Strategies for Economic Development in the Third World

 

In the modern world most of the updated technology and innovations are embedded within the large corporate institutional firms. While many of these firms are multinational with headquarters located in developed countries, these firms have the know-how and have access to the markets necessary for making use of and implementing the latest technological processes. Thus for poor countries wishing to develop and increase their wealth they must either attract these firms or possibly develop their own home-grown firms.

 

These firms, in turn require a specific set of institutions within which they operate. They need in varying degrees such institutions; as a well established set of property rights, (which are enforce in courts), a stable and corruption free government (which operates under a system of law's), a large internal market or at least be able to export and import relatively freely. And they need a certain level of physical and social infrastructure. This includes a transportation system, communication capabilities, and educational institutions.  These basic institutional characteristics are necessary to varying degrees depending on the specific industry. For instance, in India’s developing computer software industry, good technical educational institutions are absolutely necessary, while a personal transportation system of good highways is not as essential. Providing the underlying infrastructure, unfortunately, however does not guarantee the development of a new industry and economic growth.

 

Import Substitution Model

 

There have been two different growth strategies.  The dominant one is called the export growth model, while the model out of favor currently is called import substitution model. It was poplar in the '70s and '80s in many developing countries.  With import substitutions, growth comes from the growing industries producing products that would substitute for imports. Products and services produced at home would replace goods and services imported from foreign countries. Trade is not emphasized and tariffs, quotas and subsidies were used to protect and support local industries.  It was a form of national self-sufficiency, which particularly appealed to nationalistic governments. Because government was central to many important economic decisions, it requires a well functioning and a corruption free government (more so than the export growth model). This was a difficult requirement, since economic underdevelopment, is correlated with an underdeveloped and an inefficient public sector.

 

The local business elite needed to be held apart from government decision-making and yet have some input on national planning.  This is a difficult balancing act for most countries but is particularly so for the undeveloped Third World.  It was easy for the business elite to dominate local political decision-making.   The overall public goods could become compromised in this process.

 

In order for the import substitution model to be successful, the country needed a sufficiently large internal market.  Unfortunately, many attractive industries for the Third World countries required a minimum scale of production in order to use the latest technology. This condition was not always met. For instance, in Peru with a population of just over 24 million (only a tiny fraction of whom could afford to buy an automobile), Peru protected its local domestic automobile industry with high tariffs. As a result it had at one time five or six different automobile manufactures, with each producing only a few thousand cars per year apiece.  Because there are substantial economies of scale in the production of automobiles, the cost per car in Peru was much higher than it should have been. Peru was thus a high cost producer of automobiles. The industry was completely dependent on the high tariff walls (enforced by the government) to keep out competitors.  Under these conditions, business success required political access and power, rather than business and technical expertise.

 

Export lead Growth

 

Export lead growth is the process of growth in Third World countries that attempts to attract and help develop industries that produce goods for export. These exported goods need to be competitive on the world markets. It is the form of growth most in favors by international organizations such as the World Bank and had been successfully implemented by Japan after World War II. The so-called Asian Tigers nations, which include Taiwan, South Korea, Singapore, and Hong Kong successfully imitated the Japanese model in the 1970s and 1980s and now are rapidly developing middle-income countries. It is now the general model of growth in Asia and throughout the Third World.

   

The less developed Asian countries of Malaysia, Indonesia, and Thailand were implementing this model of growth when the South East Asian crisis began in 1997. This crisis, which interrupted their rapid growth spurt, can best be described as a financial panic that bankrupted a number of these countries. Because the export growth model requires a relatively open trading system the financial panic quickly spread. The negative growth lasted a couple of years. The tendency of financial panics is one of the negative aspects of export growth. In general the interdependencies that come with international trade can spread either recessions or prosperity around the world. Controlling the negative consequences is primary the responsibility of the International Monetary Fund (IMF).

 

The export growth model has been the traditional model of growth for Third World nations whom mostly exported agricultural and mineral products (which they still do).  But they faced uncertain and unstable markets where the terms of trade-- the ratio of export to import prices-- were unfavorable (or at least very unstable).  A decline in the countries terms of trade means its imports of goods become relatively expensive, while its exports become relatively inexpensive in the world markets.  Such a condition leads to a country exporting more but receiving less real income.  This process in the extreme makes the export growth model of questionable value for the developing nations. In fact, during the 1960ies and 1970ies it was replaced as the favored model of growth by the import substitution model. Thus the primary problem with depending on the export growth model is finding an appropriate stable and growing export industry. 

 

Large Third World countries relying on the unstable pricing for agricultural and mineral products have found these economic sectors even with good stable prices not large enough to significantly reduced their poverty population.  This situation can be partly explained by the worldwide improvement in technology that has reduced the need for raw materials, and by the increasing world growth in demand for services. Services and the newer technology require less of the resources of the Third World. As a result the long-term expectation for prices of raw materials is for a relative decline (relative prices are those prices as compared to all other prices), in spite of the projected increase in the world population.

 

Chile’s example

Chile is a relatively advanced middle-income country (still with the large poverty population) that has developed a strong reliance on natural resource exports.  Its primary exports include copper and a variety of agricultural (including table grapes) and natural resources products.  Cellulose the raw material for paper is one of Chileans primary exports, second in importance to copper. From 1995 to 1999 the price of cellulose has decline by 55 percent and is not expected to increase anytime soon.  As a result, Chile's producer of cellulose, Arauco, to stay competitive sharply reduced costs.  With greater automation and improve technology they significantly reduce employment and expand output at the same time.  But in doing so they effectively reduced the size of their industry’s employment and thus its impact on Chile.  The cellulose industry and Arauco, in particular, has been successful. Data shows that in 1999 they are the world low-cost producer of cellulose (they can deliver bleached pulp to a European port at $30 per ton, cheaper than their Swedish rivals).  But unfortunately for the Chile with such low export prices there is doubt that enough long-term growth in this industry will significantly reduce Chile’s poverty.

 

Mexico’s Example

Mexico is another large middle-income nation with a large substantial poverty population.  Historically it has been dependent for exports on its agricultural and natural resources, and recently on oil.  But its unique geographical location next to the United States has offered it a unique opportunity to expand its export base.  Since 1995 with the passage of the North American Free Trade Agreement (NAFTA) and even before, Mexico has become a base of U. S. manufacturers. The NAFTA agreement has eliminated some foreign ownership restrictions, and reduced many tariffs barriers (and will continue to do so as more of the agreement’s articles come into play). A dramatic process of job creation has been underway with U.S. manufacturers hiring 600,000 new workers in Mexico during the five years after the NAFTA agreement was signed. This rapid integration of the U. S. and Mexican economies has many implications and may offer to Mexico a large enough economic impact to propel it to fully developed status.  This ultimate result is still however in doubt.

 

The U.S. corporate migration has been strongly supported by Mexican policymakers (even before NAFTA).  They have opened up the economy of Mexico in such a way as to encourage this migration of new jobs into Mexico.  Many of the early jobs were in Maquiladora plants near the border, but after the NAFTA agreement, job growth has expanded to the south into towns such as Torreon, Mexicali, Chihuahua and Reynosa.  For instance, in Torreon so many multinationals firms have opened up plants that the local workforce is exhausted and the city is now drawing migrants from throughout Mexico.  In the last decade the population has doubled to 925,000 (as of 1999) and now makes John Deere tractors, Caterpillar construction equipment, Wrangler jeans, automobile parts and Tyson’s chicken. There are still problems in Mexico of poor infrastructure, crime and corruption. But the attraction of low wages can still lower a firm's labor cost and help the firm to avoid strong unions, and even some environmental regulations. The growth has caused Mexico some problems, such as various forms of pollution, water scarcity (in the desert cities of the north), and the increasing income gap between Mexico’s wealthy north (relatively so) and the poorer south.

 

India’s Software Industry

India had built a series of first-rate technical higher educational institutes in the 1950’s and 1960’s. It was one of India’s first efforts at development as a young nation, for scientific and industrial achievement. Jobs however, were not generally available locally so many of their best graduates migrated elsewhere (such as to Silicon Valley in the United States). For India this represented a significant problem as their most educated and capable leave. For India and other Third World countries this loss is termed a brain drain. Although they lose some of their most gifted citizens, it usually is not a total lost, since these émigrés help economically support their extended families back home. In some poor Third World countries, it’s their chief source of funds.

 

In 1991, facing a severe balance of payment crisis, India began opening up its economy. Barriers to importing the latest technology were removed. Tariffs were reduced and in general, the bureaucratic state controls of India were reformed and loosen (this process is ongoing). New entrepreneurial firms were able to utilize the large pool of technically skilled, English-speaking workers educated in India’s huge network of universities and engineering colleges. Software companies started up by local Indian entrepreneur began to flourish by contracting out services to mostly American high-tech firms in Silicon Valley and elsewhere. India’s chronically poor roads, unreliable phones and frequent power outages do not handicap software companies since they can ship their product over private satellite lines and build their own generators to guarantee a steady supply of electricity. By the year 2000 there were more than 600 companies in India that exported software services mostly to the United States. By 1998 these firms employed more than 280,000 computer engineers, while they produced software worth up to 2.7 billion. The software industry has produced good jobs that have had an economic multiplier effect in India and especially in the south Indian triangle of high technology – Bangalore, Madras and Hyderabad.

 

The software services as of the year 2000 accounts for only 1.3% of India’s gross domestic product (Jonathan Karp, Wall Street Journal, and Feb. 2000). This is significant, for India is the second largest nation in the world with a population of one billion. And computer software is a product that will grow in demand over time, and will not face declining terms of trade (at least, its unlikely given recent forecast). It is estimated that export revenue from India’s information-technology sector, which encompasses software services such as back-office operations and call centers, can rise from 4 billion dollars in 2000 to 50 billion by 2008.

 

But of prime concern is the worry that the boom in the software and other export industries may be distracting the country from its chronic problems and fear that the last decade of the 1990s more rapid economic growth is leaving the poor, and the poorer states, further behind, even as the size of India's middle class has doubled. For India is still a country where half the women and a quarter of the men cannot read or write; where more than half the children 4 and under are stunted by malnutrition; where one-third of the population, or more than 300 million people, live in absolute poverty, unable to afford enough to eat; where more than 30 million children 6 to 10 are not in school (New York Time, March 19, 2000).

 

The country desperately needs to attend to the fundamentals, most economists say. It must invest more in primary education and health care, build a working system of roads and power grids, reduce subsidies for power and fertilizer that go mostly to the better-off and generate higher rates of growth in agriculture and industry, which employ 8 in 10 Indians.

 

The industry has developed a business culture that has challenged the traditional Indian’s family centered corporate culture. The industry is emerging as a profound agent of corporate and economic change. The industry has introduced the use of stock options for workers, opened its books to independent outside auditors and started foundations to help the underprivileged. By its very example, the industry, with it’s many professional entrepreneur firms, may help reform and change India’s overall business culture.  

 

But its income from software exports is generally exempted from the corporate income tax. And unlike companies in other industries, high technology companies do not have to pay the 40 percent to 60 percent customs duties on computers and other technology items they import. These tax exemptions were in fact set up to encourage the industry’s growth, but as a result the industry is not yet contributing fully to India’s effort to finance its necessary social and physical infrastructure.

 

Japan’s Export Growth Model

Japan is a striking example of the success of the export growth model. Japan’s has achieved since 1960, an averaged growth rate (of GDP) of six percent per year. Japan had what is called an industrial policy where it specifically targeted certain industries for export growth. These chosen export industries were promoted and give governmental support. In the early '60s and '70s Japan targeted the automobile industry, steel industry and more recently the computer chip industry for export growth. Japan developed its own homegrown corporate institutions that have been successfully competing on the world stage. These institutions are well-known multinationals, such as Honda, Toyota, Nissan, and Sony.  Japan is now a fully developed industrialized nation.

 

Japan’s model of export growth is a different variant than that usually promoted by the international organizations since it has elements of planning and government involvement. It can be called directed export growth. There is a difference of opinion, within the industrialized nations, of whether Japan’s directed export growth model should be promoted in the Third World.

 

The problem of the export growth model is that of finding the appropriate export industry that can lead to significant growth. Whether that will happen automatically with the appropriate state policies, or whether it will require greater government involvement and planning, is a point of contention. Each industry has a different potential growth impact, and matching that potential to the needs of the Third World countries is the challenged.

 

Traditionally, mainstream economics teaches that each country will develop industries in which it has a comparative advantage in production (where it has a relative cost advantage as compared to other countries).  The country will then trade these goods, for goods in which it has a relative disadvantage in production.  Most Third World countries have a surplus of cheap labor, and as a result, automatically have a comparative advantage in labor-intensive industries.  This in fact, is one of major attractions of the Third World.  The textile industry, which uses a lot of low-wage labor, is a good example. The industry has been moving out of the United State’s south to Mexico and Asia.  To slow this reduction in textile jobs, the United States has a quota on the quantity of textiles that can be imported from those countries.  Fortunately, a country’s comparative advantage is not fixed over time. The comparative advantage of a country provides only the countries current potential. 

 

With economic development a countries comparative advantage changes.  The development of Japan over the last 50 years has demonstrated how its comparative advantage has changed.  Cheap labor was its first advantage, but its labor now is not cheap. Its firms and their know-how, give it an advantage, in manufacturing with a number of important industries.

 

Industry’s location

 

Not all industries are attracted to cheap labor.  There are many factors involved in explaining an industries location, other than labor costs.  Inertial sometimes keeps a firm from changing location at all.  Most firms change location only after a major change in their business, such as a business expansion in a new field, or an increase threat from a competitor. New firm startups can be random in terms of location, but their survival may not be random. Certain locations can be more favorable for different industries than other locations.

 

The primary locational determinant is connected to a firms (industry) cost and demand structure. Each industry or firm has different cost and demand requirements given the current technology. Some industries have a structure of cost that does not favor anyone location. Such industries are called footloose, and can be located anywhere.  There location is dependent on their origin, since there is no economic reason for them to relocate.

 

Transportation

If transportation costs are significant a firm will tend to locate, either next to a source of raw material (if the material is heavy, bulky or fragile) or near its buyers.  The Third World countries are suppliers of raw material and thus attract processing industries, but their remoteness from the buyers in the industrialized countries makes it difficult to attract these industries (unless there is the significant internal market). Services, one of the fastest growing economic sectors, generally need to be located near the buyers.  Services include everything from personal care services, hospitals, and schools to various business services.  Service industries and other market-orientated industries are unlikely to be attracted to remote (from the buyers) Third World locations.   

 

Labor

If unskilled labor cost is a large part of the total cost for the firm, firms will seek out locations that will minimize these costs. Cheap unskilled labor is the one resource the Third World has in surplus, and therefore it is a prime attraction for some industries.  The textile industry is one such industry.  It is a competitive industry (with no dominant firm or firms) and employs a lot of unskilled labor. Historically it has always moved to low-wage locations, in the United States, the textile industry moved from the New England states to the Southern states and now, it is moving to Third World countries.

 

Agglomeration

 

Some firms need and benefit from close proximity to other like firms in the same industry.  Firms by locating close to one another can produce at lower cost.  Cost for a particular firm decrease as the number of firms increase. In economics, this is an example of positive externalities (the cost reduction is external to any one firm) in production. This locational orientation results in industrial clusters and is called agglomeration, where like firms attract each other. There are number of reasons agglomerations.

 

Common input supplier

First, clusters can develop around a common input supplier.  This occurs if the individual firms are small and have high transportation (in terms of time or communications) costs.  High fashion dressmaking is an example. Dressmaking firms are small and must be prepared to change with quickly changing fashions. One of the intermediate inputs is buttons.  Button making have large economies of scale (cost decrease with increased production) and are large firms as compared to dressmakers.  Dressmakers need to be located close to buttons makers (and other input suppliers). They would be disadvantage if they moved away from the buttons makers and outside of their cluster. And as a result the fashion industry is located in clusters, and in the United States; the fashion industry is located in the high-cost cities of New York and Los Angeles.

 

Other important examples include the agglomeration of corporate headquarters. In the United States the primary cluster is located in New York City. The clustering of corporate headquarters allows corporations to take advantage of the clustering of advertising firms, economic consultants and many specialized legal services.  Outside of the cluster their choices would be limited, since many of these services still require face-to-face contact.  In the future these services may be provided at a distance using technology. Also high-technology firms, located in a cluster, can directly interact with their suppliers in the design and fabrication of component parts some of which are new and nonstandardized.

Communications and development of trust still need face-to-face contact.

 

Labor market

Second, location in a cluster allows the firm and employees to make an easy employment match. Since many employers are close, employing specialized skilled labor in the special niche of that industry, employers have an easy market to recruit new skilled employees.  Outside of the cluster, the firm is unlikely to find the specialized skilled labor required. Employees also have an advantage in the labor market, if they become unemployed or seek advancement outside of their firm. There are large numbers of potential employers available (which required no moving costs or potentially retraining).

 

Communication

Third, location in a cluster facilitates the rapid exchange of information and the diffusion of technology. With the many skilled engineers and technical personnel located in close proximity in Silicon Valley (in the high-tech computer chip industry, for example), product ideas and new production techniques are not likely to remain secret. There are many opportunities to exchange ideas in both formal and informal settings.  Suppliers of common inputs interact with designers of new products, and play and talk shop with employees from other firms, outside the workplace.

 

Industries located in clusters are difficult to relocate, since each firm has an incentive to stay put, and there is no coordinating central force to change (as is the case for a single firm). The growth of clusters depends on the industry’s final product and competition with other clusters. Developing new industries that locate in clusters in Third World countries (and any other country) is difficult and problematic.

 

Summary on location

Third World countries current attraction and probable comparative advantage lies in the production and processing of agricultural and mineral resources.  Unfortunately both tend to suffer from declining terms of trade (with one exception, oil), and with modern technology have only moderate employment levels. 

 

Third World countries other major attraction is low-cost labor. With low tariff barriers in the industrialized countries (not always the case) low-wage industries can be a major source of new employment. Unfortunately, along with low wages come labor market abuses, such as child labor, dangerous work conditions and environmental exploitation.  Also, the movements of low-wage jobs to Third World countries threaten many jobs in the industrialized countries, and tend to pull down unskilled manufacturing wages.  This of course, creates political problems in the developed countries. Long-term these low-wage industries are not attractive for the alleviation of poverty.

 

Low wages plus a potential large in-country market is particularly attractive.  China, India, Brazil, and Mexico are benefiting from this combination.  Poor countries with a small population have only low wages, and thus are far less attractive.  In addition, if the poor country is geographically remote, and sufferers under inefficient corrupt leadership, the country is unlikely to attract even low-wage industries. There are many African countries suffering under these conditions (they also face high tariff barriers in the developed countries).

 

The Japanese model suggests that it is possible for the poor countries to move away from dependence on low-wage industries.  But there may be a long transitional period.

 

Export Growth and the International Economic Institutions

 

The current principle international economic institutions support the export growth model. They use what leverage they have with Third World countries to promote trade and the general opening of their economies.  The principle international economic institutions include the following;

 

 

 1.   The World Bank whose mission, as an international agency is to lend money   to developing countries for projects to promote economic development.  Most such loans are for large infrastructure projects such as highways, dams, and various utility projects.

 

2.      International Monetary fund, (IMF) principle mission, as an international agency, is to help stabilize and secure the international financial system.  They were the primary agency involved in helping stabilize the South East Asia’s financial panic of 1997.  They lent and guaranteed funds to bankrupt countries caught up in the panic.  Their loans had strings attached with the long-term aim of moving these countries to the export growth model (reducing tariffs subsidies etc.).

 

3      The World Trade Organization, (WTO) which is a recently create international organization whose mission is to promote trade and help resolve trade grievances among trading countries (it has roots, from a older organization called the General Agreement on Trade and Tariffs-GATT).

 

 

The international monetary fund is the agency that commonly promotes economic reform, which is largely the promotion of the export growth model. The agency exercises its power, as the Third World countries develop balance of payment problems.  The country in trouble needs the IMF, to either directly loan it money, or act to certify to other lenders that the country is making progress in reforming its economy.  The IMF and the country negotiate together these reform efforts. Before money is loaned the agency makes various demands on the host country (strings are attached to the loan). In promoting export growth they have three policy thrusts; first, reduction of tariffs, quotas and subsidies, second, push the country to balance the government’s budget, and third encourage the government to reduce its involvement within local markets (Adam Smith’s Lassize Fare).  Subsidies that the government has long supported were eliminated both to save government funds, and to reduce government interference in the markets.

 

Early results of reform efforts

Most Third World countries have been persuaded to move at least somewhat toward opening its markets and balancing its budgets (it varies, with some countries enthusiastic supporter of these changes). It appears that the application of the model has been successful in helping control hyperinflation (with the help of keeping their money supply in check).  In Latin America where hyperinflation was a common problem (annual inflation of 100 percent or more), inflation now is mostly under control. The most impressive successes with economic growth have been in Asia.  Elsewhere the model has had uneven effects.

 

It appears that one of the consequences of the application of the model is a significant increase in income inequality throughout these nations, and throughout the world at large.  Outside of Asian, poverty has not been significantly reduced (actually in some countries the poor has been disadvantaged by some of the changes encouraged by the IMF). In particular, many governments of the Third World had subsidized basic foodstuffs such as bread or tortillas.  These were either eliminated or cut back.  And governments social spending on education and health in many cases were cut to help balance the government’s budget.  The IMF recently has begun to take a more generous approach to some of these spending programs. 

 

The primary problem remains finding and encouraging exports and exports markets.  Developing countries very greatly in their potential success.  The examples above, of Chile, Mexico, and India have had some successes, but other countries even with the implementation of the IMF program, show little progress.