Chapter

Introduction

Author(s):
Reda Cherif, Fuad Hasanov, and Min Zhu
Published Date:
April 2016
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Author(s)
Tim Callen, Reda Cherif and Fuad Hasanov 

Tim Callen, Reda Cherif, and Fuad Hasanov

Creativity always comes as a surprise to us; therefore we can never count on it and we dare not believe in it until it has happened. In other words, we would not consciously engage upon tasks whose success clearly requires that creativity be forthcoming. Hence, the only way in which we can bring our creative resources fully into play is by misjudging the nature of the task, by presenting it to ourselves as more routine, simple, undemanding of genuine creativity than it will turn out to be.

Albert Hirschman, “The Principle of the Hiding Hand”

Economic development can be thought of as a chain of hard challenges, complex choices in the face of uncertainties, and creative solutions. Policymakers see high standards of living and sustainable and equitable growth as the ultimate goals of economic policy. Yet in pursuit of these goals, they probably do not consciously look for challenges. Rather, people are “apt to take on and plunge into new tasks because of the erroneously presumed absence of a challenge—because the task looks easier and more manageable than it will turn out to be” wrote Albert Hirschman in his famous essay “The Principle of the Hiding Hand.” In Hirschman’s formulation, the entrepreneur undertakes the project while perceiving the project as not risky—the hiding hand principle. As obstacles are discovered midway, without the possibility of turning back, the only way forward is to overcome them. So it is on the path to economic development and diversification. Economic development is a complex process, and policymakers may hesitate to plunge themselves into this challenging endeavor, especially in the presence of large oil revenues. However, as this book shows, the countries of the Cooperation Council for the Arab States of the Gulf (commonly referred to as the Gulf Cooperation Council or GCC) and most oil exporters cannot escape tackling these challenges.

The quest for the grail of economic development and growth is far from over. One of the major difficulties in identifying the factors contributing to development or the lack thereof is the wealth of historical experiences, institutional arrangements, and policies, making it hard to isolate the most important determinants. To paraphrase Leo Tolstoy, all developed economies are alike and each underdeveloped economy is underdeveloped in its own way.

In the universe of development experiences, oil exporters represent a particularly interesting group, lacking a diversified production base despite large oil income flows. Although oil revenues brought high living standards to many of these countries, even the high-income oil exporters are lagging technologically and are not economically diversified enough. Most of their export and fiscal revenues are coming from oil or oil-related products. Non-oil output consists overwhelmingly of nontradables, in particular of low-skilled services (such as restaurants, transportation, telecommunications), while most of the tradables are imported. Many oil exporters need to upgrade technologically and diversify their production base.

The decline of oil prices between the summer of 2014 and the fall of 2015 (while this book was being prepared) reinforced the importance and urgency of diversification for oil-exporting countries. During this period, oil prices fell by more than 50 percent and remained low, raising the specter of a return of the oil slump of the 1980s to 1990s. Citizens and policymakers from oil-exporting nations still remember the ordeal their countries went through at that time. The promise of easy and swift development brought by large oil revenues failed to materialize, resulting in unemployment, falling living standards, and heavy indebtedness. Oil exporters went through what can be described as the “Greatest Depression,” which has lasted for about 30 years. Real consumption per capita on average fell by about 20 percent from 1980 and recovered to the same level only in the late 2000s as oil prices increased substantially. History does not repeat itself, but it should not be ignored.

Dealing with low oil prices in the current context of increased government spending and rising expectations about the provision of jobs and income transfers is even more challenging. Having learned from experience, many oil exporters accumulated large sovereign wealth funds during the years of high oil prices in the 2000s. Yet the funds only provide a temporary cushion. With a gathering momentum in investment in renewable energy, fuel efficiency, fracking and other technologies to exploit unconventional sources of oil and gas, and increasing use of electric cars, a secular decline in oil prices cannot be ruled out. Whether oil prices will stay low or rise again in the near future, it is high time to ask fundamental questions about the nature of oil-exporting economies. The key question is how to break the dependence on oil exports and pave the way for sustainable growth.

Despite the episodes of steep downturns in oil prices, many observers seem to consider that technological upgrade and economic diversification should not be a priority in high-income countries with long horizons of oil reserves. According to most of the recent literature, the main issues to tackle for resource-rich countries fall within three broad categories. In the first category, the main problem stems from a lack of redistribution, where wealth does not trickle down to all citizens. The argument goes that if such states were to relinquish their hold on revenues from natural resources and transfer rents directly to households, living standards would improve markedly. In the second category, the main issue facing natural resource exporters is the conduct of fiscal policy to manage volatility and provide for intergenerational equity.

In the third category, the missing ingredients of the standard recipe for growth represent the main challenge. The standard recipe includes, for example, financial deepening, openness to trade and capital flows, privatization, infrastructure development, flexibility in the labor market, and lifting legal and regulatory barriers to doing business. In short, market distortions, mostly due to the government, are preventing countries from taking off. The much-discussed topic of diversification in oil exporters is usually framed within this context, that of an enabling environment to support growth and private sector development.

In contrast, this book argues for placing diversification at the top of the policy agenda for oil exporters and traces the path to achieving it beyond the confines of the standard growth recipe. Although redistributing oil wealth and managing volatility and intergenerational equity are important, finding solutions for these problems would not prevent exporters from continuing the “secular decline” they have witnessed over the past several decades. Indeed, as shown in Chapter 1, the relative income of most oil exporters—and in particular the GCC countries—has fallen dramatically in the past 30 years, typically from above U.S. income per capita to a fraction of it. Even high oil prices would not counteract this decline. It is argued in the same chapter that the standard growth recipe is not sufficient, and the lack of sustainable growth is attributed to the lack of a dynamic tradable sector. This book focuses on the GCC countries, especially because their experience represents a quasi-natural experiment with important implications for development theory and practice. These countries have managed to achieve relatively high indicators along many standard dimensions of binding constraints on growth—for instance, availability of quality infrastructure, free mobility of capital and labor, including skilled labor, and low tariffs and taxes. Yet their productivity growth has been anemic and even negative for the past decades and the non-oil tradable sector has barely developed. Market failures are the main impediment to creating a dynamic export sector and, ultimately, sustainable growth. To correct these distortions, governments need to intervene, in particular to encourage the private sector to endeavor where it would not.

This book provides historic experiences and theoretical and empirical analyses of how different economies managed to spur long-term growth. It brings together the views of academics and policymakers. Chapters cover such regions as the Middle East, East Asia, and Latin America, and combine perspectives from various disciplines such as economics, history, political science, and social development. It is hoped that this interdisciplinary and interregional study can offer practical advice for the future while shedding new light on the past.

Part 1 discusses diversification attempts in the Middle East and North Africa region. Chapter 1 is an overview chapter presenting the case of the GCC countries to illustrate that policymakers need to consider the diversification of tradables as a policy priority. The GCC countries face the difficult task of refocusing their growth models toward creating more diversified economies, with less reliance on hydrocarbons to support growth as well as less reliance on the public sector to absorb new entrants in the job market. The chapter argues that a sustainable growth model requires a diversified tradable sector that is lacking in the GCC countries. It draws lessons from the diversification experiences of oil exporters, in particular from the few relatively successful ones—Indonesia, Malaysia, and Mexico. Success or failure appears to depend on implementing appropriate policies ahead of the fall in oil revenues.

Because export diversification takes a long time, it must start now. In contrast with the previous literature, the chapter argues that the standard policy advice—implementing structural reforms, improving institutions and the business environment, creating infrastructure, and reducing regulations—while necessary, is insufficient due to fundamental market failures stemming from Dutch disease; that is, the crowding out of the non-oil tradable sector by the income generated from oil exports. To overcome these barriers, the GCC countries need to change the incentive structure for workers and firms. The study of country experiences suggests that successful strategies mix vertical diversification (in specific sectors) to create linkages in existing industries and horizontal diversification (across sectors) beyond the comparative advantage, with an emphasis on exports and technological upgrading. Investment in skills and social development transforms the worker incentives.

Chapter 2 examines successes and failures in the Middle East and North Africa region, in particular Algeria and Saudi Arabia, the two countries that pushed most with industrialization in the 1970s. Through their experiences, the chapter discusses the mix of policies that might foster a sustainable diversification of the region’s hydrocarbon-based economies. The human capital and education aspect is critical in developing a sophisticated export base. Attempts by the two most populous Arab oil states, Algeria and Saudi Arabia, to develop industry starting with limited resources of human capital is particularly instructive. Their experiences suggest that achieving a high human capital stock before industrialization is not a requirement or an obstacle.

Part 2 examines the experiences of East Asia and Latin America. Chapter 3 narrates the extraordinary transformation of Singapore since the mid-1960s from a poor port city to one of the richest countries in the world. Singapore’s experience can be divided into five development phases, being labor intensive in the 1960s, skill intensive in the 1970s, capital intensive in the 1980s, technology intensive in the 1990s, and finally a knowledge and innovation economy since the 2000s. The chapter summarizes key policies that helped the transition from one phase to another as well the role of multinational corporations. In particular, it explores four different themes in the government’s approach to developing its exports through the examples of four industries: electronics (creating value added), precision engineering (building around the value chain), chemicals (developing clusters), and biotechnology (focusing on research and development).

Chapter 4 studies the development path followed by Malaysia and the factors that contributed to its success. Malaysia is a particularly interesting case because it is one of the very few resource-rich developing economies that has managed to build a sizable and sophisticated manufacturing export base. The chapter provides an account of the country’s social, political, and economic challenges and how they were overcome. The chapter further explains the rationale of the strategies devised to develop Malaysia’s industrial and scientific capabilities that would take the country further down the development path in the decades to come.

Chapter 5 analyzes the experience of development in East Asian countries, with a particular emphasis on Korea. The chapter anchors the discussion in an historical context and helps explain how the general prescriptions suggested in Chapter 1 were pursued in Korea and how obstacles encountered along the way were overcome. The chapter offers an account of the actual constraints, relations with the private sector, incentives, and the real objective behind its industrialization strategy.

Chapter 6 explores the Latin American experience of diversification. The chapter argues that although many Latin American countries did well in the past decade or so, they rode the wave of a commodity boom. The stagnation of productivity in the region rings an alarm bell. The chapter discusses types of policies such as public inputs and market interventions along the horizontal or vertical dimensions of diversification. It concludes with the role of science, technology, and innovation in Latin American countries.

Part 3 explores some of the key policies to support diversification. Chapter 7 brings an important contribution to the theory of development in general and to natural resource exporters in particular. It tackles the key issue of how to overcome the middle-income trap. The chapter discusses potential determinants of productivity and productivity growth in firms. It also considers potential barriers to growth in the size of firms. The chapter revisits the role of vertical targeting (or sectoral policies) and proposes some elements of a new growth strategy for middle-income countries.

Chapter 8 studies the effect of diversification beyond the GDP measure, in particular poverty alleviation, technological innovation, capital flows, women’s empowerment, and entrepreneurship. The results indicate that industrial diversification greatly improves the economy’s output in all of these nonconventional measures. Illustrating the importance of diversification, the chapter then studies the different government programs used in Organisation for Economic Co-operation and Development countries to support innovation in certain industries. In particular, it provides evidence of the effectiveness of the U.S. Small Business Innovation Research Program and its equivalents in Europe.

Chapter 9 provides the practitioner’s vision of industrial development in Brazil. It descends from a bird’s-eye view of Brazil’s industrialization toward the specifics of the role played by the Brazilian Development Bank in Brazil’s growth over the past decades. It briefly provides an overview of the country’s past industrial policies, their successes and failures, and the return of new industrial policies in the 2000s, followed by the discussion of policies and instruments that the bank has implemented as a development-oriented venture capitalist.

Chapter 10 examines the Saemaul Undong movement in Korea, arguing that it can provide a missing link between market- and state-oriented development policies. Saemaul Undong contributed to social and economic development in Korea not only as a self-help community movement but also as a mechanism of social inclusion. Its success was based on grassroots participation supported by the government and a social structure that was made more open to upward mobility by the land reform of the 1950s. For the Saemaul Undong “was in a sense, a movement for spiritual reform of Korean people, and has achieved a lot in this respect. It changed people’s attitude from laziness to diligence, from dependence to self-reliance, and from individual selfishness to cooperation with others.”1

Chapter 11 takes a look at lessons for today and the way forward. The book concludes with the transcript of a conversation between His Excellency Muhammad Al Jasser, former Minister of Economy and Planning of Saudi Arabia and currently Minister at the Royal Court, and Min Zhu, Deputy Managing Director of the IMF, on the theme of diversification challenges in developing economies.

Choe, Chang Soo. 2005. “Key Factors to Successful Community Development: The Korean Experience.” Discussion Paper 39, Institute of Developing Economies, Japan.

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