World Development Report 1991

WORLD DEVELOPMENT INDICATORS

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World Development Report 1991The Challenge of Development

Published for the World BankOxford University Press

Oxford University PressOXFORD NEW YORK TORONTO DELHI

BOMBAY CALCUTI'A MADRAS KARACHI

PETALING JAYA SINGAPORE HONG KONG

TOKYO NAIROBI DAR ES SALAAM

CAPE TOWN MELBOURNE AUCKLAND

and associated companies inBERLIN IBADAN

© 1991 The International Bank

for Reconstruction and Development / THE WORLD BANK

1818H Street, N.W, Washington, D.C. 20433 LISA.

First printing June 1991

All rights reserved. No part of this publication may be

reproduced, stored in a retrieval system, or transmitted

in any form or by any means, electronic, mechanical,

photocopying, recording, or otherwise, without the prior

permission of Oxford University Press. Manufactured in the

United States of America.

The denominations, the classifications, the boundaries,

and the colors used in maps in World Development Report

do not imply on the part of The World Bank and its

affiliates any judgment on the legal or other status of any

territory, or any endorsement or acceptance of any boundary.

ISBN 0-19-520869-2 clothbound

ISBN 0-19-520868-4 paperback

ISSN 0163-5085

The Library of Congress has cataloged this serial publication as follows:

World development report. 1978-

[New York] Oxford University Press.

v. 27 cm. annual.

Published for The World Bank.

1. Underdeveloped areasPeriodicals. 2. Economic development

Periodicals. I. International Bank for Reconstruction and Development.

HC59. 7. W659 330.9172 '4 78-67086

SThis book is printed on paper that adheres to

the American National Standard for Permanence of Paper

for Printed Library Materials, Z39.48-1 984.

Foreword

World Development Report 1991, the fourteenth inthis annual series, synthesizes and interprets thelessons of more than forty years of developmentexperience. This Report, together with last year'son poverty and next year's on the environment,seeks to provide a comprehensive overview of thedevelopment agenda.

The 1990s began with dramatic changes. Manycountries in Eastern Europe and elsewhere initi-ated ambitious reforms of their economic and po-litical systems. These reforms reflect both the accu-mulated evidence on economic policies andfundamental changes in the political environment.Not only in Eastern Europe, but also in Africa,Asia, Latin America, and the Middle East, peopleare seeking escape from poverty and oppression togain control over their own destinies and find bet-ter lives for themselves and their families. Againstthe backdrop of these transitions, this year's Re-port links the historical debates that counseledpolicymakers in their past decisions, the lessons ofexperience, and the evolving thought on how bestto proceed.

One of the most valuable lessons relates to theinteraction between the state and the market infostering development. Experience shows thatsuccess in promoting economic growth and pov-erty reduction is most likely when governmentscomplement markets; dramatic failures resultwhen they conflict. The Report describes a market-friendly approach in which governments allowmarkets to function well, and in which govern-ments concentrate their interventions on areas inwhich markets prove inadequate.

The Report looks at four main aspects of therelationship between governments and markets.First, investing in people requires an efficient pub-lic role. Markets alone generally do not ensure thatpeople, especially the poorest, receive adequateeducation, health care, nutrition, and access tofamily planning. Second, essential for enterprisesto flourish is an enabling climateone that in-cludes competition, adequate infrastructure, and

institutions. Competition fosters innovation, thediffusion of technology, and the efficient use ofresources. Third, successful economic develop-ment requires the integration of countries with theglobal economy. Openness to international flowsof goods, services, capital, labor, technology, andideas spurs economic growth. Fourth, a stablemacroeconomic foundation is essential to sus-tained progress. Restoring the confidence of theprivate sector is now a major challenge for severalcountries with a long history of macroeconomicinstability.

What are the prospects for rapid development inthe years ahead? The Report notes that a favorableinternational climate is critical for future develop-ment. The effects of the policies of industrial coun-tries on development grow, as more developingcountries turn outward and the world becomesmore and more interdependent. But the Reportstresses that, above all, the future of developingcountries is in their own hands. Domestic policiesand institutions hold the key to successful devel-opment. With strong and sustained reforms athome, the Report concludes, the pace of develop-ment can be substantially increasedto lift mil-lions of people out of poverty by the end of thedecade.

Like its predecessors, World Development Report1991 includes the World Development Indicators,which offer selected social and economic statisticson 124 countries. The Report is a study by the staffof the World Bank, and the judgments madeherein do not necessarily reflect the views of theBoard of Directors or the governments theyrepresent.

Barber B. ConablePresidentThe World Bank

May 31, 1991

111

iv

This Report has been prepared by a team led by Vinod Thomas and comprising Surjit S. Bhalla, RuiCoutinho, Shahrokh Fardoust, Ann E. Harrison, Daniel Kaufmann, Elizabeth M. King, Kenneth K.Meyers, Peter A. Petri, and N. Roberto Zagha. T. N. Srinivasan, Mark Rosenzweig, and FranciscoSagasti collaborated closely and provided extensive advice. The team was assisted by SushenjitBandyopadhyay, Fernando J. Batista, Marianne Fay, Jon Isham, Kali Kondury, Stefan Krieger, andYan Wang. Stanley Fischer played a principal role in the initial stages of the Report's preparation. Thework was carried out under the general direction of Lawrence H. Summers.

Many others in and outside the Bank provided helpful comments and contributions (see thebibliographical note). The International Economics Department prepared the data and projectionspresented in Chapter 1 and the statistical appendix. It is also responsible for the World DevelopmentIndicators. The production staff of the Report included Kathryn Kline Dahl, Connie Eysenck, AlfredF. Imhoff, Hugh Nees, Kathy Rosen, Walton Rosenquist, and Brian J. Svikhart. Cartographic serviceswere provided by Jeffrey N. Lecksell, Gregory George Prakas, and Eric M. Saks. Library assistancewas provided by Iris Anderson and Jane Keneshea. The support staff was headed by Rhoda Blade-Charest and included Laitan Alli, Trinidad S. Angeles, and Lupita Mattheisen. Clive Crook was theprincipal editor.

The advice and support of Professor Bela Balassa (1928-1991) are respectfully acknowledged. Hiscontributions to this and past World Development Reports were valuable in understanding develop-ment. The core team remembers fondly David A. Renelt (1964-1991), who contributed to the Report.

Contents

Acronyms and initials ix

Definitions and data notes x

Overview 1The world economy in transition 2Paths to development 4Elements of a market-friendly approach 6Rethinking the state 9Priorities for action 10

1 The world economy in transition 12The long view 12The setting for development 14Prospects for world development 21Quantitative global scenarios for the 1990s 27

2 Paths to development 31The evolution of approaches to development 31The determinants of the growth of income 42Components of overall development 47The way forward 49

3 Investing in people 52Welfare and growth 53Challenges in human development 59Public policy 65

4 The climate for enterprise 70Entrepreneurs unleashed 70Enterprise in agriculture 72Empowering the manufacturer 77Evidence on the productivity of investment projects 82

5 Integration with the global economy 88Channels of technology transfer 88Labor flows and direct foreign investment 93Trade policy and economic growth 96Conditions for success in trade reform 101The global climate for trade 105

V

6 The macroeconomic foundation 109

Policies to promote stability and growth 109Booms and busts 112From stabilization to growth 113The art of reform 115Investment and saving 118Global economic conditions 123

7 Rethinking the state 128The political economy of development 128Remedies: democracy and institutions? 132Equity and redistribution 137Reforming the public sector 139

8 Priorities for action 148

Tasks for global action 149Specific actions that work 152A global challenge 157

Technical note 158

Bibliographical note 165

World Development Indicators 193

Boxes

1.1 Innovations that changed the world 151.2 The Soviet economic crisis 201.3 The climate for development in the 1990s 221.4 How well did early World Development Reports foresee growth in the 1980s? 282.1 Scandinavian models of development 362.2 What's behind the Japanese miracle? 402.3 Total factor productivity in economic growth 422.4 Measurement informs policyor does it? 442.5 The contribution of aid 482.6 Noneconomic components of development: liberties 503.1 Nutrition and life expectancy 533.2 Educating women: a key to development 553.3 Meiji Japan's penchant for education 583.4 Population, agriculture, and environment in Sub-Saharan Africa 613.5 AIDS in developing countries 633.6 The role of international aid in the social sectors 684.1 A different sort of enterprise: Gurdev Khush breeds super rice at the International Rice Research

Institute 744.2 Extension and the African agricultural services initiative 754.3 Parastatal marketing institutions and producer prices: impafring competition and incentives

to farmers 784.4 The payoffs from regulatory reform: India and Indonesia 794.5 Tax reform 814.6 Wrong incentives often make private projects go under 844.7 Participation enhances project efficiency and benefits the poor 855.1 Export takeoffs: two success stories 895.2 Protection in industrial countries: a historical perspective 975.3 Trade policy and growth: the evidence 995.4 Should states intervene in trade or shouldn't they? 1025.5 Commodity price movements 106

vi

6.1 What the assessments of adjustment programs say about income performance 1146.2 Thespeedofreform 1176.3 Determinants of household saving in Japan 1226.4 Capital flight 1246.5 The 1990 Mexican debt agreement 1277.1 Fighting corruption 1327.2 Populist experiments 1337.3 The contribution of institutional innovations to development 1357.4 Setting priorities for institutional development: easier said than done 1367.5 The politics of inclusion: Malaysia and Sri Lanka 1387.6 War and development 1417.7 From a centrally planned to a market economy 1458.1 For policymakers everywhere: seven lessons in reform 152

Text figures

1 Per capita income: selected countries in 1988 compared with the United States, 1830-1988 22 Life expectancy at birth: selected countries in 1985 compared with Japan, 1900-85 33 Policy distortion, education, and growth in GDP, sixty developing economies, 1965-87 54 The interactions in a market-friendly strategy for development 65 Rates of return for projects financed by the World Bank and the IFC under different policies

and conditions 81.1 Periods during which output per person doubled, selected countries 121.2 Gains in life expectancy, selected countries and periods 131.3 Per capita output growth in the OECD and developing countries and significant world events,

1918-88 16-171.4 The share of exports in GDP, selected country groups, 1900-86 171.5 Estimates of the growth of GDP, 1965-89 192.1 The sectoral distribution of the labor force, low- and middle-income developing countries,

1965 and 1980 322.2 Per capita income, selected countries, 1960 and 1988 372.3 Estimated annual growth in real exports, selected groups of countries, 1965-89 372.4 The average annual growth of per capita income and productivity, selected economies, 1960-87 46

2.5 Female educational attainment and decline in infant mortality, selected economies, 1960-87 493.1 Male life expectancy at birth, selected countries, 1855-1985 523.2 Adult literacy, selected countries, 1850-1985 563.3 Educational attainment of entrepreneurs in five developing countries 593.4 Population change by region, 1850-2025 603.5 Distribution of deaths by cause, about 1985 624.1 Rates of return for projects financed by the World Bank and the IFC under varying foreign exchange

premiums, 1968-89 834.2 Rates of return for projects financed by the World Bank and the IFC under varying degrees of trade

restrictiveness, 1968-89 834.3 The share of public investment in total investment and the rates of return of agricultural and industrial

projects financed by the World Bank and the IFC, 1968-89 865.1 Annual net flows of capital to developing economies, 1970-88 955.2 Openness and growth in productivity: partial correlations for developing countries, 1960-88 1005.3 The share of imports affected by all nontariff measures, 1966 and 1986 1045.4 Hard-core nontariff measures applied against industrial and developing countries, 1986 105

6.1 The current account balance and the fiscal balance in Korea and Morocco, various years 110

6.2 Inflation rates and the fiscal balance in Sri Lanka and Tanzania, various years 111

6.3 The growth of GDP and private investment in Chile and Turkey, 1970-88 1136.4 Differing patterns of private and public investment in four countries, 1970-88 120

6.5 Net resource flows and net transfers to developing economies, 1980-89 126

7.1 Nation-states by type of government, 1850-1987 1297.2 Income inequality and the growth of GDP in selected economies, 1965-89 137

8.1 The annual change in per capita GDP in OECD and developing countries, 1965-90 151

vii

Text tables

1 Growth of GDP per capita, 1965-2000 31.1 Historical trends in GDP per capita 141.2 Global savings and investment 231.3 Aggregate long-term net resource flows to developing countries, 1980-95 241.4 The international economic climate in the 1990s: a comparison of recent and projected indicators 271.5 Real GDP and real GDP per capita growth rates for low- and middle-income economies,

1965-2000 302,1 The growth of agricultural productivity and the nonagricultural sectors, 1960-88 332.2 The growth of GDP, inputs, and TFP 432.3 Percentage share of output growth accounted for by factor input growth, sample of world economies,

1960-87 452.4 Interaction of policy with education and investment, 1965-87 473.1 The economic burden of adult illness, selected countries and years 543.2 The effect of an additional year of schooling on wages and farm output, selected countries

and years 573.3 Government expenditures for education and health as a percentage of GDP, 1975, 1980, and 1985 663.4 The government share in total education and health expenditures 674.1 Annual percentage growth rates of earnings, employment, and labor productivity in manufacturing,

selected economies and periods 804,2 Economic policies and average economic rates of return for projects financed by the World Bank

and the IFC, 1968-89 824.3 Average economic rates of return for projects financed by the World Bank and the IFC under varying

initial and final foreign exchange premiums, 1968-89 875.1 The relative performance of foreign firms in manufacturing, selected countries and years 945.2 Investment, growth, and net capital flows, 1970-89 965.3 Tariffs and nontariff barriers in developing countries, 1987 985.4 Intraunion trade as a percentage of total exports, 1960-87 1076.1 Investment and saving, 1965-89 1196.2 Indicators of external debt for developing economies, 1970-89 1257.1 Irregular executive transfers: average occurrence per country, 1948-82 1297.2 The success of economies with differing political systems in implementing an IMF adjustment

program 1347.3 The success of economies with differing political systems in controlling rapid inflation 1347.4 Percentage share of government expenditure in GNP or GDP, industrial countries, 1880-1985 1397.5 Percentage share of government expenditure and consumption in GNP or GDP, industrial

and developing countries, 1972 and 1986 1397.6 Public expenditure on the military compared with that on the social sectors, 1986 1428.1 Changes in GDP growth rates relative to the central case, 1990-2000 157

Statistical appendix tablesA.1 Population (mid-year) and average annual growth 181A.2 GNP, population, GNP per capita, and growth of GNP per capita 182A.3 Composition of GDP 182A.4 Consumption, investment, and saving 184A.5 Investment, saving, and current account balance before official transfers 185A.6 GDP and growth rates 186A.7 Structure of production 186A.8 GDP by sector growth rates 187A.9 Growth of export volume 187A. 10 Change in export prices and terms of trade 189A.11 Growth of long-term debt of low- and middle-income economies 190A.12 Composition of debt outstanding 191

vi"

Acronyms and initials

DAC Development Assistance Committee ofthe Organisation for Economic Co-op-eration and Development

EC The European Community (Belgium,Denmark, Germany, France, Greece,Ireland, Italy, Luxembourg, Nether-lands, Portugal, Spain, and UnitedKingdom)

ERR Economic rate of returnDFI Direct foreign investmentGATT General Agreement on Tariffs and

TradeGDP Gross domestic productGNP Gross national productG-7 Group of Seven (Canada, France, Ger-

many, Italy, Japan, United Kingdom,and United States)

IBRD International Bank for Reconstructionand Development

IDA International Development AssociationIFC International Finance CorporationIMF International Monetary Fund

LIBORNGOsNIEsODAOECD

PPPTFPUNDP

Unesco

UNICEFWHO

London interbarik offered rateNongovernmental organizationsNewly industrializing economiesOfficial development assistanceOrganisation for Economic Co-opera-tion and Development (Australia, Aus-tria, Belgium, Canada, Denmark, Fin-land, France, Germany, Greece,Iceland, Ireland, Italy, Japan, Lux-embourg, Netherlands, New Zealand,Norway, Portugal, Spain, Sweden,Switzerland, Turkey, United Kingdom,and United States)Purchasing power parityTotal factor productivityUnited Nations DevelopmentProgrammeUnited Nations Educational, Scientific,and Cultural OrganizationUnited Nations Children's FundWorld Health Organization

ix

A note on data selection

The data used in this World Development Reportcover a range of time periods and are from morethan 100 countries (both industrial and develop-ing). Data availability was the primary criterion forusage; other criteria varied from chapter to chap-ter. For details, see the technical note at the end ofthe main text.

Country groups

For operational and analytical purposes the WorldBank's main criterion for classifying economies isaccording to their gross national product (GNP)per capita. Every economy is classified as low-in-come, middle-income (subdivided into lower-mid-dle and upper-middle), or high-income. In addi-tion to classification by income, other analyticalgroups are based on regions, exports, and levels ofexternal debt.

In this edition of World Development Report andits statistical annex, the World Development Indi-cators (WDI), minor changes to country classifica-tion have been introduced. The changes are: (a)the "nonreporting nonmembers" group is now"other economies" and includes only Albania,Cuba, Democratic People's Republic of Korea, andthe Union of Soviet Socialist Republics (USSR); (b)"total reporting economies" is replaced by"world." Note that the definition of "oil ex-porters" has been changed (see the definition inthe analytical groups below). As in previous edi-tions, this Report uses the latest GNP per capitaestimates to classify countries. The country com-position of each income group may thereforechange from one edition to the next. Once the clas-

x

Definitions and data notes

sification is fixed for any edition, all the historicaldata presented are based on the same countrygrouping. The country groups used in this Reportare defined as follows.

Low-income economies are those with a GNP percapita of $580 or less in 1989.

Middle-income economies are those with a GNPper capita of more than $580 but less than $6,000 in1989. A further division, at GNP per capita of$2,335 in 1989, is made between lower-middle-in-come and upper-middle-income economies.

High-income economies are those with a GNPper capita of $6,000 or more in 1989.

Low-income and middle-income economies aresometimes referred to as developing economies.The use of the term is convenient; it is not in-tended to imply that all economies in the group areexperiencing similar development or that othereconomies have reached a preferred or final stageof development. Classification by income does notnecessarily reflect development status. (In theWorld Development Indicators, high-income econ-omies classified by the United Nations or other-wise regarded by their authorities as developingare identified by the symbol t). The use of the term"countries" to refer to economies implies no judg-ment by the Bank about the legal or other status ofa territory.

"Other economies" are Albania, Cuba, Demo-cratic People's Republic of Korea, and the Union ofSoviet Socialist Republics (USSR). In the main ta-bles of the World Development Indicators, onlyaggregates are shown for this group, but Box A.2in the technical notes to the WDI contains key indi-cators reported for each of these countries.

'World" comprises all economies, includingeconomies with less than 1 million population,which are not shown separately in the main tables.See the technical notes to the WDI for aggregationmethods used to retain the same country groupacross time.

Analytical groups

For analytical purposes, other overlapping classi-fications based predominantly on exports or exter-nal debt are used in addition to geographic coun-try groups. The lists provided below are ofeconomies in these groups that have populationsof more than 1 million. Countries with less than 1million population, although not shown sepa-rately, are included in group aggregates.

Oil exporters are countries for which exports ofpetroleum and gas, including reexports, accountfor at least 50 percent of exports of goods and ser-vices. They are People's Republic of the Congo,Islamic Republic of Iran, Iraq, Libya, Nigeria,Oman, Saudi Arabia, Trinidad and Tobago, UnitedArab Emirates, and Venezuela. Although theUSSR meets the established criterion, because ofdata limitations it is excluded from this groupmeasure.

Severely indebted middle-income countries (abbre-viated to "severely indebted" in the World Devel-opment Indicators) are twenty countries that aredeemed to have encountered severe debt-servicingdifficulties. These are defined as countries inwhich three of the four key ratios are above criticallevels: debt to GNP (50 percent), debt to exports ofgoods and all services (275 percent), accrued debtservice to exports (30 percent), and accrued inter-

est to exports (20 percent). The twenty countriesare Argentina, Bolivia, Brazil, Chile, People's Re-public of the Congo, Costa Rica, Côte d'Ivoire, Ec-uador, Arab Republic of Egypt, Honduras, Hun-gary, Mexico, Morocco, Nicaragua, Peru,Philippines, Poland, Senegal, Uruguay, andVenezuela.

OECD members, a subgroup of "high-incomeeconomies," comprises the members of the Or-ganisation for Economic Co-operation and Devel-opment except for Greece, Portugal, and Turkey,which are included among the middle-incomeeconomies.

Geographic regions (low-income andmiddle-income economies)

Sub-Saharan Africa comprises all countriessouth of the Sahara except South Africa.

Europe, Middle East, and North Africa comprisesthe middle-income European countries of Bul-garia, Czechoslovakia, Greece, Hungary, Poland,Portugal, Romania, Turkey, and Yugoslavia, andall the economies of North Africa and the MiddleEast, and Afghanistan. For some analyses in WorldDevelopment Report, Eastern Europe (Hungary,Poland, Romania, and Yugoslavia) is treatedseparately.

East Asia comprises all the low- and middle-income economies of East and Southeast Asia andthe Pacific, east of and including China andThailand.

South Asia comprises Bangladesh, Bhutan, In-dia, Myanmar, Nepal, Pakistan, and Sri Lanka.

Latin America and the Caribbean comprises allAmerican and Caribbean economies south of theUnited States.

xi

Data notes

Billion is 1,000 million.Trillion is 1,000 billion.Tons are metric tons equal to 1,000 kilograms,

or 2,204.6 pounds.Dollars are current U.S. dollars unless other-

wise specified.Growth rates are based on constant price data

and, unless otherwise noted, have been computedwith the use of the least-squares method. See thetechnical note to the World Development Indica-tors for details of this method.

The symbol / in dates, as in "1988/89," meansthat the period of time may be less than two yearsbut straddles two calendar years and refers to acrop year, a survey year, or a fiscal year.

xl'

The symbol .. in tables means not available.The symbol - in tables means not applicable.The number 0 or 0.0 in tables and figures

means zero or a quantity less than half the unitshown and not known more precisely.

The cutoff date for all data in the World Devel-opment Indicators is April 30, 1991.

Historical data in this Report may differ fromthose in previous editions because of continuousupdating as better data become available, becauseof a change to a new base year for constant pricedata, and because of changes in country composi-tion in income and analytical groups.

Economic and demographic terms are defined in thetechnical note to the World DevelopmentIndicators.

Overview

Development is the most important challenge fac-ing the human race. Despite the vast opportunitiescreated by the technological revolutions of thetwentieth century, more than 1 billion people, one-fifth of the world's population, live on less thanone dollar a daya standard of living that WesternEurope and the United States attained two hun-dred years ago.

The task is daunting, but by no means hopeless.During the past forty years many developingcountries have achieved progress at an impressivepace. Many have achieved striking gains in healthand education. Some have seen their average in-comes rise more than fivefolda rate of progressthat is extraordinary by historical standards. So ifnothing else were certain, we would know thatrapid and sustained development is no hopelessdream, but an achievable reality.

Nonetheless, many countries have done poorly,and in some living standards have actually fallenduring the past thirty years. That is why povertyremains such a formidable problem and why sub-stantial economic progress has yet to touch mil-lions of people. The sharp contrast between suc-cess and failure is the starting point for WorldDevelopment Report 1991. Why have country experi-ences been so different? What must developingcountries do if the productivity and well-being oftheir people are to increase rapidly during the nextdecade? What can the international community doto spur development and alleviate poverty? Thesequestions are all the more pressing because nearly95 percent of the increase in the world's labor forceduring the next twenty-five years will occur in thedeveloping world.

The processes driving economic developmentare by no means fully understood. But much canbe learned from experience. History shows, aboveall, that economic policies and institutions are cru-cial. This is encouraging, because it implies thatthe countries which have failed to prosper can dobetter. But it is also challenging, because it obligesgovernments everywhere (not just in developingcountries) as well as the multilateral agencies totake account of the factors that have promoted de-velopment and put them to work.

A central issue in development, and the princi-pal theme of the Report, is the interaction betweengovernments and markets. This is not a questionof intervention versus laissez-fairea popular di-chotomy, but a false one. Competitive markets arethe best way yet found for efficiently organizingthe production and distribution of goods and ser-vices. Domestic and external competition providesthe incentives that unleash entrepreneurship andtechnological progress. But markets cannot oper-ate in a vacuumthey require a legal and regula-tory framework that only governments can pro-vide. And, at many other tasks, marketssometimes prove inadequate or fail altogether.That is why governments must, for example, in-vest in infrastructure and provide essential ser-vices to the poor. It is not a question of state ormarket: each has a large and irreplaceable role.

A consensus is gradually forming in favor of a"market-friendly" approach to development. TheReport describes the various elements of this strat-egy, and their implementation in a wide variety ofcountry contexts. It goes further. It stresses thecomplementary ways markets and governments

1

Figure 1 Per capita income: selected countriesin 1988 compared with the United States,1830-1988

Thousands of dollars20

10

United States

Switzerland

_JapanFrance

GreeceUruguayChi1e

Brazil,Thailand

Algeria..-China

Sri LankaHaiti IndonesiaIndi!, 1080I yZaire0

1830 1860 1890 1920 1950 1980 88

Constant 1988 dollars 0 1988 PPP dollars

Note: Countries were selected on the basis of data availabilitySources: For United States, World Bank data and Maddison,background paper; for other countries, Summers and Heston 1991.

can pull together. If markets can work well, andare allowed to, there can be a substantial economicgain. If markets fail, and governments intervenecautiously and judiciously in response, there is afurther gain. But if the two are brought together,the evidence suggests that the whole is greaterthan the sum. When markets and governmentshave worked in harness, the results have beenspectacular, but when they have worked in oppo-sition, the results have been disastrous.

The world economy in transition

The technological changes of this century have en-abled countries to use their resources much moreproductively than ever before. Living conditionshave improved beyond recognition, not just in in-dustrial countries but also in most developingcountries. The pace of this improvement hasseemed to accelerate with time. It took the United

2

Kingdom sixty years to double its real income perperson, starting in 1780. Many developing coun-tries matched the achievement within twentyyears, after World War II.

The real income gap between the industrialcountries and some developing countries, notablythose in East Asia, has narrowed dramaticallysince World War II. But the gap between the indus-trial countries and the developing countries ofother regions has widened. The 1980s were a diff i-cult decade for most countriesthough per capitaincome in China and India, the most populouscountries, and Asia as a whole, grew substantially.In the past quarter century, per capita incomegrew little in such countries as Argentina, Jamaica,Nigeria, and Peru; in Nicaragua, Uganda, Zaire,and Zambia, it declined. Many poor countrieshave per capita real incomes that are much lowerthan that of the United States at the beginning ofthe nineteenth century (Figure 1). However, thegaps between rich and poor in infant mortality andlife expectancy have narrowed more quicklythanks to the spread of medical technology, envi-ronmental sanitation, better nutrition, education,and the natural limits to achievement in such indi-cators (Figure 2).

The crucial question for the future is whethernational and international policies will permit thepotential created by technological progress to beexploited. Sustainable development requirespeace. War and its aftermath in the Middle Easthave cast a cloud of uncertainty over that region.Ethnic strife, civil wars, and international con-flicts, as well as natural disasters, continue to de-stroy the fragile base of development in manyparts of the world. By conservative estimates,wars have been directly responsible for 20 milliondeaths since 1950. That includes more than 12 mil-lion deaths from civil wars in the developingworld. Far and away, the most important cause offamine in developing countries in recent years hasbeen not inadequate agricultural output or pov-erty, but military conflict.

Rapid development also requires that economicintegration expand for all. The boundaries thatseparate national markets for goods, capital, andlabor have continued to be eroded. Worldwidetrade has expanded by more than 6 percent a yearsince 1950, which is more than 50 percent fasterthan the growth of output. Global integration intrade, investment, factor flows, technology, andcommunication has been tying economies to-gether. But it remains to be seen whether thistrend will continue.

Increasing exposure to external influences un-doubtedly puts the developing countries at risk.High industrial-country fiscal deficits, potentiallyhigh international interest rates, weaknesses in thefinancial institutions in the United States, deterio-ration of some aspects of the financial situation inJapan, and protracted and inconclusive negotia-tions in the Uruguay Round of trade talks will alltake their toll. But global integration in the flow ofgoods, services, capital, and labor also bringsenormous benefits. It promotes competition andefficiency, and it gives poor countries access to ba-sic knowledge in medicine, science, andengineering.

Sustained development depends on global con-ditions and especially on country policies. Re-cently, countries in Eastern Europe embarked onambitious programs of economic reform, The So-viet Union grappled with difficulties of economicand political transformation. A number of devel-oping countries initiated policy improvementssimilar to the earlier ones elsewhere. Democracyswept through Eastern Europe as well as parts ofthe developing world.

The staff of the World Bank has made projec-tions for the world economy in the 1990s. If thereare no major adverse shocks and generally goodpolicies, average per capita real incomes in the in-dustrial countries might grow by about 2.5 percenta year (Table 1). This could be achieved with aninflation rate of 3-4 percent and a real interest rateof about 3 percent. If world trade expands morethan 5 percent a year and recent policy reformscontinue and are consolidated, per capita real in-comes in the developing countries might grow byroughly 3 percent a year. Better or worse externalconditions could raise or lower this outcome by0.5-1.0 percentage point. More extreme scenarios

Table 1 Growth of real GD? per capita, 1965-2000

Projected on the basis of the two main scenarios (baseline and downside) discussed in Chapter 1.Using population shares as weights when aggregating GDP growth across countries.

Sources: World Bank data and World Bank 1991a.

Figure 2 Life expectancy at birth:selected countries in 1985 compared withJapan, 1900-85

Years

1900 1920 1940 1960 198085

Note: Countries were selected on the basis ot data availability.Sources: World Bank data; United Nations 1991.

(for example, substantially lower growth rates inindustrial countries) are plausible, but not likely,particularly during a period as long as a decade.

Country studies which support these projec-tions suggest that, under more vigorous and com-prehensive reforms, the developing countries'long-term income growth could be improved by

3

80

,Greece75 : France,

United States

70 SriLankaJapan China

65ThailandBrazil

Algeria60

IndonesiaIndia

55

Bolivia50

Uganda45 Senegal

40 I I II

(average annual percentage change, unless noted)

Group

Population,1989

(millions) 1965-73 1973-80 1980-89

Projectionfor

19Osa

Industrial countries 773 3.7 2.3 2.3 1.8-2.5

Developing countries 4,053 3.9 2.5 1.6 2.2-2.9Sub-Saharan Africa 480 2.1 0.4 1.2 0.3-0.5East Asia 1,552 5.3 4.9 6.2 4.2-5.3South Asia 1,131 1.2 1.7 3.0 2.1-2.6Europe, Middle East, and North Africa 433 5.8 1.9 0.4 1.4-1.8Latin America and the Caribbean 421 3.8 2.5 0.4 1.3-2.0Developing countries weighted by populationb 4,053 3.0 2.4 2.9 2.7-3.2

1.5-2 percentage pointson average, about twicethe improvement from better external conditions.What, in detail, those reforms might be is the sub-ject of the body of the Report. These projectionsalso contain a warning: if recent reforms are re-versed, the outcome might easily be much worse.

Paths to development

The challenge of development, in the broadestsense, is to improve the quality of life. Especiallyin the world's poor countries, a better quality oflife generally calls for higher incomesbut it in-volves much more. It encompasses, as ends inthemselves, better education, higher standards ofhealth and nutrition, less poverty, a cleaner envi-ronment, more equality of opportunity, greater in-dividual freedom, and a richer cultural life. ThisReport is concerned primarily with economic de-velopment, in itself a broad idea. Any notion ofstrictly economic progress must, at a minimum,look beyond growth in per capita incomes to thereduction of poverty and greater equity, to prog-ress in education, health, and nutrition, and to theprotection of the environment.

Thinking on development has shifted repeat-edly during the past forty years. Progress has notmoved along a straight line from darkness to light.Instead there have been successes and failures,and a gradual accumulation of knowledge and in-sight. On some matters, a fairly clear understand-ing has emerged, but many questions still remaincontentious and unanswered.

Climate, culture, and natural resources wereonce thought to be the keys to economic develop-ment. Rapid industrialization, using explicit andimplicit taxes on agriculture to fund industrial in-vestment, was for many years a much-favoredstrategy. After the Great Depression and throughthe 1960s, most policymakers favored import sub-stitution combined with fostering infant indus-tries. In its day this view was endorsed, and thestrategy supported, by external aid and financeagencies.

These views have not stood the test of time.Now there is clearer evidence, from both develop-ing and industrial countries, that it is better not toask governments to manage development in de-tail. Discriminatory taxes on agriculture have al-most always turned out to be taxes on growth.Economic isolation behind trade barriers hasproved costly. Retarding competition and interfer-ing with prices, deliberately or accidentally, havevery often proved counterproductive.

4

As the importance of openness and competitionhas been realized, the conviction has grown thatthey are insufficient by themselves. Investing inpeople, if done right, provides the firmest founda-tion for lasting development. And the proper eco-nomic role of government is larger than merelystanding in for markets if they fail to work well. Indefining and protecting property rights, providingeffective legal, judicial, and regulatory systems,improving the efficiency of the civil service, andprotecting the environment, the state forms thevery core of development. Political and civil liber-ties are not, contrary to a once-popular view, in-consistent with economic growth.

As a matter of arithmetic, the growth of output canbe accounted for as the growth of capital and laborand changes in the productivity of those inputs. Pro-ductivity has grown much more slowly in develop-ing countries than in industrial countries. In thenearly seventy countries examined for the Report,changes in the use of capital made a large contribu-tion to changes in output. But the key to explainingthe differences in the growth of output from countryto country is the growth of productivity.

Growing productivity is the engine of develop-ment. But what drives productivity? The answer istechnological progress, which is in turn influencedby history, culture, education, institutions, andpolicies for openness in developing and industrialcountries. Technology is diffused through invest-ment in physical and human capital and throughtrade. Strong evidence links productivity to invest-ments in human capital and the quality of the eco-nomic environmentespecially the extent towhich markets are distorted.

The Report looks at several indexes of marketdistortion, such as the parallel-market premiumon the exchange of foreign currency and restric-tions on trade. Far more economies have had se-verely distorted price systems than only mod-erately or slightly distorted ones. Most of thecountries with severely distorted prices did poorlyin output growth and productivity. At the oppo-site extreme, the few economies that had relativelyundistorted price systems did well. In the middlethe results are more ambiguous: some economieswere successful, but others did much less well. Ingeneral, a relatively undistorted price system,other things being equal, has a better chance ofpromoting growth than a heavily distorted one. Arange of evidence also suggests what can begained by reducing interventions in the market.For instance, various degrees of reforms in Chile,China, Ghana, India, Indonesia, the Republic of

Korea, Mexico, Morocco, and Turkey during the1980s were generally followed by improvements ineconomic performance.

Is this view really consistent with the remark-able achievements of the East Asian economies, orwith the earlier achievements of Japan? Why, inthese economies, were interventions in the marketsuch as infant-industry protection and credit sub-sidies associated with success, not failure? First,these governments disciplined their interventionswith international and domestic competition. Thismeant that interventions had to be carried outcompetently, pragmatically, and flexibly; if onefailed, it was likely to be removed. Instead of re-sisting market competition, governments tried toanticipate itand when they were proved wrong,they were quick to undo the harm. Second, thesegovernments, on the whole, were careful to en-sure that intervention did not end up distortingrelative prices unduly: in trade, they successfullyneutralized the bias against exports that is usuallya by-product of protection. Third, their interven-tion was more moderate than in most other devel-oping countries. In that respect, these economiesrefute the case for thoroughgoing dirigisme as con-vincingly as they refute the case for laissez-faire.

In several respects, government intervention isessential for development. What then are the con-ditions under which government intervention islikely to help, rather than hinder? Economic the-ory and practical experience suggest that interven-tions are likely to help provided they are market-friendly. That means:

Intervene reluctantly. Let markets work unlessit is demonstrably better to step in. Certain actionsinvolving public goods readily pass this test inprinciple because the private sector does not usu-ally carry them out: spending on basic education,infrastructure, the relief of poverty, populationcontrol, and environmental protection. Certainother actions usually fail the test. For instance, it isusually a mistake for the state to carry out physicalproduction, or to protect the domestic productionof a good that can be imported more cheaply andwhose local production offers few spilloverbenefits.

Apply checks and balances. Put interventionscontinually to the discipline of the internationaland domestic markets. The Republic of Koreawithdrew its support for the heavy chemicals in-dustry when market performance showed that thepolicy was failing.

Intervene openly. Make interventions simple,transparent, and subject to rules rather than offi-

Figure 3 Policy distortion, education,and growth in GDP; sixty developingeconomies, 1965-87

GDPgrowth

(percent)A

High1distortion

Lowdistortion

Loweducation

Higheducation

Note: High distortion reflects a foreign exchange premium of morethan 30 percent; low distortion, a premium of 30 percent or less.Education is measured by the average years of schooling, excludingpostsecondary schooling, of the population age fifteen to sixty-four.High education is defined here as more than 3.5 years; loweducation, 3.5 years or less. For the derivation of data, seeTable 2.4.Sources: International Currency Analysis, Inc., various years;World Bank data.

cial discretion. Prefer, for example, tariffs to quan-titative controls.

The complementarity of a sound policy climateand market-friendly interventions is one of themost encouraging lessons of development experi-ence. Analysis suggests, for example, that theremay be an interaction between different forms ofinvestment (human, physical, and infrastructure)and the quality of policies (Figure 3). Among asample of sixty developing economies during theperiod 1965-87, those with distorted policies and alow level of education grew, on the average, by 3.1percent a year. The economies that had eitherhigher levels of education or fewer policy distor-tions did better, growing at 3.8 percent a year. Butthe countries that had boththat is, a higher levelof education and fewer distortionsgrew at 5.5percent a year. There also seems to be such a corn-plementarity between increasing physical capitaland economic policies. This research does not by

5

6

Figure 4 The interactions in a market-friendly strategy for development

Investmentin people(Chapter 3)

Competitivemicroeconomy

(Chapter 4)

Gains from trade

Ability to attract foreign investment

Stablemacroeconomy

(Chapter 6)_,,/

>

Globallinkages

(Chapter 5)

itself show causation, but it suggests that the re-suits from moving forward on several fronts atonce can be exceptionally good.

Elements of a market-friendly approach

The Report looks at the relation between govern-ments and markets under four broad headings:human development, the domestic economy, theinternational economy, and macroeconomic poi-icy. These areas of activity are interrelated. A rela-tively undistorted domestic economy rewardsthose who build up their human capital more gen-erously than does a distorted one; at the sametime, education makes the domestic economymore productive by speeding the adoption of newtechnology. To take another example, a stable mac-roeconomy helps the domestic price system be-cause it clears away the fog of inflation. But micro-economic efficiency also makes it easier to keepinflation low: with fewer unviable enterprises,there will be less need for subsidies to swell thepublic sector deficit. All four sets of actions areworth doing in their own right. But because ofsuch linkages, the results will probably be dispro-portionately strong if done together (see Figure 4).

Investing in people

The economic returns from public and private in-vestments in people are often extremely high.Markets in developing countries cannot generallybe relied upon to provide peopleespecially thepoorestwith adequate education (especially pri-mary education), health care, nutrition, and familyplanning services.

Rapid population growth is a crucial concern insome countries such as Bangladesh and in someparts of the world such as the Sahel. The growthof the population typically slows as people's edu-cation and incomes grow and they move to cities.Yet in many countries, investments in education,health, and family planning have been necessary,in addition to income growth, to reduce fertilityand slow the pace of population growth. Effectivefamily planning programs have informed peopleof the private and social costs of high fertility, en-couraged couples to reduce family size, andhelped to meet the demand for contraceptives.Such programs have worked best in countries thathave also instituted policies to improve educationfor women and increase their opportunities forwork in the modern sector.

Many governments are investing far too little inhuman development. In Brazil and Pakistan rapidgrowth alone was insufficient to improve the socialindicators substantially. In Chile and Jamaica,however, these indicators improved even in pe-riods of slow growth. Among low-income coun-tries, Guinea and Sri Lanka have the same percapita income, but average life expectancy is sometwo-thirds longer in Sri Lanka. Among middle-income countries, Brazil and Uruguay have similarper capita incomes, but infant mortality is two-thirds lower in Uruguay. By some estimatesShanghai has a lower infant mortality rate andlonger life expectancy than New York City.

In addition to increasing the quantity of humaninvestment, governments must improve its qual-ity. Too often, capital investments go forward withinadequate provision for the recurrent expendi-tures they entail, which results in wasteful under-utilization. And expenditures are frequentlypoorly targeted and involve a great deal of leak-ages. There is a need to reduce heavy subsidies forhigher education and to spend much more on pri-mary education, from which the returns are rela-tively higher. The case for a similar switch inspending from expensive curative health care sys-tems to primary systems is also strong.

More care is required to ensure that public pro-grams reach their intended beneficiaries. Exam-ples of well-designed and well-targeted social ex-penditures include a program to increase primaryschool enrollment in Peru; the provision of ruralhealth facilities in the state of Kerala in India; ef-forts to reduce infant mortality in Malaysia; andhealth programs to raise life expectancy in Chile,China, and Costa Rica. There are useful oppor-tunities for partnership with the private sector. In-volving the private sector permits services to bedelivered more effectively, as in the cases of educa-tion in Kenya, the Philippines, and Zimbabwe;and of health care in Rwanda and Zambia.

The climate for enterprise

Domestic and external competition has very oftenspurred innovation, the diffusion of technology,and an efficient use of resources. Japan, theRepublic of Korea, Singapore, the United States,and Europe's most successful economies have allestablished global competitive advantage throughthe rigors of competition. Conversely, systems ofindustrial licensing, restrictions on entry and exit,inappropriate legal codes concerning bankruptcyand employment, inadequate property rights, and

price controlsall of which weaken the forces ofcompetitionhave held back technological changeand the growth of productivity.

Examples of such restrictions at various timesinclude Argentina's policy of favoring incumbentfirms for new industrial investment; barriers to en-try or exit in many African countries, China, India,and Eastern Europe; sheltered national marketsfor parts of Europe's computer industry; extensiveprice regulations in Brazil, the Arab Republic ofEgypt, and Indonesia; capacity licensing in Indiaand Pakistan; and state control of selected indus-tries in almost all developing countries. When reg-ulatory reforms to correct the obstacles have beenundertakenas in Ghana, India, Indonesia, andrecently many other countriesthey have paid off.

An efficient domestic economy also requirespublic goods of correspondingly high quality.These include, most fundamentally, a regulatoryframework to ensure competition, and legal andproperty rights that are both clearly defined andconscientiously protected. It also requires invest-ment in infrastructure, such as irrigation andfeeder roads, which have proven to provide highreturns. The returns from research and develop-ment in agriculture, for instance, can be extremelyhigh: witness maize in Peru, rubber in Malaysia,wheat in Chile and Pakistan, and cotton in Brazil.

Domestic policy should confront entrepreneurswith the information that is embodied in prices,and it should then equip them (by means of invest-ments in infrastructure and institutions) torespond. A detailed study of the World Bank'sinvestment projects in developing countries con-firms that market incentives work. The rate of re-turn to public and private sector projects imple-mented under policies that do little to distortprices is consistently higher than under policiesthat result in more distortions (Figure 5). A sub-stantial improvement in policy is associated with a5-10 percentage point increase in the rate of returnfor projects, or a 50-100 percent increase on aver-age. Also evident are the general positive effects ofinstitution-building and investing in infrastructureon returns from projects. Again, this confirms thatgood policies and investments (including externalfinancing) are complementary.

Integration with the global economy

When international flows of goods, services, capi-tal, labor, and technology have expanded quickly,the pace of economic advance has been rapid.Openness to trade, investment, and ideas has

7

Figure 5 Rates of return for projects financedby the World Bank and the IFC underdifferent policies and conditions

Economic rate of return (percent)

20

15

10

0 High

Traderestrictions

\\

Foreignexchangepremium

0 Moderate 0 Low

Fiscaldeficit

Note: Calculated for 1,200 public and private projects. A highforeign exchange premium is more than 200 percent; moderate,20-200 percent: low, less than 20 percent. A high fiscal deficit ismore than 8 percent of GNP; moderate, 4-8 percent; low, less than 4percent. For explanation of trade restrictions, see the technical notefor Chapter 4 at the end of the main text.Source: World Bank data.

been critical in encouraging domestic producers tocut costs by introducing new technologies and todevelop new and better products. A high level ofprotection for domestic industry, conversely, hasheld development back by decades in manyplaces. The effect of import competition on firmsin, for instance, Chile and Turkey, and the effect ofgreater competition in export markets on firms inBrazil, Japan, and the Republic of Korea confirmthe decisive contribution to efficiency that the ex-ternal economy can make.

The international flow of technology has takenmany forms: foreign investment; foreign educa-tion; technical assistance; the licensing of patentedprocesses; the transmission of knowledge throughlabor flows and exposure to foreign goods mar-kets; and technology embodied in imports of capi-tal, equipment, and intermediate inputs. Policiesto promote these flows include greater openness8

to investment and to trade in goods and services.Nontariff barriers, which are especially distorting,need to be phased out, and tariffs reduced, oftensubstantially.

Governments also need to play a more positiverole. To get the most out of technology transfer,appropriate education and on-the-job training willbe required. As in Japan and the Republic of Ko-rea, government agencies and industry associa-tions can collaborate to gather and disseminate in-formation on technology, and to help developquality control for exports.

Governments in the industrial countries have aresponsibilityif not to the developing world,then to their own peopleto grant exporters in thedeveloping countries access to their markets.Without such access, reforms in the developingcountries may go to waste. For several decades,the industrial countries had been reducing theirtariffs; in the 1980s, however, nontariff barrierswere steadily raised. Between 1966 and 1986, theshare of imports to countries that belong to theOrganisation for Economic Co-operation and De-velopment (OECD) that were affected by nontariffmeasures is estimated to have doubled. In 1986,more than 20 percent of imports from the develop-ing countries were covered by "hard-core" mea-sures alone. Freeing trade within regionsas inthe case of Europe's Project 1992, the UnitedStates-Canada Free Trade Agreement of 1989, andthe proposed free trade agreement for Canada,Mexico, and the United Statesis beneficial. But itremains to be seen whether regional blocs willsupport or hinder the goal of a more open globaltrading system. At any rate, a renewed commit-ment to the General Agreement on Tariffs andTrade (GATT), together with a greater willingnessby all countries to undertake unilateral trade re-form, is highly desirable.

The macroeconomic foundation

A stable macroeconomic foundation is one of themost important public goods that governmentscan provide. Experience shows that when govern-ment spending has expanded too far, the resulthas often been large deficits, excessive borrowingor monetary expansion, and problems in the fi-nancial sector, which have been quickly followedby inflation, chronic overvaluation of the currency,and loss of export competitiveness. Excessive bor-rowing can also lead to domestic and external debtproblems, and to the crowding out of private in-vestment. Restoring the confidence of the privatesector is now a basic aspect of efforts to spur re-

newed growth and generate employment in sev-eral countries with a history of macroeconomic in-stability, including Argentina, Bolivia, Côted'Ivoire, and Ghana.

Fiscal and financial instability have sometimesbeen partly inflicted on governments by externaleventsor by internal shocks such as civil wars ornatural disasters. But governments can choosehow to respond to such pressures. In such coun-tries as Côte d'Ivoire, Mexico, Kenya, and Nigeria,the response to a temporary economic upswingwas an unsustainable increase in public spending.Countries such as Botswana, Chile, Colombia, In-donesia, the Republic of Korea, Malaysia,Mauritius, and Thailand have managed to keeptheir macroeconomic policies on course, and theirbroader economic performance has benefited ac-cordingly.

A government can maintain a prudent fiscal pol-icy by looking carefully at the division of economictasks between the government and the private sec-tor. That, as the Report argues, is desirable in anycase. In reappraising their spending priorities, im-plementing tax reform, reforming the financial sec-tor, privatizing state-owned enterprises, and usingcharges to recover the cost of some state-providedservices, governments can meet the goals of micro-economic efficiency and macroeconomic stabilityat the same time.

Developing countries are also affected by themacroeconomic policies of the industrial countries,especially when these policies reduce the supplyof global savings relative to their demand and raisereal interest rates. An adequate supply of externalcapital (concessional and nonconcessional) is es-sentialwhich calls for strong efforts by the WorldBank and other multilateral agencies, as well asbilateral sources. The decline in voluntary privatelending to developing countries needs to be re-versed. The debt crisis remains an obstacle togrowth. Overcoming it requires the implementa-tion of comprehensive adjustment programs andreturn to regular creditworthiness; expanding thenumber of countries covered by commercial-debtand debt-service reduction; more concessional re-scheduling for the poorest debtor countries; ex-pansion of debt forgiveness and deepening theconcessionality of other debt relief measures byofficial bilateral lenders; and an increase in equityand quasi-equity investment.

Rethinking the state

The approach to development that seems to haveworked most reliably, and which seems to offer

most promise, suggests a reappraisal of the respec-tive roles for the market and the state. Put simply,governments need to do less in those areas wheremarkets work, or can be made to work, reasonablywell. In many countries, it would help to privatizemany of the state-owned enterprises. Govern-ments need to let domestic and international com-petition flourish. At the same time, governmentsneed to do more in those areas where marketsalone cannot be relied upon. Above all, this meansinvesting in education, health, nutrition, familyplanning, and poverty alleviation; building social,physical, administrative, regulatory, and legal in-frastructure of better quality; mobilizing the re-sources to finance public expenditures; and pro-viding a stable macroeconomic foundation,without which little can be achieved.

Government intervention to protect the envi-ronment is necessary for sustainable develop-ment. Industrial countries as well as developingcountries face serious problems of environmentaldegradation. In addition to air and water pollu-tion, sustained development is threatened by thedepletion of forests, soil, village ponds, and pas-tures. Appropriate policies include proper pricingof resources, clearer property rights and resourceownership, taxes and controls on pollution, andinvestment in production alternatives. The experi-ence of many countries suggests that market re-forms can also help to protect the environment.But specific environmental actions are needed.Finding the least costly way to confront environ-mental ills is a high priority.

What might prevent a realignment of the roles ofstate and market? Will the political and socialstructures permit it to be implemented? Is it moreor less likely to go forward under governmentsthat are accountable to their people and that de-fend political and civil liberties? It has often beenargued that a democratic polity makes economicdevelopment more difficult to achieve. Reform al-most always comes at the expense of certainvested interests, and macroeconomic stabilizationusually means at least a temporary rise in unem-ployment. The claim is that only authoritarian gov-ernments can make the hard choices.

This is patently false. The evidence from largesamples of countries does not go so far as to showthat individual freedoms by themselves spur eco-nomic growth, but it offers no support at all for theview that they hold growth back. Neither does itendorse the notion that authoritarian govern-ments, on average, show greater promise forachieving rapid growth. And looking beyondgrowth to the other elements of economic develop-

9

ment, the lesson of experience is even less equivo-cal: political freedoms, and civil libertiessuch asa free press and the free flow of informationseem to be associated with progress in health andeducation in large groups of countries.

The interactions between political systems andeconomic policies are complex. Clearly, economicpolicies are not chosen in a vacuum. All but themost repressive governments need to retain ameasure of popular support for their actions. Of-ten this support has been bought with an assort-ment of damaging policy interventions (such ashigh tariffs, currency overvaluation, and industriallicensing) as well as corruption and wasteful pub-lic spending. Military spending remains high inmany industrial as well as developing countries.Among the latter, it is well in excess of the com-bined public expenditures on education and healthin many countries such as Angola, Chad, Iraq, theDemocratic People's Republic of Korea, Uganda,or Zaire. Insecure authoritarian governments havebeen at least as prone as democratic ones to godown this path. At the end of it, all too often, liesan economic and political crisis that sets develop-ment back years.

Many countries have suffered a vicious circle ofharmful interventions that entrench special inter-ests and lead to rent-seeking and the "capture" ofthe state. Governments sometimes intervene inthe market to address political instability and otherpolitical constraints. But the result is that all toooften, the combination of pervasive distortionsand predatory states leads to development disas-ters. Reversing this process requires political willand a political commitment to development. Im-plementing the economic reforms considered inthis Report is one way to confront the politicalconstraints on development.

Reform must look at institutions. The establish-ment of a well-functioning legal system and judici-ary, and of secure property rights, is an essentialcomplement to economic reforms. Reform of thepublic sector is a priority in many countries. Thatincludes civil service reform, rationalizing publicexpenditures, reforming state-owned enterprises,and privatization. Related economic reforms in-clude better delivery of public goods, supervisionof banks, and legislation for financial develop-ment. Strengthening these institutions will in-crease the quality of governance and the capacityof the state to implement development policy andenable society to establish checks and balances.

Experience also suggests that a relatively equita-ble distribution of income and assets broadens the

10

base of political support for difficult changes. Butcaution is needed. Redistribution through distort-ing prices (such as subsidized credit) can be dam-aging, and the benefits in any case often go to theless needy. Many of the policies recommended inthis Report would tilt the distribution of income infavor of the poor. Reducing trade protection gener-ally promotes exports and raises the incomes ofthe poor by supporting labor-intensive activities,for instance, as does spending more on primaryeducation and preventive health care, improvingthe functioning of labor markets, and enhancinglabor mobility. Some countries could improve eq-uity by reforming their highly regressive tax sys-tems. Land reform can also be beneficial, as inChina, Japan, and the Republic of Korea, althoughits feasibility in many other countries has beenquestioned. Subsidies, targeted to the poor, for theconsumption of basic food, may be needed. Every-where, well-designed safety nets are essential toprotect the most vulnerable from the short-termcosts of reform.

The speed and sequencing of policy reform haveoften been decisive. Again, it is hazardous to gen-eralize. Swift reforms may help to neutralize theresistance of interest groups opposed to change; ormore gradual reforms may allow time to addresstheir concerns. But countries such as Ghana, Indo-nesia, the Republic of Korea, Mexico, and Turkeyseem to show that packages of comprehensive re-form, with at least some bold changes made at thestart of the program, are more likely to succeed.Comprehensive reforms can make heavy demandson the administrative capacity of governments.Some argue that moving too quickly can raise un-employment, skew the distribution of income, andpromote the overrapid depletion of natural re-sources. But the social cost of failing to reform canbe very great, as Argentina, Côte d'Ivoire, Peru,and Eastern Europe all found out in the 1980s.Swift and comprehensive reforms, with measuresto reduce poverty and protect the environment di-rectly, will usually be the right way forward.

Priorities for action

The recent slowdown in many industrial countriesand renewed economic uncertainty have cast acloud over the global prospects for development.The task is formidable: for many of the world'spoorest countries, decades of rapid growth will beneeded to make inroads on poverty. And prioritiesand constraints vary widely across countries at dif-ferent stages of development. Yet the opportunity

for rapid development is greater today than at anytime in history. International links, in the form oftrade and flows of information, investment andtechnology, are stronger now than forty years ago.Medicine, science, and engineering have all madegreat strides; the benefits are available worldwide.And policymakers have a better understandingthan before of the options for development.

To seize this opportunity, industrial countries,developing countries, and external aid and lend-ing agencies need to act. The industrial countriesneed to

Roll back restrictions on trade. The UruguayRound of trade talks must not be allowed to fail.Nontariff barriers to trade need to be dismantled.Developing countries would benefit from beinggranted unrestricted access to industrial-countrymarketssome $55 billion in additional exportearnings, or as much as they receive in aid.

Reform macroeconomic policy. Reduced fiscaldeficits, stable financial systems, stable currencies,low and stable interest rates, and steady non-inflationary growth would transform the climatefor development in the rest of the world.

The industrial countries and multilateral agencies,including the World Bank can strengthen develop-ment prospects by enhancing the quantity andquality of external financial assistance. They needto

Increase financial support. More external fi-nancing, both concessional and nonconcessional,would greatly strengthen the development effort.Many developing countries continue to strugglewith heavy burdens of external debt. Furtherprogress in extending debt relief to the middle-and low-income countries is needed.

Support policy reform. Additional financingwill be far more effective when it supports sounddomestic policies. Experience shows that it payslenders and borrowers alike to ensure that invest-ments and market-friendly policies go together.

Encourage sustainable growth. The globalcommunity has a great responsibility to take com-mon action to protect the earth's environment,and to support the control of environmental deg-radation in developing countries.

But the developing countries' prospects areprincipally in their own hands. Domestic reformsensure the benefits of better external conditions.The developing countries need to

Invest in people. Governments must spendmore, and more efficiently, on primary education,basic health care, nutrition, and family planning.That requires shifts in spending priorities; greaterefficiency and better targeting of expenditures,and in some cases greater resource mobilization.

Improve the climate for enterprise. Govern-ments need to intervene less in industrial and agri-cultural pricing, to deregulate restrictions to entryand exit, and to focus instead on ensuring ade-quate infrastructure and institutions.

Open economies to international trade and in-vestment. This calls for far fewer nontariff restric-tions on trade and investments, substantiallylower tariffs, and a decisive move away from dis-cretionary forms of control.

Get macroeconomic policy right. Macro-economic policy needs to ensure that fiscal deficitsare low and inflation kept in check. Appropriate,market-based incentives for saving and invest-ment are essential if domestic resources are to playtheir essential part in financing development.

In each of these areas, the challenge to policy-makers is to exploit the complementarities be-tween state and market. They can transform theoutlook for economic development by having thestate intervene less where it may (for example, inproduction), and more where it must (for example,in environmental protection), by strengthening in-stitutions and capabilities, by finding nondistor-tionary ways to promote equity, and by fosteringchecks and balances in governments.

Succeeding in development is indeed the mostpressing of all the challenges that now confrontthe human race. Incomplete though our under-standing still is, enough has been learned in thepast forty years to point the way. Strategies inwhich governments support rather than supplantcompetitive markets offer the best hope for meet-ing the challenge of development.

11

12

The world economy in transition

Radical change is under way in the global econ-omy. Recently more than a dozen countries havelaunched major economic reforms. Democracy hasswept Eastern Europe and is making inroads in thedeveloping world. The European Community hasmoved closer to political and economic union. Ifthese events are cause for optimism, others arenot. War in the Middle East, increasing difficultieswith the Soviet Union's economic transition, andslowing world growth have been setbacks.

This Report will show that what matters most

Figure 1.1 Periods during which output perperson doubled, selected countries

Years

0 10 20 30 40 50 60

United Kingdom,1780-1838

United States,1839-86

Japan, 1885-1919

Turkey, 1857-77

Brazil, 1961-79

Rep. of Korea,1966-77

China, 1977-87

Note: For the rationale for the choice of periods, see the technicalnote at the end of the main text.Sources: For United Kingdom, Crafts 1981; for Japan, Maddison1989; for others, World Bank data.

for any country's economic development is itsown approach to economic policies and institu-tions. But global economic conditions are impor-tant. So whereas the rest of this Report is largelyabout what countries themselves can do to im-prove their performance, this chapter looks at theglobal context in which those actions will be cast.

In some ways the international economy will beunfavorable to development in the coming decade.Interest rates may remain high, and growth islikely to remain slow worldwide. No early end tothe debt crisis is in sightnor is any substantialresumption in North-South capital flows. Theneed to protect the environment poses an addi-tional challenge. Yet there are also favorable signsfor development. Real reform is being carried outin Eastern Europe. Ghana, Indonesia, Mexico, andother countries are striving to sustain their earlierprograms of reform; Peru, Tanzania, and VietNam, for example, have embarked on new ones. Ifmore countries do the sameand if their actionsfind support in greater openness in internationaltrade and financerapid progress is indeedpossible.

The long view

Economic history shows that it is possible forcountries to develop rapidly and indeed that formany countries the pace of change has acceler-ated. It shows at the same time that many coun-tries have developed very slowly, if at all. The keyto development, clearly, is to understand why therange of experience has been so wide.

The time required for substantial changes in thequality of life has shrunk steadily over the centu-ries (Figure 1.1). Beginning in 1780, the United

Kingdom took fifty-eight years to double its outputper person. Starting in 1839, the United Statestook forty-seven years. Starting in the 1880s, Japandid it in only thirty-four years. After World War II,many countries doubled their per capita outputeven faster than Japan: for example, Brazil in eigh-teen years, Indonesia in seventeen, the Republic ofKorea in eleven, and China in ten. This change inpace indicates that the industrial revolution gainedmomentum over a long period, whereas catchingup has been a more and more rapid process.

The pace of progress has hastened not only forincome and material consumption, but also forother aspects of welfare. Many developing coun-tries have approached the life expectancies of theindustrial world in a remarkably short time (Figure1.2). These changes reflect better diet, housingconditions, and access to medical care. The latter,in turn, were possible thanks to increases in foodproduction and distribution, growth in family in-comes, medical advances, public investments insafe drinking water and sanitary waste disposal,and, more recently, the development of healthcare systems.

Technological progress, more than any othersingle factor, has fueled this economic advance.Innovations have produced great strides in agri-culture, industry, and services. Famines disap-peared from Western Europe in the mid-1800s,from Eastern Europe in the 1930s, and from Asia inthe 1970s. In Africa the challenge of eradicatingfamine remains. Over time, countries have tendedto converge with respect to some aspects of perfor-mance more than others. There has been a particu-larly strong tendency toward convergence in indi-cators of basic health. Large falls in infantmortality have been achieved by many countrieseven those with very low incomes. The countriesnow classified as developing have better standardsof basic health than the industrial countries didwhen they were at the corresponding level of in-come. The same holds for literacy, although lessso. Convergence in per capita income has beenmuch more disappointing.

Despite the dramatic progress in some coun-tries, the differences in per capita incomes are vastacross countries and regions. Table 1.1 shows thegreat strides that have been made in raising in-comes around the world. But it also shows thegreat income differences and the lack of progressin many parts of the world.

Economic theory suggests that productivity andper capita incomes would converge across coun-tries over time, assuming that the countries whichare now developing get access to the new technol-

Figure 1.2 Gains in life expectancy, selectedcountries and periods

Average years gained per decade

8

41905-56

1956-78

23 41

1921-46

1946-83

1927-5

1957-87

1950-71

1971-84

32 43 38 50 44 52

India Sri Lanka Rep. of Korea Guatemala

Note: The numbers below each bar indicate life expectancy at birthat the beginning of the period. For the rationale for the choice ofperiods, see the technical note at the end of the main text.Sources: Data before 1978, Gwatkin 1978; later data for all countriesexcept India, WHO 1989; for India, United Nations 1989.

ogy introduced by the industrial countries (seeChapter 2). There is evidence that this has hap-pened in the industrial countries. With interrup-tions caused by war, the variation in their per cap-ita incomes has declined steadily over the pastcentury. This convergence began with the indus-trial revolution. In the nineteenth century, Austra-lia, Canada, Japan, the United States, and WesternEurope began to industrialize and to grow at anaccelerating rate. Some other nations followed inthe early twentieth century. But by 1945, most ofthe world had failed to make much progress.

Asia, the world's most populous region, has re-cently begun to catch upin some cases, at a spec-tacular rate. But Sub-Saharan Africa has seen itsper capita incomes fall in real terms since 1973. In1950 the region's per capita income was 11 percentof the industrial-country average; now it is 5 per-cent. Latin America has also slipped, especiallysince 1980. There are disparities within groups ofcountries, too. They are growing among the lessadvanced economies as a whole, and especially inEast and South Asia.

Extraordinary progress is possible even whencountries seem doomed to fail. Forty-three years

13

Table 1.1 Historical trends in GDP per capita

Note: Data presented are simple averages of GDP per capita. Numbers in parentheses are regional GDP per capita as a percentage of GDP in theOECD economies. Regional groupings include only non-high-income countries. Hungary is included in Eastern Europe group, not in Europe,Middle East, and North Africa.Sources: For 1830-1965, Maddison, background paper. Data for 1950-65 for Africa and the Middle East are based on OECD; data after 1965 arebased on growth rates from the World Bank data base. Benchmark values are 1980 international dollar estimates from Maddison, backgroundpaper, if available; from Summers and Heston 1984, otherwise.

ago an influential government report in an impor-tant developing country observed that labor todayshunned hard, productive jobs and sought easy,merchant-like work. The report showed thatworkers' productivity had fallen, wages were toohigh, and enterprises were inefficient and heavilysubsidized. The country had virtually priced itselfout of international markets and faced a severecompetitive threat from newly industrializingChina and India. It was overpopulated and becom-ing more so. This would be the last opportunity,concluded the prime minister in July 1947, to dis-cover whether his country would be able to standon its own two feet or become a permanent burdenfor the rest of the world. That country was Japan.The central question of this Report is why coun-tries like Japan have succeeded so spectacularlywhile others have failed.

The setting for development

The key to global development has been the diffu-sion of technological progress. New technologyhas allowed resources to be used more produc-tively, causing incomes to rise and the quality oflife to improve. Scientific and medical innovationhas proceeded at a breathtaking pace during thepast two hundred years (Box 1.1).

14

Using new technologies effectively has often re-quired adaptation and innovation in economic in-stitutions, and occasionally political and social in-stitutions, too. New means of transport extendedmarkets and thereby increased the division of la-bor, leading, as Adam Smith observed, to morespecialization: goods and labor were traded formoney instead of bartered, and so on. Today, cre-ating and strengthening market institutions is thebiggest task for the former socialist countries ofEurope and for many of the developing countries.

Global integration

Trade was crucial in the spread of technology.Countries have usually developed more quickly aspart of the world economy than in isolation, al-though protection has stimulated growth in someinstances. Historically, trade wars have retardedglobal development.

The Great Depression and its aftermath are per-haps the clearest example of this. The collapse ofthe post World War I trading system did not trig-ger the Great Depression, but it did contribute toits depth, spread, and duration. The stock marketcrash of October 1929 caused demand and trade toslump. After the failure to reach a cooperativetrade agreement in 1929, the United States raised

(1980 international dollars)

Growth rateRegion or group 1830 1913 1950 1973 1989 1913-50 1950-89

Asia 375 510 487 1215 2,812 0.1 3.6(40) (23) (15) (16) (28)

Latin America 1,092 1,729 2,969 3,164 1.2 1.2(49) (52) (40) (31)

Sub-Saharan 348 558 513 0.8Africa .. (11) (8) (5)

Europe, Middle .. 940 2,017 2,576 2.0East, and (29) (27) (26)NorthAfrica

Eastern 600 1,263 2,128 4,658 5,618 1.4 2.0Europe (64) (57) (65) (63) (56)

Developing 701 839 1,599 2,796 2.7economies (32) (25) (22) (28)

OECDmembers 935 2,220 3,298 7,396 10,104 1.1 2.3

Box 1.1 Innovations that changed the world

During the past two hundred years, a series of majorscientific and technological advances have dramaticallychanged the course of development.

Health and medicine

In the nineteenth century, improved nutrition playedthe lead role in increasing people's life expectancy andin reducing infant mortality rates. In this century prog-ress has come from the medical sciences. Jenner'ssmallpox vaccine (1790) opened the way for the vac-cination of cholera, typhoid, and anthrax. Pasteur es-tablished the relationship between microbes and im-munity (1880). Half a century later came Fleming'sdiscovery of penicillin (1929), its clinical application(1941), and the development of other antibiotics. As aresult, the morbidity rate of tuberculosis in the UnitedStates, for example, declined from 79 per 100,000 in1939 to 9 in 1988. Widespread immunization programshave contributed to dramatically reduced infant mor-tality rates, which are estimated to have declined inlow-income economies from 124 per 1,000 live births in1965 to 72 in 1985.

Food production

Steady increases in food production in the nineteenthcentury, followed by more dramatic increases in thetwentieth, made possible some remarkable improve-ments in people's nutrition. The green revolution inthe 1960s and 1970s was possible because high-yieldinghybrid varieties of wheat and maize, dwarf varieties ofrice, and chemical fertilizers and pesticides were intro-

duced. India doubled its average yield of wheat withina few years after the introduction of these improve-ments in 1966-67. In China, where rural reforms pro-vided added flexibility in farming practices, new grainvarieties and farming techniques made it possible tosupport 22 percent of the world's population on 7 per-cent of its arable land.

Transport, energy, and communications

The industrial revolution in Europe began with inven-tions that augmented labor with machinery and newsources of energy. After Savery's steam engine (1698)and Newcomen's improved engine (1712), Watt's moreefficient engines (1770 and 1796) brought steam intowide use. The production and transport of coal grewquickly. Next came improvements in oil refining(1850s), then a method of drilling for oil. The internalcombustion engine (1876) and the technologies for elec-tricity generation and transmission (1886) were part ofthe same progression, transforming old industries andlaunching new ones. Transportation was revolu-tionized along the way, with the steamship and thelocomotive (1830s), the automobile (1885), and the air-plane (1903). Harbors, highways, railways, and air-ports brought trade to the remotest of places.

The telegraph (1844), telephone (1876), radio (1895),and television (1925) changed the way people interact.With the electronic computer (1924), communicationsatellites (1960), and fiber optics (1977), information isnow transmitted and processed at breathtaking speed,yet at practical cost.

tariffs in the Smoot-Hawley Act of 1930. America'strading partners retaliated. World trade fell bytwo-thirdsfrom $3 billion in October 1929 to $1billion in July 1932. Some of the contraction wasthe result of the Depression, but the hostility to-ward trade caused damage that took decades torepair.

The deterioration of the climate for trade in 1929had followed a long period of peacetime marketintegration. Britain had entered the nineteenthcentury with an unwieldy system of tariffs andcustoms laws accumulated over five hundredyears. The transition to liberal trade was not easy.High duties on grain imports (the Corn Laws) as-sured landlords relative prosperity, while con-sumers paid high prices and export-oriented man-ufacturing was stifled. In 1845, when the potatocrop failed in Ireland, mass starvation followed.This disaster paved the way for the repeal of theCorn Laws, and Britain moved to a more liberal

trade regime. Other countries followed. Expand-ing agricultural markets lessened protectionistpressures, and the period from 1848 to 1873 be-came one of freer trade throughout Europe.

This process of international integration wasreinforced by integration within countries. In-novations in transport were crucial. Acceleratingmarket integration, along with new manufactur-ing technologies, led to rapid increases inproductivity.

Though this shift toward international integra-tion undoubtedly spurred development, it also ex-posed countries to external economic shocks, andhence to occasional setbacks. Dramatically lowerfreight rates for shipping appear to have causedprofits and wages to fall, but wages fell less so thecost of labor rose in real terms. Cheap grain fromNorth America, Argentina, Australia, and theUkraine was brought to Europe. Many countriesraised their tariffs, on manufactures as well as

15

Figure 1.3 Per capita output growth in the OECD and developing countries and significantworld events, 1918-88

Per capita output growth (percent; five-year moving average)8

1920

1918World War I ends;recovery begins

I1930

1929-39 Great Depression

1940

1944Bretton Woods conference

1950 1953

Sources: For events, Pollard 1990; for data, see the technical note at the end of the main text.

food. By 1913, the average tariff on manufactureswas 20 percent in France, 18 percent in Italy, and13 percent in Germany. Meanwhile, howeve