THE GENESIS OF THE CURRENT GLOBAL ECONOMIC SYSTEM

by Irma Adelman.

Abstract

The present paper traces the historical origins of the current global
economy. It analyzes the main features of long term economic performance
and economic linkages between developed and developing countries since the
Industrial Revolution. It is divided into epochs, distinguished by the
global trade and payments regimes and by common general characteristics of
the process of long term economic growth.

Introduction.

The main features of the global economy originated during the
Industrial Revolution. A sharp increase in the price of timber at the end of
the eighteenth century induced a search for alternative energy sources. The
search led to a cluster of inventions, implemented over a fourty-year period
during which growth suffered, that enabled a shift to steam-power to take
place. The shift to steam-power, in turn, permitted sustained, long term
economic growth for the first time in history; revolutionized the
technology of long distance transport; changed the economic and social
structure; and led to the eventual transformation of the domestic and global
economy, society and institutions.

Great Britain became the engine of world economic growth during the
Industrial Revolution era, between 1820 and 1890. It initiated the Industrial
Revolution, and competition with Great Britain and the diffusion of British
technology gave the major impetus to the industrialization efforts of the
follower countries, in both Europe and the overseas territories.

I. The Industrial Revolution Period, 1820-1913.

The Industrial Revolution started the systematic application of
science to technology, which has characterized modern economic growth. It
enabled economic development, in the sense of Kuznets'(1968) definition--
broadly based long term economic growth accompanied by structural change--
to take place in Europe and parts of the British Commonwealth for the first
time in economic history. The major difference between the period of
merchant capitalism, up to 1820, and the era of modern economic growth,
starting in 1820, was a tremendous acceleration in technical progress. The
average rate of increase of labor productivity of the OECD countries between
1820 and 1913 was almost seven times that during 1700-1820 . The
acceleration of technical progress, in turn, resulted in an average annual
rate of economic growth of real per capita GNP in the average OECD country
six times higher than during the earlier period. The extent of economic
change between 1820 and 1913 was both unprecedented and impressive: Per
capita income in the average OECD country more than tripled; the share of
industry rose dramatically; the share of employment in agriculture declined
by two thirds; the volume of world exports grew more than thirty fold; a
global economy and a global financial system were created; substantial
intercontinental capital and population movements took place, connecting
the overseas territories to the European economy; and international
patterns of specialization in production and trade emerged.

The global economic order during the Industrial Revolution era was
liberal -- a general characteristic of eras of high growth in the world
economy. The period 1820-1913 was one of very free international trade, with
no quantitative restrictions and with mostly low or no tariffs on raw material
and food imports, varying degrees of industrial protection, extremely free
international movements of labor and capital, and a fixed nominal exchange
rate under a gold-sterling-standard.

The primary effect of the Industrial Revolution on the global economy
was to enable the linking of European and overseas economies in
complementary development patterns that transmitted changes in the rythm
of economic growth in developed countries overseas. The Industrial
Revolution technology drastically lowered the cost of long distance
transport and enabled importation into Europe of food and raw materials from
overseas territories. The invention of the steamship and the later
introduction of refrigerated shipping drastically decreased the cost of bulk
transport over long distances. These innovations enabled the emergence of
a new pattern of international division of labor and complementary
international specialization in trade and production. Food and raw materials
from resource-abundant countries were exchanged for, first European and
then European and United States, manufactures. Geographical expansion of
international trade, international migration, and capital movements into
overseas territories greatly accelerated.
The Industrial Revolution also led to a substantial increase in
economic differentiation among nations. At the eve of the Industrial
Revolution, the ratio of the per capita income of the average most advanced
country to the per capita income of the average least advanced traditional
society, was 2.8 to 1, in 1960 US dollars adjusted for purchasing power
parity differences. (Bairoch, 1987). By 1913, this ratio had almost
quadrupled, to 10.4 to 1, and by 1950 it had mushroomed to 18 to 1. This
increased differentiation ultimately led to the bifurcation of the world into
a set of developed industrial countries, on the one hand, and a set of raw-
material, agricultural-staple based, developing countries, on the other.

I.1 Growth in the Current OECD Nations

Not all of the current OECD countries underwent the Industrial
Revolution simultaneously. They started at different times, and progressed
at different speeds. Indeed, the lag in the spread of the British Industrial
Revolution among OECD countries lasted between one and three generations.
In theory, the application of science to technology was open to all
countries. But, in practice, the countries that were able to take advantage
of the potential for long term economic growth introduced by the Industrial
Revolution were those whose political and economic institutions were either
already propitious or those who could adapt their institutions to enable
modern economic growth to take place. The few countries with modern
factories in 1800 and widespread industrialization by the end of the century
started with institutions best equipped for technical change. They began
with governments that protected private property, enforced private
contracts, and acted to remove legal bottlenecks to the expansion of factor
and commodity markets; with agricultural institutions that gave cultivators
reasonable incentives and provided for a wide sharing of the benefits from
agricultural improvements; with representative political institutions; and
with states with a substantial amount of autonomy. These institutions, which
constituted the domestic institutional core of modern capitalism, were
essential to the rapid diffusion of the Industrial Revolution and to the long
term economic growth which it stimulated.

Governments took the lead in generating the conditions for modern
economic growth in those follower countries that were able to achieve it.
Neoclassical models of autonomous economic growth fully applied only to the
firstcomers to the Industrial Revolution, in which the institutional
conditions for capitalism had already been established by 1820. During the
Industrial Revolution, the governments of the follower countries responded
to the economic and political challenges posed by the early industrializers
by unifying their countries politically and by creating the institutional
framework for capitalism through removing existing institutional barriers
to the growth of market systems. Government investment, government demand,
and government finance also played a leading role during the early stages
of the industrialization of the OECD latecomers. Political institutions,
particularly those that determine which economic interests the state
reflects and the degree of independence of the state, were therefore
critical to economic development and to the distribution of its benefits.

The institutions conducive to economic growth were neither immutable
nor unique. Temporary substitutes for missing domestic capital markets,
deficient factor mobility, and fragmented or small national domestic
commodity markets were provided by domestic governments, by foreign
institutions and by international factor and commodity flows. But, unless the
missing domestic institutions could eventually be developed, their absence
ultimately led to economic stagnation. Institutional development and
institutional flexibility and adaptability were therefore crucial to the
continued long term growth of both the OECD follower countries and overseas
territories. Indeed, it is the very lack of institutional flexibility, imposed
by political dependence, which was responsible for the growth without
development which characterized the evolution of the colonies during this
period.

But institutions were not sufficient by themselves to engender
economic development. The institutional core of modern capitalism had to be
accompanied by appropriate economic policies for economic development to
take place. Among countries broadly similar in their institutional structure
and resources, differences in economic policy explained variations in the
pace of economic development (Morris and Adelman 1989). The most critical
policy areas for development dealt with international trade, agriculture and
investment.

In trade policy, appropriate exchange rates and tariff levels were
critical; overvalued exchange rates could choke off economic growth. While
nominal exchange rates were fixed through the gold standard, real exchange
rates changed over time in response to changes in domestic wages and in the
domestic price level. Country tariff policies operating within this global
liberal trade regime changed systematically with industrialization levels:
some tariff-protection of infant industries was required to initiate
industrialization; eventually, however, tariff protection had to become
negligible for competitive manufacturing to develop. Thus, nowhere outside
Great Britain did initial factory-based industrialization take place without
some tariff protection (Bairoch, 1976). The large OECD latecomers to the
Industrial Revolution-- Germany, Italy, Japan, and Russia--all adopted an
import substitution industrialization strategy. However, the extent of
tariffs varied greatly across countries and, during this period, was not
systematically associated with the rate of economic growth (Morris and
Adelman, 1988).

In agriculture, agricultural productivity played a critical role in the
success of industrialization in Western Europe and Japan (Jones and Woolf,
1969), in which the Industrial Revolution had been preceded by three
centuries of slow but steady agricultural progress. Nowhere did
industrialization progress without a highly productive agriculture combined
with land-ownership institutions favorable to a wide sharing of the
agricultural surplus. Where these conditions did not already exist by 1820,
the Industrial Revolution could not generate sustained economic growth
unless they were created.

Policy and institution-induced differences in national investment
rates were also closely associated with the rate of diffusion of the
Industrial Revolution technology within and across countries. Growth since
the Industrial Revolution has been capital and energy intensive.
Technological change in industry has been labor displacing and technology
has been capital embodied. The technology of the Industrial Revolution has
therefore required high rates of capital formation. Among countries with
broadly similar institutions, the rate and structure of investment was
cloawly associated with intercountry differences in rates of economic
growth. When domestic investment rates in the lead countries slowed down,
their technological leadership diminished, and they were eventually
overtaken by more dynamic countries (Maddison 1982), as in the shift of
economic leadership from Great Britain to the United States from 1890
onwards.

Similarly, there were long time lags before the Industrial Revolution
benefitted the poor. Throughout most of Europe, the numbers in extreme
poverty increased substantially early in the nineteenth century. However,
starting with the second half of the century, however, most Western European
countries experienced substantial poverty reduction. Industrialization
significantly reduced poverty in Belgium, France, Germany, Great Britain,
and Switzerland. By contrast, in the Scandinavian countries, the lags before
poverty declined notably were of the order of two to three generations.
There major emigration abroad, the expansion of high productivity
specialized agriculture, and increases in small-scale industry eventually
raised the living standards of the poor. Everywhere, the key influences
leading to eventual poverty reduction were the establishment of institutions
and infrastructure essential to broad-based growth: market institutions and
transport networks facilitating the mobility of factors across regions and
sectors; tenure systems and structure of landholding inducing
responsiveness to market incentives and entailing increases in agricultural
productivity and a wide sharing of the agricultural surplus; and political
systems reasonably responsive to rising entrepreneurial groups.

I.2 Growth in the Overseas Territories

Long cycles in economic growth, capital formation, migration and
institution-building, linked to economic cycles in developed countries,
came to mark the economic history of land-abundant newly-settled areas in
the nineteenth century. These cycles connected the rhythm of economic
activity in Western Europe, the North Atlantic and the newly-settled areas
of Australasia (Thomas 1973). The export of capital from Europe fueled the
economic expansion of the land abundant non-European countries. By 1914,
Britain's total foreign assets were 1.5 times as high as its GDP (Maddison,
1982 p. 38) and in some developing countries foreign capital (excluding
investment by European settlers) accounted for as much as half of total
investment. Migration to overseas territories by European settlers was a
major motive force. Between 1830 and the first world war about 50 million
Europeans, 30% of Europe's population in 1830, had emigrated to the
Americas. By 1914, one eleventh of the world's total population consisted
of Europeans living outside Europe. (Thomas 1973, p 244). These settlers
brought with them financial capital, technological know-how, political and
institutional cultures, trading networks and skills.

European trade, investment, and settlement led to a phenomenal
expansion of food and raw material exports to Europe from developing
countries. The average rate of growth of real exports of land abundant
countries was about 6% per year between 1850 and 1913, about twice that of
the OECD countries between 1870 and 1913. But only in some of the non-
European societies did export-led growth result, and only in a few of those
did the export-led growth led to more general domestic expansion. The growth
that occured in the overseas territories was not generally sustained, did
not necessarily lead to structural change in patterns of production, did not
usually lead to widespread progress, and did not typically induce general
improvements in levels of living. On the contrary: in all but a handful of
natural-resource abundant countries, growth was cyclical, natural-resource
based, and of an enclave nature. The few, countries in which growth did
lead to some degree of development during the nineteenth century were
characterized by unusually favorable institutions, particularly with respect
to the power-structure of the State, which determined investment rates,
tariff and immigration policies, and land tenure conditions.

In the non-European developing countries other than Japan, this was
a period of quite limited structural change. The structure of production was
mostly dominated by the primary export sector. The land scarce, low
agricultural productivity countries attained very little modern industrial
growth. In some of the land abundant countries, rapid industrialization
starting from a very narrow base and centering on the domestic processing
of exports took place after 1870. However, in 1913, agriculture still
accounted for 37% of total employment in the average non-European land-
abundant developing country. This average was about the same as that for
Holland in 1700 or the United Kingdom in 1820.

As in the current OECD countries, the differences in rates of economic
growth among the white settler overseas territories were substantial. These
differences were explained by their natural-resource endowments,
institutions and policies. The rates of economic progress in the land-
scarce, densely populated, low-agricultural-productivity countries (Burma,
India, China, Egypt) were slow; mass rural poverty prevented significant
development of domestic markets; the forces accelerating exports and
average income growth had a negative impact on agricultural wages; faster
population growth reduced the amount of land per person; and there was no
marked change in the massive proportion of population in extreme poverty
over the century. This massive poverty was associated with inadequate land,
primitive agricultural technology, and decline in supplementary employment.
In addition, landholdings and tenure systems were unfavorable to
improvements in agricultural productivity, and transport systems were poor.
Uneven commercialization and indebtedness, due partially to recurrent
income crises arising from harvest failures as dependance on markets for
both food and income increased, led to loss of land and extreme poverty
among cultivators.

In contrast, in land-abundant overseas territories the growth of
exports was rapid; the rate of increase of real per capita GNP was about
equal to that of the current OECD countries during that period; and there was
some eventual industrialization. Among land abundant developing countries,
the domestic carryover from export expansion varied greatly. It depended on:
the strength of domestic relative to foreign interests and institutions; the
dominance of export interests; the class structure of political power; the
distribution of land holdings; the extent of development of market systems;
the functioning of (foreign-dominated) institutions that provided capital,
labor and entrepreneurship; and the policies of the government with respect
to education, transportation, tariffs and immigration (Morris and Adelman
1988).

The spread of benefits from export-expansion within land-abundant
countries outside Europe was most limited where foreigners owned most
industry, provided most commercial services, and dominated government
economic policy. Wherever the political power of landed elites continued
strong, development was dualistic; growth was limited to an export-enclave
and did not lead to systematic increase in per capita incomes; luxury goods
were important in imports and production; food was supplied by low-
productivity tenant farmers; the domestic market was small; parliamentary
systems representing indigenous modernizing interests did not develop; and
industrialization was very limited. Wherever foreigners were dominant
politically, changes in the structure of production were determined largely
by foreign trade and primary-export growth controlled domestic growth. The
rules of the economic game were set largely by expatriates, who dominated
trade and banking, provided most of the technical expertise and finance of
domestic investment, and saw to it that many institutional restrictions on
the development of factor markets, especially in land, were eliminated in the
interest of export expansion. As a result, landownership became more
concentrated. Since immigration was unrestricted, domestic wages rose, at
best, quite slowly. Where export-interests dominated, poverty was
cyclical, and its extent followed long swings in the demand for staples,
waves in immigration, and cycles in the international terms of trade. The
worst poverty occurred in urban areas, when waves of immigration coincided
with a downturn in the demand for staples and large landholdings were
predominant.

The spread of benefits from export-expansion within land-abundant
countries outside Europe was most substantial when small farmers and
domestic urban interests, comprising domestic manufacturers and labor,
attained political power. These countries eventually became OECD states.
Where the political power of expatriates and landed elites eventually
declined, the domestic carryover from export expansion was greatest; the
impetus from export expansion also spread to the domestic economy; the
shift of political power away from export interests and large landowners led
to the emergence of favorable institutions, especially with respect to land
tenure and labor markets; a domestic market for the growth of small industry
emerged; the economic and political institutions of modern capitalism
evolved; and the growth of exports and average incomes ultimately reduced
poverty, especially where, as in Canada and Australia at the end of the
century, independent family-farming systems had spread.

The states of the overseas territories were not "developmental
states"; nevertheless, the structure and activities of the state mattered.
The state set tariffs, determined immigration policy, and chose the structure
of investment in education and infrastructure. It also played a key role in
establishing market institutions, and land tenure patterns. Economic
policies mattered, especially with respect to international trade,
international factor movements, agriculture and the structure of investment.
Government investment patterns, especially in inland transport and
education, had a critical impact on the diffusion of economic growth. Where
the structure of investment in transportation gave priority to linking the
countryside to major population centers, it was likely to promote the
development of food-agriculture, particularly if land tenure, human
resources, and political institutions were favorable. Where literacy was
growing, improvements in agricultural productivity were higher, though,
given the nature of agricultural technology, it is not clear how literacy
contributed to this effect.

Thus, the Industrial Revolution technology forged a strong link
between the growth of developed countries and that of the white-settler,
overseas territories. The link operated through exports, European
settlement and capital movements. But the domestic effects of the growth of
developed nations on non-European developing countries depended on their
political institutions.

II. Wars and Cycles, 1913-1950

This period included two world wars, the Bolshevik Revolution, a strong
cyclical upswing in the nineteen-twenties, and the Great Depression.
Averages are therefore more than usually meaningless. Over the whole
period, the real GDP per capita of the average OECD country fell by only 15%
compared to 1870-1913; the rate of growth of the capital stock and of
population both declined to 60% of their previous averages; but productivity
growth continued at a somewhat higher rate than during the Industrial
Revolution.

The most glaring difference between this and the Industrial Revolution
period was not in average growth rates. Rather, it was in the much greater
degree of global economic instability and in the nature of the global
economic system. Efforts to stem the international transmission of recession
led to newly restrictive global payments and trading regimes. High tariffs
and strong quantitative restrictions were introduced. The rate of growth of
real exports fell to merely 1.5%, one fourth of its average during the
previous period. Severe constraints were imposed on capital and labor
mobility. Currencies were generally overvalued. There was a period of
collapse of the international payments regime, followed by galloping
inflation in some countries. This led to extreme policy concern with price
and exchange rate stability at the cost of high unemployment, which
persisted until the start of the second World War.

For developing countries, total GDP continued to expand at about the
same average annual rate as it had during the Industrial Revolution era.
(2%). But population growth accelerated steadily, so that the rate of growth
of GDP per capita fell from 1.2% between 1900 and 1913, to .9% between 1913
and 1929, and to .6% between 1929 and 1952-54 . Much of this growth was
due to increases in the output of extractive industries, whose real product
grew 5.5 times over this period. The extractive industries were foreign-
owned and foreign-managed, and generated almost no domestic spread-effects
except through wages. There was some industrialization: output in
manufacturing increased almost twice as fast as GNP between 1938 and
1950. Structural change in employment proceeded slowly however--the
share of manufacturing employment actually declined somewhat, the
share of employment in primary fell (from 77.7 in 1913 to 73.9 in 1950), and
the share of employment in services rose (from 12.2% to 16.7%). Exports of
developing countries rose significantly (in current dollars, the value of
developing country exports rose fivefold, and their share of world exports
increased from 19% to 31% ) but so did their imports. The exports of
developing countries consisted virtually entirely of primary products and
the growth they generated was dualistic, with limited spread effects, and
little new institutional development, except in support of the export sector.


This period thus consolidated the differentiation between developing
and developed countries and was characterized by an unstable, restrictive
global payments and trade regime.

III. The Golden Era of Economic Development, 1950-1973

The end of WWII ushered in an era of unprecedented sustained economic
growth in both developed and developing countries. World War two had
generated a period of pent-up demand and had destroyed capital and
infrastructure in Europe and Japan. The institutional framework of
capitalism, which had been temporarily abrogated by the command economies
of the second world war, was restored quickly. The Marshall Plan helped
rebuild the capital stock destroyed during World War II and generated an
investment boom in Europe. Recovery from the devastation of the war was
quick.

The Bretton Woods agreement reintroduced a fixed-exchange-rate
payments regime, based on the dollar, and supported by a system of
international institutions designed to introduce some limited flexibility and
facilitate the management of international foreign exchange imbalances. The
international economic order became liberal, with low non-agricultural
tariffs and few quantitative restrictions in the OECD countries and a fair
degree of flexibility in tariff-setting in developing countries. As a result
of the new payments system, the liberal trading regime and the very rapid
growth of import-demand in the OECD countries, the volume of international
trade expanded rapidly. Denison estimates that, between 1950-62, the
contribution of trade-barrier removal to OECD economic growth was about .15
percentage points, while Maddison estimates that it was about twice as
high.

III.1 Developed Countries

From 1950 on, progress in the OECD countries proceeded at a breakneck
speed by historical standards. The compounded annual rate of growth of real
per capita GDP in the OECD countries escalated to approximately 2.6 times
(4.9% annually as compared to 1.9%) that of the interwar period, and became
almost precisely double the previous peak growth rate of the Industrial
Revolution era. Productivity growth in the OECD countries was more than
triple (3.75 times) that of the Industrial Revolution epoch. Investment rates
were high, rising from single digit, prior to 1950, to double digit
percentages to GDP. For all OECD countries taken together, the rate of
growth of the capital stock more than tripled compared to the interwar period
(5.5 % annually as compared to 1.7%); labor force growth remained low (about
1% annually), and the rate of increase of hours worked tripled (to .3%
annually). The average stock of formal education rose very rapidly, from 8.2
years per person in 1950 to 9.6 in 1973. The amplitude of business cycles
was small, both absolutely and by historical standards. The volume of
exports grew by 8.6%, almost nine times as fast as between 1914 and 1950,
more than twice the previous peak rate, and about 50% faster than real GDP.

Since, by 1950, the institutions for capitalist growth and their
malleability had been firmly established in the OECD countries, this
unprecedentedly rapid economic expansion was based on conventional
economic forces: fast productivity growth, supported by a new routinization
of the innovation process through commercial R&D; rapid capital
accumulation and well functioning capital markets, enabling rapid
reallocation of capital and labor to more productive uses; stable and fast
growing demand, promoting high rates of resource utilization; employment and
labor force increases but only at almost a sixth of the rate of growth of the
capital stock and at slightly more than a fifth of the rate of growth of
productivity, allowing continuing increases in capital per employee and
wage increases without inflation; high rates of growth of human capital,
permitting growth in productivity; high rates of structural change, enabling
continuing good resource allocation; and cheap energy and raw material
prices, allowing, together with the growth of productivity, the combination
of high growth with low inflation rates. Governments became committed to
demand management policies aimed primarily at maintaining high employment.
There was relative peace. The result was a stable, expansionary national
and global policy framework. Never before had there been such a
(fortuitous?) concatenation of favorable economic and institutional
circumstances.

III.2 Developing Countries

The impetus from this unprecedented growth in the OECD countries was
transmitted to developing countries. The very rapid expansion of world
trade was the primary transmission mechanism and exports the were the
primary engine of growth. But, capital flows in the form of foreign aid,
foreign investment and foreign loans helped the growth of developing
countries as well.

The fast income growth in the OECD countries, the liberal global
trading system, and the stable but flexible exchange rate regime generated
a global environment favorable to rapid increases in exports from developing
countries. International foreign assistance institutions were established
for the first time in history and bilateral foreign assistance programs were
initiated.

By historical standards, the resulting growth rate of developing
countries was nothing short of breathtaking. The average rate of growth of
real per capita GNP for all developing countries rose to 3.3% , more than
triple the rate of growth of the early industrializers between 1820 and 1914.
While this growth rate of per capita income was well below that of developed
countries during that period, the major difference in growth rates was due
to differences in rates of growth of population. The rates of growth of total
GNP were almost the same as in developed countries.

As during the Industrial Revolution era, it is those developing
countries with the most developed economic and political institutions in
1950 that were the major beneficiaries from the strong growth-impetus
originating in developed countries. The developing countries with the
highest rates of institutional development had an average rate of growth
of per capita GNP about 50% higher than the average growth rate of the non-
oil countries at intermediate levels of socio-institutional development, and
more than twice the average rate of growth of the least socio-institutionally
advanced non-oil countries. Furthermore, by 1973, the overwhelming majority
of countries that were institutionally most advanced in 1950 had become
semi-industrial countries, and six institutionally advanced countries that
had been developing countries in 1950 (Greece, Israel, Japan, Turkey, South
Korea, and Taiwan) had become developed nations.

By contrast, no institutionally less advanced country in 1950 had
become a semi-industrial country by 1973. Some countries at lower levels of
socio-institutional development had experienced high rates of growth of per
capita GNP. But their economic growth was almost entirely oil and resource
based, was not self sustaining, fluctuated with external terms of trade, did
not spread significantly to the rest of the economy, and did not result in
much social and institutional development. Thus, as in earlier periods,
institutional readiness was critical to economic development.

For the first time in history, the economic expansion of developing
countries was also marked by substantial structural change in their
economies. The typical process of structural change, described by Chenery
and Syrquin (1975) from a combination of cross-country and time series
regressions fitted to data for this period, proceeded as follows. In the
average developing country with a population of 10 million, the earliest
phases of development, involved a significant rise in total, mostly
primary, exports accompanied by a substantial increase in investment in
human and physical capital (in that order). A gradual shift in export
structure towards manufacturing and a sharp drop in the share of primary
production in total output also began in the early phases of structural
change. Next, as per capita incomes increased, came shifts in the
composition of consumption, from food to non-food, which generated an
expansion in demand for manufactured consumer goods. The share of
manufacturing in total domestic output rose as a result, reaching the
midpoint of its eventual value at a per capita income of $300 in 1964 prices.
Beyond that income, value added in manufacturing started to exceed value
added in primary activities.
The structure of exports changed more slowly. Manufacturing exports
become gradually more important; they overtook service-exports in value at
a per capita income of about $300. But, in the typical process, they came to
equal primary exports only at a per capita income of $1000. The shift of
labor out of agriculture lagged significantly behind the transformation in
production structure, so that the productivity gap between agriculture and
industry increased.

Partly as a result of this increasingly dualistic structure of growth,
the distribution of income, which started deteriorating as soon as
development began, became increasingly unequal. According to Chenery and
Syrquin, inequality reached its peak at per capita income of $500, though
other regression estimates of the turning point for inequality (Anand and
Kanbur 1986) suggest that the precise location of the peak is sensitive to
the sample of countries included and the inequality curve tends to be very
flat in the middle ranges (Papanek and Kyn 1987).

When per capita income reached $800, the economic structure of the
average non-oil developing country started resembling that of a developed
country. At this point, industrial output was about three times primary
output; relative productivities in manufacturing and primary had almost
converged; employment in industry became about the same as in the primary
sector and about three quarters of that in services; and, for the average
non-oil country at this level of per capita income, the distribution of
income, was on its way to recovery.

The demographic transition started earlier than the economic
transition, with death rates falling significantly from the very beginning of
the development process and reaching the midpoint of their fall at per capita
incomes of $150. Birth rates declined more slowly, reaching the midpoint of
their eventual value only at incomes of about $350. As a result, a
population explosion marked the earlier phases of the development.

Urbanization attained the midpoint of its transition quite early, as
rural-urban migration proceeded rapidly, and about half the population
became urban at per capita incomes of $350. School enrollment ratios
reached 50% quite early, but increased more slowly thereafter.

On the whole, the characteristics of the demographic transition made
development more difficult: a population explosion accompanied the early
and middle phases of the development process, urbanization proceeded in
advance of modern job creation in most developing countries, and education
raised status and living-style expectations before the economy could
deliver on these expectations. Young, educated unemployment, of as much as
20% in some countries, became a common and persistent, feature of the urban
landscape. The middle phases of the development process were therefore
marked by significant social and political tensions, fueled by the
unevenness of the development process, by educated unemployment, and by
increases in inequality.

Once certain levels of socio-economic and institutional development
were attained, economic policies, especially with respect to trade,
agriculture, technology and investment mattered greatly. In trade, all
developing countries pursued import-substitution policies during the
fifties; most continued to pursue import-substitution policies throughout
the period. In the mid-to-late sixties, the majority of the most
industrialized developing countries shifted from import substitution in
labor-intensive consumer goods to import-substitution in intermediates and
machinery, as domestic markets for wage goods were exhausted. A handful of
successful industrializers, mostly East Asian but including Brazil, switched
in the early to mid-sixties, to export-led growth in labor-intensive products
instead of proceeding to the second phase of import substitution. The
countries that adopted this policy had the most successful development
experience. Where agricultural systems consisted of small or medium-size
commercial, owner-operated, high-productivity farms, and primary education
was universal and secondary education widespread, the shift to labor-
intensive export-led growth combined high growth with non-deteriorating
income distributions.

Agricultural development was neglected in most developing countries
during this period. Developing countries were bent on industrializing, and
cheap cereal and feed imports (largely from developed countries) provided
substitutes for the expansion of domestic grain-agriculture. The Green
Revolution technology became available for adoption towards the middle of
the period and was disseminated to some medium-to-large commercial farmers
in some regions of some developing countries. However, on the average,
productivity growth in food-agriculture was slow prior to 1973; incentives
to farmers were minimal; agricultural terms of trade were kept low to provide
low-priced food for the cities and enable the maintenance of low wages in
manufacturing. Export-agriculture was "taxed" through parastatals paying
below world-market prices with the aim (not generally realized) of using the
proceeds to finance industrialization. Public investment in agricultural
infrastructure was generally below 15% of total investment, and tended to
favor large commercial farms and export-agriculture.

Technologically, development was both capital and resource-
intensive. Marginal capital-output ratios were high, especially in the
poorest countries, where infrastructure-investment dominated most
investment. Chenery, Robinson, and Syrquin (1986) estimate that, during
this period, 70 percent of the growth of total GNP in the average semi-
industrial developing country came from increases in factor supplies and
that capital accumulation accounted for 60 of the contribution of factor
growth to GDP. Innovations, structural change, and international trade
accounted for only 30% of the growth of total factor productivity, with
resource reallocation from low-to high-productivity sectors accounting for
about half of that amount. In manufacturing, technology was imported,
capital-embodied, and fitted the relative factor scarcities in developed
countries. Endogenous technological innovations played a negligible role
in even the industrial sectors of the miracle-growth developing countries.
The adoption of capital-intensive technology aggravated the inability of
rapid growth of modern industry to absorb the new additions to the urban
labor force.

The result of these policy choices was that, despite unprecedentedly
rapid economic growth, poverty in developing countries continued to be
massive. The forces responsible for the continuation of immense poverty
were a combination of: economic dualism; lack of attention to rural
development; capital-intensity of growth; urban bias in the provision of
education and social services; rapid population growth; institutions biased
against the poor; and deteriorating income distribution during the early to
middle phases of development.

The global distribution of income remained remarkably stable between
1950 and 1973 (Adelman 1985; Whally 1979; and Summers, Kravis, and Heston
1981). But since, by 1960, about two thirds of developing countries had still
not attained levels of socio-institutional readiness sufficient for self-
sustained development, and since among countries that had, policy regimes
were not uniformly propitious, the absolute income gaps among developing
countries increased: semi-industrial countries improved their relative
income-standing while African countries were increasingly left behind. Not
only did the income gaps between groups of developing countries increase
but inequality among countries within each group of developing countries
soared as well: the Gini coefficients among average per capita national
incomes (in Kravis dollars) in the group of low-income countries rose from
.0096 in 1950 to .113 1973; and in middle-income, non-oil countries they
rose from .264 to .294. Finally, the income gaps between developing
countries as a group and developed countries as a group worsened
dramatically. In 1950, the per capita income of the ten richest
industrialized countries was 48 times that of the ten poorest countries (at
official exchange rates); by 1975, the income multiple had increased to
71.

IV. Crisis, Slow Growth in OECD countries and
Debt-Led Growth in Developing Countries, 1973-1981

Clouds were brewing in the horizon towards the end of the period of
accelerated growth. The Bretton Woods international monetary system had
become increasingly inadequate to the liquidity needs of the world economy
and, when it broke down, the stable, fixed exchange rate system was replaced
with a fluctuating exchange rate regime. There was an effective devaluation
of currencies against the dollar, contributing to inflationary pressures in
Europe and Japan. Productivity growth slowed down in most OECD countries,
as the gap between actual and best practice technology narrowed, and the
service economy expanded. The mild wage bargaining climate was replaced
by wage settlements that were outrunnig the now smaller increases in
productivity. Population growth decreased and the population was aging.
These fundamental long-run trends were exacerbated by a series of bunched
short-term price shocks: a strong cyclical upturn in 1972-73, leading to an
increase in the world price of manufactured goods; a doubling in the price
of cereals in 1973; a tripling in oil prices in 1974; and a doubling in the
price of gold between 1971 and 1973. Strong upward pressures on commodity
prices and strong inflationary expectations were the result. Balance of
payments constraints became binding. As a result, the governments of OECD
countries replaced the goal of full-employment growth with the twin
objectives of containing inflation and restoring balance of payments
equilibrium. They moderated their counter-cyclical budgetary policies;
adopted cautious macroeconomic policies; and espoused a stance of fiscal
restraint. Government deficits were reduced or eliminated and balance of
payments considerations became important.

The result was a drastic slow-down in the growth rates of the OECD
countries to, on the average, about one fourth of the previous per capita
annual real rate. GNP per capita in constant prices rose at an annual rate
of only about 2% for all OECD countries taken together. The growth in real
world trade fell to only 3.2% per year, less than one half its previous rate.
Nevertheless, non-oil imports of developed countries grew by 12%. Inflation
rates became almost triple their average of the previous decade.

For the first time in peacetime history, developing countries' growth
rates did not follow the rythm set by growth rates in the OECD countries.
Instead, developing countries responded to the change in the world
environment by an unwillingness to accept the drastic decline in their
development momentum implied by the OECD slowdown. Faced with severe
balance of payments pressures stemming from the drastic increase in oil
prices combined with lower rates of growth of export demand for their
products and with generally declining terms of trade, most developing
countries borrowed heavily to maintain their growth rates. Banks in
developed countries, especially the United States, were only too willing to
extend loans to developing countries since they were attracting an influx
of petro-dollars, on which they had to pay high interest rates, and the
slowdown in in OECD growth rates did not generate sufficiently domestic low-
risk lending opportunities. Loans to developing countries seemed a safe bet,
since no developing country had defaulted on its foreign debts since the
second World War and the number of reschedulings had been small. The result
were two-fold: a massive buildup of foreign debt; and growth rates of real
GNP that, for the median non-oil developing country, were more than double
the OECD average. Between 1973 and 1982 the foreign debt of developing
countries escalated: for the average non-oil developing country, total
foreign debt increased to a third of its GDP, and 152% of exports. In the
heavily indebted countries, the average debt service ratio became 20% of
exports, and was mounting at clearly unsustainable rates.

At the same time, growth and industrialization continued to proceed
and, while performance was mixed, some favorable structural change was
taking place in many developing countries. Despite increasing protection
in OECD countries, developing countries started penetrating the export
markets of developed countries. Some of the growth-impetus for developing
countries started to come from other developing countries, especially the
oil-exporters: South-South trade increased and so did migration to oil-
countries and remittances from them. In some labor-exporting developing
countries, worker-remittances accounted for as much as half of total export
revenues.

Agriculture received new policy attention, largely as a result of the
food crisis in 1973-4, when the world price of wheat and rice tripled and the
price of fertilizer quintupled. The previously accomplished technological
breakthrough of the Green Revolution provided a ready technology for
dissemination to non-tropical agricultural zones. Investment in
agricultural infrastructure, extension, and agricultural research expanded
and so did international lending for rural development. Agricultural
marketing institutions and agricultural terms of trade policies received
some policy attention. As a result, the rate of increase in food production
in developing countries started exceeding that in developed countries.

But the variance in growth and structural change among developing
countries rose: the most developed semi-industrial countries did very well
during this period while the least developed countries were increasingly
falling behind. And, while the share of manufacturing exports from
developing to developed countries grew, the manufactured exports came from
only a handful of semi-industrial countries.


With a few notable exceptions, overall policy reform was rather limited,
despite mounting pressures from international lenders.

V. Debt Crisis, Structural Adjustment, and Reform, 1981-1993.

The debt crisis was brought to a head by the inability of Brazil and
Turkey to meet their debt-service obligations. As a result, banks in
developed countries became unwilling to extend further loans to all
developing countries. Out of necessity, priorities in developing countries
shifted from economic growth to achieving external balance.

Adjustment patterns varied. Some developing countries adopted
restrictive import regimes, deflationary government expenditure and
macroeconomic policies, and restrictive wage policies. Others, attempted to
export their way out of the crisis. They shifted from import-substitution to
export-promotion, devalued to promote expenditure switching among imports
and domestic goods, and curtailed their growth rates temporarely. The latter
adjustment pattern was considerably more successful (Balassa 1989). Most
developing countries, however, adopted combinations of these policies and
shifted among policy regimes in a stop-go fashion.

Rampant inflation, capital flight, low investment rates, drastic
declines in living standards, and substantial increases in urban and rural
poverty have marked this period in most countries. Two thirds of developing
countries did not achieve a current-balance- surplus sufficient to service
their debts with little extra borrowing. Overall, debt service requirements
have led to a net export of capital to the developed world in the last few
years. For most countries, the adjustment cost has been quite substantial.
The average developing country has transferred more than its entire growth
of GDP abroad annually, for debt service. The most underdeveloped
countries, that had benefitted least from previous expansionary regimes,
have also been the hardest hit in the 1990s.

While the growth performance of most developing countries during this
period has been poor, the East Asian and South Asian countries have
continued, if not improved, their previous developmental performance.
Poverty in some of these countries has diminished substantially (China,
India and Indonesia) and a few (Thailand and Indonesia) may even become
semi-industrial countries.

Perhaps most importantly, this period has also been an era of
significant institutional adjustment and policy reform in most developing
countries. Many Latin American countries have adopted at least some
features of open-trade regimes. Market institutions have generally been
strengthened, especially in some African and Latin American nations. All
developing country governments have become convinced of the priority of
good economic policy over ideology and politics, though they may or may not
adopt it. Many of the economic and political institutions that form the core
of capitalist development have thus being created in a large number of
developing countries.

Developing countries are thus acquiring the institutional conditions
for development. A revival of growth in the OECD countries coupled with a
change in the international payments regime, trade liberalization, and some
debt forgiveness and rescheduling, may thus lead to the resumption of
development in developing countries.

VI. Summary and Conclusion

The major driving force for the growth of developing countries has
been exports. The global trading and payments regimes have therefore been
critical to economic growth. There is no historical exception to the
statement that periods of high growth within countries have been periods of
fixed or narrowly fluctuating exchange rates, elastic payments systems, and
liberal trading regimes. In contrast, periods of slow growth have been
periods of sharply fluctuating exchange rates, inelastic payments systems
and restrictive trading regimes.

But exports did not always result in development. Whether, in a given
country, the impetus from exports initiated structural change in addition to
economic growth, and whether the benefits of development became widespread
and growth self-sustained has depended on the country's economic
institutions and political structure. Countries with more developed market
institutions and with political systems that were more responsive to the
interests of domestic modernizing elites developed, while the growth of the
other countries remained cyclical and narrow based.

Development has always been associated with greater inequality among
nations, as those countries that were institutionally readier for
development were the first to profit from the impetus imparted by exports and
those that were not were left behind. Within countries, the early and middle
stages of the transition to developed state greatly increased inequality as
individuals that had the financial, real, and personal resources to benefit
from the opportunities opened up by economic expansion became richer while
those with few or inappropriate resource-endowments were displaced and/or
left behind. In a few countries with exceptionally favorable initial
distributions of endowments, with well developed institutions, and with
policies leading to rapid labor-intensive growth, development was
egalitarian almost from the very start. In general, whether the eventual
decrease in inequality occured at late stages of development was a matter
of policy and institutional choices. The critical choices related to
educational policies; the labor-intensity of growth; tenurial institutions
in agriculture; agricultural productivity; and agricultural terms of trade.

Policies, particularly with respect to international trade and
agriculture, have mattered greatly to economic development. Countries that
were unable to adopt infant-industry protection policies in the early stages
of their industrialization could not get a start. By the same token,
countries that failed to switch from import-substitution to outward-oriented
policies once the first phase of import substitution was completed, grew
more slowly and weathered the shocks of the nineteen seventies and eighties
with greater difficulty. But, experience indicates that, to be successful,
the promotion of outward-oriented policies must be accompanied not only by
changes in commercial policy but also by institutional reform--the
dismantling of unfavorable institutions and the liberalization of factor and
commodity markets.

Progressive agriculture has been essential to sustained
industrialization and to broad-based development historically. With the
exception of city-states, no countries became developed or semi-industrial
without at least moderately productive agricultures, and at least moderate
increases in the productivity of domestic-food agriculture. The
overwhelming majority of semi-industrial countries have a significant,
economically viable, surplus-producing, family-farming system, though this
system could be combined with large commercial farms providing most of the
food for cities, on the one hand, and with substantial subsistence farming
on the other.

Finally, the nature of government investment patterns, particularly in
education, agricultural infrastructure, and internal transport, was critical
to broad-based development.

The development process is complex and successful development policy
requires complementary and coordinated institutional reforms, investment
and price policies, and trade strategies. Piecemeal change is less effective
than coordinated change. Policy change without institutional reform can
have perverse long run effects, especially if existing institutions do not
provide for broad-based economic growth with a relatively widespread
sharing of its benefits.

As to the future, history provides reasons for cautious optimism. The
current era is most analogous to the fourty-year span of invention-clusters
and slow growth preceding the Industrial Revolution. Like the steam-engine
of the Industrial Revolution era, the current electronic Communication
Revolution is in the process of altering all aspects of the national and
global economy, society and polity. It is transforming the industrial
structure, industrial organization and workplace within the OECD countries;
leading to the creation of a new kind of labor force; altering working-
patterns and permitting a new level of decentralization of productive
employment; revolutionizing the technology of long distance communication;
changing the international patterns of division of labor; inducing far
reaching changes in economic and social structure; and leading to the
eventual transformation of the domestic and global economy, society and
institutions. New kinds of transnational firms, engaging in global
specialization and subcontracting, have emerged. Financial and capital
markets have become globalized, and respond instantly to changes in any
part of the globe. A liberal economic trading order is in process of being
forged.

But, as during the Industrial Revolution, the international system and
national societies are grappling with the problems of adapting their
societies and institutions to rapid technological change. As some
countries, regions, social classes and individuals are better equipped in
terms of institutions, values and skills to take advantage of the
Communication Revolution economic and social inequality both within and
across nations is again increasing rapidly. Economic and social gaps within
nations are mounting, and generating increased social tensions, civil and
regional wars, and the mushrooming of humanitarian emergencies. There is
a new, different kind of anomie associated with the disappearance of
community-values, community-life, and community-loyalties arising from the
globalization of production and consumption and from faceless
communication. Globalization of capital is generating footloose firms and
footloose capital, and giving rise to a substantial rise in personal economic
insecurity and its generalization to strata that have been accustomed to
secure employment and secure economic status.

The technology of the Communication Revolution is in place, but the
institutions, values and commitments implied by the globalization it
generates are yet to be forged. Will humanity rise to the challenge? I
believe we eventually shall and when we do a new Golden Era of economic
growth and development will commence.

References

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Keywords

Industrial Revolution
Global payments system
Global trading system, liberal, restrictive
economic development
developing countries
land-abundant or resource abundant overseas territories
resource-poor or densely populated countries
follower countries
technology
technical progress
sustained economic growth
structural change
institutions, institutional development
institutional flexibility
modern economic growth
industrialization
quantitative restrictions
tariffs
import substitution
primary exports, extractive industries
transport
growth rates
OECD or developed countries
semi-industrial countries
government or the state
factor and commodity markets
land tenure
agriculture , agricultural productivity, Green Revolution
investment
education or human capital
foreign trade
economic cycles
capital flows
immigration, expatriates
poverty
income distribution
political institutions
economic dependance
exports, export expansion, export-led growth, carryover from exports
sustained economic growth
structural change
levels of living
dualism, export encalve
policies, trade policies, agricultural policies, immigration policies and
educational policies
population growth, demographic transition
links between developed and developing countries
Wars
Great Depression
Golden Era of Economic Development
Bretton Woods
Marshall Plan
exchange rates, fixed, fluctuating, overvalued
foreign debt,developing countries
structural adjustment