Better balance needed between states and markets to spur progress in least developed countries, report says

Global economic crisis highlights need for "developmental state" approach that can help world´s poorest nations build more resilient, broad-based economies, study says

Geneva, 16 July 2009 -- The world economic crisis, which has hit least developed countries (LDCs) severely, should be a point of departure for a new development approach in which the state plays a greater role, UNCTAD argues in its Least Developed Countries Report 2009(1).

The crisis has laid bare the structural deficiencies of the globe´s 49 poorest nations and has demonstrated their inability to achieve long-term growth and poverty reduction, the study says. It contends that a re-consideration of the role of the state is necessary to overcome LDCs´ structural constraints and reduce their dependence on external support.

The report, released today, is subtitled "The State and Development Governance".

The LDCs urgently need to stimulate investments rapidly and extensively to achieve long-term restructuring of their economies and to generate productive employment. Some 843 million people live in the LDCs, a high proportion of them young, and LDC populations are growing rapidly. For LDCs, the market has not been able to generate sustained and inclusive growth, in part because the market only works through incremental changes and small steps. These countries therefore need to "build developmental states," which the report says is "a state whose ideological underpinnings are developmental and one that seriously attempts to deploy its administrative and political resources to the task of economic development".

This is not a matter of going back to old-style development planning or even the developmental state model typical of the East Asian economic miracle. Rather, it is a question of finding new forms of development governance appropriate for the Twenty-First Century.

Such a forward-looking developmental state would be particularly concerned with harnessing knowledge and technological learning for development and would seek to promote learning and upgrading of products and processes through new design and product differentiation.

However, the Twenty-First Century developmental state must also be a democratic developmental state in the sense that it creates and renews the micro-foundations of democratic practice to harness local, bottom-up energies to solve development problems and create development opportunities. Moreover, it should embrace a wide range of governance modalities and mechanisms within a mixed economy model to harness private enterprise, through public action, to achieve a national development vision.

The report sketches out a practical, alternative economic strategy and a fresh agenda for LDC policymakers, which includes institutional capacity-building and the strengthening of the market-complementing developmental state. It argues that there is a need both for developmental agricultural policies (see UNCTAD/PRESS/PR/2009/029) and developmental industrial policies (see UNCTAD/PRESS/PR/2009/031) buttressed by pro-growth macroeconomic policies (see UNCTAD/PRESS/PR/2009/030). Governance should be oriented towards fostering markets´ creative function of stimulating economic change, based on a social contract that enables participation in decision-making and provides a more effective public voice.

Effects of the global economic crisis on LDCs

Between 2002 and 2008, the LDCs achieved strong economic growth. But this positive economic performance was particularly related to high commodity prices, record levels of private capital inflows, and increasing official development assistance (ODA) and debt relief. LDCs export structures remained highly concentrated and highly dependent on primary commodities, low-skill manufactures, or tourism. Now that the crisis has hit, export earnings have fallen significantly. FDI inflows also are declining, owing to (a) lower expectation of profitability; (b) reduced access to credit to finance new investments; and (c) balance sheet consolidation by transnational corporations. Workers´ remittances, which in recent years have become an important source of external resources for several LDCs, also are set to decline as a result of the crisis.

African LDCs are likely to be more severely affected than Asian LDCs, which have more diversified economic structures.

To face the adverse effects of the crisis, LDCs need to receive international support. It is therefore crucial that donors do not reduce the levels of ODA they send to LDCs. Such a reduction has been observed in previous cyclical downturns affecting donor countries. On the contrary, the report says, given the gravity of the current crisis, donors should respect their own pledges to significantly scale up ODA.

It is also vital that there is a domestic policy response, however. This should not only try to deal with negative impacts of the crisis itself, but seek to build a more sustainable and inclusive development trajectory.

The challenge of institution-building

Building developmental state capabilities will require a re-orientation of public administration reforms which are currently aimed at good governance.

Good governance is one of the four major pillars of most of the national poverty reduction strategies which LDCs now prepare. The most common priorities are decentralization, improving the efficiency of public administration, and fighting corruption. In addition, during 2005-2007, about 20% of total ODA to LDCs - some US$4 billion per year during 2005-2007 - was devoted by donors to improving governance capacities.

This joint engagement recognizes the importance of governance for economic success. However, implementing the good governance reform agenda has led to a "reform overload" in a number of countries. Officials have been swamped by a constant round of institutional changes. In addition, some recommended institutional innovations regarded as best practice in advanced countries have not travelled well to very poor countries.

The simple fact is that LDCs have very few financial resources to govern, and different approaches and priorities are in order. The average government final consumption per capita in LDCs in 2006 was just US$60 per capita, compared with $215 per capita in lower middle income countries, $1,051 per capita in upper middle income countries, and $6,561 per capita in high income countries. This $60 covers all government current expenditures for purchases of goods and services (including compensation of employees).

The report argues that it is necessary now to introduce a more explicit development dimension into governance reforms. What is required is good development governance within the framework of a developmental state.

Just as institutions cannot be transferred from advanced countries to very poor countries, it is unrealistic to expect that institutions from successful developmental states, such as in East Asia, can be transferred with success. Institutional reforms to strengthen development governance must be adapted to LDCs´ actual technical and political capacities. Developmental state capabilities can be built incrementally through policy learning and institutional experimentation. These efforts should focus initially on extending the experience of "islands of excellence" that do exist in the public administration of several LDCs (for example, in finances ministries). Governance reforms should also be targeted at supporting institutions which can facilitate investment, technological learning and structural transformation within agriculture and within LDC economies as a whole.

Building new developmental state capabilities will help LDCs create more resilient, dynamic and inclusive economies for the post-crisis era. This is a long-term process. However, in the short-term, an important initiative LDC governments could take in addressing the crisis and in building such capabilities is to create domestic growth coalitions that mitigate the impact of the crisis.

Domestic growth coalitions exist when national governments and domestic business elites actively cooperate to promote investment, technological progress, and structural change. Such cooperation was an important ingredient of successful developmental states, for example in East Asia, in the past. They should also provide an effective beginning for government-business problem solving in dealing with the current crisis. The crisis in fact presents an opportunity for change. It may be used to spur transformations in the way states act, and it may help them to build alliances that link the interests of rural and urban areas -- including the agricultural and industrial sectors -- and that build on the shared interests of the public and private sectors.