CIAO DATE: 9/99

The New Global Economy and Developing Countries:
Making Openness Work

By Dani Rodrik

Overseas Development Council

 

The following is a summary of Making Openness Work, ODC Policy Essay No. 24, which was released in January 1999 (ISBN: 1-56517-027-X, $13.95). To order a copy of this publication follow this link: http://www.odc.org/publications/pe24bib.html

Developing countries can thrive in the new global economy—but only if they combine economic openness with a clear domestic investment strategy and effective civil and political institutions, Dani Rodrik argues in this provocative new book published by the Overseas Development Council.

Emerging-market nations must participate in the world economy on their own terms, not the terms “dictated” by global markets and multilateral institutions. The pursuit of so-called “international competitiveness” has too often crowded out traditional development concerns related to industrialization and poverty in many emerging economies, says Rodrik.

The appeal of opening up to global markets is based on a simple, but powerful promise: international economic integration will improve economic performance. As countries reduce their tariff and non-tariff barriers to trade and open up to international capital flows, growth will increase, the theory goes. This, in turn, will reduce poverty and improve the quality of life for the vast majority of the citizens of developing nations.

The trouble is, there is no convincing evidence that openness, in the sense of low barriers to trade and capital flows, systematically produces these results.

The lesson of history is that ultimately all successful countries develop their own brands of national capitalism. The states which have done best in the postwar period devised domestic investment plans to kick-start growth and established institutions of conflict management. An open trade regime, on its own, will not set an economy on a sustained growth path.

Openness to the global economy can be a source of many economic benefits: imports of investment and intermediate goods that may not be available at home at comparable cost, the transfer of ideas and technology from more developed nations, and access to foreign savings which can help poor nations get around some of the traditional obstacles to rapid growth. But it is domestic investment that makes an economy grow, not integration into the global economy.

The global economy’s potential benefits can be realized fully only when the complementary policies and institutions are in place at home. Too often, claims by the boosters of untrammelled international economic integration are frequently inflated or downright false.

Making “openness” work depends on a country’s ability to manage turbulence in the new globalized economy. “Openness” is a mixed blessing, one that needs to be nurtured to make it a positive force for economic development. Economic openness is part of development strategy—never a substitute for development strategy.

The evidence from the experience of the last two decades is quite clear: the countries that have grown most rapidly since the mid-1970s are those that have invested a high share of GDP and maintained macroeconomic stability. The relationship between growth rates and indicators of openness—levels of tariff and non-tariff barriers or controls on capital flows—is weak at best. Policymakers therefore have to focus on the fundamentals of economic growth—investment, macroeconomic stability, human resources, and good governance—and not let international economic integration dominate their thinking on development.

 

An Investment Strategy

In the long run, investment is key to economic performance. Recent studies on the sources of East Asian growth have highlighted the overwhelming importance of accumulation for the countries in that region. While opening up to the world economy can sometimes stimulate investment, it is a mistake to believe that there is a determinate relationship between openness and investment levels. Governments in East Asia complemented their outward-orientation with a coherent domestic investment strategy that raised the private return to capital and kindled the animal spirits of entrepreneurs.

There is no single way of raising the private return to capital to start this process. Even among the East Asian cases, investment subsidies took different forms. Governments have to be imaginative in devising investment strategies that exploit their countries’ resources and capabilities, while respecting administrative and budgetary constraints.

 

Strengthening Institutions of Conflict Management

The ability to maintain macroeconomic stability in the face of turbulent external conditions is the single most important factor accounting for the diversity in post-1975 economic performance in the developing world. The countries that were unable to adjust their macroeconomic policies to the shocks of the late 1970s and early 1980s ended up experiencing a dramatic collapse in productivity growth.

The countries that fell apart did so because their social and political institutions were inadequate to bring about the bargains required for macroeconomic adjustment—they were societies with weak institutions of conflict management. In the absence of institutions that mediate conflict among social groups, the policy adjustments needed to re-establish macroeconomic balance are delayed, as labor, business, and other social groups block the implementation of fiscal and exchange-rate policies. The result is that the economy finds itself confronted with high inflation, scarcity of foreign currency, and a myriad of other bottlenecks.

Societies with deeper cleavages (along ethnic, income, or regional lines) are particularly susceptible to policy paralysis of this sort, making institutions of conflict management all the more important in such societies. Evidence shows that participatory political institutions, civil and political liberties, high-quality bureaucracies, the rule of law, and mechanisms of social insurance such as social safety nets can bridge these cleavages. These institutions are important both for coping with turbulence in the world economy and for countering the possible widening of inequality that openness can bring.

 

Implications for International Governance

It is not realistic to expect that national development efforts will converge on a single model of “good economic behavior”; nor is it desirable that they do so. The economies that have done well in the postwar period have all succeeded via their own particular brand of heterodox policies. Macroeconomic stability and high investment rates have been common, but beyond that many details have differed. Correspondingly, the rules of the international economy must be flexible enough to allow individual developing countries to develop their own “styles” of capitalism, in the same way that countries such as Japan, Germany, and the United States have in the past evolved their own different models.

 

Conclusion

Development policy is prone to fashions. During the 1950s and 1960s, when import-substitution was in vogue, there was excessive optimism about what government interventions could achieve. Now that outward-orientation is the norm, there is excessive faith in what openness can accomplish. Early on, planning models emphasized capital accumulation at the expense of price incentives and the role of markets. Today the importance of investment is consistently downplayed. The swing of the pendulum from one extreme to another creates blind spots, risking yet another unproductive change in fashions.

The internationalization of production and investment raises a fundamental question of accountability: to whom will national economic policymakers be accountable? The implicit answer provided by the globalization model is that they will be accountable to foreign investors, country-fund managers in London and New York, and a relatively small group of domestic exporters. In the globalized economy, these are the groups that determine whether an economy is judged a success or not, and whether it will prosper.

This would not necessarily be a bad thing if the invisible hand of global markets could always be relied on to produce desirable outcomes. The reality is considerably more murky. It takes too much blind faith in markets to believe that the global allocation of resources is enhanced by the twenty-something-year-olds in London who move hundreds of millions of dollars around the globe in a matter of an instant, or by the executives of multinational enterprises who make plant-location decisions on the basis of the concessions they can extract from governments.

Consequently, governments and policy advisors alike have to stop thinking of international economic integration as an end in itself.

Developing nations have to engage the world economy on their own terms, not on terms set by global markets or multilateral institutions.