In the post war period, different economic theories of development emerged, such as capital fundamentalism (linear stages approach); structural change theories or international dependent theories; the Washington Consensus – the neoliberal theory or market fundamentalism; endogenous growth theories; and an eclectic combination of all of the foregoing.79 However, ‘despite generally ignoring or rejecting the importance of institutions for development, most of these theories have institutional connections … these so-called non-institutional theories have important institutional implications that are not always acknowledged or recognized.’80
The class of theories identified as ‘capital fundamentalism’ or ‘linear stages approach’
state that in order to create adequate investment and accelerate GDP growth, countries have to activate foreign investment and domestic savings.81 This theory had a central policy implication of a state-centred approach for the promotion of savings and investments in the post-war period. There were tax incentives for production by private
78 Trebilcock and Mota Prado (n 69) 41.
79 ibid 8.
80 ibid.
81 Michael Todaro and Stephen Smith, Economic Development (11th edn, Addison Wesley 2012) 110.
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companies to promote savings and investment. Further, there were high levels of investment in state-owned companies.82
The ‘capital fundamentalists’ presumed that there was a functioning bureaucracy, tax organisation and institutional features of a working economy. Nevertheless, they did not find the solution for acquiring these institutions.83
Two competing categories of theories, structural change theories and international dependence theories replaced the ‘linear stages approach’ in the 1970s. These two theories went further than economic policies and emphasised the need for political and social change to foster development.84 According to structural change theories,
‘underdeveloped economies transform their domestic economic structures from a heavy emphasis on traditional subsistence agriculture to a more modern, more urbanized, and more industrially diverse manufacturing and service economy’.85
Dependency theories emerged in developing nations, such as those in Latin America, in response to an overly-simplistic consideration of economic development. According to these theories, the international economic order is divided and there is a need for a link between an agrarian boundary and the industrial centre.86 These theorists advocated economic nationalism.87 The theories envisaged high levels of tariff protection to safeguard local industry based on import substitution industrialisation.88
82 Michael Trebilcock, ‘What makes poor countries poor? The role of institutional capital in economic development’, in Eduardo Buscaglia and others (eds), The Law and Economics of Development (JAI Press 1997) 17.
83 Pranab Bardhan, ‘Symposium on the State and Economic Development’ (1990) 4 Journal of Economic Perspectives 3.
84 Trebilcock and Mota Prado (n 69) 9.
85 Todaro and Smith (n 81) 110-111.
86 ibid 122.
87 Brian Tamanaha, ‘The Lessons of Law and Development Studies’ (1995) 89(2) American Journal of International Law 478.
88 John Coatsworth, ‘Structures, Endowments and Institutions in the Economic History of Latin America’ (2005) 40(3) Latin America Research Review 126.
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Regarding the polarisation of the international economic order, these theories based their claim on the assumption that exploitation of former colonies had remained, and in some cases had been intensified, after independence. The transformation required under these theories demanded that the state implement polices to nurture industrialisation and modernisation of the agricultural sector. This needed a modern educational system to train the agriculturists and workforce as well as urban planning and infrastructure investments. However, these assumptions did not take into account the complex institutional framework that is required by the state to implement them. Hence, like
‘capital fundamentalism’ or the ‘linear stages approach’, these theories did not address the institutional implications in their theoretical models.89
Structural change and dependence theories were replaced by the development theory and practice which was dominated by a single predominant paradigm that positioned market forces at the centre of the policy. That prevailing paradigm was termed ‘market fundamentalism’ by financier George Soros. This theory and practice came to be known as ‘neoliberalism’ in Latin America.90 This neoliberal theory comprised policy prescriptions known as the ‘Washington Consensus’.91
The main principles of the Washington Consensus were liberalisation, macro-economic stability, foreign direct investment (FDI) priority, privatisation and stimulation of private entrepreneurship. It was followed by Latin American countries in a meticulous
89 Trebilcock and Mota Prado (n 69) 9, 10 and 45: ‘some dependencistas were also influenced by Marxist ideas that the division between rich and poor is required to support the global capitalist system.’
90 Robin Broad, ‘The Washington Consensus Meets the Global Backlash: Shifting Debates and
Policies’ (December 2004) 1(2) Globalizations 129. See also G Soros, On Globalization (Public Affairs 2002) 4–10.
91 See John Williamson, ‘The Washington Consensus as policy prescription for development’ in Timothy Besley and Roberto Zagha (eds), Development Challenges in the 1990s: Leading Policymakers Speak from Experience (OUP 2005) 33.
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manner. However, the approach of developing countries in other regions of the world was more cautious.92
The neoliberal theory or the Washington Consensus disregarded the role of the state in the provision of pre-conditions for the markets to operate. Markets require the regulation of the banking sector, capital markets, the trade system, the tax system, healthcare, education, competition policies, infrastructure investment and an effective legal system. The lack of attention on these institutional networks became one of the main reasons for the failure of the Washington Consensus.93 The neoliberal theory did not explain the rates of technological change and productivity growth. Neither could it explain the fickle, long-term growth rates experienced by various countries.94
Endogenous growth theory replaced the neoliberal theory. This theory emphasises that economic development is an endogenous outcome of an economic system. It is not the consequence of forces that intrude from outside.95 Trebilcock states that:
Endogeneity, in economics, refers to the fact that variables in a certain model are not independent – that is, changes in one variable will produce changes in another variable, and vice versa. Endogenous theories of growth thus claim that these variables, such as technological change, are not independent: they impact on growth, which in turn impacts on them.96
In this theory, there is a two way interaction between economic life and technology for economic growth. Technological progress in this system transforms the very economic
92 V Bulmer-Thomas, The Economic History of Latin America since Independence (CUP 2003) 3.
93 Dani Rodrick, ‘Goodbye Washington Consensus, Hello Washington Confusion? A Review of the World Bank’s Economic Growth in the 1990s: Learning from a Decade of Reform’ (2006) 44(4) Journal of Economic Literature 973. Also see Robin Broad and John Cavanagh, ‘The death of the Washington Consensus’ in Walden F Bello, Nicola Bullard and Kamal Malhotra (eds), Global Finance: New Thinking on Regulating Speculative Capital Markets (Zed Books 2000).
94 Subrata Ghatak, Introduction to Development Economics (4th edn, Routledge 2003) 58.
95 Paul M Romer, ‘The Origins of Endogenous Growth’ (1994) 8 Journal of Economic Perspectives 3.
96 Trebilcock and Mota Prado (n 69) 12.
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system that generates it. Endogenous growth theories understand and concentrate on this interplay to achieve economic growth.97
It is striking with regard to this theory that, in contrast to the neo-liberal theory, it is
‘somewhat more sympathetic to a more activist policy role for the state in realizing the dynamic economies associated with the introduction and exploitation of modern technology and its accompanying externalities and spillovers’.98
This theory is the one that most explicitly advocates the role of institutions amongst all economic theories of development. However, this theory lacks any insight that would improve the institutions. Eventually, because of the deficiencies in neoliberal policies, an agreement has evolved that it is the quality of state intervention which matters rather than its quantity. In the last decade, the institutional perspective on development has become important in development thinking as depicted in the mantra, ‘institutions matters’ or ‘governance matters’.99