Is active state intervention a necessary condition for economic success?

By Haris Seedat - Economics Student @ Pembroke College, Cambridge

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This essay will discuss the role of the state in achieving economic targets such as growth, income equality or stability. There exists a large amount of historical evidence to draw from on the diverse approaches states have had to these targets and their effects. I will first consider how necessary state intervention is in achieving the goals, then I will argue that it is not a sufficient condition for many of these goals, and finally I will discuss whether this question can really be answered without defined criteria for ‘economic success’.

There is very little historical evidence of economies experiencing sustained rapid growth, development or stability without at least some government role in encouraging it. Despite neoclassical theory claiming a free market completely free of intervention will provide pareto efficiency – this does not have much evidence to support it. However, there is strong evidence that government policies can be effective in promoting growth. For example in the 18th century, Britain adopted strong interventionist policies in expanding the export sector. Export duties were abolished and replaced with export subsidies, Walpole introduced import tariff rebates on raw materials used for the export of manufactured goods and regulation was introduced to control the quality of British exports, with the aim of protecting their reputation. As the first proper application of the ‘infant industry’ strategy of growth, these policies were stunningly effective at building Britain’s textile industry and protecting it whilst the industrial revolution gave Britain a technological lead over others. Whilst the USA had the highest industrial tariff rate in the world in the 19th century they were also the fastest growing economy. Chang argues that the growth was because of these policies, not despite it.

The use of industrial policy also plays a significant role in development. In the 17th-18th century, countries such as France and Sweden employed industrial espionage in order to close the technological gap between their industries and others, improving their efficiency. State Owned Enterprises were also common and successful in encouraging technological spill overs. For example, Prussia pioneered ‘model factories’ in the then high tech industries of metallurgy and munitions, whilst these may not have been competitive on their own, they were invaluable in demonstrating new technologies to the private sector, and encouraging capital investments in these, eventually allowing them to develop efficient industries. State funding of Research and Development can also help countries maintain a technological lead over others. The US funded vast amounts of research in post war period primarily for military purposes, however spill over into the commercial sector meant that the US had an advantage in the new industries of aerospace, internet and consumer electronics. Governments can provide the basic research that the private sector adapts into commercial uses. The state plays a very powerful role in economic development and without state intervention, I believe development is much less likely.

However, whether state intervention is a sufficient condition for economic success is far more debateable and history provides ample evidence where state intervention has failed to bring about growth or stability, either because of poor execution or other factors preventing growth. During the 20th century many countries in South America and Africa state-led development funded by foreign aid or World Bank loans. These policies often involved large capital investment in infrastructure deemed too risky by the private sector to finance. Institutional and political failures such as corruption and cronyism caused many projects to fail, and they did not pay off – leaving the state with large amounts of foreign debt obligations. Many LEDCs were sent into debt crises leading to the state becoming a drag rather than a promoter to economic growth and development. Cronyism also left room for rent seeking, which absorbed valuable resources. Neoliberal institutions such as the IMF and World Bank then forced the adoption of free market principles such as those in the Washington Consensus in exchange for debt relief, barring the ability of the state to aid development even if management of the state improved.

However, I believe that to answer this question is impossible without a stronger definition of ‘economic success’. Economic success could be defined as achieving the most efficient allocation of resources in which case neoliberals would argue the state should be non interventionist and allow the market to achieve pareto efficiency on its own. Or economic success could be defined as full employment, in which case monetary doves would argue the state should utilise monetary policy to keep unemployment at the natural rate rather than using it to maintain price stability. There are many possible criteria for ‘economic success’ and all lead to different answers on the role of the state.

In conclusion, I believe that whilst state intervention is not strictly necessary for growth or development, intervention is definitely a powerful tool in achieving it. And despite this, the state is certainly necessary in providing basic functions such as the guarantee and enforcement of property rights, contracts and rule of law in order to facilitate any sort of economic success. There is a lot of modern evidence to show us that state intervention to encourage development can often go wrong and so it is not a sufficient condition for growth to occur.

Further reading:

1. Chang, H-J. Kicking Away the Ladder – Development Strategy in Historical Perspective, chs. 2 and 4 2. Coates, D., Models of Capitalism: Growth and Stagnation in the Modern Era, ch. 7. Evans, P. Embedded Autonomy, ch. 3 3. Lindert, P., Growing Public: Social Spending and Economic Growth since the Eighteenth Century, ch. 2 4. Sachs, J. & Warner, A., Economic Reform and the Process of Globalisation, Brookings Papers on Economic Activity, 1995, no. 1 (Read only pp. 1-20) 5. Williamson, J. ‘The Washington Consensus as Policy Prescription for Development’ in T. Besley & N. Zhaga (eds.), Development Challenges in the 1990s: Leading Policymakers Speak from Experience, also see the comments by A. Amsden and R. Ffrench-Davis that follow (the book can be downloaded from: http://www- wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2005/07/11/00009 0341_20050711100940/Rendered/PDF/329210Developmental0Challenges01public1. pdf)