The Role of Medium-Term Plans in Development
The use of development planning to foster economic growth has been a
general practice in almost all developing countries since World War II. It is perhaps
pertinent, therefore, to enumerate at the beginning of this essay the major factors that
are considered responsible for long-run economic growth. Economic growth means sustained
increase in per capita output, which in the final analysis reflects continuing improvement
in labor productivity.
Economists sometimes differentiate economic growth from economic
development in that growth refers only to quantitative changes, while development involves
not only quantitative but also qualitative changes, such as changes in industrial
structure, economic institutions, and even the sociocultural environment. However,
anything that grows changes. Without socioeconomic changes, economic growth could not be
sustained for very long. This may be why certain economists, notably the late Simon
Kuznets. use the term growth rather than development in dealing with the
process of economic development (Kuznets 1966; see also Rostow I960).
Economic growth can be attributed to the following factors:
(1) A growing stock of knowledge from which continuous technical
progress, in the form of more efficient methods of production, new products, or the
ability to take advantage of other countries' advanced science and technology, can be
made. Without technical progress, existing sources of growth would gradually be
exhausted, and the growth rate would decline and eventually approach
zero. The economy would become stagnant.
(2) A group of people who have the spirit of entrepreneurship to take
the initiatives and risks necessary to apply new technology to production. Without
entrepreneurs, there would be no innovation, and the increasing stock of knowledge would
not be relevant to economic development.
(3) A healthy, disciplined, and well-educated labor force willing to
work and responsive to the incentive systems of the economy.
(4) A well-organized social, cultural, and institutional framework
within which economic activities take place. In a centrally planned economy government
authorities make major decisions on resource allocation. In a mixed-market economy it is
the private sector that functions as the major engine of the economy in cooperation with
the public sector. As Barend A. de Vries has correctly noted:
Without a viable private sector, government cannot (in most
circumstances) stimulate or sustain economic growth. Conversely, without a reasonably
efficient public sector capable of providing at a manageable economic cost the
necessary infrastructure and an overall environment conducive to sound investment, the
private sector is unlikely to make its full contribution to development. If government is
inefficient and ineffective, or if it pursues policies that significantly distort private
sector decision making, both the private sector and the overall prospects for economic
development suffer, (de Vries 1981, 11 12)
(5) A constant flow of savings put aside from current production,
and large enough in percentage of GNP to finance investment. A country cannot, however,
save what it does not produce. A certain portion of what has been saved has to be
exchanged, through international trade, for products consistent with domestic investment.
Part of domestic investment could also be financed by foreign savings through trade
deficits. A low saving ratio, under-development of international trade, and lack of
sufficient foreign capital inflow can all cause bottlenecks limiting the economic growth
of a country.
Each of these factors can be interfered with by government action, and
could therefore be included in development planning. Important though all of these factors
are to economic development, none has been a major subject of economic analysis, with the
exception of savings and investment. Modern articulated comprehensive development planning
for mixed-market economies owes its origin to Keynesian economics, in
which savings and investment play a key role.
This chapter consists of seven sections. Section 2 will trace the
beginning of postwar comprehensive national economic plans and their later development.
Types of plans, in terms of length, will also be discussed in this section. Section 3
deals with the objectives of planning in general and the relationship between growth and
planning in particular. Section 4 is on resource mobilization and the allocation of
resources between the public sector and the private sector and on determination of
investment within the private sector. In section 5 education and research and development
are discussed in connection with investment in human capital and technical progress.
Section 6 is on price stability and income distribution. And the last section, section 7,
contains concluding remarks.
Development of Economic Planning
Economic plans may mean many different things. Broadly defined, an
economic plan is a systematic arrangement of policy measures designed to achieve certain
objectives or goals in connection with the economy as a whole or with a particular aspect
of the economy. In this sense, one can hardly think of any economy that has not adopted
economic plans of one kind or another as a device for improving economic situations. But
the use of comprehensive national development plans to promote nationwide economic
development came into existence and emerged in developing countries only after World War
II. Development planning improved only gradually and has reached its present level of
sophistication as a result of both accumulated experience and advances in economics and
During the early postwar years economic plans in many developing
countries were often just wish lists and collections of proposed investment projects. W.
Arthur Lewis included in a development plan any or all of the following parts:
(1) a survey of current economic conditions;
(2) a list of proposed public expenditures;
(3) a discussion of likely developments in the private sector;
(4) a macroeconomic projection of the economy;
(5) a review of government policies. (Lewis 1966, 13)
They were gradually developed into a body of consistent goals to be
obtained and policy measures to be adopted. Modern articulated comprehensive national
development planning would not have been possible without the existence of macroeconomics
and national income statistics.
In the 1950s and the early 1960s, when post-Keynesian growth theory
was prevailing, the Harrod-Domar model was widely used in development planning to
calculate the capital requirement necessary to achieve a certain rate of growth or to
determine a growth target given the financial resources available for domestic investment.
Following the development of neoclassical growth theory, the Harrod-Domar fixed
coefficient production function was replaced by more general forms of production
functions. Manpower planning was brought into the picture at least partly as a result of
the emergence of the investment-in-human-capital thesis. Of course, there were other
factors that also had something to do with the inclusion of manpower and education in
development planning, for example: (1) in order to raise production as the
unlimited-supply-of-labor stage ended, improvement in the quality of labor by way of
education was required; and (2) as capital accumulated and became abundant, availability
of skilled workers gradually became a limiting factor to further growth.
In 1961 the General Assembly of the United Nations designated the 1960s
as the Development Decade and called upon member countries to accelerate programs not only
in economic growth but also in social development. In response to this idea of
socioeconomic development, UN experts promoted the inclusion of social considerations such
as employment, education, health care, housing, social welfare, income distribution, and
regional development into overall development planning; they emphasized the need for
intersectional coordination and integration (United Nations 1963).
However, the integration of economic and social development planning has
never been successful. This is because we know very little about the interrelationships
between economic and social variables. Although certain social aspects have been included
in development plans, they are in most cases formal and superficial, and only passively
involve the redistribution aspect of development at most, in the sense that the
benefits of economic growth should be widespread through social programs. After all,
economic development is, in the final analysis, a sociocultural process, and sociocultural
behavior is difficult to plan. Thus the basic nature of economic development largely
limits the effect that can be expected from development planning.
Development plans can be put into three categories in terms of length:
long-term plans, medium-term plans, and short-term plans. A long-term plan is a
perspective plan that covers a period of fifteen, twenty, or even twenty-five years
strictly speaking, more a projection
into the future than a plan for the future. It predicts certain major
variables, such as population, labor force, and productivity in the distant future to
serve as a background for the formulation of medium-term plans. Examples of long-term
plans are the Soviet Union's 1960 80 twenty-year plan, and the French 1969 85
projection. Recently, the Republic of China on Taiwan completed a long-term projection
into the year 2000, against which its 1986 1990 four-year medium-term plan was
The long-term plan is basically a supply-side plan. This is because, in
the long run, economic growth is a result of increases in production capacity rather than
in demand. And increases in production capacity involve improvement of the quantity and
quality of the labor force, capital accumulation, and most important, technical progress,
which reflects applications of advancing knowledge to actual production. Technical
progress not only raises the productivity of labor and capital but also creates new
products, offsetting the effect of the law of diminishing utility and opening up new
dimensions for demand. Since knowledge concerning technical progress is limited, and is
even more so as the period of observation extends, a long-term plan cannot be expected to
be as comprehensive as a medium-term plan.
The duration of medium-term plans varies from three to seven years. Most
countries adopt five-year plans, as have the Republic of Korea, India, and the Soviet
Union. However, it is by no means necessary that a country always stick to the same
duration in its medium-term planning. In the case of France, the first plan was for seven
years (1947 53), but the following plans were for four years. Taiwan's medium-term
plans have been four-year ones, except for a six-year plan in 1976 81. Medium-term
plans are in operation in most developing countries. A complete medium-term plan consists
of three basic components: objectives, projections, and policy measures. Objectives are
the points we intend to reach with the help of certain policy measures; projections are
the places we would arrive at without adopting any government policy. A medium-term plan
consists of variables on both the supply side and the demand side. A key factor that
connects supply and demand is investment, which is by definition an addition to the
capital stock. Whenever net investment is not zero, the capital stock changes, and so does
production capacity, or potential GNP.
The short-term plan is an annual plan, used for adjustment in order to
keep development planning close to reality. It is also used to link economic plans to
government budgets. A short-term plan is a plan on the
demand side simply because potential supply is fixed in the short run.
However, investment and certain elements of government budget expenditure, such as those
on social infrastructure, education, and research and development, do add to supply
capacity. This change in production capacity will not, however, be shown in the current
The characteristics of development plans, and the ways in which
government actions affect economies through planning, vary with different economic
systems. Plans in centrally planned communist countries are basically controlling plans,
whereas those in mixed-market economies are mostly indicative plans. A controlling plan
gives orders to the various units of the different sectors of the economy. Its effect on
the economy is direct and by command. An indicative plan only indicates intentions and
recommends policies to fulfill them. Its effect on the economy, apart from the public
sector, is indirect and through the influence of public policies on the private sector. In
a mixed-market economy, some sectors such as the government and public enterprises
can be controlled by plans and others can only be influenced by policy actions. The
control over the public sector may be tight or loose, and the influence on the private
sector may be heavy or light in different countries and in the same country at different
stages of development. This is what makes development plans different from one another.
The four-year and six-year economic plans of Taiwan may be taken as
examples of indicative plans. Taiwan started its first four-year medium-term plans in
1953. During the first two four-year plan periods, 1953 60, the fundamental
development strategy was the so-called inward-looking, import-substituting policy. Certain
consumer goods industries, notably textiles, were selected for development under the
protection of foreign-exchange controls and high tariff duties to supply the domestic
market. Government intentions for private industrial development were carried out mainly
through selective allocation of financial resources at differential rates of interest.
And, until 1965, when it was terminated, U.S. aid was one major source of financing.
Toward the end of the 1950s, when the domestic market was becoming
saturated with primary import-substituting products, the government undertook a series of
foreign trade and exchange reforms. In so doing, it changed the development strategy to an
outward-looking, export-promoting policy. The New Taiwan dollar was devalued. Import
controls were relaxed. Throughout the 1960s, industrial development very much followed
market forces rather than government decisions, with the importing sector still
considerably protected by high tariffs and
some import controls, and financial allocation in favor of exporting
industries. In the mid 1960s export-processing zones were established to encourage
development of the industries in which the economy possessed a comparative advantage.
The 1970s showed a reverting tendency toward more government
intervention in private investment. The petrochemical intermediate products industry was
established under government planning to supply the "downstream" industries.
This is an example of so-called second-phase import substitution. Electronics and
machinery were selected as "strategic" industries and enjoyed credit from banks
with matching government funds to lower the interest rate. But the intervention was
gradually reduced, and in the early 1980s the government eventually decided to liberalize
the whole economy and go international.
Objectives of Planning
The objectives that are commonly mentioned in medium-term development
(1) high growth rate in terms of GNP and per capita GNP;
(2) high level of employment or low rate of unemployment;
(3) a stable general price level;
(4) improvement in income distribution; and
(5) improvement in the balance of international payments.
The last is not on the same level as the first four objectives, which
may be considered the ultimate ends, in the sense that they are not used as means to
achieve other ends. They are ends in themselves so far as development planning is
concerned. The reason that balance-of-payments improvement is included as one of the
objectives is that developing countries are often troubled by balance-of-payments deficit
problems in the course of development. Additional objectives, such as improvement in
industrial structure, diversification of production or exports, and more balanced
development among regions, are also often found in development plans.
These objectives are not necessarily consistent, and may, in fact,
conflict with one another in many cases. For example, rapid growth in production and full
employment may be contradictory; rapid growth and a stable price level are difficult to
attain at the same time; and many economists believe that high rates of growth and
equitable income distribution conflict with each other. This, of course, may be
oversimplified. Some of the conflicts could be resolved, or at least reduced to a certain
incorporating appropriate policies into the plan. In the case of
Taiwan, a high rate of growth, a low rate of unemployment, and improvement in the size
distribution of income have all been achieved at the same time. The achievement may be at
least partly attributable to two particular policies among its development plans:
(1) Method of production, in terms of labor/capital ratio, varies as
relative prices (the wage rate and the interest rate) change over the course of
development. To be specific, labor-intensive methods of production were encouraged when
labor was an abundant factor in the economy, and only as labor gradually became scarce
were more capital-intensive and technology-intensive production methods recommended in the
1970s and 1980s.
(2) Industries have been dispersed, helping factories to have easy
access to labor (Ranis 1979, 222 24). This has not only raised the level of
employment, and therefore reduced the rate of unemployment, but has also improved income
distribution by way of raising labor's share of income in relation to capital's. This may
also to some extent have been responsible for the price stability Taiwan was able to
maintain prior to the early 1970s, since easy access to labor helped avoid an early labor
shortage, which in turn prevented the wage rate from increasing excessively. But not every
country has this kind of advantage. A prerequisite of the dispersion of industries is a
well-developed system of transportation and communication.
If the objectives of planning are inconsistent in that the achievement
of one may retard another, decisions must be made concerning the priorities of the
objectives. Take the Republic of Korea and the Republic of China on Taiwan for example. In
their respective development plans, Korea has assigned higher priority to growth, relative
to price stability and equitable distribution, than has Taiwan.
Planning and Growth
While the priority system may differ in different countries and even
at different times for the same country, economic growth is always the most important
objective to be pursued in all development plans. At this point the following questions
naturally arise: Does development planning really foster economic growth? If it does, then
why. how, and to what extent does it do so? What are the factors that influence the
effectiveness of a development plan?
Despite the prevalence of planning in almost all developing countries,
economists have become skeptical about the effectiveness of economic planning on growth.
After quoting Albert Waterston as saying that there have been many more failures than
successes in the implementation of development plans in postwar planning history, and that
the great majority of countries have failed to realize even modest output targets in their
plans except for short periods, Michael Todaro concludes: "After more than two
decades of experience with development planning in Third World countries, the results have
been generally disappointing" (Todaro 1981, 459).
Another textbook writer, Clarence Zuvekas, even goes so far as to say:
The macroeconomic plans adopted by developing countries vary in
complexity and technical soundness, but with few exceptions they have one common
characteristic: their ineffectiveness. The acceleration of economic growth rates since
1960 has had little to do with the preparation of planning documents which prescribe the
speed and direction of growth and identify the policy instruments that are to be used to
achieve national economic objectives and growth. Indeed, economic growth has often
proceeded in directions not foreseen by the plan, or if in accordance with the plan, would
have occurred even without the plan. (Zuvekas 1979, 191)
However, neither the poor record of growth rates nor the wide divergence
of growth performances from planned targets is by any means clear proof of the dysfunction
of development planning in promoting economic growth. There are areas that have to do with
economic growth, but in which very little can be done in medium-term planning, such as
entrepreneurship and cultural variables. And there are other areas where planning does
carry a certain influence, such as the mobilization of physical and human resources.
Ineffectiveness may result either from a deficiency of the plan or from its poor
implementation. The often-mentioned shortcomings of development planning include
inappropriate theory and techniques, inadequate and inaccurate data, and lack of
willingness or administrative capability for implementation.
Economic growth in terms of per capita output (as it was defined in the
introductory section of this chapter) results from increases in employment as a percentage
of population, and in labor productivity.
The increase in the employment ratio is limited first by the size of the
labor force and then by the age structure of the population. The difference between
employment and the labor force is unemployment. And the size of the labor force is
determined by the participation ratio, given the number of the population beyond a certain
age, say fifteen years of
age. Generally speaking, in a rapidly growing economy, the rate of
increase in population first rises to a high level and then gradually dedines. As a
result, the proportion of the population that is of working age first declines and then
increases. Usually, the labor-participation ratio also increases as the economy grows.
Therefore, in the course of development, there is a period of time when the potential
supply of labor increases as a percentage of the total population. However, this tendency
does not last very long before the structure of the population ages.
The increase in labor productivity is a combined result of a number of
factors, such as improvement of the quality of the labor force, increase in the amount of
capital per worker (in other words, the capital/labor ratio, or the capital intensity),
and, most important, technical progress. The contribution of the increase in capital
intensity to productivity improvement would decline gradually to zero at a given level of
technology because of the law of diminishing returns. There would be no incentives for
investment, and the net saving ratio would tall to zero. In the long run, then, technical
progress is the only source of economic growth in terms of both per capita output and
Technical progress is a simplified concept involving a multiplicity of
factors. First, there has to be a constant flow of new technology that can be applied to
production in the form of either new products or new methods of production. Then a
group of innovative entrepreneurs must exist who will take risks to apply new technology
to actual production, otherwise advancement in technology would not be relevant to
economic growth. Quality of the labor force has to be continuously improved, as do the
sociocultural conditions under which investment and production are taking place.
The role of development planning in promotion of economic growth is (1)
to mobilize idle labor for production, (2) to promote domestic savings and to attract
foreign capital for investment, (3) to provide education and training or otherwise invest
in human capital in order to upgrade the quality of the labor force, (4) to encourage or
undertake research and development in science and technology, and (5) to improve
sociocultural conditions in order to facilitate investment and production, among other
Resource Mobilization and Allocation
The mobilization of idle labor as a source of economic growth works
only in the early stage of development, when there is large open and dis-
guised unemployment. Furthermore, additional savings will be required
to finance the mobilized workers. The mobilization-of-idle-labor thesis has never played a
major role in development planning. However, the mobilization of savings has always been
central to development planning.
In most developing countries, savings generated from the private sector
are rarely adequate to sustain even a moderate growth rate. Therefore, public-sector
savings and savings by state-owned enterprises have been heavily relied upon to finance
investment in social infrastructure, such as transportation, communications, irrigation
systems, and electric power. But the record is not impressive in most cases. According to
an early study by the secretariat of the Economic Commission for Asia and the Far East of
the United Nations, while net domestic saving as a percentage of national income was less
than 10 percent for selected ECAFE countries (with the exception of Japan [27.7 percent)
and Burma [15.6 percent]) during the 1950s, public saving was less than halt of private
saving in Burma, Taiwan, and Japan, less than one-fifth in India, and negative in South
Korea. Public saving was equal to private saving in Ceylon and exceeded private saving in
the Philippines, where net domestic saving was only 2.5 percent of national income. The
same study reveals that the public sector was not able to generate enough saving to
finance public investment in the period of 1950 60, with the exceptions of Ceylon
and the Philippines. For four out of the eight selected countries, more than 60 percent
was financed by external sources (United Nations 1962).
In a recent study Lin Wu-Lang reports that in most developing countries,
net government saving (as a percentage of total current general government revenues) is
generally less than 25 percent; that government net savings generally form not more than 3
or 4 percent of gross domestic product; and that within the public sector, public
enterprises, instead of contributing to it, make large and growing claims on the
government budget (Lin 1985).
In the early postwar years, when the saving ratios in most then
underdeveloped countries were low and the public sector was sought as a major source of
saving to finance investment, few came away with any significant results. In order to have
a higher public-saving ratio, government revenues have to be increased relative to
government expenditures. This, in turn, depends upon efficient administration and a sound
and flexible system of taxation, both of which were lacking in underdeveloped countries.
As development economists used to argue in the
late 1950s and early 1960s, an underdeveloped country was
underdeveloped because the administration was underdeveloped, and so was the tax system.
Even if public-sector saving could be increased by an increase in
government revenues, whether it would be a net increase to the economy as a whole or
merely an increase at the expense of saving in the private sector, so that total saving of
the economy would not increase, is still difficult to say. The effect of an increase in
public saving by way of an increase in tax revenues and the profits of state-owned
enterprises is twofold. On the positive side, through increasing public investment in
social infrastructure, which would reduce costs of production and improve efficiency in
the private sector, private investment would be encouraged. On the negative side, the
increase in taxes might reduce private saving and weaken incentives to invest, therefore
retarding economic growth. As a result, in the long run, increases in tax revenues might
even decline rather than increase.
Alan Reynolds (1985) has demonstrated that in countries where average
tax rates as a percentage of GDP were high. increases in real tax revenues over the
seven-year period 1975 82 were generally low, and in many cases negative, while
those countries where average tax rates were low nevertheless enjoyed rapid increases in
real tax revenues. In promoting national saving to finance domestic investment in a
developing market economy, behavior in the private sector is always of first importance.
In the early postwar years when development economics first emerged,
many economists argued that an underdeveloped economy was underdeveloped because its
saving ratio was inadequate to finance the high rate of investment required to sustain
even a modest economic growth rate. The low saving ratio was a result of low per capita
income, which in turn was owing to the low rate of economic growth. This process formed
the so-called vicious circle of poverty that was so difficult for poor countries to break
Low saving ratios were a major characteristic of underdeveloped
economies. Some people even went so far as to argue that there was a lack of thrift in
underdeveloped countries they simply would not save enough to get ahead. However, as
T. W. Schultz has correctly pointed out, a stagnant poor economy fails to save enough to
start growing not because of lack of thrift but because of lack of incentive (Schultz
1967, 28). At any given level of technology, capital will accumulate through investment
until the marginal productivity of capital, and therefore its rate
of return, approaches zero, at which point there will be no incentive
for investment. Net investment will fall to zero, and so follows net saving if there is no
opportunity to invest abroad. (Investing abroad prevents saving from declining to zero
even though there is no return on investment at home.) Technical progress raises the
marginal productivity of capital and incentives to invest on the one hand and improves
profits and ability to save on the other. A country is never too poor to save a small
portion of its production, but lack of technical progress makes saving and investment
So a low rate of saving may be a limiting factor to growth in the early
stage of economic development, as in the 1950s and early 1960s in many developing
countries. But once they have started growing as a result of technical progress,
developing countries will generate their own savings to finance at least part of the
investment required for sustaining growth. And in many developing countries saving has
considerably increased as a percentage of GNP since the late 1960s. This may be a major
reason why saving has gradually become a less favored subject in development economics.
Generally speaking, the saving ratio increases as the economic growth rate increases,
which provides incentives and improves the ability to save. But there are other factors
that also affect saving and help explain individual differences in the saving ratio among
Among all developing countries, Taiwan has generated the highest saving
ratio in the past decade or so. Its gross national saving as a percentage of GNP has
exceeded 30 percent annually since 1972, the only exception being 1975, when it dropped to
26.19 percent as a result of the first oil crisis. In comparing economic development in
Taiwan and South Korea, Tibor Scitovsky summarizes the factors responsible for Taiwan's
high household saving as follows:
The slightly faster growth of Taiwan's GNP; the slightly faster
increase in the proportion of its labor force receiving part of its income in the form of
bonuses; people's lesser spending and need to spend on education; the greater proportion
of people saving up to establish independent businesses; the greater number of businessmen
saving up to enlarge their already established independent businesses; and people's
greater willingness to save especially for their old age, due partly to their greater
affluence, and partly to the more secure and higher returns on their accumulated savings.
(Scitovsky 1985, 249)
Savings can be encouraged by tax incentives, high interest rates, and
price stability Price stability provides certainty and security in saving. Governments
that adopted expansionary monetary and fiscal policies to
provide forced financing for investment often found only worsening
inflation and a declining saving ratio in the long run. S. C. Tsiang (1984) criticizes the
"misguided monetary policy," under the influence of Keynesian economics, of
keeping interest rates low in order to stimulate investment and prevent cost-push
inflation in the 1950s and 1960s for discouraging, rather than promoting, saving by the
public. He argues that Taiwan was probably the first among the developing countries to
abandon a low-interest rate policy to combat inflation and encourage saving, and was
proven successful in the early 1950s and again in 1974.
In the past twenty years or so, Korea and Taiwan have achieved
approximately the same average annual growth rate. However, since the early 1970s. Taiwan
has been able to generate more than enough savings to finance its domestic investment,
while Korea (though also high in saving ratio compared to many other developing countries)
has had to depend heavily on capital inflow in order to maintain its rapid growth. The
domestic saving-investment relationship has far-reaching effects on the foreign sector,
and the difference between saving and investment at home always equals that between
exports and imports. In recent years Taiwan has suffered from an increasing trade surplus,
and Korea from trade deficits; both have their roots in saving-investment positions.
Determination of Investment
With regard to the allocation of resources available for investment,
two questions are essential in development planning: one is how much of the resources
should be allocated to investment in social infrastructure and how much to productive
investment; and the other is to what extent should the productive investment be guided or
intervened in by government policies. Whether investment in infrastructure should lead or
follow productive investment has been an issue in development economics. The advantage of
low infrastructure investment is that more resources can be available for productive
investment, but the disadvantage is that inadequate infrastructure investment may become a
bottleneck and therefore retard growth. The advantage of overinvestment in infrastructure
is that it facilitates productive investment, but again, the disadvantage is that, in the
face of limited resources, it may crowd out productive investment. Intelligent planning
serves the purpose of maintaining balance between the two categories of investment, and
makes sure that the growth rate is maximized. However, owing to both the large scale and
the indivisibility of social infrastructure, exact balance is neither possible nor
necessary. In this respect, the concept of balance applies only in the long run.
As for government guidance or intervention in productive investment,
it can vary from complete control (in the form of state-owned enterprises) at one extreme
to total determination by market forces at the other. Even in the private sector there are
various degrees of government intervention. The choices made will depend upon the ideology
of the economic system, the theories believed by the decision makers and planners, and the
stage of development of the economy, among other things. In order to influence private
investment, the government may use protective tariffs, import controls, foreign-exchange
policies, credit allocations, differential interest rates, direct assistance, and
privileges and persuasion of influential government officials. In Taiwan in the 1950s,
private investments were directed to the area of import substitution in order to save
foreign exchange and to meet domestic demand. In the 1960s investments in exporting
industries were encouraged in order to take advantage of the world market. As can be
imagined, relatively more government measures (compared to market forces) were adopted to
serve the purposes of the 1950s than the 1960s. In recent years the government has decided
to go international and to further liberalize the economy in order to enjoy the benefits
of comparative advantage, and thus to improve the economic efficiency of resource
The rationale behind government intervention in private investment is
that while the market or the price system could achieve static efficiency by maximizing
current output with given production factors under ideal conditions, it would not
automatically lead to technological advancement and structural improvement. In this
respect, government must play a role. As Oskar Lange once remarked: "Consequently,
the problem of development planning is one of assuring that there be sufficient productive
investment, and then of directing that productive investment into such channels as will
provide for the most rapid growth of the productive power of national economy" (Lange
Investment resources have been directed to import-substituting
industries or to exporting industries in different countries and at different time periods
in the same country. In recent years emphasis has been given to high-technology industries
in many middle-income developing countries. Judged by past performance, there have been
successes as well as failures. Generally speaking, those countries that pursued
export-promoting development strategies have proven more successful than others. And of
all the successes, four resource-poor exportoriented developing economies with small
domestic markets (Korea, Taiwan, Hong Kong, and Singapore) have emerged as outstanding.
development of high-technology industries in developing countries has
yet to be seen.
After reviewing more than three hundred plans, a World Bank report
emphasizes the importance of consistency of development planning with the market and the
price system, saying: "There is strong evidence to suggest that policies leading to
high distortion in prices and incentives also lead to significant losses in growth and do
not necessarily produce benefits in terms of equity" (Agarwala 1983, 13).
This report lists the following as policies that countries with
relatively high growth rates have pursued:
¢ Avoiding appreciation of the real effective exchange rate
¢ Keeping the effective protection rate of manufacturing both low and
even among products
¢ Avoiding the high taxation of agriculture by holding down producer
¢ Keeping interest rates positive and avoiding real wage increases not
justified by rising productivity
¢ Applying cost-recovery principles in the pricing of infrastructure
¢ Avoiding high and accelerating inflation
One common characteristic of these policies is that development
incentives operate within the framework of the price system, not against it. Arnold
¢ Make the tax system simple, easy to administer, and neutral and
non-distorting with respect to resource allocation
¢ Avoid excessive income tax rates; high rates distort behavior and
create disincentives to economic activity, while yielding little revenue
¢ Avoid excessive use of tax incentives to achieve particular
objectives; excessive tax incentives too often direct scarce resources to less efficient
¢ Take advantage of international trade and modify tariff schedules in
the direction of greater equality
¢ Let public enterprises operate like private interprises; when public
enterprises and private enterprises compete, let their competition be governed by the same
rules (Harberger 1984, 427 66)
Here again, the underlying principle is to be consistent with, and make
use of, the market, not to distort it.
Government policy has universally been taken to provide the necessary
incentives to channel investment resources to areas thought to be the most favorable to
long-run growth. However, it should be kept in mind that economic growth is a
sociocultural process that proceeds only gradually in terms of technological progress and
improvements in industrial structure. The more ambitious the goal is, the larger the
incentives offered will have to be. Too often in the history of the development of the
Third World, government incentives have turned out to be so great that investments were
induced in areas far from the reach of technology, and where little comparative advantage
existed And yet the burden had to be shared, in one way or another, by the economy as a
whole. Whether a developing country chooses to be more or less ambitious in its industrial
policy to push its economy to the developed state is a matter not only of economic
calculation, but also of political philosophy.
Both South Korea and Taiwan have adopted export-led, outward-looking
development strategies in their development plans to take advantage of international trade
and their comparative advantages in labor-intensive industries. Both have pursued
industrial policies to guide and influence private investments in order to speed up
improvement in industrial structure and technological progress. And in recent years, both
have moved to more technology-intensive industries and have emphasized the development of
high-tech industries. The government of the Republic of Korea seems to have been playing a
more energetic and aggressive role than has the government of Taiwan in promoting
industrial development. In Taiwan, business leaders, and many government officials as
well, have always admired the strong leadership of the Korean government and the prompt,
extensive, and often efficient policy measures that it has taken to promote development.
However, despite the aggressiveness of the Korean government and all the efforts it has
made to accelerate economic development, the performance of the Korean economy in terms of
growth has been no better, if not worse, than that of Taiwan over the past years. And
Taiwan has achieved a more stable price level, greater equality in income distribution,
and stronger balance-of-payments positions than has Korea, and indeed, perhaps any other
developing country. The difference lies in the fact that development planning and
government policies have been less forceful in Taiwan than in Korea, and more room has
been left for market forces to operate. Whether Korea has built up greater potential
capability for future development is yet to be seen.
Planning Education and R&D
Economists have long realized the importance of education to economic
development. "The progress and diffusion of knowledge are constantly leading to the
adoption of new processes and new machinery which economize human effort," Alfred
Marshall pointed out in his Principles of Economics (1920, 222). In fact, a major
theme of Marshall's book at the macro-level was, in modern language, the promotion of
economic growth by way of the progress and diffusion of knowledge. Thanks to T. W.
Schultz, "human capital" has been a useful concept for analyzing economic
development since the early 1960s.
The stock of human capital accumulates through investment in education.
In the simplest form of the production function, total production is a function of
technical progress, the amount of (physical) capital stock, and the labor force. Education
has to do not only with the labor force, but also with technical progress. The level of
economic development that a country has attained very much reflects the general level of
the education of its people. Education is a means to achieve economic development as well
as development in other areas. It is also more than a means; it is an end in itself. As a
means, education is an investment good, but as an end, it is a consumption good. The
importance of education therefore goes beyond the scope of economic development.
But investment in education is limited by scarce resources, as is
investment in social infrastructure. This is especially true in the early stages of
development, when there is a serious capital shortage. Given the condition of capital
shortage, education and productive investment compete for scarce resources. How to
allocate limited resources between the two is a difficult decision to make.
Education planning may have three main objectives: (1) to provide the
people with the general knowledge, the basic skills, and the discipline that are required
for living in a modern society; (2) to supply the economy with an adequate labor force of
the quality required for growth; and (3) to develop higher education and the pursuit of
advanced studies in order to provide a growing number of highly qualified people and to
build up an increasing stock of knowledge, both of which are necessary for a country's
long-run development, economically and otherwise.
Whereas inadequate education retards economic growth, too much education
draws resources from productive investment, which also reduces the growth rate. The
structure of education in terms of levels of education and areas of discipline has a great
deal to do with economic
growth. Too much emphasis on higher education at the expense of
secondary and primary education does little to benefit growth. One can easily think of
many formerly colonial developing countries that have quite a number of very well educated
top people, but poorly educated or even illiterate general publics. These countries are
characterized by slow growth and inequitable income distributions. The expensive
investment in higher education seems to have contributed little to their economic
development. This is understandable, because the structure of education was not consistent
with the demand for labor. It is advisable for a developing country, in which national
savings are inadequate to finance domestic investment, to plan its education in accordance
with projected growth targets.
In planning education, it is important to keep in mind that economic
development is a gradual process, and that an economy does not jump, but grows. Any
country that has invested aggressively in higher education in its early stages of
development, when the average qualification required of its workers is primary or at most
secondary education, will find itself involved in a heavy cost that it can only expect to
recover, with uncertain possibilities, in the very distant future.
In this regard, planning investment in education and planning investment
in infrastructure are very similar, in that maintaining some kind of balance between
education or infrastructural investment and productive investment is of utmost importance.
A roughly balanced allocation of resources between education or infrastructure on the one
hand and productive investment on the other is consistent with the basic principle of
In the case of Taiwan, the government has taken a gradual approach in
educational development to correspond to its economic development. In the beginning, six
years of free compulsory education were required as a minimum for all boys and girls of
school age. Later the minimum requirement was extended to nine years, with the additional
three years free from entrance examination, but not compulsory. Now, the government is
talking about another extension to twelve years, with vocational education being the main
stream at the senior high level. This new system is currently in the experimental stage.
During the 1952 53 school year, only 33.8 percent of primary school graduates
enrolled in junior high schools, 62.9 percent of junior high graduates enrolled in senior
high schools, and 46.2 percent of regular senior high graduates enrolled in institutions
of higher education. In 1985 86 the percentages increased to 99.4, 73.3, and 80.3
respectively (Taiwan 1986, 284).
As for the structure of secondary education, Taiwan has so far
followed a 70:30 ratio between vocational senior high and regular senior high in terms of
enrollment, on the grounds that vocational school graduates will go to work and regular
senior high graduates will pursue higher education. However, as the economy becomes more
and more sophisticated as a result of sustained development, the question of whether the
country should produce more graduates from vocational senior high schools to take
advantage of their technical skills, at the cost of a lack of general knowledge, or more
from regular senior high schools to take advantage of their better basic knowledge and
flexibility in adapting to changing technology deserves careful study.
When a country is getting rich and has more resources available for
investment after a certain number of years of rapid growth, the time has come to consider
allocating a higher percentage of resources to higher education. Too many college
graduates may cause difficulties in employment at the beginning, but in the long run some
people will create their own jobs and others will adjust by lowering their expectations
and content themselves with positions that in the past would have been considered low for
them. The general level of the society in terms of education and culture is upgraded in
the process. There will be an increasing number of people considering an increasing
proportion of education as a consumption good rather than an investment good. In this way,
a country spreads its performance from the economic sphere to the sociocultural sphere and
becomes, then and only then, a developed country.
Education is the basic source of technical progress. However, as the
final source of economic growth, technical progress does not necessarily have to come from
research and development. In a developing country, whose general level of technology is
low, new methods of production and new products can be learned and adopted rather easily
from developed countries. In this sense, developing countries have the
"advantage" of less development. Developed countries cannot do this; since they
are at the top level of technology, almost everything new has to be developed by itself.
It is natural, therefore, that the cost of technical progress is higher in developed than
in developing countries. This "advantage" of less development helps explain why
certain developing countries have performed better than developed countries in terms of
economic growth in recent years.
Of course, a country cannot pick up technical progress from easy
sources forever. Domestic capability for research and development has to be built up as
the economy progresses. Enterprises in developing countries are often criticized for not
doing, or not knowing how to do, research and development. And governments are often
tempted to require enterprises in both the public and the private sectors to undertake
R&D, or to allocate a certain percentage of total sales (or some other reference
figure) for the purpose of R&D. However, if there are easy and inexpensive ways to
make money, why should firms adopt expensive, uncertain, and sometimes even unnecessary
ways, with which they may not be familiar? Businesses differ widely from one another. It
is difficult for one general rule to apply to all firms as far as R&D is concerned. In
planning technical progress and R&D, it may be useful to recall the basic principle of
economics that incentive systems are always preferable to forceful, quantitative measures.
Stability and Equity
It is often argued that price stability and economic growth conflict
with each other, and that growth and equitable income distribution are also conflicting.
Both arguments require clarification. The trade-off between the rate of growth and the
rate of inflation is essentially a short-run relationship. In the long run, sacrificing
price stability does not benefit economic growth. On the contrary, countries that suffered
from serious inflation have seldom achieved significant performance in terms of growth.
This is because in the long run, economic growth is a supplyside phenomenon, but inflation
is mainly a demand-side monetary problem. In the short run, excessive demand causes both
the price level and the growth rate to increase. But in the long run, economic growth
results from real technical, economic, and sociocultural factors. Inflation discourages
saving and productive investment and consequently is harmful to long-term economic growth.
Theoretically, development planning works better in the area of
maintaining price stability than in other areas of development. All the government has to
do is to manage the aggregate demand by means of monetary and fiscal policies so that it
does not exceed the aggregate supply. But in reality it has been difficult for many
developing countries to avoid budget deficits and rapid increases in the money supply.
Therefore, this is not a problem of development planning, but rather a problem of
implementation of the plans.
Whether rapid growth and equitable distribution of income conflict
with each other depends on the definition of equity and on the government policies adopted
to improve income distribution. Imposing high marginal rates on personal income tax as
well as on corporate income tax in order to improve uneven distribution weakens incentives
to work and to invest, thus reducing growth rates. In recent years, ideas regarding
equitable distribution have been changing toward emphasizing improvement in the living
standard of the people at the bottom of the distribution rather than taking away incomes
from those at the top.
Taiwan adopted one particular industrial policy that has had a
significant side effect on income distribution. Manufacturers were induced to establish
their factories on industrial estates throughout the island, near the sources of the
supply of labor, rather than concentrating in cities. This has the following advantages:
(1) There is easy access to workers, resulting in rapid increases in
employment and growth without causing rapid increases in the wage rate.
(2) More people remain living in rural areas while taking jobs in nearby
cities and the urban problems that often occur in the process of rapid industrialization
are therefore reduced.
(3) The chances of cost-push inflation caused by large increases in the
wage rate owing to rapid expansion in employment are reduced.
Taiwan was able to adopt this industrial policy because of its very well
developed transportation and communication systems. Few areas on the island cannot be
reached with modern means of transportation and communication. This has enabled Taiwan to
achieve relatively balanced development between different regions and between urban and
rural areas compared to many other developing countries. Since the main source of income
of the rich is capital and that of the poor is labor, rapid increases in employment and in
the real wage rate (as a result of rapid increases in labor productivity) have been the
major factors that helped improve Taiwan's size distribution of income.
Social welfare programs have long been relied upon as a means of
improving the well-being of the economically weak. Although strengthening social welfare
programs is an increasing demand in developing countries, and many development plans have
included social welfare schemes as an integral part, it is important to keep in mind that
every dollar that goes to welfare could be used for productive purposes, and that the col-
lection of an additional dollar through progressive income tax, as is
usually the case, reduces the incentives to work and to invest. So the key issue of
planning in social welfare is how to allocate scarce resources between investment and
welfare in order to balance growth and equity. For a rapidly growing economy, increases in
the real wage rate and expansion of employment would help solve many of the poverty
problems that would otherwise call for welfare programs.
Another thing about welfare that is important and worthy of note is the
substitutability between government programs for social welfare and private
responsibility. In a traditional society, the family is the basic unit of social security.
The family serves the functions of health insurance, unemployment insurance, retirement,
and old age care. The more a government does to provide social welfare, the less private
responsibility will be. From the private point of view, it is nice to have a comprehensive
social welfare system taking care of all anxieties. But the negative aspect is that
incentives to save, invest, and work hard will be weakened.
So, while a social welfare system is important for helping to improve
income distribution and provide social security, a critical consideration in the early
stages of development is whether an additional dollar should go to productive investment
or to equitable income distribution. When the economy becomes richer, a major
consideration is the choice between incentives to saving, investment, and hard work on the
one hand and social welfare and equity on the other. These, however, are questions more of
value judgment than of economic calculation. As an economy progresses, welfare
expenditures as a percentage of the GNP usually increase. Many developed countries have
come to the point where the percentage is so high that people have begun to wonder whether
it should be reduced in order to give more incentives to economic growth. This is not yet
a relevant question for most developing countries.
Modern articulated comprehensive development planning for mixed-market
economies owes its origin to Keynesian economics, which is fundamentally a theory of
demand management. Although development of econometrics and growth modeling has helped
make medium-term development plans more and more sophisticated, the basic framework of the
plans is still demand-sided. But economic growth is in the long run a supply-side
phenomenon. Planning affects long-run growth only when
factors on the supply side are affected. Although medium-term planning
has been extended to cover manpower, education, and sociocultural, institutional, and even
environmental aspects of development, the core of almost all medium-term plans remains an
aggregate demand management model formulated with simultaneous equations consisting of
only economic variables. An economically sound development plan may not help long-run
growth very much if the factors responsible for growth are left unaffected. There are
three major functions that an economically sound medium-term plan may have:
(1) Prediction of aggregate growth targets such as the GNP growth rate,
the rate of saving and of investment, the government budget, and the balance of trade and
balance of payments. However, econometric models constructed mainly from the demand side
work better in the medium term than in the long run. In the very long run, investment and
the stock of capital are insufficient to predict growth potential. In predicting growth
potential in the very long run, economists are no better, though no worse either, than
experts in science and technology.
(2) Evaluation of major investment projects. Projects that are
technically feasible may not necessarily be economically justifiable. Developing countries
that are too ambitious and apply advanced technology to production, ignoring comparative
advantages and market conditions, often retard, rather than foster, economic growth.
(3) Coordination of macroeconomic policies to avoid inflation and
conflicts of objectives.
Realizing that economic growth involves more factors than just economic
variables such as saving, investment, and employment, development planning should also
take into consideration education, science and technology, research and development,
manpower, and social and cultural factors. Market forces should be respected. Flexibility
in implementation of development plans should be provided in order to allow for changes in
external conditions and inadequate knowledge on the part of the planners.
At its present level of sophistication, good (from a purely economic
point of view) development planning still does not assure rapid economic growth. Even
growth models of the highest standard, neatly designed at the forefront of the science of
economics, may not help growth in the real world very much, since the final sources of
growth are not
areas with which modern economics is accustomed to dealing. But
without adequate planning, the growth rates realized will certainly be short of their
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