The Role of Government; D. Bandow

Alas, the result has been a dismal failure: Many underdeveloped states have actually been growing poorer. Economic growth will come only when governments realize that their proper role is to stay out of the way, to stop impeding the development that would naturally occur but for state intervention. Mr. Bandow, a monthly columnist for The Freeman, is a SeniorFellowat the CatoInstituteand the author and editor of several books, including Perpetuating Poverty: The World Bank, the IMF, and the Developing World. History of Development Theory Extensive state economic intervention has long existed around the world, including the West, for political as well as philosophi cal reasons. Such policies have been espe cially evident throughout the twentieth cen tury. In particular, the vast majority of Third World states traveled the socialist path as decolonization proceeded after World War II. Their decision was in part nationalistic; many new countries believed that true in dependence required indigenous control of economic resources. Statism also tended to benefit, both economically and politically, the elites that gained power after indepen dence.

But there was also a genuine belief that the government had to guide the development process. Said Ghana's Kwame Nkrumah: "Only a socialist form of society can assure Ghana of a rapid rate of economic progress without destroying that social justice, that freedom and equality, which are a central feature of our traditional way of life." A Western Import This dirigistephilosophy was not, however, based on local tradition. Indeed, the very concept of development was an alien idea 135 136 THE FREEMAN • MARCH 1997 introduced by the West. Having helped ordain the goal of rapid industrialization, Western politicians and economists also played a ma jor role in developing the statist strategies that many Third World nationalists were to call their own. Many Westerners have acted as the sirens in Homer's Odyssey, luring Third World economies, instead of wandering sea farers' upon the rocks. Perhaps the most important of these was Lenin. While Marx, ironically, viewed the colonial experience as a progressive force in the undeveloped world (in The Communist Manifesto, he lauded the potential of capitalism to transform such societies), it was Lenin, in Imperialism: The Highest Stage of Capitalism, who specifically applied socialist principles to underdeveloped states.

The British Fabian socialists argued for a more gradual collectivist transformation. Ac cording to Indian economist Jagdish Bhag wati, this approach exercised "a powerful impact through the large numbers of the Indian elite that were processed through the English educational institutions prior to In dian independence in 1947." Other develop ing countries-especially other former Brit ish colonies-looked to Fabian principles as they structured their economies. Along with the philosophy came practical economic controls. The policies promoted by the London School of Economics eventu allysuffused the British Colonial Office.Many officials in London as well as colonial gover nors, writes P.T. Bauer, "took for granted the case for the most diverse forms of state economic intervention." Business licensing, trade restraints, agricultural marketing boards, and more were part of the adminis trative apparatus handed over to many new governments when countries gained indepen dence.

Western development economists, who ad vised both underdeveloped states and West ern aid agencies, generally leaned toward the so-called "structuralist school," which treated developing economies as inflexible and unre sponsive to market forces. Leading propo nents of this view included Gunnar Myrdal, Albert Hirschman, Hans Singer, Ragnar Nurkse, and Paul Rosenstein-Rodan. AntiCapitalist Bias So pervasive was the anticapitalist bias in terms of Third World development that even economists who recognized an important role for the private sector in advanced econ omies viewed developing states differently. Wrote Robert Heilbroner, "in the great trans formation of the underdeveloped areas, the market mechanism is apt to play a much smaller role than in the comparable trans formation of the West during the industrial revolution." Heilbroner saw the need for more than just active public-sector manage ment: "Powerful, even ruthless, government may be needed."

The most fundamental principle of collec tivist development dogma was the need for central planning. Development specialists like Myrdal advocated a ubiquitous public sector: "One of the most serious shortcomings of policy in the countries in which compre hensive planning has been undertaken is the failure to plan more ambitiously and on a larger scale." Finally, even some Western economists who did not advocate full government eco nomic planning nevertheless endorsed the sort of micromanagement that has been in creasingly recognized as a failure in the in dustrialized nations. Expansive fiscal and monetary policies, for instance, were a Keynesian norm. Equally persistent was pressure on developing countries to increase taxes. Revisionist Economic Thinking These theories dominated international economic policy for about four decades fol lowing World War II. But reality finally in truded as it became evident that the differ ent statist economic theories had been put to the test and found wanting. By 1989 his tory had clearly rendered its judgment on collectivism. The obvious lesson of this ex perience has received increasing acceptance: Without relatively open markets, little de velopment will occur, irrespective of the efforts of governments in poor or rich nations.

What Causes Development? The West's dramatic escape from poverty has always been a good place to start in attempting to understand development. The rapid economic and social progress of. Eu rope, during which people first rose out of the dismal poverty that characterized most of human history, was largely limited to a specific kind of regime-classical liberalism. The re sulting·systems generally allowed markets to operate, respected the rule of law, protected private property, and permitted competi tion. Historian Ralph Raico explains that the "European Miracle" developed because of greater market autonomy, which was possible only through "the inhibition of the predator state." Obviously, individual national experi ences varied, but the grand sweep of history presents powerful evidence that the West's development was not accidental. Observed economist David Osterfeld in his well documented book Prosperity Versus Planning: "The likely relationship between the West's economic institutions and its economic growth and development cannot be ignored."

This experience has been repeated rather more quickly and notably in East Asia, where it has taken but a generation or two for desperately poor nations to develop among the world's most successful economies. (This is not to say that all these were exemplars of laissez faire. Rather, all broadly relied on market forces, despite varying degrees of government economic involvement.) What makes the East Asian experience so impor tant is that it is more recent and reflected a conscious break with the reigning collectivist consensus, and succeeded so spectacularly. Lessons for Developing Nations What was true of Great Britain, the United States, Japan, and South Korea is also true of today's successful developing states. Perhaps the best broad-based study of economic pol icies over the last two decades is Economic Freedom of the World: 1975-1995, by econo mists James Gwartney, Robert Lawson, and Walter Block. They created an index of 17 THE ROLE OF GOVERNMENT 137 component parts to measure economic free dom, as well as three alternative summary indexes. Ranked highest were Hong Kong, Singapore, the United States, and New Zea land. At the bottom came numerous Latin American and African countries. Most im proved between 1975 and 1990 were Chile, Iceland, Jamaica, Malaysia, and Pakistan.

Although, as noted earlier, international comparisons are fraught with difficulty, two particularly important lessons emerge. First, economic policies matter. Report Gwartney, Lawson, and Block: The 14 countries that earned a summary rating grade of either A or Bin 1993-1995, achieved an average annual growth rate in per capita real GDP of 2.4 percent during 1980-1994 and 2.6 percent during 1985 1994. In contrast, the average annual growth of per capita real GDP for the 27 countries with a summary rating of F - in 1993-1995 was minus 1.3 percent during 1980-1994 and minus 1.6 percent for the 1985-1994 period. Twenty-one of the 27 experienced declines in real per capita GDP during 1980-1994. Obviously, the results for individual coun tries may be affected by many factors. But the overall result is compelling. Explain the authors: "No country with a persistently high economic freedom rating during the two decades failed to achieve a high level of income. In contrast, no country with a per sistently low rating was able to achieve even middle income status."

Second, changes in economic policy affect national growth rates. According to the study, the 17 nations with the greatest increases in economic freedom enjoyed an average annual growth rate of 2.7 percent in per capita GDP from 1980 to 1990, and 3.1 percent from 1985 to 1994. All 17 grew, while 11 of the 16 nations with the largest drops in economic freedom suffered a decline in per capita GDP. Similar are the results of the 1996 Index of Economic Freedom, written by Heritage Foundation analysts Bryan Johnson and Thomas Sheehy. They explain that their anal ysis "demonstrates that economic freedom is the single most important factor in creating 138 THE FREEMAN • MARCH 1997 the conditions for economic growth and pros perity." Their data also demonstrate that countries which place the greatest reliance on open markets consistently have the highest growth rates. Studies by other analysts and organizations yield the same general conclusion. Research ers at Cornell University and the Organiza tion for Economic Cooperation and Devel opment (OECD) have used a computable general equilibrium (CGE) economic model in an attempt to measure the impact of different policy measures. Market-oriented reforms in exchange-rate, fiscal, and mone tary policies all improve economic growth rates.

A decade ago economists E. Dwight Phaup and Bradley Lewis surveyed a dozen "win ners" (with average annual growth rates ex ceeding six percent) and a score of "losers" (average growth rates below 2.2 percent a year). The average annual growth rates were 7.7 percent and one percent, respectively. Phaup and Lewisconcluded: "It would appear that whether LDCs are winners or losers is determined mainly by their domestic eco nomic policies. Resource endowment, lucky circumstances, former colonial status, and other similar factors make little difference in the speed with which countries grow econom ically. The results of domestic policy choices pervade every economic area." Phaup and Lewis found that growth rates correlated well with an index for overall economic distortion, such as price controls. Similar was the role of trade. Countries that relied on exports grew far faster than those which practiced import substitution. The two economists stated: "From this experience it can be concluded that exports cause GDP growth, rather than the reverse, even though exports are normally considered exogenous."

They found that rough indexes regarding "investment climate" yielded similar results. Government spending, in contrast, was ad versely correlated with economic growth. Also apparently related to economic growth, though the data did not yield a statistically significant result, were tax revenues. Ex plained Phaup and Lewis: "There was a difference in the ratio of income taxes to GDP; the average for the slow growing na tions was higher. Such a result is consistent with the hypothesis that high and progressive income tax rates muffle incentives and slow productivity growth." Policy Differences In 1996Mancur Olson, Jr., of the Center for Institutional Reform and the Informal Sector at the University of Maryland (College Park), came to much the same conclusion. He re ported that such factors as access to knowl -edge and capital cannot explain the relative income differences between nations. "The only remaining plausible explanation is that the great differences in the wealth of nations are mainly due to differences in the quality of their institutions and economic policies," he explained. He found that poorer nations with the best economic policies consistently grow the fastest.

Phaup and Lewisrelied in part on a detailed World Bank study, published as part of the 1983 World Development Report. The Bank assessed the relative economic distortions in 31 primarily developing nations and found that countries with the least interference with the marketplace had annual growth rates twice as fast as those of nations with the most inefficient policies. The more market oriented countries also enjoyed far greater domestic savings, additional output per unit of investment, and increases in both agricul tural and manufacturing output. The Bank estimated that inefficient intervention-such as inflationary exchange-rate, fiscal,and mon etary policies; price distortions; bad invest ments; and expansive regulation-could cut annual GDP growth by as much as two per cent. The Bank has focused particular attention on protectionism. In 1987 the institution devoted much of its annual World Develop ment Report to trade. It concluded: "The economic performance of the outward oriented economies has been broadly supe rior to that of the inward-oriented economies in almost all respects." The World Bank has similarly reported on the impact of agricul ture policies. Here, too, it found that inefficient government actions, macroeconomic as well as sectoral, tended to discourage food output, while market-oriented reforms in creased agricultural production.

America's Agency for International Devel opment (V.S. AID) has reached similar con clusions. According to V.S. AID: "Recent academic and policy experience has shown a linkage between international trade policy and overall economic progress." Particularly important, in its view, were open trade poli cies-more outwardly oriented countries grew by upwards of four times as fast as more protectionist states. V.S. AID also pointed to the friendliness of the investment climate to domestic and foreign business alike. Specific Experiences These sort of general assessments are re inforced by the results of narrower studies of different regions and nations. For example, David Osterfeld reviewed the economic im pact of a range of variables: corruption, food, foreign aid, migration, multinationals, popu lation, and resources. His conclusion was that development occurred most quickly in an "enabling environment" in which the rule of law was stable, property was protected, polit ical power was decentralized, and most of the economy was private. The primary obstacle to sustained economic development, he ex plained, "is an environment that penalizes individual initiative, is hostile to private own ership, discourages saving and investment, and severely restricts the operation of the free market."

Numerous international examples support this thesis. The East Asian economic power houses of today-Hong Kong, Japan, Singa pore, South Korea, Taiwan-were much poorer than such Latin American countries as Argentina after World War II. Of the many differences between them, the most important is the economic road taken. Latin America firmly embraced the dirigistemodel. East Asia chose various forms of capitalism. The na tions of Africa, the poorest on the globe, followed Latin America over the abyss of collectivist development strategies. The city-states of Hong Kong and SingaTHE ROLE OF GOVERNMENT 139 pore possess little other than open economic markets. They have developed nonetheless. Resource-rich countries like Mexico and Zaire have, in contrast, struggled economi cally for decades. States as varied as Argen tina, Brazil, India, and Tanzania .failed to prosper so long as they emphasized state-led development plans; all four have since ad justed their policies, leading to greater eco nomic progress.

Lessons from Africa The World Bank has devoted particular attention to Africa. As far back as its 1981 report, Accelerated Development in Sub Saharan Africa: An Agenda for ACTION, the Bank concluded that other "factors impeding African economic growth have been exacer bated by domestic policy inadequacies." Thir teen years later, in its Adjustment in Africa: Reforms, Results, and the Road Ahead, the Bank went much further. Far from being merely an additional problem, "the public sector lies at the core of the stagnation and decline in growth in Africa." In short, gov ernments were attempting to do far too much, and were doing it badly. Similar have been the results of other research by several Bank economists. Studies of Brazil, Chile, Pakistan, Philip pines, and Turkey in the 1960sconcluded that trade restrictions alone were costing these countries between four and ten percent of their GDP. Countries that improved their policies-Brazil, Colombia, and South Ko rea-significantly improved their employ ment and output. Sri Lanka changed govern ments, and economic policies, in 1977; the resulting liberalization had dramatic eco nomic results. A 1993 Bank review of the adjustment experience of 18 developing coun tries, Boom, Crisis,andAdjustment, found that good policies, especially freer trade and mac roeconomic stability, were important for eco nomic success. Obviously, every country is the beneficiary or victim of unique circumstances, which makes anyone pairing suspect, but the overall picture-South Korea versus North Korea, China versus Taiwan, Asia versus Africa-presents a consistent picture, and is 140 THE FREEMAN • MARCH 1997 particularly telling when it involves divided cultural groups like Germany, Korea, and China.

Conclusion Every nation's economic environment is made up of a complex aggregation of indi vidual laws and regulations. All governments, including those in the industrialized West, do dumb things-sometimes out of ignorance, sometimes in response to interest group pres sure, and sometimes in an attempt to achieve noneconomic ends. The basic question is whether economic stupidity is the exception or the rule-whether, in essence, the government acts as if its role is to manipulate the economy. What is needed in America and around the world is not more efficient government reinvented by "progressive" politicians with slightly greater respect than their predeces sors for markets. The real answer is less government. That is, when it comes to devel opment, the state's role in society is to provide the legal framework and physical security for private economic activity, not to act as an agent of economic change itself.

Foreign governments that want to help poorer nations should step out of the way of private development rather than subsidize public enterprises. The history of foreign aid is one of failure-Western assistance for regimes that were simultaneously authoritar ian and collectivist ended up making their people poorer rather than richer. In fact, abundant outside aid long inhibited the com mitment to reform of even more responsible governments. By masking the pain of eco nomic failure, development assistance allows borrowers to delay market reforms, worsen ing the underlying problem. The point is, it is necessity, brought on by collectivist and pop ulist economics, that almost always drives the reform process. Instead of offering new aid programs, in dustrialized states should reform their own economies, encouraging faster global growth, and open their markets to Third World prod ucts. The latter step is particularly important, since poor nations need to participate in the international economy to grow. The benefit of free access to Western markets would vastly exceed the value of foreign aid now or likely to be offered.

The crisis of international poverty well illustrates the fact that restricting government to its proper role is a matter of economic as well as philosophical necessity. The people of poor nations have learned through painful experience that government cannot create growth. Perhaps u.s. politicians will eventu ally comprehend that lesson too. 0 THEFREEMAN IDEASON LIBERTY 1996 Bound Volume S turdily sewn in a single volume with navy blue cloth cover and gold foil stamping, the twelve issues from January through December 1996 - 854 pages, fully indexed for handy reference to the latest literature of free dom. More than 100 feature articles on topics such as education, environment, government regulation and control, health care, individual rights, money, morality and ethics, private property, voluntary action, and international trade. Reviews of more than five dozen books-and all the 1996 issues of Notesfrom FEE.

AvailableFebruary15, 1997. $24.95 each Save! Special introductory price: $19.95, through April 30, 1997 FEE Classic Reprint The Source of Rights by Frank Chodorov T he basic axiom of socialism, in all its forms, is that might is right. And that means that power is all there is to morality. If I am bigger and stronger than you and you have no way of defending yourself, then it is right if I thrash you; the fact that I did thrash you is proof that I had the right to do so. On the other hand, if you can intimidate me with a gun, then right returns to your side. All of which comes to mere nonsense. And a social order based on the socialistic axiom which makes the government the final judge of all morality-is a nonsensical society. It is a society in which the highest value is the acquisition of power-as exemplified in a Hitler or a Stalin-and the fate of those who cannot acquire it is subservience as a condi tion of existence.