Imperfect govts AND imperfect markets: Choice before developing countries

Source: http://jang.com.pk/thenews/apr2008-weekly/busrev-14-04-2008/p2.htm

By Aftab Ahmad Khan

Governments throughout the world are confronting the challenge of costly public programmes, bureaucratic inefficiencies and inadequacies in economic performance by turning to the private sector and free markets for assistance.

Three key reasons explain this phenomenon. First, during most of the 20th century governments increased the scope of their involvement in economic life of their countries. Whether through regulation, taxation or expropriation, the growth of government was sustained and relentless, and it took place in North and South, rich and poor nations making no distinction between democracies and dictatorships. By attempting to do so many things and produce so many goods and services, government management became thinly spread across a wide range of product lines, and quality and efficiency suffered as a result.

Secondly, from the perspective of government budgets, the mismanagement and inefficiencies manifested themselves in higher cost to produce government goods and services. This led to more government spending and higher deficits, which in turn led to more borrowing and higher taxes. Confronted with burgeoning deficits and collapsing services, many governments have no choice but to get rid of losing enterprises.

The fiscal deficits became specially acute in developing countries. As debt levels mounted, governments were forced to consider policy alternatives that would reduce the financial burden on the public sector.

Thirdly, while all governments grew during the 20th century, some governments grew more rapidly than others. Many market economies were better able to limit government growth than their socialist counterparts. By the 1980s, the results were unambiguous; countries that were successful in limiting growth in the government and maintaining a viable and competitive private sector experienced much higher rates of economic growth and prosperity than those who followed the opposite course of action. In a large number of countries state intervention in economic development instead of promoting growth spawned inefficiency, instead of re-distributing resources to the poor and the powerless the interventionist state too often coincided with elitism, corruption and dictatorship.

These trends created on environment conducive to limiting the role of the government. Developments in the private sector also provided a powerful impetus to the anti-statist trends. The private sector gradually became more efficient in developing countries of Asia and Latin America.

Private entrepreneurs emerged more successful, financial markets began to develop, policy and regulatory frameworks conducive to private initiative evolved, and transfer of technology through private channels became easier and more efficient. As private sector capabilities improved, there was less need to rely heavily on the state as entrepreneur and leader.

An important lesson that has emerged from the development experience of recent decades is about the role of the state. This role is crucial, but it must be kept within the limits of the scarcest resource in developing countries, that is the supply of competent and honest administrative talent. A large public sector exhausts this resource with strongly negative consequences.

Free market policies in recent years have received powerful support from the International Monetary Fund (IMF) and the World Bank. A large number of countries which are receiving loans from these international financial institutions have to abide by the conditionality of implementing a structural adjustment programme with emphasis on pulling back the interventionist state.

The objective of structural adjustment programme, observes a World Bank report “is to restore rapid economic growth while simultaneously supporting internal and external financial stability. As such these programmes have macro-economic and micro-economic aspects. The major macro-economic objectives are to improve the external balance and domestic fiscal balance. An adjustment programme thus commonly includes a combination of (a) fiscal and monetary policies to bring about aver-all demand reduction, and (b) trade policies (mainly the exchange rate and import / export taxes and subsidies) to alter the relative incentives between tradable and non-tradable goods. On the import side, the major objective is to improve efficiency in the use of resources by removing price distortions, opening up more competition and dismantling administrative controls (de-regulation).

Such programmes include those for government expenditure and the management of public enterprises including reduction in government presence in areas where private enterprise can operate more efficiently.” Simply put, structural adjustment means less government, free trade and more private enterprise.

Notwithstanding the current fascination with the charms of the market and disillusion with government in the Third World, it is an indisputable fact that a liberal market oriented economy can only yield positive results in a milieu characterised by good governance.

According to the IMF, good governance has been found to have a direct impact on economic efficiency and growth which it tries to promote as part of its mandate. The IMF has contributed to good governance through its policy advice, technical assistance and dissemination of codes and best practices aimed at strengthening institutions and systems and functioning of markets. Through its technical assistance, the IMF “(i) helps improve the management of public resources through reforms of public sector institutions (the treasury, the central bank, public enterprises and the official statistics function including such administrative procedures as expenditure control, budget management and revenue collection; and (ii) supports the development and maintenance of an open and stable economic and regulatory environment, for example price systems and related regulations - conducive to efficient private sector activities.”

The main ingredients of the British concept of civil service that we inherited in Pakistan were public confidence in the freedom of civil service from all political bias; minister’s confidence in obtaining loyal service from civil servants irrespective of what political party was in power, high staff morale based on confidence that promotions and other rewards do not depend on political origins or partisan activity but on merit. A really substantial commitment to political action would undercut staff morale and raise a multitude of suspicions, legitimate or otherwise. Unfortunately the role of the civil servant in Pakistan has been changing from being a functionary whose sole interest is the welfare of the public and impartial administration of laws to that of a mere agent of the government in power.

Experience of a large number of countries across the globe clearly demonstrates that for free market reforms to work, government institutions must work. Even with cutbacks in the role of the government the state remains a major actor in macro-economic policy making, infra-structure and social programmes. But because government effectiveness in many developing countries is undercut by low pay and pervasive corruption, governments themselves need institutional reforms that will raise productivity and wages and reduce corruption.

In the debate over the relative powers of state and market in economic life, one notices a significant shift in the position of many economists and aid agencies. During the 1950s and 1960s, they advocated an interventionist state that would plan, mobilise and manage the nation’s resources. This they argued was necessary in developing countries because markets had failed. Most aid agencies and economists now argue that the private sector should take the lead in mobilising and managing resources because governments in a large number of developing countries are crippled by inefficiency, corruption and over-centralisation.

In actual fact in most developing countries neither markets nor governments work efficiently. The problem would be easier if the choice were between perfect markets or imperfect governments, or between perfect governments and imperfect markets. In reality the actual choice is some compromise between imperfect markets and imperfect governments.