of the Latin American debt crisis in Mexico, in
August of that year. It is highly relevant that inflows
remained quite large during 1982 (about 10 per cent
of GDP), but much less than net inflows in 1981, to
which the economy had become used. Actually, the
economic authority was obliged to devalue by June.
This intensified the deep recession already at work,
with a 14 per cent GDP drop in 1982; open unem-
ployment was affecting one in every three workers
in 1983, there were countless bankruptcies including
most of the private banks and a huge increase in
poverty and income inequality was evident. In 1982,
the Chilean economy – even with null inflation, fiscal
surplus, widespread privatizations and free imports
– experienced the deepest and more regressive adjust-
ment in all of Latin America.

The combined changes to the production struc-
ture, the repression of labour rights and the financial
reforms, combined with real macroeconomic insta-
bility, caused severe distributive setbacks. The ratio
between household per capita incomes of the richest
and poorest quintiles increased from 13 in the 1960s to
16 in 1976–81, (and to 20 during the 1980s, Ffrench-
Davis, 2014), while the Gini index increased by
4 percentage points (and 5 more points in the 1980s).

In summary, prior to the debt explosion, the
neo-liberal experiment had produced a society with
increased inequality on many fronts in 1974–1981,
a predominance of financierism over productivism
(namely at the expense of increases in productivity
of labour and capital, as well as productive entre-
preneurship), a highly pro-cyclical macro-policy
regime, as well as a meagre and regressive average
economic growth. The 1982 crisis further worsened
this mediocre outcome, which was so unfriendly with
development. Only by 1988 was Chile able to recover
the GDP per capita of 1981.

B. Counter-cyclical regulation of the
capital account: 1990–1995

After the great debt crisis, Latin America
regained access to private capital inflows by the early
1990s.7 Chile was one of the first to attract new funds
and was among the countries facing the greatest sup-
ply of inflows in relation to its economic size.

With the return to democracy in 1990, the
Chilean economy faced the challenges of achieving
a high and sustained average growth and serving the
vast social debt accumulated during the dictatorship.
There were significant reforms of the market model,
including labour reforms (which restored several
labour rights), a tax reform reintroducing taxes on
profits eliminated by the dictatorship (which raised
public revenues geared to increase social expendi-
ture and improve the distributive effects of the tax
system) and a substantive counter-cyclical reform in
macroeconomic policies.8

In fact, the shadow of the great recession
of 1982, including its negative impact on growth
and equity, was quite present in the minds of the
new authorities. Consequently, the top priorities
for implementing macroeconomic policies were
achieving sustained equilibrium in financial markets
and the real economy, diminishing vulnerability to
external shocks and improving employment. The
macroeconomic reforms were implemented in the
capital account, exchange rate, monetary and regu-
lation policies, under the view that the equilibrium
of the “real” economy was crucial for growth with
equity; in parallel, the Government took care of fiscal

Chilean public policy in the first half of the
1990s represented a significant step towards a
counter-cyclical approach to macroeconomic man-
agement. In brief, policymakers responded to the
massive availability of foreign capital by implement-
ing counter-cyclical policies to moderate short-term
and liquid inflows, while keeping the door open to
long-term flows. In a tightly coordinated action by
the Ministry of Finance and the autonomous Central
Bank, the authorities made use of a wide range of
measures to regulate the surge in the offer of finan-
cial inflows in 1990–1995. As a crucial element,
this included an unremunerated reserve requirement
(called encaje) established to raise the cost of bring-
ing in short-term capital, which is a market-based
instrument that affects relative costs. The rate of

87Is Chile a Role Model for Development?

the encaje, its coverage and the term for which it
was retained in the Central Bank were periodically
adjusted according to the intensity of the supply of
funds from abroad and the evolution of international
interest rates (Ffrench-Davis, 2010). Up to 1995, the
authorities systematically monitored avoidances that
might be appearing in the effectiveness of the encaje.

The authorities also used exchange rate inter-
vention to hold down its real appreciation to a level
consistent with the external balance, as well as
monetary sterilization to keep domestic demand
consistent with potential GDP. These and other
counter-cyclical policies supported a development
strategy that encouraged export growth and its
diversification, as well as productive investment and

Three other policies contributed to the success
in managing capital inflows. First, there was a respon-
sible fiscal policy, whereby permanent increases
in social spending were financed with permanent
new taxes. Consequently, Chile had a significant
non-financial public sector surplus in 1990–1997,
averaging 1.8 per cent of GDP which was used to
reduce the large external liabilities generated dur-
ing the 1980s crisis. The prudential fiscal approach
included a stabilization fund for public copper
revenues, which contributed to stabilizing public
expenditure and preventing excessive exchange rate
appreciation. Of course, running a fiscal surplus does
not guarantee financial stability; recall that the great
1982 crisis occurred despite Chile having had large
fiscal surpluses.

Second, prudential banking regulations had
been introduced in 1986 in response to the banking
crisis of 1982–1983. The democratic authorities
effectively resisted pressures to weaken supervision
when lobbying sectors argued that the system was
sufficiently mature to self-regulate. This deterred
capital inflows to trigger another domestic credit

Third, authorities continually monitored aggre-
gate demand and its consistency with productive
capacity. Consequently, macroeconomic disequilibria
were not allowed to accumulate. Some overheating
occurred in 1991 and 1993, although the authorities
conducted a downward adjustment in aggregate
demand in due time. Chile was able to make active
monetary policy with a significant interest rate dif-
ferential with the one of the United States when

needed for domestic equilibria, thanks to the policy
space provided by the encaje.

The set of policies was highly successful, in the
sense that during 1990–1995 – and especially when
the contagion of the tequila crisis spread in 1995 –
the current account deficit was moderate (2.3 per
cent of GDP in 1990–1995), its financing mostly
involved long-term inflows, international reserves
were increased, the total short-term external liabili-
ties were held to a fairly low magnitude,9 aggregate
demand was consistent with potential GDP and the
real exchange rate was kept at a sustainable level,
as shown by the moderate deficit on current account
financed by greenfield foreign direct investments.
All these are conditions of comprehensive real
macroeconomic balances. They would not have been
feasible without regulating capital inflows, managed
flexibility of the exchange rate (see Williamson,
2003) and pursuing an active monetary policy.10
Strategic features of the policies used were in frontal
contrast with the mainstream fashion of full capital
account liberalization and fully free or fully pegged
exchange rate policy.

When the Mexican exchange rate crisis ex-
ploded, the Chilean economy proved immune to
contagion; in 1995 it exhibited a vigorous GDP
rise. In 1990–1995, average GDP growth peaked
at 7.9 per cent, with some improvement in income
distribution (see table 1) and a sharp drop in poverty.
The producers of GDP – labour and capital, the
real economy – benefited from comprehensive real
macroeconomic stability.

One main merit of the policies during 1990–
1995 is that Chile successfully resisted pressures
of the fashion in academia in the United States and
IFIs, as well as the temptation to achieve a faster
disinflation by absorbing larger capital inflows at the
expense of exchange rate appreciation and a larger
external deficit. High productive investment was the
main factor behind the outstanding sustained GDP
growth. As empirical studies robustly show, given
its irreversibility, private investment responds posi-
tively to real macroeconomic equilibria, whenever
they appear to be sustainable (Agosin, 1998). For
real sustainability, it must fulfil two key conditions:
first, effective demand has to be consistent with the
productive capacity being generated; and, second,
key macro-prices (particularly the exchange rate)
must be consistent with a sustainable external bal-
ance (Ffrench-Davis, 2006). In the six-year period

88 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

from 1990 to 1995, actual and potential GDP rose at
similar rates, with the economy working close to the
production frontier; namely, with a minor output gap
and a sustainable external balance. Indeed, these are
crucial ingredients of real macroeconomic balances.

However, macroeconomic policies lost their
strength after 1995. Paradoxically, the autonomous
Central Bank gradually moved towards the neo-
liberal fashion of capital account and exchange
rate liberalization. In fact, in 1996–1998, Chile did
partially bend towards the powerful international
fashion of promoting capital account liberalization,
allowing a real appreciation of the peso and imbal-
ances such as in the external accounts and a domestic
aggregate demand growingly intensive in imported
components. This fashion was generally in command
in emerging economies, pressed by the United States
Government, the IMF and World Bank, the OECD
and generally in the Anglo-Saxon academic world.
It had been reinforced under the belief that the
management of the tequila crisis had shown that the
world had learnt to control financial crisis; indeed,
such over-optimism was also absorbed domestically
by business leaders and some public authorities. The
weakening of the counter-cyclical approach took the
form of principally allowing leakages to the encaje
and stepping-back in the managed flexibility of the
exchange rate.

Therefore, when the Asian crisis contagion
reached Chile in 1998, the economy had accumu-
lated rather significant imbalances, whereby the real
exchange rate appreciated by 16 per cent between
1995 and 1997 and the current account deficit jumped
to 4.8 per cent of GDP in 1996–1997, versus 2.3 per
cent in 1990–1995, which further worsened with a
sharp negative terms of trade shock in 1998. Fiscal
responsibility had been kept, with an actual surplus
averaging 2.1 per cent of GDP, while a larger private
deficit was financed by the rise in their external
liabilities, encouraged by a weaker regulation of the
capital account and exchange rate appreciation.

In 1996–1997, Chile continued to record
vigorous growth, with both output and investment
remaining at high levels. A determinant factor behind
the record investment ratio was the high employment
of productive capacity as shown. However, as previ-
ously mentioned, macroeconomic conditions were
becoming vulnerable to changes in the international
environment, with the appreciation of the exchange
rate and rise of external deficit. As said, Chile did step

back in 1996–1998, albeit only to a mid-of-the-road
position. While it did not dismantle regulations, it
allowed a gradual weakening of their effects (Le Fort
and Lehmann, 2003; Ffrench Davis, 2010, ch. VIII);
accordingly, disequilibria were moderate after six
years of counter-cyclicality and only a couple of
years of soft pro-cyclicality.

Therefore, Chile had advanced towards devel-
opment with the significant macroeconomic reform
in 1990–1995, with some steps back in 1996–1997,
while it only had made minor progress with respect
to productive development policies. Later, it gave
up liberalizing the exchange rate in 1999 and the
capital account in 2001. Table 3 compares the average
performance of GDP and wages in 1990–1998 and
1999–2013, showing a large contrast. The capital
formation ratio is rather similar and suggests a sharp
drop in total factor productivity, partly associated
with real macroeconomic instability.

C. Contagion, counter-cyclical response
and recovery in 2008–2013

When the contagion of the global crisis arrived
in 2008, economic activity in Chile suffered a sharp
recessive adjustment between late 2008 and 2009,
led by a contraction of capital inflows, trade volume
and copper price. In contrast with a mostly neutral

Table 3

WAGES, 1990–2013

(Per cent)

1990–1998 1999–2013

GDP 7.1 3.9

GDP exported 9.9 4.3

Rest of GDP 6.5 3.8

Net capital formation
(per cent of GDP) 13.1 12.6

Index of real average wages 3.9 2.1

Real minimum wage 5.3 3.5

Source: Author’s calculations, based on Ffrench-Davis (2014,
table I.7).

Note: Data refer to annual average rates of growth unless
otherwise specified. Data for 2013 are provisional. Data
for net capital formation in 2010 were not adjusted for
an estimated drop of 3 per cent in the stock of capital
due to the destruction generated by the earthquake of
27 February; which would cut the average 1999–2013
ratio by 0.5 points.

89Is Chile a Role Model for Development?

approach since the late 1990s, the Government
adopted a resolute counter-cyclical approach, making
use of the sovereign fund that had been accumulated
during the boom in copper prices in accordance with
the structural fiscal balance approach adopted in 2001.

Expenditure was increased by 17 per cent and
some tax rates were reduced transitorily (on fuels,
loans, SMEs), despite fiscal income having fallen
10 per cent in 2008 and 20 per cent in 2009.11 This
implied a transitory actual deficit of 4.4 per cent of
GDP in 2009. The Central Bank sharply reduced the
monetary policy interest rate, albeit in a delayed deci-
sion. The strong counter-cyclical fiscal policy was the
main force compensating for the negative external
shocks. The domestic economy (GDP non-exported)
already exhibited a significant recovery push by the
last quarter of 2009, outlining the effectiveness of
the counter-cyclical fiscal policy.

The counter-cyclical behaviour of the Treasury
had to coexist with huge outflows of funds from
residents, principally the private social security
firms, which transferred abroad the equivalent of
10 per cent of GDP in 2009.12 The liberalization of
residents’ capital flows hampered macroeconomic
management for their pro-cyclicality joined that of
the financial flows of non-residents. The liberaliza-
tion of the capital account continued to be costly for

By the last quarter of 2009, the economic recov-
ery was well advanced, although it was momentarily
stopped by a severe earthquake on 27 February 2010,
only a few days before the end of President Bachelet’s
Government and the beginning of that of President
Piñera. In a few weeks, the recovery recommenced.
The high level of domestic demand, a consequence
of the counter-cyclical policy of 2009, was further
increased by reconstruction costs following the
earthquake of February 2010. Given that installed
capacity was significantly underutilized – despite the
destruction caused by the earthquake and the subse-
quent tsunami13 – the accelerated public expenditure
was consistent with a move toward macroeconomic
equilibrium (using capacity) as long as a recessionary
gap prevailed.

Indeed, in 2010, reconstruction spending
strongly contributed to the reactivation of domestic
demand and thus to that of GDP, without inflationary
pressures. Of course, the recessive gap was being
reduced during the adjustment period, increasing

employment and stimulating capital formation,
although there were no structural progress in the gen-
eration of GDP, manufacturing remained depressed
and export diversification stagnated. It was rather
the recovery effect. With recovery, employment
and income distribution improved, albeit returning
to the social achievements already attained by the

Actual GDP was increasing strong until 2012,
with an average 5.7 per cent annual rate over the
three-year period. To avoid the recurrent mistake
of confusing sustainable growth with recovery of
economic activity, it is necessary to measure per-
formance from peak to peak. If growth is measured
from the previous peak of 2007, actual GDP growth
averaged 3.9 per cent, which is consistent with the
fact that actual GDP only rose 4.1 per cent in 2013.
The economy had reached full capacity and the
4.1 per cent reflected the fact that potential GDP
growth was closer to that figure than to 5.7 per cent.14

It is similar to the 3.9 per cent growth of the previous
nine year period (1999–2007), but much lower than
the 7.1 per cent recorded in 1990–1998. Moreover,
average real wages and minimum wages had risen
much slower during the 15 years that followed since
1999 (see table 3).

Slow economic growth and social indicators
returning to achievements conquered almost two
decades ago do not provide a “model” of develop-
ment. However, there is more. The transition from the
recessionary gap to close to full employment and use
of potential GDP undoubtedly reflects one essential
macroeconomic balance. Nonetheless, macroeco-
nomic equilibria cover other important dimensions
than inflation under control, including external and
comprehensive fiscal balances. Therefore, to achieve
sustainability, fiscal and external accounts must also
converge to a sustainable balance when the recessive
gap disappears.

Very early in the transition of actual GDP toward
potential GDP, there was a significant exchange rate
appreciation and new permanent public expenditures
without the corresponding permanent fiscal income.
As a result, when the recessionary gap disappeared in
2012 and early 2013, two macroeconomic disequilib-
ria had emerged: (i) a strongly overvalued exchange
rate; and (ii) a public budget supported by transitory
high copper prices. For several years, imports and
fiscal expenditure were growing much faster than
the quantum of exports and tax proceeds.

90 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

During 2009, the external sector regained a
surplus due to jumps in the copper price. Meanwhile,
after having experienced a strong revaluation up to
$435 pesos to the dollar in March 2008, the exchange
rate underwent a sharp devaluation, reaching $650
by late 2008. Then, it responded to the subsequent
dominant expectation that Chile was emerging from
the crisis. Consequently, there was a new trend
toward appreciation, with the exchange rate having
appreciated to $460 by mid-2011.

These intense fluctuations are in sharp contrast
with the view that the exchange rate is a determinant
variable for the allocation of resources for export-
ers and those competing with imports. Evidently,
derivatives markets do not solve the obstacle that
instability brings for decision-makers of irreversible
investment; rather, this instability is quite detrimental
to development.

Table 4 shows that imports grew notably faster
than GDP and exports for a full decade, with the gap
financed by a high price of copper. Notwithstanding
that high price – probably a transitory high one – the
current account was exhibiting a 3.4 per cent of GDP
deficit in 2012–2013. Additionally, a previous trend
towards some export diversification had been stagnat-
ing (a sort of Dutch disease was at work).

The fiscal disequilibria are also depicted in
table 4. In this six-year period, GDP increased by
26 per cent, while fiscal expenditure rose by 52 per

cent, without any significant tax reform. The dif-
ference was covered by fiscal income from copper
exports.15 In fact, there is a dangerous dependence
of public expenditure and private imports on a high
copper price.16 Several permanent increases in public
expenditure – such as continued implementation of
the social security reform of 2008, increase in post-
natal benefits and elimination of a 7 per cent tax on
some pensions – have been financed to a minor degree
by a tax adjustment that raised the rate on profits
but reduced the progressive income tax. Financing
has mostly come from the transitory tax proceeds
generated by copper. In 2012, the Treasury spent the
equivalent of fiscal revenue from copper correspond-
ing to a $3.30 price per pound, compared with less
than (a current) $1.00 in 2004–2007.

Obviously, permanent expenditure already at
work and other required to finance new public goods
and inclusive productive development demand a
substantive tax reform that collects in a progressive

In brief, the inflation rate had been notably
moderate. In contrast, there have not been sustain-
able balances between (quantum) export supply
and import demand, nor between permanent public
expenditures and structural tax income, as well as
between the evolution of aggregate demand and
potential GDP. The real economy has responded with
a modest 3.9 per cent average GDP growth, lower
than the 7.1 per cent recorded in 1990–1998.

Table 4


2007 2012 2013
Annual average growth

(Per cent)

GDP 100.0 121.0 125.9 3.9
Exports 100.0 103.0 107.9 1.3
Imports 100.0 140.9 145.6 6.5
Real fiscal expenditure 100.0 146.5 152.4 7.3
Real fiscal non-copper income 100.0 132.0 136.1 5.3
Domestic demand 100.0 135.6 140.2 5.8

Source: Author’s calculations, based on Ffrench-Davis (2014, table X.5).

91Is Chile a Role Model for Development?

One distinctive feature of neo-liberalism is its
neglect of the implications of initial inequality and
sectoral imbalances; of the heterogeneity in produc-
tive structures, among diverse economic agents, and
in access to voice and power of different sectors;
of the social and allocative implications of market
segmentations; and of the difficulty of transparently
transmitting information to diverse economic agents
so that they can face comparable opportunities.

Ultimately, neo-liberalism underestimates
the frequent presence of destabilizing adjustment
processes, lags and overshooting, as well as the
incompleteness of markets and institutions in
developing nations. These elements represent severe
obstacles that prevent “neutral” and indirect global
economic policies from being effective.

Excepting the first years of return to democracy in
1990, an output gap prevailed for most of the time. The
Chilean economy has been out of real macroeconomic
equilibria, with significant output gaps, with only in
1991–1997, 2007 and 2012–2013 operating close
to potential GDP. Furthermore, a quite unstable and
outlier exchange rate has worsened trade performance.

The specific policies and approaches used in
each of the three episodes varied, evolving from
the extreme naiveté of the 1970s into the pragmatic
approach of the early 1990s. The end of the century
saw a move away from macroeconomic sustainabil-
ity as authorities gave in to the temptation to move
toward financial globalization without properly tak-
ing account of the underlying risks.

For both growth and equity, it is necessary to
reach sustainable real macroeconomic balances.
Beyond low inflation and fiscal responsibility, an
exchange rate management functional for pro-
ductive development and an active management
of aggregate demand in levels consistent with
productive capacity are also required. The recent
performance has been deficient on this matter. In
returning to macroeconomic policies for develop-
ment, the regulation of speculative capital flows
deserves top billing among the list of actions for
inclusive development.

Nonetheless, real macroeconomics is not
enough. The 1990s experience was notably success-
ful in growth with stability, although productive
structures improved too mildly, as well as income
distribution. It implied progress toward develop-
ment, albeit in an incomplete manner. For long-term
sustainability, the economic agenda requires further
deep reforms to “complete” long-term innovative
financing for development (with pro-SMEs and
pro-employment biases), labour training and tech-
nological innovation, among others.

The strong expressions of domestic discon-
tent present in recent years can be interpreted as
a reinforced message of the urgent need to design
and implement coherent strategies and make major
inclusive reforms to productive structures and public
social and economic policies. The great challenge
is to move towards comprehensive development
with an increasingly inclusive and more equitable
productive system.

III. Closing remarks


1 Details are analysed in Ffrench-Davis (2010, chap-
ter VIII) and Lefort and Lehmann (2003).

2 The measurement of economic growth should be
made between comparable macroeconomic situa-
tions. We compare years with a high level of capacity
use, namely those with actual GDP close to potential
GDP. Significant recoveries of economic activity
such as in 2004–2008 and 2010–2012 came after
recessions that cannot be ignored. On the contrary,
the vigorous growth from 1990–1998 followed an
overheating economy in 1989.

3 In 1979, Chile moved to the then known as “monetary
approach to the balance of payments”, which involved
fixing the nominal exchange rate and determining that

the money supply would only be increased (reduced)
in response to purchases (sales) of dollars by the
Central Bank. It is similar to the “currency board”
adopted by Argentina in 1991 and that collapsed in
the midst of a dramatic crisis in 2001–2002.

4 Pro-cyclical monetary and exchange rate domestic
policies were aggravated by a huge jump in interest
rates in the United States in late 1979 and the dollar
appreciation in 1981, which additionally raised the
cost of the outstanding foreign debt.

5 Based on the national accounts, the share of “trad-
ables” was estimated to have fallen about 5 percent-
age points of GDP, instead of increasing as expected
with trade liberalization.

92 Rethinking Development Strategies after the Financial Crisis – Volume II: Country Studies and International Comparisons

6 In his interesting evaluation of the experiment,
Foxley (1983) presents several revealing citations,
including one from an editorial of the Wall Street
Journal: “USA should borrow the economic team of
Chile” (18 January 1980), referring to the incoming
Reagan presidency.

7 See, for instance, the classical paper by Calvo,
Leiderman and Reinhart (1993).

8 The reforms approved by the Parliament (including
the tax reform) were always less comprehensive
than those originally proposed by the Government.
A determining factor was the group of senators
appointed under the Constitution designed by the
dictator Pinochet in 1980, which more than com-
pensated for the majority achieved by candidates of
the new democratic Government in 1989 and 1993
parliamentarian elections.

9 In Ffrench-Davis (2010 and 2014), I conduct a
detailed analysis of empirical literature critical and
supportive of the working of the encaje.

10 Good luck also played a role, with a sharp improve-
ment in the terms of trade in 1995, although it still
remained 20 per cent below the average in the last
biennium of the dictatorship.

11 Ffrench-Davis (2014, ch. IX, table IX.2). This
chapter discusses policies between the contagion of
the Asian crisis and the start of the global crisis.

12 Ffrench-Davis (2014, ch. X, table X.1). This chap-
ter details the policy answer to the contagion in
2008–2009, recovery in 2010–2012, and building
of dependency on a very high price of copper.

13 The Central Bank estimated that potential GDP had
been reduced by 1.0 to 1.5 per cent by the earthquake
and tsunami.

14 To be accurate, adjustment must be made for the
destruction by the earthquake of February 2010 of
capacity by adding 1–1.5 percentage points for the
loss of potential GDP, thus arriving at an annual
average for growth of close to 4.1 per cent in the
six-year period 2008-2013. An additional adjustment
could be made if it is assumed that the contribution
of export volume to GDP growth would increase if
world trade was normalized.

15 Real tax income from copper depends on both its real
price and the costs of production, which have been
increasing fast in real terms. Note that as the Chilean
tax system is highly dependent on the VAT, tax rev-
enue grows faster than GDP as the external deficit
increases as happened in 2010–2013. See table 4.

16 Based on the significant revenue from copper mining,
the opponents of tax reform have claimed that there
are “sufficient fiscal resources.” They do so without
examining the need to revise downwards sustainable
revenue, with a “reasonable” trend estimate of cop-
per prices.


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Volume I: Making the Case for Policy Space
Edited by
Alfredo Calcagno, Sebastian Dullien, Alejandro Márquez-Velázquez, Nicolas Maystre and Jan Priewe

United Nations publication, sales no. E.15.II.D.9

ISBN 978-92-1-112894-9

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

Alfredo Calcagno

Jan Priewe

Eric Helleiner

Veerayooth Kanchoochat

Robert H. Wade

Roberto Frenkel and Martín Rapetti

Rachel Denae Thrasher and Kevin P. Gallagher

The first volume of this publication appeared in September 2015. Below are the contributions to volume I.