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CHAPTER OUTLINE
I. This chapter begins by asking “what makes development happen?” The
authors then provide an overview of the history of developmental thought—
with special emphasis on the role of the government. The material reviews
Smith, Ricardo, Marx, Harrod- Domar and more contemporary thoughts on
the nature and role that government should exercise in the economic realm.
The discussion then moves to the issue of economic development after World
War II. Here, an interesting comparison is drawn between the countries
being “redeveloped” in the West after the war, to those achieving in de pen-
dence who were “developing” in de pen dently for the rst time. The dynamics
between the two provide keen insight as to why post- colonial countries had a
very different set of issues to contend with compared to those of a Eu ro pe an
continent undergoing redevelopment.
II. Role models for developing countries were undergoing signi cant change
themselves by the 1980s. The Soviet model, frequently studied and mimicked
by some countries, was itself in the nal stages of economic decline. Develop–
ing nations began to look for alternative models of development. It was at this
time that the Washington Consensus became attractive to a number of devel-
oping countries, while the World Bank simultaneously began to promote the
need for “structural adjustment” in the developing nations of the world.
III. This chapter looks at the hard and challenging road faced by Rus sia and the
nations of Eastern Eu rope after the collapse of communism in that part of
the world. Many of these nations, while attempting to implement parts of the
Washington Consensus, also adapted “shock therapy”— with rather destabi–
lizing results in each nation’s po liti cal economy. What was unforeseen by
many observers was that while many of these countries wanted to modernize
States and Markets
CHAPTER 5
States and Markets | 31
their economies, po liti cal and business leaders in most of these countries had
no established institutions (or experience) to help with taking the fast track to
a more free- market economy.
IV. After examining the problems of Rus sia and Eastern Eu rope, the discussion
returns to the developing nations of the world. The importance of the Wash-
ington Consensus is reexamined. The authors state that the Consensus is still
valuable but not perfect, and that one must remember how internal and exter-
nal events have indirectly set developing nations back over the past several
de cades. Whether it be government corruption, civil unrest (often tied to
corruption), or the nancial crises that occurred in 2008, such internal and
external events must be taken into consideration when assessing the validity
of the Consensus. In the end, after surveying a number of countries, the
authors remind the reader that “no one size [remedy] ts all.”
Boxed Examples
Box 5– 1: Market Failure
Box 5–2: Ghana after In de pen dence
Box 5– 3: The Declining Effectiveness of Government Intervention in the
Market: Korea, 1960s– 2010
There are three boxed examples. The rst describes how market failures can
occur and how governments face the challenge of deciding if, when, and how to
intervene. The second examines how Ghana, after in de pen dence, became reliant
on one resource— cocoa—which was ne until the price fell. The text looks at the
Ghana Economic Recovery Program, supported by the World Bank and IMF, and
the state of the nation’s economy after several de cades of instability. The third
provides a case study of South Korea, which has moved away from an economy
based on strong government direction and intervention. The example shows how
the government has made signi cant progress since 1998 in removing itself from
direct involvement in the economy.
In the New Edition
Chapter 5 raises the central question: what makes economic development happen?
The seventh edition authors take a fresh look at that question, signi cantly updat-
ing the material from the sixth edition while tracing the evolution of thought
about development from Adam Smith through notions of the big push advanced
in the 1940s by economist Paul Rosenstein- Rodan to more recent debates over
structural adjustment and the Washington Consensus.
32 | Chapter 5
Class Notes
Chapter 5 addresses two fundamental questions: What institutional foundation is
best for economic development and why? It is important to provide students (1) a
balanced view of both the advantages and the shortcomings of market forces, (2)
a careful explanation of why controls so often fail and prove counterproductive as
tools for ameliorating market failures, and (3) a grasp of the serious problems
associated with the transition to wider reliance on market forces starting from a
position encumbered by the institutional, po liti cal, and economic legacy of perva–
sive controls. Absolutes should be avoided. Remind students that Korea has
succeeded despite departures from laissez– faire policies and that Rus sia’s move
to free markets triggered a long and painful adjustment.
Remind students that there is no single answer or formula to the issue of “cor–
rect” development. The ocean of literature that exists on the cultures, traditions,
economics, politics, and geography of these nations may all lead to different
answers to the problems. For the sake of keeping lectures and discussions focused,
the importance of the ten main goals expounded by Williamson in the Washing–
ton Consensus must continue to serve as the most valuable springboard by which
progress can be mea sured.
Two major historical events have helped shape discussions on economic devel–
opment policies: the end of colonialism after World War II and the dissolution of
the Soviet Union in 1991. The post– colonial era saw newly emerging nations often
undertaking economic agendas that were not in their own best interest— and
were perhaps pursued as a reaction against the former colonial powers and their
values. However, by the 1980s, even nations that had modeled nearly their entire
economy on the Soviet model began to shift away— particularly China and India.
More would follow. Today, the struggle for economic development faces different
challenges in different continents, in different regions, and sometimes even in
different areas of the same countries! This chapter should serve as one of the
most dynamic units for discussing what needs to be done for economic develop-
ment to truly succeed. Term papers can provide students an excellent opportunity
to explore problems par tic u lar to a single country, and—if time permits— class
discussion on each student’s ndings could enlighten all in the classroom.
QUESTION BANK
Concept Map
States and Markets
Development Thinking After World War II
Fundamental Changes in the 1970s and 1980s
Structural Adjustment, the Washington Consensus, and the End of the
Soviet Model
States and Markets | 33
Soviet Command Model to Market Economies
Was the Washington Consensus a Success or a Failure?
1. After David Ricardo and Karl Marx, economists shifted to trying to under–
stand how markets worked, and economic growth was:
a. taken for granted.
b. taken to a higher level of research.
c. suppressed as an area of research, as a reaction to the writings of Marx
and Engels.
d. assumed to have already been achieved by all nations in the world of that
day.
2. Since the end of World War II, the debate in economic development has been
or ga nized around:
a. suppressing worldwide communist revolution.
b. a revival of the insights offered by John Stuart Mill.
c. the proper role of government in development.
d. creating a multipolar world.
3. The Harrod- Domar model placed investment and capital at the center of:
a. exploitation of the masses.
b. economic growth.
c. enhancing a nation’s status among the community of nations.
d. the tariff and quota debate.
4. In the 1960s, which economist developed the theory of the “two- model gap,”
proposing that there was not just a savings gap but also a foreign exchange
gap and that the latter was the major constraint on development?
a. John Maynard Keynes
b. Milton Friedman
c. Vinay Bhargava
d. Hollis Chenery
5. It is argued that the Marshall plan succeeded in rebuilding war– torn nations
after World War II due to:
a. the people’s knowledge and understanding of the role of government and
government– created institutions.
b. the directives laid out within the plan by Marshall and Truman.
c. a desire to pursue corporatism an a new economic model.
d. the in uence of the Protestant work– ethic, as described by Max Weber.
6. Although aid to post– World War II nations was successful in helping them
rebuild, similar aid to less- developed nations failed to produce the same
results because:
a. miscalculations of aid were based on per capita income in each nation.
b. critical institutions within these governments were missing.
c. countries refused to play by “the rules of the game.”
d. of the problem of asymmetric information.
7. After World War II, many leaders of former British colonies, who had been
educated at British universities, espoused:
a. strong monarchical views.
b. Keynesian economic doctrines.
c. Fabian socialist views.
d. Peronist economic and leadership values.
8. The Soviet Union was attractive to developing countries because:
a. it was very effective at producing and supplying consumer goods.
b. it had transformed a backward economy into an industrial power house
that defeated the strongest military in the world— Nazi Germany.
c. Lenin’s Capitalism, the Highest Stage of Imperialism was a best– seller in
their nations.
d. the people were fascinated with the idea of becoming technocrats.
9. During the 1950s, all of the following countries were inspired by the Soviet
model of development EXCEPT for:
a. China.
b. India.
c. Ghana.
d. Burma.
10. Raul Prebisch, based at the Economic Commission for Latin America and
Hans Singer, based at the United Nations Industrial Development Or ga ni za-
tion, both provided the intellectual rationale for:
a. import substituting industrialization.
b. the rapid development of the ser vice sector industry.
c. free trade.
d. liberation theology.
11. One of the criticisms of the growth policies of the 1960s was that too much
attention was paid to the growth rate of GDP and not enough attention was
paid to:
a. the foreign exchange rate.
b. monetary and scal policies.
c. how the bene ts of growth were distributed.
d. General Agreement on Tariffs and Trade (GATT).
12. East Asia’s “four tigers” (Korea, Singapore, Hong Kong, and Taiwan) all
achieved rapid industrial growth by:
a. eliminating virtually all government interventions.
b. heavily subsidizing exports, while prohibiting competing imports.
c. imposing effective central planning.
d. fostering a development strategy based on export of manufactures.
13. The international or ga ni za tion responsible for helping developing countries
design and nance structural adjustment programs with the aim of becoming
more market– based is the:
a. World Bank.
b. Or ga ni za tion of Petroleum Exporting Countries.
c. United Nations.
d. International Monetary Fund.
14. Structural adjustment programs are designed to:
a. promote the growth of industry rather than agriculture.
b. assure that scarce foreign exchange is rationed in accordance with a ve–
year plan.
c. dismantle controls that interfere with market allocation and ef ciency.
d. stop in ation.
15. Compared to the situation in a competitive market, in a monopolistic market,
rms generally:
a. use more ef cient technologies.
b. sell a greater share of output in parallel markets.
c. produce less, while charging higher prices.
d. are more likely to succeed in response to infant industry protection.
16. Which of the following is NOT one of the ve elements needed to support a
well- functioning market system?
a. holding the exchange rate xed
b. achieving a relatively stable macroeconomic environment
c. allowing relative prices to re ect relative scarcities
d. establishing competition
17. The essence of a big bang approach to economic reform is:
a. letting economic conditions get so bad that reforms are welcomed as a
relief.
b. imposing high tax rates to nance government expenditures.
c. instituting the full range of structural and stabilization reforms over a
short period of time.
d. restoring growth through heavy military spending.
18. China and Vietnam are examples of formerly planned economies that:
a. adopted the shock– therapy approach to liberalization.
b. began their reform programs by privatizing large state– owned industrial
enterprises.
c. suffered severe economic contraction during the transition to a market
system.
d. managed the transition to a market economy in gradual steps.
2. Big push, backward linkages
4. West Pakistan, East Pakistan
6. South Korea, Taiwan
8. Shock therapy, gradualist approach
10. Structural adjustment, economic distortions