Part II - Lessons from Country Case Studies

Introduction to Part II

At the core of the IDP is the idea that we can gain more knowledge about the role of institutions by undertaking in-depth country case studies than by carrying out broad quantitative exercises based on a large sample of countries. The reasons behind this research strategy have been explained in detail in Chapter 2. We believe that any institutional analysis that ignores the precise context in which institutions operate is destined to generate only limited insights. The value of large data-based cross-country exercises is essentially exploratory, while the relevance of more sophisticated exercises that overcome the problem of causality – micro-historical studies using regression discontinuity and similar methods in particular – is all the greater as they are seen as complementary efforts to the sort of investigation conducted in this book.

In-depth country case studies not only have the advantage of throwing light on the conditions and circumstances that form the context in which development policies must be understood, but they also enable us to get a grasp of the dynamic processes under way. Policy decisions and institutional choices can thus be analysed in their context and in the light of their succession over time, in the form of a series of steps that could help consolidate a rather well-defined development trajectory or correspond more to strides ahead followed by backward moves, or to temporally inconsistent paths. Clearly, this sort of dynamic analysis necessitates a political economy approach in the sense that institutional choices are not seen as the simple outcomes of decentralised decisions by a multiplicity of private actors, but rather as outcomes decisively influenced by political actors or state agents who have their own preferences and interests (see Chapter 1).

To the six country case studies presented below, we apply the institutional diagnostic approach outlined in Part I. They therefore provide us with many opportunities to test its pertinence. As explained earlier, four country case studies are original: they rely on our own in-the-field investigations of many aspects of their institutional setup and their contexts, both static and dynamic. The countries selected for this purpose – Tanzania, Benin, Bangladesh, and Mozambique – are not trapped in the rather extreme situations of the so-called fragile countries. They offer hope and potential for development, and their study is therefore capable of highlighting the extent to which, and the ways in which, critical institutions may propel or constrain development. The other two countries that will receive our attention, South Korea and Taiwan, are different since they have already completed their take-off into sustainable development and have done so in a remarkably short period of time. Because of this performance and the important contributory role of successful institutions, we wanted to revisit their experiences in the light of our institutional diagnostic approach. Here, instead of in-the-field investigations, we rely on the available literature.

The above case studies are presented in the following order: Bangladesh and Tanzania (Chapter 3), Benin and Mozambique (Chapter 4), South Korea (Chapter 5) and Taiwan (Chapter 6). The reason why we devote less space to the former four countries is that, as has been pointed out earlier, each of them is the object of a separate book and the final chapters of these books offer synthetic analyses on which the present accounts could be anchored.

3 Uncertain Development Trajectories in Bangladesh and Tanzania

I Bangladesh

A Is the ‘Bangladesh Paradox’ Sustainable?

The Bangladesh paradox consists of the apparent contradiction between the superior growth performance of the country over the last two or three decades and the dismal state of its institutions, at least as gauged by most international governance indicators. The IDP case study on Bangladesh attempts to explain this paradox and address the issue of its sustainability.

What follows is a short summary of this case study conducted according to the methodology described in Chapter 2. It starts with a brief presentation of the geographical, demographic, and historical context of development in Bangladesh, before focusing on its economic achievements but also on its challenges going forward. Institutional issues are then taken up, before presenting a full institutional diagnostic of Bangladesh’s development perspectives and then concluding.

B The Geophysical and Population Context

Occupying the delta plains of major South Asian rivers – the Ganges, the Brahmaputra, and the Meghna – Bangladesh covers a 150,000-square-kilometre tract of land surrounded by India, except for a short border with Myanmar in its southeast. With 165 million inhabitants, it is the most densely populated country in the word (excluding city-states like Hong Kong and Monaco). It has a tropical monsoon climate with heavy seasonal rainfall, hot temperatures, and high humidity. The combination of its climate, its dense river network, the low elevation of most of its land above sea level, and its geographical position at the very back of the Bay of Bengal make it prone to frequent natural disasters, including floods, cyclones, and tidal surges. For the same reason, it is one of the countries that is most threatened by climate change.

These natural conditions affect the country’s development potential and some of its development features. The scarcity of land is especially important since it affects agricultural production and constrains the extension of cities and non-agricultural activity. Over time, arable land as a proportion of total land has shrunk, the average farm size has fallen – it is today around 0.6 hectares – and landlessness has increased in rural areas. Meanwhile, urbanisation has progressed rapidly – at an annual rate of almost 1 per cent of the population – so that the competition between agriculture and other activities for land is fierce.

Land scarcity would be even more worrisome if the rate of population growth had not fallen in a rather spectacular way over time. The fertility rate was above six children per woman at the time of independence in 1971. It is now close to two. Consequently, the annual population growth rate has declined from 3 per cent to less than 1 per cent. Ethnically, the population is extremely homogeneous: 98 per cent of the population belong to the Bengali ethnic-linguistic group, while the remainder comprise several tribal groups in the hilly parts of the country. The same homogeneity is observed with regard to religion, with more than 90 per cent Muslims and 8 per cent Hindus.

This religious homogeneity, as compared to Bangladesh’s neighbour India, is mostly due to the historical origins of the country as the isolated eastern part of Pakistan, itself the result of the partition of the Indian provinces of Punjab and Bengal along religious lines at the time of India’s and Pakistan’s independence in 1947. Today’s Popular Republic of Bangladesh thus results from a sequential process of independence: from India or the United Kingdom at the time of the partition, and from West Pakistan twenty-four years later, after a short but deadly war in which dissident Bengali forces defeated local West Pakistani forces thanks to the support and very effective involvement of the Indian army.

C A Short Political History of Bangladesh

Independence was proclaimed on 16 December 1971. Since then, however, the political history of Bangladesh has been rather turbulent, at least until a little more than ten years ago. As it had a clear impact on development, and on the evolution of institutions in Bangladesh, it is worth briefly listing the main episodes in that history, and the enduring struggle between the two main political parties, the Awami League (AL) and the Bangladesh National Party (BNP).¹

1 The Difficult Advent of Democracy (1971–1990)

The AL had been in existence practically since the creation of Pakistan, at the time of partition. Of a clear socialist bent, the party relentlessly pursued autonomous status for the eastern part of the country, starting with the right to use the Bengali language rather than the Urdu spoken in the western part. Mujibur Rahman joined the League shortly after its creation and soon became its main leader, attracting as much popular support for himself personally as for the League itself. This backing was so strong that the AL won the 1970 national election against the main western party. Violent repression by the defeated government followed, which triggered the independence war, which was deadly but short. The East defeated the West with Indian support. In 1971, Mujibur Rahman became the president of the now independent East Pakistan, which was renamed Bangladesh – ‘Bengali land’. At the same time he won the title of ‘father of the nation’.

After a violent war, which had followed a devastating cyclone, Bangladesh was in a dire state. Mujibur Rahman almost had to reconstruct the country. His period of leadership was short but intense. Guided by four fundamental principles – ‘nationalism, secularism, democracy, socialism’ – he laid the foundations of a new state along socialist lines, including the nationalisation of many industries and businesses abandoned by the West Pakistanis after the war, land reform and the introduction of agricultural cooperatives, and the expansion of primary education and other public services. Time was too short for Rahman to see the result of these initiatives. Showing a personal inclination towards religious movements, Rahman’s rule was soon violently opposed by Communists, while, paradoxically, Muslim extremists reproached him for the secularist principle he had enshrined in Bangladesh’s constitution. Sheikh Mujib, as Rahman was known, ruthlessly repressed these movements, jailing and often eliminating opponents to his rule, progressively transforming a liberal parliamentary political system into a single party (AL) authoritarian regime.

Rahman was assassinated in a coup managed by young army officers in November 1975. A period of disorder comprising various coups, countercoups, and assassinations followed, until army chief Ziaur Rahman (‘General Zia’) took power in 1976. After running the country as ‘chief martial law administrator’ for some time, amidst continuing disorder and coup attempts, Zia overwhelmingly won the presidential election that was called in 1978. Soon after, he founded the BNP with a view to uniting people behind principles different from those promoted by the AL, particularly secularism and socialism. He also reinstalled the religious Jamaat-e-Islami party, which had been banned after independence on charges of complicity with West Pakistan.

Zia’s rule was short too, though less disorderly than Sheikh Mujib’s. In effect, he put the Bangladeshi economy back on track. On the economic front, he focused on boosting agricultural and industrial production by promoting private sector development, export growth, and the reversing of farm collectivisation. Production quotas and other restrictions on economic activities were lifted. A rural development programme was implemented, which comprised innovative social aspects as well as measures to control population growth. Major infrastructure projects were launched, including irrigation canals, power stations, and roads. On the political front, Zia reversed the strong secularist principles imposed by Sheikh Mujib, giving more public space to religion and a greater voice to Islamic movements in a restored multi-party system. Once elected as president, he normalised political life, re-established public order, and tried to rein in the military.

Zia, too, was assassinated in 1981 by a previously high-ranking officer who had been demoted. The rebellion was quickly put down and a civil caretaker government was put in place. Yet the army was not willing to step aside. Another coup soon unfolded, and power fell into the hands of General Ershad, the very officer who had subdued the uprising that followed Zia’s assassination.

When he declared himself president in 1983, Ershad immediately faced violent protests from most political parties, as well as from university students and the civil society in general. Thanks to the army’s support, he managed to stay in power; he created his own political party, the Jatiya Party, and called a parliamentary election in 1986. The AL, small left-leaning parties, and Islamic parties participated in the election, but the BNP boycotted it. The election was won by the Jatiya Party, amidst allegations of election-rigging and manipulation.

In 1989, General Ershad passed through parliament an amendment to the constitution that made Islam the ‘state religion’. Protests amplified, huge marches took place in the later months of 1990, and eventually the military also withdrew their support for the general. Ershad resigned and handed over power to a neutral interim caretaker government, which was mandated to hold free and fair national parliamentary elections within the following 3 months. This was the end of the military rule in Bangladesh and the beginning of democracy. But politics did not become more peaceful.

2 The Competitive Democratic Era (1990–2011)

Two strong personalities have marked Bangladeshi political history since the return to democracy and the 1991 election, who perpetuate the dichotomy that appeared soon after independence between the two differing approaches of Sheikh Mujib and General Zia to the economy and the society. In the post-1990 period, the daughter of the former, Sheik Hasina, headed the AL, whereas the widow of the latter, Khaleda Zia, led the BNP. The political history of Bangladesh in the 1990s may be summarised as a continuous struggle between these two personalities who democratically succeeded each other at the helm of the country but, at the same time, did all they could, often undemocratically, to eliminate their competitor from the political map. One of them eventually won.

It cannot be said that the struggle between the two parties had greatly to do with different views of, or strategies for, Bangladesh’s development; rather it had to do with personal animosity between the party leaders and, more decisively, the control of the society and sources of rent within it. All means to win the fight were used, from organising violent protests, to election-rigging, to jailing opponents, to boycotting elections with the hope of nullifying them, to buying support. If the regime was officially democratic, political practices were not.

The BNP won the 1991 election and Khaleda Zia became prime minister after a vote on the constitution transformed the presidential system set up by General Zia into a parliamentary regime. Accusations of election-rigging in the replacement of one particular MP triggered a protest and a general boycott of parliament by the opposition, led by the AL. Likewise, the 1996 election, initially won by the BNP due to the opposition boycott, raised so much protest that the government had to accept new elections under the aegis of a caretaker government. The AL won, and Sheikh Hasina became prime minister. The economy of Bangladesh grew steadily during Sheikh Hasina’s tenure as prime minister, yet politics remained very tense, with several protests and strikes led by the BNP, political violence in the streets, and boycotts of parliamentary proceedings.

The rotation in regard to which party held power continued. The BNP prevailed in the 2001 election, organised again by a caretaker government. Khaleda Zia returned to power with a strong anti-corruption programme, which led to her government jailing Sheikh Hasina for a while on corruption charges. Towards the end of 2006, as new elections approached, the country again witnessed serious political unrest, with a demand for a ‘free and neutral’ general election under a neutral caretaker government. This led to the formation of a ‘civil’ caretaker government backed by the military in January 2007, which ruled for the next two years while trying to ‘normalise’ the political game, including through a failed attempt to exile the two ‘begum’² contenders.

In the December 2008 national election, the AL returned to power, with 230 out of 300 parliamentary seats, and Sheikh Hasina returned as prime minister. In May 2011, the Supreme Court ruled that the system of the interim caretaker government was unconstitutional – a decision that was motivated by the experience of a two-year period during which the caretaker government practically abolished political parties and launched policy reforms, which was not within its formal mandate. This ruling de facto reinforced the party in power. The BNP boycotted the 2014 election, fearing it would be fixed and amidst severe repression by the AL government. It failed in imposing a caretaker government arrangement for that election. Consequently, the AL found itself with an overwhelming majority of seats in parliament. It has remained in power until now.

3 The Era of the Dominant Party

After again winning the election in 2020, Sheikh Hasina has now run the Bangladeshi government for fourteen years. The question then arises of whether this longevity is the result of an effective steering of the economy and the society, or of specific policies implemented by the AL, or the vanishing of the main opposition party.

Most Bangladeshi political commentators seem to agree on the fact that ideological differences between the two parties are small. The AL is considered to be positioned on the centre-left, with possibly more liberal views than the BNP, which is more centre-right and conservative, in part because it is closer to Islamic values. However, this can hardly be taken as the reason why the latter has lost traction with the public. Doubtlessly, being in power helped the AL weaken the BNP – for instance, by jailing Khaleda Zia, whose son seems not to have been an effective substitute for his mother. But it is equally certain that the BNP has made political mistakes that have progressively driven it away from its electoral base. In fact, many people feel that the two parties are equally corrupt, undemocratic, and ideologically neutral, but also that Sheikh Hasina has been smarter and shrewder than her opponent.

In any case, since 2008, Bangladesh has clearly entered into an era of a dominant party whereby the AL not only steers the country but also exerts tight control over the whole society, thanks in particular to a ubiquitous presence in rural areas and effective networking in urban areas. With Khaleda Zia jailed on corruption charges for several years since 2018 and her son Tareqe in exile, and also sentenced to multiple years in prison in Bangladesh, the BNP has been decapitated. In the absence of effective and dynamic substitutes for the historical leaders of the main opposition party, the AL seems to have few obstacles to a long tenure in power.

Compared to the tumultuous past, this dominant party regime provides a degree of stability in the political system never seen since independence. This has undoubtedly had a favourable impact on economic development, even though, interestingly, growth was apparently little affected by the political turbulence of the competitive democracy era. However, this political stability should not be confused with progress towards democracy. Recent national elections, and many local-level elections, aroused allegations of irregularities. A decline in participation in elections is observed. There are concerns that the national parliament is dysfunctional when it comes to having meaningful debates on development issues, democratic rights, and freedom of expression. There are also concerns among civil society about the squeezing of the democratic space. It remains an open question the extent to which this state of affairs threatens political stability and the AL’s dominance in the future.

D Sources of, and Challenges to, Economic Growth

Bangladesh’s experience in regard to economic growth and development over the five decades since independence has generated much interest among academics and development practitioners, both at home and abroad. From its war-torn economy of 1972 until now, Bangladesh has been able to increase its per capita GDP in real terms 3.7 times (from US$460 in 1972 to US$1,700 in 2018),³ cut the poverty rate from as much as 71 per cent to 20.5 per cent over the same period, become the second largest exporter of RMG in the world, and registered some notable progress in social sectors. In 2015, it graduated from the World Bank’s low-income category to lower-middle-income country category. Also, Bangladesh is now on track to meet the criteria for graduating from least developed country (LDC) status by 2024. At the same time, however, Bangladesh’s development has happened in a widely recognised context of weak institutions. It has always been ranked in the very bottom of most international rankings of governance indicators. As was just seen, up to the late 2000s, its political climate was extremely tense, unstable, and often violent. All of these factors have prompted some analysts to term Bangladesh’s economic development success as the ‘Bangladesh paradox’ or the ‘Bangladesh surprise’.⁴ The rest of this short summary of the IDP Bangladesh case study is devoted to explaining this paradox and, most importantly, to assessing whether it can be sustained: namely, whether growth can continue at the same speed without a major change in the institutional setting.

1 Growth Performance

GDP growth in Bangladesh has accelerated continuously since the days of independence. From an annual rate of around 3.7 per cent in the 1970s, it reached 4.7 per cent in the 1990s, and has gained 1 per cent every decade since then. It was close to 7 per cent just before the break caused by the COVID-19 pandemic in 2020. With an annual population growth rate now of around 1 per cent, GDP per capita has followed a growth trend of 6 per cent over the last ten years or so. Few countries can boast such performance.

From an accounting point of view, roughly two-thirds of the increase in GDP per worker results from capital accumulation and one-third from total factor productivity (TFP). Within a causal perspective, however, three main factors are behind Bangladesh’s growth performance: (a) RMG exports; (b) hard currency remittances from the huge and growing population of Bangladeshi workers abroad, predominantly in the Gulf countries; and (c) a reasonable macroeconomic management.

2 The Key Role and Challenges of the RMG Sector

The growth of Bangladesh’s RMG exports has its origins in the international trade regime in textiles and clothing, which, until 2004, was governed by Multi-Fibre Arrangement (MFA) quotas. This quota system restricted competition in the global market by providing reserved markets for numerous developing countries, including Bangladesh, where textiles and clothing items were not traditional exports. Bangladeshi entrepreneurs were smart enough to seek help from South Korean companies in setting up their operations and making sure they would reach their quota. They were also able to make deals with the government to obtain exceptional facilities. Yet the real surge in RMG exports took place after the MFA regime ended, when the international market was liberalised and the RMG Bangladeshi sector appeared as particularly competitive, partly because of its previous experience within the quota system and partly because of its very low labour cost, relative to other producers in developing countries (outside China). RMG exports thus increased from US$5 billion in 2003 to US$40 billion in 2019 (at 2015 prices), an annual growth rate of 13 per cent.

The growth of RMG exports has been one of the main growth drivers of Bangladesh’s economy over the past three decades. By its forward and backward linkages, and by the hard currency it provides to the whole economy, its contribution is much larger than a simple calculation based on its GDP share would suggest. An econometric exercise has suggested that the elasticity of GDP to the volume of exports is around 22 per cent. Since 2004, it would thus have contributed almost 3 percentage points to overall GDP growth – about half of it.⁵

Despite this impressive growth record, it bears emphasis that the export base and export markets have remained rather narrow, which is a matter of great concern. Undiversified exports, both in terms of market and product range, are likely to be much more vulnerable to external and internal shocks than well-diversified exports. Despite repeated government statements, and even commitments, Bangladesh’s diversification of manufacturing exports seems to have failed. UNCTAD’s⁶ export concentration index even suggests that, instead, export concentration has increased over the last two decades. It is higher today than in the average low- or lower-middle-income country. The performance is equally dismal with respect to the Economic Complexity Index, thought to be related to the process of economic growth.⁷

This situation is still more worrying today as graduation from LDC status will terminate the trade preferences Bangladesh enjoys in advanced economies’ markets, as pressure increases internally to improve the conditions of RMG workers, and as technological progress drastically modifies production conditions in the RMG sector.

3 The Role of Migration

It is estimated that 10 million Bangladeshis are working abroad today, three-quarters of them in the Gulf countries. They send home some US$22 billion in remittances. This is approximately half the export revenue of the RMG sector. Unsurprisingly, the amount remitted – and, presumably, the number of migrants – closely follows the level of economic activity in oil-exporting countries. Remittances rose from US$2 billion in the early 2000s to US$16 billion in 2014, as the price of oil roughly doubled during that period. They then stagnated, before recently rising again.⁸

In the econometric exercise referred to earlier, which estimates the sources of growth in Bangladesh, the elasticity of GDP growth to remittances, after deflating them by the appropriate price index, turned out to be 0.14. Given an average growth rate around 11 per cent, real migrant remittances explain approximately 1.5 percentage points of the annual growth rate of GDP over the last two decades or so. Together with RMG exports, they thus represent practically two-thirds of overall GDP growth performance.

There are no precise data on the gross or net annual flows of migrants from Bangladesh and back. From the national economy perspective, it is the net flow that matters.⁹ Based on rough estimates of the number of Bangladeshi workers abroad, the average net outflow might have been as high as 400,000 workers a year over the last two decades.¹⁰ Such a figure suggests that roughly 30 per cent of the net annual increase in Bangladesh’s labour force is employed abroad. In other words, the increase in the local labour force would have been 40 per cent higher without the migration outlet. The stock figure is a little less alarming: if all Bangladeshis working abroad were to return, the labour force would grow by 15 per cent.

Based on these estimates, not only did migration contribute to growth through remittances it also considerably eased the pressure on the supply side of the labour market, especially for low-skilled work.

4 Structural Economic Transformation in Bangladesh

Bangladesh may be considered the typical country as regards the Kuznets/Lewis theory of dual development (Kuznets, 1955; Lewis, 1954). Overpopulated, with huge pressure on land, without natural resource rent, the economy is divided into two sectors: a traditional, mostly agricultural, sector that is home to a majority of the population, but with surplus labour, low marginal productivity, and low average income; and a modern or formal sector employing people at a higher level of productivity and with higher wages but where employment is limited by available equipment. Capital accumulation in that sector, most often assimilated to manufacturing and associated upstream and downstream sectors, is the engine of growth of the economy. It generates both aggregate growth and structural transformation by employing a rising share of the labour force, thus reducing the employment share of the agricultural sector, lowering the extent of surplus labour, and increasing average income. If accumulation takes place at a rate that is fast enough, a time comes when surplus labour has been eliminated from the traditional sector, the marginal labour productivity gap with the modern sector starts to shrink, and the traditional sector modernises. At the same time, clear improvements take place in terms of poverty and income distribution.

Such a view of development is extremely schematic. Actual development processes are much more complex than this simple accumulation and sectoral transformation mechanism. Moreover, there are many factors that may derail this mechanism, starting of course with a low accumulation process in the modern part of the economy. Yet this model provides a simple benchmark by which to evaluate development progress: in particular, the capacity of the economy to absorb the huge pocket of poverty in the traditional sector.

Where does the economy of Bangladesh stand on this dualistic path? Without any doubt the structure of the economy has drastically changed over the last two or three decades. The GDP share of the agricultural sector fell from 32 per cent in 1991 to 13 per cent in 2018, whereas its employment share plummeted from almost 70 per cent to 40 per cent. Overall labour productivity thus increased thanks to this major structural shift. An interesting feature of that process, however, is that within-sector productivity also increased at a fast speed. This is true of the manufacturing sector, where it was multiplied by almost eight, in part thanks to the increasing specialisation in RMG, but also in agriculture, where average labour productivity was multiplied by four.

The possibility that the average labour productivity gains in agriculture might be essentially the reflection of less underemployment in farming has to be examined. In fact, something of this type may have occurred in the early 2000s, when the absolute number of people employed in the agricultural sector declined rather sharply, at the same time as average productivity was increasing. From the mid-2000s on, however, the number of workers has remained approximately constant, while productivity continued to increase at a fast speed. This logically leads us to conclude that surplus labour was eliminated around that time in Bangladesh. Even though the productivity gap between agriculture and manufacturing keeps widening, this is not the case when the comparison is made between agriculture and the rest of the economy: here, the gap is closing.

This apparent success of the Bangladeshi economy in completing the first step of the structural transformation while recording substantial progress in productivity across sectors must nevertheless be mitigated by the key role played by migration. Per se, it is unlikely that the dynamism of the manufacturing RMG sector and its backward and forward linkages would have been strong enough to achieve the structural transformation just described. In the absence of migration, and over two decades, the non-agricultural sector should have absorbed 8 million more workers – roughly a third of the jobs that were actually created.

As for overall growth, Bangladesh’s success in triggering this structural transformation of its economy, and the subsequent drop in poverty, is, in major part, the result of RMG exports and migration. Yet the fragility of this twofold engine of growth and structural transformation cannot be underestimated. On the one hand, remittances depend on oil and gas price cycles in Gulf countries at a time when efforts will be made in the world to reduce fossil fuel dependency. On the other hand, RMG exports may be affected by the loss of LDC status in a few years, by harsh competition in the world, and by the need to lift the pressure on labour cost that has led to an almost continuous increase in income inequality over the last three decades.¹¹

E Social and Institutional Challenges of Bangladesh’s Development

Bangladesh’s undeniable success in terms of economic growth and structural transformation, particularly over the last two decades, hides not only some fragility but also deep weaknesses, which may develop into a true handicap in the future. As is well-known, Bangladesh ranks near the bottom of most international governance scales, be it in terms of the control of corruption, state capacity, or the rule of the law. In-depth analysis of several sectors, as conducted in the IDP case study of Bangladesh, makes it possible to document more precisely the flaws in the management of the economy that lie behind this dismal ranking. Such flaws can be observed in most sectors, from infrastructure, to tax collection, to the disastrous regulation of the banking sector, to the judiciary, and to the state bureaucracy, as exemplified in the educational sector. It is fair to say that some progress is being made in some domains, in particular in the provision of energy and the electrification of rural areas, and in school enrolment. It is also the case that, in social matters, an extremely dynamic NGO sector, some parts of which have a worldwide reputation, like Grameen Bank and BRAC, is partly remedying the weaknesses of the government’s management, especially in the fields of health, education, and the fight against poverty in general. Yet huge progress is still to be accomplished, as can be seen from the few examples briefly summarised below.

Little will be possible, in fact, if public resources remain as limited as they are today. With total tax receipts below 9 per cent of GDP (among the lowest in the world) and limited non-tax public revenues, Bangladesh’s public sector suffers from severe atrophy and has a restricted capacity to provide the public goods and services that are needed to extend the industrialisation process beyond RMG exports and to cover basic social needs in the areas of education and healthcare.

On several occasions, the present government has explicitly mentioned the need to raise taxation. Analysis shows that a large part of the problem comes more from tax collection than from too low tax rates or too narrow a definition of taxable assets. No reform has been implemented so far. An ambitious reform of VAT collection was proposed a few years ago but was cancelled at the last moment. The blockage seems to come from an implicit coalition between tax personnel and politically powerful taxpayers, which successfully prevents the introduction of automated procedures that would improve asset transparency, both for direct and indirect tax, and therefore tax collection. The consequence of this situation is not only a dearth of public services, but the informalisation of the economy, since a majority of small and medium firms are able to evade taxation.

The banking sector is another area where corruption is a source of inefficiency. Bangladesh is at a stage where this sector, which was initially completely state-owned, has been substantially privatised, with several new banks recently licensed. Yet some important banks and financial institutions remain in the hands of the state, leading to a dual structure of the whole sector. If, overall, the sector has been, and still is, effective in supporting the development of the RMG and other sectors, most often through exclusive deals made between powerful entrepreneurs and private banks, it also shows major weaknesses and exhibits serious failures of regulation, most notably apparent in recurrent excessive non-perfoming loans (NPL). Often caused by fraudulent behaviour rather than problems of profitability, NPLs exert adverse effects on the efficiency of the economy, reinforce the culture of corruption in the country, and contribute to rising inequality. Several major scandals have occurred, showing how deep corruption may be entrenched in this sector, despite, paradoxically, its capacity to finance the dynamic part of the economy.

A major institutional weakness of the banking sector is the lack of autonomy of the central bank in regard to regulating the sector, because of the clear subordinate position of the governor with respect to the government, and, through political links, private bankers. In this respect, the Bangladesh Association of (private sector) Banks, and the increasing political support it can command, represents a major obstacle to effective regulation.

Primary schooling may serve as a good illustration of the issues that are typical of the delivery of public services in Bangladesh: positive efforts are made but their results fall short of what is expected. In primary education, the government boasts an impressive record in regard to increasing enrolment and achieving gender parity. But this is tempered by the growing body of evidence showing that learning outcomes for many children are extremely poor. The main systemic challenges in this sector can be categorised as follows: (i) a complex coexistence of various actors faced with confusing and sometimes conflicting divisions of responsibility; (ii) a lack of resources – Bangladesh devotes only 0.8 per cent of its GDP to primary education, infrastructure is poor, and teachers’ salaries are abnormally low, being slightly under per capita GDP; and (iii) in regard to teacher recruitment and management, recruitment is flawed, with corruption problems including political influence and bribing, while the monitoring of teachers (absenteeism or performance) is weak.

Although the problems in Bangladesh’s education system, and indeed in its public services more generally, are both severe and deep-rooted, there are various reforms which could and should be undertaken but which have been set aside. The historically low budgetary allocation towards primary education suggests that an increase in resources to the sector ought to be a major political priority, even though it will not solve all the problems.

Land markets raise important institutional issues in many developing countries but especially so in Bangladesh, as land is so scarce, and the population is so large. The way they function in Bangladesh leads to two major difficulties: an inequitable and not necessarily more effective distribution of land, and constrained industrial development. The growing inequality in the distribution of land results from arrangements that involve corruption, nepotism, and the interference of business elites acting through political parties, rather than neutral market operations. Consequently, the land administration has not only been captured by elites but has also become resistant to reform or effective regulation, and the more the system works in their favour the greater their resistance to reform. The same analysis applies to Bangladesh’s attempt to use Special Economic Zones (SEZs) to attract industrial investors despite the scarcity of land. The institutional mechanisms for acquisition and compensation are subject to a range of corrupt practices, which in turn create vested interests that resist change and a bias towards politically connected purchasers, or towards those who are willing and able to pay bribes. Such an environment is inimical to a good business climate and undermines the potential industrial incentives provided by the SEZs.

Another consequence of the way land reallocation operates is the dispossession of some landowners, who then become pure land tenants. Landlessness has greatly increased in rural areas, with the proportion of pure tenants surging from 45 per cent to 65 per cent since 2000 (Sen, 2018). Moreover, a survey conducted by the Manusher Jonno Foundation in 2015 found that around 70 per cent of households reported losses of land in the previous ten years, with 17 per cent reportedly the victims of land grabbing (MJF, 2015). Such a situation reveals not only illegal land acquisitions but also the incapacity of the judiciary to handle such abnormal behaviour. Weak judiciary systems are a feature of most developing countries, if only due to a lack of resources and a lack of human capital. In the case of Bangladesh, however, the situation is worse because of an implicit coalition of most actors within the judiciary, from clerks to lawyers to judges, in delaying the conclusion of cases, and repeatedly bribing plaintiffs to supposedly accelerate procedures. Meanwhile, land grabbers exploit the lands they have seized.

One could multiply the examples of ill-functioning public entities. What is surprising is that these are often well documented in the media and yet do not arouse any real corrective reaction by those government agencies that are supposed to control, in an independent way, behaviour that deviates from legal norms. The reason is that those agencies are, in effect, tightly controlled by the government. As an example, the head of the Anti-Corruption Commission is appointed, and may be dismissed discretionarily, by the government. In addition, the Commission must obtain the government’s permission to investigate or file any charges against bureaucrats or politicians. Even when granted such permission, the Commission may end up declaring suspected government members innocent, against existing evidence. This has recently occurred in the case of a widely publicised scam.¹²

An interesting question in view of this situation is why such scandals do not help the opposition parties gain more support. One reason is their present weakness. Another is the conviction among the public that they were equally corrupt when in power, and would still be if they were to come back. This kind of affair is therefore considered something almost ‘ordinary’.

One could also consider that the abnormally low level of governance quality in Bangladesh is of lesser importance in the public opinion than the good performance of the economy. After all, incomes are growing and poverty falling, and even though inequality is increasing, most people have seen their standard of living improve. Thus, why should they care about poor governance?

Of course, this is fine as long as growth continues to be strong, with more RMG exports and more people going to work abroad. The challenge is that this may not last if no action is taken to diversify the economy and to prevent the growth engine slowing down in the coming years. Ill-functioning institutions may hinder a positive turnaround. This is one of the key elements of the institutional diagnostic that was established for Bangladesh.

F The Bangladesh Institutional Diagnostic

Medical diagnostics start with listing symptoms, before elaborating on the proximate causes of those symptoms and then identifying the deep factors that may permit or prevent correction of them. Our institutional diagnostic follows the same logic.

1 Institutional Weaknesses and their Economic Consequences

In establishing an institutional diagnostic of economic development in Bangladesh it is first necessary to identify the obstacle that prevents the implementation of a strategy of diversifying manufacturing exports, which will avoid a future slowdown of the pace of growth and structural transformation. It should be noted, moreover, that this diversification should take place as much within the RMG sector, the production of which remains extremely concentrated around a few limited ranges of products, as in other labour-intensive sectors like footwear or leather products. The in-depth analysis in the IDP case study of Bangladesh suggests that, following Hassan and Raihan (2017), this obstacle is to be found in the culture of ‘deals’ that characterises policymaking in Bangladesh. To be sure, planning exercises are undertaken at five-year intervals, and these prioritise manufacturing export diversification through a list of sectors supposed to benefit from the same advantages as the RMG sector. There were some fifteen such sectors in the last five-year plan. Practically speaking, however, decisions about implementation are taken based on arrangements between the political elite in power and dominant entrepreneurs, or sectoral representatives in the case of the RMG sector, without real consideration in regard to the priority list. As a result, most support to exporting activity and infrastructure investment is concentrated in the latter.

Although this supremacy of deals over formal industrial policymaking has worked in the past, as exemplified by the phenomenal development of the RMG sector, it has now become an institutional obstacle to the diversification of the economy. This is due to a kind of capture of the government by part of the business elite, and the short-sightedness of both sets of actors.

A second generic institutional weakness that comes out of the analysis in the previous section is the ineffectiveness of the regulation that the state is supposed to exert over economic activity to prevent inefficient and inequitable outcomes. This is evident in the dysfunction of the banking sector, the failure to regulate labour conditions in a key sector like RMG (as evidenced by the Rana Plaza accident¹³ and the downward pressure on wages), the dismal performance in regard to taxation, and the poor performance in many other areas, including transport, drug administration, and, of course, the Anti-Corruption Commission.

The third major institutional weakness is state capacity. This major governance failure in Bangladesh takes different forms. Some are readily apparent, such as the lack of public resources and therefore the limited provision and low quality of public goods, the lack of skills in public service, and an inefficient administrative organisation. These are common across low- and lower-middle-income countries. Other forms of governance failure are more obscure, though equally devastating. This is the case of the high level of corruption found in most administrative clusters, which tends to make the delivery of public services both inefficient and inequitable, reduces revenues, and often discourages economic initiatives.

These generic institutional weaknesses of the Bangladeshi economy are not independent. Moreover, they must be considered more as the symptoms than the causes of ill-functioning institutions. A more complete picture of the institutional diagnostic appears in Table 3.1, which tries to put the preceding weaknesses in a double perspective: it shows, on the one hand, the social and economic consequences of the preceding weaknesses, and, on the other hand, the proximate causes and deep factors behind them. In reading this table, though, it is important to keep in mind that there is no one-to-one relationship between items at the same level in various columns. Causality must be understood as proceeding from column to column rather than from item to item.

Table 3.1 Institutional diagnostic table for Bangladesh

Deep factors	Proximate causes	Institutional weaknesses	Economic and social consequences
Political settlement (political and industrial elites against labour) Winner-takes-all electoral democracy Vertical structure of political parties Vibrant civil society Population pressure on land (migration) Role of donors	Elite capture of government (e.g., RMG entrepreneurial class) Weakness of labour organisations Lack of resources and skills in the public sector Corruption equilibrium: – anti-reform coalitions – clientelism Inadequate laws and administrative organisation Opacity and unaccountability	Supremacy of ‘deals’ over formal industrial (and development) policymaking Ineffective regulation – banking system – tax system – labour conditions Weak state capacity: – weak delivery of public goods and services – ineffective and corrupt judiciary – corruption – ineffective and corrupt judiciary	Past successful development based on RMG exports but threats to future growth Excessive export concentration Suppressed labour regime Gender discrimination NPL leakage of resources Misallocation of investments Unattractive investment climate Abnormally low tax revenues Limited quantity and quality of public goods (education, infrastructure) Rising inequality and slowing down of poverty reduction Compensation for limited public goods by, and poverty reduction role of, NGOs

2 Proximate Causes

Six items appear in the ‘proximate causes’ column. Some of them are rather obvious. The lack of resources and skills or the culture of corruption, where every actor expects others to behave in a corrupt way, are directly responsible for the weak state capacity and the ineffective regulation of the economy by the state. It bears emphasis in the case of Bangladesh that the lack of resources is partly self-inflicted since it is largely due to the abnormally low level of taxation. There is thus a circular relationship between the proximate causes and the symptoms of institutional flaws. It is also clear that the elite capture of the government by the entrepreneurial class, particularly from the RMG sector, explains the supremacy of deals over formal industrial policy. As the sector gained in importance, both through its size in the domestic economy and its dominant role in exports and general economic growth, it quickly acquired considerable leverage over the government, whichever party was in power at the time. Equally clear is the role that the weakness of labour organisations and their acceptance of low wages play in helping the RMG sector maintain its global competitiveness, and therefore its dominant position in the home economy. Here, too, the relationship is circular.

Several laws and administrative organisations are obsolete or inadequate, and weaken the institutional framework. This includes some land laws inherited from the colonial or the pre-independence period, and overlapping administrative responsibilities in land matters, primary education, and the regulation of banking. The independence of regulatory agencies from central power is another area that needs reform. As they presently stand, these agencies favour the opacity and unaccountability of the public sector and severely limit its exposure to the public opinion, despite a vibrant private mediatic context.

3 Deep Factors

Deep factors are those factors that constrain reforms that would remedy the proximate causes of basic institutional weaknesses. It bears emphasis that the term here refers to institutional factors that may hinder development, and not to development itself. For instance, the geopolitical location of Bangladesh is a deep factor that influences its development, but it is not clear that it plays a direct role in explaining the basic institutional weaknesses or the proximate causes set out in the diagnostic table above. Unsurprisingly, many of these deep factors are thus of a political economy nature.

The political settlement between the industrial elite and the political elite, whatever the government in place, is a case in point. This factor echoes the elite capture proximate cause discussed above but is more fundamental. The political settlement factor refers to converging interests between whoever is in government and the industrial elite, especially the RMG business leaders. The implicit agreement provides that the government will provide strong support to the rapid development of RMG exports, at the cost of repressing labour, a condition that may be necessary to maintain the global competitiveness of the sector. Overall economic growth is the government’s reward, the growth of their profits is the industrial elite’s reward. As long as growth prospects remain favourable, and in the absence of major political change, this settlement may persist.

A second deep political economy factor refers to the winner-takes-all type of political confrontation between the two main parties in Bangladesh during the so-called competitive democracy regime described earlier. It may explain the absence of long-run structural reform during that period, as parties in government were too busy reinforcing their political base to win the next election. It is now the third time in a row that the AL has won elections, so that one may reasonably question whether a profound change has taken place in Bangladeshi politics. It must be recognised, however, that the democratic debate about long-run development objectives has always played a limited role in Bangladesh. This is even more true today, when the party in power has been able to successfully weaken and repress the opposition. Nor is a democratic debate taking place within parties. The two leaders have managed their respective parties with the same iron fist for the last thirty years, with little space left for dissenting minorities. The dynastic nature of power within the two parties does not suggest that this state of affairs is about to change.

The existence of a vibrant civil society, most notably NGOs, is another factor that has sometimes been proposed to explain the relative inertia of successive governments on the social front. Yet the substitutability between the government and NGOs is necessarily limited. The size of needs in areas like education and healthcare is such that NGOs can only play a marginal role, even though that role is crucial for the poorest segment of the population.

The inclusion of population pressure among the deep factors is meant to stress the high specificity of Bangladesh in this respect, and, implicitly, the major role of migration in reducing that pressure from an economic, social, and political point of view. Likewise, the mention of donors is made to recall the role they played in the past in financing the development of the economy and, in several instances, guiding its macroeconomic policy. Bangladesh’s aid dependence has been limited over the last decade – that is, 1 per cent of GDP on average.

In the field of medicine, a diagnostic normally ends with a prescription. In the present case, the prescription would consist of those reforms meant to correct for the causes of institutional weaknesses, as identified by the diagnostic. The nature of reforms that would improve state capacity and the delivery of public services, modify inadequate laws, fight rent-seeking and corruption, and efficiently regulate the banking sector are rather evident. They are listed and discussed in the IDP case study of Bangladesh. More important is the political feasibility of these reforms, which depends on the deep factors that have just been listed but which may take on a different aspect in the particular context that characterises Bangladesh today.

G Conclusion

The preceding diagnostic may seem unduly negative. This is essentially because it is in the nature of a diagnostic to identify existing flaws and potential obstacles to progress, rather than positive factors. Despite an institutional framework that is extremely weak by international standards, the Bangladeshi economy has been able to grow at a fast pace, to reduce poverty, and even to undertake important reforms in the past decades. Even within a turbulent political context, Bangladesh’s governments have shown a strong political will for reform on multiple occasions in the past, such as when they supported the RMG sector at an early stage, when they opted for rigorous macroeconomic policies, when they invested massively in power generation or liberalised imports, and when they opened up the economy. Political power, political determination, and policy wisdom were present in many uneasy but key decisions, as, for instance, when food rations were abolished on the grounds that they were a costly way of supporting the urban middle class, rather than the poor, or in the case of the pioneering introduction of food and, later, conditional cash transfers to accelerate universal primary school enrolment. In one way or another, the main question that arises from the preceding diagnostic is thus whether reforms aimed at eliminating notorious rent-seeking opportunities are much more difficult to achieve. Is the present Government of Bangladesh in a situation to undertake them, and is it willing to carry them out?

That the government is in the hands of a strongly dominant party ensures that political leverage for reforms does in principle exist. But at the same time the weakness of the opposition is a disadvantage because the threat it can issue against a wavering government is weak. Up to now, moreover, the economy has done well, with solid growth benefiting most of the population – though more so those at the top of the income scale – and without preventing part of the population having to go abroad to support their family. On grounds of pure political strategy, the incentives for reform may thus seem relatively weak. However, the present diagnostic has exhibited the serious risks to the future rate of growth in Bangladesh. At the top of the list, the COVID-19 pandemic has already slowed down growth, and potential geopolitical tensions in the post-COVID world add to the uncertainty arising from too specialised a development strategy. Taking advantage of the present political situation to launch reforms and to show results regarding both economic diversification and governance would do much to reinforce the party in power. If a power rotation takes place, on the other hand, these reforms would constrain the new government to follow the same principles of good governance and a sound rule of law, thus weakening its control over the opposition. For the party presently in power, and for the whole society, this is clearly a win-win strategy.

As mentioned at the beginning of this summary, the dichotomy observed in Bangladesh between weak institutions and robust growth was termed the ‘Bangladesh paradox’ or ‘Bangladesh surprise’. At the end of this diagnostic one may ask whether such a paradox or such a surprise will persist. The answer is most probably not. Either growth will slow down without institutional improvement, or growth, and the transformations that come with it, will continue at the same pace but institutions will have been reformed. It behoves the present government to decide which direction to choose, considering that the political opportunity for ambitious institutional reforms may not last.

II Tanzania

The following pages summarise an in-depth study of the relationship between institutions and development in Tanzania conducted following the methodology set out in Chapter 2. Only the essence of the original study is reproduced in this summary, but it is hoped that its main lessons for the understanding of the economic challenges faced by Tanzania, and the way they depend on institutional weaknesses, are truthfully presented here.

The summary is organised in the same way as the original study except for the thematic studies, which provided detailed examples of the way the nature and functioning of institutions affect Tanzanian development. Instead of summarising these, the summary focuses on what was learned from these studies about possible institutional obstacles to an acceleration of development.

A Geographical and Demographic Context

Today’s United Republic of Tanzania results from the union of Tanganyika – a large area a few degrees below the equator on the shores of the Indian Ocean – and the Zanzibar archipelago off its coast. Tanzania is the biggest of the eastern and southern African countries, excluding South Africa. Except for the coastal area and Zanzibar, it consists of extensive rolling plains, interrupted by the Great Rift Valley, which cuts across the east of the African continent from north to south. The Rift crosses Tanzania in its western part, where it is interspersed by Africa’s three great lakes – Victoria, Tanganyika, and Malawi (or Nyasa) – the shores of which are shared with neighbouring countries. Four major ecological regions are usually distinguished because of their highly differentiated climates: the mountain lands in the north (home to Kilimanjaro) and in the southwest receive generous amounts of rain; rainfall is also satisfactory in the lakeshore regions, especially lake Victoria’s; however, the high plateaus that fill the centre of the country are semi-arid, whereas the coastal area is both hot and humid.

Overall, the country enjoys a high agricultural potential, which is presently far from being fully exploited. Only 30 per cent of the land suitable for cultivation is being farmed, often under harsh conditions, despite numerous rivers and lakes, which offer a huge potential for irrigated agriculture. Other natural resources include minerals like gold, some other metals, and gemstones, and fuels (essentially coal and gas), of which abundant reserves have recently been discovered offshore. Another natural resource is the beauty of the country’s mountainous, sea, and savannah landscapes, as well as its world-famous reserves of wild animals, which altogether attract a considerable flow of tourists.

Tanzania is home to some 60 million people. Given its size, it is sparsely populated. However, as in most African countries, its population is growing very quickly and will reach 100 million before 2040. Because of the pace of demographic growth, the fast increase in the degree of urbanisation has not prevented the population density doubling in rural areas over the last thirty years, making land progressively less abundant.

The ethnic composition of the population is somewhat remarkable for its diversity, which is thought to have had a favourable influence on the early development of this part of Africa. About 120 different ethnic groups, most with their own language, cohabited for two centuries before colonisation, without any of them trying to dominate the others or to control the whole area. Still today, the largest group represents only 13 per cent of the population and the second largest only 4 per cent. Such an ethnic diversity is without any doubt due to the size of the area, the variety of its habitats, and the relative impracticability of travelling long distances. There is no doubt either that this demographic feature of Tanzania partly explains the political stability of the country once those heterogeneous groups were integrated into a single nation with a common language – the Swahili – and political institutions after independence. It also explains why Tanzania differs from its neighbouring countries and most sub-Saharan countries, where ethnic rivalry is frequent and has caused friction and conflicts that have proved harmful to development.

The presence of non-African racial minorities is another element in the heterogeneity of the population, with rather different implications. Arabs and Indians had always been present in the coastal area, the former being especially powerful when Zanzibar was the home of the Sultanate of Oman and controlled the whole East African shore from the late seventeenth to the late nineteenth century. More Indians arrived during the period when both Zanzibar and the mainland were under a British Protectorate. Like Arabs, Indians were especially active in trading, and more recently in light manufacturing. Both groups remain small minorities today, but their early business specialisation gave them economic power that is out of proportion to their demographic weight. The social distance between these groups and Tanzanian Africans is still detectable nowadays.

The European presence goes back to colonial times in the late nineteenth century, when Germany colonised the interior part of what is today mainland Tanzania, under the name of Tanganyika.

B A Short Account of Tanzania’s History Up to Independence

German rule did not last long since the Germans were forced to leave after being defeated in World War I. Yet, despite fierce hostility from the indigenous population, the German colonisers were able to develop major export crops (sisal, coffee, cotton), to start the construction of a railroad network, and to lay the foundations of an administrative structure, as well as an educational system.

After the German defeat in 1918, Great Britain was entrusted with the Protectorate of today’s mainland Tanzania. The country was then in a state of extreme underdevelopment, which had even worsened as a consequence of the fierce battles fought in that part of Africa between German, British, and Belgian colonisers, during the war. Yet two major factors prevented an economic development comparable to what could be observed in neighbouring British colonies. One was the relative lack of fertility of a large area in the interior of the country, which was invaded by the tsetse fly as a consequence of the war. The other was the limited attractiveness for European settlers of a territory whose political status was uncertain – being neither a colony nor an independent state. These may also be the reasons why the British administration was initially rather unambitious in its management of the country, mostly perpetuating the German colonial policies.

Things started to change after World War II as the newly created United Nations strengthened its control over territories with Protectorate status and pushed for more participation by the indigenous population. British ‘indirect rule’ was replaced by formal local governments with a multi-tier structure and increasing African involvement, while the Legislative Council of the Protectorate was progressively opened up to elected African members.

Independence was obtained peacefully. Under the leadership of Julius Nyerere, the Tanganyika African National Union (TANU) won practically all the seats on the Legislative Council open to election in 1958, and again in 1960. The British colonial secretary then acceded to TANU’s demand for a ‘responsible government’ by Africans. One year later, independence was declared, with TANU as the party of government and Nyerere as prime minister. Three years later, the new Republic united with Zanzibar, where a violent revolution against the Arab minority, which ruled the islands, had just brought to power an African-dominated party. Together, they formed the United Republic of Tanzania, with Nyerere as president.

C A Synthetic View of Tanzania’s History since Independence

1 The Socialist Era

Very much marked by neo-colonialism, development during the first years after independence was disappointing; an alternative strategy was called for. The president spelled out such a strategy in his famous ‘Arusha Declaration’ in 1967. It was a socialist-oriented development programme adapted to the African context under the label ‘Ujamaa’ (‘familyhood’ in Swahili). It comprised three dominant approaches: (i) an emphasis on the agricultural sector and the urgent need to improve its productivity, most importantly through regrouping dispersed subsistence farms into Ujamaa villages, which involved displacing part of the population; (ii) state control of the means of production and exchange, and thus nationalisation of a major part of the non-agricultural sector; and (iii) addressing the social demand for education, health, equality, and participation in public decision making.

Ten years later, the results of this strategy were far from spectacular. Nationalisation did not deliver on its promises because of mismanagement by bureaucrats, interference between managers and politicians, and mounting corruption at the head of nationalised companies. The results were especially bad in the agricultural sector. Although some productivity gains were achieved in the extensive cultivation of some export crops, the collective farms proved disappointing and villagisation essentially disrupted production processes. In a few years, Tanzania passed from being a net exporter to being a net importer of food crops. GDP growth slowed down, and income per capita started to fall after 1976, while severe balance of payment problems developed due to the poor outcomes of the Ujamaa strategy, a costly war with Uganda after the latter invaded the north-western part of the country, and strongly adverse changes in the terms of trade.

A National Economic Survival Programme was launched in the early 1980s, but it came too late and the international development community was called in to rescue the country. Nyerere resisted the pressure of donors and the IMF, which made their aid conditional on his amending his socialist strategy and implementing a return to market mechanisms. As the economic situation of the country continued to deteriorate, however, he was finally forced to accept a stand-by agreement with the IMF in 1985, after having broken off relations with that organisation a few years earlier. This agreement prefigured the Structural Adjustment Programme (SAP) signed later with the World Bank, whose aim was to see Tanzania transition back to a market-led economy and, as a matter of fact, to undo much of Nyerere’s efforts to build a socialist economy. Nyerere then decided not to run for a new presidential mandate and left to his successor the task of managing the transition.

If the economic achievements of the Nyerere era were disappointing, the same cannot be said in the non-economic sphere. The nation-building project, which Nyerere embarked on notably by disbanding the multiple chiefdoms existing in the country and promoting Swahili as the lingua franca, brought about national unity and deep cohesion. This successful national integration drive was complemented by major social investments in literacy, education, and health programmes. In comparison with many other African countries, Tanzania is exceptional in the political stability it has experienced since independence, under the influence of Nyerere’s probity and respect for constitutional rules. It is thus not surprising that, despite a failing development strategy, Nyerere is considered by a large majority of the population as the father of the nation.

2 The Return to a Market Economy

At the time of Nyerere’s retirement in 1985, Tanzania was among the poorest economies in the world and faced a double challenge: to reduce poverty and to transition to a market economy regime.

If the disorder caused by the transition was particularly noticeable during the first five years after the Nyerere era, it took substantially longer for this process to be completed and fully consolidated. Judging from the rate of inflation it was only slightly before the turn of the new millennium – that is, roughly fifteen years later – that the economy seems to have stabilised. The adjustment to a new regime indeed required major changes, from reactivating the price system and the agricultural distribution network to privatising the multitude of state-owned enterprises (SOEs), including in the banking sector, to dismantling privatised monopolies, and to downsizing and reforming the civil service. Overall, this heavy agenda was successfully and rather peacefully managed by the administrations that succeeded Nyerere.

Advances were also made on the front of political institutions, with two major constitutional changes taking place. The first change limited to two the number of five-year terms that a president can serve consecutively. The second change, common to many African countries, abolished single party rule. While the dominant single party, which had morphed from TANU to Chama Cha Mapinduzi (CCM) after the union with Zanzibar, remained foremost, opposition parties started to play a significant role in the political debate.

Quite remarkably, all of these changes in both economic and political institutions took place peacefully. The three presidents in command since the launch of the SAP in 1985 each ruled for two consecutive terms before leaving the political scene and letting new general elections – usually considered to be fair by outside observers – to take place in a rather quiet atmosphere (the elections to the autonomous government of Zanzibar being an exception). It is only in the last two presidential elections that serious accusations of vote-rigging have been put forward, at the same time as open political tricks appeared. In 2015, CCM nominated John Magufuli as its candidate, instead of former prime minister Edward Lowassa, who was the frontrunner but who had been involved in a big corruption scandal. The latter then defected from CCM and ran for president as the candidate of the main opposition party, which suggests that little ideological differentiation exists across the political scene. Lowassa was defeated and unsuccessfully charged the government with rigging the election. The situation was considerably worse in the 2020 election when Magufuli was re-elected with a suspicious lead over the other candidates, commonly attributed to harsh repression, manipulation, and widespread fraud. Magufuli died – probably from COVID, after having denied the reality of the pandemic – shortly after his apparently fraudulent re-election and was replaced at the helm of the country by his vice-president. At the time of writing, it is too early to know whether his move towards authoritarianism and away from the democratic practice which had prevailed since independence will persist.

Corruption has always been behind most Tanzanian politics and may be considered an inherent weakness of the country. Yet over time scandals have tended to become more frequent and to involve larger amounts. This has sometimes reached such an extent that donors, who are particularly important in the funding and designing of Tanzania’s development strategy, have in various instances suspended their assistance. Magufuli was chosen as the CCM candidate in 2015 mostly because the party had been badly discredited due to a series of high-profile corruption affairs, and he was elected thanks to his anti-corruption image, acquired while he was Minister of Public Works in the previous government. Some considered his authoritarianism necessary to fight corruption and there are indeed some signs that corruption has receded. It remains to be seen whether this will be confirmed in the coming years.

D Economic Development Challenges

It would be tempting to say that the development of Tanzania since the mid-1990s – that is, after the transition to a market economy was fully achieved – has been a success story. On average, GDP grew at the rate of 6.2 per cent a year but, because of fast population growth, the growth rate of GDP per capita was only 3.4 per cent. Income per capita almost doubled over the last two decades, and Tanzania recently graduated from low-income to lower-middle-income status in the World Bank’s country classification. However, a careful review of the Tanzanian economy suggests that maintaining past rates of growth may raise serious challenges.

The first cause for concern is the uncertainty about what could be Tanzania’s long-run engine of growth. To a large extent, growth during the last two decades was pushed by the demand side of the economy, itself fed by increasing export revenues arising from improving terms of trade, and foreign financing. A sign of that bias is given by the exceptional dynamism of the construction sector, which grew twice as fast as the whole economy over the whole period. On the supply side, manufacturing has done slightly better than the rest of the economy, especially on export markets, but it is presently too small – less than 10 per cent of GDP – to significantly pull the economy forward. Agricultural exports have not over-performed either. Overall, it turns out that a good part of overall productivity gains over the last twenty years was due to a net reallocation of labour away from low-productivity agriculture to the rest of the economy. However, instead of being in favour of the high-productivity sectors, as in the celebrated Lewis model, the reallocation has concentrated on low-productivity sectors like retail trade or social and personal services. That such productivity gains are not sustainable in the long run is exemplified by the fact that productivity in these sectors has fallen, precisely because of the net influx of workers from agriculture. As high-productivity sectors absorbed only a tiny share of the net migration of workers, there is a risk that, without a powerful engine of growth in high-productivity sectors, labour will remain highly concentrated in the low-productivity part of the economy, thus contributing to slow overall economic growth, a slow reduction of poverty, and increasing inequality.

A second related challenge is precisely to selectively improve within-sector productivity, not to save on labour – the absorption of which is per se a major challenge – but, quite the contrary, to increase competitiveness in tradeable and reasonably labour-intensive sectors where autonomous development looks possible. Maintaining the investment rate at the 35 per cent of GDP level observed today should significantly contribute to this goal by drastically improving the infrastructure needed to achieve this objective. But such a high investment rate is itself a challenge. Exploiting untapped sources of efficiency gains is also needed. For instance, the difficulty of establishing firm land rights is often mentioned as a disincentive for innovation and investment in modern agriculture and agroindustry. The same is true of the lack of some skills in manufacturing, or rent seeking by bureaucrats.

The third challenge lies in freeing the economy from its strong dependency upon foreign financing. Even though it has declined over the recent years, foreign financing has always been sizeable. Official development assistance still represents 5 per cent of GDP – that is, a bit more than a quarter of the government budget and 14 per cent of gross investment. On various occasions, donors have mentioned their wish to reduce their support, arguing that this would be an incentive for the economy to become more autonomous. The Tanzanian government has explicitly concurred with this view. Yet it is unlikely that the current growth trend would be maintained if this flow was to dry up. Private foreign funds are not negligible either. Since the mid-2000s, foreign direct investment amounted to a little more than 3 per cent of GDP.

An important unknown for the future development of Tanzania is the fate of its huge offshore natural gas reserves, which were discovered in 2017. These could provide Tanzania with substantial additional revenues for twenty to thirty years after a five-year investment period. Their extraction cost is apparently high, so profitability requires an export price higher than has been observed throughout the 2010s. Negotiation with foreign companies for extraction, liquefaction, and export of gas broke down a few years ago, but they have just been reactivated. There is still much uncertainty about the extra income flow Tanzania could get in the long run from its gas reserves, even though earlier estimates suggested it could be modest if prices stay on their long-run trend.

A final cause for concern relates to the social side. Inequality has been increasing and poverty has receded at an unexpectedly slow pace. That growth has not trickled down more vigorously to all segments of the population is a challenge for the future. Increasing inequality may have adverse effects on future development through the demand side of the economy, by reducing the aggregate propensity to consume, and more fundamentally by undermining the social and political climate. The same remark applies to the stagnation of school enrolment, which is somewhat below universal primary schooling, and the low quality of the educational system in general, which may put future growth, poverty reduction, and the social equilibrium at risk.

More direct diagnostics of development challenges and firm manager surveys in Tanzania point to the lack of infrastructure, notably in electricity, the limited supply of skilled labour, and the low quality of the civil service and public service delivery as obstacles to accelerating, or even maintaining, the pace of economic growth. These obstacles are common to most low-income or lower-middle-income countries, however, so the real issue is whether Tanzania is successful in progressively overcoming them.

E The Perceived Quality of Institutions

The capacity of the country to address the development challenges summarised above depends on the quality of its institutions, which themselves will determine the effectiveness and inclusiveness of the policies that must be put in place. This is the goal of the in-depth study of Tanzania that is being summarised here. Before synthesising its conclusions, however, it is worth recalling the results of the thorough review of institutional indicators, and of opinion surveys undertaken in Tanzania, with the objective of getting a first idea of possible obstacles to future development.

According to several international databases on governance indicators, the most fragile institutional areas in Tanzania are the control of corruption, on the one hand, and government effectiveness, or administrative capacity, on the other. What is remarkable, however, is that in these two dimensions, as well as others, the quality of Tanzanian institutions turns out to be fully comparable to, and sometimes better than, its neighbours’ – except Rwanda for the business environment – and even institutions among low-income countries, which have done significantly better over the last three decades. Opinion surveys among the Tanzanian population and among various types of decision makers also point to corruption as a severe institutional weakness, and further stress several institutional factors that may hinder future development. These include land rights issues, ineffective checks and balances on the executive, weak regulation of big business and utilities, a poor investment climate, and an inefficient civil service.

Of course, the institutional indicators and the preceding list of shortcomings are mixed bags. Yet the general picture they draw of economically relevant institutional challenges in Tanzania is consistent with a cursory review of Tanzania’s political and economic history over the last three decades or so. It should also be noted that, when gathering personal opinions on the matter, we often heard that the control of corruption or state capacity are not worse in Tanzania than in comparator countries, and therefore cannot be considered as specific problems hindering Tanzanian development. This is not a convincing argument, though. Of course, these institutional weaknesses may have a negative impact in the other countries too. That they are present elsewhere does not mean that making progress at home on those institutional dimensions would not yield substantial benefits.

F Identifying Major Institutional Weaknesses

Having reviewed the main challenges of economic development, as well as the current political context of Tanzania, it is now time to focus more closely on institutional issues. Following the methodology set out in a previous chapter, the next step is to consider several thematic areas where development challenges are most apparent and are likely to provide evidence or hints on the way institutions help or hinder those changes that make development. Five such studies were conducted in the case of Tanzania. They focused on the following topics: (i) business and politics; (ii) state coordination and decentralisation; (iii) the civil service; (iv) land management; and (v) the regulation of the power sector. The main institutional weaknesses revealed by these studies are succinctly analysed in what follows.

The relationship between big business and politics has shaped Tanzanian development ever since independence. It is thus crucial to understand the nature of the forces that shape it, and their outcome.

A word about the players first. On the business side, most European capitalists left at the beginning of the socialist era and business was then essentially in the hands of Tanzanian Indians and, later, Arabs, a natural extension of the control they had very early on in trade activities. As a matter of fact, indigenous entrepreneurs at the head of medium and large firms or groups have always been a minority in Tanzania, to such an extent that there is only one African Tanzanian name in the list of the twelve richest businessmen in the country. On the political side, the government should be the main actor. However, the dominant party (CCM) has also played an important role because of the fragmentation of political power within the party – that is, the presence of several groups with major influence and with possibly diverging views on the ‘right’ policy. Nyerere was able for some time to control them, so that political power was reasonably centralised in the hands of the president, yet his grip had started to loosen by the end of his last term, possibly because of the disorder created by the nationalisation process and the multiplication of sources of rents linked to the expansion of parastatals and resulting from increasing disorganisation. Things became worse during the transition back to a market economy. On top of the opportunities arising from the privatisation drive, politically powerful individuals within CCM were able to make deals with businesses for their own interest, and then to impose them on the party and on the executive, using the prospect of party dismantlement as a threat. Deals could be of varying kinds. They could involve conceding competitive advantages to a business group against campaign financing, other indirect electoral benefits, or personal enrichment, or syphoning public resources through schemes involving private business. Major corruption scandals arose in those days, to such a point that donors suspended their aid on various occasions. A climax seems to have been reached at the end of the second term of Kikwete, Magufuli’s predecessor. The dominant party’s popularity was thereby severely damaged, and the party had to opt for an openly anti-corruption candidate to have a chance of winning the election. Over the last few years, the new president tried to turn the tide by attempting to regain the full control of the party, partly through internal politics, and partly by working to dry up those sources of rents originating in deals with the private sector, a strategy that led him to be particularly tough with both domestic and foreign big business.

Whether this strategy was successful, and whether it will be maintained, is still to be seen. Yet several interesting lessons can be drawn from this sketchy history of business and politics in Tanzania.

A first lesson is the utmost importance of the structure of political power. In Tanzania, the business–politics issue is not a ‘government versus private sector’ story only: it also comprises the control of the president over the dominant party. It is because the unity of the party is decisive at election times that it is difficult for the president to openly sack powerful party members who use their influence to sell competitive advantages to big business. This is a game with a bad equilibrium, where no player has an interest in making clean moves, with some entering into illegal deals and others not sanctioning departures from good conduct. At the end of the day, the personality, legitimacy, and authority of the leader is determinant.

A second lesson concerns the ineffectiveness of industrial policies, or even their fuzziness in a country where firms can buy direct competitive advantage through political friends. In Tanzania it has long been the case that ‘traders’ have an advantage over ‘industrialists’ because they are able to generate more resources and so to convince policymakers to maintain low tariffs on some strategic goods, the imports of which they control. Sugar and rice are typically goods which need some initial protection to generate the economies of scale that would make their cultivation and industrial transformation competitive. Absent this protection, they would be outcompeted by the imports favoured by the traders.

A third consequence of the varying relationship between business and politics since independence, and possibly of the dominance, until now, of big business by Tanzanian Asians and Arabs, is some heterogeneity or hesitation among policymakers about the latitude to be left to the market with respect to state authority. This situation creates some uncertainty, which is necessarily harmful to the economy.

Having established such a diagnostic, two questions should be asked. First, if vertical industrial policies fostering specific activities that are against the interests of dominant business groups are politically difficult to implement, why not promote horizontal policies that simply consist of improving the investment climate for all businesses by getting rid of numerous administrative frictions and burdens, whose main function is often to provide rent opportunities to certain bureaucrats? The point here is that corruption is contagious: it cannot be stopped in the middle range of the bureaucracy when illegal deals continue at the top. Also, it is not clear that dominant business interests could get a better investment climate than the one they enjoy through their partial control of politicians.

Second, can it be argued that the Tanzanian economy is doing relatively well, so that the business–politics collusion issue may not really be a big problem after all? Maybe, but the key question is whether it is possible to accelerate the present trend and, most importantly, to make it more sustainable and less uncertain in the future, when the external context may change and become less favourable? The relative weakness of tradeable sectors like agroindustry and manufacturing was underscored above, and it may be the case that the nature of the business and politics relationship bears some responsibility here. Yet progress has been made and it is unlikely that big business would not seize opportunities if they existed in these areas. On the other hand, choices may have been made that have curtailed these opportunities: think of the case mentioned earlier of the capture of some import markets that may have outcompeted domestic production.

This issue of central control, which is so clearly illustrated by the inherent difficulty faced by the executive in regulating big business groups, despite their crucial role in the dynamics of the economy, is present in other aspects of public management. Paradoxically, successive administrations have apparently been strongly determined to centralise decisions and control, even though such a move was not justified in some cases, while a deficit of coordination exists between the executive and various decentralised administrative units and public agencies. That lack of control gives some leeway to civil servants operating in those entities – and therefore provides rent-seeking opportunities, which they are happy to exploit.

There are various reasons for such a situation. First, it is objectively the case that some sectoral administrations are simply ill-structured, which sometimes results in overlapping responsibilities, inefficient management, and possibly rent seeking. Examples include the following: land management, with a National Land Use Planning Commission that is redundant due to the presence of the Direction of Urban and Rural Affairs in the Ministry of Agriculture; the lack of coordination between the Tanzanian Revenue Authority, responsible for tax collection, and the Minister of Finance, which decides about tax schedules; confusion of mandates between local government executives and central government-appointed officers; or the intricate set of relationships between local government authorities, the Prime Minister’s Office, the Minister of Finance, and various other ministries. Likewise, firm managers insist they must obtain the agreement of an abnormally high number of government agencies before they can market a new product or service, when only a couple of them could do the same job.

A second reason for coordination failures may be found in the complexity of various laws. The laws that govern the acquisition of land rights are especially intricate and require a heavy administrative apparatus, from central government to local village level. It is tempting for those in charge, and who are supposed to know the law, to take bribes from those who do not, or who are confused about certain aspects of the law. This is true at all levels: from an investor wishing to develop a large plantation to villagers concerned with the implications of leasing some of their land. The sensitivity of land rights in a country where a sizeable proportion of the land is cultivated by small farmers and is exchanged or transferred according to local customary laws is high. Hence the need for safeguards designed to avoid awkward situations in which villagers come to lease part of their land to a big company without knowing all the implications of such a transaction. The complexity of the existing law has been abundantly stressed and commented upon. Several reports have been commissioned which make suggestions for improving it, and successive governments have declared they would follow suit. Yet nothing has been done for the moment. The same complexity and procrastination is observed in the relationship between the central and local governments: a reform was voted on in the late 1990s and was supposed to be implemented by 2008, yet it is still pending more than ten year later.

Both the intricacy of the structure of public management and the complexity of the law may be related to another specificity of the Tanzanian economic culture: a selective distrust of market mechanisms. Such an attitude may be inherited from the socialist era, although the generation that had some responsibility during that time is now retiring. It is more likely due to the multiple cases of corruption that took place during the period of the return to a market economic regime – a period that was nicknamed Mzee Riukhsa (‘everything goes’) by Tanzanians. Likewise, in the 2010s, the leaders of CCM were afraid they would lose the coming election because of their tarnished image due to multimillion-dollar scandals. It is striking, too, to see how, in some respects, land laws appear to be reminiscent of the planning era and its deep suspicion of market mechanisms, and this despite the fact that the law was voted well after the end of the socialist regime. There may be good reasons for this, but too rigid a process of land allocation entails various types of costs and leads to missed economic opportunities that would benefit the whole country. Moreover, since market mechanisms will become more pervasive in the not-so-distant future, it may be good policy to quickly engineer a smooth transition to a more market-friendly environment.

The will to maintain electricity production and distribution as much as possible as a vertical public monopoly also betrays this bias against market mechanisms. It may be a holdover from the socialist era and the view that such critical goods as power should be publicly managed. However, it is more likely a reaction to earlier corruption scandals linked with the subcontracting of power generation to private firms. Despite such scandals, a public monopoly continues to be seen by the public, and by many policymakers, as a guarantee against private providers charging exorbitant prices. But it also provides influential politicians with rent-seeking opportunities, particularly in procurement operations, including with private power providers.

Institutional weaknesses in Tanzania’s public sector are also observed at a more basic level. Comparative institutional indicators, opinion surveys among ordinary people and various types of decision makers, and most policymakers converge in considering the under-performance of the civil service as a serious development impediment. The lack of resources, due to both the low level of income per capita and the limited share of recurrent public expenditures devoted to this service, certainly bears some responsibility for such a situation. But the overall setup of the delivery of public services plays a role too. The misalignment of civil servants’ incentives, the lack of effective monitoring and evaluation capacity, the high degree of corruption, as well as under-skilled staff and weak management of administrative units and government agencies, have also been regularly denounced. Two Public Service Reform Programmes have been carried out, which were supposed to make recruitment more rigorous and to introduce a dose of performance-based staff management. Improvements were noted, but serious challenges remain, and several observers felt – a few years ago – that some progress had even been reversed (see Mukandala, 2023). The culture of promotion based on seniority or partisan links, rather than merit, of recruitment based on other grounds than capacity, of shirking, of diverting resources, and of taking bribes is said to be still very present today.

All of these failings are difficult to quantify. Measurement of their economic consequences is still more of a challenge, except maybe in a few sectors. Because of the service it delivers and the size of the staff it employs, the education sector has been subject to more quantitative evaluation exercises than any other. There, the picture is far from favourable. On the supply side, teachers have long been castigated for their absenteeism – found to be as high as 31 per cent in a survey conducted in 2014. They are also frequently under-qualified, with a minority of them achieving the required standard in maths or English tests. The result is that even though school enrolment has progressed – though it is not yet fully universal – learning outcomes are poor. Half of Grade 4 children were not able to carry out two-digit subtraction in 2016. Although progress has apparently been made over recent years, a report by the World Bank concluded in 2018 that a ‘learning crisis remains in Tanzania’. Even though this kind of quantitative evaluation can hardly be performed in other areas of public sector activity, there is no reason to believe that their outcomes do not suffer from the same deficit of quality.

Results of surveys about the relationship between firms and the public administration, and anecdotal evidence, confirm the foregoing statement. They also suggest that corruption, in the form of giving and accepting bribes, is widespread. It has already been mentioned that Tanzanian political life has been interspersed with increasingly frequent and large corruption scandals, which are probably just the tip of the iceberg. The concern here is about ordinary corruption that is taking place between middle-tier civil servants with some rent-seeking power and firms or citizens. The root cause lies in weak or ill-defined institutional rules. Here, too, the perception is that progress has been made recently thanks to the energetic anti-corruption policy launched by President Magufuli. Judging from the absence of big scandals in recent years, this is probably accurate. At the ordinary level, however, data are not available to know whether Tanzanian society is in the process of moving away from this equilibrium whereby corruption has become a kind of social norm.

Infrastructure development, electricity in particular, is another area where the score of public management is pretty low by all standards, despite its crucial importance for economic development. As mentioned earlier, the production and distribution of electricity are managed by a public monopoly, TANESCO (Tanzania Electric Supply Company). This national company produces around half of the electricity it distributes, the other half being provided by private producers – after, occasionally, resounding corruption scandals relating to the way they were selected. Electricity has long been priced at a rather low level, which has prevented the public company expanding production and meeting demand, a situation that has resulted in economic growth not being as fast as it could have been with a proper power supply. The sector is regulated in parallel by the Ministry of Mining and a regulation agency, EWURA (Energy and Water Utilities Regulatory Authority), in another case of overlapping responsibility. A few years ago, EWURA endorsed an increase in the electricity prices charged by TANESCO, which was long overdue in view of inflation. Recently, the late President Magufuli opposed that increase. Despite the measure being fully justified and EWURA being internationally praised for its impeccable professionalism, its director was sacked. This was possible because in Tanzania the president has the power to singlehandedly appoint and fire the managers of public agencies, including EWURA, but also the Fair Competition Commission, the Central Bank, and the Commissioner Auditor General. The reason invoked for the sacking was that the price increase would hurt poor people and the ensuing social cost would allegedly be worse than stagnating production capacity in the future. This may well have been the opinion of the leadership, whereas the regulators thought differently. The institutional failure here may originate in either of the two following sources: the social criteria applied by the leadership were inadequately specified in its mission order, or the late president took the liberty of ignoring, and even criticising, legal expert opinion.

There thus seems to be a paradox in regard to the type of leadership exerted in Tanzania. Centralisation appears extreme, and probably excessive, in some areas, whereas in areas where it would be most needed it meets obstacles arising from the fragmentation of political power.

G The Institutional Diagnostic

We could continue to review evidence of institutional weaknesses in Tanzania, but the main conclusions to be derived from the thematic studies undertaken as part of our in-depth diagnostic methodology should be clear by now. Summarising as much as possible the points made in the preceding pages, the institutional challenges in Tanzania come under the few general headings shown in the right-hand-side column of the diagnostic table shown in Figure 3.1. In reading the table it must be borne in mind that its entries are not independent. For instance, rent seeking and corruption, which are seen to be ubiquitous in Tanzania, are partly caused by the inadequate structure of decision making and the weak regulation of business, as much as they are partly responsible for the under-performance of the civil service, including business regulation. Also, the order of appearance of the various headings is not necessarily related to the severity of the corresponding institutional challenges. As a matter of fact, their mutual dependency prevents us from establishing such a ranking.

Figure 3.1 Institutional diagnostic for Tanzania

Taken together or separately, these institutional weaknesses explain the economic challenges confronting Tanzanian development. For instance, it is easily understood that the difficulty of diversifying exports through appropriate industrial policies is related as much to the uneasy regulation of business, given its relationship with politics, the lack of coordination across administrations, and the poor investment climate created by the under-performance of the civil service. The same factors – and others – may explain the slow productivity gains in agriculture, or the lagging development of infrastructure – at least until the Magufuli administration. This relationship between institutional weaknesses and economic challenges is analysed in more detail in the original Tanzania case study.

Identifying and recording institutional challenges is one thing. However, a diagnostic would not be complete without an analysis of the factors that are responsible for them. The identified weaknesses are the symptoms, while the underlying problem may lie elsewhere. Most causal factors have been alluded to in the preceding pages and are listed in a summary way in the middle column of Figure 3.1. In reading it in connection with the column to its right, it is important to note that items at the same level in the two columns are not necessarily to be associated one to one. The misalignment of incentives in the public sector directly weakens the performance of the civil service, either directly through absenteeism or loose monitoring and evaluation, or indirectly through rent-seeking. At the same time, the poor delivery of public services may result in large part from the lack of skills or resources. Likewise, the nature of the leadership and, most importantly, its control over powerful factions within the party in power is essential to understand the structure of decision making, the extent of rent-seeking and corruption, and the difficulty of regulating business.

This control of the party is partly influenced by voters’ support, since political allies will defect if they expect a defeat in the next election. In turn, voters’ support depends on the trust inspired by the leadership through the transparency and accountability of its actions. The ability of a leader to oversee the public administration and the whole public decision-making process thus strongly depends on his/her personal capacity to control the political scene and to inspire trust in the population. Needless to say, the nature of the leadership item among the proximate causes of institutional weaknesses also includes the very motivation of the leader. In most preceding points it is implicitly assumed that the leader pursues the common good more than his/her personal interest or that of his/her clique, which indeed seems to have been the case in Tanzania since independence.

Finally, the issue arises of what could be done to combat those proximate causes of the identified institutional weaknesses. Getting more resources to improve the quality of public services, realigning incentives in the public sector, simplifying laws that are felt to be unnecessarily complex, and promoting transparency and accountability through more systematic monitoring and evaluation of the public administration and agencies are obvious measures that would improve the institutional framework of development. They are discussed in some detail in the Tanzania volume. They may raise trade-offs with economic efficiency, however, particularly when they require the collection of additional public resources. Most importantly, they generally generate both winners and losers, at least in the short and medium run, so that their implementation heavily depends on political economy factors. Beyond the proximate causes of the institutional weaknesses, there are deep factors which make the effects of these causes more or less easy to reduce. They appear in the left-hand column of Figure 3.1.

The nature of the political game that is played out in society is the first of these deep factors. On the one hand, the constitution sets the rules, assuming of course it is strictly applied and cannot be easily modified. For instance, it may be the case that it gives too much power to the executive in some areas – for instance, in appointing and suspending people in key positions. On the other hand, in any period there is a structure of political power which evolves only slowly over time – possibly as a function of the pace and structure of economic development – and which makes some reforms possible or impossible. After Nyerere in Tanzania, the fragmentation of the dominant party (CCM) into several factions made it difficult for the executive not to satisfy the demands of powerful factions since the risk would be the dismantlement of the party and the loss of power. As factions were often associated with business interests that provided them with political, if not monetary, benefits, the state was partly captured by business interests and, in some areas, unable to implement policies that would be detrimental to some of them although beneficial to the country. Modifying this equilibrium involves pure political confrontation between the main actors rather than policy reforms. Magufuli wanted to achieve such a change in the deep factors. It is not clear that he succeeded.

The ethnic structure of the population, including the concentration of big business in non-indigenous hands, or the presence of ethnic cultures and customary laws that sometimes conflict with the statutory law, and the historical legacy in terms of culture, ideology, religion, or trust among citizens, call for the same type of observation. These are deep factors which may affect the proximate causes of institutional weaknesses and may be subject to changes, most notably as a result of development itself, progress in education, or contacts with the rest of the world, but only over a long period.

Among the deep factors, the reference to the role of donors deserves some remarks. In the past, donors have clearly played a huge role in triggering major institutional changes in the way the Tanzanian economy works. This was obviously the case with the SAP, which caused the return to a market economy in the second half of the 1980s, but it has also been the case on several other occasions since then. The weight of donors in pushing reforms derives from the sizeable contribution of aid to the public budget and the domestic economy in general. For instance, the World Bank, which has always pushed for an ambitious decentralisation programme, suspended part of its funding in an effort to impose the decentralisation of the collection of the property tax in 2014 – which was nevertheless re-centralised a few years later. Likewise, donors have cancelled payments several times to protest against big corruption scandals involving government officials, and successfully requested that the latter resign from their positions. Outside these extreme cases, project and programme financing by the World Bank and other donors gives them the opportunity to express their views about the direction in which some institutions like the judiciary or tax collection authorities should be reformed. Even though it is up to the government to decide whether to accept such programmes or not, the funding provided by donors is not a feeble argument.

H Conclusion

The preceding remarks about the deep factors behind the proximate causes of the identified institutional weaknesses may be deemed overly pessimistic. They seem to imply that, at the end of the day, reforming institutions to make them more development-friendly is essentially a matter of politics, or possibly the endogenous consequence of development itself, or the long-run effect of educational progress. This pessimism must be somewhat tempered, though.

First, if big reforms are politically hard to impose, smaller reforms addressing some of the weaknesses detected at a minor level of political sensitivity might be consensual. It is probably in everybody’s interest that the educational system is run more effectively, bureaucratic services are competently and honestly delivered, and land management is more efficient. A lot of experimental work has been done in these areas in the economic development literature, which might be a source of inspiration for the design of these reforms. It is not the purpose of the present diagnostic to delve deeper into that kind of detail and it is sufficient to recognise that institutional improvement is now possible in specific sectoral areas.

Second, the Tanzanian economy has done rather well over the last two decades despite the institutional weaknesses uncovered in this in-depth institutional diagnostic exercise. We have stressed the fact that the weaknesses that were identified concerned the acceleration of the present pace of growth and its sustainability in the case of substantial changes in the international context. It cannot be excluded that the deep factors that are found to be obstacles to substantive institutional reforms may be progressively altered with the continuation of present development trends in the coming one or two decades. If this happens, some of the reforms suggested by the diagnostic might become more feasible, especially so if the political elite undertakes its own institutional diagnostic along the lines of the present exercise.

Instead of pessimism, lucidity is the right attitude to adopt in the face of the complex relationship between political economy institutions and development uncovered by the present diagnostic.

4 Distorted Development in Benin and Mozambique

I Benin

A Defining the Question behind the Institutional Diagnostic

The Republic of Benin (formerly known as Dahomey) is a country in West Africa that is bordered by Togo to the west, Nigeria to the east, Burkina Faso to the northwest, and Niger to the northeast. It is a rather small country, with a population of approximately 11.49 million people (2018 estimate) and it is about the same size as three of its neighbours yet is considerably smaller than one of them, Nigeria, which has a population close to 200 million.

There are several reasons why Benin is an interesting country to study, and some of them have no doubt contributed to making it an aid darling for many donors. First, although it is made up of an extraordinarily varied mosaic of peoples and ethnic groups, this does not seem to have created serious problems as in certain other parts of sub-Saharan Africa. Second, it is a place with a long legacy of all sorts of political entities, running from old kingdoms or empires to principalities and microstates (possibly born of the breaking up of kingdoms or empires), which have also coexisted with stateless areas dominated by non-hierarchised families and clans. Because over the last ten centuries the country has been the locus of numerous waves of migration from neighbouring countries, it is a multinational state with strong links to its neighbours, and has porous and flexible borders considered from the standpoint of human settlement. Relatedly, with its direct access to the sea in its southern part, Benin has long been a nexus of trade networks and routes actively engaged in regional and even external commerce. These seem to be ideal conditions for long-term development based on an open (small) market economy. Third, although it was subject to a long-enduring Marxist-Leninist military regime under Lieutenant-Colonel Mathieu Kérékou (1972–90), Benin has proven able to transition to democracy peacefully and then to enjoy political stability through a long period of regular democratic elections. Fourth, being deprived of mineral and non-mineral resources, the country is apparently in a position to eschew the resource curse that has impaired growth and development in many African countries endowed with abundant such resources.

The picture appears less rosy, however, when completed by a number of hard facts. Ranked among the world’s poorest countries at the time of independence (1960), Benin has barely succeeded in improving its position since then: although quite volatile, the annual growth of its GDP per capita hardly reached 1 per cent, a disappointing performance partly explained by a very high population growth rate of close to 3 per cent. In addition, improvements in the standard of living have been not only slow but also unequally distributed. The coastal cities of Porto Novo and Cotonou, together with their hinterland, constitute the growth pole of Benin’s economy. It is in their tiny departments that poverty is kept under control, unlike in many other parts of the country, where it remains intolerably high. The northern and rather remote part of the country, in particular, suffers from neglect, in the form of a lack of critical public investments, and this is despite the fact that its political representatives have not been consistently deprived of access to the highest levels of state power. Not surprisingly, achievements on the poverty front are also dismal since there does not appear to have been a noticeable reduction in the incidence of poverty during the last decades. Moreover, there is evidence that the severity of poverty has increased significantly, as reflected in the decline of the real expenditures per capita of the bottom 40 per cent of the population. Since the same holds true for income inequality, it can be confidently said that growth in Benin has not been inclusive, to put things mildly: the gains from growth have disproportionately accrued to the top of the living standard distribution.

As could be expected on the basis of the low per capita income growth performance, the economy of Benin is afflicted by low rates of labour productivity growth throughout most sectors. It is striking that capital per capita has contracted over the whole period since 1970. It thus contributed weakly to growth of per capita income, which largely resulted from TFP growth. In addition, the observed change in TFP largely reflects major changes in the sectoral structure of the economy, away from agriculture and towards manufacturing and, above all, services. Here, too, the situation is rather worrying: while most of the limited overall productivity gains can be attributed to labour movements from lower to higher productivity activities, they have come at the cost of decreasing productivity in many of the latter activities. In other words, no sector emerges as a genuine growth engine. A possible exception is perhaps the financial sector, but this has practically no impact on employment. From an examination of the evolution of the structure of output, employment, and productivity, it therefore appears that most TFP growth is due to net labour migration out of agriculture, with no autonomous productivity gains in the destination sectors.

The question that then arises is how Benin came to waste its development potential. Any institutional diagnostic of the country must attempt to provide an answer to that question. This is the task to which we now turn.

B Two Pseudo-Engines of Growth

A valid starting point is the observation that Benin’s economy has rested on two pseudo-engines of growth: the cotton sector and the illegal cross-border trade with Nigeria. Cotton is the backbone of the formal Beninese economy, representing a large share of its export revenues, tax proceeds, manufacturing output, and (formal) employment. As for its contribution to GDP, it is of the order of 10 per cent or more. It is well known that the price of raw cotton is subject to wild world price fluctuations, hence the need to smooth their impact on producers and to diversify the sector by encouraging the production of cotton-based textile products. If the former requirement has been satisfactorily met, the same cannot be said of the latter, which raises the whole issue, to which we shall return, of the reasons underlying the weak performance of the manufacturing sector. Moreover, it appears that over long periods of time Benin’s cotton sector has performed much more poorly than its two main rivals in West Africa, Burkina Faso and Mali. Thus, after substantial growth from 1980 to the mid-1990s, production did not grow for the next twenty years, and it even fell dramatically in the mid-2000s. It is only recently that production has been able to overtake its 1996 record level.

Because Benin did badly compared to its regional competitors during a prolonged period, we cannot account for the erratic performance of its cotton sector by simply referring to depressions in world prices or adverse weather conditions in the country. More structural factors specific to Benin must therefore have been at play. The first thing to note here is that the general organisation of the cotton sector does not essentially differ between the three main West African producer countries, and producer prices are also comparable. Activities ranging from the provision of inputs and credit to producers to the collection of cotton seeds and the purchase and ginning of their harvests are integrated under a monopolistic structure. Whereas in Mali a national company is in command of the whole sector (except production), in Burkina Faso and Benin an Association Interprofessionnelle du Coton (AIC) is in charge, which comprises several private or semi-private companies. In the case of Benin, however, the organisation of the cotton sector has been deeply unstable until recently. After the demise of Kérékou’s Marxist regime, it was subject to periodic stints of privatisation, re-nationalisation, and re-privatisation. Behind all of these destabilising moves there has been cutthroat competition between powerful men eager to control the sector and its juicy rents. And if some stability has eventually returned to the sector, allowing for its recent improved performance, it is only because it has now fallen under the indisputable control of a unique businessman who also happens to be the President of the Republic, Patrice Talon. Talon has been nicknamed the ‘king of cotton’ by the people.

By 2019, when Nigeria decided to close its land borders to goods movements, informal cross-border trade (ICBT) had developed into an important segment of Benin’s economy. First, Benin had huge unofficial re-exports to Nigeria, and second, it fraudulently imported a sizeable share of key imports from its big oil-producing neighbour. The illegal nature of this cross-border trade, favoured by the porosity of the borders and the heavily protectionist policy of the Nigerian government, needs to be stressed: goods re-exported to Nigeria, which were legally imported into Benin, faced stiff tariffs or were banned from import into Nigeria. At the port of entry in Benin (Cotonou), the destination of these goods declared at the customs was either a landlocked neighbouring country, for which import taxes and customs duties are low, or the domestic market. Once customs had been cleared, the goods were diverted to Nigeria via a network of informal intermediaries who organised their transportation and smuggled them over the border. Similarly, the large flow of goods imported by Benin from Nigeria, consisting mainly of products that are heavily subsidised in the latter country (oil, in particular), and of other consumer, intermediate, or capital goods, were smuggled into the former country. They thus escaped tariff duties and were sold on the domestic market through informal channels similar to those operating in the re-export sector. Quite evidently, the illegal character of this trade induced its informal organisation.

Dating back to the first oil shock in the 1970s, it is Nigeria’s oil rent which fed ICBT: Benin’s re-exports were driven by Nigerian demand, itself heavily dependent on oil revenues. On the other hand, Benin’s cross-border imports were partly driven by the share of the oil rent that the Nigerian government decided to allocate to the subsidisation of its domestic oil prices, thus creating a positive income effect for a large mass of the population. In this way, Benin shared the oil rent with Nigeria, including through low prices for fuel, and its institutions and policies were shaped by a sort of ‘entrepôt state’ strategy aimed at transforming the country into a regional trading hub centred on the port of Cotonou. Because there was full knowledge that goods imported into Benin in a fully official and legal way were to be de facto diverted to Nigeria in fraudulent ways (that is, by circumventing Nigeria’s import tariffs), we can safely say that Benin’s strategy was not only to tolerate but also to encourage the informal, fraudulent re-export trade.

That ICBT has been a major sector of activity in Benin can be judged from the following figures: at peak times of the trade, Benin’s estimated gross value of imports of products typically destined to be re-exported to Nigeria represented more than 25 times the gross value of Benin’s official exports to Nigeria (Golub and Mbaye, 2023). Still more strikingly, the contribution of ICBT to Benin’s GDP is estimated to have been in the range of 10–12 per cent, including customs and other tax revenues (6 per cent of GDP). It has also been a major provider of informal jobs, a direct upshot of the labour-intensive character of many activities involved. Seen in this light, ICBT seems to have played an important role in the economic development of Benin. But there are several flip sides of all these achievements, which we mention now.

The first shortcoming of the situation is the presence of effects akin to those of a Dutch disease. Strictly speaking, Dutch disease occurs when a boom in an export sector (for example, natural resources) causes a decline in other sectors (like agriculture or the manufacturing sector) as a result of an appreciation of the country’s currency. The consequence is that the country’s other exports become more expensive while its imports become cheaper. The latter effect causes the domestic production of importables to be less competitive. While Dutch disease is most often sparked by the discovery of new natural resources, it can also be caused by any development that results in large inflows of foreign currency, including a sharp surge in natural resource prices, in foreign assistance, and in foreign direct investment.

In the case of Benin, such Dutch disease-type effects can also be observed but, as seen above, the causes are rather different, consisting of a combination of policies based on trade quotas and tariffs, as well as high oil prices in Nigeria, coupled with the use of the resulting rents to illegally import re-exported goods from Benin. The latter thus benefits from effectively higher export prices in the sector of goods illegally re-exported to Nigeria, and from a stronger Nigerian demand for these goods than would be the case under a free international trade regime. It also enjoys lower prices for the goods which it itself illegally imports from Nigeria and which are subsidised by the Nigerian government (oil products, in particular). Such price and quantity effects discourage domestic production, as epitomised by the fate of formal activities of gas distribution, cement factories, and breweries, which have been partly driven out of business.

A second shortcoming arises from the tax losses caused by the informal nature of trade transactions based on imports from Nigeria, and the taxes foregone as a consequence of the displacement of formal domestic activities sparked by these imports. As a third shortcoming, there is the fact that, because the illegal trade is carried out on a large scale, bribery and corruption are pervasive at each stage of the process. A critical level at which malpractices occur is the customs office at Cotonou port facilities: given that it can provide regular and considerable rents, powerful people strive to capture this key office and, given the high stakes involved, the struggle has been unsurprisingly fierce. It is actually revealing that the same man who succeeded in gaining control of the entire cotton sector also ended up owning the customs office. Here is another facet of the resource curse problem that typically harms countries enjoying abundant and valuable natural resources. In this specific case, the valuable resource consists of imports that can be re-sold at much higher prices to a vast neighbouring country.

Finally, grounding growth in ICBT is highly risky as it requires two parties to play the game of undertaking illegal activities. The risk is especially high when the two parties are of significantly different sizes, so that the distribution of bargaining power between them is very unequal. Thus, when in 2019 the Nigerian government abruptly and unilaterally decided to close its land border with Benin, the Beninese government was taken off guard, and a critical source of the country’s economic prosperity was disrupted overnight. To the extent that ICBT activities are nevertheless pursued, they now involve much higher risk premia, resulting in lower profits, lower employment, and business failures.

There are two immediate lessons to be learned from the above account: (i) Beninese growth has been anchored in two fragile sectors of activity, thereby calling into question the sustainability of the underlying development strategy; and (ii) the concentration of economic power in the hands of a small clique, and even a single businessman, augurs badly for the possibility of a competitive environment. The first problem means that Benin is, and will remain, highly dependent on external financing, and on foreign aid in particular since its attractiveness for foreign direct investors is low. An ominous sign of its excessive external dependence is the rapid growth of its external debt as a percentage of GDP after the major debt write-off that took place in the early 2000s. As for the second problem, it is the more serious because of the close connection between business and politics, which is our next point.

C Political Instability and the Confusion between Business and Politics

Politics in Benin has always been characterised by a deep intrusion of business interests. This was even true under the Marxist-Leninist regime of Kérékou, which was marred by numerous scandals resulting from the lust for private wealth accumulation among Kérékou’s ruling inner circle. After the demise of this pseudo-socialist regime, came the Renouveau Démocratique (Democratic Renewal), with its promise of a more transparent and competitive political game that would put an end to kleptocratic practices and blatant favouritism. Unfortunately, these hopes were soon shattered as the old game continued to be played by new actors. In essence, the political system remained patrimonial, in the sense that wealth and power are narrowly intertwined.

At the root of the problem lies the critical role of private financing of electoral campaigns. As has been substantiated in the companion book on Benin, empirical evidence shows that firm owners tend to provide financial support to local politicians in exchange for policy concessions. The most important of these concessions are public procurement arrangements, policy commitments aligned with the firm’s interests, and direct appointment to the bureaucracy of relatives and other acquaintances of the firm’s owner. Interestingly, it appears that their order of importance varies depending on the degree of political uncertainty: when election results are more uncertain as a result of a higher number of candidates, business firms tend to lay more stress on the second and third types of demands. Moreover, their requests for influence and control over the recruitment of officers in all sections of the public sector increase. Finally, in the absence of what they consider to be a ‘good candidate’, the option of themselves running for elections, which amounts to direct state capture, becomes more attractive.

In such a context of pervasive attempts at direct and indirect state capture, it is not surprising that the number of political parties soared to reach the astronomical figure of 250 by the late 2010s. This number considerably exceeds the number of ethnic groups in the country, although the latter is quite large, testifying that many of these parties represented narrower factions inside ethnic groups or regroupings stretching across clans and based, for example, on local and regional identities. Far from being strong organisations articulated around programmatic and ideological platforms, political parties are patronage machines led by powerful and wealthy men. Because of the large rewards of political power (remember the juicy rents created by the ICBT and the cotton sector, in particular), these oligarchs or faction leaders (often called ‘Big Men’) are involved in nasty fights that cause a lot of political instability in the country. Especially destabilising is the opposition between the three main factions composing the dominant ethnic group (the Adja-Fon). Perhaps paradoxically, the other three main groups, namely the Yoruba, the Bariba, and the Atacora, have continuously played a mediating role which has sought to reduce the resulting tensions, whether in an authoritarian (the Kérékou regime) or a democratic setting. Behind this political instability are the constant manoeuvres and shifting alliances and loyalties (including party switching) in which Big Men indulge, depending on their interests as they perceive them at particular moments.

In addition to encouraging political instability, the Big Men system has had a demoralising effect on the population. People witness a succession of obscure political moves and subsequent institutional changes (think of the back-and-forth movements between the public and private status of the companies or agencies in charge of the cotton sector since 2000), as well as scandals whose most common manifestations are sheer favouritism, abuse of public positions, tax evasion, and the embezzlement of public resources. Accusations of embezzlement and rent capture concern not only prestigious construction projects but also programmes that are critical for the well-being of the population and the long-term development of the country (such as water, electricity, and other vital infrastructure projects). Given that most of the misdeeds and cases of extortion go unpunished or uncorrected, it is understandable that the population nurtures a deep mistrust of public institutions. This is especially true of the tax authorities and the judicial system, for which Benin exhibits worse trust indicators than many other African countries.

It is too early to tell how much the rise of Patrice Talon to the presidency is a game-changer. One thing is certain, however: his chaotic ascent to supreme power, itself a reflection of astute tactical moves based on coalitions and counter-coalitions, has been aimed at suppressing instability and establishing law and order in the country, at the price of sacrificing democratic principles. The difference with the experience of Rwanda, which Talon holds in high esteem, is that while Rwanda’s leader is himself the richest businessman in his country he also has a reputation of being incorruptible. The story of Talon’s rise to the presidency is so revealing of the way politics works in Benin that we cannot resist the temptation of telling it to the reader. In order not to break the continuity of our general argument, however, we have deferred the story to an appendix. Here, we want to stress that, in acceding to the presidency after having gained control of the most important sectors of the Beninese economy, Talon put an end to an era in which political leaders were frontmen acting at the behest of powerful businessmen, rather than these businessmen themselves. In this sense, the democratic façade behind which the latter could previously hide themselves has collapsed to reveal the true nature of Benin’s political system.

D Neglect of Critical Public Goods

We have emphasised above some adverse effects of a political system that is penetrated by business interests: namely, political instability and the diffusion of a culture of corruption and cronyism. We now want to add a number of other, equally important, effects. To begin with, the patronage logic governing politics implies that priority is given to pork-barrel projects: transfers that do not typically benefit the poorest sections of the population, and the delivery of local public goods targeted at specific groups. General public goods, such as health, education, nationwide communication, and power infrastructure, tend to be neglected. It is true that efforts have recently been made to fill some of these gaps, yet they still do not reflect sufficient awareness of the critical role these factors play in sustained growth and development. Thus, while the construction of main roads is essentially financed by external aid (think of the two parallel highways linking the southern and northern parts of the country), the building of rural, farm-to-market roads in remote areas, which should be the responsibility of the national government, has not received the attention it deserves. Also, the costs of electricity and telecommunications services are generally higher in Benin than in other African countries, and their quality is often mediocre. Revealingly, access to electricity is the constraint most often cited by economic operators.

The education picture is dismal, as attested to by the catastrophic record for literacy achievements: on this front, Benin ranks among the worst performers in the world. Increasing enrolment at both primary and secondary levels has been actively pursued during the last decades, yet at the price of stagnation – and perhaps even deterioration – of schooling quality (as measured by learning outcomes). These disappointing results are less of a mystery when we learn that the activities of the teacher training schools in Benin were discontinued during the 1990s, which immediately caused a severe shortage of teachers in many parts of the country, particularly in the north. There, outsized classes (with classes reaching up to 120 pupils in Natitingou), teacher absenteeism, and substitution of poorly trained teachers for the missing qualified staff attained unprecedented levels, thereby increasing the inequality between the north and the south in terms of the quality of basic education. Drastic cuts in the budget of the Education Ministry actually followed a policy of fiscal restraint imposed by the IMF and the World Bank within the framework of three successive Structural Adjustment Programmes (SAP 1989–99). More efficiency in the use of the diminished public resources available was expected by the World Bank, particularly in the form of training and upgrading of government staff, yet this did not come about. However blame is apportioned for the situation, the resulting discontinuation of teacher training schools has been disastrous and in blatant contradiction of the World Bank’s sectoral strategy.¹

Being deprived of mineral and non-mineral resources, Benin needs to base its long-term growth strategy on the emergence and rapid development of sectors that create substantial added value, whether in the processing of agricultural goods, the production of simple manufactured goods, or the delivery of services. In the absence of serious investment in human capital formation and improvement of physical infrastructure, foreign investors will not be attracted to Benin and the country will remain heavily dependent on foreign aid.

E Low State Capacity and Weak Public Management

A political system captured by private interests can negatively affect state capacity in several ways. It can lead to the understaffing of administrative departments that are not considered a priority by these interests, and may even be seen as antagonistic. This seems to be the case for the tax collection department, whose size is clearly below that required to function effectively. Departments can also be captured through the appointment of ‘yes people’ or the exertion of strong pressure on the decision-making process. In Benin, this applies to the judiciary, whose officers comply with instructions coming from high-level politicians or officers belonging to the executive. It is therefore no wonder that people in Benin have a particularly deep mistrust of the representatives of these two institutions: tax collection officers and judges.

Moreover, under the influence of various lobbies, different parts of the administration and the government may make uncoordinated, divergent decisions that contribute to creating a chaotic and confused legal environment. Land laws and their implementation are an example that comes to mind here. In this matter, indeed, the reform process has been immensely complex, volatile, and non-monotonous. Many changes thus succeeded each other, involving backtracking, not only with respect to the provisions of the successive laws but also with respect to the institutions in charge of their implementation. Regarding the first source of instability, as a result of regular shifts in the relative bargaining power of various interest groups, the law has remained largely unpredictable. Uncertainty exists about (i) whether and to what extent the current law is going to be implemented, and (ii) about whether the current law will be replaced by a different law in the (near) future. Some provisions, such as the authorisations required to buy rural lands, the obligation to officially record rural land transactions, or the possibility of forcing the owner of uncultivated rural land to rent it out, are clearly unenforceable and people do not seem to care about them. Others, however, create a genuine uncertainty that can discourage investment, particularly in urban and peri-urban areas or in areas where migrants coexist with autochthonous populations. To some extent, the issue here is one of misalignment of the law with respect to state capacity: a complex law is enacted for which the state does not have the administrative resources required for effective implementation. Of course, if the provisions of the law are misguided or superfluous, it may turn out that this misalignment is of no direct consequence.²

Regarding the second source of instability, the fact is that many institutional choices appear to be the outcome of fierce struggles among rival administrative entities. This is particularly evident at the highest level of the state, where there has been constant wavering about whether to assign the responsibility for land regulation to the Ministry of Agriculture, the Ministry of Town Planning, or the Ministry of Finance. Another example is the strong resistance of rural municipalities to attempts to reduce their prerogatives in land matters. Their resistance paid off, since the right to deliver attestations of customary ownership, which belonged to the Agence Nationale du Domaine et du Foncier (best translated as National Agency for Land Administration) under the 2013 law, was shifted to municipalities under the 2017 law. Rural municipalities also successfully opposed the complete suppression of sale conventions, through the requirement that land transactions must be instantaneously registered by notaries. Finally, the professional bodies that earn incomes from land regulation – notaries, barristers, architects, and land surveyors in particular – played a decisive role in killing the provision of the 2013 law regarding the five-year confirmation period during which property rights must be verified.

F Institutional Diagnostic of Benin: A Compact View

Having expounded the critical elements of the diagnostic, we can now take a comprehensive view in which the institutional weaknesses of Benin are traced back to their deep and proximate causes, and their economic consequences are brought into relief (see Table 4.1).

Table 4.1 A synthetic ordering of the institutional factors impeding Benin’s long-term development

Deep factors	Proximate causes	Basic institutional weaknesses	Economic consequences
Politics dominated by big business Multiple ethnic groups and a regional divide Geography: a small country with a big and resource-rich neighbour Colonial legacy of top-down management of key economic sectors (cotton, in particular) Accommodating donors	Policy instability (1): frequent changes in law Policy instability (2): frequent changes in the organisation of key economic sectors (e.g., cotton sector) Lack of long-term development planning Elite capture of key state functions Weak state, unable to control administrations, and with insufficient resources for an efficient management of the public sector Existence of rent opportunities in illegal trade with big neighbour Lack of genuine competition in the cotton sector	Widespread corruption and cronyism Weak law enforcement and legal instability Weak regulation of key sectors dominated by big business Low state capacity: understaffing or capture of key administrations; poor inter-department coordination Neglect of critical public goods (e.g., education or power generation) Opacity of policy decisions and economic management; lack of accountability of key public agencies Outsized informal sector driven by ICBT	Low quality of education Low sustainability of the growth pattern: weak productivity growth; low diversification; low level and pace of industrialisation Poor investment climate High, rising inequality between people and regions; slow progress on the poverty front Chronic aid dependence Lack of citizens’ trust in key institutions (the judiciary and tax collection) Vulnerability to external shocks

In short, five deep factors ultimately help to account for the key institutional weaknesses detected in Benin: (i) a political system that is characterised by a neo-patrimonial logic and where there are multiple contenders; (ii) a social landscape in which multiple ethnic groups have coexisted for a long time; (iii) a geographical/neighbourhood landscape in which small Benin has a long border with a big neighbour (Nigeria); (iv) a legacy of centralised management of key economic sectors (the cotton export sector, in particular) dating back to the colonial period; and (v) the heavy presence of aid agencies, which tend to shut their eyes to the dysfunctional aspects of the political system.

Political instability and the lack of long-term economic planning are the result of unruly competition and factional bickering between Big Men who are uncertain about their political future. This competition is especially fierce, and uncertainty especially great, because of the division of the Beninese society into multiple ethno-regional groupings. Key state functions are captured by the dominating faction(s), resulting in a weak state that is unable to exert control over all its administrations, a difficulty that is compounded by a lack of administrative resources (skills, staff, and equipment). This situation of low effectiveness in the management of the public sector and unfair distribution of the country’s rents is not adequately mitigated by the pressures emanating from external donor agencies or international (African) institutions. It is not mitigated either by pressures to open up key economic sectors (the cotton sector, in particular) to competition, owing to a long tradition of public monopoly that is easily transformed into private monopoly. As for geography, the presence of Nigeria at the border of Benin gives rise to considerable opportunities for rent that can be earned through illegal trade.

The main economic consequences are as follows: a spatially lopsided development pattern that is, moreover, precarious (subject to external shocks) and unsustainable; chronic dependence on foreign resources resulting from slow productivity growth and pervasive inefficiencies in the running of the state; and a bad investment climate caused by poor governance, widespread corruption, and confusing and loosely enforced laws and regulations. Since foreign direct investment is therefore deterred, foreign aid is the buoy that keeps the country’s finance afloat.

G Policy Implications and Recommendations

Priority attention in any reform process ought to be given to ways of breaking the link between politics and business, which is at the root of many institutional failures and economic problems. Since the financing of electoral campaigns provides oligarchs with a privileged channel for influencing politics, it should be regulated by law. Here we can think of capping the amount of financial contributions to politicians and imposing rules requiring transparency regarding the amount and the source of donations. The problem with such rules is that in weakly governed countries they tend to be ignored whenever they are enacted. This is illustrated by Benin, where they indeed exist but are not strictly enforced. The same restriction probably applies to all rules prescribing rigorous impact evaluations of public sector actions so as to achieve greater accountability of major actors at the state level. And it also applies to many laws, decrees, and regulations that ban day-to-day malpractices, such as the taking of bribes, petty corruption, and money extortion by local officials. Thus, although signboards warning against practices of bribery are displayed in local police offices, nobody really cares.

Clearly, attacking the key issue of the intrusion of business into politics upfront is unlikely to bear much fruit. This is especially true today since the richest businessman in the country holds supreme political authority. More feasible reforms should aim at radically transforming the Beninese economy so as to increase the average income per head of the population and to anchor growth in more sustainable sectors than cotton and the ICBT with Nigeria. Since Nigeria’s borders have now been abruptly closed to flows of goods, the latter sector has ceased to be a reliable source of incomes and employment for Benin. The path forward must therefore be based on a sectoral transformation of the economy and strong measures to improve labour productivity in key sectors.

Regarding the first dimension, a realistic strategy consists of promoting agro-processing industries outside the cotton sector. This involves: (1) the identification of agricultural products for which the country’s natural conditions are appropriate and which can generate enough added value; and (2) the integration of their producers and intermediaries into a value chain that includes input and credit supply; collection of the produce; and its transportation, storage, processing, packaging, and marketing up to the point of the final consumers in rich countries, if needed. In a country like Benin, where there are many experienced traders and middlemen (including those of Indian or Pakistani origin who criss-cross the country) this is best done through a great deal of market activation or facilitation. On the part of the state, the main tasks required are the construction and maintenance of rural feeder roads, which can be branched off into the main grid, and the effective suppression of all of the money-extorting posts on the routes used by producers and traders.

Valuable efforts in this direction have actually started to be made. Thus, for example, schemes for the production and export of pineapples and pineapple products (like juice or jam) have recently been launched under the impulse of the present government and with the financial and logistical support of several aid agencies and development cooperation programmes (French, Belgian, Canadian, etc.). The organisation of the value chain up to a European food distributing company (the Carrefour chain of supermarkets in France), the high quality of the product, and the quick supply response from the farmers in the Allada region are important advantages for the success of this initiative. To the extent that fertiliser use is almost non-existent in the cultivation of pineapples in Benin, and provided that some logistical and other difficulties are overcome, a promising niche is the market for organically produced, fresh pineapples.³ When pineapples are processed into juice or jam, expansion is mostly constrained by foreign competition, especially in the European markets, where Chinese and Thai exporters presently enjoy a price advantage. Beninese firms must therefore look for closer foreign markets, such as Burkina Faso and Nigeria, until they improve their competitiveness (through the development of by-products, for example).

Clearly, in the context of a competitive world market dominated by big value chains, the government has a key role to play in the detection of profitable opportunities, the organisation of effective linkages with distant markets, research and development destined to improve the quality of the product and uncover promising by-products, and the like. These are complex tasks requiring appropriate skills, learning by doing, exposure of management staff to foreign experiences, and well-functioning infrastructure (adequate harbour facilities, non-corrupt customs, good roads, reliable internet and mobile phone services, and a regular supply of electricity).

Increasing labour productivity in industrial ventures is another pressing challenge for Benin. This requires not only that more efficient production techniques and capital equipment are used but also that better management systems are put in place. The most effective way to attain this objective is to mobilise foreign direct investment, but that requires, in turn, that governance conditions are improved in the country, so as to reassure potential investors.

Finally, one of the most pressing challenges confronting Benin is education. If significant efforts have been made to increase enrolment, much remains to be done to improve educational quality to reach decent standards, starting with the primary school level. Furthermore, technical and professional schools must be created to help fill the prevailing skills gaps in the labour market. In the absence of significant improvements in educational quality, it is difficult to see how labour productivity can be raised, technical and organisational innovations adopted, and foreign direct investment attracted so as to gradually move Benin to the status of an economy with an intensive degree of skilled labour, as befits a country that is deprived in terms of mineral and non-mineral resources.

Benin is endowed with entrepreneurial people and well-experienced traders and merchants, as well as a good climate and fertile agricultural lands in certain parts of its territory. It has a comparative advantage not only in traditional products such as cotton but also in new agricultural products that can be processed and sold at remunerative prices in the international, regional, and domestic markets. In sum, Benin has a strong potential for development that can be unleashed if only the right institutional and policy environment can be established. Whether this can be done while the link between business and politics remains unbroken is a pivotal question. What needs to be stressed is that Talon’s accession to the presidency has perhaps changed the rules of the game by ending the noxious competition for political leverage between a few oligarchs. It will therefore be especially interesting to see how far his regime will go towards transforming the economy, controlling corruption, and improving the country’s human capital and infrastructure.

It cannot be denied that the main planks of Talon’s reform programme closely match our own recommendations. Think of his reforms of the education system (with an emphasis on the creation of technical schools and training institutions), his plans for infrastructure expansion (including the improvement of the generation and distribution of electricity, considered as a critical constraint on industrialisation), and his measures intended to diversify the economy in the sense of adding value to agricultural and raw material (e.g., cotton) products. However, given the concentration of economic and political powers in his hands, it is legitimate to ask how he will be motivated to bring more competition to key sectors of the economy and fight ‘grand’ corruption, rather than only petty corruption and small-scale bribery. In addition, in a country where freedom of expression is highly valued and where free elections and changes of incumbents became a regular feature of the political scene during the last decades, the question arises as to how sustainable his undemocratic regime will prove to be.

II Mozambique

A Defining the Question behind the Institutional Diagnostic

Mozambique is a large, sparsely populated country with twenty-five main rivers that empty into the Indian Ocean and that physically divide the country. The main river is the Zambezi, which is navigable for 460 km out of a total of 820 km and flows eastwards across the territory. Located on the east coast of southern Africa, Mozambique, whose population is around 30 million, borders six other countries: Tanzania in the north, Malawi, Zimbabwe, Zambia, and Swaziland to the west, and South Africa to the south.

There are several reasons why Mozambique is worth studying, and some of these reasons have no doubt contributed to making it an aid darling, like Benin, for many donors. First, the country attained its independence late in the process of decolonisation, in which respect it is similar to other Portuguese colonies in Africa (Angola, Cape Verde, and Guinea Bissau). Moreover, it started from a very low base in terms of infrastructural development, education, and levels of living of the autochthonous population. Outright chaos broke out at the time of independence (in 1975), following the massive outflow of Portuguese settlers, who had occupied central positions in every layer of the economy. The country was then the poorest in the world and was in blatant need of external assistance. Second, like Angola, Botswana, Namibia, and Zimbabwe, Mozambique has been governed by the same party that took over after white rule ended (Frelimo). This party historically enjoyed huge prestige and legitimacy, and therefore embarked on a nation-building process under auspicious circumstances. At the same time, however, it quickly declared itself a Marxist-Leninist vanguard party, dedicated to central planning and opposed to private sector development. Third, because it has a long coastline and has enjoyed the presence and influence of Arab traders for a long time, Mozambique has potential in terms of developing trade links, while the proximity of South Africa, and its sizeable and more sophisticated economy, offers many attractive opportunities.

To date, however, the hopes placed in Mozambique’s development have largely been disappointed: economic growth has been below potential, social progress has been slow, structural transformation of the economy has barely begun, growth has been unequally distributed across the national territory, and dependence on external financing (development aid in particular) has not abated. Regarding the first point, it is noticeable that until the early 2000s, the donor community generally considered Mozambique a development success story: after the end of the internal war (between the ruling Frelimo and the opposition party, known as Renamo) in 1992, real GDP growth (per capita) was vigorous, easily outstripping the global average and surpassing many other countries in the region. This performance reflected the combination of a return of displaced people to their homes, the rebuilding of private and public infrastructure, supported by foreign aid, and private investment (domestic and foreign).

The trend was not sustained, however: the pace of real aggregate growth peaked at the turn of the new millennium and then slowed moderately during the 2000s (when the rate of real per capita growth was equal to 3.4 per cent per year). As a result, Mozambique is no longer a star growth performer and lags behind its peers in the region (Ethiopia, Ghana, and Tanzania). Similarly, if particularly strong gains were obtained on the poverty front in the immediate post-conflict period, less impressive gains have been recorded since then. Mozambique thus remains a very poor country by any measure. In 2017, it ranked 180 of 186 countries in terms of real GDP per capita, and 180 out of 189 on the United Nations’ Human Development Index.

During the decade starting in the late 1990s and ending in the late 2000s, Mozambique showed a promising trend, characterised by vigorous growth in the manufacturing sector, dominated by large-scale capital-intensive investments (particularly in the Mozal aluminium smelter), and by robust service sector growth. Then a turning point was reached, which was triggered by important foreign direct investments in the natural resources sector, mainly coal extraction and natural gas development, following the discovery of abundant reserves in Cabo Delgado. The same period also witnessed a rapid growth in private services, financial services included, but a declining trend in the contribution of agriculture to growth.

Much of Mozambique’s growth has been fuelled by significant inflows of foreign exchange, both public and private. These inflows have generated spillovers, either directly into consumption – total consumption has consistently equalled about 90 per cent of GDP– or indirectly into income through investment. Moreover, their pattern has shifted increasingly towards capital-intensive natural resource investments, and it seems highly likely that this trend will persist in the foreseeable future. What is worrying is that the economy seems to have become less diversified over time, as revealed by the shifts in the composition of its exports. Thus, manufacturing exports (aluminium) plateaued by the later 2000s, while, starting roughly in 2010, natural resources exports (mainly coal) have quintupled in value and now account for around 50 per cent of all exports. Correspondingly, there is a relative shift towards lower value-added exports.

Finally, the authorities, in spite of the consistent political domination of the Frelimo party, have signally failed to reduce regional disparities and to therefore tame the resentment of people who do not live in the country’s prosperous south. This failure is tragically attested to by the insurgency that broke out in Cabo Delgado in 2018.

B Difficult Initial Conditions

Modern Mozambique was born in especially difficult circumstances, not only because of the sudden departure of 80 per cent of the Portuguese settler population but also due to its geopolitical position in the context of the Cold War. The situation was complicated by the fact that Frelimo, which led the liberation war against the colonial power, came to exert a decisive political influence when the new People’s Republic of Mozambique was founded and proclaimed as a one-party socialist state. This posed immediate threats to Rhodesia and South Africa, which feared a Communist presence on their borders. Furthermore, the decision of the Mozambican government to enforce UN sanctions against Rhodesia in 1976 increased regional tensions, so much so that Rhodesia and South Africa moved to support and finance Renamo, the movement opposed to Frelimo’s socialist orientation and whose leadership came from the centre of the country. After Zimbabwe (formerly Rhodesia) attained independence in 1980, the apartheid regime of South Africa continued to stir ethno-regional differences and grievances in Mozambique, and it turned Renamo into a significant military force capable of disrupting and sabotaging facilities in large parts of the country. The war rapidly escalated and Renamo’s ruthless warfare contributed to undermining Frelimo’s nation-building efforts and to destroying valuable infrastructure.

It was only in 1992, following the demise of apartheid in South Africa, that a peace treaty was eventually signed between the two contending parties, thereby opening the way to less chaotic progress and a more stable security situation. Two years later (1994), the first multi-party elections were organised, which, like all the subsequent ones, confirmed the domination of Mozambican politics by Frelimo. Simultaneously, as an aftermath of the collapse of the Soviet empire, the international environment was dramatically modified, and Frelimo was forced to change course. Suddenly deprived of its main external financial support, the government had no other choice than to turn to Western donors (beyond the Nordic countries of Europe, which had been present much earlier) and to accept the free-market policies which they imposed. This implied the forsaking of the central planning strategy centred on import substitution and the forced mechanisation of agriculture, which Frelimo actively pursued after its transformation into a Marxist-Leninist party in 1977. Aid then flowed to the country which was now widely perceived as a donor darling.

Why is it that the strong growth that ensued, largely as a result of the return of a large number of refugees, did not lead to a significant structural transformation of the economy and to sustainable growth at the same level? And why is it that it did not lead to noticeable social achievements, greater national integration, and deep institutional change? This is the question that we now want to address. In order to answer it, we need to lend special attention to geographical and political factors, which appear to have had a determining impact on policies and institutions.

C Geographical Constraints

A basic fact about Mozambique is its low population density: equal to 40 people per square kilometre of land area, which is perceptibly lower than the average for sub-Saharan Africa (48 people per square kilometre), itself much below that observed for East Asia and South Asia (excluding high-income countries) – respectively, 131 and 389 people per square kilometre (United Nations Food and Agriculture Organisation and World Bank data). An immediate consequence of a low population density is the high per unit cost of providing and maintaining infrastructure (transport, telecommunications, electricity, etc.), and of delivering public services. It is therefore no wonder that sub-Saharan Africa generally has a low density of paved roads, particularly rural roads, and a low density of railways links. Nor is it surprising that in remote areas the communication links that exist are often badly maintained, and, as a result, the operating costs of the vehicles tend to be abnormally high, with adverse effects on the efficiency of transport services (see Platteau, 2000: Chap. 2). Equally serious are the effects of low population density not only on the amount and quality of health and education services but also on the amount and quality of other state-provided services, such as agricultural extension, training, irrigation, and various support services to farmers and small-scale entrepreneurs. Quality is affected insofar as it is difficult to attract skilled labour to isolated places that lack many of the amenities that can be found in areas of higher population concentration.

All of these forces arising from the same fundamental cause, low population density, help explain why distant areas in which the population is highly scattered are backwards and remain so. High transaction costs – transportation and communication costs, in particular – are responsible for low human capital development and slow economic growth, which themselves tend to determine such high costs. Behind the nasty feedback effect that causes low-level trap equilibria in remote areas, two mechanisms (at least) are at work. On the one hand, out-migration resulting from a lack of economic opportunities raises the per unit costs of public goods and services even further and, on the other hand, slow growth implies that business activities are not brisk enough to create a strong demand for transportation and communication, as well as for training, irrigation, and extension services. In rich countries, the vicious circle just described may be broken because income redistribution between different regions is both more affordable and better organised, and public service delivery to isolated areas is often subsidised by taxpayers living in thriving urban environments.

The tendency of poor countries to neglect maintenance of infrastructure, which was pointedly stressed by Alfred Hirschman (1958) a long time ago, is certainly verified in the case of Mozambique. Routine maintenance is generally delayed and migrated from the recurrent to the investment budget, where donors are more likely to help finance major rehabilitations once the infrastructure has degraded substantially. This sort of last-minute rehabilitation is a much more costly solution than regular maintenance, both in terms of the civil engineering work itself and in terms of vehicle operation costs (since the infrastructure remains degraded for a longer time). In addition, major rehabilitation work is not easily contractible to small local firms, which thereby miss precious opportunities to earn incomes and accumulate professional experience. The latter argument applies particularly to rural road networks.

In Mozambique, the problem is actually aggravated by two circumstances. First, not only is the country sparsely populated, especially in its central and northern part, but its space is also physically divided by numerous rivers. The resulting fragmentation makes its spatial integration by means of communication infrastructure comparatively costly. Second, the southern, richer, part of Mozambique, in which the capital city (Maputo) is located, is close to a large and economically more dynamic country, namely South Africa. It is no exaggeration to say that Mozambique’s south is much more tightly integrated with South Africa than with the central and southern parts of the national territory. This situation is a historical legacy of the colonial period, during which Mozambique was treated as a transit country. Since its transport infrastructure was built primarily to serve mining and farming activities in the much larger economies of South Africa and Rhodesia, the rail and road networks ran east–west, with little communication infrastructure to support north–south traffic.⁴ Moreover, there were few rural roads linking farms to markets, and those that there were, were quite distant from each other.

The post-independence period did not bring any major change to the unbalanced distribution of communication links. Thus, large trunk roads in the east–west corridors were financed by donors whose priorities rested on estimates of internal rates of return, themselves narrowly dependent on vehicle operation costs. Furthermore, small rural roads and feeder roads received only a small share of the budget for the construction and maintenance of roads. After the first free elections were simultaneously held in Mozambique and South Africa in 1992 – no doubt a consequence of the end of the Cold War and the demise of the apartheid regime – borders and trade flows between the two countries were reopened, leading to increasing economic integration between southern Mozambique and South Africa. An important upshot of this is that Maputo, the capital city of Mozambique, where a modern urban elite and the country’s middle class are concentrated, is much closer to the agricultural heartland of South Africa than to its own rich farmland in the central and northern provinces. Encouraged by low transportation costs (and also massive corruption in the customs services), the demand for agricultural and other consumer goods has been consistently directed towards South Africa.

Geographical factors and the absence of vigorous policies aimed at redressing the ensuing imbalances have therefore created a situation in which the interests of the domestic industrial and service sectors have been continuously disregarded. South African supermarket chains distributing South African and Asian products have thus expanded into all provincial capitals to cater to the needs of city dwellers in Mozambique, and even staple foods are imported in this way. In short, the urban middle class of the country has been de-linked from its own agriculture and this process of distorted integration is deepening over time. As a matter of fact, with infrastructure investments (especially around Maputo) concentrated at the starting point of a new corridor leading to Durban, the connection between southern Mozambique and South Africa will only become closer, at the expense of the central and southern regions. The consequence seems inescapable: inter-regional inequality is bound to grow and national integration to become increasingly difficult.

In this context, the question as to whether the recent discovery of massive reserves of natural gas in the Rovuma Basin off the coast of Cabo Delgado (in 2016) can be a game-changer appears highly critical. This external shock offers a golden opportunity to redistribute income-earning and employment opportunities towards the northern part of the country, and thereby stop the national disintegration just described. At the same time, however, we know too well that golden opportunities of this kind can easily turn into a natural resource curse, as so many African countries in similar situations have experienced. Unfortunately, the omens are not good because escaping the curse requires a government that will take decisions driven by long-term considerations and by the general interests of the population, rather than by the selfish interests of an elite living in the southern part of the country. The recent insurrectionary events in Cabo Delgado suggest that at least part of the local population holds a pessimistic view that sees such a requirement as unlikely to be met. In order to make our own assessment, the next step is naturally to look at the way politics functions in Mozambique and, in particular, how it relates to business interests – and with what consequences.

D Politics and Business

As pointed out earlier, defining features of the post-independence political regime in Mozambique are: (i) the initial merging of the Frelimo party with the state; and (ii) the continuous domination of the same party even after multi-party elections were organised. As a result, an enduring one-party state has so far presided over the destiny of the country. In theory, this could help promote development by prompting the leadership to design and implement a unified long-term strategy of investment, growth, and social advancement. But the same conditions can also have the effect of undermining this capacity if the lack of political contestation prevents the correction of wrong-headed policies, or if they cause political rulers to be more concerned with tightening their grip on power and preserving the accompanying economic privileges than with increasing the well-being of the population. To look into this matter, we need to distinguish between the period when a socialist state was in place and the subsequent period of formal democracy.

When Frelimo acceded to political power at independence, it embarked on a programme of radical change based on Marxist-Leninist principles. Practically, this meant discouraging private initiative, adopting protectionist policies and the import substitution strategy, as well as transforming the agricultural sector into one based on large-scale mechanised farms. This approach rapidly proved to be a failure, which was officially recognised at the Fourth Party Congress in 1984. Because of the situation of war into which the country fell, however, there was no immediate effect of this reckoning. Policies were not re-orientated – in particular, the contemplated shift from socialist agriculture to a strategy centred on the development of small-scale peasant farming.

A more important turning point was reached in the 1990s when liberalisation and privatisation policies came about in the wake of the Structural Adjustment Programmes (SAPs) conceived by the World Bank and the International Monetary Fund (IMF). The separation of economic and political powers, merged by design during the immediate post-independence period, was then on the cards. Yet, instead of being mitigated or suppressed, the interpenetration of business and politics was actually reinforced. Privatised enterprises were taken over by party members, civil servants, and army officers, thereby ensuring de facto continuity with the previous state of affairs. This strategy was justified by the almost total absence of an experienced and independent business class in the country, and by the need to prevent the return of foreign capitalists, foremost among whom were Portuguese and South African business firms or groups. Its effectiveness was nonetheless doubtful inasmuch as a fraction of the new private entrepreneurs went broke or quickly liquidated their assets, and it is revealing that other entrepreneurs who continued their activities struck deals with foreign partners who possess the required skills and capital.

Whichever is the case, it bears emphasis that most new firm owners, some of whom acquired the public assets at very low prices, benefitted from some sort of exclusivity (such as a licence, a quota, or a contract for supplies to the government). When they were not closed down, therefore, public companies were simply transformed into private monopolies that continued to depend on government protection for the preservation of their privileges. Profits were (and remain) especially high in trade in imported consumer goods and exports of primary products, tourism, and construction activities stimulated by land development and privatised real estate. The privatisation process was questionable in terms of efficiency but equally from the standpoint of equity. This is not only because the emerging group of private firm owners was overwhelmingly made up of government officials and public servants, but also because entrepreneurs with ties to the opposition were consistently excluded.

The pattern of business–politics relationships is thus one in which big business is organised by politicians, rather than the other way around (big business exerts a strong influence on politics by financing the campaigns of politicians). As there is no credible alternative political force, Frelimo is in a comfortable position that allows it to continuously lock in the political allegiance of the business community. Being deprived of the possibility of hedging their bets by financing the campaigns of multiple political parties, members of the business elite of Mozambique have their privileges narrowly tied to Frelimo’s continuing in power. The Frelimo machine is oiled by their money, which includes donations by foreign business partners and associates, but that money itself is obtained thanks to egregious advantages dispensed by the party’s top brass.

Why is it that Frelimo has enjoyed, and continues to enjoy, such a strong incumbency advantage? The answer is twofold. For one thing, Renamo, its main rival, has difficulties attracting many voters, especially the young, owing to excessive centralisation of its party machine. And, for another thing, elections tend to be manipulated through fabrication of the list of candidates and voters register, intimidation during campaigns and on the day of the election, as well as through manipulation of the results achieved by stuffing ballot boxes and tinkering with the final tabulations. The tampering with the democratic process is made easier by the limited access of independent (external) observers to the different stages of the elections. The end outcome is that elections in Mozambique are not free and fair, and most observers agree that the situation is not changing for the better.

Does the above account mean that there is no stiff competition in Mozambique’s political arena and that, as a result, its political leadership is able to ensure the continuity of the country’s development strategies? The answer is negative since, inside Frelimo, various factions fiercely fight for access to power positions. Financial strength being a key determinant of the ability to rise within the party’s machine, this elite rivalry creates a fertile ground for the spread of money politics and influence peddling. Thus, if the control of the state allows privileged access to capital accumulation and juicy rents, it is conditioned by the control of Frelimo, as witnessed by the fact that the president of Frelimo almost automatically becomes the president of the republic, and the party’s candidates for parliament are appointed on the basis of blocked party lists. There is no such thing as dynastic power, so that the struggle between different political barons, each with his own support network of business people and other allies, is a play for high stakes.

It is thus at the level of the primaries, which is an internal affair, that economic leaders choose which alliances they wish to enter into, hedging their bets with a view to reducing future risks for their businesses. On the other side of the bargain, those inside the party who want to stay in central party organs and obtain high offices in the government need to raise funds both to finance the party and to capture votes at the primaries. Vote-buying therefore lies at the heart of primary elections in Mozambique, and it has become common practice only because of the complicity of the courts, which shut their eyes to corruption and other illegal acts. A portentous upshot of the internal tensions inside Frelimo provides an answer to a question that was raised earlier: despite the existence of a de facto one-party state, there is no guarantee of policy continuity over time. The possibility of the instability of development strategies is illustrated by the difficult transition from President Guebuza to President Nyusi, who was not Guebuza’s preferred candidate and had a different approach to policy and reform.

Clearly, the most important potential advantage of a regime founded on an overwhelmingly dominant party has not materialised in the case of Mozambique. Changes at the level of the presidency can cause significant shifts in development-related policies, can explain the piecemeal approach to policy formulation, as well as major rotations of personnel in government and leading positions in the public administration. Moreover, in the very logic of political patronage and crony capitalism, members of the government are inclined to view their ministry as their own fief: that is, they see it as a source of rents that should naturally accrue to them for personal appropriation and for redistribution to the network of their supporters, brokers, and financiers. In these conditions, strategic information-sharing and coordination between different parts of the executive tend to be obstructed, with the effect of seriously impairing the effectiveness of development policies. To this shortcoming of political patronage must be added another one, better known among economists: it fosters pork barrel projects, private transfers, and local public goods at the expense of public goods that are in the general interest, such as education and health.

Finally, it must be emphasised that the onset of extractive industries and, subsequently, the awarding to international companies of exclusive rights to explore and exploit oil and gas reserves in Cabo Delgado (in 2006), followed by the confirmation of the existence of plentiful reserves of natural gas (in 2010), have created new rent opportunities, real or anticipated, that have considerably raised the stakes involved in the struggle for political power and influence. It is probably no coincidence that the trend of an improvement in governance indicators was reversed after the occurrence of the aforementioned shocks to the economy. More specifically, it is hard to dissociate from the ‘pre-boom curse syndrome’ scandals such as the hidden debt scandal (2016), which has deeply affected both the economic and political climate in Mozambique and the country’s relations with the international community. Corruption, cronyism, and money politics, which pose a genuine danger to the vitality and sustainability of the economy, are unlikely to recede in the new rent-prone environment. This is especially true because of the weakness of anti-corruption institutions and their lack of independence from political influence.⁵

E Institutional Diagnostic of Mozambique: A Compact View

Having expounded the critical elements of the diagnostic, we can now take a comprehensive view in which Mozambique’s institutional weaknesses are traced back to deep and proximate causes, and their economic consequences are brought into relief (see Table 4.2). Bearing in mind the analysis presented in the three sections above, the factors featured in the table, as well as their chosen location, are almost self-explanatory.

Table 4.2 A synthetic ordering of the institutional factors impeding Mozambique’s long-term development

Deep factors	Proximate causes	Basic institutional weaknesses	Economic consequences
– Physical and human geography (1): low population density – Physical and human geography (2): proximity to a big and sophisticated economy – Colonial and geopolitical legacy: a one-party state, initially socialist, inheriting a situation of widespread poverty – Natural resources endowment: natural gas – Critical dependence on external finance: aid and foreign direct investment	– Large inter-regional disparities – Fusion of politics and business, with an upper hand for politics – Continuation of one-party state, with internal competitive clientelism – Weak policy continuity – Lack of separation between executive, legislative, and judiciary	– Weak national integration and strong centrifugal tendencies – Widespread corruption and cronyism, and lack of transparency and serious auditing – Low state capacity: poor coordination between departments and low administrative skills – Low state capacity: inability to implement announced plans and strategies – Lack of sufficient attention to critical public goods (e.g., education and health)	– Lack of an inclusive growth engine and lopsided development pattern – Slow poverty reduction and rising inequalities – Low level of domestic savings and inefficient financial sector – Low quality of education and health – Poor investment climate – Chronic aid dependence – Vulnerability to external shocks

The deep factors, which ultimately account for the key institutional weaknesses detected in Mozambique, can be distilled down to five. The first and second are the binding constraints born of the physical and human geography of the country, consisting of low population density and proximity (on the southern border) to a big and more sophisticated neighbour. The third factor is the legacy coming from the colonial period, and the geopolitical situation of Mozambique. What we have essentially in mind here is the one-party state born of the liberation struggle, the socialist approach to growth and development that it initially took, and the context of Cold War tensions that it had to face. The fourth factor is the presence of rich natural resource endowments, mainly in the form of natural gas reserves, which have been discovered rather recently. And the last factor is the critical dependence of Mozambique on external finance for its continuation and development. Among the sources of external financing, aid occupied pride of place until the discovery of gas resources. From then on, foreign direct investment has assumed growing importance.

The way the chain of causation unfolds from these deep factors to lead to the economic liabilities which we observe today can be seen in the table and directly linked to the preceding discussion. It is nevertheless important to stress that if the proximate causes can be usefully explained in the light of the deep factors, they are not mechanically determined by them. If this were the case, there would be no ground for formulating policy implications as we do in the next and last section. Thus, for example, the adverse effects of low population density on remote areas could have been mitigated if the government had chosen to take steps towards countering them, instead of letting market forces freely operate. This would have allowed the populations inhabiting these areas to benefit from better services like education, health, and agricultural infrastructure and extension. To take another example, the fusion of politics and business in the framework of an overwhelmingly dominant party could have given way to a more genuinely democratic regime if the authorities had chosen to bring more competition into the political arena, instead of confining it to the internal space of Frelimo.

As a last illustration, we can cite the country’s tight dependence on external finance. Here, the government could have decided to be more autonomous vis-à-vis external forces and international organisations and donors if it had chosen to tax its well-to-do people more effectively. Admittedly, such a step would have been difficult to take soon after independence, when Mozambique was in a formation state and in the midst of a nasty war that was not of its own making. At a later stage, however, the emergence of a prosperous group of rich businesspeople, state officials, and middle-class residents of big cities, such as Maputo, opened up the possibility of taxation and income redistribution to the benefit of the rest of the population, and the poor in particular. That this course was not followed can obviously not be blamed on deep factors.

F Policy Implications and Recommendations

An important policy implication of the diagnosis proposed is the need to correct the disequalising effects of market forces in the form of growing inter-regional disparities and increasing income inequality. Two lines of reforms spring to mind. First, infrastructural investments aimed at better connecting the poor central and northern parts of the country to its much more prosperous south should become a major plank of any comprehensive development strategy. There is a strong argument for creating a single Ministry of Infrastructure Development, which would be fully dedicated to a task that is presently split over separate ministries, such as Health, Education, Transport and Communications, Agriculture, Public Works, and Energy and Mineral Resources. Such a step would help bring forth a more coherent and unified approach to infrastructure development.

Second, a core element of any growth strategy should be the active support of small- and medium-scale agriculture and agro-processing activities in areas where land is of a sufficient quality. Moreover, special attention ought to be paid to the central and southern parts of the country, where such lands exist, so that both inter-regional and personal income inequalities, as well as poverty, are simultaneously reduced. To be effective, this strategic orientation requires the reinforcement of the institutions in charge of the delivery of agriculture services, including irrigation, credit, training, supply of modern inputs, and marketing outlets, of the support for the development of appropriate technologies used in the processing of agricultural products, and of the dissemination of more efficient storage and distribution technologies.

In terms of infrastructure, priority should be awarded to the construction and maintenance of farm-to-market and feeder roads, which are presently underdeveloped. Regarding credit to smallholders, the creation of a lower-risk agricultural bank, such as is found in many developing and developed countries, must be seriously contemplated. Loan guarantees are a pivotal issue here, and it is therefore essential to analyse it carefully. In particular, are the possession rights of Mozambican farmers sufficient to enable them to use their land as collateral to obtain credit? If not, is there any conceivable alternative collateral, such as standing crops, that could avoid the costly step of formalised land titles? Regarding agro-processing, focus must be on the transformation of products, such as fruits and vegetables (baby corn, green beans, citrus fruits, bananas, and mangos), cereals (maize and related products, sesame), and cut flowers.

All of the above requirements will not be met unless competent national and regional agencies for project identification and appraisal are put in place and receive the support of local bodies and NGOs with experience of grassroots development elsewhere in Africa. In this regard, two remarks deserve to be made. To begin with, it is important that public resources are not allocated based on a mechanical fixed-rates criterion. In Mozambique, debates about the budget shares to be allocated to different sectors are often reduced to references to various international declarations, such as the 2003 Maputo Declaration and the 2014 Malabo Declaration. According to these declarations, 10 pre cent of the total state budget should be allocated to agriculture (it was 5.7 per cent in 2018). Instead, the allocation of the budget should be based on explicit socioeconomic criteria and the ensuing analysis should demonstrate the ability to achieve targeted outcomes in line with established policy goals. This is a complex exercise since expenditures in education, health, energy, roads, bridges, transportation, communications, rural commercialisation, and many other sectors all interact with, and impact on, agriculture. For instance, the promotion of tourism and agro-tourism, the production of electricity from hydropower and natural gas plants, as well as transportation services, are activities that could easily be expanded in the wake of, or concomitantly with, agricultural growth. Finally, in a longer-term perspective, and given the risks of climate change for agricultural production, it is imperative to develop clear adaptation strategies and technologies that are environmentally friendly and resilient to climate shocks.

The second remark is related to the necessity to avoid a top-down approach. Effective development of smallholder agriculture will not be achieved unless rural communities are involved in more than perfunctory ways. More concretely, they should not only be consulted by specialised agencies in charge of agricultural development, they ought also to be key actors in the establishment and operation of local institutions intended to solve their most pressing problems, such as how to store and dispose of their harvests most profitably, how to ensure proper maintenance of local public goods (e.g., roads, irrigation and draining facilities, collective granaries), how to secure supplies of critical inputs, how to organise training in such a way that it does not disrupt their ordinary activities, and so on. It is at this low but essential level that the contribution of NGOs can prove most useful.

Besides the need to correct for growing inequalities, it is hard to see how the country’s development potential could be better mobilised in the absence of serious measures aimed at combatting the most egregious dysfunction of the prevailing political system. This is the most difficult task and, obviously, it cannot be tackled upfront because any direct reforming attempt is certain to arouse the stubborn resistance of the entrenched ruling elite, whose interests would be unavoidably harmed. This said, even though it will be difficult to break the link between politics and business, the hope of mitigating its worst effects must be actively entertained. Below, we suggest some measures in this direction.

The effective separation of the executive, judicial, and legislative powers is an objective that should not be lost sight of. Limiting our attention to the judiciary, an important first step would be to create an additional post of president of the judiciary. Instead of being appointed by the president of the republic, the president of the judiciary should be elected by all judges, whose votes would have equal weight, so that no one would have special voting powers. He or she would be barred from fulfilling the standard jurisdictional function of the courts, and his or her mandate would be of limited duration (four to five years) and would not coincide with the years of presidential and parliamentary elections. A body for oversight and control could be elected for the same period as the president of the judicial power. Composed of judges acting collectively to approve the way the budget of the justice department is allocated and to manage complaints, its members would represent, in due proportions, different areas or courts, but not different categories of judge. Following this recommendation, the president of the Supreme Court would keep the position of primus inter pares but would not represent the judicial power.

As much as possible, laws should be enacted that prevent the use of public funds or resources for campaigning purposes. The best way to ensure proper law enforcement is to guarantee the freedom of the press and its right to exert pressure on the government and other public agencies for maximum transparency and accountability. This should also apply to other forms of regulation and contracts, in particular those that involve large sums of money. In this respect, it is advisable to establish a public company charged with the task of exploiting and extracting hydrocarbons on a large scale and in the general interest of the population. A competitive and transparent policy in line with best international practices should be developed to hire managers, engineers, and other professionals. Also, the public company should be managed in an autonomous manner, implying that it should be immune to any direct political interference. It should be supervised by an administrative board, which in turn operates under a transparent management system. The participation of new international companies competing in the exploration and production of hydrocarbons should be kept open.

Genuine decentralisation must be pursued on the basis of the approval by the parliament (April 2019) of three bills providing for the election of provincial governments and assemblies, and the creation of a secretary of state for each province. Since the stated goal of these initiatives is to further democratise and empower local levels, it is critical that these reforms do not end up in a situation where the position of provincial state secretary offsets the political power of provincial governors (who are locally elected).

Given the pivotal role of human capital accumulation for long-term development, efforts to improve education quality must not be spared. The present state of affairs is unsatisfactory, in part because pupils and students are too often allowed to graduate at higher levels while they do not actually satisfy the minimum standards officially required. Class and teacher attendance needs to be tightly monitored and mechanisms need to be created to allow for the denunciation of attempts to buy certificates. Mutatis mutandis, the same principles apply to the health sector where, in addition, the Ministry of Health (a normative and regulatory body) ought to be separated from the National Health Service (the implementing agency) to avoid evident conflicts of interest.

Our last point concerns the dependence of Mozambique on foreign aid. What we wish to stress is that the government must be able to assess and address the concerns of donors while taking into account the general interests of the country. This implies that it has the capacity to balance the conflicting interests of different foreign countries (as different as China and the USA) against Mozambique’s long-term goals. The possibility must therefore be accepted that aid offers are rejected when they are not in line with national policy and plans. This has concrete implications. In particular, the Foreign Service should be strengthened so that all aspects of foreign policy can be brought to bear on relations with foreign countries. Furthermore, transparent rules of the game based on clear and objective criteria must be laid down for all foreign investments (public and private), and they should be duly implemented. Such measures will not achieve their purpose if there is no strong interface, chaired by the prime minister, between key coordinating ministries and sector ministries, such as the Ministry of Industry and Trade, the Ministry of Energy and Mineral Resources, and the Ministry of Agriculture and Rural Development.

5 Directed Development with Big Conglomerates South Korea

I Introduction

The objective of the following pages is not to provide yet another account of the Korean miracle.¹ In line with the preceding summary of the IDP and methodology, the main question asked is as follows: ‘What would have been the conclusion of an institutional diagnostic of the development potential of South Korea conducted in the mid- or late-1970s, at a time when the country was still a low-income country, at roughly the same income level as the case studies in the IDP project?’ Of course, the context and method of such an exercise would be different from the diagnostic exercises undertaken within the IDP project since it would rely exclusively on the existing literature on early Korea’s development and on statistics available for that period rather than later on. In the 1960s or 1970s there were no institutional or governance indicators comparable to those existing in international databases today, no surveys were run about how people felt about the institutional context of economic development, and thus no thematic study could have been launched based on the information gathered from such surveys. Yet the abundant literature that exists on Korea’s development permits us to partly fill in the holes and to formulate a diagnostic that is approximately comparable to those in the IDP project.

Such an undertaking has a twofold objective. On the one hand, it provides a kind of test of the general approach to diagnosing institutional weaknesses and strengths in connection with economic development features and challenges, as pursued in the IDP. On the other hand, and most importantly, it offers a benchmark for the diagnostic exercises undertaken on today’s low-income countries. South Korea is undoubtedly a development success story. Yet this was certainly not evident back in the early days of its take-off. It is thus particularly interesting to see what a diagnostic would have made of its institutional framework in terms of being a facilitator of, or an obstacle to, its future development at a time when the latter was still very uncertain, and what can be said a posteriori about the role of institutions in development achievements.

This abridged institutional diagnostic of South Korea during its take-off period is organised along the same lines as the institutional diagnostics completed within the IDP. Following this introduction, the next two sections summarise the geographical and historical context of South Korea’s early phases of development. The fourth section deals with the main features of that development, the main challenges the country overcame, and those it was still facing around, say, the mid-1970s. The next section analyses the process by which key policy decisions were taken and implemented within the institutional framework that existed in those days. In view of that background, Section VI then presents an institutional diagnostic of South Korean development as we believe one could have been established more or less at the middle of the 1970s. A few general remarks are then offered in conclusion.

II Geographical and Early Historical Context of Modern Development in South Korea

The Korean peninsula is a stretch of land that forms a kind of bridge between the Asian continent, essentially China in the north and Japan in the southeast. This location explains much of the historical episodes that have shaped modern Korea. The eastern part of the peninsula is mountainous, although more in the north than in the south, whereas the western and southern parts consist of hills separated by narrow valleys and coastal plains. The climate is temperate, with rainfall concentrated in summer. The south is more suitable for farming, rice being the dominant crop. Historically, the south was thus more oriented towards agriculture, and had always been a net exporter of rice before World War II. By contrast, the north of the peninsula is very rich in mineral resources, including coal, iron ore, and a wide variety of non-ferrous metals and rare earths. Consequently, the north was more industrialised than the south after the splitting of the country.

Population density has always been high in Korea. However, the separation of the peninsula into two parts at the end of World War II introduced a strong asymmetry. Around the 1970s, the period we shall focus on here, South Korea sheltered 32 million people, with a density of 365 inhabitants per square kilometre. North Korea’s population was half this size, spread over the same surface area. Already at this time, South Korea was the most densely populated middle-sized country in the world. Population growth was slightly below 2 per cent but was receding at a quick pace thanks to a fast drop in fertility – from around 6 children per woman in 1960 to 2.7 in 1980 (it was a little more than one in 2018). The demographic transition was just beginning: the population was still very young, with around half being below twenty-five. Historically, the Korean population has always been culturally and ethnically very homogeneous. This remains the case today within each of the two entities that share the peninsula, but much less so when comparing the two, in view of the markedly different paths they have followed since separation.

A major turning point in Korea’s history before its separation into North and South was Japanese colonisation. It is thus convenient to divide the following brief account of Korea’s history before the split according to that event.

A Korea until the Japanese Annexation

The history of the Korean peninsula goes back very far. In the Common Era, three epochs can be distinguished, up until the current period. The first extends throughout the first millennium and witnessed a constant rivalry between two or three kingdoms, some of them stretching at times far north into Manchuria and even Siberia, with repeated interventions by China and Japan within peninsular conflicts. The second covers the second millennium until the early twentieth century. One of the aforementioned kingdoms had become dominant and thus was able to rule over the whole peninsula. Two dynasties, the Goryeo and the Joseon, occupied the throne for almost 500 years each, but in both cases they were in a subservient position with respect to China for a large part of their rule. The third period witnessed the entry of Korea into the modern age, essentially through its being forced to end its isolationist policy and to open up to trade, first with Japan and then with the West. The influence of Meiji’s Japan and its push to promote the modernisation of Korea grew during the last third of the nineteenth century, until the first Sino-Japanese war in 1894–5 freed Korea from China’s suzerainty and saw it fall under Japanese control. Efforts to resist that pressure, notably by seeking support from Russia, failed, and Korea became a Japanese protectorate in 1905. Five years later, after the assassination of the Japanese resident general, the country became a Japanese colony.

B Japanese Rule

Japanese colonisation lasted forty years, until the defeat of Japan in World War II. It was particularly severe at the beginning of the period, as Japan sought to quickly impose its rule and way of life on Korean society, and again in the last ten years, as Japan first prepared for the war and then fought it, first against the Republic of China and then against the Allies. During these two episodes, particularly the last one, the coloniser engaged in the forced Japanification of the Korean population and its mobilisation for its own benefit and as part of the huge war effort. This went as far as forcing Koreans to adopt Japanese names and prohibiting the Korean language in schools. In between these two periods, however, life in Korea could be said to resemble the days of allegiance to the Chinese emperor, except that the Japanese suzerain was more severe – but also more modern and entrepreneurial. Moreover, with time, Korea acquired a kind of central place in the colonial power’s strategy of expanding across the Asian continent, and benefited from the development of transport infrastructure and industrial hubs aimed at supplying military equipment for the Japanese troops and settlers in Manchuria – or Manchukuo as it was called under Japanese rule.

The jury is still out about how to evaluate Japanese colonial rule and its contribution to the foundation of modern Korea. The legacy of that period is complex, with both positive and negative elements. Some historians emphasise the fact that colonial rule coincided with the modernisation of the economy and suggest that the former facilitated the latter. This view, which refers to ‘colonial modernity, has much in its favour.² Undeniably, Japanese rule brought huge investments in infrastructure (railroads, roads, and ports), industrialisation opportunities, initially for both local and Japanese markets and later for war equipment and weaponry provision, up-to-date technology, a modern schooling system, high standards of efficiency in business as well as in government matters, and the effective training of local bureaucrats. Even though it cannot be discarded that such an evolution would have taken place by mere replication of what could be seen across the strait that separates the peninsula from Japan, the latter’s oversight may have accelerated and deepened this process by bringing its example closer to the Koreans and by providing opportunities for new developments.

Several of the aforementioned development factors were already in gestation before Japan’s annexation. For instance, education had been flourishing in the last two decades of the Joseon dynasty. Private schools were increasing in number, and a public educational system was about to be created. If the Japanese introduced new schools and a new curriculum (although the latter was initially shorter for Korean students), unlicensed private traditional schools spread because of the limited space in the formal system, especially in rural areas. This appetite for education has undoubtedly been a characteristic of Korean society ever since. Likewise, some industries already existed before Japan’s takeover, although apparently concentrated in the north. Moreover, this small group of entrepreneurs was able to take advantage of, and to learn from, collaboration with Japanese business, in particular the zaibatsus present in Korea (zaibatsu refers to large family-controlled and multi-firm conglomerates that developed in Japan after the Meiji Restoration of 1868). These large Japanese business conglomerates were later to inspire the Korean chaebols.

The benefits from this modernisation of the Korean society and economy went primarily to the coloniser. Korean workers were underpaid in comparison with Japanese workers, and landlords and farmers were dispossessed by Japanese settlers and firms, which acquired swathes of land and transformed a portion of farmers into tenants, tenants into landless workers, and workers into jobless migrants who moved to the cities. The traumatic experience of the war period, when Japanification became the watchword of the colonisers and Koreans were controlled based on the needs of the occupier, must also lie on the negative side of the balance, even though it is sometimes considered that this experience forged the national spirit that would later reveal itself in the postcolonial era. The tearing apart of families and communities through migration to various neighbouring countries, and the near-total breakdown of society, were aspects of this trauma.

Beyond these hardships, and beyond the economic legacy of Japanese colonisation, the model offered to the Korean population of Japanese state-directed economic development, first across the Korea Strait and then on its own territory, would later prove important in the post-war period and after the North–South separation. There is no doubt that key players in the modern history of Korea were very much influenced by this example.

Koreans rejoiced at the end of the war and the departure of the Japanese occupiers. They certainly thought that the trauma of war was behind them and immediately started to think about a new structure of government for the peninsula. They did not know that a still more dreadful tragedy was awaiting them.

III Early Post-Independence History

The origins of the division of the peninsula between North and South are not completely clear. At the end of World War II, a decision was taken to place liberated Korea under a trusteeship, headed by the victors, for a few years, until the economy and the society stabilised. It was resolved that the Soviet army would occupy the northern part of the peninsula and the US army the southern part, in order (it was said) to guarantee a smooth and peaceful return to normality. On both sides, the trusteeship and the division were bitterly contested by the population, but steps were taken to restart political life in a unified country as soon as possible. However, ideologies quickly differed between the two sides. Under the leadership of Kim Il Sung, Communists rapidly dominated in the North, supported by the Soviet Union, whereas liberals led the game in the South, under Syngman Rhee, a pillar of the independence and a strongly anti-Communist public personality who had spent the last years of Japanese rule in the United States.

The determination to reunify the country was strong in both the North and the South and early moves were made in this direction. The South proclaimed the Republic of Korea in August 1948, followed a month later by the North proclaiming the Democratic Popular Republic of Korea. Three months later, the General Assembly of the United Nations recognised the former as the sole legal government of Korea. This was seen as a provocation in the North and the peninsula was soon dragged into war.

A The Korean War

War broke out in June 1950. The North, militarily stronger than the South and counting on the support of unofficial volunteer forces from China and equipment from the USSR, saw the opportunity of unifying the country under its own rule. Its army crossed the 38th parallel demarcation line and invaded the South. After early successes, the Northern forces were repelled by the Southern army, powerfully backed by the US army and other United Nations allies. In turn, the Southern forces invaded the North, triggering a strong intervention by China, which could not accept the military presence of the United States near its border. With such support, the North succeeded in crossing the demarcation line again, only to be repelled once more a few months later. A stalemate around the line then settled in, lasting almost two years, while difficult armistice negotiations involving UN forces, China, and the Northern army took place. A conclusion was finally reached in July 1953, which ratified the division of the peninsula into two countries. However, the treaty was not signed by Syngman Rhee for the South and the North never fully dropped the idea of reunifying the peninsula, as was evident in its multiple attempts to intervene south of the 38th parallel demarcation line, which had become a 4-km-wide demilitarised zone.

The damage of the war was enormous. It is estimated that approximately three million Koreans, or 10 per cent of the population, lost their lives, two-thirds of them civilians killed in aerial bombings. Around ten million families were broken apart because of the war and the division of the country. Material losses amounted to roughly one year of GDP, approximately 30 per cent of all productive assets and infrastructure. Experts estimate that GNP in the first year after the war was 30 per cent below the pre-war level in North Korea and a little more than half this in South Korea.³ Not only was the South less affected than the North, but its physical capital was also less damaged and numerous refugees from the North made up for the loss of population. The North had initially been more industrialised and richer, thanks to mineral natural resources, but it would take much more time to rebound. By contrast, the South was back to its pre-war income levels by 1953, although it is fair to say this was very much thanks to generous US aid.

B Post-War Politics

Three stages can be distinguished in the history of post-war South Korea: the reconstruction during the first normal years of democratic life until 1960, the dictatorship under Park Chung Hee and later Chun Doo-Hwan, and the definitive return to democracy in 1987 (which is outside our period of interest in the present analysis). Interestingly, this periodisation fits rather well the main features of economic development and the strategies that were implemented during this period.

Post-war South Korea was to be dominated by the personality and authority of Syngman Rhee, who was president from 1948 onwards. Rhee was a rather rigid and authoritarian character, and had a very personal sense of the interest of the country. He headed the Liberal Party, which had no clear ideology other than seeking to enrich its most notable members. Very quickly, the issue arose of Rhee’s serving a third four-year term, which required a modification of the constitution. The necessary amendment was passed (though it was one vote short of the two-thirds majority required). Rhee was re-elected in 1956, but with a much smaller lead than in the previous elections. Ageing, heading a deeply corrupt regime that was perceived as ineffective in pushing the economy forward and curbing poverty, his personal aura as a nationalist figure had started to fade by this time, whereas the opposition, regrouped within the Democratic Party, was gaining increasing support.

Rhee stood again as a candidate in 1960, together with a vice-president who it was supposed would be his successor if he had to resign because of his age. He won by a landslide thanks to flagrant vote-rigging, but his election triggered vigorous protests. Students organised a march towards the presidential residence and police fired on and killed 139 of them. Protests continued the following day, but the army refused to fire on demonstrators. Having clearly lost the little popular support that was left him, Rhee resigned. An interim government was then formed, which set out to write a new constitution that would reduce the power of the executive in favour of the parliament.

The government that came out of this process faced a difficult situation. The economic recovery process was slow, inflation was accelerating, the political context was essentially unstable due to the relatively inexperienced political parties and a constitution that reduced the power of the executive, workers were striking for higher wages, students were demonstrating almost uninterruptedly, while some voices were rising in favour of opening a dialogue with the North. It was in the middle of this chaos that some high-ranking army officers, concerned about the increasing climate of corruption, the incapacity of the politicians to re-establish order, and the danger of showing too much weakness in the face of the threat posed by Communist North Korea, organised a coup in May 1961. While General Park Chung Hee was placed at the head of the military junta that would govern the country for a few years, his rule was to last almost two decades in total.

C The Park Era

Park’s career before the coup had been rather turbulent. Initially a schoolteacher, he went on to enrol in the Japanese army. After graduating from officer school in Manchukuo and spending some time as a foreign student at the Japanese Military Academy in Tokyo he served in the Manchurian Infantry Corps. He was then twenty-seven, and this Japanese experience was to have a big influence on his later views about economic development and industrialisation. At independence, he entered the Korean Military Academy and was then assigned to the US–Korean force. Before reporting for duty, however, he was arrested because of his links with Communist movements within the Korean army. He eventually got himself out of trouble and was attached as a civilian to the intelligence unit at army headquarters. Two years later he was reinstated in the army at the outbreak of the Korean War. Amid strong suspicions regarding leftist attitudes within the South Korean army, it is remarkable that Park was not only reinstated but then pursued a brilliant military career, despite his past Communist record – not only during the war, when the army expanded massively, but also thereafter. This indicates an impressive personality, which appealed to his superiors, as well as a powerful friendship network within the army.

The political platform of the junta was unambiguous in its anti-Communist orientation and its aim of reinforcing links with the United States. It also had a revolutionary element, in its determination to root out corruption and to eradicate the misery of the masses. In addition to consolidating Park’s control over the army, and the political system in general, the first years of the junta were devoted to establishing the administrative structure that would be able to achieve Park’s ambitions. Especially important in this respect were the Korean Central Intelligence Agency (KCIA), a formidable organisation with observers in practically all business, academic, political, and social groups, and the Economic Planning Board (EPB), staffed with highly competent technocrats and responsible for designing and managing the country’s economic growth strategies, starting with the first Five-Year Development Plan.

However, the junta did not last long. The US mission in Korea, which had remained powerful since the end of its de facto protectorate in the post-war years, if only through the huge aid it was providing to the economy, impressed upon Park the need to return to a civil regime. Somewhat reluctantly, Park accepted, and democratic rule was re-established. Park resigned from the army and, with the implicit support of the KCIA, created his own Democratic Republican Party. He was elected president in 1963, though by a relatively small margin. His tight, quasi-military control over the political system was maintained during his term, within the apparent limits imposed by democracy. Then, in the election in 1967, with satisfactory results on the economic front, Park easily won again.

The prospect of the 1971 election reopened the issue of a constitutional amendment that would allow Park to seek a third term. The opposition tried to resist this and several student demonstrations were organised to mobilise opinion against it. Yet the amendment was passed, although allegedly in a somewhat suspicious way. However, the newly re-elected president’s position was much less secure than it had been previously. Soon after, Park declared a state of emergency, officially because of renewed threats from North Korea and geopolitical changes that were leading the United States to reduce its military presence. One year later, martial law was instated, the Assembly and political parties were dissolved, and the existing constitution was replaced by a new one, called the Yushin constitution, officially to permit South Korea to adjust more flexibly to the changing international security order.

Practically speaking, the new regime was a barely concealed dictatorship that empowered Park to rule without constraint and that sheltered him from legislative and judicial controls. He had become, to all intents and purposes, a life-long president, his re-election relying on a hand-picked National Congress for Unification. South Korea then entered a dark period of authoritarianism and ubiquitous repression, and in some cases elimination, of all political enemies of the president. At a later stage, Park even had to separate from old supporters he thought were becoming too ambitious as competitors. Amid mounting public discontent he became a more and more solitary ruler. The economic situation itself was becoming critical at the end of the 1970s, because of swelling domestic and foreign debt and the shocks caused by oil price booms. Had he lived, Park would probably have faced a difficult time, but he was shot in October 1979 by the KCIA director, a friend whose motivation for the assassination is still unclear.

The rest of the country’s political history is of lesser importance for our purpose since we aim to adopt a perspective that corresponds to the early history and the situation of South Korea in the mid- or late-1970s – say, some time before Park’s death. For the sake of completeness, however, some major events that took place in the next decade must be mentioned because they shed light on the state of South Korean society and the inherent difficulty it faced in those times as regards installing a stable democratic regime.

D The Chun Dictatorship and the Difficult Return to Democracy

For a brief period, Koreans thought they would return to a freer regime and the Yushin constitution would be abolished. A kind of caretaker government was appointed until a new constitution could be voted on and a new government elected. All parties prepared to compete, but in a kind of repeat of 1961, a group of generals organised a coup and took power. Chun Doo-Hwan, the new strong man, easily stepped into Park’s shoes. Yet the coup aroused the ire of the public. Students protested the martial law, as well as the continuation of the Yushin constitution. One massive demonstration was repressed by the army, leading to 2,000 casualties. Although forever discredited in public opinion, Chun was able to consolidate his power and ruled until the end of his term, which he had pledged not to go beyond. Chun then tried to singlehandedly impose his protégé Roh Tae-Woo as the new president. Huge protests immediately took place, with a large part of the population, not only the students, taking to the streets and demanding a new constitution. Chun gave in, the constitution was amended, and – apparently fair – elections took place in 1987. It was eventually won by Roh. His five-year term was essentially transitional, but it represented a major turn in Korean society towards democracy.

The constitution, which had gone through no fewer than ten changes since the first republic in 1948, was not reformed again. Elections went on to be held every five years in a peaceful way, and with perfect regularity.

IV The Pace and Structure of South Korea’S Economic Take-Off and Industrialisation⁴

The take-off of the South Korean economy in the two and a half decades between the end of the Korean War and shortly before Park’s assassination was truly phenomenal. On average, the annual rate of growth of GDP was 8 per cent, with GDP increasing sevenfold. In the following pages, we give more details on this dazzling development, insisting first on the major structural transformation of the economy, which was both the cause and the consequence of that vibrant growth, which was essentially engineered by manufacturing exports. We then focus on how the impressive accumulation of capital and infrastructure needed for such development was made possible. We finally touch upon social aspects, including the fast progress in education and the inclusiveness of growth throughout this take-off period. The next subsection then turns to the main policy decisions and strategic orientations that contributed to such outstanding results.

A Growth and the Structural Transformation of the Economy

It took some time for the rate of growth of the South Korean economy to reach the stellar level that made it possible to later approach the ranks of the advanced economies. This progressive acceleration reflects the gradual rise of its main engine, the manufacturing sector. Until 1975, manufacturing value-added systematically grew at a rate roughly double of the rest of the economy, but its contribution to overall growth increased with its size: it was small in the late 1950s, when the manufacturing sector represented only 10 per cent of GDP (at current prices), but it was much more important when it approached 20 per cent ten years later – see Table 5.1.

Table 5.1 South Korea: growth, employment, productivity, and structural transformation, 1955–1985

Year	1955		1960		1965		1970		1975		1980		1985
GDP at factor cost (1970=100)	33		40.3		57.4		100		160.8		242.6		381
Five-year average growth rate			4.1		7.3		11.8		10		8.6		9.4
Population (1970=100)	69.9		79.5		90.7		100		109.8		118.6		128.1
Gross national income (GNI) per capita at constant factor cost (1970=100)	47.1		50.7		63.3		100		146.4		204.5		297.4
Five-year average growth rate			1.5		4.5		9.6		7.9		6.9		7.8
Sector structure of GDP (market prices) (%)(current price and constant 2015 prices)	Curr.	Const.	Curr.	Const.	Curr.	Const.	Curr.	Const.	Curr.	Const.	Curr.	Const.	Curr.	Const.
Agriculture	42.3	31.7	38.6	27.6	34.4	26.8	27.1	17.2	23	13.9	15	8.7	10.4	7.8
Manufacturing	10.9	3.3	11.9	4.5	16.7	5.9	16.7	8.3	21.4	11.9	21.8	15.2	25.4	16.6
Other	46.8	65	49.5	68	48.9	67.3	56.2	74.5	55.6	74.2	63.2	76.1	64.2	75.5
Total employment (1970=100)					82.2		100		121.1		140.6		153.6
Sectoral structure of employment (%)					59.4		50.4		45.8		33.9		24.9
Agriculture					9.2		13.2		18.6		21.6		23.4
Manufacturing					31.4		36.4		35.6		44.5		51.7
Other
Overall labour productivity (1970=100)					69.8		100		132.8		172.5		248
Labour productivity by sector (1970 overall productivity = 100)
Agriculture					31.5		34.2		40.3		44.3		77.8
Manufacturing					45		62.9		85.3		121.5		176.4
Other					149.2		204.6		276.7		295		362.4
Decomposition of overall productivity gains
Productivity gains							30.2		32.8		39.7		75.5
Of which: structural change							8		0.4		23.5		20.9
autonomous gain							22.2		32.5		16.2		54.6

Source: Bank of Korea and Economic Statistics Yearbook for employment figures.

Unsurprisingly, a major structural transformation of the economy accompanied this performance. As has been the case for practically all development experiences in history and across countries in the contemporary period, the share of agriculture fell rather regularly over time, on average by one percentage point of GDP every year. This drop in the agricultural share benefited both manufacturing and the rest of the economy, mostly the former until 1965 and both equally afterwards – at least when considering GDP at constant prices. In this respect, it may be noted that the relative price of manufactured products relative to that of other sectors tended to fall throughout the period, in line with the fact that productivity gains are faster in industry – partly thanks to a greater substitutability of labour by equipment – than in services. In the case of South Korea, this phenomenon was amplified by the outward orientation of the manufacturing sector and its exposure to foreign competition. The same cannot be said of the agricultural sector, even though it also produces a tradeable good.⁵

The structural transformation must also be considered from the point of view of employment. This is done in the second part of Table 5.1. Because employment data are not comparable before and after 1963,⁶ the beginning of the period had to be ignored. Over the next fifteen years, however, the share of agriculture in total employment, which was initially close to 60 per cent, was halved. Given the progression of total employment, the volume of employment in the sector increased until the mid-1970s, but then decreased at a fast pace afterwards. Initially, the manufacturing sector was the main beneficiary of the net flow of workers leaving agriculture. In a later stage, however, this flow went to other sectors, among which services was the most important.

Sectoral changes in labour productivity underpin this bi-dimensional reallocation of output and labour. In this respect, it is interesting to observe that the first phase of South Korean development illustrates – but also somewhat contradicts – the familiar Lewis–Kuznets view in development theory. This theory holds that the structural transformation of the economy led by the movement of workers from rural informal production to modern industry and services is the main engine of growth in early phases of development. Capital accumulation takes place in the modern sector of the economy, which easily expands employment by drawing on under-employed workers, or surplus labour, in the informal or traditional agricultural sector. If the former is sufficiently dynamic and labour-intensive, there comes a moment at which the surplus labour disappears in the informal sector. A ‘turning point’ is thus reached at which labour earnings begin increasing in both sectors and the agricultural sector starts to modernise. Such a scenario fits well the development of South Korea until the early 1970s: labour productivity was approximately constant in agriculture, whereas labour flowed from agriculture to (mostly) the manufacturing sector.

Where South Korea fits the theory less well is in the observation that the structural reallocation of labour away from low-productivity agriculture to the rest of the economy did not contribute much to the overall productivity gain in the economy. The latter amounted to a little less than a doubling in the decade after 1965. However, as can be seen at the bottom of Table 5.1, the main contribution to those gains was not so much the reallocation of labour away from agriculture – the row titled ‘structural change’ – as the autonomous productivity gain within manufacturing and other non-agricultural sectors. The reason for this is essentially that the labour reallocation took place mostly between agriculture and manufacturing, and the productivity gap between these two sectors was initially limited. The productivity gains within manufacturing and other sectors thus proved to be the dominant force behind the overall productivity gains. An explanation of this evolution within the Lewisian framework is that the composition of those sectors changed because of major policy choices and, most importantly, the deliberate export orientation of manufacturing, its necessary increase in international competitiveness, and the accompanying changes in supporting sectors. Later, things changed substantially, when the economy settled into this new regime and the productivity gap between agriculture and the rest of the economy was drastically amplified, especially with respect to the manufacturing sector – possibly because of the progressive shift there from light to heavy industry. Structural change was then the dominant contributor to overall productivity gains between 1975 and 1980, even though the average within-sector, or ‘autonomous’, productivity gains were still substantial.

The increasing productivity gap between agriculture and the rest of the economy in the early part of South Korea’s take-off should be emphasised because it is somewhat original when compared to other successful development stories in Asia, particularly Japan and Taiwan.⁷ In contrast to those countries, where initial major agricultural productivity gains permitted the development of the manufacturing sector, agricultural productivity in South Korea was low by international standards and stagnant. Such a state of affairs was due to the quality of the soil, the limited size of farms consequent upon a strongly egalitarian land reform, the low productivity of labour-intensive traditional farming techniques, and the lack of incentives and capacity to innovate in an over-populated rural sector. As a matter of fact, it is only when the development of the manufacturing and ancillary sectors had permitted absorption of the labour surplus in agriculture that productivity growth accelerated. The productivity figures in Table 5.1 suggest that this ‘Lewisian turning point’ could have been reached in the early 1970s,⁸ and this seems to be confirmed by the fact that the volume of agricultural employment started to fall around the same time. Yet agricultural productivity and rural incomes continued to lag behind the rest of the economy, to such an extent that the government had to engage in a vigorous policy to support farmers’ income, through infrastructure investment, ambitious agricultural extension programmes, and heavy price subsidies. Yet it was only after 1980, well after the South Korean economy had taken off, that agricultural productivity got off the ground.

A factor that is worth stressing – because it contributed to growth in income per capita that was faster than the growth in labour productivity – was the increase in the participation rate of the population to the labour force. This is due to two factors. On the one hand, the share of the population that was of working age tended to increase due to the fast reduction in fertility rates. On the other hand, an increase in the female participation rate was observed in the last 1960s, possibly because of the opening up of numerous female jobs in newly exporting factories.⁹

As a final comment on interpreting the figures shown in Table 5.1, it is important to stress that the contribution of the manufacturing sector to the overall growth of the economy went beyond its share in GDP times its growth rate. If it had not done so, then the contribution of manufacturing to South Korean growth in the earlier phases of its take-off would have been modest, despite its phenomenal growth rate. However, this argument ignores first that the expansion of a sector that was mostly oriented towards exports fed domestic demand, and therefore the growth of domestic-oriented, or non-tradeable, sectors and, second, the powerful backward and forward linkages between manufacturing and other sectors such as transport, communication, trade, and finance. On top of this, by making foreign exchange available, manufacturing exports contributed to facilitating imports of equipment and, through them, the diffusion of modern foreign technology throughout the economy. Unfortunately, no precise quantitative estimate of the actual contribution of the manufacturing engine of growth – beyond strict accounting practice – seems to be available.

B The Financing of Accumulation and Industrialisation

How was such a successful industrialisation take-off possible? The answer is through fast-growing investment that was largely funded by foreign sources, especially foreign aid in the first phases of the industrialisation process, quickly supplemented by growing domestic savings. Table 5.2 shows that the rate of fixed capital formation over GDP progressively increased from 11 per cent in the 1955s to more than 30 per cent by 1980, although the bulk of the increase really started only in the late 1960s. Given the limited initial stock of capital, even a low investment rate in these early years was able to generate a rapid increase in the equipment and infrastructure available for production. Young (1994, 1995) has estimated that the annual rate of growth of capital may have been above 16 per cent on average between 1965 and 1980 for the whole economy, excluding agriculture, contributing to a little less than half of the 11 per cent average annual GDP growth, the rest being almost all due to the growth of the labour force, after accounting for its increasing education level (on which more below), thus leaving a very limited role (roughly 1 per cent per year) of total factor productivity (TFP).¹⁰ Early growth in South Korea was thus mostly guided by factor accumulation.

Table 5.2 South Korea: expenditures out of GDP, foreign financing, composition of exports, 1955–1985 (current prices)

	1955	1960	1965	1970	1975	1980	1985
Expenditures out of GDP (% of GDP)
Private consumption	88.2	83.1	81.7	73.1	68.3	63.2	57.4
Government consumption	9.4	14	9.5	10.5	10.7	11.9	10.4
Gross fixed capital formation	11.1	11.6	17.1	27.1	28.5	30.5	29.9
of which: change in inventory	1.2	0.5	1.6	2.7	3.5	0.5	0.3
Exports	1.4	3.7	8.3	14.5	29.6	35.2	38.4
Imports	10.2	12.5	16.6	25.3	37	40.9	36.1
GDP	100	100	100	100	100	100	100
Net factor income from the rest of the world	1	0.8	1	0.5	−0.9	−2.6	−3.3
GNI	101	100.8	101	100.5	99.1	97.4	96.7
Financing of capital formation
Domestic saving	2.4	2.9	8.8	16.4	21	24.9	32.1
Foreign saving	8.8	8.8	8.3	10.8	7.4	5.8	−2.2
of which: foreign aid	7	7.9	7	3	1.1	0.2	−
Composition of exports (% of total)
Manufacturing		13	58.2	78.2	83.5	86.3	96
of which: miscellaneous		1	19.6	41.2	37.4	31.4	47.8
of which: clothing			11.9	32.5	22.9	17.9	25.4
Others		87	41.8	21.8	16.5	13.7	4

Source: Bank of Korea, Economic Statistics Yearbook, various years.

Note that all ratios refer to three-year averages around the year that heads the column, so as to smoothen short-run shocks – like oil prices in 1975 or 1980.

Capital accumulation in a low-income country requires savings and domestic currency to buy equipment, which is mostly imported. In the case of South Korea, both came from foreign savings and the deliberate export orientation of industrialisation throughout the period under analysis. Up to the mid-1960s, foreign aid, the bulk of which was provided by the United States, played a leading role, as it covered a major part of imports, including in the 1950s in the form of agricultural products. Things changed when the country approached self-sufficiency in the 1970s and donors’ assistance was progressively phased out, at which time foreign loans were used to finance the accumulation of capital that was not covered by domestic savings, even though the propensity to save was making huge progress – part of which was generated by the implicit taxation of depositors in a fully nationalised bank system.¹¹ Relying on foreign loans implied a rapid accumulation of debt. From an almost insignificant level in 1960, foreign debt grew to 40 per cent in the early 1970s. It then went down, only to surge again in the early 1980s during the global macroeconomic crisis that followed the second oil price boom. It is remarkable that the growth rate of GDP was little affected by debt. As a matter of fact, the investment rate kept increasing, reflecting a rather voluntaristic macroeconomic management.¹² As the domestic saving rate stayed on an upward trend, the country soon became autonomous in the financing of its investment operations.

Sustaining a high investment rate in a developing economy requires having enough foreign currency to buy goods that are not produced at home. Here lies South Korea’s major achievement: its capacity to expand manufacturing exports, which became the true engine of growth, not only through their contribution to GDP but also through making foreign currency available for the import of equipment and foreign technology within the manufacturing sector itself, and also within the whole economy. Exports grew at an annual rate that was rarely below 15 per cent and was frequently above 30 per cent throughout the two decades from 1960 onwards, going from 4 per cent of GDP in 1960 to 30 per cent fifteen years later. Exports initially comprised chiefly food products, inedible oils, and crude materials, including various types of metal ores but during the 1960s the composition of exports drastically moved towards light manufactured goods – with clothing and footwear in the first place. As a result of an ambitious and resolute policy, however, they were then increasingly directed towards heavy and chemical industries (HCI) in the late 1970s, apparently against what had seemed to be the country’s comparative advantage – that is, labour-intensive exports based on cheap and high-quality labour. It is the success of this bold policy that can be fairly termed the South Korean miracle.

The destination of exports also changed radically over time. The main client in the late 1950s was Japan and exports consisted of traditional products. Then destination countries were diversified, with the United States becoming the prime client at the expense of Japan, while exports concentrated on light manufacturing, mostly clothing and footwear. In the late 1970s, the composition of exports shifted again and started to include an increasing proportion of heavy industry, and clients comprised more developing and emerging countries.

Back in the early 1970s, however, foreign currency sources had had three major origins. First, Japan’s reparations payments for its forty-year colonial rule, after South Korea reconciled with its former coloniser; second, payments made by the United States in return for South Korea’s participation in the Vietnam War; and, third, public works and building contracts in the Gulf countries after the first oil price boom – which, incidentally, provided Hyundai’s founder, Chung Ju-Yung, with a leg up into big business. These last two items show another key feature of South Korean development: the capacity of its rulers and entrepreneurs to take advantage of all opportunities that might arise and that might be profitable for the country or for private business.

C Social Aspects: Education, Inequality, and Agriculture

The preceding tables and comments summarise in a very succinct way the first twenty-five years of South Korea’s outstanding economic development. However, this picture would be incomplete without looking at their social counterpart. Here, too, the achievements were quite remarkable.

On the educational front, South Korea invested massively after its liberation from the Japanese coloniser, which had not done much in regard to the schooling of the indigenous population. Primary education was made a right in the 1948 constitution and the number of schools then mushroomed, despite a lack of resources in terms of teachers, school buildings, and textbooks. It has been said that student–teacher ratios were frequently as high as 100, and most schools operated two or three shifts a day. An important point is that this resulted as much from political will and policy decisions as from the fact that households themselves were eager to have their children educated so that they could qualify for good jobs – to such an extent that an author referred in those days to the ‘widespread Korean obsession with learning’.¹³ In many instances, however, the burden of providing schooling was on communities, with little help from local or central governments. Whatever the case, primary school enrolment was nearly universal by 1960, and the demand for secondary and tertiary schooling was also extremely high by international standards. On the other hand, the role of university students in the events that led to the resignation of Syngman Rhee in 1960, and later on in the country’s political history, testifies to the importance of universities in the social and political life of the country already in those days.

This appetite for education never dwindled, so that fast progress was achieved at the level of the whole population. According to the Barro and Lee database, the average number of years of schooling in the working-age population increased from 4.5 in 1950 to 7.12 in 1975.¹⁴ As a basis for comparison, the same figure is still below six in Bangladesh and Tanzania, forty-five years later. South Korea was also ahead of other late industrialisers – for example, Singapore, Brazil, and Turkey – on several key education indicators, such as secondary and post-secondary school enrolment, the number of tertiary students abroad, and the number of engineering students as a proportion of university students. As a sign of the strong demand by the population for good education, Amsden (1989) mentions the fact that teachers in South Korea were relatively well paid in comparison with army officers – at a time when the military were at the head of the whole society – or professionals and technicians.

Despite this clear quantitative advantage, several weaknesses affected the educational sector, including too generalist a curriculum, a poor vocational training programme, and, above all and for quite some time, a clear over-supply of educated workers for the existing demand. There were periods characterised by high levels of unemployment among highly educated people, and the preparation of the first Five-Year Plan in 1963 found an excess of high-level personnel in the bureaucracy. This issue was sufficiently serious for the Park administration to impose quotas to reduce college enrolment at a certain stage.

Another important social aspect of the early decades of South Korea’s development concerns the moderate degree of inequality of the distribution of income, its stability over time, and its impact on the speed of poverty reduction. A side issue is that of the maintained income balance between the rural and the urban sector, where the engine of growth of the whole economy lay.

The relatively low level of inequality in comparison to many developing countries at the same income level is partly explained by the agricultural reform that was launched at independence, which redistributed land from Japanese and large domestic landowners to small farmers and former tenants, with a 3 hectares cap on each farm. The reform also abolished the tenant status. Given the importance of agriculture at that stage of the development process, the impact on the equality of the income distribution was substantial. This was reinforced by the relative equality in the distribution of educational levels in comparison with many developing countries.

To prevent an increase in inequality, the challenge was then to maintain a balance between the booming urban sector, led by manufacturing development, and the agricultural sector. As mentioned earlier, the balance initially moved against the latter. On the one hand, productivity was often low because farm size was too small.¹⁵ On the other hand, grain production was rather heavily taxed, making life extremely difficult for small farmers. Average productivity was low – see Table 5.1 – and, if it increased somewhat during the 1960s, this was because of the flow of under-employed agricultural workers towards employment in the expanding industry. In the 1970s, the government’s action to level off productivity and incomes across sectors yielded effective results. Especially important had been the reversal of the production tax into a subsidy through guaranteed prices that were above market level. Some of the support to agriculture went through the Saemaul programme, which was the first community-driven development experience in the world. This programme was as much social as economic, one of its goals being to achieve rice self-sufficiency.

With a roughly constant distribution of income – except for some short-run fluctuation episodes – the reduction of poverty followed the continuous increase in mean income per capita. The poverty headcount – the proportion of people below a certain income threshold defined as the ‘poverty line’ – cannot be computed for Korea before 1965, due to a lack of representative household income and consumption expenditure data. However, available estimates for the following fifteen years suggest that the poverty headcount declined rapidly, from 40.9 per cent in 1965 to 23.4 per cent in 1970, 9.8 per cent in 1980, and 4.5 per cent in 1984.¹⁶ Thus, poverty was virtually eliminated within twenty years.

Such was the spectacular economic take-off achieved by South Korea in the twenty-five years or so after the end of the Korean War and the division of the peninsula that had led to it. It is now time to describe the way that such results were achieved, or, in other words, the strategies that were designed to that end, as well as the institutional framework within which they were elaborated and implemented

V The Design of Early Development Strategy and Policy

Much has been written to explain the South Korean ‘miracle’. The point here is not to offer an exhaustive summary of that huge literature, which, as a matter of fact, is often focused more on East Asia rather than the single South Korean case – as can be seen from the influential 1993 World Bank report on ‘The East-Asian Miracle’. The goal of the following pages is more modest. It intends to list the main policy decisions and economic practices that led to Korea’s stellar development from the mid-1950s to the 1980s, as well as the institutional framework within which these decisions were taken, and these practices developed.

Three periods are traditionally distinguished in the early development of South Korea: the 1950s under the presidency of Syngman Rhee and its import substitution strategy; the 1960s under the military rule of Park Chung Hee and the extremely fast development of light manufacturing exports; and the 1970s under the dictatorship of Park and the ambitious bet on the development of heavy industry. We will follow that order. Yet, because of the similarity of economic policymaking in the last two periods, they will be dealt with together, whereas a third subsection will explicitly handle the way the decision was made regarding the heavy industry venture.

A The 1950s: Recovery, Import Substitution, and Corruption

It is not clear why this early period of South Korean development has been given the ‘import substitution’ label. It was, rather, a disorganised period of economic recovery after independence from Japan and the Korean war, which would better fit the expression ‘everything goes’.¹⁷ It is true that imports played a dominant role since the production capacity of the economy was limited. This explains the early formation of big trading businesses, which took advantage of the relationship with Rhee’s government to obtain import rights in certain key areas. As a matter of fact, this is when the first big South Korean business groups (chaebols) appeared or expanded, as was the case for Samsung, which had engaged in trading activities since the period of Japanese rule, or LG, which was founded in 1958 to provide the local population with imported home appliances. Progressively, however, these trading companies got into local production, benefitting as they did from comfortable import barriers.

As was seen earlier, the generalised climate of corruption, including a government that maintained itself in power through bribery, vote-rigging, and intimidation, a flourishing black market in foodstuffs provided by the United States, and rents granted to a few business groups through import rights or high-level protection, severely undermined Syngman Rhee’s regime. Student protests and accompanying turmoil pushed him out of the political arena. However, the democratic government that replaced him did not prove more effective in improving the country’s economic prospects or in curbing corruption or political decay.

B The Economic Policy under the Military Junta and the Park-Led Civilian Government

As a matter of fact, there was little difference between the military and the civilian governments headed by General Park. However, several institutional reforms that were to have long-lasting implications were imposed by the military junta, which could probably not have been affected otherwise.

1 The Revolutionary Objectives of the Military Power

The junta that took power after the coup of May 1961 did so explicitly to end the previous era of economic and social disorder and to put an end to corruption. With General Park Chung Hee at its head, it presented itself and its overall programme as a ‘National Revolution’. The words are important here because, in many respects, the beginning of Park’s era as ruler of South Korea was indeed a revolution from the point of view of politics, institutions, and economic policy. This state of affairs did not change much when the junta gave way to a civil regime, with Park as president, in 1963, as the army remained extremely powerful and military personnel continued to be strongly represented in most high- and middle-tier state decision-making units. The initial revolutionary impetus of the junta thus remained present for a long time under Park’s leadership. Its main dimensions may be briefly described as follows.

First, the military in power drastically modified the way the country and the economy were run. The army had inherited a strong sense of discipline from the Japanese era. Once the power struggle about who would command the junta ended, a rigorous, well-qualified, and corruption-free administration was set up. The bureaucracy was reformed by introducing within it a military structure, especially a deep respect for the hierarchy and a strict observance of orders coming from superiors. The change from the rather disorganised management that was in place before was drastic. At the same time, a powerful intelligence unit was installed whose mission was to reinforce Park’s grip on the whole political and economic system, including, in some cases, some army factions. The KCIA played a key role throughout Park’s rule. In particular, it was the KCIA that managed the reorganisation of the bureaucracy along the preceding lines, notably through major purges and a drastic reduction in the number of bureaucrats, by getting rid of those who were found to be ineffective and/or rent seekers.

Second, the junta, and Park at its head, wanted to truly revolutionise the way the economy was run, which implied two big changes: (i) the introduction of serious economic planning; and (ii) fighting corruption. On the first account, a true ‘planning’ attitude and practice was introduced in policymaking. Planning was not new in South Korea, but it was previously ineffective. In 1962, the first Five-Year Economic and Development Plan was launched, essentially a top-down set of policies designed and executed by a highly able group of civil servants, the Economic Planning Bureau (EPB), whose head practically had prime minister rank.

In regard to corruption, the junta arrested all those who were taking undue advantage of the previous disorder within the economic system: ‘illicit’ profiteers of all types, tax evaders, ‘hoodlums, as well as Communist sympathisers.

Of very special interest, and of key relevance for the forthcoming development of the country, was the initial threat issued to the owners of big businesses – that is, the so-called chaebols – who had built up huge rents under the previous regime, that they could be dispossessed of their wealth and could see their enterprises nationalised. In a celebrated encounter between Park and Yi Pyong Chol, the founder, owner, and manager of Samsung, then the most powerful group in South Korea, the latter suggested that instead of expropriating them, it might be better to have the chaebols work to advance the junta’s policy, while maintaining the threat of full expropriation in the case of non-compliance or misconduct¹⁸ – which occurred later in the case of Samsung, which was caught up in a corruption affair and which had to hand over its fertiliser company to the state. This general deal between Park and the chaebols, despite the general mistrust of the former and the army in regard to business, was to become the spearhead of South Korea’s astonishing industrialisation process.

Third, as part of this fight against corruption and despite the chaebols’ owner-managers being conditionally spared, all banks were nationalised so that credit operations could be under full central control. Other state-owned companies already existed at the time the junta took power, or were created shortly afterwards. In general, they produced basic commodities or utilities such as energy, water, and transport infrastructure. The most famous was the Pohang Iron and Steel Company (POSCO), created at the time the Park administration decided to launch its HCI programme.

Fourth, Park, as well as the army, were openly anti-Communist, an attitude that can be easily understood in view of the deep rivalry with North Korea. However, things went deeper than mere political divergences. Communist North Korea was a constant threat, which required permanent surveillance of its possible links with people in the South, as well as heavy military investment, especially when the US military presence started to weaken in the late 1970s. Park embarked on his heavy industry programme and on the creation of POSCO partly so that South Korea would be able to produce military equipment. Another aspect of the anti-Communist bias of the regime that succeeded to the junta was its repression of unions and labour movements.

To these basic changes brought about by the shift to a military regime, which were tightly maintained afterwards, it is crucial to add some of the key ideas held by the ruler and the small group of advisers around him. These ideas, indeed, inspired his policy during his twenty-year hold over South Korea’s economy and society, and to a large extent explain the development achievements that could be observed at the time of his death in 1980.

2 Park’s Views about South Korean Development

A few fundamental principles inspired Park’s development policy from the first moment of his accession to power. One was a strict rejection of Communism as an economic system, despite his youthful flirtation with Communist movements before the Korean War. However, this did not mean for him relying blindly on market mechanisms: the state had to have its say in development orientations. A second principle had to do with the example of Japan, which he knew rather well and had been able to observe as a former student in Tokyo’s Military Academy. He reportedly repeated throughout his leadership that his goal was to reach the development level of Japan in a ‘single generation’. Another principle was well portrayed in his familiar saying, ‘rich state, strong army’, which he understood as implying a two-way causal relationship: a strong army would allow business to prosper while being sheltered from North Korean actions, and a prosperous state would be able to afford such a strong army. But building a strong army also required developing some heavy industrial capacity. A fourth principle that guided Park’s action was highly diplomatic: it was the care he took to preserve peaceful collaboration with the US administration and its representatives in Seoul. This had not always been the case under the previous regime. Some tensions arose at times between Park and the US representatives, but it cannot be denied that, overall, the United States played a huge role in South Korean development, not only through its financial assistance but also through its economic advice. The US interest in such a collaboration must not be underestimated either. In the geopolitical context of those days, it was important for the Western superpower and its promotion of market capitalism that South Korea succeed and clearly overcome Communist North Korea.

With such principles, and given the rivalry with North Korea, which was able to live for a while on the strong industrial base it had inherited at the time of the separation, the economic goal of Park’s regime could not be other than the pursuit of the fastest possible economic growth.

3 The Light Manufacturing Export Drive of the 1960s

This quest for fast growth relied on two pillars: the export orientation of the economy and heavy investments in infrastructure. On both fronts, success was quick and stellar thanks to original, voluntarist, and clever policies. Yet it is the phenomenal progress in exports that calls for the most detailed explanation.

The choice of export orientation as a strategy of development was based on an assessment of development limits experienced in the previous period and the relative failure of protection to produce fast import substitution-based growth. The analysis by Park and his advisers at the EPB was that such a policy would not succeed because the domestic market was too small and economies of scale could not be developed; hence the export orientation emphasis of the first Five-Year Development Plan. But an objective is nothing without the right instruments to achieve it. This is where South Korea was extremely innovative.

The key to the extraordinary South Korean export drive in the 1960s lay partly in the reform of the exchange rate, partly in the authoritarian management of Park’s team, partly in an effective bureaucracy (both in key administrations and in the nationalised banking system), and very much in the dynamism of private enterprises. There is indeed a notable difference between this pragmatic approach to export-led growth and both the neoclassical explanation that is often given of the South Korean miracle as the mere result of moving to a ‘free-market’ and ‘free-trade’ economic regime (Balassa, 1988), as well as the heterodox view that South Korean success was essentially the result of inspired stewardship which went as far as ‘getting the prices wrong’, to use the words of Amsden (1992).

The civil government before the junta had rationalised the foreign exchange market by eliminating a complex multiple exchange rate regime and adjusting the official rate to the rate observed in the curbed market. The won had thus been devalued by some 160 per cent in the space of two years, and foreign exchange management had been made simpler.¹⁹ This increased the profitability of exports. The second impetus to exports was given by several types of incentives provided to exporters, which comprised: (i) tax incentives; (ii) tariff exemptions and credit facilities on imported inputs; (iii) export credits at subsidised interest rates; and (iv) foreign currency loans. Among them, interest subsidies were probably the most important: by 1965 the subsidised rate to exporters was 6.5 percentage points for an official lending rate of 26 per cent – and a domestic inflation rate of 13.6 per cent, making the real borrowing rate of exporters negative.²⁰ Most importantly, however, these subsidised credits were granted by the nationalised banking system conditionally on complying with export targets set by the government for large trading companies in charge of exporting the production of medium or large chaebol companies, which would soon be at the head of a true global distribution network. This is where a competent and non-corrupt administration and banking system were crucial. On top of this, the export targets were changed over time, based on the objective of the Five-Year Economic and Development Plans and based on firms’ views on what they could achieve from one year to the next. These targets were set in negotiations with high-level government representatives, if not with Park himself for the largest chaebols.

Even with such advantages, it took extremely dynamic entrepreneurs to penetrate foreign markets and then to increase their market share. This is where the chaebols played a huge and crucial role. In a few years, between 1962 and 1971, exports of light manufacture – wigs, clothing, footwear, and plywood – increased by US$700 million (7 per cent of 1971 GDP), essentially starting from scratch. Such rapid progress is doubtless proof of the strong ability of Korean entrepreneurs not only to seize the opportunities offered by export and industrial policy incentives but also to make their way in foreign markets. At the same time, huge economies of scale made them increasingly competitive, which also suggests that, thanks to multiple export incentives, they accumulated solid rents that could be reinvested in other activities.

The economy grew rapidly. GDP was multiplied by 2.5 between 1962 and 1971. Could it have continued to expand at the same pace, based on the same line of exports? Korea’s world export share in clothing trade was only 4.4 per cent at that time, but, of course, was much less if the world market, including national production for domestic consumption, is used as the reference. Moreover, it turned out that clothing exports from South Korea would go on to increase by US$1,600 million between 1971 and 1976, when they amounted to 10 per cent of world exports. Why then did the Park regime decide to launch the HCI programme, deviating completely from successful labour-intensive manufacturing exports?

4 Park’s Dictatorship, the Chaebols, and the Heavy Industry Venture of the 1970s

After the serious social turmoil surrounding Park’s aspiration to a third mandate, which was contrary to the existing constitution, martial law was decreed, putting an end to all protest, and a new (Yushin) constitution was passed that gave Park nearly dictatorial power. He then bluntly pushed the economy towards heavy industry, despite the general opposition that had expressed itself before the promulgation of the new constitution, and against the wishes of several of his advisers and top experts in ministries and government agencies, who favoured the continuation of the light manufacturing export strategy. Park’s motivation might have been his ambition to replicate the Japanese development model ‘in a single generation’, but he also had a firm conviction that, in the very long run, light industry, including in those days consumer electronics, was a dead end in the journey towards joining the club of rich countries.

The HCI strategy relied on two pillars. On the one hand, it was necessary to build a powerful steel industry that could provide the basic metallic inputs needed by lots of kinds of heavy manufacturing. The state-owned POSCO had already been included in the first Five-Year Development Plan as a strategic industry but had not been implemented due to a lack of resources. It was maintained in the second Five-Year Plan, despite the opposition not only of a large part of the civil society and the bureaucracy but also of the World Bank, which had turned down a loan request, and of the US representative. Funding was finally available thanks to the US$500 million reparations payment made by the Japanese government in the late 1960s. Construction of the steel complex started in 1970 and the first POSCO mill became operational in 1973, with a capacity that was apparently among the highest in the world.²¹

The second pillar of the HCI strategy relied on the chaebols, from which Park required extended efforts to make their way in heavy industry exports, always with the same strategy of offering huge advantages of various sorts and making them compete against each other in the pursuit of an export breakthrough in a specific industry. This kind of tournament rule of the game, plus the risk of bankruptcy in the case of failure, was indeed a clever way of making sure that competitors would do their absolute best to succeed.²²

One of the best examples of that strategy was the launch of an export-oriented shipbuilding industry. South Korea was already producing small fishing ships, but it did not have the capacity to produce huge vessels of the type increasingly demanded by marine transporters and oil producers. Park invited three chaebols to get into that business – Hyundai, Daewoo, and Samsung – providing them with the same types of incentives as had been provided for light manufacturing exports but also with particularly important subsidised credits from domestic banks, as well as publicly guaranteed foreign loans, and promising nice rewards to the winners. It was obviously a hugely risky bet for a country that was renowned for wigs, apparel, and footwear exports to get into this kind of heavy business. Hyundai won the race, with a rather daring gamble involving two simultaneous contracts: one for two tankers to be delivered to a Greek company, and another for the purchase of a shipyard design and shipyard equipment from the Japanese Mitsubishi. The tankers were built at the same time as the shipyard was constructed. Both Samsung and Daewoo were also operational and active in that line of business a year later. Quite remarkably, South Korea soon became a major global actor in shipbuilding.

Not all industrial ventures under the HCI project did so well. Moreover, they were not always devoid of political machinations involving Park and close collaborators competing to succeed him. It was thus not uncommon for generous state advantages to be provided to a chaebol for some industrial venture in return for funding political campaigns or other political expenses. The whole manufacturing export drive strategy launched in the 1960s progressively evolved towards crony capitalism due to the growing economic power of the chaebols and the financing needs of the political game played by the small team in power.

The car industry, an important component of the HCI programme, which finally produced Hyundai’s Pony for the domestic market and then Latin America, is a good example of the intertwining of chaebols, Park and his close collaborators, powerful state executives in key positions, politicians, and foreign multinational companies.

The story starts in the 1960s, when car assembling companies were launched as a substitute to car imports. Various chaebols were present at this time, supported by a particular political faction and associated with foreign constructors. According to the competition model imposed by Park, three chaebols competed in the domestic market, which was much too small to exploit economies of scale. Even so, protection made the business highly profitable and fed both the chaebols and the political factions behind them. The EPB then imposed an increase in the number of locally produced parts and, a little later, requested the creation of a local engine plant for the whole industry, which would benefit from generous subsidised credit and access to guaranteed foreign loans. Competition then took place between a chaebol, Sinjin, partnering with General Motors, and Hyundai, initially associated with Ford and later with Mitsubishi. Because Hyundai intended to produce not only a local engine but a full car, it finally won the deal and benefited from additional help from Park’s cabinet, drawing on the newly created National Investment Fund, based on compulsory deposits of savings collected by non-bank financial institutions. The Pony car was launched in 1975 in the domestic market, while Sinjin continued to assemble General Motors cars, which were now much less popular than the national brand. Other assemblers went bankrupt in the process.

The provisional end of the story is that Hyundai almost immediately sought to export the Pony to gain in economies of scale. The car was shipped to the Central American market. Yet, despite its record low price – in large part thanks to the huge subsidies received from the state – the car was of bad quality and exports failed to pick up. Advanced countries’ markets were inaccessible because high marketing barriers and the low quality of the Pony. It took several years and the mediation of Japanese companies for Hyundai to enter the low end of the US market around 1985.

Even before the assassination of Park in 1979, the central government had lost its hold over the chaebols. They had become ‘too big to fail’ and enjoyed extensive freedom with respect to the government. Some of them had incurred big losses in several failed ventures and could not repay their huge debts. Yet they controlled too many activities and employed too many people to allow them to go bankrupt. They were generally bailed out by the nationalised banking system. It was only after the death of Park, and with a lot of difficulty, that the fabric of the chaebols could be rationalised through mergers in order to reduce this kind of risk.

Meanwhile, the state-owned steel company POSCO, heavily subsidised throughout its first years of existence, had been able to achieve international competitiveness, in large part thanks to Japanese technological support. By 1981, it was supplying not only the domestic market but also the Japanese market.

It is difficult to evaluate the exact contribution of the HCI drive to South Korean development. Judging from the following decades of industrialisation it looks like a resounding success. Yet, as suggested by the preceding examples, it was costly, not only in terms of the various business failures it produced, by the cronyism it triggered, and the economic inefficiency it generated when various chaebols competed in markets that were too small for them, but also the damage it caused to the rest of the economy, especially to the SMEs that were unable to obtain resources in a banking system almost entirely devoted to the chaebols and SOEs. Yet success was undeniably there. Exports increased by US$18 billion – representing a stunning rate of annual increase of 22 per cent in volume – between 1970 and 1980, with a large and increasing contribution of heavy manufacturing and with the positive effects seen above on the whole economy. The lingering question, however, is whether the same result could have been obtained with another strategy that would have extended the light manufacturing drive, which had been so successful in the 1960s and continued to be so in the 1970s progressively towards more capital-intensive activities instead of this abrupt dive into heavy industry.

VI An Institutional Diagnostic of South Korea in The Mid-1970S

It is a challenge to produce a diagnostic of a country that did so well on both the economic and social fronts as South Korea, even when considering the country at a time when its development level was comparable to that of contemporaneous lower-middle-income countries. It is indeed tempting to say that the country got everything right. Looking at it from the standpoint of the late 1970s, however, the feeling might have been somewhat mixed. Analysts in those days would have been looking at a country that had taken off thanks to a specific set of institutions, initial conditions, and a strong will to access prosperity after half a century of privation, a country that took its chances as a labour-intensive manufacturing exporter with phenomenal discipline and effectiveness. However, they would also have noticed some late changes in the way the country and the economy fared. Success was still as phenomenal as it had been before, but the governance of the country had changed somewhat, with an omni-president running the country together with huge business groups about to become multinational corporations and intending to push the country forwards in a kind of breakneck race. As a matter of fact, a setback was not far off when Park was assassinated. The 1979 oil price boom revealed major weaknesses in the South Korean economy inherited from the heavy industry programme that had been pursued in the preceding years: a huge foreign debt, a high rate of inflation, a nationalised banking sector crippled by non-performing loans (NPLs), some major chaebols that were near bankruptcy (with potentially explosive effects on the whole economy), and possibly a change under way in the international trade order, with the second doubling of oil prices in a few years.

In view of such a situation, it seems logical to articulate an institutional diagnostic of South Korea in the late 1970s in two parts: one relating to the institutions built since the creation of the Republic of Korea, and the causes of their success in setting its remarkable export-led growth path; and another focusing on the changes that are perceptible when looking more carefully at the 1970s.

The ‘diagnostic table’ (Table 5.3) has been developed following the same principles as those used in the case studies of the IDP project, with a central column listing readily observable institutional strengths and weaknesses, a column to its right listing the main economic consequences, a column to its left listing their major proximate causes, and, finally, an additional column on the left-hand side listing the deep factors behind those causes. Note that, for the sake of conciseness and simplicity, no representation has been made of the causality relationships between the various items in each column for a given period. In effect, causality applies among whole sets of items in the various columns, rather than among items on the same row.

Table 5.3 Institutional diagnostic table for the three periods of South Korean development until 1979

Deep factors	Proximate causes	Institutional strengths and weaknesses	Economic consequences
	First and Second Republics (1953–1961)
Education level	Reconstruction period	Imprecise long-run strategy	Slow growth
	Weak political regime	Rent-seeking and corruption	Weak macro policy (over-valuation of the currency, inflation)
Homogeneity		Land reform	Key role of imports
	Junta and Third Republic (Park civilian regime): 1962–1971
War legacy	Military-style National Revolution	Effective planning cum market system	Explosive labour-intensive export-led growth
	Japanese development template	Control of the financial system	Fast structural transformation
Northern threat	Foreign aid	Efficient and disciplined bureaucracy	Contained inequality
		Clever export-led industrialisation incentive system	Foreign lending/debt
Difficult democratic learning process		Presidential control of big business	Increasing concentration of business sector
		Crony oligopolistic capitalism	Infrastructure development
		Repression of social movements
Foreign influence	Fourth Republic (Park authoritarian regime, 1972–1979)
Japan	Park’s HCI objective	Centralisation of decisions around Park (bypassing planning design)	Move towards heavy industry exports (HCI)
US	Signs of elite capture	Autonomisation of chaebols (‘too big to fail’)	Booming exports and GDP growth
		Further concentration of production apparatus	Successful major industrial projects (POSCO)
		Excessive distortion of market mechanisms	Further development of infrastructure
			Mounting foreign debt
			Critical situation of some chaebols

The originality of this table for South Korea is that it is broken down into three periods – the same periods that were used to organise the discussion in the preceding pages. The reason for this lies in the deep differences in the way institutions functioned in South Korea during the post-war period, during the period of the junta and the first Park terms, and the period after the Yushin constitution, which gave quasi-dictatorial powers to Park. Sticking to the strict diagnostic exercise announced at the beginning of this chapter, it might have been sufficient to focus on the last period. Enlarging the lens allows us to see the evolving nature of institutions and how the way they were defined and worked in a given period affected how they would perform in the next period. For instance, the 1961 military coup in South Korea and the type of institutions set up by the military junta and then by Park’s administration cannot be understood without some knowledge of the previous period. Likewise, the situation in the late 1970s, which is the core subject of our inquiry, can only be apprehended by reference to the institutional setting and economic success of the preceding period.

The various entries in the table for the first two periods, as well as the list of ‘deep factors’, have been discussed at some length in the preceding pages and do not need further comments. The table essentially summarises what factors explain South Korea’s remarkable development throughout the 1960s. Yet those entries will be helpful below in producing a diagnostic of the last period.

Examining South Korea in say 1978, at the time when its income level was roughly comparable to that of Bangladesh, Benin, Mozambique, and Tanzania in 2020,²³ and scrutinising it in the same way as we did for those four countries, what would be our conclusion?

The first conclusion is obviously that in the span of a few years South Korea had developed an institutional setting that was particularly effective for development purposes. While its income level was perhaps comparable to the IDP case study countries today, it could count on huge advantages in terms of the educational level of its population, an effective and competent bureaucracy, and major infrastructure capital. It could also rely on an effective economic policy machinery, based on a planning bureau populated by high-level experts and a network of correspondents in the presidency, the ministries, state agencies, and nationalised banks.

Even though it was also set to evolve, this institutional setting was an enormous asset for future development. It was itself the joint result of various factors: (i) an ethnically homogeneous population eager to get out of dire poverty after forty years of Japanese rule and three years of a deadly war, and frustrated by an ineffective and highly corrupt government; (ii) an army that, implicitly siding with the population, had carried out a coup and installed a junta willing to operate a radical change in the way the economy worked; (iii) the Japanese model of development, which was well known to the leaders of the junta, that could be used as a template; (iv) a well-trained elite and a sufficiently educated population that could form a competent bureaucracy; (v) the rivalry with North Korea; (vi) the support of the United States; and (vii) a gifted, clever, ambitious, and patriotic leader. In a few years, and based on a vigorous export-led strategy, the South Korean economy had taken off.

Signs did exist in the 1970s that the machinery was evolving. First, centralisation had strengthened, and the planning entity had lost some power in favour of the president’s office, in an effort by the latter to impose the HCI programme, which was far from consensual among top experts in the planning bureau and other administrative entities. Park’s obsession with the HCI programme had much to do with some of the ‘deep factors’ listed in the diagnostic table. The hostile relationship with the Northern neighbour would at some stage make armament production necessary in the South, which would require massive heavy industry inputs, steel in the first place. Also, North Korea boasted a steel industry, which caused South Koreans to feel somewhat ashamed of their apparel, wig, and footwear exports. Finally, was it not the case that the steel industry had been a key factor in Japan’s development and its military power?

Park’s strong will to move on with the HCI programme to intensify industrialisation and to continue with hypergrowth was also behind the constitutional change that gave him quasi-dictatorial power (on top of the more obvious objective of muting the opposition and democratic forces). Yet this move towards heavy industry exports entailed changes in the relationship between the president and the chaebols, which were the spearheads of this new strategy. They had already acquired considerable economic power in the previous period. The intensification of industrialisation, which could not rely on medium-sized enterprises, gave them still more power. At the same time, because of their earlier success in international markets, they had acquired considerable autonomy with respect to the central power, through their size, the holding structure they adopted to control a batch of very diverse activities, and through their links with multinational corporations in domestic and foreign markets. Given the huge financing facilities granted to them by the central power, they were able to keep expanding, sometimes in extremely risky ventures, following their own strategies. Paradoxically, the centralisation of economic power in the presidency came with some loss of control over the chaebols. In addition, the chaebols were also important in providing resources that allowed Park to pursue political objectives at a time when the opposition, labour unions, and civil society were gaining vigour, in part as a result of the astounding economic progress of the past fifteen years or so.

More autonomous, because more economically powerful, and essential for the continuation of fast economic growth, the chaebols apparently did not enter the political game. Thus, it would be an exaggeration to refer to elite capture. What seems certain is that they implicitly had a say in regard to economic policy, which had not been the case a few years before. In effect, by the late 1970s South Korea was converging with those modern societies where captains of industry or CEOs of major companies are at the same time the vectors of economic activity and progress as well as major interlocutors – and in some cases economic guides to governments. Such an evolution was not necessarily negative, even though it did not fit well with an authoritarian regime.

Another consequence of the huge advantages given to the chaebols to enable them to perform their breakthrough in heavy industrial exports was a deeply distorted financial market, where state-owned banks could not fully play their role of efficient resource allocation agents because of the huge funding requirements needed for the chaebols’ ventures and, in some cases, for bailing them out. Such financial repression by the central power could have been very effective in the 1960s at the time when the manufacturing export engine needed to be kickstarted, but it was not adapted to an economy whose volume had quadrupled and whose citizens were now three times richer.

The years after Park’s death were difficult ones, not least because of the second oil price boom, which severely affected the heavy industry due to its energy needs, but which also revealed weaknesses in the economic fabric woven by the chaebols. Under Chun’s dictatorship, several years were needed to put an end to the ‘everything goes’ attitude that had prevailed during the last years of Park’s era, and to restructure the chaebols into a sustainable but still fantastically effective driver of industrialisation and development, thus ensuring the final success of Park’s risky HCI bet.

VII Conclusion

Retrospectively, General Park’s leadership was decisive in setting South Korea on a development trajectory that led the country from lower-income country status in the early 1960s to being admitted to the OECD club of rich countries less than forty years later. There was still a long way to go when he was assassinated, and the path has not always been an easy one. Without the vigorous take-off of the 1960s under Park, however, it is unlikely that South Koreans would have attained the prosperity they enjoy 60 years later.

The development of South Korea in the 1960s should indeed be an example for least advanced countries (LACs) today. As poor as some LACs are today, South Korea was very much disorganised after passing through a major conflict, was without natural resources, had no clear development strategy, and was home to a corrupt regime, but a radical turn towards a labour-intensive manufacturing export strategy was taken in two or three years and propelled the economy on a rocket-speed development trajectory. Its key assets on that journey were a capable and disciplined bureaucracy, a dynamic entrepreneurial class, a population eager to learn, and effective and smart (although authoritarian) stewardship.

The debate will probably still last quite some time about whether the authoritarian nature of that leadership should be considered as another favourable asset in the early development of South Korea. From an economic point of view, however, the point may not be so much the nature of the political regime but rather the stability that it brought, in contrast to what had been observed in the previous post-war period.

With the Japanese development model in mind, but short of funds, South Korea was able to exploit all opportunities that arose to increase the resources that could be invested in its development. But it is certainly in its management of the business sector and the attribution of what could be called ‘conditional rents’ that the country was most innovative and successful. Providing heavily subsidised funds and other advantages to light manufacturing exporters conditionally on reaching predefined objectives proved highly effective. The same can be said of the competition imposed later on chaebol conglomerates in the conquest of foreign markets in heavy manufacturing. Yet this strategy would not have succeeded without a skilled and transparent bureaucracy that was able to tightly monitor business. Even though it was successful, however, it must be recognised that this strategy was a real bet. It could have failed, which would have had dramatic consequences for development.

It also bears emphasis that the South Korean economy was not devoid of corruption. Business was also often asked to contribute to the campaigns of top politicians, including Park himself, to such an extent that towards the end of his era the chaebols had acquired real leverage over the government, which made regulating them less effective. As a matter of fact, this culture of corruption has not completely disappeared, as can be seen from the numerous scandals that continue to tarnish South Korean political life. In the case of South Korea, however, this might appear more the consequence of a successful development strategy based on the relationship between the state and business than as a handicap for the implementation of such a strategy. This does not mean it is costless, of course.

A last lesson of South Korea’s early development for today’s LACs concerns the distribution of income and the accumulation of human capital. Not only was the degree of inequality moderate by developing country standards, but it was remarkably constant. This low level of inequality is to be related in part to the land reform that was implemented upon the departure of the Japanese colonisers, but also to the homogeneous progress of education within the population throughout this period. In addition, there was a constant concern on the part of the leadership to avoid mounting imbalances between the rural sector and the highly dynamic manufacturing sector and ancillary activities in urban areas. This relative stability of the distribution of income permitted economic growth to translate immediately and effectively into the reduction of poverty. At the same time, it did not prevent democratic movements forcefully expressing their discontent whenever possible in the face of essentially autocratic regimes – until democracy finally prevailed.

6 Directed Development with Mixed Firm Types Taiwan

I Introduction

There are several reasons why development scholars should be interested in the case of Taiwan. As one author has written: ‘It once had a single dominant party following the Leninist model; it now has a competitive multiparty system. It was once a classic economic dependency relying on the sale of primary products (sugar and rice); it is today a leading exporter of manufactures. Its Land-to-the-Tiller programme offers one of the most successful examples of creating a foundation for social equity and balanced growth’ (Chan, 2002: 174–5).

The achievements of Taiwan are so varied and impressive that it is justified to talk about ‘Taiwan’s development miracle’. After presenting some of the most salient achievements we will search for explanations behind them; thereafter, we will raise the key issue of their replicability in different contexts. Important indicators of Taiwan’s success are as follows:¹

1. a. Fast economic growth: The gross national product (GNP) grew at an average of 8.8 per cent between 1953 and 1986, and per capita GNP at 6.2 per cent during the same period. As a result, the relative gap in per capita income between Taiwan and most advanced economies was narrowed down at an amazing speed. Thus, while in 1971 the per capita income in Taiwan represented hardly more than 8 per cent of the per capita income in the United States, its share rose to a staggering 39 per cent twenty years later (in 1991). In the early 1990s, per capita income in Taiwan exceeded that of Greece and Portugal but was smaller than that of Spain. In the 2020s, Taiwan occupies the fifteenth position in the ranking of the world’s countries in terms of gross domestic product (GDP) per capita.

2. b. Fast economic growth, accompanied by unusually equal income distribution: Incomes in Taiwan are much more equally distributed than in the typical developing country and more equally distributed than in some rich advanced countries, such as the United States and Japan (and South Korea).

3. c. Rapid improvements in material welfare: In 1982, already, almost all households in the country had electricity, televisions, refrigerators, and motorcycles, while two-thirds had piped water, telephones, and washing machines.

4. d. Remarkable speed of the demographic transition: The rate of population growth decreased from 3.5 per cent in 1953–62 to 2.9 per cent in 1963–72, 1.9 per cent in 1973–82, and 1.2 per cent in 1986 – that is, a two-thirds fall within about thirty years.

5. e. Rapid increase in life expectancy, school enrolment, and literacy: Between 1960 and 1977, Taiwan, together with Hong Kong, performed better in both life expectancy and literacy than all other cases in a sample of 100 developing countries, both market and non-market (Communist) countries. By 1982 life expectancy at birth was seventy-five years for women and seventy years for men. Moreover, virtually all primary school-aged children went to school, almost all of them went on to junior high school, and 80 per cent of senior high school graduates went on to schools of higher education.

6. f. Rapid increase in earnings from manufacturing industries: Real earnings in manufacturing increased at a rate of 15 per cent a year between 1960 and 1980, a period during which Taiwan embarked on industrialisation.

7. g. Strong competitiveness in international trade: Taiwan is one of the most trade-dependent countries in the world (behind Hong Kong, Singapore, and some small petroleum exporters), and from being a leading exporter of agricultural products it has become a leading exporter of increasingly sophisticated manufactured products (most noticeably, TSMC, from Taiwan, is one of the world’s leading chipmakers in the 2020s). While in 1955, 85 per cent of Taiwanese exports consisted of agricultural or processed agricultural products, based mostly on rice and sugar, industrial products made up no less than 90 per cent of total exports around 1990.

8. h. Taiwan’s economic transformation happened within a short time period of twenty-five years in a context of remarkable macroeconomic stability, without inflation and without recession. A milestone in Taiwan’s development was its relaxation of stringent foreign exchange controls that had been in place for four decades and which had made Taiwan’s foreign exchange reserves the world’s biggest after Japan (by 1987).

9. i. Political liberalisation and the democratisation of the country was initiated by the one-party state itself, and proved to be effective and sustainable.

These stunning aspects of Taiwan’s performance have been achieved despite a number of adverse initial conditions. Let us mention the most important of these. First, the newly independent Republic of China had to accommodate a massive influx of immigrants from mainland China who relocated to Taiwan after the defeat of the nationalists against the Communists.² (In this respect, the situation of Taiwan closely resembles that of newly independent Pakistan, where immigrants from India settled in big cities and initially dominated politics.) The process did not go smoothly, and an ethnic conflict broke out which was caused by the seizure of political power by the mainlanders. This was despite the fact that the islanders had originally come from China two or three centuries before (Wade, 1990a: 232). Riots quickly erupted and a harsh repression followed, which saw 30,000 Taiwanese people killed in early 1947. In 1949, martial law was declared by the Kuomintang (KMT), the party of the Nationalist immigrants from China, which was to last for thirty-eight years and was used as a way to suppress the political opposition during the years it was active. During the White Terror, as the period is known, 140,000 people were imprisoned or executed for being perceived as anti-KMT or pro-Communist. Many citizens were arrested, tortured, imprisoned, and executed for their real or perceived link to the Chinese Communist Party. Since these people were mainly from the intellectual and social elite, an entire generation of political and social leaders was decimated. On the other side of the coin, a large number of the migrating mainlanders were trained and experienced professionals.

The second adverse initial condition faced by Taiwan is the fact that although the country is comparable in size to Belgium or the Netherlands, it has much less arable land and many more people to feed. The first feature is the result of the fact that two-thirds of the country is mountainous. To make things worse, not only does Taiwan have a rugged topography, but many of its agricultural soils are also of rather poor quality. As for the second feature, Taiwan started with a high population density that was partly attributable to the massive immigration from mainland China. This exceeded 230 people per square kilometre in the early 1950s (reaching 572 people per square kilometre in the early 1990s), which translated into a very high level of effective land pressure given the aforementioned soil characteristics. Finally, the country is endowed with few mineral resources and small quantities of natural gas.

How did Taiwan succeed in overcoming these adverse conditions to engender a continuous and rapid development process that has been considered almost miraculous? To what extent can we attribute the country’s success to other initial conditions that were favourable: in particular, the broadly impressive Japanese colonial legacy, and the massive financial and technical aid received from the US government, which in the 1950s equalled 43 per cent of gross investment (Chang, 1965: 152)? And to what extent is the success traceable to efficient institutions and policies? It is impossible to answer these questions since the specific contributions of these factors cannot be adequately disentangled. What can be convincingly argued, however, is that Taiwan has successfully exploited the available opportunities and the advantages it had at its disposal at the start of its development process. As will become clearer in this chapter, both the strategic and institutional choices made by the Taiwanese government, whether helped by US advisers and the Japanese legacy or not, displayed a remarkable degree of pragmatic wisdom and consistency. Moreover, they were backed by strong political resolve and a highly competent administrative machinery. In the following sections, we start by looking at the deep transformation of agriculture and the rural economy initiated in Taiwan after independence. Thereafter, we will try to understand in what ways the Taiwanese state has been a developmental state, a mixture of relation-based authoritarianism, a devoted and competent bureaucracy, and a state apparatus immune from pressures from private interests.

II Transforming The Rural Landscape

A Taking Stock of Impressive Achievements

One of the great challenges of development, as seen by Ragnar Nurkse (1953) and Arthur Lewis (1954), is how and how fast the surplus labour existing in a large low-productivity sector, whether it consists of agricultural or other informal economic activities, can be absorbed in a modern or formal high-productivity sector, typically industry (and associated services). What Lewis has called the ‘turning point’ or the ‘commercialisation point’ is the threshold beyond which the two sectors start competing with each other on an equal footing: that is, the high-productivity sector must be ready to raise its wages to be able to attract labour from the low-productivity sector. At this point, there is no more excess labour in the latter and labour productivity increases in both sectors. Development is under way. Another related way of defining the turning point is when the absolute size of the agricultural labour force starts declining in absolute terms despite a positive natural growth rate of the rural population.

What do we find for Taiwan? Although an ever-increasing number of farmers left agriculture to live and work in growing urban areas, the population pressure on farmland was severe, especially during the early 1950s (Fei et al., 1979: 46–7). Thus, the agricultural population increased by one-third between 1952 and 1964 (from 4.26 to 5.65 million people) and, since the total farmed area stayed more or less constant, this meant that the average farm size fell to about 1 hectare (from 1.3 hectares in 1952). A few years later, however, the size of the absolute population engaged in agriculture reached a peak of 6.15 million (in 1969), from which point it started to decrease sharply – in particular, until 1975, when it was only 5.3 million (Thorbecke, 1979: 185). The labour slack that had prevailed during the years 1950–65 had gradually become exhausted: thus, total worker-days of labour in agriculture dropped from a maximum of 306 million in the years 1966–8 to about 285 million in 1973–5. This was the combined effect of a reduction in the number of worker-days per average worker and of the total number of agricultural workers.

The occurrence of the Lewisian turning point in the second half of the 1960s is confirmed by the rise in the same period of the agricultural wage compared to that of factory workers (Thorbecke, 1979: Thorbecke, 1979: 185–6). Moreover, labour costs became the fastest growth component among all agricultural inputs and, as expected in these conditions, the multiple cropping index (i.e., the ratio of planted area to cultivated area), after reaching a peak of 187 per cent in 1965–9, decreased steadily to 139 per cent in 1985–9 (Wu Huang, 1993: 51). Logically, the drop in the share of the agricultural population in the total population fell even more dramatically than the absolute number of agriculturalists, namely from more than 52 per cent in 1952 to hardly more than 15 per cent in 1985–9 (Wu Huang, 1993: 51).

What did Taiwan do to bring about the advent of the turning point in such an exceptionally short period of hardly more than fifteen years? Did the transformation process conform to the Lewis (and Nurkse) model, in which the expansion of a modern (and urban) sector gradually absorbs the surplus labour released by a stagnant traditional (and rural) sector? In sum, the answer to the first question lies in the conjunction of rapid technological progress in agriculture and an unwavering drive towards rural industrialisation – two engines of change supported by purposeful policies and strong institutions. While the former force led to increases in land productivity followed by increases in labour productivity, the latter gave rise to a steady expansion of off-farm employment opportunities. The same factors are behind the answers to the second question and imply that the Taiwanese pattern of development does not strictly confirm the predictions of the Lewisian model.

The socioeconomic environment in which the structural changes occurred had itself been deeply transformed by an ambitious land reform programme which Taiwan’s government embarked upon soon after independence, and which produced one of the most effective land redistribution schemes seen in the whole developing world after World War II. Its initial motivation was mainly political: the government, dominated by Chinese mainlanders and strongly authoritarian, wanted to buttress its legitimacy by winning widespread support among the rural masses of the island. Giving the bulk of rural dwellers making up the island’s population, a stake in the new regime was the way that was chosen to achieve this result (Wade, 1990a: 241). It also helped a great deal that the KMT’s ‘catastrophic learning experience’ on the mainland convinced its leadership that failure to carry out land reform in (mainland) China had been a crucial mistake that must not be repeated in Taiwan. In the specific context of the latter country, land reform was the easier to implement as the social status and prestige of the local landlord class had been irretrievably dented by their active collaboration with the Japanese colonial authorities (1895–1945).³ Moreover, strong opposition by Taiwanese landlords was not feared by the new government because these landlords had been greatly intimidated by the violent suppression of dissent during the chaotic interregnum of 1945–7, and they knew that the regime was not beholden to their interests (Park and Johnston, 1995: 197–8). The undertaking turned out to be a major success, both in terms of its political objective and in terms of reducing inequality and boosting economic performance. The rural inhabitants thus became staunch and obedient supporters of the regime, at least during the first decades, while the landlords were forced out of agriculture. Rural inequality was dramatically reduced.

Regarding economic achievements, it is admittedly impossible to say whether the route chosen was more or less conducive to growth and development than what a hypothetical modernisation process based on the extant feudal structure would have been. What can be confidently asserted, however, is that given the path chosen, maximum effectiveness was probably attained by means of the policy and institutional strategies followed to emancipate small cultivators. Going one step further, a long tradition of development economists argues that small farms are more efficient than large farms under conditions of land scarcity and labour surplus (see Mill, 1848; Sen, 1960, 1966; Schultz, 1964; Chayanov, 1966; Berry and Cline, 1979; Feder, 1985; and, for a survey, Ray, 1998: 446–55).⁴ For them, the idea that an alternative policy anchored in big feudal farms could have yielded better economic results just makes no sense. This is especially so because rice is traditionally the main staple food in Taiwan, and is a labour-intensive crop that, moreover, requires much care (i.e., not only the quantity but also the quality of labour matters). It is therefore particularly suited for small-scale agriculture in which the cultivator is the residual claimant. Revealingly, already in the 1920s and 1930s, when Taiwanese farmers adopted the high-yielding ponlai rice varieties, large landowners found it advantageous to rent out land to them in small parcels to be farmed intensively (Park and Johnston, 1995: 199).

On the other hand, rice being regarded as a wage good, a sufficient supply was necessary for economic stability and as a hedge against inflation. These objectives were of paramount importance given the bitter experiences of the food shortages and hyperinflation of the 1940s, which contributed to the loss of the Chinese mainland. As one author has written: ‘Against this historical background, Taiwan’s agricultural policy gave the highest priority to price stability and food production for basic foodstuffs, especially rice’ (Wu Huang, 1993: 54).

We can now proceed by examining the Taiwanese strategy for rural development in more detail.

B Radical Land Reform

The land reform process was implemented quickly but in three gradual stages: rent reduction, public land sales, and the Land-to-the-Tiller Programme. These three steps had the drastic effect of converting in a very short period a landlord-tenant system to owner-cultivator agriculture based on small farms (see Koo, 1971; Thorbecke, 1979: 172–6). Initiated in 1949, the rent reduction programme limited farm rents to a maximum of 37.5 per cent of the annual yield of the major crop. This ceiling was significantly below the 50 per cent level historically practised in the more fertile areas. The immediate effect of this measure was to improve the lot of the tenants, while correspondingly reducing the incomes of the landlords and land values. The second stage of the reform consisted of the sale of public land that had been acquired after World War II from the Japanese colonisers. This land was made available for purchase by farming families and, to encourage the ‘equalisation’ of land ownership, the quantities that could be acquired by a single family were strictly limited.

Finally, the third and most important step in the land reform process was the Land-to-the-Tiller Programme, promulgated in 1953. It provided that any land in excess of 2.9 hectares was to be confiscated by the government and redistributed. The effect was to practically eliminate the upper tail of land distribution and to drastically reduce the proportion of tenants.⁵ In the absence of a sizeable landless class, the transformation of non-owners of land into peasant owners did not cause the average farm size to be unviable. As for the landlords, they were compensated in two ways: they received commodity bonds carrying an interest rate much smaller than the market rate, and shares of stock in four big industrial firms. The monetary value of the compensation was calculated as the equivalent of 2.5 times the annual yield of the major crop, which was considerably below the average market value of paddy fields. Ho (1978: 271–4) estimated that the resulting wealth redistribution effect represented approximately 13 per cent of Taiwan’s GDP in 1952. He also calculated that the increase in the income of the average tenant between 1948 and 1959 (the year in which he would become an owner-cultivator) was about 6.5 times higher than what it would have been had he remained a tenant benefiting only from the rent reduction measure (increases of 107 per cent and 16 per cent, respectively). Because landlords promptly sold their industrial stocks at prices far below value, and because a large portion of the proceeds went to consumption, the majority of them ended up being not much better off than the new owner-cultivators (Yang, 1970, cited from Fei et al., 1979: 43).

As we have learned from numerous disappointing experiences of land reform across the world, a redistribution of land can achieve its objectives only if effective accompanying measures are set in place as early as possible to raise farm incomes through increased land productivity (see, for example, Kikuchi and Hayami, 1978). On this level, too, Taiwan was remarkably successful. The complementary measures were not only designed and implemented almost immediately after land had been redistributed, but they were also comprehensive and supported by strong institutions, resulting in continued output growth during the transitional period and later. During the 1952–64 period, the net agricultural output grew by an impressive 80 per cent (5 per cent a year): that is, at a much more rapid pace than the agricultural population, which increased by about one-third (Fei et al., 1979: 47–8). This included infrastructural investments, such as in irrigation and feeder roads; the provision of credit and extensive services; the organisation of input delivery (chemical fertilisers, high-yielding seed varieties adapted to local soil conditions, water pumps for drainage, etc.) and output marketing; price stabilisation; and, last but not least, the strengthening and transformation of the farmers’ associations inherited from the Japanese colonial period (Cheng, 2001: 21). Also noteworthy are the considerable resources put into agricultural research. Thus in 1960 Taiwan had 79 agricultural research workers for every 100,000 persons active in agriculture, compared with 60 in Japan, 4.7 in Thailand, 1.6 in the Philippines, and 1.2 in India (Fei et al., 1979: 49).⁶

Agricultural development in Taiwan did not only result from well-thought-out policies but also from strong support organisations. The Chinese–American Joint Commission on Rural Reconstruction (JCRR), which was almost totally financed through US aid funds, played a critical role in agricultural research, extension, and innovation, as well as in the planning and implementation of Taiwan’s strategy for agricultural growth. The JCRR was a major catalyst for harnessing resources and ensuring their best use within the perspective of an owner-cultivator model of rural development. Since it was insulated from the daily political and bureaucratic pressures of the relevant ministry or administration, the JCRR could take a long-run view of the whole process (Thorbecke, 1979: 201–2). In this respect, the importance of the international context, and the Cold War in particular, cannot be overestimated. Whereas the United States helped to introduce radical social and economic reforms in its Cold War allies in East Asia, it tended to be a conservative influence working against such changes in Latin America (Chan, 2002: 183). This differential approach is explained by the presence of a serious threat from Communism in the latter region, and its near absence in the former.

In addition, as pointed out by Eric Thorbecke (1979: 181): ‘Perhaps the most noteworthy feature of agricultural planning in Taiwan has been the attempt at local participation. Starting with the First Plan, government agencies were required to specify goals on a county-by-county basis in consultation with local people and taking local conditions into account’. Whereas the farmers’ associations and credit cooperatives set up by the Japanese to facilitate agricultural extension were top-down institutions dominated by landlords and merchants, the Taiwanese government and the JCRR decided to organise farmers into multipurpose farmers’ associations whose membership was restricted to cultivators, to serve their exclusive interests. These were gradually expanded to include not only irrigation associations but also a credit department, which not only granted loans to farmers but also accepted deposits from them, and to provide facilities for purchasing, marketing, warehousing, and processing. In the words of John Fei and co-authors (1979): ‘The associations thus became clearing houses for farmers, who controlled and maintained them and viewed them as their own creatures’ (p. 45). At the same time as these associations grew in importance, credit became available to farmers from the JCRR, government-owned banks, and government agencies catering to the needs of farmers. That their entry into the rural credit business was effective is attested to by the fact that farm loans provided by the official channel and formal institutions soon came to represent the lion’s share of the total (Ho, 1978: 179–80). The close relationship between farmers and their local multipurpose associations thus played a major role in promoting agricultural development by reducing liquidity constraints and transaction costs (Park and Johnston, 1995: 200).

If it is true that the farmers’ associations were tightly controlled by the Nationalist party in power, it is equally true that the party was eager to involve the farmers in order to best meet their needs. Additional functions serving the same purpose were also fulfilled by so-called public service centres, of which there was one for each township. Staffed by full-time party officials whose job was to ensure that things evolved in line with the party’s interests and recommendations, they included an extension section that organised farming study groups, training courses, and demonstrations (Wade, 1990a: 242; Park and Johnston, 1995: 200).

C Rapid Technological Change in Agriculture

The problem of land pressure was overcome in three ways: through substantial increases in land productivity at the intensive margin; through the diversification of agricultural production into more profitable crops; and through the part-time reallocation of labour to off-farm activities. In this subsection we deal with the first two points while the third one is deferred to the next subsection.

Increases in agricultural production stemmed from two sources: increased yields in traditional crops, such as rice and sugar, and the introduction of new crops. The first result was obtained thanks to a combination of factors. One of these consisted of the expansion of fixed capital, which increased by one-third during the years 1952–64, mainly as a consequence of investment in irrigation and flood control facilities and of the introduction of small tillers to replace water buffalo, and other small mechanical devices. Moreover, and thanks to the adequate supply of credit, working capital grew even more dramatically than fixed capital (by as much as 140 per cent during the same period), reflecting the continuous introduction of new seed varieties, chemical fertilisers, pesticides, insecticides, and commercial feeds. What bears emphasis is that the technological change was generally of the labour-intensive and land-and-capital-saving type. This effect was reinforced by the shift to more labour-intensive crops, such as vegetables, some of which – for instance, mushrooms and asparagus – require considerable amounts of labour per land unit (Fei et al., 1979: 48–50; see also Lee and Chen, 1979).⁷

Finally, thanks to the considerable attention given to agricultural growth and development, substantial savings could be transferred from agriculture. The net real capital outflow from the agricultural sector in the form of rents, interest payments, taxes, and others was positive throughout the pre-turning point period. More specifically, the compulsory purchase scheme for rice, and the rice-for-fertiliser barter programme, were implicit taxes that exceeded the total income tax of the whole economy almost every year before 1963 (Kuo, 1975: 161).

A major lesson to keep in mind is that, during the critical period which preceded the reaching of the Lewisian turning point, when agricultural population continued to increase (although at a reduced pace), the number of working days per worker steadily increased while the number of working days per hectare of land rose even more dramatically (from 170 in 1948–50 to about 260 in 1963–5).⁸ This being said, the smaller farms remained unable to generate sufficient income, or to keep the entire family workforce fully employed, and, for them in particular, the availability of off-farm income-earning opportunities was of great consequence. Since the average farm size more than halved between 1940 and 1970, it was also helpful for many other farming households. In 1970, 44 per cent of Taiwanese farms contained less than 0.5 hectares of cultivated land (Ho, 1979: 88).

D Rural Industrialisation

Equally remarkable was the success achieved by the government’s rural industrialisation programme, which really started after the mid-1950s. Between 1956 and 1966, manufacturing employment increased at a yearly rate of 7.2 per cent in rural Taiwan, substantially faster than the rate of increase in urban areas. Paradoxically, therefore, the share of the rural sector in the country’s manufacturing output increased during that pivotal transitional period leading up to the turning point. In 1966, agriculture employed just 54 per cent of the rural labour force while manufacturing employed 10 per cent (as compared to 20 per cent for urban Taiwan). Thanks to the decentralised industrialisation drive, an increasing number of farm households were able to combine farming with part-time or full-time employment in non-farm activities, thereby easing the pressure of the population on the land and reducing their incentive to migrate to cities.

In 1970, full-time farm households (those whose income was entirely obtained from agricultural activities) comprised only 30 per cent of all farm households (compared with 45 per cent ten years earlier), while those who earned more income from side-line activities worked out at 29 per cent (compared with 23 per cent ten years earlier). In addition, the proportion of family farm workers engaged in off-farm activities (for at least thirty days a year) increased from about 25 per cent to more than 31 per cent during the years 1960–70 (Ho, 1979: 88–9). The sector-wise distribution of farm household members who worked off their farms indicates that while one-third of them were engaged in activities associated with agriculture, fishing, and forestry (foremost among which were working as hired hands on other people’s farms, and fish culture), as many as 26.5 per cent were found in manufacturing and mining (with 11.7 per cent in commerce; 5.8 per cent in home handicrafts; and 5.6 per cent in public administration and education). Five industries represented the bulk of rural manufacturing employment: food, textiles and apparel, metal products, chemicals, and machinery and equipment. The rural areas absorbed the largest shares of the increase in employment between 1956 and 1966 in textiles and apparel (55 per cent), food (57 per cent), wood products (including furniture) (41 per cent), and non-metallic mineral products (63 per cent). Note that, as expected, rural industrial establishments had an average size smaller than their urban counterparts and they were also more labour-intensive (Ho, 1979: 83, 88–89, 95).⁹

The growing contribution of off-farm employment to farm household income is evident from the following evidence. From 1952 to 1972, the real income of an average farm household more than doubled, with the larger part of this increase being attributable to the very rapid growth in income from off-farm activities (a minor part was caused by rising agricultural productivity). More precisely, an average farm household earned 13 per cent of its income from off-farm sources in 1952, 25 per cent in 1962, 34 per cent in 1972, and 43 per cent in 1975. Revealingly, the income of farm families was strongly correlated with the share of their income obtained from non-agricultural sources. Access to sources of non-agricultural income was thus a key determinant of household welfare, especially for small farms which relied more on these sources than larger farms. Partly because of this inverse relationship between farm size and resorting to off-farm employment, the distribution of income among farm families became increasingly equal (Ho, 1979: 77, 90–2).

Two other interesting features deserve mentioning. First, a large number of farm household members obtained clerical jobs, an achievement that would have been impossible if the rural population had not been reasonably well educated. Second, a large share of those employed in full-time off-farm jobs were women (about 40 per cent in 1970). They were found in large numbers not only in home handicrafts activities but also in manufacturing and mining, where they comprised 42 per cent of the total number of household members employed full-time (Ho, 1979: 89).

The question naturally arises as to what enabled Taiwan to successfully implement a decentralised model of industrialisation. An array of factors were at play (see Ho, 1979: 93–5). To begin with, on the demand side, rural industrialisation was facilitated by the presence of a highly commercialised and productive agricultural sector, which provided an expanding demand for all sorts of non-food consumer goods and services, as well as for material inputs and capital goods used in agriculture. Being location-specific, most services demanded by farm households were locally provided. As for goods, those with relatively high-income elasticities, such as furniture, household utensils and furnishings, and clothing were produced in small to medium-sized firms operating in rural areas. In addition to a high level of agricultural commercialisation and technological development, two factors came to play a determining role in stimulating demand for industrial products. First, increasing rural incomes was a central policy goal of the Taiwanese government and it achieved a remarkable degree of success as early as the 1960s, despite consistent extraction of resources from the agricultural sector. Second, Taiwan enjoyed a low degree of income inequality (even before the 1949–53 land reform), thereby ensuring a large base for the expansion of demand linkages (Park and Johnston, 1995: 184–9).

Alongside this demand-side force, a series of supply-side factors must be mentioned. First, the government decided to continue the colonial Japanese policy of promoting large-scale agro-industrial firms in the countryside (in the colonial period, these were mainly sugar refineries). When the sugar industry went into decline (after Taiwan lost the protected market of Japan), efforts were directed towards the development of new food-processing industries, particularly the canning of vegetables and fruits, the entire production of which was exported. Second, the rural areas of Taiwan were blessed with effective infrastructure. For one thing, the rugged mountain chain that runs from the north-eastern corner of the country to its southern tip forced farms and the rural population to concentrate in the western part, an area endowed with a particularly well-developed transport system. As a result of massive public investments made by the government, combined with the infrastructure inherited from the Japanese, Taiwan came to enjoy not only a trunk road and a rail track connecting its two main port and industrial cities (Taipei in the north and Kaohsiung in the south), but also a very dense network of paved roads and highways, feeder roads, and railroads in its western portion.¹⁰ For another thing, rural electrification, which began early in Taiwan, had reached 70 per cent of its farm households by 1960.

Last but not least, Taiwan had human capital that was ready to support rural industrialisation. Here again the country benefited from the Japanese legacy. In the 1930s the colonial power had embarked on an intensive programme to educate the islander population, with a special focus on primary education in rural areas. After independence, this effort was actively pursued by the new authorities, so much so that, when rural industrialisation was initiated, a highly literate workforce was available all across the country (nearly 90 per cent of the total population over the age of six was literate).¹¹ In addition, two-thirds of the farm population had some formal education. A lack of semi-skilled labour was thus not an obstacle to the growth of rural industry. On the contrary, ‘a plentiful stock of disciplined, literate, and highly adaptable rural labour’ constituted the most valuable resource of the country and ‘an important nexus of agricultural-industrial interactions’ (Park and Johnston, 1995: 189–91). Also worth stressing is the important supply of industrial entrepreneurs, in rural areas particularly, who started their careers as agricultural workers, small agents, or traders for agricultural products, and as owners of small workshops (e.g., metalworking for simple agricultural tools), or who were the children of those occupying such positions (pp. 192–5). This echoes the way modern entrepreneurship historically developed in Japan and other Southeast Asian countries (Smith, 1959; Hayami and Kikuchi, 1982). It seems that over time many farmers became experienced users of markets, and acquired a good understanding of the functioning even of export markets.¹²

In the same connection, it bears emphasis that during the years 1952–86, the growth of domestic market demand was much more important than export growth in regard to labour absorption. In a dynamic context in which newly emerging sectors require time to gain experience and become internationally competitive, the importance of domestic demand as a predecessor of export demand appears to be critical.¹³ As we are aptly reminded by Albert Park and Bruce Johnston (1995), significant export sectors for manufactured products, such as the textile sector in a first phase of industrial development, began as relatively inefficient producers for the domestic market (pp. 183–4).

E The Subsequent Stage of Agricultural Transformation

Taiwan’s growth and development model clearly differs from the Lewis model. Whereas in the latter the rural sector is conceived as just a reservoir of labour that is underutilised in agricultural activities and is available for absorption in a dynamic urban industrial sector, in Taiwan growth was engineered simultaneously in the two sectors. In the rural sector, increasing income came not only from technological innovations and shifts in crop choice in agriculture, but also, and to an even greater extent, from the expansion of labour-intensive rural industries. As a result of these two forces, both land productivity and the productivity of household manpower grew steadily. Furthermore, with women’s increasing participation in off-farm employment expansion came a declining trend in fertility rates and rural population growth: the crude birth rate for the whole of the island fell from 37.7 per 1,000 inhabitants in 1961 to 27.2 in 1975 and 23.0 in 1979, a large part of this decrease being attributable to a fall in marital fertility. This trend accelerated when the demand for a smaller family size among the Taiwanese population was matched by an active official policy of family planning.¹⁴ Taiwan was thus unique in its capacity to reach, in an amazingly short space of time, the point from which rural real incomes increased and the rural workforce decreased in absolute terms.

From then on, the same forces continued to operate. In particular, the proportion of full-time farm households fell from 49.3 per cent to 13.0 per cent between 1960 and 1990. Moreover, in the latter year 30.0 per cent of these households were aged farmers who largely lived on transfers received from relatives or other sources. On average, off-farm income represented 63.0 per cent of the total income of all farm families in the late 1980s, up from 40.7 per cent in 1965–69. On the other hand, the increase in the real cost of agricultural labour resulting from growing shortages of rural labour induced a fall in the multiple cropping index, measured by the ratio of planted area to cultivated area (Wu Huang, 1993: 51–2).¹⁵

Government policy quickly adapted to the new circumstances: thus, the agricultural programme of the Fifth Economic Plan (1969–72) called for the improvement of labour productivity instead of land productivity, with the objective of raising the farmers’ income. This marked the end of the era of the so-called ‘development of agriculture to foster industry, and the beginning of a new chapter of agricultural policy aimed at shifting from taxing to subsidising farmers. At the same time, there was acute awareness of the need to enlarge the size of farm operations so as to increase the use of mechanisation and thereby overcome the labour constraint. Under the farm mechanisation programme initiated in the 1970s, the government underwrote half of the cost of grain dryers, power tillers, and similar equipment, in an effort to free more labour for non-agricultural activities (Park and Johnston, 1995: 201). But it was only later, with the second phase of the farmland reform programme launched in 1983, that the government officially stated its intention to encourage the consolidation of farm plots into larger entities. Because it was reluctant to modify the existing land ownership structure, and continued to adhere to rigid land regulations that prevented the emergence of an open land market, the programme consisted of non-market initiatives, such as joint decision-making in specific operations, joint management, contract farming, and the promotion of specialised production areas. These measures were not sufficient to achieve the goal of farm size enlargement on a large scale. The fact of the matter is that the government did not want to lose the political support of the peasantry and confront the traditional attachment to land (Wu Huang, 1993: 55, 60).

What eventually aroused the opposition of farmers, especially after 1987, when rapid political liberalisation occurred, was another plank of the new agricultural policies, namely the move towards agricultural trade liberalisation. Initiated under the pressure of the United States towards the late 1970s, the policy was based on scheduled stage-by-stage reductions in tariffs and non-tariff barriers for agricultural goods. Agreed in exchange for US concessions on industrial products, these measures had the effect of transforming farmers from long-time obedient and staunch supporters of the regime into more independent actors ready to undertake rebellious actions against the government. The atmosphere was politically charged as fears of major disruptions were fuelled by the phasing out of sugar operations and the rapid decline of Taiwan’s world-renowned canned food exports in the late 1980s.¹⁶ But the opposition did not really succeed in changing the government’s mind. In the subsequent plans, the authorities continued to assert their intention of transforming Taiwanese traditional agriculture into a modern sector open to foreign competition and based on internationally competitive products (Wu Huang, 1993: 55–9).

Similarly on the industrial front, growing labour scarcity persuaded the technocracy to encourage diversification into increasingly more sophisticated export products; and economic liberalisation, when it came, aroused the opposition of firms that were used to being sheltered from the full pressure of international competition (Cheng, 2001: 34–6).

III Taiwan’S Developmental State

Often dubbed a developmental state, the Taiwanese state proved remarkably effective in propelling the country on the path to sustained growth and development. Most important among its pro-development characteristics were its unified decision-making structure and its total dedication to long-term objectives, its autonomous bureaucracy, and its insulation from private interests and lobbies. In the following, we elaborate on these three attributes.

A A Nationalist One-Party System

To begin with, modern Taiwan was built on the basis of a one-party state system that, rather paradoxically, followed the Leninist model (Chan, 2002: 174). Until the political liberalisation that started in the mid-1970s, it was no doubt authoritarian, yet not totalitarian.¹⁷ The Taiwanese regime during this period can best be defined as one of ‘authoritarian corporatism’ (Wade, 1990a: 27). To understand how this could be established in the country, it must be borne in mind that Taiwan ‘had never been an independent state with its own indigenous bureaucracy and landed elite’ (p. 231). For fifty years, the Japanese had imposed on the local population the rule of a strong colonial state which stood above and apart from a weak civil society. The colonial administrative structure penetrated right down to the village level and ensured that no local formal organisation came into existence beyond kinship and residential groups. Furthermore, not only did the colonial authorities prevent wealth accumulation in the hands of their Taiwanese subjects, but they also kept them out of senior managerial positions in large-scale commercial and governmental organisations (they even prohibited the founding of religious institutions, such as Christian churches). It is therefore not surprising that when they were chased out, the Japanese left behind them a leadership and managerial vacuum (Wade, 1990a: 232).

Contrary to what was observed in many postcolonial countries, in Taiwan the vacuum was filled by the incoming mainlanders, from whom the islanders had been cut off during the years of Japanese occupation. The only ‘legal’ basis of legitimacy for political takeover by the former rested on their claim that they were the rightful government of the entire country of China. Coming to power as though it was occupying an unfriendly region, the mainlanders’ party organisation, the KMT chose to impose strict controls on the population and was little inclined to bargain with established groups or organisations. Much as in the case of Japanese colonisation, the weakness of existing organisations and elites made the task rather easy (Wade, 1990a: 233–4). It is noteworthy that, in transplanting itself to Taiwan, the KMT succeeded in shaking off its predatory nature and in providing political space for technocrats to implement a series of industrialisation programmes and strategies (Cheng, 2001: 19).

The KMT landed in Taiwan equipped with a ready-made ideology defining the appropriate relations between state, party, and society. The central tenet was that, first, only a powerful military and a strong government could enable the island to regain control of mainland China, and, second, that this mission justified minimal commitments to existing social groups and limited the reliance on markets. Those two forces were indeed regarded as potential threats that could constrain state actions. As stressed by Robert Wade (1990a), the KMT’s Nationalist ideology was of a special kind since the largest part of the nation lay outside the border. It could therefore afford to be more uncompromising in the sense of refusing all bargains or agreements that could jeopardise the goals of national development and reconquest (1990: 234–5). State control was very encompassing since the KMT had effective control over all social groups, via the incorporation into its party structure of sector-based associations, such as those for labour, state employees, women, students, intellectuals, and various professions. Its hand was so strong that it was able to direct and mediate the selection of leadership for these associations, thus operating according to the principle of democratic centralism. Needless to add, the outspoken local elite were either co-opted or suppressed (Chan and Chu, 2002: 198).

Because of its belief that its defeat by the Communists had partly been caused by what it considered party indiscipline, the KMT simultaneously set to tighten the party’s organisation and to purge it of its unreliable elements. Factionalism within the party was bridled, with the effect of making the party state not only an omnipresent but also a coherent entity placed under the paramount leadership of general Chiang Kai-shek. In sum, the mainlander leaders saw themselves as being at war, thereby vindicating the creation of a one-party state and the promulgation of the longest-running period of martial law in the world (Wade 1990a: 235–7; Cheng and Chu, 2002: 198).

The issue then is how the new regime succeeded in infusing its ideology into the population. The answer lies in the significant efforts made by the government to create a common Chinese-ness amongst Taiwanese citizens, through the school system and intensive campaigns of ‘ideological moulding’. These efforts were centred on the diffusion of the three central values of the nation, the family, and obedience to authority, rallied around the symbols of Sun Yat-sen, Chiang Kai-shek, and the national flag (Wade 1990a: 243–6). As we have seen earlier in the case of the rural population, however, the major way used by the authorities to establish their legitimacy consisted of economic development and more equal income redistribution.

Even aside from these formal, corporatist channels, many people had contacts with the political-economic establishment via their personal networks. As in South Korea, Taiwan’s political regime was ‘relation-based’, implying a lack of separation between the legislative, executive, and judicial spheres; a decentralised system in which ministries and bureaus were in direct relation to networks and business firms; and the availability of ex-post renegotiation possibilities (in contrast to rules-based regimes), ensuring a good measure of flexibility about the ways to achieve the (inflexible) goals set by the central power. Relation-based authoritarianism is different from standard authoritarianism in the following sense: under the latter regime, private agents comply with government prescriptions because the government is omnipotent, whereas under the former they fear that non-compliance will entail the government’s unfavourable treatment in the future (Okuno-Fujiwara, 1997: 378–80, 391–3). This mode of authoritarianism seems to be in tune with ‘the East Asian tradition of a high degree of personalisation of government’, in which ‘benign neglect is not a politically feasible option’ (Lau, 1997: 68–9).

B An Able and Cohesive Bureaucracy

When they attempt to characterise a political regime, social scientists, including economists, are typically interested in determining whether and to what extent the executive, legislative, and judicial powers are separated – seen from which standpoint, Taiwan’s political regime clearly appears undemocratic. Seen from this angle, the state bureaucracy is viewed as an arm of the executive, so that the issue of the relationship between a government and its bureaucracy does not arise. This issue, however, is of the utmost importance since top bureaucrats occupy permanent positions and therefore stand as guarantors of policy continuity. Of course, a new government can decide to re-orient policies and the role of the bureaucrats is then to follow suit. The problem comes when bureaucrats are subject to continuous and arbitrary pressures from the executive, and when these pressures are not aimed at a better implementation of officially sanctioned policies. For reasons explained earlier, the Taiwanese bureaucracy was not subject to that risk: the state was fully committed to its objectives and the bureaucracy formed a cohesive entity that was fully devoted to the state and insulated from the political elite.

The Japanese colonial power bequeathed to Taiwan (and South Korea) a modern, meritocratic, and authoritative bureaucratic structure. Thanks to a long tradition of bureaucratic statecraft which drew its legitimacy from the claim that its civil servants were the best and the brightest elements of the society, the Taiwanese had no difficulty in adhering to Japanese doctrines (which Japan itself had imported from Prussia). It is therefore no surprise that all of the offices and a substantial portion of the personnel from the colonial era were carried forward into independence (Woo-Cumings, 1997: 328). The civil service continued to be ‘merit-oriented in recruitment and promotion, lifelong in tenure and relatively uncorrupted by comparison to other developing countries’ (p. 332).

With the arrival of the mainlanders, the quality of the Taiwanese bureaucracy was not affected, even though the jobs of state bureaucrats down to quite low levels were now occupied by the newcomers. Being an alien force, these bureaucrats ‘had no choice but to identify their own interests with those of the state, their protector, making for an unusual merging of interests between state rulers and their officials’ (Wade 1990a: 339). These were ideal conditions for the prevalence of clean and competent officials since the bureaucracy was ‘neither caught between and penetrated by struggling interest groups nor subverted from above by the politics of rulers’ survival’ (p. 339). Moreover, the bureaucracy formed an elite civil service possessing a strong corporate identity and internal coherence, and, in no small measure, the presence of dense informal networks linking officials in different bureaus and ranks helped reinforce these two features.

There is another important reason why the bureaucracy achieved a high degree of internal coherence, and it can be traced back to a critical decision taken in mainland China in the early 1930s (see Wade 1990a: 246–8, on which our account is based). The Natural Resources Commission (NRC) was a sort of Economic Planning Bureau created by the Nationalist government of Chiang Kai-shek. In the 1920s and 1930s, however, responsibility for industrial policy was so diffused that no less than five ministries claimed to be in charge of its design and implementation. In addition, political connections determined appointments to leading economic policy positions. A critical moment came with the shock caused by Japan’s conquest of Manchuria in 1931, and the sense of external threat that ensued. The political leadership responded to this challenge by recognising the urgent need to create a non-political (but patriotic) bureaucracy comprised of the best experts available. It is in this spirit that in 1932 the government thus founded the National Planning Defence Commission, whose name was changed to the National Resources Commission a few years later (in 1935). The Commission was to work under the direct supervision of Chiang Kai-shek, and to act as a unique centre of command.

In conclusion, it was a sense of national emergency – the idea that the regime could not survive in the absence of a large cadre of experts in production and planning – which justified the replacement of a politicised and fragmented institution by a new technocratic and integrated one. This lesson was learned for good and was transplanted in due time to Taiwan, where a cohesive and competent bureaucracy prevailed – and continues to prevail to this date. Moreover, because the weakness of the Nationalist government, both against foreign aggression and the Chinese Communists, was attributed partly to the subjection of corrupt bureaucrats to powerful private lobbies, the KMT leaders wanted to endow China, and later Taiwan, with a bureaucracy that would also be autonomous in the sense of being immune from the pressures of the private sector. Their suspicion vis-à-vis the business elite, and their determination to subjugate them, was reinforced by the fact that, after the defeat of the Nationalists at the hands of the Communists, few big mainland capitalists chose to follow Chiang Kai-shek to Taiwan, preferring other destinations – the United States and Hong Kong in particular. Moreover, the few that went to Taiwan eschewed significant commitments of capital until a bilateral treaty between the United States and Taiwan guaranteed the latter’s security (Woo-Cumings, 1997: 330–1).

C An Autonomous State System

1 The State–Business Relationship until the Late 1980s

The suspicion towards big (mainland Chinese) capitalists nurtured within the National Resources Commission explains why the Taiwanese policy network included hardly any representatives of private business, and why ‘the government retained a striking degree of autonomy in setting the directions and details of policy’ (Wade 1990a: 304). K. Y. Yin, although he went through several rounds of resignation and reinstatement, was the main architect of the country’s economic development strategy (Cheng, 2001: 27). Contrary to what has been observed in other Southeast Asian countries, South Korea in particular, there was no intimate state–business relationships in Taiwan, and the KMT party state did not actually encourage the creation of big industrial concerns. On the other hand, because its official ideology was based on Sun Yat-sen’s doctrine of ‘people’s livelihoods’, which advocated the harmony of the interests of capitalists and workers, it was eager to regulate private business capital and instead promote the formation of state capitalism. In accordance with this principle, most industrial assets under the Japanese colonial administration, and most zaibatsu, were converted into SOEs. Whether in finance, public utilities, or the industrial sector, these types of firms predominated until the drive for economic liberalisation gained momentum in the second half of the 1980s.

The enterprises taken over from the colonial administration covered a large number of manufacturing sectors – energy, fertilisers, sugar-refining, tobacco and wine, steel, shipbuilding, heavy machinery, construction, and defence-related industries – as well as a wide array of service-based sectors, such as public transportation, shipping, insurance, and non-banking finance. In most of these sectors, the private sector was either barred from entering or effectively crowded out (Cheng and Chu, 2002: 197, 199). When the state itself established new upstream industries, it either handed the factories over to selected private entrepreneurs (for example, in the sectors of glass, plastics, steel, and cement) or ran them as public enterprises (Wade 1990a: 78). In the former instance, the beneficiaries were typically loyalist mainlanders, members of a few politically well-connected native families known for their loyalty to the regime, or local county-level patrons with a stake in region-based oligopolies.¹⁸ Whichever was the case, they were called on to run the new enterprise as a private firm or to participate in it as a shareholder (and manager) of a semi-public concern (Cheng and Chu, 2002: 202–3). What needs to be emphasised is that, as a rule, the KMT was always keen to maintain a system of competitive clientelism so as to keep rent-seeking activities in check. In practice, this meant that it typically cultivated at least two competing factions in a given county, thus preventing a single faction from reaching a position of political monopoly over the distribution of economic rents (Cheng and Chu, 2002: 208).

It also bears emphasis that, for fear of encouraging powerful groups that could one day challenge the state, the Taiwanese government consistently exhibited a preference against big businesses. Just to cite one example, when it decided to start promoting the petrochemical industry in the 1960s, when the private sector was still reluctant to participate, it allowed a public enterprise, China Petroleum Company (CPC), to undertake the most upstream naphtha cracking production. But the government was simultaneously responsible for the allocation of feedstock to undertake midstream production. At this level, an egalitarian approach was followed in the sense that the feedstock from the CPC’s naphtha crackers was distributed among as many independent firms as possible. Moreover, when the Formosa Plastics Company, then the largest conglomerate in Taiwan, applied for a licence to build its own naphtha cracker, its request was repeatedly turned down, at least partly on the ground that monopolisation of upstream supplies had to be avoided to leave room for smaller firms (Chu, 1999: 18).

SMEs were no doubt a dynamic element of the Taiwanese economy, particularly in manufacturing exports, where their share peaked at 75 per cent in 1982 (Chu, 1999: 10). A distinctive feature of most SMEs is that they were owned and run by islanders, and were typically of the family type. In addition, for their operations they typically rested on the informal horizontal networks that are characteristic of traditional south China society (Ho, 1980; Orru, 1991; Kao, 1991; Luo, 1997; Hamilton, 1997, 1998).¹⁹ These networks, in which relationships are very functional, enabled the SMEs to get access to all the resources, financial and non-financial, necessary for their foundation and survival (Hattori and Sato, 1997: 353). Finally, many SMEs had quite flexible modes of organisation, including non-factory forms, such as the putting-out system for labour-intensive tasks, member units of a network of similar types of firms, and subcontracting to large firms involved in direct exports (Chu, 1999: 8–12).²⁰

The aforementioned features of the SMEs explain why their social links with the government were ‘tenuous at best, involving very few lineage bonds, marital links, school ties, or links due to a common social background. The formal channel of contact between the two sides was through industrial associations, which were shaped and managed by the party state. The important point is that, with a huge state sector inherited from the Japanese, the relocation of a continental-sized civil and military service to the island, and the strong political and financial support of the United States, the Nationalist regime did not need the political support of the business sector (Cheng and Chu, 2002: 197–8). This was especially true because there was no strong local business class, since the Japanese had gone and the islanders had been subdued by the colonial bureaucrats, who were adept at state-guided development (Woo-Cumings, 1997: 330–1).

Clearly, in the above-described political environment, economic technocrats operating mainly within the purview of the National Resource Commission had a wide latitude to manage development plans and projects, free from societal pressures. As pointed out by Tun-Jen Cheng and Yun-Han Chu (2002), they were answerable only to the party’s top leadership, and were responsible mainly for the overall performance of the economy and the success of the targeted sectors. Their political fortunes hinged less on maintaining privileged ties with the business community than on their credibility in the eyes of the political leadership, and they naturally ‘cautioned themselves against nurturing intimate ties with private businesses, be they natives or mainlanders’ (p. 199). We have already stressed that the autonomy of the economic technocrats vis-à-vis business was greatly enhanced by the existence of an economic base independent of the private sector. In effect, in addition to its monopoly or near-monopoly position in a vast number of manufacturing firms, it also directly controlled agricultural exports – the most important foreign exchange earner – and the entire banking sector.

As things happened, economic technocrats initially opted for a mixed strategy using both an import-substitution strategy based on SOEs, and privileging HCI, on the one hand, and an export strategy centred on agricultural and agro-processed products, on the other hand (export promotion efforts started as early as the early 1950s, with twenty exports singled out for government assistance). In a subsequent stage, as the role of SOEs shrank relative to the private sector in the 1960s, export-led industrialisation became the dominant plank of the national development strategy. But throughout the 1960s and 1970s, the SOEs continued to play their role of deepening and upgrading the industrial base while implementing anti-cyclical policies and supply-side management. They also served as a training ground and a reservoir for the economic bureaucracy, allowing the technocratic elite to incubate an army of satellite suppliers and downstream firms (Cheng and Chu, 2002: 199–200).²¹

To be the engine of export-oriented industrialisation was the central task assigned to the private sector, and to fulfil this objective its firms enjoyed a variety of policy incentives – tax benefits in particular. Noticeably, the use of highly distortionary measures, such as targeted lending, was consistently avoided by state bureaucrats (Wade, 1990a: 159–75; Park and Johnston, 1995: 196). The key point is that many of the industrial policy measures were product- or industry-specific, not firm-specific. Even more importantly, they did not discriminate against the SMEs. For instance, export loans and fiscal benefits were awarded to any firm that succeeded in receiving export orders.²² This was the government’s general line of conduct: rents awarded to private firms were performance-based and all the benefits and special privileges were of no value to new enterprises and of no cost to the government unless the new enterprises turned out to be profitable and generated taxable profits. This was particularly evident for incentive measures such as investment tax credits, accelerated depreciation, and tax holidays for new enterprises (Lau, 1997: 60).

Besides the aforementioned direct incentives, the SMEs benefited from the government’s effort to persuade foreign corporations to invest in the country with the explicit aim of increasing local content in their assembly operations. This was a great boon for the SMEs, which mushroomed and prospered in the wake of foreign investments (Cheng and Chu, 2002: 200). Furthermore, already in the 1970s Taiwan set up a number of national research institutes, among which the Industrial Technology Research Institute played an important role in initiating or reviving several major manufacturing areas, such as bicycles, sporting goods, computers and computer peripherals, and semi-conductors (Lau, 1997: 63–4). Evidence nevertheless indicates that technical assistance from the state mainly benefited large-scale enterprises (Wade, 1990a). As for credit provided by commercial banks, this went primarily to large firms, while SMEs mostly relied on informal credit markets, especially rotating credit societies (hui) and the use of post-dated cheques (Park and Johnston, 1995: 196). At least, this was true until the 1970s, when the state decided to boost lending facilities for these firms in order to support the country’s export drive (Cheng, 2001: 31; Chu, 1999: 19).

In the matter of education, both SMEs and big firms benefited greatly from governmental efforts. It is remarkable that, from early on, a two-track educational system was in place, which sent many primary and middle school graduates to vocational schools. By 1971, the country could thus rely on no less than 316 training institutes and, from that date, the number of students in vocational senior high schools exceeded the number of students in academic ones (Park and Johnston, 1995: 191). This is an exceptional state of affairs if we compare Taiwan to other Asian countries. Engineering was especially popular and about one-quarter of all university graduates since 1960 have been engineers. If they are clubbed together with science students, they accounted for over one-third of post-high school (junior college plus university) graduates during the 1960s, more than 40 per cent during the 1970s, and half by 1980 (Wade, 1990a: 64–5). Engineering studies were not only prestigious, a situation which already prevailed in China in the early twentieth century, but they were also considered a fast track to management positions in the industrial sector. Hence in 1971 Taiwan had more engineers per 1,000 people employed in manufacturing than any other of a sample of fourteen middle-income countries, with the exception of Singapore (p. 65). Since engineering skills are so essential for running industrial firms and improving technology and products, Taiwan’s performance in the education sector comes out as a critical factor in its industrial success.

Did the ambitious plans of the planning technocrats lead to strong inflationary pressures? The answer is negative because their projects were severely held in check by a conservative central bank that enjoyed strong regulatory power over the banking sector. Interestingly, Taiwan’s monetary discipline was initially motivated by the determination to prevent a replay of the disastrous hyperinflation and currency crisis of 1947–8, which had contributed to the defeat of the KMT leadership by the Communist regime in 1949. The consequence of the rigorous regulatory regime, which lasted for almost four decades, is that most private firms were only moderately leveraged, particularly in comparison to South Korea (Li, 1995: 103–9; Cheng and Chu, 2002: 201).

Finally, how state–business relationships were formally organised in Taiwan is a question which we have only slightly touched on so far. The state organised the private sector into a hierarchy of associations along the corporatist line. Membership was compulsory and associations covered every product line, every aspect of business activities, and every step of the production processes. Regrouped into three peak federations whose leaders were usually handpicked by the head of the state, they functioned as an arm of both the state economic bureaucracy and the Nationalist party. The purpose was to conduct industrial surveys, collect and disseminate business information, solicit policy inputs, and implement sectoral policy. As for the business representatives, they could use the regular meetings to convey their problems and present policy suggestions to the party and the government.

According to Cheng and Chu, (2002), however, the system of corporatist industrial associations did not work quite as intended. For one thing, the rule of compulsory membership was never effectively enforced, and many firms ultimately did not have licences to operate. And, for another thing, most business associations were barely functioning, owing to a lack of finance, or they were under the control of leading and politically active businessmen. As a matter of fact, the primary function of a large number of these associations was political co-option, ‘as successful business elite would bid for organisational leadership first, and then political offices, all under the auspices of the KMT’ (2002: 202). These imperfections should serve to qualify the somewhat idealised picture of state–business relations in Taiwan, in which a competent state negotiated on economic policies with representative business leaders (see, for example, Johnson, 1987).

In general, an important advantage of corporatist arrangements, whether they apply to business or other social groups, is that they allow the state to channel and restrain demands addressed to it as those demands arise and grow. This advantage is all the stronger where the arrangements are constructed before interest groups begin to gain strength, and where the demands emanate from encompassing organisations – two conditions which were rather well satisfied in the case of Taiwan (Wade, 1990a: 339).

2 The State–Business Relationship after the Advent of Democracy

We have seen above that combining the one-party state system based on the principle of central planning with considerable financial clout the KMT was able to overrule local factions and big business, not to speak of social organisations such as labour. In the mid-1980s, though, it began to initiate a series of political reforms (including the lifting of martial law in mid-1987) aimed at making stepwise progress towards a rule-of-law system (Wang, 2002). In the late 1980s, the sudden crisis that arose over the political succession to the regime’s strongman, Chiang Ching-kuo, had the effect of accelerating the pace of political transition and economic liberalisation. These events provided the business elite with a golden opportunity to enhance their bargaining power, particularly their capacity to influence strategic decisions at the policymaking level. Full-scale national elections in the early 1990s broke the firewall between local and national politics, as a result of which candidate-centred campaign financing, political machine-based vote-buying, and pork-barrel politics were no longer confined to the local level. In these new circumstances, ‘business groups became the most sought-after patrons of elective politicians and local factions, and when they had a well-delimited regional base, they did not hesitate to invest heavily in the election of the county magistrates and city mayors. Some groups even fielded their own family members as candidates instead of bankrolling their political agents’ (Cheng and Chu, 2002: 203–4).

The same process was noticeable at the national level. The national legislature (the Yuan) progressively became ‘an arena for horse trading among economic officials, party officials, and lawmakers who act as surrogates of special business interests’ (Cheng and Chu, 2002: 204–5). As a consequence, the government had to bargain with lawmakers on the content of legislative proposals and the timetable for their implementation. Another effect of the change is that interpersonal connections between the KMT leadership and the business elite were accentuated and ‘the economic policymaking process began to show signs of politicisation’ (Cheng and Chu, 2002: 204–5). The democratic transition thus gave an impetus to policies of economic liberalisation that had been debated since the early 1980s. Business groups benefited most from the new policies (in particular, the removal of barriers to entry to a series of SOE- or parastatal-dominated sectors), denoting their rising political clout.

All this being reckoned, there is little doubt that the influence of the business community remained constrained both by its low internal cohesion and the immense wealth of the KMT. The former factor largely resulted from the heterogeneity of this community, made up of large-scale industrial groups coexisting with a host of family-owned firms that craved individual connections and preferred specific rewards for their political investment to the collective advantages of business associations. The rift between these two components was widened as economic officials succeeded in fostering a new crop of SMEs in high-tech industries. These firms, which acted as a link in the global production chain of Western firms, were destined to become the mainstay of Taiwan’s industry and export sector, hence the strengthening of their bargaining position vis-à-vis rent-seeking big business. As for the latter factor, it must be borne in mind that the KMT controlled a huge party apparatus and a considerable economic empire. Thanks to these assets, the KMT continued to be the only power bloc in place. The implication is that it largely retained its ability to lock in the political allegiance of the business groups, to set limits on influence-peddling, money politics, and policy contestation, as well as to impose a hard budget constraint on rent-seekers. For example, the KMT was strong enough to deter the individual members of provincial assemblies from reckless requests for lending to their clients (Cheng and Chu, 2002: 205–9). In the words of Cheng and Chu, (2002): 207):

Democratisation of the polity has not transfigured the KMT’s power structure at the core. It has remained essentially a hierarchical structured constellation of entrenched state and party elite based permanently in the state and party apparatus. Its decision-making process continued to follow the principle of democratic centralism.

Up to this point, the process was under control and seemed to herald a protracted transition from authoritarianism to democracy, as described by Chan (2002). The presidential election of March 2000, however, disrupted this apparently smooth process and constituted a watershed in Taiwan’s politics: the KMT was dislodged from power, thus marking the first transfer of political power in the history of post-war Taiwan. The state–business relationship was bound to be affected, especially because the downfall of the KMT meant a sizeable reduction in the political clout of most big business groups allied with it. These were denounced as part of a mafia state by the victorious opposition. At the same time, the economy was being gradually restructured, with business captains in the high-tech industries emerging as the new pivot of Taiwanese industry. Similar to the entrepreneurs of the traditional SMEs in the pre-democratic days, their inclination was towards political neutrality or even passivity. Interestingly, and providing evidence of the adaptability of the one-party state’s economic strategizing, the newly emerging information sector, in which semi-conductor and computer firms featured prominently, had been actively promoted by KMT technocrats, who increasingly saw the role of the state as one of technology supporter, research coordinator, and supplier of human capital.²³ In this sense, it is correct to say that ‘the developmental state in Taiwan [was] not unravelled, it [was] merely reconfigured’ (Cheng and Chu, 2002: 209–11; see also Li, 1995).

IV Conclusion: A Compact Institutional Diagnostic of Taiwan

To end our analysis of the case of Taiwan, we lay out the diagnostic table in Table 6.1. This case poses an interesting challenge because some of its initial conditions at the time of independence were not a priori favourable, and yet there is no doubt that characterising Taiwan as a development miracle is not an excess of language. Since the content of the table speaks of itself, discussion of its various elements is unwarranted. Three central lessons deserve to be drawn from the whole exercise.

Table 6.1 A synthetic ordering of the institutional factors behind Taiwan’s development

Deep factors	Proximate causes	Institutional strengths and weaknesses	Economic and political consequences
Geography: a largely mountainous country Demography: a high pressure of population History and Japanese colonial legacy: * huge infrastructural investment; * educational effort; * rural industrialisation initiated; and * an authoritarian state History and mainland China: * authoritarian security-based regime; * strong suspicion vis-à-vis business elite; * a strong commitment to development; and * skilled administrators Foreign assistance: massive aid from the United States in Cold War context Bitter opposition between mainlanders and islanders	Political stability caused by one-party political system Clear sense of mission among the political leadership and big role of central planning Able and competent bureaucracy dominated by economic bureaucrats Remarkable use of well-designed, performance-based incentives Use of stepwise interventions rather than disruptive policies Key role of exports and export diversification Subjugation of private business interests and use of corporatist arrangements Commitment to equality, both at individual and spatial level: * radical land reform; * rural industrialisation; and * control of rent-seeking Great attention to human capital development, both general and technical	Developmental state backed by a strong Natural Resource Commission (economic planning agency) Strong state legitimacy anchored in economic growth with equity Strong state capacity with effective law enforcement and legal stability Regulation of key sectors dominated by big business Rent-seeking under control Incentive systems for small and medium-sized firms Availability of important public goods: education, electricity, communication, and transport Lack of accountability of key public agencies Limited property rights in relation to land	High quality of education, especially in engineering and science High sustainability of the growth pattern: dynamic industrial sector able to adjust to international competition Emergence of a new class of high-tech firms Swift emancipation from aid dependence Capacity of the political system to evolve towards democracy and economic liberalisation Erosion of corporatist arrangements Rising civil society Worrying vulnerability to takeover by mainland China

First is the strong influence of historical legacy, coming both from colonial Japan and mainland China. For one thing, the Japanese contribution to Taiwan’s development consisted of laying the basis of a dynamic smallholder agriculture; creating and expanding transportation, irrigation, and electrical power systems; improving education and sanitation; establishing financial institutions, agricultural parastatals, and farmers’ associations; sparking agro-processing industries (centred on rice and sugar); and clarifying property rights so as to facilitate an effective system of tax collection (Cheng, 2001: 20–1).²⁴ For another thing, and rather surprisingly, although the Nationalist immigrants to Taiwan were staunch anti-Communists, the regime they established on the island was not only authoritarian but also gave such an important role to central planning and state-led economic guidance that it was considered as inspired by Lenin’s principle of democratic centralism. The replicability of Taiwan’s experience is evidently limited by the deep legacy bequeathed by the Japanese colonial officers and the Kuomintang.

Second, the growth pattern of the Taiwanese economy was anchored in the modernisation and commercialisation of smallholder agriculture and in the development of rural industries tied to the farming sector through numerous supply and demand linkages. These included the supply of labour, capital, and even industrial entrepreneurs, on the one hand, and the demand for intermediate inputs, agricultural equipment, and non-food consumption items, on the other hand. The power of this development model, in which the rural sector was considered as a full-fledged engine of growth from the very beginning, lay not only in its dynamic properties based on manifold interlinkages between sectors, but also in its strongly egalitarian tendencies.

Third, distinctive features of the developmental state of Taiwan proved critical for the country’s successful performance on the economic and social fronts. In the critical stages of its growth and development process, the country (i) was led by a one-party state possessing a unified vision of the national future and endowed with a competent and cohesive bureaucracy; (ii) was able to prevent its capture by private interests; (iii) used a minimum of coercion and a maximum of performance-based incentives to align business interests with the general interest; (iv) proceeded in sequential steps rather than in big jumps; (v) invested large amounts of public money in infrastructure and in human capital; and (vi) gained its legitimacy, especially among the islanders, through its impressive achievements in terms of economic growth, equity, and multidimensional welfare. The resulting development model has turned out to be extraordinarily resilient, as attested by Taiwan’s ability to adapt to the challenges of globalisation, liberalisation, and democratisation, as well as its ability to weather the Asian regional financial crisis of the late 1990s. At the root of this resilience lies the implementation of an incentive scheme based on fiscal incentives, technological support through the sponsoring of research and development activities, participation in the formation of venture capital firms, and the provision of crucial public goods, rather than credit allocation and a loose monetary policy. Also critical has been the gradual emergence of a polymorphous industrial structure dominated by a great variety of SMEs, rather than by national champions susceptible of becoming too big to fail (Cheng, 2001: 32–6).