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Towards a new paradigm for development: Strategies, policies, and process

Presentation by Dr. Joseph E. Stiglitz, 2000

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What: This lecture sets out the foundations of an alternative paradigm to the well-documented failures of the Washington consensus, one which is based on a broad conception of development, offering a different perspective on the role of international assistance and the ways in which it should be delivered. It starts by describing this broader vision and then goes on to explain why not only the Washington consensus but also earlier development paradigms failed: they viewed development too narrowly. It identifies some of the key factors including recent events in East Asia and the Russian Federation that helped us to realize the inadequacies of the old approaches. It outlines the key principles and major components of a development strategy based on this broader vision of development. It concludes with some general observations, focusing on the importance of trade and the work of UNCTAD in furthering development based on this new paradigm. Who: For teachers and students of development strategies. How: Can be used as a background reading material on development approaches and issues.

TOWARDS A NEW PARADIGM FOR DEVELOPMENT:
STRATEGIES, POLICIES AND PROCESSES







In an address to the World Institute for Development Economics Research (WIDER) in
Helsinki at the beginning of this year,1 I argued that we needed to go beyond the Washington
consensus:2 there were broader objectives to development than were embodied in that consensus,
the set of policy recommendations upon which it focused was certainly not sufficient for
development, and indeed some of the most successful developers had paid little heed to its
dictums. That consensus all too often confused means with ends: it took privatization and trade
liberalization as ends in themselves, rather than as means to more sustainable, equitable and
democratic growth. I talked there about many of the ways in which the Washington consensus had
gone astray. It focused too much on price stability, rather than growth and the stability of output.
It failed to recognize that strengthening financial institutions is every bit as important to economic
stability as controlling budget deficits and increasing the money supply. It focused on privatization,
but paid too little attention to the institutional infrastructure that is required to make markets work,
and especially to the importance of competition.


In today’s lecture, I want to go beyond these by now well-documented failures of the
Washington consensus to begin providing the foundations of an alternative paradigm, especially
one relevant to the least developing countries. It is based on a broad conception of development,
with a noncomitantly broader vision of development strategies and a quite different perspective on
the role of international assistance and the ways in which it should be delivered. The remainder of
this lecture is organized around five parts. First, I shall describe this broader vision. Second, I
shall explain why not only the Washington consensus but also earlier development paradigms
failed: they viewed development too narrowly. I shall outline briefly some of the key factors –
including recent events in East Asia and the Russian Federation – that have helped us realize the
inadequacies of the old approaches. Third, I shall outline what I refer to as the key principles of a
development strategy based on this broader vision of development. Fourth, I shall outline the
major components of these new development strategies. And fifth, I shall conclude with some
general observations, focusing on the importance of trade and the work of UNCTAD in furthering
development based on this new paradigm.



1 Stiglitz (1998a)


2 Throughout this speech, I have in mind a somewhat different conception of the Washington consensus than
the one orginally outlined by my colleague John Williamson (1990), who coined the term. As Williamson (1997)
himself notes, the term has evolved over time to signify a set of “neoliberal” policy prescriptions, rather than the more
descriptive usage that he originally intended in discussing reforms undertaken by Latin American economies in the
1980s. Tthe policies that now fall under the “Washington consensus” rubric are often – and, as I argued in my
WIDER lecture, incorrectly – taken to be both necessary and sufficient for substantial development.




I. Development as a transformation of society


Development represents a transformation of society, a movement from traditional
relations, traditional ways of thinking, traditional ways of dealing with health and education,
traditional methods of production, to more “modern” ways. For instance, a characteristic of
traditional societies is the acceptance of the world as it is; the modern perspective recognizes
change, it recognizes that we, as individuals and societies, can take actions that, for instance, reduce
infant mortality, extend lifespans and increase productivity. Key to these changes is the movement
to “scientific” ways of thinking, identifying critical variables that affect outcomes, attempting to
make inferences based on available data, recognizing what we know and what we do not know.


All societies are a blend. Even in more “advanced” societies there are sectors and regions
that remain wedded to traditional modes of operation, and people wedded to traditional ways of
thinking. But while in more advanced societies these constitute a relatively small proportion, in
less advanced societies they may predominate. Indeed, one characteristic of many less developed
countries is the failure of the more advanced sectors to penetrate deeply into society, resulting in
what many have called “dual” economies in which more advanced production methods may co-
exist with very primitive technologies.


Change is not an end in itself, but a means to other objectives. The changes that are
associated with development provide individuals and societies with more control over their own
destiny. Development enriches the lives of individuals by widening their horizons and reducing
their sense of isolation. It reduces the afflictions brought on by disease and poverty, not only
increasing lifespans, but improving the vitality of life.


Given this definition of development, it is clear that a development strategy must be aimed
at facilitating the transformation of society, in identifying the barriers to, as well as potential catalysts
for, change. These notes outline some of the ingredients of such a new development strategy.
Approaching development from the perspective of transforming society has profound implications
not only for what Governments and aid agencies do, but also for the way in which they proceed –
how they engage, for instance, in participation and partnership. Thus, this paper can be seen as
providing an analytic framework for much of the rethinking that has been occurring in the last few
years about how best to promote development.




II. The need for a new development strategy


The experience of the past 50 years has demonstrated that development is possible, but not
inevitable. While a few countries have succeeded in rapid economic growth, narrowing the gap
between themselves and the more advanced countries, and bringing millions of their citizens out of
poverty, many more countries have actually seen that gap grow and poverty increase. Today the
number of people living in poverty – even measured by the minimal standard of a dollar a day – is
about 1.3 billion.3 Strategies of the past, even when they have been assiduously followed, have not
guaranteed success. Furthermore, many of the most successful countries (representing the largest
part of growth within the low income countries) have not actually followed the recommended
strategies, but have carved out paths of their own.

What development is not: a critique of previous conceptions


Many previous development strategies have focused on pieces of this transformation, but
because they have failed to see the broader context, they have failed, and often miserably. Most of
these have focused narrowly on economics. Economics is important: after all, one of the features
which distinguishes more developed from less developed countries is their higher gross domestic
product (GDP) per capita. But the focus on economics has confused not only means with ends,
but also cause with effect. It has confused means with ends, because higher GDP is not an end in
itself, but a means to improved living standards and a better society, with less poverty, better health,
and improved education. Contrary to Kuznets’s contention, by and large, increases in GDP per
capita are accompanied by reductions in poverty.4 It has confused cause with effect, because to
some extent, the changes in society which may be called “modernization” are as much a cause of
the increases in GDP as a result.



3 While the fraction of the world’s population in absolute poverty – living on under $1 a day – has declined


from an estimated 30.1 per cent in 1987 to 29.4 per cent in 1993, the total number of poor has increased, from 1.23
billion to 1.31 billion (World Bank, 1996). The soaring population in some of the poorest countries makes the battle
against poverty an uphill fight.


4 For instance, Deininger and Squire (1996) find that 77 out of 88 decade-long periods of growth were
accompanied by reductions in poverty. While from today’s vantage point this may not seem surprising, it seems at
odds with the conventional wisdom of the Kuznets curve. Kuznets argued that in the early stages of development,
growth would be associated with increases in inequality; in fact, Deininger and Squire find that inequality fell as
often as it rose during periods of growth. Kuznets, however, lacked the extensive cross-country datasets we have
today, and his conclusion was based on data from only a handful of countries.




For more than four decades, development was seen (at least by those in the mainstream) as
mainly a matter of economics – increasing the capital stock (either through transfers from abroad
or through higher savings rates at home) and improving the allocation of resources. These changes
would lead to higher incomes and hopefully higher sustained growth rates.5 Less developed
countries were portrayed as identical to more developed countries – except perhaps in the extent
of the inefficiencies in resource allocations (which, in turn, were related to the greater incidence of
missing or malfunctioning markets). Economists of the left and the right differed in how best to
improve resource allocation, and what role government should play. Economists of the left
attributed the underlying problems to market failures. The thrust of the development
programming models that were popular in the 1960s was for government, using these models, to
replace the absent and imperfect markets, to guide the economy towards a more efficient allocation
of resources. Economists of the right assumed, by contrast, that government was the problem:
once government could step out of the way, markets by themselves would lead to efficient resource
allocation. Thus both saw the problem of development as one of improving resource allocation;
they simply had different strategies for improving resource allocation. One sought to use
government to complement markets, the other sought to reduce the role of government, which was
seen as part of the problem of development, rather than as part of the solution. It was argued that
Governments claimed for themselves a role for which they were intrinsically unsuited. And
overall, they claimed for themselves too large a role. Not only did they lack the capabilities to
undertake a major role in resource allocation, but incentives in the political process ensured that
whatever capabilities they had were often directed not at increasing national production, but at
diverting rents to the politically powerful. The solution, in this perspective, was reliance on
markets, and in particular, the elimination of government-imposed distortions associated with
protectionism, government subsidies and government ownership.


In the 1980s, the focus shifted to macroeconomic problems, to the adjustment of fiscal
imbalances and misguided monetary policies. Given the macroeconomic imbalances, it was
impossible for markets to function, or at least function well.


Notice that all three of these development strategies saw development as a technical
problem requiring technical solutions – better planning algorithms, better trade and pricing
policies, better macroeconomic frameworks. They did not reach deep down into society, nor did
they believe such a participatory approach was necessary. The laws of economics were universal:
demand and supply curves and the fundamental theorems of welfare economies applied as well to
Africa and Asia as they did to Europe and North America. These scientific laws were not bound
by time or space.

The lessons of history


As remarkable as the narrow focus of these approaches was their lack of historic context.
They failed to recognize that: (a) successful development efforts in the United States as well as
many other countries had involved an active role for government; (b) many societies in the decades
before active government involvement – or interference, as these doctrines would put it – failed to
develop; indeed, development was the exception around the world, not the rule; and (c) worse still,
capitalist economies before the era of greater government involvement were characterized not only
by high levels of economic instability, but also by widespread social and economic problems; large
groups, such as the aged and the unskilled, were often left out of any progress and were left
destitute in the economic crashes that occurred with such regularity.


Indeed, one of the puzzles is how these narrow approaches could ignore the failure of


5 Ironically, the growth theory literature that helped give rise to this conception of development emphasized
that higher savings rates would lead to higher growth rates only temporarily.




certain regions within seemingly developed countries to develop, such as the south of Italy. No
trade barriers separated the north from the south; the overall macroeconomic framework in both
regions was the same; and the south even benefited from economic policies specifically designed to
encourage it. Yet while the north boomed, the south stagnated. This by itself should have
suggested that there was more to development than was acknowledged by the technical approaches;
for instance, trade liberalization, as valuable as it might be, would not solve the probelm of Italy’s
south.

Defining Events


Three events of the past quarter-century have played a central role in helping to shape
views concerning development strategies.

Collapse of the socialist/communist economies and the end of the cold war


The first event is the collapse of the socialist/communist economies and the end of the cold
war. Some observers have focused on a single lesson that emerges – the inefficacy (and dangers) of
a large government role in the economy. From this, some jump to the opposite conclusion: that
reliance should be placed on markets.


But the failure of the communist system was as much a failure of the political and social
order on which it was based as of the economic system itself. The economic models that showed
the equivalence between market socialism and capitalist economies were fundamentally
misguided,6 partly because they did not grasp the role of institutions (beyond abstract markets) in
the economy, but partly because they did not grasp the importance of the interface between the
economy, narrowly defined, and society more generally.7


There are broader implications of the end of the cold war: the ideological debates should
be over; there should be agreement that while markets are at the centre of the economy,
Governments must play an important role. The issue is one of balance, and where that balance is
may depend on the country, the capacity of its Government, and the institutional development of
its markets. In other words, development advice should be adapted to the circumstances of each
country.

The limitations of the Washington consensus


The second defining event was that many countries followed the dictums of liberalization,
stabilization and privatization, the central premises of the so-called Washington consensus, and still
did not grow. The technical solutions – the prescriptions of the Washington consensus – were
evidently not enough. This should not have come as a surprise; as I noted before, history was not
encouraging. Moreover, developments in theoretical economics, many of which emphasized the
limitations of the market, should have served to provide insights into both the historical as well as
the more recent “market failures” of the Russian Federation and East Asia.



6 See Stiglitz (1994).


7 The inadequacy of the traditional perspectives is nowhere more apparent than in the experience over the past decade
in the former Soviet Union (discussed below), particularly in contrast to the successful experiences in China, which
managed to find strategies well adapted to its particular situation. The following is one measure of China’s success in
devising a strategy: if the separate provinces of China were treated as separate data points, the 20 fastest-growing
economies in the world between 1978 and 1995 would all have been Chinese (World Bank, 1997a).


In many ways, the problems in the Russian Federation seem of a very different nature than




those in East Asia, which I will discuss in greater detail in a moment: in the Russian Federation, we
see an economy in transition facing huge government deficits and severe political problems. Yet
there are some common threads. In both cases, the Washington consensus failed, and for similar
reasons: a failure to understand the subtleties of the market economy, to understand that private
property and “getting prices right” (that is, liberalization) are not sufficient to make a market
economy work. An economy needs an institutional infrastructure. To be fair, the failures in the
Russian Federation were of an order of magnitude greater than those in East Asia, which had had
remarkable growth, stability and reductions in poverty over a span of more than a quarter-century.
While the banks in East Asia lacked adequate supervision, the banks in the Russian Federation not
only lacked that supervision, they did not even perform their core function of providing capital to
new and growing enterprises. We all know that the standard theorems of economics emphasize
that an economy needs both private property and competition. The Washington consensus, while
occasionally paying lip service to the latter, placed its emphasis on the former, thinking that with
private property, at least owners would have an incentive to increase efficiency. Worries about
distribution and competition – or even concerns about democratic processes being undermined by
excessive concentration of wealth – could be addressed later! The Russian Federation succeeded
in turning ordinary economic laws on their head, in that it managed to reverse the usual trade-offs
between equity and efficiency. Reforms such as moving from inefficient central planning to a
decentralized pricing mechanism, from inefficient State ownership to private property and the
profit motive, should have increased output, even if perhaps at the price of a slight increase in
inequality. Instead, the Russian Federation achieved a huge increase in inequality, at the same time
that it managed to shrink the economy, by up to a third according to some estimates. Living
standards collapsed with GDP statistics, as life spans were shortened and health worsened. All too
late, it was recognized that without the right institutional infrastructure, the profit motive –
combined with full capital market liberalization – could fail to provide incentives for wealth
creation and could instead spark a drive to strip assets and ship wealth abroad.

The East Asian miracle


The third defining event was the East Asian miracle: the rapid growth of the countries of
East Asia showed that development was possible, and that successful development could be
accompanied by a reduction of poverty, widespread improvements in living standards, and even a
process of democratization. But for those advocating the technical solutions, the East Asian
miracle countries were deeply disturbing, for these countries did not follow the standard
prescriptions. In most cases, Government played a large role. They followed some of the
standard technical prescriptions, such as (by and large) stable macroeconomic policies, but ignored
others. For example, rather than privatizing, some Governments actually started some highly
productive steel mills, and more generally pursued industrial policies to promote particular sectors.
Governments intervened in trade, though more to promote exports than to inhibit particular
imports. And Governments regulated financial markets, engaging in mild financial restraint,
lowering interest rates and increasing profitability of banks and firms (as opposed to financial
repression, which results in negative real interest rates). Many of the policies on which the
Governments focused were simply areas that had been ignored in the past; these included, for
example, the heavy emphasis on education and technology, and on closing the knowledge gap
between them and the more advanced countries.8 While the impact of individual policies remains
a subject of dispute, the mix of policies clearly worked well. Perhaps if these countries had
followed all the dictums of liberalization and privatization, they would have grown even faster, but
there is little evidence for that proposition. In some cases, such as financial restraint, there is some
evidence – as well as a considerable body of theory – that suggests that these policies did enhance
growth.


8 Though, to be sure, these had been important components of the United States development
strategy in the nineteenth century.





But perhaps the most important lesson of East Asia was that, to a large extent, the countries


there succeeded in a transformation of their societies, a fact that is evident to any visitor to the
region. To be sure, the transformation is far from complete: witness the sectors in several of these
countries that exhibit rigidities and have failed to adopt modern technologies and modes of
business. And while the crisis facing East Asia today has raised questions in many circles
concerning the East Asian miracle the fact of the transformation remains. Even if these countries
face a few years of zero or even negative growth, their per capita GDP as they enter the twenty-first
century will be a multiple of what it was a half-century ago, and far higher than countries that have
pursued alternative development strategies. Equally importantly, poverty rates will be a fraction of
what they were a half-century ago, though undoubtedly higher than at the beginning of the decade.
Literacy will remain near-universal, and health standards will remain high. A careful reading of the
East Asian experience over the last several decades – of what strategies led to those remarkable
achievements – will reveal that many of the views reflected here were incorporated in the
development strategies of the fastest developers.9

The East Asian crisis


This is not the place for an extended exegesis either of the cause of the crisis or its depth,
and I have spoken extensively about these matters elsewhere.10 Nevertheless, there are important
lessons to be learned from the crisis concerning the design of development strategies. These
lessons have not been completely lost on the world over the past year, even if they have at times
become, in my view, somewhat muddled.


To show how views about development have begun to change because of the crisis, it is
worth thinking back to 1997. How much the world has changed in but a short year! A little more
than a year ago, in Hong Kong, China, there was a debate about extending the charter of the
International Monetary Fund (IMF) to include a mandate for capital market liberalization. Critics
of hedge funds were seen as financial Luddites who wished to reverse the course of history and the
inevitable domination of free markets.


Today, there is widespread recognition that even countries that pursue good economic
policies can suffer from the volatility of short-term capital flows. While the risks and market
failures (including externalities associated with contagion and systemic failures11) associated with
short-term capital flows have now become apparent, the benefits, especially for countries like those
in East Asia with high savings rates, remain unproven.12 But the East Asian crisis has raised
questions about the Washington consensus itself: the source of the problems were items that were
simply not emphasized in the earlier policy prescriptions. Ironically, in identifying these new
sources of potential problems, much of the popular discussion has shifted attention away from
another set of problems – that associated with the financial and capital market liberalization which
were a central part of the Washington consensus.


9 See World Bank (1993) and Stiglitz (1996).


10 See, for instance, Furman and Stiglitz (1998) and Stiglitz (1998b) and (1998c).


11 The arguments for bailouts, as well as the very existence of bailouts, provide overwhelming support for the
view that there may be marked discrepancies between private and social net returns on short-term capital movements.
These discrepancies at the very least call for a review of feasible government actions to redress this market failure,
which has imposed such huge costs on millions and millions of people (though to be sure, some of these costs might
have been reduced if the crisis-response policies had been better designed).


12 See Furman and Stiglitz (1998) for a discussion of both the evidence and the theory explaining why the
result that liberalization does not yield higher growth (see, e.g., Rodrik, 1998) should not come as that much of a
surprise.





Thus, while the countries of East Asia that encountered economic problems were widely


chastised for having weak financial institutions, the Washington consensus had failed to stress that
weak financial institutions could be as important a source of macro-instability as excessive
government deficits. And much of the recent discussions have failed to note the role that financial
market liberalization – often under pressure from outsiders – played in contributing to the
weaknesses in financial institutions.13 It is far easier to strip away regulations than to create the
requisite institutional infrastructure for financial markets to function. For a recent reminder of the
difficulties of regulating financial institutions (including banks) – even in the most developed
economies – we need only consider the bailout of Long-Term Capital Management, the huge
hedge fund based in the United States that reportedly had an exposure of more than a trillion
dollars before its crash.14


Indeed, it can be argued that excessively risky lending and inadequate financial-sector
supervision in the developed countries contributed to the crisis. We now realize that for every
borrower there is a lender, and the lender is as much to blame as the borrower. Thus, if the
borrowers in East Asia are to blame, so too are the lenders from developed countries. And to the
extent that the foreign banks were marginal lenders, they deserve even more of the blame: foreign
lenders to the Republic of Korea’s highly leveraged firms (or to banks that had themselves made
extensive loans to highly leveraged firms) knew that these enterprises’ debt-equity ratios were far
higher than any financial analyst would have called prudent. Yet supposedly well-managed banks,
supervised by supposedly sophisticated regulatory authorities, made these loans. Moreover, these
loans were not driven by government pressure. Is there a suggestion that in some countries bad
loans result only from crony capitalism, while in others they result from the natural working of
market processes?15


The East Asian crisis has put a sharper spotlight not only on financial institutions, but also
on broader aspects of political and economic life. For instance, a lack of transparency has been
widely identified as having contributed to the crisis. There is little econometric evidence to support
that conclusion16 – and our scepticism is reinforced when we remember that the previous three
major crises occurred in Scandinavian countries, which are among the most transparent in the
world. But the emphasis on transparency is welcome, in that it raises the importance of broader
societal issues. Transparency is necessary for effective participation in decision-making, and
participation, I shall argue, is an essential part of successful development as a transformation of
society.


13 Research by Demirgüç-Kunt and Detragiache (1998) in fact shows the systematic relationship between
financial market liberalization and economic crises.


14 The bailout has raised a lot of questions that put a new perspective on the charges in East Asia: Did the
bailout represent crony capitalism, given that one of the partners in the hedge fund was a former vice-chairman of the
Federal Reserve Board? Did the regulators really not realize the size of the threat? And if so, what does this say about
the supervisory capacity of supposedly the most sophisticated regulators in the world, with the longest tradition of
regulation, extending for almost a centrury and a half? If not, what does this say about their understanding of financial
markets? Or was the defence of the government role – the threat of contagion – just a cover-up? While Federal funds
were allegedly not involved, did the discretionary regulatory powers provide implicit threats (of tighter supervision in
the case of non-cooperation) and promises (of regulatory forbearance if the bailout proved costly)? Was there a
deliberate attempt by all participants to restrict transparency, by not revealing to the market all the relevant
information?


15 For instance, there is no evidence that government pressures caused the excessive real-estate lending in
Thailand.


16 See, in particular, Furman and Stiglitz (1998), who show that transparency in East Asia on average (at least as
gauged by standard measures) was no less than in other countries that did not experience a crisis; the crisis countries of
East Asia had had three decades of remarkable growth, yet, if anything, transparency had increased rather than
decreased prior to the crisis.




III. The principles of the new development strategy


The new development strategy takes as its core objective development, the transformation
of society. It recognizes that an integral part of successful development is the increase in GDP per
capita. But this is only part of the story, and even this will not be achieved unless the country
adopts a broader development focus. If successful, the new development strategy will not only
raise GDP per capita, but also living standards, as evidenced by standards of health and literacy. It
will reduce poverty – our goal should be its elimination, a goal that the more successful economies
have actually attained (at least by the absolute poverty standard). It will be sustainable,
strengthening the environment. And the real societal transformations will enhance the likelihood
that the underlying policies will be durable, withstanding the vicissitudes sometimes accompanying
democratic processes.


The discussion on principles is divided into three sections: what development strategies are,
and how they differ from plans; how we can catalyze society-wide change; and why participation
and ownership are crucial.

The concept of development strategies


Corporations have increasingly found corporate strategies of use in guiding their thinking
and longer-term investments. Development strategies need to be thought of in the same light,
rather than as the detailed programming models and development plans of the past, which
originally grew out of an attempt to make central planning work. Development strategies, while in
some ways less detailed than these planning documents, are in many ways more ambitious, for
they set out a strategy not just for the accumulation of capital and the deployment of resources, but
for the transformation of society.


A development strategy needs to set forth the vision of the transformation, what the society
will be like 10 to 20 years from now. This vision may embrace certain quantitative goals, such as a
reduction in poverty by half, or universal primary education, but these are elements in or targets for
the transformation process, not the vision of the transformation itself.


This vision needs to include a view of the transformation of institutions, and the creation of
new social capital and new capacities, in some cases to replace traditional institutions that will
inevitably be weakened in the process of development. In other cases, the new institutions will
contain within them elements of the old; there will be a process of evolution and adaptation. Some
of these transitions may be difficult, either to articulate or to implement: How will societies that
have traditionally discriminated against women achieve a higher degree of equality, at the same
time that they maintain traditional values?


A development strategy has sometimes been likened to a blueprint, a map of where the
society is going. But this metaphor is misleading, and understanding why helps us to see the
difference between plans of the past and development strategies of the future. The development
process is too difficult for us to write down today a blueprint or a map of where the economy will
be going over the next ten years, let alone a quarter of a century. Doing so requires too much
information, and knowledge that is not currently available. In the past, planning documents have
failed to take into account virtually any of the major uncertainties facing the development process.
While in principle a development plan could map out how the economy would respond to the
myriad of different contingencies that might occur in the coming years, in practice this is seldom
done.


By contrast, a development strategy is a living document: it needs to set forth how it is to
be created, revised and adopted, the process of participation, the means by which ownership and




consensus is to be obtained, and how the details will be fleshed out.


The development strategy fulfils several functions as it sets forth its vision for the future.

Development strategies and priorities


All societies are resource-constrained; poor countries even more so. Beyond general
resource constraints are the constraints on the capacity of government, the limitations on the
number of issues which it can pursue. While there are many pressing needs, it is imperative that
the development strategy set priorities. A key aspect of prioritization is an awareness of
sequencing: what tasks have to be done before other tasks. It may, for instance, be essential to
establish a competition and regulatory framework before privatization; or it may be essential to
establish a financial regulatory framework before capital market or financial sector liberalization.

Development strategies and coordination


In traditional economic theory, prices perform all the coordination that is required in an
economy. But this requires a full set of markets – an assumption that patently is not satisfied in less
developed countries. Having a sense of where the economy is going is essential: if, for instance, an
economy is to move to the next stage of development, the appropriate infrastructure, human
capital and institutions all have to be in place. If any of the essential ingredients is missing, the
chances of success will be greatly reduced. Not only must there be coordination of different
agencies within and among levels of government, there must be coordination between the private
sector and the public, and among various parts of the private sector.


The kind of coordination provided by the development strategy is markedly different, both
in spirit and detail, from the kind envisioned (but never actually achieved) in indicative planning.
While indicative planning saw itself as a substitute for missing markets, attempting to provide
detailed coordination of input and output decisions of various industries, development strategies
focus more on the broader vision, including entry into new technologies or new industries.

Development strategies as consensus-builders


The process of constructing a development strategy may itself serve a useful function, in
helping build a consensus on a broad vision not only of the country’s future, and key short- and
medium-term objectives, but also of some of the essential ingredients for achieving those goals.
Consensus-building is not only an important part of achieving political and social stability (and
avoiding the economic disruption that comes when claims on a society’s resources exceed the
amount available17); it also leads to “ownership” of policies and institutions, which in turn enhances
the likelihood of their success.

Catalysing society-wide change: beyond enclaves and projects



17 For an analysis of the effects of hyperinflation, often caused by such an imbalance between resources and


objectives, see Bruno and Easterly (1998).


If the transformation of society is at the heart of development, the question becomes how
to bring these changes about. One of the major roles of the development strategy is to serve as a
catalyst, for example by identifying the areas of a country’s dynamic comparative advantage.
Identifying these areas and publicizing such information is a public good, and as such is a
responsibility of government.

Transforming whole societies





To be effective, this attempt to serve as catalyst will need to embrace the ambitious goal of


encouraging society-wide transformation. Earlier, we noted that all too often, development efforts
succeeded in transferring technology without transforming societies, in the process creating dual
societies with pockets of more advanced technology but little more. In a sense, duality – in which
only isolated enclaves are developed – represents a failure of the development process. Our goal is
to understand in part what went wrong, and why these enclaves did not serve as “growth poles”,
catalysts of development beyond their narrow confines.


The same could be said about many development projects. A project may be good in the
sense that it yields high project returns, but it may have little development impact. Of course, high
returns are better than low, but if benefits do not spread to the broader society, then the project
cannot be judged a true success.


In some cases, the lack of development impact may result from fungibility: a country has a
range of projects that it wishes to undertake, some with high social returns and some with low,
perhaps even negative, returns (sometimes because they are designed primarily to enrich the ruling
elites). The country “sells” the good projects to the aid donors, which allows it to shift its own
resources from those projects to others that have low social returns. Ascertaining the additionality
associated with a project – what occurred that would not otherwise have happened – is often
difficult if not impossible. But, in any case, we should be aware that the marginal contribution may
be far different from the way it appears at first blush.


Part of the Government’s role as a catalyst is to undertake projects that can lead to social
learning – that is, projects from which the country can draw widely applicable lessons, for instance
about the viability of an industry. The benefit of the investment is not just the direct returns from
the project, but also what can be learned for other projects from its success or failure. Because
these learning benefits cannot be appropriated fully by private agents, there will be too little of this
kind of experimentation within the private sector. A critical aspect, then, of the Government’s
decision to undertake a particular project should be whether it can be scaled up. A project that
succeeds only because of massive investment of resources that could not be mobilized more
generally, or only because it requires an input which is not generally available, is not a good
candidate for scaling up.


To make this point more concrete, let me suggest a couple of examples. A project that
provides more textbooks to a school may, for instance, be able to increase the effectiveness of that
school, but if there are no resources available to provide similar textbooks to all schools, the
project will have very limited developmental impact. By contrast, a project that develops a new
curriculum that is better suited to the conditions of the country and motivates children and their
parents more effectively, can have nationwide impact. A project that demonstrates that local
participation in education and local control of rural schools increases school accountability (as in El
Salvador18) or student performance (as in Nicaragua19) could be replicated nationwide (or indeed,
even worldwide), with limited additional resources. Indeed, such local involvement can itself be a
catalyst for community-based development efforts that go beyond education. There are strong
externalities associated with such projects. Not only do others learn directly from how the project
itself performs, but in the process of learning to interact to address educational problems, the
community learns how to deal with other issues as well, and how to engage each other in a process
of consensus formation. This concern with scaling-up must be at the core of Governments’
involvement with projects, if that involvement is really to have the desired transformative effect.


18 See Jimenez and Sawada (1998).


19 See King and Ozler (1998).





Participation, ownership and the role of outsiders


Seeing development as a transformation of society also has clear implications for where the
locus of development efforts must be, and how the process of assistance must be organized, as I
will explain in this section.

Why imposing change from the outside cannot work



This much seems clear: effective change cannot be imposed from outside. Indeed, the


attempt to impose change from the outside is as likely to engender resistance and give rise to
barriers to change, as it is to facilitate change. At the heart of development is a change in ways of
thinking, and individuals cannot be forced to change how they think. They can be forced to take
certain actions. They can be even forced to utter certain words. But they cannot be forced to
change their hearts or minds.


This point was brought home forcefully at a recent meeting of finance ministers and central
bank governors from the countries of the former Soviet Union. All could articulate perfectly the
requirements of sound macro-policy, as each announced that he subscribed totally to those policies
– including those whose practices deviated markedly from the professed beliefs.


Indeed, interactions between donors and recipients may sometimes actually impede the
transformation. Rather than encouraging recipients to develop their analytic capacities, the process
of imposing conditionalities undermines both the incentives to acquire those capacities and
recipients’ confidence in their ability to use them. Rather than involving large segments of society
in a process of discussing change – thereby changing their ways of thinking – excessive
conditionality reinforces traditional hierarchical relationships. Rather than empowering those who
could serve as catalysts for change within the society, it demonstrates their impotence. Rather than
promoting the kind of open dialogue that is central to democracy, it argues at best that such
dialogue is unnecessary, and at worst that it is counterproductive.

Ownership and participation


Thus, key ingredients in a successful development strategy are ownership and participation.
We have seen again and again that ownership is essential for successful transformation: policies
that are imposed from outside may be grudgingly accepted on a superficial basis, but will rarely be
implemented as intended. But to achieve the desired ownership and transformation, the process
that leads to that strategy must be participatory. Development cannot be just a matter of
negotiations between a donor and the Government. Development must reach deeper. It must
involve and support groups in civil society; these groups are part of the social capital that needs to
be strengthened, and they give voice to often-excluded members of society, facilitating their
participation and increasing ownership of the development process.20 By involving these groups,
the process of strategy formulation may be able to elicit the commitment and long-term
involvement that is necessary for development to be sustainable. Ownership and participation are
also necessary if the development strategy is to be adapted to the circumstances of the country; our
research shows that projects with higher levels of participation are in fact more successful, probably
in part because those projects make fewer erroneous assumptions about the needs and capabilities
of beneficiaries.21



20 Whether or not these groups are representative needs to be borne in mind, of course, when we


assess the weight that should be accorded to this voice in the expression of development strategies.


21 See World Bank (1995, 1998b ) and Isham, Narayan and Pritchett (1995).





Outside agents, including donors, can encourage ownership through persuasion – that is,


through presenting evidence, both theoretical and empirical, that particular strategies and policies
are more likely to bring success than other approaches. But the degree of ownership is likely to be
even greater when the strategies and policies are developed by those within the country itself, when
the country itself is in the driver’s seat.


Some, in their enthusiasm for ownership and participation, have implied that these
participatory processes by themselves would suffice. But while individuals within a community
may actively participate in discourse about what to do and how to do it, there must be more to this
process than simple discourse. First, for participation to be fully meaningful, it should be based on
knowledge; hence the crucial role of education and of capacity-building. Second, merely calling for
participation does not resolve the issue of incentives: individuals (and groups of individuals or
organizations) need to be motivated to be involved. In particular, it will be difficult to sustain
participation if participants sense that they are not being listened to, that their views are not taken
into account in decision-making. There has to be a sense that the process of decision-making is a
fair one, and this in turn requires participation in the process that constructs institutional
arrangements for decision-making. Even if there has been full representative participation, each
individual has to have appropriate incentives to take the desired actions. Indeed, one of the
reasons for participation is so that policy makers can have a better understanding of what incentives
are necessary. Institutions, incentives, participation and ownership can be viewed as
complementary; none on its own is sufficient.


Participation and ownership are crucial, then, and it is clear that the involvement of
outsiders cannot take the place of this local ownership. Nevertheless, as I will discuss later,
outsiders do have a role in facilitating the process, and in assisting in the provision of resources and
knowledge.




The need for inclusion and consensus-building


One of the obstacles to successful development has been the limited ability of some
countries to resolve conflicts. The ability to resolve disputes is an important part of social and
organizational capital. Reforms often bring advantage to some groups while disadvantaging others.
There is likely to be greater acceptance of reforms – and a greater participation in the
transformation process – if there is a sense of equity and fairness about the development process,
a sense of ownership derived from participation, and if there has been an effort at consensus
formation. Numerous examples (such as Ghana) have shown the importance for instance of
consensus formation in achieving macroeconomic stability. By contrast, a decision to, say,
eliminate food subsidies that is imposed from the outside, through an agreement between the
ruling elite and an international agency, is not likely to be helpful in achieving a consensus – or,
therefore, in promoting a successful transformation.




IV. The components of a new development strategy


While the details of a development strategy will differ from country to country, one
constant is that since a development strategy outlines an approach to the transformation of society,
it must address all components of society.

Loci of development


In particular, a strategy must include components aimed at developing the private sector,
the State (the public sector), the community, the family and the individual. The different
components of the development strategy are intricately interrelated. For instance, at the centre of
the strategy for the development of the individual is education; but enhancing skills is also critical
for the private sector strategy, and the increase in wages for women that results from improved
female education has a strong bearing on the family.


(a) Private sector development. In the past, too often development strategies focused on
government; this was natural, given that to a large extent, the “plan” was a plan for public action, a
blueprint for the Government. But given the broader role that we see for development strategies, it
is natural to begin our discussion with the private sector, which will, after all, typically be at centre
stage.


A key objective is the creation of a strong, competitive, stable and efficient private sector.
Among the elements of strategies which advance that objective are:


• A legal infrastructure, providing (and enforcing) competition laws, bankruptcy laws
and, more broadly, commercial law;


• A regulatory framework which encourages the private provision of infrastructure
where possible, which maximizes the extent of feasible competition and which
ensures that where competition is not possible there is not abuse of market power;


• The government provision of infrastructure, where private provision of
infrastructure does not occur;


• A stable macroeconomic framework;
• A stable and effective financial system, which requires a regulatory framework that


not only ensures safety and soundness, but also enhances competition, protects
depositors, creates confidence that there is a “level playing field” in securities
markets by protecting investors from abuses, and identifies underserved groups
within society;


• An adjustment strategy for the elimination of those distortions in the economy that
interfere with the efficient deployment of resources.



The failure to establish some of the key institutional predictions to a market economy is


perhaps one of the factors contributing to the failures in the transition to a market economy of
many of the countries of the former Soviet Union. The failure to establish a sound legal and
regulatory environment for banks, securities markets and the financial sector more broadly is now
recognized to have played a large role in the East Asian crisis. Indeed, the importance of the
financial sector for development had been reflected not only in the World Bank’s research, but
also in the Strategic Compact that was formulated well before the East Asian crisis occurred.22



22 For a description of the Strategic Compact, see
http://www.worldbank.org/html/extpb/annrep97/overview.htm.



If the private sector is to flourish, the environment must be conducive to private-sector




development. A key part of that environment is the quality of the labour force – an educated,
healthy workforce is essential.



(b) Public sector development. The development strategy needs to pay particular attention


to the public sector. After all, if the Government cannot manage its own affairs, how can it be
expected to manage (or even affect in an appropriate way) the affairs of others? The key question
behind the strategy for the public sector is to identify the role of the Government – both what the
Government should do and how it should do it. And the question should not be whether a
particular activity should be carried on in the public or private sector, but how the two can best
complement each other, acting as partners in the development effort. Related issues include what
tasks should be undertaken at what level of government, and how Governments can most
effectively interact with civil society, creating the conditions that are most conducive to the
transformation of the whole society.



Central ingredients to the public sector strategy23 are: (i) a focus of the public sector on the


unique functions that it must perform, such as creating the enabling environment for the private
sector (discussed in previous paragraphs), ensuring that health and education are widely available,
and spearheading the drive to eliminate poverty; (ii) a strengthening of the capabilities of the public
sector, including the development of an effective civil service, and a restructuring of the public
sector, to make more effective use of incentives and of market and market-like mechanisms; and
(iii) a matching both of responsibilities and modes of operation to the capabilities of the State.


(c) Community development. While certain activities are most effectively undertaken at
the national or international level, much of life centres around communities, and communities are
often the most effective vehicle for bringing about the transformation of society. National
Governments are simply too remote, and the opportunities for meaningful participation are too
limited. Well-designed development projects (such as those that have been financed through social
funds) can be a catalyst for community development. Participation at the community level allows
the choice of project to reflect the needs and preferences within the community, and the project
design to reflect local information, ensuring that local conditions, preferences and circumstances
are taken into account. Equally importantly, local participation engenders commitment, which is
necessary for project sustainability over the long run, and participation in the project itself becomes
part of the transformation process. There is growing evidence concerning the relationship between
participation and development effectiveness.


(d) Family development. A major determinant of success in raising income per capita is
population growth, which stems from decisions made within the family. Another major
determinant is female education, also a decision made within the family; the impact of female
education is reflective of the key role that women play in educating the next generation. During the
key formative years of a child, the family is responsible not only for education, but also for
nutrition and health. More broadly, we have become increasingly aware of the importance of
family development, of what goes on within the household. And just as we have become aware of
the power of the family as an instrument for development, we have also become aware that in
many parts of the world there are frequent instances of dysfunctional behaviours, including within-
family violence.



23 See World Bank (1997b).


(e) Individual development. In the end, the transformation of society entails a
transformation of the way individuals think and behave. Development entails the empowerment of
individuals, so that they have more control over the forces that affect their lives, so that they can
have a richer, healthier life. Education and health are at the centre of efforts to achieve individual




development.

Resources, knowledge and institutions


We have provided a framework for thinking about development strategies that focuses on
five levels – the private sector, the Government, the community, the household and the individual.
A second cut at the development strategy approach emphasizes not the levels on which it operates,
but what it must provide.


(a) Resources. As I noted earlier, development entails more than resources: returns on
capital, even defined broadly to include human capital, depend heavily on the availability of
complementary inputs such as a well-managed economic environment and well-functioning
institutions. Nevertheless, it is clear that resources are an important ingredient in development. A
development strategy must outline the following: plans for developing physical capital and human
capital, as well as preserving natural resources; plans for encouraging saving and investment, and
for filling the gap between the two; plans for schools and for financing them; and plans for using
and renewing natural resources.


(b) Economic management. One of the defining characteristics of less developed
countries is a paucity of resources, which is why it is all the more important that the resources that
are available are well deployed. Comprehensive development strategies must set out to identify the
most important distortions in the economy, and how they are to be addressed, taking full account
of the social costs and distributional impacts of policies. Accordingly, the ingredients in economic
management need to be broader than the traditional lists, which focused largely on liberalization,
privatization and macro-stability.


(c) Knowledge management. Development requires closing the gap not only in “objects”,
in human and physical capital, but also in knowledge. Knowledge and capital are in fact
complements: improved knowledge enhances the return on capital, while additional capital
provides the opportunity to make use of recently acquired knowledge. Incorporating knowledge
into the development strategy requires creating capacities to absorb and adapt knowledge (through
investments in human capital and in research institutions), investing in technologies to facilitate the
dissemination of knowledge and creating knowledge locally. Thus, a development strategy needs
to outline a strategy of knowledge management. The World Bank increasingly thinks along these
lines, conceiving of itself as a “knowledge bank”, with one of its central tasks being to help
countries to close the knowledge gap24. It can provide the cross-country experience that, when
melded with local knowledge, makes possible effective choices of development policies,
programmes and projects.



24 See Wolfensohn (1998) and World Bank (1998a).


(d) Sector and sub-national strategies. In many cases, it is useful to narrow one’s focus
from the whole economy to a sector, to some industry (the health care sector or agriculture), to
some region, to cities (an urban strategy) or to the rural areas. The cities represent an arena in
which a cluster of concerns jostle together forcefully – infrastructure, the environment, health and
finances. In some ways, cities are microcosms of the economy as a whole, and integrated solutions
to a city’s problems may provide insights into integrated solutions for the economy as a whole.
Moreover, many cities have been more successful in achieving modernization than rural areas, and
it is thus natural to focus particularly on cities in trying to achieve societal transformation.




(e) Social and organizational capital. Another form of capital, beyond physical capital,
human capital and knowledge, is also essential for a successful transformation: social and
organizational capital, which includes the institutions and relations that mediate transactions and
resolve disputes. I will elaborate a bit on this point, because it is too often given short shrift in
policy discussions. Traditional societies often have a high level of organizational and social capital,
though this capital may not be of a form that facilitates change. But in the process of development,
this organizational and social capital is often destroyed. The transformation may weaken
traditional authority relationships, and new patterns of migration may sever community ties. The
problem is that this process of destruction may occur before new organizational and social capital is
created, leaving the society bereft of the necessary institutional structure with which to function
well.25


Social and organizational capital cannot be handed over to a country from the outside. It
must be developed from within, even if knowledge from outside about key ingredients can facilitate
the creation of this social and organizational capital. The pace of change and the pattern of
reforms must be adapted to each country’s ability to create social and organizational capital. This
factor may, in fact, be the most important constraint on the speed of transformation. In earlier
development literature, in the days when it was thought that the main factor separating developed
from less developed countries was physical capital, there was considerable discussion of countries’
absorptive capacities.26 From the perspective of this paper, the issue is not the pace of absorbing
capital, but the pace of societal transformation.


China has demonstrated that a country can absorb enormous amounts of physical capital
quickly. In the early stages of development, the needs for roads, schools, energy,
telecommunications and other elements of the infrastructure are huge, and it is hard to believe that
more resources could not be productively used. But simply providing these ingredients does not
constitute development.



There has been much talk of late about capacity-building. The relatively easy part of


capacity-building is providing the human capacity, the education, the skills and the knowledge
required for development. The hard part of capacity-building is the development of the
organizational and social capital, including the institutions that enable a society to function well.
There are many dimensions to this:


• The enabling environment for the private sector, which includes markets and the legal
infrastructure that is necessary for markets to function well;


25
The Russian Federation’s recent experience offers an excellent, if sobering, example. Almost a decade after


the process of transition to a market economy began – after the inefficient system of central planning was
replaced by a more decentralized, market-oriented system, after the distortionary pricing patterns were, by and
large, eliminated, and after private property was supposed to restore incentives that seemed so lacking under
the previous regime – output remains a third below what it was before the transition started. The underlying
resources may have deteriorated slightly, but the human capital and knowledge base remains. The explanation
is that the destruction of organizational and social capital, a process which had in fact begun under the previous
regime, continued. Policy makers made inadequate efforts to develop new bases, and to provide the legal
infrastructure necessary for markets, including bankruptcy, competition and contract laws and their effective
enforcement.


26 Rostow (1960, pp. 143-44).


• The knowledge environment, which enables new knowledge to be absorbed, adapted
to the circumstances of the country, and put to use;


• The policy environment, which includes the capacity to make key decisions concerning
development strategies.





Consistency, coherence and completeness


We have described the various pieces that constitute an effective development strategy,
from two points of view: the levels on which it must operate and the building blocks that it must
provide. But the whole is more than the sum of the parts, and the parts must not only be
consistent with each other, but must also fit together and together set forth a “road map” – a vision
of the future combined with a framework for realizing that vision.


The development strategy envisioned here is not a one-year plan, or even a five-year plan.
The fruits of enhancing nutrition or education to a pre-school child will not be fully felt until a
decade or more later. The vision must be long-term, while at the same time pointing to actions to
be taken today. To be meaningful, the vision and actions must be set within a coherent framework,
which requires setting priorities, encouraging partnership and taking into account the global and
regional environment.


(a) Priorities. We know that so much is needed for successful development, including the
actions listed above and more. Earlier, we emphasized that, given limitations on our resources –
including our own and the developing country’s administrative capacities – we need to set
priorities. We argued earlier that one of the purposes of a development strategy was to establish
these priorities. We can now flesh out in greater detail both the principles for setting priorities and
the priorities which most less developing countries will share. In particular, we and developing
country Governments, need to focus on leveraging – on identifying areas where their limited
actions can have large-scale effects, and where the absence of requisite action on their part can have
disastrous effects. Although the particular priorities will differ from country to country, there are
some common elements:


• Among the most important is education, because without education a country cannot
develop, cannot attract and build modern industries, and cannot adopt new growing
technologies as rapidly in the rural sector. But most fundamentally, if development
represents the transformation of society, education is what enables people to learn, and
to accept and help engender this transformation. Education is at the core of
development.


• Infrastructure – in particular communications and transportation – is vital for the
conduct of business in the modern world. It is also necessary to reduce the sense of
isolation of those in developing countries, which is one of the most crippling aspects of
underdevelopment. But today we realize that much of the infrastructure can be
provided privately, provided that the Government establishes the appropriate
regulatory and legal environment. Doing so must be given a high priority.


• Health – because an unhealthy population cannot be a productive labour force,
because a basic standard of health should be viewed as a fundamental human right,
because it is unconscionable that diseases that could be eradicated or least controlled
continue to afflict millions in the less developed would, often robbing them of any
human dignity. Today, however, we recognize that other actions are at least as
important as the provision of medical services in maintaining overall health – including
warning against dangerous behaviours (such as smoking) and encouraging other
behaviours (such as good diets).


• Knowledge – because, like education, it enriches the human spirit and because, like
education and health, it leads to a more productive society. The power of knowledge
is enormous: with increased knowledge, the output that can be produced with the
limited amounts of resources can be multiplied by orders of magnitude.


• Capacity-building – because in the end, successful development, and a successful
transformation, must come from within the country itself, and to accomplish this it
must have institutions and leadership to catalyse, absorb and manage the process of




change and the changed society.

(b) Partnership and country assistance strategies. A country’s own development strategy


provides, then, the overall framework for thinking about a country’s plan for change. Within that
framework, various donors, including the World Bank, can act as partners in the development
effort by identifying where they can be most effective. These roles will include not only transferring
capital, but also providing the knowledge that is essential for development and capacity building.


But partnership goes beyond the country and the aid donors. Recall that development
entails transformation of the whole society; hence the whole society must be engaged. The
development strategy needs to outline how this engagement will occur. It should set forth, for
instance, a view about the role of government, and, within the public sector, a framework for
decentralization: it needs to describe areas where the private sector and civil society should take the
lead, and more broadly the “terms of the partnership” between government, the private sector and
civil society.



( c ) Consistency with the global and regional environments. We have emphasized that


all five components of the development strategy are interrelated: for instance, strategies for the
private sector must be complemented by strategies for the public sector; and strategies at the
national level must be complemented by strategies at the community level. At each level, the
strategy must be consistent with the environment within which it is embedded, at levels above and
below. And all the strategies are embedded within an ever-changing global environment. This
global environment has opened up new opportunities – vast international markets for goods, so
that countries need not be limited in their growth to domestic demand, and the possibility of vast
flows of international capital to complement domestic resources. But these opportunities have
been accompanied by new challenges. For example, heavy dependence on exports of goods or
imports of capital exposes a country to the vicissitudes of markets abroad, such as a foreign
economic downturn that may close off opportunities for exports or a sudden change in investor
sentiment that may reduce sharply the capital inflows from abroad. The magnitude of these risks
may depend little on how well the country manages its own economy. It takes strong government
actions, and strong economic institutions, to weather these storms – and even then there may be
large costs to the economy. For many less developed countries, the impacts may be – and
experience has shown frequently are – disastrous. An essential part of the new development
strategies must be to take advantage of the new global environment while at the same time reducing
the country’s vulnerability to the inevitable shocks that are associated with global engagement.


All countries, developed and less developed, share our planet, and thus must husband
together our globe’s scarce resources, including the atmosphere. The preservation of our
atmosphere – avoiding the build-up of greenhouse gases – is an example of an international public
good, the benefits of which accrue to all people.27 A development strategy needs to set forth a
vision of how these international collective needs are to be addressed.


There is another aspect of global development, which becomes particularly important when
one sees development through the lens of a societal transformation. We have seen that some
countries have had remarkable success in making that transformation, and that there is much those
who are in the early stages of a transition can learn from those experiences. As more successes
(and failures) occur, these successes (and failures) have impacts on others, as each extracts the
lessons that can be learned from each of the experiences. The spreading of experiences no doubt
played a role in the successive development of the countries within East Asia.





27 For a discussion of the concept of an international public good, see, for instance, Stiglitz (1995).




At the same time, many countries’ strategies must be set within the context of developments
within their region. This is especially true of small countries, and even more so of landlocked
countries, for whom access to markets is critical. But it is not only transportation issues that have
to be dealt with on a regional level. There are, for instance, a myriad of environmental and natural
resource issues (most notably dealing with water) that can only be addressed at a regional level.




V. Learning from openness: trade, foreign capital
and the new development strategy



Where does openness to the outside world fit into this vision of a new development


strategy? Our new understanding of development as a transformation of society – rather than just
the accumulation of physical or even human capital – gives us a lens with which to examine this
question. It reveals that trade can play a crucial role, although not through the mechanisms that
economists have traditionally stressed.

Trade and the development transformation


Let me take a moment to explain this. In the standard textbook model of international
trade, openness to foreign goods is supposed to bring benefits primarily through its effects on the
market price of imported goods. If Indonesia produces mid-size automobiles domestically at a
cost of $40,000 each but can import them at $20,000 apiece, then opening to auto imports yields a
net gain in welfare: the increase in consumer surplus more than offsets the fall in profits enjoyed
by Indonesian manufacturers. Indonesia can then move the resources formerly employed in
producing cars – the idle labour, human and physical capital, and land – and shift them into an
industry in which the country has a comparative advantage (textiles, in the classic story). Barring
terms-of-trade effects, the resulting increase in efficiency will allow Indonesia to be better off as a
result of trade liberalization, even if we don’t assume that foreign countries respond with market-
opening of their own. The magic of comparative advantage is that a poor country benefits from
trade even if, in absolute terms, its productivity is lower than its trade partners’ across the whole
range of goods.


This standard model tells an important tale, but one that is far from the whole story. There
is much more going on, in ways that contribute directly to the transformation of society. Consider
the gaps between the standard Hecksher-Ohlin trade model and what we see in practice. First,
both rigorous empirical research and country experience suggest that the growth effects of
engagement in the global market place are far larger than would be predicted by the standard
model.28 Most specifications of empirical growth regressions find that some indicator of external
openness – whether trade ratios or indices of price distortions or average tariff level – is strongly
associated with per capita income growth.29 And countries (especially small, poor ones) that have
tried autarky have typically found themselves lagging far behind in development, for reasons that
apparently stem in part from their closed borders. Yet the standard Hecksher-Ohlin model
predicts gains from trade that are relatively small, consisting only of the well-known Harberger
triangles in the supply-demand diagrams. Clearly, something is missing from the standard story.30


28
See, for example, Romer (1994).


29
See, for example, Sachs and Warner (1995).


30
The most important gains from trade may come from the increased variety of goods – particularly goods that


are inputs into production processes – to which an open trading system offers access (Rodriguez-Clare, 1996,
and Stiglitz, 1997b). That is, rather than just reducing the price of goods that are already available domestically,
trade also offers access to many goods (such as semiconductors or numerically controlled machine tools) that
simply were not available at any price under autarky. The new inputs bring down costs and spur innovation in
the importing economy.


A second problem is that industry-level evidence is also inconsistent with the standard
model. Recall that in that model, trade causes economies to shift intersectorally, moving along
their production frontier. But in reality, the main gains from trade seem to come from an outward
shift of that production frontier, with little intersectoral movement. In essence, trade makes it




possible for the economy not just to consume a given basket of goods at lower cost, but also to
produce a given pre-opening set of goods at lower cost. (And any increase in quantities can be
explained by the producers’ Harberger triangles).


What is going on here? The evidence suggests strongly that opening up to the outside
world leads to an improvement in the technology of production. When I say “technology”, I have
in mind something far broader and more important than the technical blueprints that lie behind
the production of any given good. Technology here means anything that affects the way in which
inputs are transformed into outputs – not just blueprints, but also market and non-market
institutions and modes of organizing production. A major difference between developed and less
developed countries is the difference in the efficiency with which inputs are transformed into
outputs;31 trade reduces the discrepancy.


If what we are concerned about is the transformation of society, then we must adopt
policies that ensure that openness leads to that broad transformation. It is crucial that trade and
foreign direct investment (FDI) not be confined to small enclaves, even if those enclaves give a
temporary boost to our statistical measures of national output. For example, a wealth of gold
resources in an area far from a country’s population base might well be successful at attracting FDI
and increasing mineral exports, but may well do little to spur development over the long term. In
designing policies to spur openness and capture its potential benefits, we need to focus on realizing
the transformative power of interaction with the outside world. To put it succinctly, our goal
should be not a dual economy, but a developed economy.


Both trade and FDI have important roles here. Our understanding of how these roles
work remains incomplete, but it is growing. I have already spoken a bit about trade. FDI is of
similar importance, because when capital enters a country through direct investment, it typically
comes in a package with management expertise, technical human capital, product and process
technologies, and overseas marketing channels – all of which are in scarce supply in the typical
developing country. Evidence suggests that if the society puts in place the appropriate
complementary policies and structures, FDI can give a boost to the technological level and growth
of the host country. The fears about FDI in the 1960s and 1970s were based largely on the notion
of FDI as an enclave phenomenon; in its more modern incarnation, which is typically better
integrated into the surrounding society, FDI is something to attract, not to fear. International
competition among multinationals has become more robust, so that the foreign corporation
receives fewer monopoly rents and the host country gets a larger share of the benefits from
investment.

Implications for the international architecture and financial flows


31
The World Development Report 1998/1999 (World Bank, 1998) focuses on these issues, emphasizing that


it is knowledge (broadly defined) and not just inputs of physical or even human capital that matters. In
standard economic models,


Q = A f(x, y),


where Q is output, A is a measure of efficiency, x is a vector of factor inputs, and y is a vector of traded inputs.
The standard theory argues that y, the vector of traded inputs, is a function of market prices v; distortions in v
caused by autarky lead to lower Q for any given x. By contrast, in the newer perspective discussed above, trade
may play its most important role in increasing A.


In recent months, the rethinking and soul-searching that has followed the global financial
crisis has led to much discussion of how to redesign the international financial architecture. The
new development strategy that I have outlined here has important implications for that design
process. How, for example, should we think about short-term capital? First, note that short-term




capital is especially volatile, as the experience of the past year has reminded us repeatedly. Even as
FDI flows have largely continued unabated, short-term capital flows have completely reversed in
many of the crisis countries. Second, short-term capital has none of the added benefits brought by
FDI – benefits that seem ancillary in the old view of development as accumulation of capital, but
that are recognized as central when we view them through the lens of the new development
strategy. With today’s volatility of short-term capital, one cannot make good long-term investments
based on this short-term capital. But equally importantly, short-term capital does not in itself bring
development transformation. (Similarly, hedge funds do not bring development, especially if they
go bankrupt.) Indeed, in societies with high domestic saving rates and hence relatively low quality
of marginal investments, short-term capital may retard that transformation. The high development
costs exacted by abrupt capital-flow reversals – the lost years of education, the rise in infant
mortality, the job losses – can easily swamp any marginal benefit derived from such flows, as
happened in East Asia.

Implications for the developed countries: What are their responsibilities?


It is clearly in the interest of developing countries to engage fully with the world through
trade and through attracting FDI. But the trade policy agenda for the developing world – or at least
the agenda advocated for developing countries by the West – has in recent years suffered from its
single-minded focus on liberalization through reduction of trade barriers in those countries. To
complement this argument, important as it is, we need to ask also what the responsibilities of the
developed world are in the area of trade policy. It is not for me to lay out all those responsibilities
here, but let me suggest several developments that have clearly helped delay the progress toward
transformative development through openness:


• First, the Uruguay Round trade agreements – for all the benefits they brought to the
world’s consumers, producers and taxpayers– did too little to ensure the opening of
markets to developing-country exports. Consider the empirical estimates of net
benefits by region, calculated just after the agreement was signed: according to these
estimates, sub-Saharan Africa was a net loser as a result of the Uruguay Round.32 To be
sure, Africa failed to gain largely because it did too little to liberalize its own barriers to
trade, thus depriving itself of the opportunity to lower costs and spur efficiency and
innovation domestically. But the Uruguay Round also offered relatively little in the way
of new market access for the products that Africa is most able to export. As suggested
by the experiences of East Asian economies, much of the learning opportunity offered
by trade takes place in export markets, as developing-country firms build relations with
sophisticated customers and compete head-to-head with the best producers in the
world. Success in export markets requires learning, and the export champions can
then bring these lessons home to apply in the domestic market. Note that I am not
claiming here that lack of market access is the only, or even most important, barrier to
African exports. African countries can still do much to make life easier for exporters,
whether by improving communications infrastructure, revamping transportation
facilities or reducing unnecessary bureaucratic obstacles to exports. But market access
is one area where the developed world is uniquely positioned to give a boost to the
development transformation that I have called for.





32 Harrison, Rutherford and Tarr (1995).




• Second, and a related point, is that we must continue working to stem the tide of the
new protectionism in the West. The last two decades have seen a rise in the use of
creative new measures to block imports. Examples include nuisance anti-dumping
claims, lodged under laws that often make little economic sense; countervailing duties
that similarly lack objective justification;33 and barriers to genetically altered products,
which are likely to become steadily more important as developing-country exports
make greater use of those products. Developed countries often have the luxury of
large and well-paid legal and lobbying industries in their capitals, industries that can be
quite innovative in devising new means of restricting competition. From an equity
standpoint, it is essential that we stamp out these innovations as energetically as we
work to lower developing-country barriers to trade.



• Third, international protection of intellectual property rights should strike a balance


between the interests of producers and users. Those users include not only many firms
and consumers within the developing world – who are more often technological
adapters and users than innovators – but also the academic community throughout the
world (developed and developing). Yes, it is important to give incentives to innovators
by ensuring them a return on their investment in research and development. But we
must remember that knowledge is a crucial input into production processes, whether in
agriculture or high-tech industry, and that unlike physical inputs into production,
knowledge can be shared ad infinitum without any additional cost. Thomas Jefferson
likened the creation of knowledge to the lighting of a candle in the darkness: many
other candles can draw their light from that first candle without diminishing its power
or brilliance. Excessive protection of intellectual property rights may end this virtuous
cycle of knowledge transmission and regeneration in the developing world. There is
no easy answer, but that should not stop us from asking questions. It is for this reason
that we have devoted a section in this year’s World Development Report to the issue of
intellectual property rights.34



In all these cases, we should seek to construct not just good policies, but also a sense that


the process by which policies are devised is itself fair and open. Without such a sense of fairness,
the developing world will retreat from its reforms of recent decades. Worse still, the perception of
hypocrisy reinforces the sense of unfairness: even as the more developed countries preach the
doctrines of openness, they engage in restrictive practices. Even as they preach that countries must
undertake the painful measures of liberalization – which may entail losses of jobs and industries –
developed countries use anti-dumping and safeguard measures to protect their own industries that
are adversely affected. Moreover, they do so even when their economies are at full employment,
so that the risks of extended unemployment are minimal, in marked contrast to the situation in
many less developed countries, where unemployment is high and safety nets are inadequate. And
even as the developed countries dismiss the political problems facing less developed countries, they
justify their own resort to these protectionist measures as necessary to overcome even worse
protectionist sentiments within their own countries.



33 For a discussion of these barriers, see Finger (1993) and Stiglitz (1997a).


34 World Bank (1998a).




As I said in my Fiesole speech earlier this week, the pendulum of opinion has swung
before, and it now risks swinging too far back in opposition to openness.35 Our task is to lessen the
momentum of this pendulum swing, by increasing the equity of the international architecture for
trade and finance. Retreat from openness in the developing world would unacceptably delay the
development transformation that it so sorely needs.



35 Stiglitz (1998d).




VI. Concluding comments


We have learned in the last half-century that development is possible, but also that
development is not inevitable. We have learned that development is not just a matter of technical
adjustments, but a transformation of society.


In my opening remarks, I referred to the disillusionment with the Washington consensus,
which provided a set of prescriptions that failed to foster this development transformation. That
consensus was too narrow both in its objectives and its instruments. I have tried in this lecture to
set out the foundations of an alternative paradigm to the Washington consensus. In a way, what I
have said is far from revolutionary: within the World Bank and the development community more
broadly, there has been increasing attention over recent decades to issues of health and education,
and we have moved beyond measures of GDP to look at lifespans and literacy rates. We have
recognized the importance of economic security and stressed the creation of safety nets. There has
been a growing consensus behind the objectives of democratic, equitable and sustainable
development. Here, I have tried to argue that the whole is greater than the sum of the parts, and
that successful development must focus on the whole – the transformation of society. We are well
prepared for this task, precisely because we have increasingly taken within our ambit a broader
range of issues – even though all too often we have underemphasized important components, such
as the role of competition and financial markets and the institutional infrastructure more broadly.


But I have also tried to argue here that a successful development transformation affects not
only what we do, but how we do it. Yes, this broader perspective affects the strategies and policies,
but it also affects the processes. It argues for openness, partnership and participation, words that
too often sound like appeals to the politically correct nostrums of the day. I have tried to argue
that there lies behind these words a theory of development, as well as evidence that these processes
can lead to more successful development efforts.


Honesty, however, requires me to add one more word. In calling for a transformation of
societies, I have elided a central issue: transformation to what kind of society, and for what ends?
Further, some have worried that development will destroy traditional values. In some cases, there
will be a clash between science and traditional beliefs. But development today often focuses on the
preservation of cultural values, partly because these values serve as a cohesive force at a time when
many other such forces are weakening. Maintaining social organization and enhancing social
capital are part of the key to successful development transformations. Moreover, it is important to
note that much of the progress that is associated with successful development – the mothers who
do not have to see their children die in infancy, who see the opening of minds to new knowledge
and the increased opportunities – these reflect almost universally held values.


But there is a further reason that I believe in openness, especially openness in process:
these contribute to a more open, democratic society. For me, these are values in their own right.




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