The State and economic development

The following article appeared in The News on January 30, 2013. (http://www.thenews.com.pk/Todays-News-9-157286-The-state-and-economic-development) 

The role of the Pakistani state in the country’s economy has recently come under scrutiny - in reference to the ongoing electricity and natural gas/CNG crisis. The argument usually put forward is that these crises occur because of the state’s involvement in the economy. What needs to be done is to pull the state out from this mess and let the markets regulate the economy. The underlying logic is that market determined prices are the best signals for efficient allocation of resources. This understanding is flawed and based on an uninformed view of history of economic development in various parts of the world.

History tells us that the state has had a highly important part to play in promoting economic development and growth in both the late developers of the 19th and early 20th centuries (Germany, The Netherlands, and Japan) and the developing/third world countries that emerged in the wake of World War II (South Korea, Malaysia, Taiwan, Brazil). The role of the state in both these sets of countries has been twofold. First, it played a crucial (or instrumental) role in guiding the economies towards a capitalist model of economic growth. This meant that the state took an active role in not just industrialising these economies through state-owned enterprises but also by cultivating a class of capitalists.

This was achieved under a highly regulated market that could ensure the achievement of end goals. Second, the state spearheaded the effort of long-term infrastructure development in the country.

Broadly speaking, this included building roads, establishing electricity grids and networks, creating health care and providing sanitation works, and establishing primary and higher education facilities. This, of course, is stylised history as all history mostly is! But this was pretty much the blueprint that economies followed in order to develop and grow and it relied heavily on the state’s role in managing the economic affairs of a country. The important lesson to take home is that the state had a larger economic plan that it pursued using various strategies.

So, why have these (or other such) countries have been able to ensure growth while others have failed. Answers abound. The past 10 years have seen a resurgence of New Institutional Economics that stresses on creating a strong institutional framework under which economies must function.

The state’s role is recognised to the extent that the ‘rules of the game’ (institutions in academic parlance) must be clearly enunciated and enforced. The rest, more or less, should be left for the markets to determine. This, unfortunately, is a highly simplified notion of the way economic development has (successfully) unfurled under the bright blue sky in different regions of the world. This is particularly so when countries with similar institutional arrangements perform very differently economically.

A more nuanced understanding, in my opinion, is provided by the political settlement literature developed by Mushtaq Khan and the state’s embedded autonomy literature developed by Peter Evans.

There are important differences between the two but there are also some interesting similarities that I will use here. Political settlement is defined as a combination of institutions and distribution of power that can be reproduced over time.

Khan argues that once a stable and reproducible macro-political equilibrium emerges, the relative power of various organisations can evolve along a stable path. This ensures that the benefits or returns to these organisations are according to their relative strength as well. In case of an unstable political settlement organisations will continue to change it in order to bargain for more than what their relative strength may allow.

A stable political settlement requires a ‘neutral’ ruling elite to successfully manage conflicts that may emerge between various interest groups or classes within a society. In more academic parlance it requires a state that is ‘relatively autonomous’ yet embedded with various interest groups to pursue the state’s larger economic objectives. Evans’ work shows that while being relatively autonomous it is important for the state to successfully embed itself with various social groups in order to incorporate them in a coherent growth and development strategy.

In other words, Evans’ work suggests that inclusivity is as important as relative autonomy to pursue a growth strategy. A point to be highlighted here is that this perspective does not undermine the importance of institutions. It lays stress, however, on contextualising the institutional framework in the political settlement arrived at between various classes/interest groups in the society.

When looked at from this perspective it becomes clear why certain nation states have been able to pursue sustained economic growth development. For example, the nation states that emerged in the wake of World War II were characterised by two types of settlements: one political and the other fiscal. These settlements essentially took place between the ruling elite (or the coalition of dominant classes/institutions) and the subordinate classes.

The political settlement dealt with how to exercise political authority and determine its various loci of power - federal, provincial, and central. The fiscal settlement dealt with the agreement between the ruling elite and the subordinate/working class on the issues of taxation - whom to tax and how much.

In the post-World War II states of western Europe this meant that a system of progressive taxation would allow the ruling elite to institutionalise a welfare state that provides public goods for the subordinate/working classes and public infrastructure for growth and development.

The institutional framework that emerged in the wake of WWII thus reflected this political settlement. One can also see similar effective political settlements emerging in other parts of the world in the past 60 years. Again, South Korea, Malaysia, and Taiwan are useful examples to look at.

This perspective also allows us to understand why Pakistan has been unable to sustain economic growth over a long period of time. The nature of political settlement is unstable since it benefits the few at the cost of the many. The political settlement is unfair not just between the owners of the means of production - the capitalists, the large agriculturalists - and the working class but also between different ethnic groups in the country.

The unfair nature of political settlement (vis-à-vis economic and fiscal policies) in Pakistan is most evident in our taxation structure. The state’s inability to collect taxes is a direct outcome of the existing institutional arrangement under which taxes are collected.

Economic growth in Pakistan can be sustained only if the existing political settlement in the country changes and makes the process of economic growth more inclusive. The remedy here then is not to withdraw the state from management of the economy but perhaps involve it more holistically while making it more accountable for its activities.