. '.:'V14.Y,[I.',/'rTTF7Y~F|J'*',;'|''IIf1n}JMecPreiAedroAspehndJose AnlGria[.. :;-~~~~~~~~~~~~~-YI.'-,PauKrugmanADDtESSThIStateand EconomicieDevelopment:qrd.A MeicaPespetivePerospeAnhosAnge GuRriaATowardaCoTterCntoTeFWRreviutoiANDeveopment ThEory,;.aandProducingIdeas,Paul M. Romer. .KEYNtoEconomicDevelopment?RichardB. Freeman*LaborMarketAdjustmentin TransitionalEconomies,Jan Svejnar*InformationFlowsandDiscriminationin LaborMarketsin Ruraly,TwAreasIn Develoming Countries,Andrew 0.Foster and Mark R.. . ,. KosnowledgeProperty, and the System Dynamics of Technoiogicai Change,Paul A. David.oAccumulatingTechnologicalCapabiltyinDevelopingCountries, LMarin Bell and Keith Pavitt iI..*TechnologyGaps betweenIndustrialand DevelopingCountries:D.KePgAreThereDividendsforLatecomers?Howard Packh.l.i.InternationalCapitalFlowstoLatinAmerica:What Is the Promise?Pedro-Pablo Kuczynski*CapitalFlowstoDevelopingCountries:Implicationsfromthe EconomiesIn Transition?Susan M. CollinsF*Conversionof OfficialBiliateralDebt:The Opporturiltiesandthe Issues,Stophany Griffith-Jones:;i'ROUNDTABuLEDlScuSSNThe Health of the Public: A PublicResponsibility? Julio Frenk,,EyitayoLambo,W. HenryMosley,F;,4;,!:and Uwe Reinhardt!T;;;.. ,,,,;:S,;!,i^,,1.'=.!,!I ,! 77,777....... '..,7;.F.. .Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPROCEEDINGS OF THEWORLDBANKANNUALCONFERENCEONDEVELOPMENTECONOMICS1992SupplementtoTHEWORLDBANKECONOMIC REVIEWandTHEWORLDBANKRESEARCHOBSERVEREDITIORSLawrenceH. Summersand ShekharShahEDITORIALCONSULTANTElinor BcrgBANKThe World Bank Annual Conferenceon DevelopmentEconomics is aforum for discussion anddebate ofimportant policy issues facing developing countries. Theconferencesemphasize thecontribution that relevant policy,empirical, and basic economic researchcan make tO understand-ing deelopmentprocessesand to formulatingsound developmentpolicies.Conferencepapers arewritten by researchersin and outside the World Bank. The conferenceserieswas started in 1989.The Proceedingsof theWorld Bank Annual Conferenceon DevelopmentEconomics is publishedas aspecial supplement tothe World Bank's professional economics journals, TheWorld BankEconomic Review andThe World Bank ResearchObserver. All current subscribers receive thissupplementtothe journals. The Editorial Boards of the Review and the Observerdo not reviewthe Proceedings,nor are the papers selectedfrhomtde conferenceand published here subject to thepeer reviewprocess through which regular submissionsto these journalsmust pass. Summariesareinduded of selected floor discussionsand the roundtable discussion; they attempt to convey thesense andsubstance of whatwas discussed, interventions by participants from thefloor, andresponses by panelists. Theyhave not been reviewed by theauthors, thediscussants, ortheparticipants.The views and interpretations expressedin this Proceedingsvolume do not necessarilyrepresentthe views of the World Bank or its memnbercountries and should not be attributed to the WorldBankor its affiliated organizations.@ 1993 TheInternational Bank forReconstruction and Development/ THEWORLD BANx.Allrights reserved.Manufactured in the United States of America.First printing March 1993ISSN 1014-7268ISBN0-8213-2211-7Material in this journal is copyrighted. Requests forpermission to reproduce arrides should beaddressed to the Office of the Publisher, the World Bank, Washington, DC 20433, U.S.A. TheWorld Bank encourages dissemination of its workand will normally give permission prompdyand, when theintended reproduction is for noncommercialpurposes, without asking afee. Per-missionto copy portions for dassroom use is granted through the CopyrightClearance Cencer, 27CongressStrt,Salem, MA 01970, U-S.A.TheWorld BankEconomic Review is indexed inCurrent Contents I Socal&, Behavioral Sci-ences, theSocial Sciences Citation Index,the Journal ofEconomic Literature, andthePublicAffairs Information Servce.TheWorld Bank Research Observer isindexed in the Journal ofEconomic LJteraure, che Standard PeriodicalDirectory, the Public Affairs Information Service,Inc.,and,online, by the Economic Literature Index andDIALOG.It isavailable in microformthrough UniversityMicrofilms,Inc., 300 North Zeeb Road, Ann Arbor, Ml 48106, U.S.A.PROCEEDINGSOFTHE WORLDBANKANNUALCONFERENCEONDEVELOPMENT ECONOMICS1992Supplement to THiEWoRtLDBANKIECONomicREvIEwAND THiE WORLD BANKRESEARCH OBSERVER.IntroductionLawrence H.Summers andShekhar ShahOpenLingRemarks7LewisT.PestonKEYNoTEADDRESS9The State and EconomicDevelopment: A MexidcanPerspectivePedro Aspe and joshAngelGurriaGRownH ANDDEvELOPMENTTHEoREsToward a Counter-Counterrevolutionin DevelopmentTheory15PauilKrugmanCommentJosephE.Stiglitz.39Comment,Laljayawardena 51FloorDiscussion 59TwoStrategies for EconomicDevelopment:Using Ideas63and Producing IdeasPaulM.RomerComment,KaushikBasu93Comment,MarceloSelowsky 99Comment, T. N. S-inivasan103FloorDiscusion111- LawrenceH.SxmmersandShekharSlwah~~~~~- -iiContentsXLABORMARETS ANDDEVELOPMENTLabor Market Institutions and Policies:Help or Hindrance117to Economic Development?Richard B. FreemanComment,VictorE. Tokman145Comment, KwaduwoA.Tutu151Floor Discussion153Labor Market Adjustment in Transitional Economies157Jan SvejnarComment, MarekG6ra169InformationFlows and Discriminationin Labor Markets173in Rural Areas in DevelopingCountriesAndrewD. Foster andMarkR.RosenzweigComment, Nancy Birdsall 20SFloor Discussionof Svejnar and Foster-RosenzweigPapers209TECHNOLOGYKnowledge,Property, and the SystemDynamics215of TechnologicalChangePaulA.DavidComment,Ashok Desai249Comment,Morris Teubal253AccumulatingTechnologicalCapabilityin Developing257CountriesMartin Bell and KeithPavittTechnologyGaps between Industrial and Developing283Countries:Are There Dividendsfor Latecomers?HowardPackComment,John Page303Comment,JorgeM. Katz307Comment, CarlDahlman313Floor Discussionof Bell-Pavittand Pack Papers317ContentsiiiINTERNATIONALCAPITALFLOWS- - .!uj''.-.International Capital Flows to Latin America: What Is323-: ~~the Promise?Pedro-PabloKuczynskiComment, AlbertFisblow337Comment, MarioI. 81ejr341Floor Discussion345Capital Flows to DevelopingCountries: Implicationsfrom the349Economiesin Transition?SusanM.CollinsComment, Andrts Inotai371Comment, IsbratHusain379Conversionof OfficialBilateralDebt: The Opportunities383and the IssuesStepbanyGrzffith-JonesComment, Jonatban Eaton403Floor Discussionof Collins and Griffith-JonesPapers409ROUNDTABLEDIscussIoN413The Health of the Public: A Public Responsibility?Julio Frenk,Eyitayo Lambo,W. HenryMosley,and Uwe ReinhardtPROCEEDINGSOFTHEWORLDBANKANNUALCONFERENCEONDEVELOPMENTECONOMICS1992IntroductionLawrence H.Summers andShekhar ShahThe papers collected in this volume were presented at the World Bank's AnnualConference onDevelopment Economics inWashington, D.C., April 30andMay 1,1992. Now in its fourth year, the conferenceseriesis aimed at expand-ing the flowof ideas among developmentpolicy researchers and practitonersaround the world.The Bank is an institution in which ideas are as important asfinance. It not only disseminatescurrent knowledge about developmentbutisalsoengaged infurtheringthis understanding. Asthelargest internationalagency concernedwith economicdevelopment,the Bank seeksto share with thedevelopmentcommunity the issues and concerns thatstaff members face on adaily basis, to expose Bank staff to recent research in economics,and to improveinteractionwithpolicymakcersandresearchers indeveloping andindustrialcounties. The annual conferences,and the wider disseminationof their delibera-tions in the proceedingsvolumes,contribute to these objectives.The 1-992conferenceaddressedfour themes: theories of growth and develop-ment, the operation of labormarkets, technology and its role in development,andinternational capitalflows. Theformatoftheconferenceallowed eachtheme tobe explored at some length, first by the authors,then by commentsfrom invited panelist,and finally through floor discussions.The 1992 confer-ence continued the tradition of holding a roundtable discussionrelated to thesubject ofthe nextWorld Development Report:healthpolicy in developingcountries.In his opening remarks, LewisT.Preston, the president of the World Bank,emphasizedthe importance of developmentresearch at the Bank. Noting thatthe search for knowledgeabout developmentis vital, he emphasizedthe need topresent such knowledge in dlear, pragmatic terms thatcan be easily communi-cated andimplemented in the diverse economic, socdal, andcultural circum-stances of individual developingcountrics.The keynote address by Pedro Aspe, Mexico's minister of finance and publiccredit, and JoswAngel Gurrfa, Mexico's undersecretaryfor interationalfinan-cialaffairs, focused onthepublic sector andonMexico's structural reformLawence Summersis the World Bank'schief economist and vice president, DevelopmentEconomics,and Shekhar Shah is deputy administrator of theakerld Ban's ResearchAdvisoryStaff.@ 1993 The InteracionalBank for Reconstructionand Development iTHEWORlBANKz-andintemationacapitalflows.Thformatoftheconerenceaslowedeac2Introductionprogram. Gurria,. whodelivered the address, provided aninsider's view of thereform process and the transformation that has made the government leaner buthas also strengthened its role in providing social infrastructure, health and edu-cation services,public safety, and the administration of justice.How have theories of growth and development shaped our thinking on devel-opment policy? In a reassessment of what heterms "high development theory,"Paul Krugman tracedthe ideas of Paul Rosenstein-Rodan, Albert Hirschman,andothers who emphasized the increasing returns and pecuniary external econ-omies thatarise fromtheeffects ofmarketsize. Krugmanarguedthattheseimportant ideas faded from mainstream economics notbecause of intrinsic logi-cal flaws butbecause the authorsfailed to codify their ideas ininternally con-sistent,formal models. These ideas also lost popularity in the face of the neo-classical counterrevolutionagainst interventionist development models. New,morerigorousdevelopments inintemationaleconomics, growththeory,andindustrial organization, Krugman argued, suggest thatthe time is now ripe for a"counter-counterrevolution"thatwouldseekamiddlegroundbetween theextremes of afree-marketorthodoxyandstate control.Krugman's reading ofthe history of these ideas was challengedin spirited retorts by Joseph StiglitzandLal Jayawardena.Paul Romer's paperincorporated"ideas" as afacterof productionand con-trastedalternative development strategies basedonusing existing ideas, as inMauritius,and on producingideas, as in Taiwan (China). He argued thatitiscrucial to distinguish ideas from human capital because ideas as economic goodsoften differ from both public and private goods. Moreover, explicit attention totheeconomic roleof ideas canserve as apowerful toolfor analyzing growththeories.Romerwasultimately pessimistic abouttheabilityofcountriestofollow an interventionist industriapolicy aimed atproducing ideas rather thanusing existing ideas. He noted thatuntil adequate national institutions for fos--teringthe productionof ideas come into existence, the gains from internationalintegration offer the best hope for development.Inhis paperontheroleoflabormarketinterventionssuch asminimumwages, job security, andcollective bargaining, Richard Freeman contrastcd thepositions of the "distortionists" andthe "institutionalists" regarding the desir-ability of such interventions. After assessing the evidence available tohim, hecondudedthatneither side hada clear-cut case. Thedistortionist argument, heargued,suffers fromthe absence of aconvincing androbustmeasure of labormarket distortions andfrom its reliance on weak cross-country time-seriesdataratherthandetailed investigations of specific interventions in particularcoun-. tnes.Freeman suggested that the decline in real wages during the past decade inseveral developing countiesmayindicate thatlabormarketsaremuch moreflexible than the distortionists generally assume. Turning to the institutionalists,Freemanalh-afound little evidence for the value of socialized pacts andconsulta-tive modes; of labormarketadjustment. Against this backdrop,Freeman pro-. . . posedadifferent modeloflabormarketinstitutionsasserving thepoliticalIntroduction3economy purpose of shifting attitudes and expectations of relative rewards in thelabormarket, and hence moving the perceived short- and long-run costs in favorof reform programs. He argued thatsuch a pragmatic approach, based more onunderstanding the role of interventions and institutions in specific settings, mayyield better insights for the design of adjustment programs.Twoother papers addressed the theme of labor markets. Andrew Foster andMarkRosenzweig emphasized theimportanceofinformationflows inrurallabormarkets withheterogenous labor,on thebasis of theirexaminationofworkers' actual productivity and the a priori productivity perceivedby employers.Using a rich dataset on time and piece-rate wages in casual labormarkets, theypresented empirical evidenceon the significant effects of information barriers onemploymentdiscrimination andoutlinedthepolicy interventions thatmightreduce the cost of such information barriers. They pointed in their policy con-clusions to the implications for worker mobility, permanency of labor contracts,- and private returns to human capital (and therefore investments in such capital)*0- and to the role ,hat such interventions as public employment programs can playin influencingthe structure of information flows. They also suggestedthat infor-mationonthe form of workerpayment (piece-rate versus trnewages) canbe- very important and thatinferencesthat ignore this distinction can yield mislead-ing conclusions.JanSveinar's paper,whichsurveyed labormarket developments in EasternEurope-particularlyPoland,Hungary,andCzechoslovakia-askedwhythemicroeconomic transformation hadso farproved tobe more difficult thanthe-process of macroeconomic stabilization-in these countries. Svejnar discussed thedesirability of the wage norm-arguingthatprofitable enterprises inthe trad-ables sector should be permitted to operate withouta strict norm-andrecom-mendedtheimposition of hardbudgetconstraints.Hearguedfor -the use ofsocial ratherthan private welfare criteria to deal with redundant laborin stateenterprises. Finally, he noted thatlaborunionsmay not have been suffidendyinvolved inthe design of reforms andcould become strongopponentsof thetransition, particularly in the face of rapidly rising unemployment.On the theme of technology, Paul David used a systems-theoreticapproach toexplore therelationships between technological change andthe acquisition ofknowledge. He argued against alinear, unidirectional scheme of technologicalchange that placed-fundamental scientific discoveriesand experimental findingsatoneend,andimitationand'diffusion oftechnology attheothererd.Hesuggested, forexample, thateven if theinterests of industrial anddevelopingnationsare identified, respectively, withthese earlier andlaterstages, thatinitself wasnotsufficient toclarify thecurrentNorth-Southdisagreements onintellectual property rights. David called instead for an evolutionary approachto the analysis of interactions between scienceand technology, with attention tothedynamicfeedbacks andnonlinearities thatareoftenoverlooked.Inthiscontext he examined the appropriability problem that affects the production anddiffusion of information.4.IntroductionIn his:paper on the role of technology in developingcountries, Howard Packexamined the issue of 'convergence"and asked whether low-incomedevelopingcountries can benefit from being latecomers by using the stock of knowledge ofmore advanced countries, thereby achievingrates of per capita income growththatare higher than expectedon the basis of their accumulationof physical andhuman capital. Pointing to several important empiricalproblems with the con-vergence hypothesis when itis tested using time-series datafortotalfactorproductivity growth,he argued thatmuch of the unexplained growth can beshown to have come from the shift from agriculturetoward manufacturing andservices.Pack discussed the experiencesof the Republic of Korea andTaiwan(China)-economiesthat have successfullyshifted to a higher production func-tion through technologyand development.Keith Pavitt andMartin Bell explored the lessons for developing economiesfromthe experience of the industrial countries with technology development.They argued for a view of technologicadinnovation and diffusion thatis muchmore firm- and industry-specificand that takes into account the learning capa-bilities of finns in different policy settings. They also made the point that grow-ing specialization andvertical disintegration have weakened the link betweenproduction capabilitiesand technologicalaccumulation.Turning tothefinal conference theme, international capitalflows, Pedro-Pablo Kuczynskidiscussedthe reasons for-andthe promise of-theresurgenceof capital into many parts of Latin America.He traced the internal and externalcauses for these reflows, emphasizingthe significantchanges in economic poli-cies in virtually all of these countries, and called for the developmentof fixed-incomecapital markets to channelthe inflows into essentialinfrastructural proj-ects. Kuczynski highlighted the need for political andsocial stability in LatinAmerica and observed that if such stability is to be achieved,it is imperativethatthe economicconditions of the poor improverapidly.In her paper, Susan CoDlinsasked whether developmentsin Eastern Europeand the former U.S.S.R. are likely to divert capital flows from developingcoun-tries. Collins maintained that demand from Eastern Europe is unlikely to mate-rially affect developing countries' prospects for private capital flows, which inany case appear limited. She examined the implicationsfor all otheraid recip-ients of the sustained increasesin official developmentassistanceto four coun-tries (China, Egypt, Israel, and Bangladesh)since 1970 andfound significant-diversionin thatspecificcase. To the extent that there are parallelsbetween aidallocation for these four countries then, and Eastern Europe now, Collins sug-gestedthat some diversionof aid may occur.Stephany Griffith-Jones, in her paper onthe conversion of official bilateraldebt,looked for parallels between such debt conversion, particularly by low-incomedevelopingcountries, and the ongoingprocess of convertingcommercialdebt,mainly in the middle-incomecountries. She examined the potential bene-fits and costs of official debt conversionand suggestedthatunlike commercialdebt conversionsthathave focused on debt-equity swaps, official debt oonver-IntroductionSsion could profitably examine the scope for directing greater funding to socialsectors, to poverty alleviation, and to the environment, on the grounds of highsocia1rates of return.'As in previous years, the planning andorganization of the 1992 conferencewas a joint effort. We both benefitedfrom the guidance and support of GregoryIngram, administrator of the World Bank's ResearchAdvisoryStaff, the organi-zational home of the conference.We would also like to thank other staff mem-bers, in particular the conference coordinator, JeanGray Ponchamni, whosesuperb organizational skills kept the conferenceon track. She was ably assistedby Mantejwinder Jandu.Finally, wethankthe editorial staff, especially ourconsultant, Elinor Berg, as well as Sandra Gain and Patricia McNees.PROCEEDINGSOFTHEWORLDB A NKANNUALCONFERENCEO ND E vE L OPME NTECONOMICS1992OpeningRemarksLewis T.PrestonI am pleased tobe here this morning to inaugurate the Bank's Fourth AnnualConferenceon DevelopmentEconomics.To all of you, a warm welcome.I particularly want to welcome those of you who are attending the conferencefrom other parts of the world. I believeitis imperativethat the Bank remain anopen institution, constantly looking for opportunities to strengthen its linkswiththe developmentcommunity.This conference is animportant opportunity for us to share ourvaried per-spectives on the problems of development. The economics of development iscentral to the mission of the World Bank. Economic developmentand the alle-viation of poverty have been the Bank's unchanged businessfor twenty years.I want to stress thatdevelopmentresearch-theanalysis of why developmenttakes place in some settings, and why poverty persists in others-isalso centralto the Bank'smission.As Larry Summersemphasizedin his ad-dressto last year's conference,knowl-edge is essentialfor effectiveaction in a world of finite resources. It is the searchfor ideaswhich could make a differenceto developmentthat has kept researchatthe center stage in this organization.In this pursuit of worthwhile ideas, we must continue to examine develop-ment policy in pragmnatic,operational terms that we can discusswith our mem-ber countries and that they can implement and sustain under diverse social andpolitical circumstances.Over time ourresearch topics have broadened toindlude issues in health,education, andenvironmental management. Yet we have notabandoned ourpast focus on capital accumulation, industrialization, andthe role of govern-ment. Even now we are hard at work improvingour understandingof how theselast three elementshave successfullytransfonredJapanandthe newly indus-trialized countriesin East Asia.We have learned thatitis unrealisticto believethat the invisiblehand of themarket is all that is needed to promote development.Governmentsmust lend themarket a helping hand-bydoing well those things thatonly the public sectorcan do and by avoidingthose activities best left to the private sector.Developmenteconomics is atonce the oldest and the newest branch of eco-nomics. Adam Smith began, after all, with an inquiry into the nature and causesLewisT. Pteston is president of the WorldBank.d1993 The [nternationalBank for Reconstuction and DevelopmentroTHEWORLDBANK78OpeningRemarksofthe wealthofnations, andyet thereismuch we donotknow.Overall,'advances in developingcountries in the past twenty-fiveyears have been impres-'sive.Life expectancy has risen by ten years,infant mortality rateshave beenhalved, and per capita income in low-incomecountries has nearly doubled.Atthe same time, country-by-country experience has been highly variable.Thirty-six countries were poorer at the end of the 1980s than they were twenty-five years ago, and incomes declinedon two continents in the past decade. Weneed to understand the reasons for this dedine if we are to reduce poverty andimprove livingstandards.Increasingour knowledgeabout the determinants of developmentwill requireingenuity and resources as well as insights about what policies to pursue. Wealso havemuch tolearn from the different perspectivesandexperiences thateach of us brings to the common pursuit of such knowledge.Developmentneeds the help of practitioners, policymakers, andscholars to*;;-- identify the ideas and areas thatshould be pursued and to seek the approachesthatare likely to yield the highest returns. It is only through an open dialoguethat allows us to test each other's premisesand assumptionsabout developmentand challenges past practices that we can hope to shape the intellectualfounda-tions for effectivedevelopment.As several of the papers atthis conferencewill tell us, ideas areseminal tosuccessfuldevelopment. We can generate new ideas, and we can adapt and useexisting ones. I invite all of you to join both of these ongoing endeavors at theWorld Bank.Y.PROCEEDINGSOFTHEWORLDBANKANNUALCONFERENCEONDEVELOPMENTECONOMICS1992KEYNOTE ADDRESSThe State and Economic Development:A Mexican PerspectivePedro Aspe and Jose Angel GurriaSome time ago, Albert Hirschman (1958) said that developmentis like a jigsawpuzzle: itiseasier.tofitinaparticular piece whenthe adjoining pieces arealreadyin place; the piecesthat are hard to find are those with only one neighborin place.This clever analogy evokes two very inportanteconomic principlesthatboth researchers and policymakersare rediscoveringas we move from thedecade of adjustment to a new period of rtform and growth. The first one is thatduring the early phases of development, when aneconomy is no more thanacollectionof fragrnented markets and regions, the establishmentof governmentinstitutions, the construction of infrastructure, andthe direct participation ofthe state in some areas of the economy are not only desirable but indispensablepreconditions for the growth process.The second principle ismore in line with the recent theories of endogenouseconomicgrowth (seeScott 1991; Romer 1989; Lucas 1988; and Uzawa 1965).It reflects the notionthatthe opening-up of investment opportunities throughchanges in the environment where individuals work, save, and invest both cre-ates and reveals new investment opportunities. In Hirschman's example, oncethe difficultpartsof the puzzle have been solved, the remainingpieces begin tofall into place almost automatically.What this means for the role of the state ineconomic development is that after an initial period of protection andgoven-ment intervention, growth no longer responds as strongly to further involvementas itdid during the very first stages of industrialization. Furthermore, this anal-ogy conveys thenotion thatonce thebasic institutional framework has beenimplemented, the public will be betterserved by indirect support of economicactivity through deregulation,privatization, trade liberalization, and a competi-tiveenvironmentthanbydirectgovernmentparticipationinproductionactivites.With these two principles in mind, we would like to briefly elaborate on theconsequencesof structural reform of the public sector, using the Mexican expe-nence as an example.Pedro Aspeis Mexico'sministerof financeand publiccredit, and Jose A. Gurrla is Mexico'sunder-secretaryfor international financial affairs.The address was deliveredby Mr. Gurria.1993 The Internationm Bank for Reconstructionand Development /THEWORLDBANK9-10KeynoteAddress'From a long-term perspective, Mexico's years of low outputgrowth andhighinflation are more the exception than the rule. For example, between 1950 and1970 Mexico hada remarkable macroeconomic record: gross domestic product(GDP)expanded atanaverage rateof nearly6.6percent ayear,while annualinflation-wasbelow 4.5percent.This era wasinmany ways the result of theripening of institutions broughtinto being by the Mexican Revolution (1910-20),combined with the morestable performance of world markets. The devel-opment strategy was aimed at linking markets throughoutthe country by invest-ing heavily in infrastructure,telecommunications, energy, andtransport.Agri-culturalproductionwas stimulatedby landdistribution,andindustrializationwaspromotedthroughimportsubstitution.- Thesestructuralelements werebacked by strict fiscal andmonetary discipline. Throughoutthese years publicsectorborrowingrequirements wereconsistently less than3percentofGDP,whiletheavailableinstrumentsofmonetarycontrolemphasized priceandexchange rate stability.These results suggest thattherewas noreason toargue thatMexico's eco-nomic strategy-basedon protection,financial repression, andthe strong pres-ence of the state-wasnotadequate. At the same time, some problems revealedthat there was a limit to how far and how long this strategy could continue. Forinstance,in the late1960s itwasalready apparentthatdomestic andforeignprivate investment were slowing down.One -important reason for this was thatprotected oligopolies hadalready achieved strong market presence and had littleincentive to keep on growing by increasing employment and productivity. Thusin the 1970s, pressed to offer workfor a rapidly increasing population,Mexicohadtwoalternatives:shift toanexport-orientedeconomy, as the Republic ofKorea did in 1965, or stay the course, filling the gap created by the dedining roleofprivateinvestment withgovernment spending.Atthetimetheauthoritiesopted for the latter.By 1972 Mexico was on the road to higher inflation. The public sector deficit,which was slightlymore than2 percent of GDP in 1971, began to grow, financedby aninflation taxandexternal borrowing,and reached 9.1percent of GDPin1976. Facing its first financial crisis since 1940-andthe first devaluation of thepesoagainstthedollarintwenty-twoyears-thegovernmentconceded thatMexicohadtoundertakeastructuralreform torestore growthandstability.However,thediscovery oflarge oilreserves andthepossibility of continuedaccess to internationalfinancial markets notonly postponedthe needed reformbutconvmincedtheauthoritiesthattheeconomycould groweven faster.Forsometime GDPincreased atabout9percent ayear,as inflation crept intothedouble-digit range, until1982, when Mexico reached the limit of external bor-rowing capacity.The 1982 crisis was the worst since the Great Depression. The event was notatemporary slowdownbutthe reflection of fundamental disequilibria thatseri-ously jeopardized the long-term viability of the economy. The cumulative effectsof previous fiscal andexternal imbalances created majorhurdles.Overall, theAspeand Csurrna 11publicsectorborrowingrequirement was16.9percentof GDP.Netexternaltransfrrsin the following years amounted to 6 percent of GDP.On the structuralside, the financial sector lacked the flexibility to halt capital flight andto inter-mediate savings efficiently; excessivereliance on oil exports made the fiscal andexternal accounts extremely vulnerable to terms of trade shocks; the tax systemwas seriously impaired by evasion andconspicuous subsidies; and the economyremainedshielded frominternationalcompetitionby prohibitivetariffsandnumerous quantitativerestrictions. Tradepolicy, in particular,fostered ineffi-cient private enterprises inthe industrial sector, many of whichhadto be res-cued by the government.In retrospect,the purpose of government intervention during the 1970s andearly 1980s was to maintain emnploymentand economic activity while respondingto the most pressing social needs of the population. The years of adjustment andcrisis proved thatby trying too hard,the authorities failed to meet both goals. Agrowth strategy based on expanding inefficientparastatals could not be sustainedwithahardextemalbudget constraint.Covering the losses of the parstatalsdiverted resourcesfrom investmentsin health, education, and infrastructure.For example, Sidermex, a steel complex, accumulated losses of more than $10billion ina decade as aresult of poormanagement, badinvestment decisions,andsevere unionproblems. Thosesame resources could have provided drink-ablewater,sewerage,andhealthandeducationfacilities toallthemarginalcommunities in the southeastern part of the country.For the past ten years Mexico has followed an economic strategy that combines- . stabilization and structural change. President de la Madridemphasized the per-manent correction of macroeconomicimbalances, while the government of Presi-dent Salinas de Gortarihas stressed eliminating the institutional distortions thathadinhibited the participation of the civil society in the developmentprocess.Onthemacroeconomic side,theadjustmenthasbeen extraordinary.Thebudget deficit, which had reached 17 percent of GDPin 1982, recorded a surplusof 6 percent last year.The public sector balance registered adeficit of slightlymorethan1 percent of GDPlast yearandis expected torecord asurplus of 1percent in 1992 (without the proceeds from privatizations). But far more inpor-tantthanthefigures themselves isthewayinwhichadjustmentwasimple-mented in the broader context of the reform of the state.Tomake adjustment permanent,itwas necessary toreduce thesize of thegeneral government; to privatize, shutdown, or transfer parastatal enterprises;torenegotiate the external debt; andtoputin place fiscal reforms thatwouldlowertaxratesandincreasecompliance. Inaddition,toreinforce theanti-inflationary thrustof adjustment, nontariffbarriers were eliminated andtariffswere lowered and rationalized.Theoutcomeof thestabilization effortisencouraging sofar.Inflation fellfrom anannualized rateof nearly 200 percent in January1988 to18.8percentin- 1991. After zero growth between 1982 and1988, GDPhas been growing at-twicethe rate of population growth for the past three years.12KeynoteAddressThe old literature on development andthe new views on growth point to theimportanceof government efforts tobridge missing markets andopenoppor-tunities for civil society. From the perspective of Mexico's experience, we shouldadd athird element to this list: the social dimension of a leaner-butstronger-government.Today, state participation in economic activity is very different from a decadeago.Growthpolicies are geared towardcreating apropitiousclimate fortheparticipationofindividuals.Insteadofsubsidiesandnationalization,theemphasis is onthe elimination of institutionalconstraints on competition, thecreation of new markets, and the generation of opportunities for all members ofthe population.Let me illustrate with some examples.Inthefinancial sector,the authoritieshaveintroducednewinstrumentstomakepossibleintertemporalandintergenerationaltransfersandtohedgeagainstinflationandexchange raterisks.Transactionsthatwereimpossibleonly three years agoare nowencouraged throughinflation- orexchange-rate-indexedbonds,flexible-rate andvariable-maturitytreasury bills,orspeciallydesigned individual retirement accounts.The apparatus of development financing has also been revamped. In 1987 theNationalIndustrial Development Bank (Nacional Financiera) allocated 94 per-centof its totalcreditprogram to large (andinefficient) parastatalenterprisesandthe remaining6 percent tosmall andmedium-size enterprises. In1991itapplied only 6 percent of totalcredits toparastatals andthe rest tothe privatesector.Creditpolicy aims toprovideaccess, notsubsidies, tosmall entrepre-neurs who are ineligiblefor financing throughnormal commercial bank lendingbecause they lack a credit history.Fiscal reform,apartfrom theinternationalharmonizationof ratesandtheeffort toincrease compliance, also focuses onintegrating marginal producersintothe formaleconomy throughatransitionalregime thatdoes notrequiresmall firms to maintain complex accounting standards but obliges them to regis-ter revenues andexpenses so thattaxes can be calculated. Aside from the directrevenue implications, this reform helps small firms change from inefficient enti-tiestocompetitive enterprises.The financial information they record fortaxesalso helps them to track their profit performance and to compare it against theircompetitors'.In additionto the divestiture or closing of more than900 of the 1,155 enter--prisesunderstatecontrolin1982,Mexicohasderegulated groundandairtransport,telecommunications,fisheries,textiles,automobiles,andforeigninvestment and has passed new laws on technology, patents, and trademarks. Arecent constitutionalreform gives legal title tovery small holdings (knownas-eidatarios),to communalworkers, and to smallfarmersso that theyare free tosedlor lease the land or use it as collateral.Intheexternalsector theunilateraldismantling oftradebarriershasbeenfollowedbyaseries ofbilateralandmultilateralnegotiationsforfree tradeareas. An agreement has already been signed withChile, negotiations are nowAspe and Gurria13underway with Canada and the United States to form aNorth AmericanFreeTrade Area, and talks are being held with Venezuela, Colombia, and the Cen--tral American countries.Thenewopportunitiestoconductbusiness haverenewed enthusiasm forforeign anddomestic investment. Foreign investmentflows in 1991 reached $12 billion, the largest amount ever recorded and almostequal to total foreign investmentin Mexico prior to 1982.The reform of the state, however, is not exclusivelyaimed at increasingeco-nomic efficiency andpromoting faster growth.Italso hasavigorous socialdimension. The correction of fiscal disequilibria has gradually strengthened thestate's capacity toprovide basicsocial infrastructure, healthandeducation,public safety, and the administrationof justice. In 1982 the federalgovernmenttransferred an amount equivalent to 12.7 percent of GDPtO the parastatals; in1991 thatfigure was 2.5 percent. In contrast, social spending, which in 1988was 32 percent of total programmable spending and 6 percent of GDP,increasedto almost 8 percent of GDPand 45.5 percent of programmablespending in 1991.(In pesos, this translates into a 60 percent real increasebetween 1988 and 1992.)Decentralized social participation has been encouraged. The NationalSoli-darity Program to fight poverty is an example of the new approach. The actionprogram of Solidaritybegins with the creation of a committeein a giventown orlocality. Thiscommittee provides the govemment withaproposal, andtheproject is undertaken cooperatively.The raw materials, such as bricks, cement,and wood, are provided by the government, the engineeringskills by universitystudents, and the labor by the local population. The program has disbursed $1billion a year since 1989 (0.4 percent of GDP)but has already achievedremark-able results because ithasactively involved large anddiverse sectors ofthepopulation.In three years6 million people have been given access tohealthservicesfacilities; 8 million people have been provided with drinking water; 11million people in more than 10,000 communitiesnow have electricity;a millionandahalf children are receiving education inthe newschool facilities refur-bished by parents andteachers; and aquarter of amillion children have beengranted cash scholarships tocomplete their primary education. Hundreds ofnew projects and initiatives take shape every day across the nation. In 1992 thebudget for this program is more than $2 billion.Our generation was educated in a context in which the greater presenceof thestate was considered asynonym of social justice. For many years when it wasnecessary to promote industrialization, the state created enterprises and publicentities tochannel resources andsubsidies. Itbought companies infinancialdifficultiesto savejobs and support production. We now see that these were notalways the right decisions.We now know thata bigger state is not necessarilyamore capable state. From the perspectiveof the past twenty years inMexico, abigger state eventuallycaused lower growth, adiminishedability to respond tosocial needs, and, in the end, a weaker state. The reform of the state has meant achange fromapaternalistic government toonethatinsists on market-drivenmeasures, without forgettinghow much is due to those who need more.14Keynote AddressIn the past decade the people and the government of Mexico have come a longway,butthere isstillalong waytogo.Inflation mustbe broughtdown tointernational levels. Improvements are necessary in reregulation, deregulation,and the modernization of government institutions to encourage growth. Reformwill only be completed, however, when all Mexicans have adecent standard ofliving, accessto training,and job and businessopportunities.The new views of economic developmentchallenge both government and civilsociety. They are based on the importance of the citizen andthe proper organi-zation and operation of the state. The ultimate goal is to esablish an economy inwhich access to opportunitiesis the same for everyone within an open and fullydemocratic society.REFERENCESHirschman, Albert.1958.TheStrategy of EconomicDevelopment.NewHaven, Conn.:Yale UniversityPress.Lucas, Robert E., Jr.1988. "On the Mechanics of Economic Development."JournalofMonetary Economics 22(July):3-42.Romer,Paul.1989."Increasing ReturnsandNewDevelopments intheTheoryofGrowth."NBERWorking Paper 3098.Cambridge, Mass.:National Bureau ofEco-nomic Research.Scott,Maurice FG.1991.ANewViewofEconomicGrowth:FourLectures.WorldBank DiscussionPaper 131. Washington, D.C.Uzawa,Hirofumi.1965."OptimumTechnical Change inanAggregative ModelofEconomricGrowth." InternationalEconomicReview6(1):18-31.PROCEEDI NGSO-FTHEWORLDBANKANNUALCONFERENCEONDEVELOPMENTECONOMICS1992Toward a Counter-Counterrevolutionin Development TheoryPaul KrugmanDuring the 1940sand 1950sadistinctiveset of ideasemergedin developmenteco-nomicsthat stressedthe importanceof increasingreturnsand pecuniaryexternalecon-omies arisingfromthe effects ofmarket size.Unfortunately,the economistswhoproposedtheseideaswereatfirst unable,and laterunwilling,to codify them in clear,internallyconsistentmode/. Atthe same time the expectedstandardof rigorin eco-nomic thinkingwas steadilyrising.The resultwas that developmenteconomicsas adistinctivefieldwas crowdedout of the mainstreamof economics.Indeed, the ideasof'bigh developmenttheory"cameto seem not so much wrongas incomprehensible.This paper argues that in light of new developrmentsin industrialorganization,internationaleconomics,and growth theory, the old developmenteconomicsnowlooks much moresensiblethan it seemedduringthe '5:ounterrevolution"againstinter-ventionistdevelopmentmodels.Whiledevelopmenteconomicshas beenused tojustifysome highlydestructiveeconomicpolicies,thereis a validand usefulset of core ideasthatcan be usefullyresurrected.Tbus thispapercallsfora"counter-counterrevolution"that restoressome of the distinctivefocus that cbaracterizeddevelopmenteconomicsbefore1960.Once upon a time there was a field called developmenteconomics-abranch ofeconomics concerned with explaining why some countries are so much poorerthan others and prescribingways for poor countriesto becomerich. In the field'sglory days in the 1950s, the ideas of developmenteconomics were regarded asrevolutionary andimportant-and commanded both great intellectual prestigeandsubstantialreal-worldinfluence.Moreover,developmenteconomicsattracted creative minds and was marked by agreat deal of intellectual excite-ment.Thatfield no longer exists. There are, of course, many excellent people whoworkon theeconomics ofdeveloping countries. Some of the problems theywork on are essentiallygenericto all countries, but there are also issuesuniquelycharacreristicof poorer countries, and in this sensethere is a field that focuses onthe economicsof underdevelopment.But it is a diffusefield: those who work onPaulKrugmanis professorof economicsat the MassachusettsInstituteofTechnology. 1993TheInternationalBankfor Reconstructionand DevelopmentiTHE WORLDSANKis- 16Toward a Counter-Counterrevolutionin Development Theorythe economics of agriculture in the developingcountries, for example, have little(if any) overlap with those who work on developing country trade in manufac-tures,who in turnhardly talkto those whofocus on the macroeconomics ofdebt andhyperinflation. And very few economists would now presume to offergrand hypotheses about why poor countries are poor or what they can do aboutit. In effect, a counterrevolution has swept developmenteconomicsaway.This paper argues thatthe counterrevolution went toofar.I will argue thatduring the 1950s a central core of ideas emerged regarding external economies,strategic complementariEy,andeconomic development thatremainsintellec-tually valid andthatmay continue to have practical applications. This set ofideas, whichIwillrefer toas "high development theory,"'anticipated inanumber of ways the cutting edge of modem trade and growth theory. But highdevelopment theory wasvirtually buried,essentially because thefounders ofdevelopment economics failed tomake their points withsufficient analyticalclarity to communicatetheir essenceto other economists, and perhaps to them-selves.Recentchanges in economicsnow make it possible to reconsiderwhat the- developmenttheorists said and to regain the valuable ideas that have been lost.In other words, this paper caDlsfor a counter-counterrevolutionin developmenttheory.It is somewhat awkward to present a paper thatis to some extent a history ofthoughtataconference on current research. But development is oneof thosefields (growth, trade,and regional economics are others) in which recent con-cepts canleadtoarediscovery ofthe validity ofdiscarded insights. And bylinking old ideas with the new, we may avoid repeating old mistakes andget achance to make new ones instead.I.A MOTIVATINGExAMPLE:THE BIG PUSH REVISITEDTheBig Push paperof Rosenstein-Rodan (1943) hasinspired many inter-pretations.Some economists readitasessentially Keynesian, astoryaboutinteractions between the multiplierand the accelerator. Rosenstein-Rodanhim-self seemsto have had some more or less Keynesianidea about effectivedemandin mind, with (as we will see) considerablejustification. Other economistssaw itas an assertion that growth must be somehow "balanced" in order to be success-ful. Indeed, Hirschman (1958) cast The Strategy of Economic Development asanargument with-andrefutation of-Rosenstein-Rodan(and othersofthebalanced-growth school), which I will argue was both amisunderstanding andself-destructive. Yetothereconomists triedtogenerate low-level equilibrium- :trapsby invoking such mechanismsas interactions among income, savings, andpopulationgrowth(see, forexample, Leibenstein 1957;Nelson 1956).Such1.It will becomeapparentthat what I identias'highdevelopmenttheory" is essentiallythe nexusamong the external economy/balanced growth debate,the concept of linkages, and the surplus labordoctrine. This theory's golden age began with Rosenstein-Rodan (1943) and more orless ended -withrHirschinan(1958).Obviously thisnexus does notcover all ofwhatwashappening inthe field ofdevdopment economicseven at that time, but it is the core of what I believcneeds to be recaptured.Krugman17mechanisms can also justify aBig Push, butthey are very far from the spirit ofthe original story.Fairly recently, however, Murphy, Shleifer, and Vishny (1989) offered a for-nmalizationof the Big Push that is quite dose to the original spirit andalso quiterevealing abouttheessentialaspects ofhighdevelopmenttheory.Iofferaslightlystreamlined presentation of their model and then turn to what it tells us.The Big Push Model of Murphy, ShZeifer,and VishnyThemodel examines aneconomy thatis closed tointernationaltrade.Theeconomycanbedescribed byassumptions aboutfactorsupply,technology,dernand, and market structure.This model can serve as a motivating example toexplain both the elements of high developmenttheory and why that theory failedto establish a secure place in the mainstream of economics.Factorsupply.Theeconomyisendowedwithonlyasinglefactorofproduction-labor-infixed total supply L. Labor can be employed in either oftwo sectors: a "traditional" sector, characterized by constant returns,or a 'mod-ern"sector, characterized by increasing returns.Although thesamefactor ofproduction is used in the traditional and modern sectors, it is notpaid the samewage.Labormustbepaidapremium tomove fromtraditionaltomodernemployment. We let w>Ibe the ratio of the wage rate that must be paid in themodern sector to that in the traditional sector.Tecbnology.It is assumed that the economy produces N goods, where N is alarge number. We choose units sothattheproductivity of laborinthe tradi-tionalsector isunityineach ofthe goods.Inthemodernsectorunitlaborrequirements are decreasing in the scale of production.For simplicity, decreas-ing costs takea linear form.Let Q,be the productionof good i in the modernsector. Thenif the modernsector produces the good atall,the laborrequire-ment will be assumed to take the form-(1)- Li=F+cQwhere c'f'. Thus the:relative sales of a Western firm will be(A.11)SW/SE=S-Iw1(a1)[(1+r)Ta1+(1- 'r)Tr0].Howhigh awage cansuch a firm affordto pay? It is easiest tothink of thefirm as using an operating surplus to cover fixed costs. The operating surplus,.36Towarda Counter-Counterrevolutionin DevelopmentTheoryin the Dixit-Stiglitzmodel, is proportional tosales. The fixed cost is incurredinlabor,sothemaximum relative wage thatthefirmcan affordtopayisdefined by':- (A.12)S =Sw.This givesus the wage equation*- (A.13)[1W.7..1+2-aThe final step is to ask whether this maximum nominal wage implies arealwage higher or lower than the real wage in East. Sincethis is a lone defectingfirm,all manufactured goods(except for its own negligiblecontribution) would have tobe imported. Recallthatonly a fraction r of a good that is shipped arrives. Theprice of manufactured goods in West will therefore be 1Irtimes as high as that inEast. The overall price index, which is a geometric averageof manufacturesandagricultural goods, will thus be r'-times as high. The maximum relative realwage a defectingfirm can pay is thus*(A.14)c, =Wt=- + 2-1+1TA concentration of all manufacturing in East is an equilibriumonly if this rela-" :'tive real wage is less than one (that is, a defectingfirm could not profitably inducelabor to move). We can immediatelynote that if manufacturingwere a smallpartof the economy (rclose to zero), concentrated manufacturingwould never be anequilibrium. Equation A.14 would reduce to.(A.1S)Co [&l+z Tse]lTwhich is alwaysgreater than one becauseof Jensen's inequality.This result arisesbecause of the attractionof dispersing productiontoward the dispersed ruralmarket.A comparison of (A.14) and (A.15) reveals immediatelythe potential ro'of alarge manufacturing sector to generatelinkagesthat lead to concentration. In thecase with large sr, the first term becomesless than one and is smallerthe larger is r.This first term represents the attraction to workers of locatingdose to the existingmanufacturing concentration to have accessto the goods it produces; in effect itmeasures a forward linkage. At the same dine, a large rshifts the weights oti theaverage insidethe brackets from the second term, which exceedsone, towartl thefirst term, which is less than one, and therefore reducesthe sizeof this second Lermas well. This effect occurs becausethe larger the manufacturingsector, the largerthe market in the region that gets the manufacturing. That is, this effect arisesbecause of the attraction of producing near the market provided by other firms-in effect a backward linkage.If the forward and backward linkagesare strong enough, which they will be if r- V-5- is large enough, there will be enough strategiccomplementarityto lead to concen-Krugman37trated manufacturing.Krugman (1991) shows that this depends on the degreeofeconomies of scale; concentration is also more likely when scale economiesare- - -stronger.- Finally, we may note that if concentration in East is an equilibrium, so is con-- centration in West, becausethe regionsare symmetric.Thus strong forward andbackward linkagesimply multipieequilibria.This model is, of course, verysimplifiedcomparedwith the ideasof linkagethatwere in the minds of most developmenttheorists. In particular, there are no inter-mediate goods and thus no input-output structure. But it does show in the sim-plest fashion that these conceptsdo at least make sense.REFERENCESDicken, Peter, and Peter Lloyd. 1990. Locationin Space. London: Harper and Row.Ethier,Wilfred.1982."Nationaland InternationalReturnsto Scalein the ModernThe-ory of InternationalTrade."AmericanEconomicReview72:389-405.Fleming,J. M. 1955."ExternalEconomiesand the Doctrineof BalancedGrowth."Eco-nomicJournal65 (June):241-56.Grossman,GeneM., and ElhananHelpman.1991.InnovationandGrowthin the GlobalEconomy.Cambridge,Mass.:MIT Press.Helpman,Elhanan, and Paul Krugman.1985. Market Structureand ForeignTrade.Cambridge,Mass.:MIT Press.Hirschman,Albert0.1958. The StrategyofEconomicDevelopment.New Haven,Conn.:YaleUniversityPress.Krueger,Anne. 1974."The PoliticalEconomyof the Rent-SeekingSociety."AmericanEconomicReview64(3):291-303.Krugman,Paul. 1990."EndogenousInnovation,InternationalTrade, and Growth."InPaulKrugrnan,ed., RethinkingInternationalTrade.Cambridge,Mass.:MIT Press.1991.GeographyandTrade.Cambridge,Mass.:MITPress.Leibenstein,Harvey.1957.EconomicBackwardnessand EconomicGrowth.NewYork:Wiley.Lewis,W. A. 1954."EconomicDevelopmentwith UnlimitedSuppliesof Labor."Man-chesterSchoolof EconomicandSocialStudies22 (2):139-91.1955. The Tbeoryof EconomicGrowth.London:Allenand Unwin.Little,1.M. D. 1982.EconomicDevelopment.NewYork:.20thCenturyFund.Little,I. M. D., Tibor Scitovsky,and MauriceScott.1970.Industryand Tradein SomeDevelopingCountries.Oxford,U.K.:OxfordUniversityPress.Lucas,RobertE., Jr. 1988. "On the Mechanicsof EconomicDevelopment."JournalofMonetaryEconomics22:2-42.McKinnon,Ronald.1973.Moneyand Capitalin EconomicDevelopment.Washington,D.C.:BrookingsInstitution.Murphy,KevinM., AndreiShicifer,and RobertVishny.1989."Industrializationand theBigPush."Journalof PoliticalEconomy97 (October):1003-26.Myrdal, Gunnar. 1957. EconomicTheory and Under-developedRegions.London:Duckworth.Nelson,R. R. 1956."A Theoryof the Low-LevelEquilibriumTrap in UnderdevelopedEconomies."AmericanEconomicReview46 (December):894-908.38Towarda Counter-Counterrevolutionin DevelopmentTheoryNurksc, Ragnar. 1952. "SomeInternationalAspectsof the Problem of Economic Devel-opment." American EconomicReview 42 (May):571-82.Porter, Michael. 1990. The CompetitiveAdvantageof Nations. New York: FreePress.Pred, Allan. 1966.The Spatial Dynamics of US Urban-IndustrialGrowth. Cambridge,Mass.:MITPress.Romer, Paul. 1986.'Increasing Returns and Long-Run Growth." Journal of PoliticalEconomy 94:1002-37.Rosenstein-Rodan,Paul N.1943. 'Problems of Industrializationof Eastern and South-Eastern Europe." Economic Journal53 (June-September):202-11.Scitovsky,Tibor.1954! "TwoConcepts of External Economies."Journal of PoliticalEconomy 62 (April):143-57.Young, Allyn. 1928. "IncreasingReturns and EconomicProgress."Economicjournal 38(December):527-42.PROCEEDINGSOFTHEWORLDBANKANNUALCONFERENCEONDEVELOPMENTECONOMICS1992COMMENTON "TOWARDA COUNTER-COUNTERREVOLUTIONIN DEVELOPMENTTHEORY," BYKRUGMANJosephE. StiglitzI wholeheartedly agree with the main points thatProfessor Krugman raises soeloquently. I would like to raise two related issues. First, I do notthink Krug-man'sinterpretation oftheintellectual history ofdevelopment economics isquite right. Second, although Krugman has identified two factors that representimportantcritiques oftheneoclassical paradigm andform thebasis fortheconstruction of a'new view," his vision is toonarrow: there are equally impor-tant factors that he has ignored. In brief, Krugmanargues that:* High developmenttheory left the mainstream of economics.* The reason for this was that "developmenttheoristswere unable to formulatetheir ideas with the precision required by an increasinglymodel-orientedeco-nomic mainstream, and were thus left behind."-*Attention was diverted by ideas like Lewis's (1955) surplus labormodel thatcould be easily formalized.* Real-world events, such as the failure of industrialization, "called into ques-tion [the idea that] coordinating investmentsin the face of external economieswas a major part of the underdevelopmentstory.'- The resurrectionof high developmenttheory can be attributed to the develop-ment of simplemodels of increasingreturns.Each of these propositions is debatable. To take the first, whether an idea isor is notin the mainstream depends on whatriver you are sitting beside. Themainstream looks quite different dependingon whether one is viewing it fromthe banks of the Charles (that is, from the MassachusettsInstitute of Technol-ogy), the Cam (Cambridge), or the Cherwell (Oxford), let alone from the shoresofLake Lagunita (Stanford University). Atthese institutions-andothersscholars never stopped talking about the importance of externalities, retums toscale,imperfect competition, andtechnological change andtherelationshipsamongtiem.Research continued onmodeling notonlythe endogeneity ofmarket structure but also "endogenous growth," with theoretical and empiricalJoseph E.Stiglitz is professor of economics at Stanford University.Heis indebted to Joshua Cans,Mark Cersovitz, and AndrbRodriguez for helpful commentson the issues raised here.0)1993 The InternationalBank for Reconstructionand Development/THE WORLDBANK3940Commentworkaimedatunderstandingthedeterminantsofthetransfer,absorption,development,andadaptationof newtechnologies. These ideas were andcon-tinuetobeamajor -focusofacademicresearch andastandardpartofthegraduate curriculum.At Cambridge, for instance, throughoutthe 1950s, 1960s, and1970s Kaldor(1970,1972)emphasizedthreeoftheelementsthatKrugmanstresses-increasingreturns,imperfectcompetition,andtechnologicalchange.WithMirriems(KaldorandMirrlees1969),heprovided aformal modelof growththeory thatcapturedsome of his ideas. Kaldor recognized the profoundpolicyimplications of these ideas, and they provided the theoretical foundations for theselective employment tax enactedby the Labourgovernment duringhis tenureas economic adviser.'AtStanford,Arrow(1962)developed oneofthecentralversions ofwhatwouldlaterbecalledamodelofendogenousgrowth.Uzawa(1963,1965)developed another,at Stanford andChicago.2Many otherformal models wereconstructedandpublished,including thewell-known paperby Inada(1969),which actually used the word "endogenous.'Tobe sure, we were notsatisfied withthe models offered. Theresults, par-ticularlythose pertainingtosteady states,werehighly sensitive tothe specialparameterizations,andoneof theobjectives, ofthe research programwastoexplore these sensitivity issues. (Inada 1969 illustrates this line of analysis.) Andwe were aware thatwith increasing returns,markets would be imperfectly com-petitive,andweneededtomodelthoseimperfections.Krugmanisrightinidentifying the advances in the theory of imperfect competition of the 1970s asprovidingacrucial building block. But hefails tomention the otherproblem,raising the interesting question of the extent to which progress can be attributedtoa lowering of standards-awillingness to workwith special (should I say adhocd) consequential parameterizations,whichgenerated resultsthatwere notrobust.The1970sand1980s were markedby advancesin themodeling ofexter-nalities, technological progress, and returnsto scale. Majorstrands of researchonevolutionary modeling were associated with Nelson and Winter (1982) andDosi and others (1988); the analysis of network externalities was undertaken byDavid(1987)andArthur(1985,1988,1989)andtheworkonthemiicro-economics oftechnological progress by DasguptaandStiglitz (1980a,1980b)andStiglitz (1988). Aoki (1970)formalized the concept of Marshallianexter-nalities,andGreenwald andStiglitz (1986)provided ageneral frameworkforthe analysis of externalities. Although they focused on incomplete marketsand1.Kaldor(1970)exploresthe implicationsof these ideas in the contextof regionaldevelopment.Seealso Kaldor(1972).2.Modeling"endogenousrtechnicalchangewas a major thrust of researchin this period. See, forinstance,-thecollectionof essaysby Shell (1967); Atkinsonand Sriglitz(1969);Bardhan{1970);andTeubal(1967).Stiglitz41imperfect information,their, framework was equally applicable toeconomieswith tax distortions andimperfect competition. They showed thatwhat mightbe thought of as pecuniary externalities essentially always mattered, as long asthe economy was not(constrained)Parectoefficient, and thatin these circum-stances the economy was essentiallyneverconstrained Pareto efficient.Indeed, notonly did Krugman ignore major strands of theoretical work;healso ignored major empirical research projects thatwere exploring some of thecentral issuesof high developmenteconomics, such as the Economic Commis-sion for Latin America (EcLA)program under Jorge Katz (see Katz 1987).Notonlywasresearch onthese ideasunderway,butpolicies were alsoinformed by these perspectives. I have already referred to the selectiveemploy-ment tax in Great Britain. Certainly current writings on the policies pursued inJapan(see Komiya, Okuno,andSuzumura 1988), the Republic of Korea (seeAmsden 1989; Pack and Westphal 1986), and Taiwan (China) (see Wade 1990)suggest that these economic theories were an important part of the intellectualbackground for those programs.In short,in my reading of intellectual history, high development economictheory never died; itwas alive andwell, andthe restof the world may havetaken little note of its absenceon the banks of the Charles.Iwouldlike to agree with Krugman concerning the importance of theory andmodels for shaping the direction of the profession. Yet I remain unpersuaded ofthe dontmant role assignedby Krugman, for several reasons.The first is perhaps a normative rather than a positive argument: that we canwrite down a modtlof a phenomenonproves almost nothing. It does not maketheidea r-ight or wrong,importantorunimportant. It is-atmost-atest ofcertain logical relations, of the consistencyof certain ideas. Formalizingideas isextremely important for quite another set of reasons: it leads to better and moreconcise debates and to precise and more useful questions!Second,therewereformalmodelsavailable. ManyofushadpublishedmodelswithallthecharacteristicsthatKrugmanwouldlike-simplicity,ele-gance,and rigor.Thelackof such models simply cannotaccountfor the tempo-rary demise of high developmenttheory-ifthathad happened.Conversely,hadRosenstein-Rodan(1943)succeeded in formalizinghis ideas,Idoubtthatthoseideas wouldhave beenany morepalatable.In hismodeltheincomeeffectsassociatedwithincreasing returnsleavetheeconomystuckinalow-level equilibrium.As Krugmanpoints out,theproblemarises from a lack ofdemand,butonceweopentheeconomytointernationaltrade,thisargumentloses its force.3I also takeissue withKrugman's contentionthatwhataccountsforthe centralroleof surpluslaborin the1970s is nottheimportanceofsurpluslaborbut the3.There are contexts in which a more subtleversion of the argument might be relevant: incomeeffesare obviouslyimportant for nontraded goods, and there may be spilloversbetween the returns to scale fornontraded intermediate goods used to produce traded and nontraded final goods.42Commenteaseofmodeling it.Themodelwassuccessful because itdescribed centralaspects of the development process, includingthe reallocation of labor from thelow-productivityrural sector to the high-productivityurban sector and the highrates of capital accumulation that were facilitated by low wages. These are stillimportantaspects ofthe development process, although they are far from thewhole story.4I would submit thata farmore plausible explanation for the seeming demiseof high developmenttheory is thatthe same currents that led to the dominanceoffree market ideology inthe UnitedKingdom andtheUnited States werereflected-atleastintheUnitedStates-inthedominance ofthoseideas incertain intellectual circles. In short, it was as much the market demand for ideasas the supply of models that was crucial.Krugman is correct in his contention that real world events, such as the failureoftheplanning paradigm,reinforced thesecurrents,buttheydonotfullyaccount for them. I say this for two reasons. First, the critique of the neoclassicalparadigm wasfarbroaderthanits omission of increasing returnsandexter-nalities. In the1970s we realized notonly thatthe informational assumptionsthatunderlay thatmodel were implausible but thatall the results of the modelwere highlysensitiveto these assumptions(see, for instance, Stiglitz 1985). But acareful analysis of the implications of imperfect and costly information provideda cntique of both the free market and the planning paradigms (see Stiglitz 1992).Krugman seems tosuggest thatonce the planning paradigm was rejected, theonly alternative wasthe free market paradigm. There were alternatives avail-able,and toexplain whichalternatives the profession focused on,one has tolook elsewhere.Second, notonly is Krugman's view of the intellectual alternative incorrect;his analysis ignores the debates about the successof the East Asian economies,whichwas based, according tosome interpretations,on selective govemmentintervention, consistent with thenew insights of microeconomic analysis (seeAmsden 1989;Komiya, Okuno,andSuzumura1988). Amsden cites Kaldor(1970),while Itohandothers(1991)citepapers fromthe1970sandearly1980s, well before the formal models that Krugmanwould like to credit with theresurgence of high developmenteconomicswere written.S4.Krugman seems tobeunaware of theworkthatoriginally established Lewis's reputation asaneconomist (see, for example, Lewis 1949): the importance of overheads (nonconvexitiesand increasingreturns),which hestressed throughout the1970s and1980s in courses on development economicsat--Princeton.S.This is not the only evidence that intellectual developmentsoutside economicshelp us understandthe dominanr ideas in economics. How else could we account for the prevailing fashion of the time: theemphasis on models assuming full enployment? Surely memoriesare not so short as to relegatethe GreatDepression to ancient history.Were economists soconfident aboutthenewerathattheeconomicdownturnsin 1982 and1991,accompanied by rising unemployment, came as atotal surprise? Whatabout thepersistent unemployment in Europe in the 1980s? Here was anarea in which simple modelswith altemative explanations were available.Stiglitz43THEVISIONKrugmantakesfar toonarrowa view of thedevelopment processand of whatis wrongwithboth thestandardneodassicalandthe planningparadigms.I havealreadyillustratedone limitationof his vision: If the centralproblemswere thoseof externalitiesandincreasing rectuins, theplanningprocess wouldhavebeen anappropriateremedy.But thatassumptionignoredinformationproblems,whicharenowrecognizedto be central.Evidendy,govemmentsare notwell equippedto identify projectsand motivateprojectmanagers.But these were nottheissuesonwhichtheplanningmechanismfocused,and,notsurprisingly,itdidnotresolve them.FinancialInstitutionsIndeed,thequestionofwhogets fundingandhowitis usedis theessentialproblemaddressedbyfinancialinstitutionsin capitalisteconomies.Theypro-videtheinstitutional"solution"totheinformationproblem.How,when,andwhetherthey workis certainly partof thedevelopmentstory.Recent researchinmacroeconomicshasemphasizedthemarkedlydifferentconsequencesofdebtandequity forrisk;it hasidentifiedfailuresin bothaspects of the capitalmarket(thepresenceofdebtandequityrationing).Thereis hereanotherlinkbetweenanelastic laborsupplyandeconomicgrowth.Earlierliteratureemphasizedtheimportanceofcapitalaccumulation;thenewliteratureemphasizestheforminwhichcapitalisaccumulated-equityversusdebt(seeGreenwald,Kohn,andStiglitz1990).Equityisviewedasbeingmorepowerful.Lowwagesresultinhigh profitsandtheaccumulationof equitycapital,thusfacilitatingthe growthprocess.Krugman'sfailure to mentiontheimportanceof these institutionsin thegrowthprocessis perhapsthebestexampleofwhatImeanwhenIsaythatabroadervision is required.PoliticalEconomyIninterpretingthegeneralproblemofgovernmentinterventionstocorrectmarketfailures,Krugmanrefers toproblemsofpoliticaleconomy.Tobe sure,theseproblemsareimportant.But hisanalysisoftheissues isbothincompleteandmisleading.As notedearlier,politicaleconomyproblemsarenottheonlysource of thefailure of the planningparadigm.Moreover,rent-seekingbehavioris,atthevery least,anincompleteexplanationforthefailureof publicsectorenterprises.Krugmanfails tonotetheexistence-letalonetheimportance-ofrent-seekinginmodernmanagerialcapitalism(see S.lleifer andVishny1989;Edlinand Stiglitz1992).Andfinally,ascribingtopolitical problemsthefailuretodevelopdoesnotexplainthedifferencesin regionaldevelopmentthathavecharacterizedvirtuallyallcountriesatvariousstagesoftheirgrowth.(SeeGreenwald,Levinson,and Stiglitz 1992fora discussion of how localized knowl-edgeofcapitalmarketscanexplain patternsofregional development.)Norcan:tLheaullusioutpoliticaleconomy problems explain the many successfulgovern-44Commentmententerprises. Theymayrepresent aminority ofall such enterprises, butthere are enough successesto make it plausible that successis not just a matter ofluck.Externalities andIncreasing ReturnsThere is no single explanation of why countries grow or fail to grow. Increas-ingreturns,externalities, andlearningbydoingmaybe-andundoubtedlyare-important,butmodeling themin awaythatprovides insights intothedevelopment process requires morecarethanhastypically beentaken,andmany of the models formulated to date simply miss the essential issues.Consider, forinstance, the modern renditionof the Big Push argument, atleast asinterpreted by Murphy,Shlcifer, andVishny (1989). Ihavealreadysuggested thatthose arguments, based onincome effects, have dubious plau-sibility (intheir presentformulations) whenappliedtoeconomies thatfacetrading opportunities.6Orconsider the argument originally modeled by Aoki (1970) andincorpo-rated in Romer's (1986) growth model-thatwe can reconcilelearning by doingwith competitivebehavior when learning is external to the firm (and internal tothe country). If the spilloverto other firms is less than100 percent (and it is hardto believe that those outside the firm learn everything) any time there is learningby doing, competitionwill be imnperfect(see Dasgupta and Stiglitz 1988).Ortaketheargumentthatwhatisimportantare"aggregate increasingreturns."Thatsuggests thatlarge economies haveadistinct advantage oversmall economies;it does not explain how a small economy could grow into a bigeconomy.Theessentialproblem-frombothananalyticandapolicyperspective-isto identify the nature of the externalities that are not internalizedby markets and the sources of the returns to scale.Coase (1960) went toofar when he (or his disciples) asserted thatall exter-nalities couldbe internalized; yet manycan be.Indeed,aprimary themeofChandler's (1977) classic study is that firms are analternative to markets andsucceed in internalizing certain externalities tosolve failures of coordination.(See Sah andStiglitz 1989 foradiscussion of "diffuse externalities" thatarerelativelyunamenable to internalization; see also Stiglitz 1991.)Similarly, it makes a great deal of difference whether the locus of increasingreturns is within an industry or within the broader economy. In the former caseeven asmall economy can,by specializing, avail itself of increasing returns;surely there are industries in which the minimum efficient scale of production isrelativelysmall.6.Or considertheargumentthatbecauseearlyinnovatorsget to choosetheproductin whichthey thenspecialize,theycanchoosea productwitha betterlearningcurve.Inan internationalcontextthesecffectsare essentiallyundoneby changesin relativeprices(Skeath1989). Indeed,if we focus,for simplicity,onthe caseof uniTarypriceelasticities,priceeffectswillpreciselyundo outputeffects,so that incomeratesofgrowthwillbe the samein-allcountries.Stiglitz4SWhen the economiesof scale are spread more broadly, one must ask how theyarise.Andoffsetting theseeconomies ofscale arediseconomies ofscale-congestion economies. Regional economics providessome insight intotheseissues. We see agglomerations, economic activity that is not dispersed. Yet wealso see viable communities, with high percapita income, thatarerelativelyisolated geographicallyand are relativelysmall, certainly under a million popu-lation. These communities are, of course, part of larger communities,but whatare the effectivebarriers? If there were none, everyonewould be equally a partofthe worldeconomy andcouldtake advantageof whatever economies ofscale were relevant atthis highly aggregate level. But costs of communicationandtransporthelpdelimit thescope ofcommunities. These costs,in turn,have implicationsfor patterns of development;at certain stages of developmentand for certain products, they may be larger. Unfortunately,models with aggre-gateincreasing returns toscale give usabsolutely no insight into the relevantissues.One attractionof models with economies of scale andexternalities isthatusing models with nonconvexities and externalities makes it easy to constructmultiple equilibria, as Krugman effectivelyillustrates. (Seealso Sah and Stiglitz1989; Stiglitz1987, 1991; Murphy, Shleifer,and Vishny 1989). And it is tempt-ing to try to interpretthe differing situations in which industrial and developingcounties find themselves as reflecting these different equilibria. But again, wehardly neednonconvexities andexternalities togenerate multiple equilibria.Solow (1956) showed us how we could dothatwith his simple model; all weneed is to have savings rates or reproduction rates depend (in a particular way)on the capital-labor ratio. These models were inadequate because some of theircentral implications-suchas convergencein the rateof growth of income percapita and equalization of factor prices7-seemed counterfactual.Differencesin TechnologyThere is, fundamentally, only one way to resolve the paradox that all factorsreceivelower returns: the "effective"technologiesin the two countries are differ-ent.There are tworeasons thatthis mightbeso.Ifeconomies ofscale aresignificant,larger economiesare better off. For reasons already cited, I find this7.Stiglitz(1970) and Inada (1968) extend the standard theory to the contcxt of growth. The implica-tions for factor priCesacross countries remain even after human capital is introduced; they are simply aconsequenceof the negative slope of the factor price frontier. For instance, if interest rates are equa!ized,it must be the case that if unskilled wages are lower in one country, skilled wages are higher.The criticalassumption,of course, is that all countries face the same technology.By the same token, in internationaltrade models with factor price equalization, suChas that cited by Helpman and Krugman (1985)-2sinearlier models of local public goods with free migration of labor and goods (for example Stiglitz1977)-one can easilyobtain asymmetricmultiple equilibria;yet welfare of all those of a givenability is identicalin all communitiesand countries. Such models, accordingly,have little to contribute to our understandingof the developmentproblem.46Commtentexplanation-atleastasit isusually presented-atbest incompleteandat worstmisleadingorwrong.8Thesecondl reasonthattechnologymaybelesseffectiveinadevelopingcountryis simply differentialknowledge.Toeconomistswhoare usedto assumlU-ingthateveryonehasaccesstobest-practicetechnology,thisexplanationisanathema;itis toosimple,itis adhoc,oritleaves unexplainedwhycountries*~~~lackaccess tobest-practicetechnology.Yet once werecognize thatinformiationiscostlyto obtainanddisseminate,thatfirmsin industrialcountriesmayhavestrategcreasonsfor withholdingtheirmastadvancedtechinology, andchat localconditionsmake necessaryadaptationofthe technolog'y for theparticularcoun-try,theexplanationofdifferentialknowledgemakesperfectsense(seeGans1989).Thatit is commonsense is a virtue,nota vice.Thedevelopingcountriesprovidearichsetoffactsandphenomenatobeexplained.Thechallenge for ecoonomictheoryis to devise models thataccommo-dateasmanyof theseaspossible.Doingso will,as Krugmnanrightlysays,takeusbacktowhathe callshighdevelopmenteconomics,butit isa vision ofhighdevelopmenteconomictheorywhich,althoughitincorporatesexternalitiesandnonconvexities,isricherandmoreCo'mplex thanonethatincorporatesthosefeaturesalone.REFERENCESAmsden, A. E.1939. Asia's NextGiant. South Korea and Late Industrialization.NewYork: Oxford Univerity Press.Aoki,Masahiko. 1970.'ANoteonMarshaflian Process under Increasing Returns."QuarterlyJournal of Economics 84(1) (February):100-12.1987. "An Incentive-CompatibleApproximnationof Nash-like Solution underNonclassical Environments.'InThomas Graves, Ray Radner,andStanley Reiter,eds., Info6rmation,.Incentives and Economic Mechanisms:Essays in Honor of LeonidHurwicz. Minneapolis:Universityof Minnesota Press;London: Blackwell.Arrow,IK.3. 1962."The Economic Implications ofLearning byDoing." Revtiew ofEconomic Studies 29 (June):15S-73.*~~Arthur,W.B.1985. "Competing Techniques and Lock-in by Historical Events: TheDynamicsof Allocationunder IncreasingReturns." StanfordUniversity.S.One variant of the model attempts to identify the source of the returns by focusing explididy onissues of nontradlability(Rodriguez 1992). I: shows how a small economy-opento trading many, but notall, goods and services-maybe caught in a low-levelequilibrium in which there are no incentives forcapitalto flow intothe country andin which both skilled andunskilled laborers receive low wages. Itrests on the reasonablehypothesis that there artnonconvexitiesin the production of intermediate goods,some of which (such as services)are essentiallynontradable, and that the range of the intermecdiatesthatare available depends on the pattern of production of final goods. Countries that produce to their current*~~~comparativeadvantage (based on their current supply of these intermnediategoods,not the underlyingfactor prices) may produce final goods that; do not generate demnandfor the large variety of intermediate*~~~goodsneeded to produce complexgoods at competitivecosts. But these intermediategoods form the basisof industrialization. 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London: Allen and Unwin.Murphy,Kevin M.,Andrei Shleifer, and Robert W. Vishny. 1989. 'Industrializationand the BigPush."Journal of PoliticalEconomy 97(5):1003-26.Nelson, Richard R., and SidneyG. Winter. 1982. An Evolutionary Tbeory of EconomicChange. Cambridge,Mass.: Belknap Pressof Harvard UniversityPress.Pack, Howard,andL.E.Westphal. 1986."IndustrialStrategy andTechnologicalChange: Theory versus Reality."Journalof DevelopmentEconomics 22:87-128.Rodriguez, Andres. 1992. "The BigPush in a Small Open Economy." Stanford Univer-sity. Departmentof Economics, Stanford, Calif.Romer, Paul. 1986."Increasing Retums and Long-Run Growth." Journal of PoliticalEconomy 94(5):1002-37.Rosernstein-Rodan,Paul N.1943. "Problemsof Industrializationin Eastern and South-eastern Europe." Economic Journal53 (June-September):202-11.Sah, Ray, andj.E. Stiglitz. 1989. "Sourcesof TechnologicalDivergencebetweenDevel-oped and Less Developed Countries." In Guillermo A. Calvo and others, eds., Debt,Stabilizationand Development:Essays in Memory of CarlosDiaz-Alejandro.Oxford,U.K.: Blackwell.Shell,Karl, ed. 1967. Essays on the Theory of Optimal Economic Growth. Cambridge,Mass.: MITPress.Shleifer,Andrei, and Robert W. Vishny. 1989. Management Entrenchment: The Caseof Manager-SpecificInvestments."Journalof FinancialEconomics 25:123-39.Skeath, Susan. 1989. "Learning, Price Effects, and Income Growth." Princeton Univer-sity, Princeton, NJ.Solow, Robert M.1956."A Contribution to the Theory of Economic Growth." Quar-terly Journalof Economics 70(l):101-8.Stiglitz, J.E.1970."Factor Price Equalization inaDynamic Economy." Journal ofPoliticalEconomy 78 (May-June):456-89.. 1977. "Theory of Local Public Goods." In M.S. Feldstein and R. P.Inman,eds., The Economicsof PublicServices.New York: Macmillan.1985. "Information and EconomicAnalysis:A Perspective."Economic Journal95, supplement(March):21-41.. 1987. "Learning to Learn: LocalizedLearning and TechnologicalProgress."InPartha Dasgupta and Paul Stoneman, eds.,Economic Policy andTechnologicalPer-formance. Cambridge, U.K.: CambridgeUniversityPress.. 1988."Technological Change,SunkCosts,andCompetition." BrookingsPaperson Economic Activity 3:883-947.1991."Social AbsorptionCapability andInnovation."Paper preparedforKorean DevelopmentInstitute, 20th AnniversarySymposium,Seoul,June.1992. "Whither Socialism?:Perspectivesfrom the Economicsof Information."WicksellLecturespresented in Stockholm,May.Teubal,Morris.1967."Inflation,Unemployment, andEconomic Growth."Ph.D.thesis. Universityof Chicago, Chicago, Ill.Stiglitz49Uzawa, Hirofumi. 1963. "Ona Two-SectorModel of Economic Growth I."In J.E.Stiglitz andHirofumi Uzawa, eds.,Readings in theModernTheory ofEconomicGrowth. Cambridge,Mass.: MIT Press.1965.'OptimalTechnical Changes inanAggregativeModelofEconomicGrowth." InternationalEconomic Review 6 Uanuary):12-31.'Wade,Robert. 1990. Governingthe Market. Economic Theory and the Role of Govern-ment in East Asian Industrialization.Princeton, N.J.: Princeton UniversityPress.Wright, Gavin. 1987. "The Economic Revolution in the AmericanSouth." Journal ofEconomic Perspectives1 (Summer):161-78.PROCEEDINGSO FTHEWOR L DH A NK-ANNUALCONFERENCEO ND E V E LOPME NTE CONOM ICS1 992COMMENTON "ToWARDA COUNTER-COUNTERREVOLUTIONIN DEVELOPMENTTHEFoRY,"By KRUGMANLal jayawardenaProfessor Krugman seeks toexplain-the disappearance of "'high developmenttheory," which spanned the period between 1943 and1958 and was associatedwithsuch names as Rosenstein-Rodan, Fleming, Nurks'e, Myrdal,Scitovsky,and Hirschman. He argues that its eclipse,despite the continuingrelevance of itsinsights totheever-present problemofaccelerating development, occurredbecause its pioneers were unable "toturn their intuitive insights into clear-cutmodels that could serve as the core of an enduring discipline."Krugnmandraws out the policy implicationsthat follow from his legitimizationof the underlying economic assumptions of high developmenttheory in aman-ner that would carrconviction to mainstream economictheorists. There seemto be two implications:first, a caution against carrying a free-marketorthodoxytoofar becausethere is an intellectuallysolid case for some governmentpromo-tion of industry and, second, a need to shift the researchon trade and industrialpolicyawayfromitsfocusongovernment failure orthehorrorsofimport*substitutionand the distortions imposed by government policy andtowardaConcernwith market failure.The difficultyconfronting anyone asked to comment on Krugman's paper isthatthere is notagreat deal in itwithi which one can disagree. My principalreservation is whether the failure of high developmenttheory to model its resultswasthesole reasonforitsdisappearance. Itherefore faxed oneofthefewsurviving members of thatgeneration, Albert Hirschman, to check outmy in-tuition. His faxed response is worth quoting:Myreaction tothe Krugman paperis,ofcourse, thatIamdelighted:delighted to be rehabilitated and to be present, unlike most other contribu-torstohigh development theory,atourcollective rehabilitation atthehands of Krugmnan.It certainly is true that the failure of the proponents of"high developmenttheory" to speak the modelinglanguage contributed tothe loss of influenceof their ideas in the 1970s and 1980s. But here I agreeLai Jayawardena iS assistant secretary-general,United Nations, and director, WorldInstitute for Devel-opumentEconomicsResearch,Helsinki. The InternationalBankfor Recoonstructionand Development/THFWORLDBANKSi2Commentwith you that this is not the whole story. His is essentiallywhat is called an"finternalist" account inthe history and. sociology ofscience. Itried tosupply the "externalist" side of the story in my article on "The Rise andDecline of DevelopmentEconomics."Hirschman (1981), inproviding his "externaliste explanation, argues thatdevelopmenteconomicsas formulated in the period of high developmenttheorywas characterized by twobasic ingredients: arejection of the monoeconomicsclaim, whichargued thatthe sameeconomic laws wereapplicable tobothdeveloping andindustrial countries, andanassertion ofthemutualbenefitdaim, which held that economicrelations between these two groups of countriescould be handled in ways that would yield gains to both. The available compet-ing. approaches toeconomics were situated differently with respect toeach oftheseingredients. Orthodox economics asserted boththe monoeconomicandmutual benefit claims, while the neo-Marxist economic theories, which gainedground later, rejectedboth claims. Hirschman traces the declineof developmenteconomics totheconsequencesof the"strange alliance ofneo-Marxism andmonoeconomics." In brief, the neoclassicalright faulted it for having forsakenthe true principlesof efficientresourceallocation prescribed by monoeconomicsin thatit,forexample, promoted inefficient import-substituting industrializa-tion in developingcountries. And for the neo-Marxist left, exemplifiedby econ-omists such as Paul Baran (1952), developmenteconomics was notsufficiendyradical.Even more fatal, in Hirschman'sview, were the political disasters that struckmany developingcountries after the 1960s. It was the resulting self-doubt andfailure tomount acounterattack against the "unholy alliance of neo-Marxistsandneodassicists" thatdoomed development economics. Atthesame time,growingdisenchantmentwith developmentassistanceunderminedinterest in the"mutual interests" idea-inspite of attempts by such international groups as theBrandt Commission (Independent Commission on International DevelopmentIssues 1980) to keep the theme alive. (Paradoxically,the current concern abouti-heglobal environment might help reinstate the mutual benefit claim for ade-quate resource transfers to developingcountries and lead to a revival of interestin developmenteconomics.)Krugman's thesis hasalso beenunderlined inWilliamson's (1990) paper,which states the "Washingtonconsensus"on policy reform. Having outlined thefive elements thatconstitute the consensus-abalanced budget, relative pricecorrection (principallya competitiveexchangerate), liberalization of trade andforeigninvestments,privatization,anddomesticmarketderegulation-Williamson adds:A striking fact about the list of rolicies on which Washington does have acollective view is thatthey all stem from classicalmainstream economictheory, at least if one is allowedto count Keynesas a classicby now. Noneof the ideas spawned by the developmentliterature, such as the "big push,"Jayawardena 53balanced orunbalanced growth,surplus labour,oreventhetwo-gapmodel, plays any essential role in motivating the Washington consensus.This raises the question as to whether Washington is correct in its implicitdismissalof the developmentliterature as a diversionfrom the harsh real-ities of the dismal science.What is significantis that the only reaction to this view during the conferencecame from Stanley Fischer, chief economistof the World Bank atthe time,whoargued against an"active industrial policy" in developing countries despite itssuccess"on balance . ..in parts of East Asia"(Williamson 1990).INDUSTRIAL POLICY INEAST ASIAAny lack of rigor in articulating high developmenttheory did not prevent itsderennined andfruitful application in East Asia, particularly in JapanandtheRepublic of Korea, whose planning models embodied its insights. Unlike thecases of South Asia andLatin America, there islitde evidence tosupport theview thathigh development theory was invoked inEastAsia insupport ofinefficient import-substitutingindustrialization.Efficientimport substitution, incontrast, endeavoredto promote sdected infant industries with the potential tocompete as exporters in international markets. The successof East Asian inter-ventionist strategies in "picking winners" has sparked an intense debate withinthe World