The Untenable Developmental State Economic Model

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Introduction

The developmental state is a term used to describe industrialised and rapidly developing economies. In these economies, policies that bring rapid economic change are formulated and implemented by the governments concerned.

Previously, the term developmental state was used to describe the East Asian economies such as South Korea, Taiwan, Singapore, Hong Kong and even Japan and China, where governmental policies played a vital role in the exponential economic growth of these countries from the early eighties.

Chalmers Johnson, an eminent Political scientist who did large quantities of research on Asian economies, first used Developmental State as a term in his book MITI and the Japanese Miracle (Stubbs 2009, p.4). However, the term has lately been used to describe states outside Asia that have similar development styles, such as Botswana in Africa and some Latin American countries.

The rapid industrialization and economic growth that characterised the East Asian economies were of much interest to western scholars. According to Hayashi, there exists two types of criticism for the developmental state (2010, p.46).

The first type states that, developmental states are not a decisive factor in economic growth and that other developing countries would do well to forgo the form of economic growth exhibited by development states.

This is because, according to economists like Paul Krugman, development states had exhibited a sham growth that did not take into account a concept known as total factor productivity, where all variables that play a part in economic growth are included in the calculation of growth and GDP.

According to Krugman therefore, these developmental states would soon crumble under illusionary the weight of the deceptive economic growth. The second class of criticism states that, although a slight level of growth was achieved by the developmental states in the eighties and nineties, such a model of economic growth is no longer viable in todays globalized world.

The emergence of the developmental states of East Asia was in a sense a rebellion from the economic models practiced by the former colonial masters of these countries. According to Kim, these East Asian states desired to pursue unique economic strategies that were customised to fit the cultural, political and economic realities of East Asia, distinct from the policies advocated by fly-by-night western economists (2009, p.383).

These countries felt that the economic practices proposed by their former colonial masters were far-removed from Asian realities, and purposed to chart their own paths towards industrialization and economic growth.

The Asian economic crisis of 1997-1998 affected most countries in Asia. Those severely affected were Thailand, South Korea, Indonesia and Malaysia. Other countries affected were The Philippines and Laos. India, Japan and China were less affected, but suffered a loss of confidence in their markets. Therefore, the crisis reach spanned the entire Asian continent.

Eventually, as the crisis deepened, the International Monetary Fund (IMF) had to step in and bail out some of these economies. During the years when the model of the developmental state was being touted as one of the best models that a country in need of rapid industrialization and economic growth could adopt, the East Asian countries served as the prototypical examples.

The general belief was that these countries had sound fiscal policies and the high-capital flows into these countries were evidence of investor confidence in the said policies. However, when the crisis began, the model of the developmental state, especially when juxtaposed with countries in the west with differing economic policies, did not appear as reliable and stable as earlier thought.

Additionally, because of the intervention of the IMF, and the subsequent actions by these countries in adopting policies proposed by the IMF, the developmental state as a model of growth for developing countries needs re-thinking. In light of these developments since the East Asian financial crisis of 1997-1998, the notion of the developmental state, as a model for growth, is economically nonviable.

Moreover, the concept of globalization has rendered governmental influence on economic progress unfeasible. Additionally, because in the aftermath of the financial crisis the Asian states affected adopted western economic structures and policies, the notion of the developmental state as a model for rapid industrialization is unsustainable.

Prior to 1997-1998 Financial Crisis

During the 1980s and early 1990s, Asian countries attracted foreign investors in droves. Countries like Indonesia, Thailand and South Korea posted double-digit growth rates for many consecutive years (Stubbs 2011, p.155). This seeming economic boom saw high interest rate returns for investors, and capital inflows to these countries increased.

These Asian countries, especially South Korea, Taiwan, Hong Kong and Singapore earned the admiration of the IMF and the World Bank, and were given the moniker Asian Tigers to describe their successful and aggressive growth towards industrialization.

The 1997-98 Asian Financial Crisis

The 1997-1998 Asian financial crisis began in Thailand, where due to the countrys massive foreign debt, its currency was rendered valueless. Soon the effects of Thailands currency collapse spread to other Asian nations, and countries such as China and Japan, though relatively less so, were also affected.

Because of the significant investments made by international and foreign investors in these economies, the IMF had to step in to pre-empt a worldwide financial crisis. The IMF started a bail out program for the economies of South Korea, Indonesia, Thailand and other affected nations.

South Korea

As one of the countries that was most affected by the crisis, South Korea accepted the IMF bail out funds in order to restore its economy. The immediate aftermath of the crisis was an increase in the level of unemployment in the country; the IMF request to reduce public spending and downsize workers in the public sector only worsened matters.

Additionally, many of the large corporations in the country had chalked up astronomical debts and were nearing insolvency when the crisis began.

Government efforts to shore up the activities of conglomerates such as Kia motors, the countrys largest car marker at the time, had served to laden the company with poor debt. Typical of developmental states, the South Korean government had made efforts to bail out the company prior to the crisis.

According to Jung and Clark, many South Koreans believe the IMF intervention worsened the crisis, with some going as far as blaming the IMF for instigating the crisis (2010, p.30).

Indeed, even though South Korea accepted the bail out money from IMF, it did not strictly adhere to the conditions set by the monetary institution (Su-Hsing & Ming-Jang 2010, p.175). For instance, the government rejected the condition of reducing its public spending, and on the contrary offered welfare funds to the needy and others most affected by the crisis.

In the long term, the stance of the government bore fruit, and by the year 2007, the South Korean economy was again recording consistently high levels of growth.

Thailand

Thailands economic growth prior to the financial crisis of 1997-98 was one of the highest in the world. As the epicentre of the financial crisis, panic began through investor speculation on the strength of the countrys currency. The central bank, in the face of massive lay offs and loss of jobs and businesses, refused to devalue the currency.

Thereafter, many of the countrys financial and industrial institutions collapsed, and more workers lost their jobs. A high number of expatriate workers also left the country. By December 1997, the government of Thailand accepted bail out packages from the IMF, and implemented the conditions that the IMF set for granting the funds.

These conditions included limited government spending, high taxation, and maintaining high interest rates. Additionally, all institutions and firms that could not sustain themselves and were insolvent were not to be bailed out. Within seven years of implementing these measures, Thailand was firmly on the road to economic recovery, and paid its IMF debt within the stipulated period.

Indonesia

Indonesias financial crisis was least expected amongst the Asian nations. Indonesia, unlike other East Asian nations that were affected by the crisis, had low inflations, a stable currency, adequate foreign reserves, and its currencys exchange rate to the dollar was stable. However, financial contagion stemming from Thailands collapse led to speculative ambushes on the rupiah, Indonesias currency.

Soon the countrys premier stock exchange reached its lowest points in history, and the political class, led by the president, decided to accept IMFs bail out funds of $20 billion dollars. The crisis claimed several political scalps, including that of President Suharto.

The president, in an attempt to contain the crisis, had earlier sacked the central Bank governor whom he accused of formulating defective policies that failed to arrest the economic decline that was plaguing the country.

Malaysia

Prior to the crisis, Malaysia attracted large foreign investment. Like other developmental states, government hand in promoting the country as an investment hub was significant in attracting high numbers of foreign investors. The Kuala Lumpar Stock exchange at the time was the most active in the world.

However, in 1998, due to the effects of the financial crisis in other East Asian nations, the Malaysian economy went into recession. Industrial sectors like the construction industry, one of the foremost industries in the country, shrunk massively. Massive lay offs and downsizing of staff followed.

The government intervened to slow the currencys decline against the dollar. Malaysian economic authorities formed task forces to oversee he stabilization of the economy, and Malaysia was the only country to decline aid from the IMF. By the year 2005, measures to contain the crisis had taken effect, and the Malaysian currency was de-linked from its previous fixed exchange status.

China, Japan and the USA

China was not intensely affected by the financial crisis. Its currency, at the time, traded at about 8 RMB to the dollar. However, due to the decline in the relative value of most Asian currencies occasioned by the crisis, China was faced with the need of devaluing its own currency so that its exports could remain competitive.

Chinese authorities decided not to devaluate the currency, and in the end, China was able to survive the financial crisis with the barest of losses to its economy and prestige. Japanese investments in other Asian nations suffered because of the collapse of these economies during and after the financial crisis.

Additionally, in 1998 the economy suffered a recession due to low foreign exchange occasioned by competition from cheaper sources of goods from other Asian nations.

In the US, although the economy did not undergo a recession, fears of collapse fuelled by the crisis occurring in Asia led to the brief suspension of trading at the New York Stock Exchange. Similarly, the country experienced reduced consumer spending amid speculation of the outcome of the Asian financial crisis.

Lessons Learnt

Prior to the financial crisis of 1997, these East Asian economies were believed to have implemented sound fiscal policies that would forestall the occurrence of a financial crisis. Therefore, even the most ardent sceptics of the Asian miracle like Paul Krugman could not predict the scope and intensity of the crisis.

According to Ka Ho, Lawler, and Hinz, the Asian financial crisis worsened the existing social gaps that existed priors to the crisis (2009, p.146). Educational opportunities for the poor became limited, and access to social services was hindered by the lack of funds in government treasuries in these Asian nations (Ramesh 2009, p. 80).

The IMF intervention was conditional, and the nations affected had to pursue frugality measures crafted by the IMF in order to reduce public spending, increase revenue and restore investor confidence.

The Role of the IMF

As earlier stated, one of the main reasons that the Asian states pursued the developmental state economic model was a desire to curve out economic paths that remained true to Asian conditions. For many of the countries in Asia, simply following western models of economic growth was not tenable.

Therefore, adoption of the developmental state model by these countries was, as much an act of defiance, as it was a pursuit of a unique economic growth model. The IMFs role in reducing the effects of the financial crisis through bailing out these economies took several angles.

The conditions set by the IMF served to achieve certain purposes, which many in the Asian region felt was a form of neo-colonialism, and a movement towards a form of economic models many Asians countries had strived so hard to disassociate with the western model.

Westernized Financial and Banking Institutions

Ultimately, the IMF wanted the Asian nations affected by the crisis to adopt financial models moulded in the form of those found in Europe and the USA. As far as the IMF was concerned, the developmental state models had failed at its most critical point.

The financial crisis that plagued Asian nations, which until the actual crisis began were believed to be examples in sound financial and economic management, was proof of failure of the developmental state model for the economic growth. Therefore, the IMF facilitated bail out funds with conditions that required these countries to restructure their economic and financial institutions, industries and policies.

According to Pettis, emerging economies that pursue aggressive policies aimed at industrialization have to be aware of imminent collapse wrought by unstable institutions (2001, p.17).

Pettis states that, countries that industrialize over a long period are better placed to deal with sudden economic shocks because the economic industries in these countries usually stabilize over long periods, enough to withstand sudden economic shocks. Therefore, the IMFs role was to steer these economies away from the developmental state model and towards a more western economic orientation.

Transparency

A strong feature of the developmental state is a lack of financial openness to foreigners or the outside world. Whenever government is involved in economic matters, many times the need to pursue genuine economic policies and the desire to placate the electoral masses usually conflict.

Subsequently, many developmental states find themselves issuing economic data that the masses and the electorate will find pleasant, while hiding or failing to disclose economic data that may place the government in a negative light (de Boyrie 2009, p.5).

Indeed, developmental states tend to have minimal democratic practices, and sometimes need to maintain a positive economic image for the public and investors overrides the need for full disclosure (Pempel 1999, p.14). Some analysts believe that one of the reasons that remarkably few economists predicted the Asian financial crisis of 1997-1998 was because the data that the economists worked with was not comprehensive.

Therefore, while these economies were given a clean bill of health in the economic books of western scholars as late as 1996, the real data or economic trends that would have allowed for some sort of prediction was overlooked, or simply unavailable for outside scrutiny.

Therefore, one of the conditions set by the IMF was that the financial institutions that were to be given the bail out money would disclose all their financial activities, and such activities should henceforth be subject to public scrutiny (Best 2010, p.30). As shown in the economic data of the countries that were affected by the Asian financial crisis of 97-98 in this paper, all of these countries showed healthy economic data prior to the crisis.

Even Thailand, the country that precipitated the crisis, enjoyed an economic growth rate of 9% in the year preceding the financial crisis. The belief that the governments of these countries had withheld crucial data that would have pre-empted the crisis thus holds water.

Restoration of Confidence in Asian Markets

In order to facilitate quick economic recovery and restore investor confidence in the Asian markets, the IMF proposed measures to realise the same. In countries such as Thailand, Indonesia, and South Korea, the beginning of the financial crisis saw them hold remarkably little in foreign reserves.

Therefore, the IMF instructed these countries to maintain high interest rates to ensure that their respective domestic currencies remained in the hands of locals, thereby maintaining confidence in these currencies.

Similarly, the crisis led to a reduction in capital flow to the Asian region, and fearful of speculative buying and withdrawal of investments that would bring a global crisis, the IMF sought to restore investor confidence in the Asian markets as soon as was practically possible (Kaufman, Krueger, & Hunter 1999, p.35).

In the pursuit of restoring investor confidence, the Asian economies that accepted bail out money from the IMF resorted to adopting financial practices similar to those of western societies like the US.

Vindication of the Western Model over the Developmental State Model

Ultimately, the fact that these Asian states accepted bail out funds in order to restore their economies points to a victory of the western route towards economic progress and industrialization over the developmental state model. The policies pushed by the IMF, and adopted by these countries, ultimately worked. In essence, the developmental state model failed when it mattered most.

Globalization and the Notion of the Developmental State

The Asian Financial crisis of 1997-1998 had profound effects on the social, economic and political sectors of the East Asian economies. The immediate aftermath of the crisis saw these states grapple with massive unemployment, lack of access to social services and increased poverty rates.

Since the crisis, changes in the modus operandi of world economies, precipitated by technological advances, have ushered in global markets for national economies. Through globalization, traditional country boundaries that restricted trade have been eliminated, and business transactions across national barriers are common and necessary.

According to Green, globalization is changing the way countries run their economies and industries in Asia (2007, p.25). Outsourcing of labour across national boundaries, exchange of goods and services over the Internet and technological transfer have all contributed to creating economies that rely less on governmental policy and more on the individual innovativeness of citizens.

Conclusion

Certainly, the East Asian developmental states prior to the East Asian financial crisis of 1997-198-98 were models on achieving high economic growth and rapid industrialization. Variously called the Asian miracle, Asian tigers and other such epithets, analysts of these economies prior to the crisis were confident in the model as a vehicle towards economic progress.

However, the financial crisis of 1997-1998 calls for a re-think concerning the efficacy of the developmental state as a model for economic and industrial growth. As discussed in this paper, the financial crisis called into question various attributes of the developmental state.

Overall, the inability of these developmental states to secure their economies by themselves and only doing so through the assistance of worldwide monetary institutions such as the IMF indicates a considerable failure of the development state notion (Muchhala 2007, p.45).

The intervention by the IMF, and the subsequent policies adopted by these states, point to the weaknesses in the development state model. Firstly, in order to recover from the financial crisis, these states had to acquire financial models similar to those of the western world. This indicates a failure of the financial model espoused in developmental states.

Secondly, these states had to pen up their economy for more intense international scrutiny. Thirdly, these states had to restore confidence in their markets by practicing policies such as implementing high interest rates, an idea prevalent in western economic policies.

Ultimately, because these states had to forgo their developmental state models in order to recover from the financial crisis, the developmental state model thus becomes effectively redundant.

Finally, as discussed in the paper, the changes in world economic practices have served to obviate the need for adoption of a development state model for economic growth. Globalization has shattered traditional trade and economic activity beliefs. In the present day, economic transactions rely less on governmental regulation, and more business activities are carried out across national and international boundaries than ever before.

Such open, quick and innovative transactions carried out over the Internet and through technological transfers have placed market forces firmly out of the hands of governments. The notion of the developmental state thus belongs to a bygone era.

Reference List

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