The Role of the Market Mechanism, the State, NGOs and

the Development Process

ECON 3508 November 1, 5 and 7, 2007

I. The Market Mechanism: Role, Advantages and Disadvantages

Historical Background- Ubiquity of markets, though not necessarily the

“market mechanism.”- Independently invented in all parts of the world;- Within older civilizations, long predating contact with

“the west;”;- Within centrally planned economies;

Emergence of market-oriented societies in recent decades or the last few centuries

What Markets Do:– Resource Allocation: determination of what is

produces, how, and for whom;

– Market prices as “communications systems” communicating demands of producers to suppliers of goods and services;

– As “incentive systems” providing suppliers or producers with the incentives and means to fulfill the demands of purchasers

– As “orchestration systems” coordinating innumerable economic actors and actions

– Can serve as “mechanisms for the social control of economic activity.”

Advantages or Strengths of the “Market Mechanism”

– Spontaneity of functioning; automaticity;

– Makes possible “consumer sovereignty;”

– Makes possible socio-cultural pluralism– Permits genuine multi-culturalism

– Decentralization of economic decision-making; permits immense varieties of goods and services;

– Incentive structures permit and encourage self-activation by all economic actors;

– Enforces “economic discipline” on market actors: the “hard budget constraint.”

– Permits private, co-op, & state (all levels) enterprise to co-exist

Weaknesses or Disadvantages: “Market Failures”

– income distribution and equity are not generated in

socially acceptable ways;

– public goods are not provided acceptably;

– external costs and benefits from individual actions generate socially and economically inappropriate results;

– producers and not consumers may exercise “sovereignty”

– tendencies towards monopoly, oligopoly or collusion may weaken the social control of economic activity exercised through markets

– the environment as a public good is not managed acceptably through markets.

Legal, Institutional, Cultural and Social Factors Relevant for the Effective Functioning of Markets

• Maintenance of Law and Order; • Personal security;• Enforcement of contracts• Maintenance of a Level of Trust• Honesty and Non-Corruption in Government and Enterprises, Public and

Private• Diffusion of Power, especially an Independent Judiciary• Competition, not Monopoly Control• Altruistic or Public Action to Maintain the Relevant Communities• Provision of public goods• Social policies and social safety net• Free Flows of Information• ?Materialistic Values? • ?Delayed Gratification? • ?Rationality unconstrained by Tradition?

• Source: Todaro, citing Keyfitz and Dorfman, modified by A. Ritter

Legal and Economic Factors Facilitating

the Functioning of Markets

1. Clear Delineation of Property Rights and their Transfer

2. Stable Currency and Macro-economic Environment

3. Appropriate Legal Framework or Environment:

4. Contract law, Patent and copyright law, Commercial law

5. “Freedom of Enterprise” i.e. Freedom to establish independent businesses

• subject to the regulatory environment

6. An Appropriate Regulatory Environment (to reduce negative externalities and for social protection)

7. Environmental law; 8. Health and safety legislation; 9. Labour legislation10. Provision of Public Goods by various levels of

Government12. Competition Policy, Control of Natural Monopolies13. Social Policy, Social Safety Net

II. The State and Development Processes: Role, Advantages and Disadvantages

Historical Background:

– ubiquity of “Planning since time immemorial;

– provision of public goods and in all complex civilizations as well as simpler societies

– Post-War development planning; excessive expectations followed by disenchantment.

The Role of the State and Public Planning: Central Tasks– Maintenance of a basic civilized order for the

functioning of society and economy

– Law and order and personal security;

– A regulatory framework

– Provision of Public Goods and Services, including those necessary for basic human development

– Adjust for external costs and benefits;

– Environmental Protection;

– Achieve a more socially and politically acceptable distribution of income

Strengths of the Public Sector– Can represent the Commonweal; – No reasonable alternatives often for the

provision of public goods;– Capacity to improve equity and social

justice in ways markets can not achieve;– Macro-flexibility:” the capacity to

mobilize resources rapidly and in large magnitude for collective action.

Weaknesses of the Public Sector: “Public Sector Failure”

1. “Weaknesses of Public purpose:” • Is Government in fact incorrupt, altruistic,

benevolent and public-spirited?• Or is it corrupt, predatory, kleptocratic?• Is it privilege-protecting, class-based or ethnically

based?

2. Susceptibility to capture by pressure groups, vested interests, especially the economically and politically powerful?

3. General Problems Intrinsic to Bureaucracy:

– Deformation of incentive structures;

– Inexorable tendencies to expansion;

– Absence of “Hard Budget Constraints” or clear financial discipline;

– Tendencies towards rigidity, inflexibility and sclerosis over time.

4. Promotion of “Rent-Seeking Behavior:” shaping rules, policies, taxes and expenditures for private gain;

5. Possible Imposition of Centrally-Determined preferences on people

6. Specific Weaknesses of “Development Planning”

III. The “NGO Sector” (See the text)

Conclusions from the discussion of the Role of the Market, the State and NGOs

IV. “Resurgence of the Market” 1980s and 1990s.

– Following the 1950s-1970s when the “market mechanism” was de-emphasized

– Reasons for this resurgence

– “The so-called “Washington Consensus”

The “Washington Consensus”1. Fiscal Discipline

2. Tax Reform, broadening base, cutting rates;

3. Focus public expenditures: health, education and infrastructure;

4. Unified and competitive exchange rates;

5. Trade liberalization

6. Liberalize DFI

7. Privatization

8. Financial liberalization

9. Deregulation

10. Secure property rights

Sorce: Todaro & Smith, from Dani Rodik, JEL 34 March 1996.

Politics and History of the Washington Consensus– Polemics re “Neo-Liberalism”, pro and con

– Economic Prosperity and such policies

Weaknesses of the “Washington Consensus”– De-emphasis on equity issues;

– Doctrinaire implementation in some cases

– Over-emphasis on the value of the market mechanism and undervaluation of the need for state action

The “Santiago Consensus”

The “Santiago Consensus”1. Development must be “Market-Based”

But “Market Failures” exist.

2. A Major Role for Government – Macroeconomic management– Basic public goods;– Tech transfer– Environmental protectoion– Help private sector overcome “co-ordination failures”

3. Social Equity: fairness in income distribution and poverty reduction

4. Provision of fundamental public goods, e.g. legal structure, law and order, security of property rights

Source: Text, from Santiago Chile: UN and Chilean example and World Bank pronouncements

Currently:

Is the pendulum swinging to the left?

African cases

Asian Cases

Latin America: Co-existence of • Santiago Approach,

• Washington Approach and

• Neo-Populist/Socialist Approach

V. Development Planning

1. Definition

2. The Potential and Promise of “Planning: in the 1950s-1970s

3. Types of Plan

4. What was in a Plan?– Planning and Budgeting

5. Specific Weaknesses of Development Planning– Politics of Planning was often ignored

(See accompanying Charts)

– Implementation was often weak– Unrealistic planning documents– Logistical weaknesses (staffing, information,

implementation mechanisms)– Assumption of Good Governance was nit

always correct

VI. The Problem of Corruption

1. Definition:

2. Varieties of Corruption

3. Consequences

4. Solutions to Corruption?