Neoliberalism Brings Dead Ends

By Meles Zenawi Meles Zenawi served as President and Prime Minister of Ethiopia between 1991 and 2012. This commentary is extracted from a draft research paper presented at Columbia University, United States, titled, Africa Development: Dead Ends and New Beginnings. The neo-liberal paradigm which suggests a non-activist and non-interventionist state, a night watchman state, as conducive to economic growth bases such conclusions on two pillars. One pillar has to do with the assertion that competitive markets are both pervasive and efficient. The second pillar has to do with a political economy based on the theory of socially wasteful rent-seeking activities and the rational choice theory of solely self-interest maximizing individuals.    Government created rent does not necessarily have to be socially wasteful.  It becomes wasteful only if solely self-interest maximizing individuals use it to create wealth at the expense of society and only if the state is incapable of improving on the market; there are no market failures. The theory of solely self-interest maximizing individuals does not hold water.  History, common everyday observation and theoretical analysis based on the two suggests that an economy based on complex economic interaction such as a market economy requires a blend of self-interested and non-self interested behaviour: a blend of social and individual norms that maximize survival potential  within an appropriate social context. In the absence of such norms, the state, if it can exist as a coherent corporate entity for any period of time, becomes predatory. A properly behaved night watchman state populated by interest maximizing individuals is thus a practical and theoretical impossibility.  Only individuals with a blend of self-interested and non-self interested behaviour can create a night watchman state, and such people are equally capable of creating a state which intervenes in the economy in the larger interest of society. Creating the proper blend of norms, values and rules to reduce uncertainty and transaction costs is a critical factor in accelerated growth and development.  The creation of such social values and norms is termed social development or social capital accumulation.  Social development is thus not only an essential element of development but also a critical instrument of accelerated economic growth.   The accumulation of social capital, which plays such a critical role in accelerating economic growth, is a public good which has increasing returns to scale.  It is, hence, undersupplied by the market and is subject to vicious and virtuous cycles.  Social capital is created by social activity through civic engagement in the context of horizontal and dense networks; it is inculcated and sustained through modelling, socialization and sanctions.  The state plays a critical role in social capital accumulation through undermining patronage networks and promotion of fairness and equity, through the promotion of participation and democracy, and through appropriate sanctions and efforts at socialisation. Of course, the neo-liberal paradigm correctly identifies technological change as the heart of the development process and as the only source of continuous increase in per capita income.  However, it treats technological change as an exogenous factor, as a sort of Black-box and thus does not even attempt to explain it in economic terms.  However, developing countries cannot compete simply on the basis of factor endowment, or by buying up the latest machinery. They need to assimilate technology developed elsewhere and they need to continuously move up the technology ladder, if they are to achieve continued growth and development.  Technological capability accumulation is as central to developing countries as it is to developed countries.  The difference is that, in developing countries, such accumulation takes place primarily through the assimilation of foreign technology rather the development of new technology. Firms take a lot of risk and incur heavy expenses to identify and assimilate foreign technology but are unable to fully appropriate the benefits of their efforts.  Indeed, national development would be hindered if they were to fully appropriate the benefit of their effort as the newly introduced technology would not be diffused.  There is thus a fundamental market failure in technological capability accumulation in developing countries. Moreover, the required external environment is such that it would not be possible to create it through the market mechanism alone. Technological capability accumulation in developing countries is as plagued by pervasive market failure as is the development of new technology. A deeper analysis of technological change shows that it is plagued by information failures and extreme forms of information asymmetry, of increasing returns, of extensive externalities, and coordination failures.  It shows that technology has the essential characteristics of a public good. In other words, a deeper analysis of technological change shows that in both developed and developing countries technological change takes place in an environment of pervasive market failures. A historical analysis of technological development shows that successful societies have developed national innovation systems that address market failures, and that such systems are based more on the structures and histories of the economies rather than on relative factor prices.  It shows that there are differing national systems of innovation reflecting the differing histories and structures of the economies which can do the job. It would be impossible to envisage successful technological development outside of such institutional environment in any country, developed or developing. Cleary, then, when it comes to the heart of accelerated economic growth, when it comes to technological development, the neo-liberal assumption of efficient competitive markets has no basis in fact or theory.  Its assumption of a night watchman state as an instrument that facilitates technological development by letting the markets do the job while it stands guard protecting property rights and enforcing contracts has no basis in fact, in history or theory.  Certainly, the neo-liberal paradigm cannot guide the heart of development and technological growth.

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