Is a strong state a prerequisite or an obstacle to economic growth?

Sungjin Park, Wellington College, United Kingdom

Joint Third Place for the 2020 History Prize ​| 8 min read 

Introduction

There has been much ink spilt in favour of the limited government. Bodies of empirical work confirm the economic benefits of free markets and the robustness of such evidence seems hard to deny: markets deliver economic growth and governments make plenty of mistakes.1,2 A cursory glance at such evidence may lead to the presumption that strong states hinder economic growth. That is, if markets and private transactions are the engines for economic growth, strong states may seem a mere obstruction. However, this laissez-faire line of thought overlooks the state’s role in providing the very background for such growth-conducive arrangements.

 

Indeed, much of recent empirical and theoretical work has been devoted to buttressing the exact opposite intuition. In work-related to the economic development of weak states in Africa, for instance, the factor crucial to the failure of economic development of African states has been identified as the state’s lack of capacity rather than an overwhelming projection of state power.3,4 More significantly, the main lessons learned from Acemoglu and Robinson’s seminal work in historical institutionalism show that growth requires an agglomeration of institutional factors that incentivize agents to behave in ways that are conducive to economic growth.5

 

Now, the aforementioned confusion arises because of a mistaken understanding of what ‘prerequisite’ means in this context. A strong state being a prerequisite for economic growth does not mean that a strong state is a sufficient condition for economic growth. This understanding of ‘prerequisite’ would make the question overly tendentious in favour of the ‘obstacle’ view. There are simply too many strong states that fail at delivering economic growth. For instance, in Venezuela’s case, widespread nationalisation scared foreign investors and inefficiencies in state-owned firms severely hindered economic performance. We may say without qualm that Venezuela was and is a strong state, albeit one in which the strong state acts as an obstacle to growth.

Thus, a proper understanding of ‘prerequisite’ should be that a strong state is a necessary condition for economic growth. That is, wherever there is economic growth, there is a strong state that undergirds that growth, while it is possible to have a strong state that does not deliver economic growth. I will argue that a strong state is a prerequisite for economic growth. I will argue that a strong state enables sociopolitical stability, which acts as the minimal institutional preconditions on which incentives for growth are guaranteed.

In defining state strength, I will stay neutral by following Acemoglu in measuring state strength as having two dimensions along state capacity: economic and political.6 A state can be strong economically, in which case it has the capacity to utilize and direct resources throughout its territory. (i.e. through taxation and spending) If a state is politically strong, then rulers are not easily replaceable whereas the opposite is true for weak states. These definitions of state strength leave it open whether strong states are prerequisites or obstacles to economic growth because they measure the underlying capacity of states, which can manifest in ways that are conducive or opposed to economic growth.

Political Weakness, Unpredictability and Underinvestment

Political instability is defined as the propensity of a change in the executive, either by “constitutional” or “unconstitutional” means.7 When there is political instability, social instability, measured by incidence of revolution, frequency in change of power and likelihood of war become much more likely.8 In the absence of a politically strong state that guarantees such social stability, the following problem for economic growth arises.

First, institutional predictability is threatened, which significantly reduces consumer and investor confidence. A lack of consistent policies augmented by the likelihood of expropriation by various actors facilitates capital outflows. This is because investors’ propensity to invest depends on the knowledge that financial institutions will generate returns on savings and investments in the long-run; politically weak states fail to guarantee this due to the risk of unrest.9 Moreover, inconsistent expropriation creates uncertainty for firms and makes the state a less attractive place to invest. Under these conditions, households are also disincentivized from saving with financial institutions, which are perceived to be insecure. The net effect is a decrease in the overall capital stock and significantly lower economic growth than in the counterfactual.

 

Second, continuity in infrastructural investments is threatened. Under conditions of political weakness, the state does not have sustainable infrastructure strategies because of persistent changes to policy priorities and a lack of transparency in infrastructure projects’ procurement.10 This means that firms have little incentive to cooperate and invest and mechanisms such as public-private partnerships (PPPs) are likely to fail to be efficient.11 Thus, for instance, politically weak states such as the Democratic Republic of the Congo, suffer from chronic supply-chain disruption due to seasonal flooding and inadequate road networks.12,13 This represents a large obstacle to growth because crucial infrastructure such as transport infrastructure minimizes downtime and delays and allows for smooth supply chains, allowing industries to be consistently more productive.

 

This trend of political weakness of states further exacerbates economic weakness of states by laying ground for states’ inability to facilitate investments in high value-add industries. For instance, much of the literature on the resource curse attributes many resource-rich African states’ dependence on low-value and volatile raw materials to be based on just such a lack of state capacity to set up crucial infrastructure.14 This is consistent with the observation that most weak African states have mainly been exporters of lightly processed or unprocessed natural resources which, when processed, increase in value by up to 400 times that of the original commodity.15

 

Instability, Clientelism and Waste

Political weakness also generates systematic incentives for wastefulness which saps economic growth potential. Socio-political instability owing to the political weakness of states means higher stakes for incumbent regimes and reliance of client-patron networks in regions where state power does not penetrate.16 That is because there are divergent levels of penetration in state power, incumbent regimes require cooperation from regional players and survive by private goods provisions to their small winning coalitions instead of public goods provisions for the wider public.17

 

These clientelist networks are detrimental to economic growth in at least the following two ways. First, client networks often foster a culture of corruption in which regional players are able to run graft schemes through which much of the resources devoted to those projects are divided up for private gain.18 Especially because clientelist networks often operate on the basis of guaranteed employment, “underinvestment stems from the need to keep offers of employment credible in order to increase the probability of re-election”.19 As a net effect, clientelism creates a feedback loop which prevents businesses from being established, hindering economic growth and limiting tax revenue to already weak states, trapping them in a cycle of under-investment.20

 

Second, clientelist networks that stem from the weakness of states lead to wastefulness in public investments. Because weak governments need to consistently invest in the same actors that make up the winning coalition, redundant infrastructure investments happen. For instance, construction of the Kenyan standard gauge railway project was conducted at highly inflated prices, with land confiscation and unfair compensation, local procurement and employment benefiting regions affiliated with the ruling party.21

Strong States and Stability

In strong states, such crucial stability is preserved, allowing the state to generate institutional setups that are conducive to growth. In recent history, strong states have mainly existed in two different forms: authoritarian strong states and OECD-type democratic nations, which Acemoglu refers to as “consensually strong states.”22

 

In consensually strong states, there is a state-society consensus; firms and households trust the government and state actors opt to provide public goods to the taxpayers rather than expropriate for private gain.23 This firstly allows firms and households to invest and save with relative long-term certainty, which generates higher returns on capital. Further, democratically strong states’ capacity to collect taxes permit government investment in infrastructure, legislature and the judiciary which ground the operation of markets. Finally, strong institutions shape the decisions made by the ruler, acting as a check on arbitrary decision making and preventing catastrophic decisions which could lead to economic ruin.24 Given appropriate operation, this democratic stability creates a stable base for business activity, investor and consumer confidence, and thus sustained economic growth.

In contrast, authoritarian strong states are generally more interventionist, and exert more control over their markets: there are usually no fully functioning check-and-balance systems in place. This can drive economic growth or, if the strength is misapplied, can cause the strong authoritarian state to become an obstacle. For instance, strong authoritarian states’ ability to intervene in the private sector can lead to certain groups being favoured in return for support, which can reduce market efficiency, or leaders pursuing policies aimed at consolidating power and lining allies’ pockets rather than enriching the country. Strong authoritarian states’ ability to rewrite laws to their benefit makes private-state contracts insecure, reducing trust and business confidence, and misapplication of power can cause them to “become predators of private sector wealth”.25

 

History provides numerous examples of strong authoritarian states which hampered economic growth in these ways. In Hussain’s Iraq, frequent, arbitrary interventions in the market made the Iraqi economy highly unpredictable, leading to chronic problems in savings and investments.26 Likewise, the USSR suffered due to government intervention and the development of a command economy with price floors and ceilings. This created inefficiencies and market collapses, which led to further controls, further inefficiencies, and further economic woes.27

 

On the other hand, a strong authoritarian state pursuing growth-oriented policies can act as a robust engine for economic growth. The so-called Asian Tigers - Taiwan, Singapore, Hong Kong, and South Korea - were all, to large extents, strong authoritarian states during periods of rapid economic growth. All four Tigers saw state-led investment in education, combined with government financing which created low-interest corporate loans to fuel business growth and ultimately the policies were carefully fostered economic incentives, rather than arbitrary interventions.28

 

An instructive example is found in the industrial strategy of Park Chung-hee’s military regime in South Korea, which saw exponential growth since the 1960s. The strategy was to direct massive state-led investments in high-value-add infrastructures and industries. For example, the 1973 National Investment Fund Act allowed funds collected from state bond issuance to be lent out at low-interest rates to companies engaged in heavy industry and chemical sectors. Policies such as these introduced long-term certainties in the financial system at a time when investment destinations were generally unpromising by ‘picking’ winners in conglomerates such as Samsung, Hyundai and LG. This contributed to a sustained increase in savings and investments.29

 

These targeted interventions, such as the demand that major companies deliver certain levels of production and profitability in return for government support, allowed private actors to pursue profits but, crucially, left them with the freedom to choose the means to that end.30 These policies also aligned the interests of the government and conglomerates, encouraging cooperation for large infrastructure projects such as the Gyeongbu Highway and investments in state-led enterprise projects such as the Pohang Iron & Steel Company. Growing tax revenues also aided further investments in further large-scale infrastructure projects. 31,32

 

Conclusion

Alexander Hamilton once wrote “the state ought to excite the confidence of capitalists, who are ever cautious and sagacious, by aiding them to overcome the obstacles that lie in the way of all experiments,”33 and these words are consonant with my findings. Strong states are required as a

minimal background for economic growth.


However, that doesn’t mean that strong states are a panacea. While strong democratic states which minimize market intervention are generally able to sustain moderate economic growth, strong authoritarian states show a much wider range of outcomes. Misdirected and arbitrary institutions can create obstacles to economic growth and even catastrophic outcomes. On the other hand, careful interventions and management of industry can create the type of growth seen in the ‘Asian Tigers’ economies.

 

 

I conclude that although a strong state is a prerequisite for economic growth, the extent to which this strong state acts as an obstacle or an enabler depends on policies, markets and institutions.

Footnotes

 

1 F. Fukuyama, ‘The End of History?’, The National Interest, no. 16 (1989), pp. 3-18: 1.

2 W.M. Morrison, ‘China’s Economic Rise’, Congressional Research Service (2019), p. 10.

3 R. Wike & S. Schumacher, ‘Satisfaction with democracy’, Pew Research Centre, 27 February 2020. Available at: https://www.pewresearch.org/global/2020/02/27/satisfaction-with-democracy/.

4 See D. Acemoglu, ‘Politics and Economics in Strong and Weak States’, NBER Working Paper 11275 (2005), pp. 19-25. Acemoglu gives as examples the United Kingdom (with its NHS and welfare system), and Sweden.

5 P. Hanson, The Rise and Fall of the Soviet Economy: Economic History of the USSR 1945-1991, Routledge (Abingdon, 2003), p. 131.

6 C. Miller, The Struggle to Save the Soviet Economy: Mikhail Gorbachev and the Collapse of the USSR, North Carolina U.P. (Chapel Hill, NC, 2016), p. 57: ‘In theory, the CPSU controlled the economy, but in reality the industries controlled the party.’

7 R. Parker, ‘Inside the Collapsing Soviet Economy’, The Atlantic, June 1990.

8 A. Maddison, Chinese Economic Performance in the Long Run, 960-2030, OECD Development Centre (2007), p. 150.

9 Quoted in R. McGregor, ‘How the state runs business in China’, The Guardian, 25 July 2019.

10 A. Ogushi, ‘The disintegration of the Communist Party of the Soviet Union’, PhD thesis (University of Glasgow, 2005), p. 231. See also Appendix II.

11 M. Gilman, No Precedent, No Plan: Inside Russia’s 1998 Default, M.I.T. Press (Cambridge, MA, 2010), pp. 192-3.

12 Miller, Putinomics: Power and Money in Resurgent Russia, North Carolina U.P. (Chapel Hill, NC, 2018), p. 15.

13 A. Aslund, Building Capitalism: The Transformation of the Former Soviet Bloc, Cambridge U.P. (Cambridge, 2002), pp. 118, 308. Russian male life expectancy dropped nearly 10%, and suicides rose 60%, showing the extent of economic stress.

14 Economist Intelligence Unit, ‘Are state-owned enterprises reformable?’, 18 December 2018.

15 World Bank, Sodruzhestya nezavisimykh gosudartsv v 2005g (Moscow, 2006).

16 Miller, Putinomics, p. xiii.

17 It can also go the other way: the political subjection of the Venezuelan state oil company, PDVSA, means that its workers are hired on a basis of political allegiance to the United Socialist Party of Venezuela. In 2002, when PDVSA employees went on strike to protest the policies of Chávez, 19,000 were fired, and Intevep, the research and development arm of PDVSA lost 80%, reducing its ability to innovate and compete globally. 1976-92, 29% of PDVSA revenues went towards costs, and 71% to the government. Because of this, Chávez and his successor Nicolás Maduro have been accused of treating it like a ‘piggybank’.

18 See G. Di Bella, O. Dynnikova, S. Slavov, ‘The Russian State’s Size and its Footprint: Have They Increased?’, IMF WP 19/53 (2019). See also Appendix III.

19 Miller, ‘Russians Lower Their Standards’, Foreign Policy, 11 February 2019.

20 EIU, 2018. See also Appendix IV.

21 ‘Chinese Multinationals Gain Further Momentum’, Vale Columbia Centre and Fudan University survey, 9 December 2010. Available at: https://emgp.org/wpcontent/uploads/2018/07/China_2010.pdf.

22 McGregor, ‘How the state runs business’.

23 Morrison, ‘China’s Economic Rise’, summary.

24 A. Bruce-Lockhart, ‘China’s $900 billion New Silk Road. What you need to know’, World Economic Forum, 26 June 2017. Available at: https://www.weforum.org/agenda/2017/06/china-new-silk-road-explainer/. It is estimated that 80% of funds invested in Pakistan, 50% in Myanmar, and 33% in Central Asia will be lost (J. Kynge, ‘How the Silk Road plans will be financed’, Financial Times, 9 May 2016). However, the trade off for this is an increase in Chinese hard power: land collaterals for debt in Kyrgyzstan (where per capita debt was $703 in 2018) or the entire Hambanthota Port in Sri Lanka (See M. Abi-Habib, ‘How China Got Sri Lanka to Cough Up a Port’, New York Times, 25 June 2018. Available at: https://www.nytimes.com/2018/06/25/world/asia/china-sri-lanka-port.html). In addition, it may prove to be a boon for the Chinese workforce, since 89% of BRI contracts will go to Chinese corporations.

25 J. Kurlantzick, State Capitalism: How the Return of Statism is Transforming the World, O.U.P. USA (New York, NY, 2016), p. 111.

26 Miller, The Struggle to Save the Soviet Economy, p, 178: ‘Where the Soviet Union diverged from China, it was because powerful interest groups obstructed Gorbachëv’s policies’. Elsewhere, a school of thought argues that the new “interest group” in Russian politics is not economic, but military-political: the old guard of the KGB, the new FSB and SVR security services. For the best piece on this, see C. Belton, Putin’s People: How the KGB Took Back Russia and then Took on the West, William Collins (London, 2020).

27 In 2016, Xi Jinping released a statement saying that ‘one million’ Chinese officials had been punished for corruption between 2013- 16 (https://www.bbc.co.uk/news/world-asia-china-37748241).

28 For an interesting and suggestive investigation of the Belt and Road Initiative, refer to P. Frankopan, ‘The Roads to Beijing’, in The New Silk Roads: The Present and Future of the World, Bloomsbury (London, 2019), pp. 87-151.

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