Development debates in a historical perspective: Part 1

By José Antonio Ocampo

UNCTAD Prebisch Lecture 2023 – Published in three parts

The concept “development” was originally thought in strict economic sense – as rising per capita income. Under the United Nations leadership, it came to encompass its social and environmental dimensions: the International Labor Organization developed the concept of “basic needs” in the 1970s, and the United Nations Development Program that of “human development”. The environmental dimensions of development were also gradually incorporated and led to a broad concept of “sustainable development” that in the United Nations terminology includes the economic, social, and environmental dimensions, as incorporated in particular in the “sustainable development goals” approved in 2015.

Development economics was born in the 1940s and 1950s in Eastern Europe and Latin America, the two regions of the developing world that had achieved an intermediate level of development. Paul Rosenstein-Rodan and Raùl Prebisch are clear examples. From the start, it was associated with broader intellectual economic debates, particularly on the role of the state in economic policy, which had made a push forward in the 1930s with the Keynesian revolution.

The United Nations played an important role in development thinking and in advising developing countries at the time. ECLAC was an early leader in this regard, with Prebisch as the intellectual leader. The UN also became the center of the debates on the need to reform the world economic system. Since its creation, UNCTAD played a crucial role in this regard.

The ideas put forward by the new field of economics took place in a world economy that was already highly unequal in terms of levels of development, and characterized by a division of labor in which developed countries were exporters of manufactures and developing countries of primary goods. This was behind Prebisch’s view of the world system as a “center-periphery”. In his view and that of Hans Singer, one feature of that system was the tendency for the terms of trade to move against primary goods and, thus, of developing countries.

We should add that the basic conception of classical development economics was the need to industrialize to accelerate economic growth and technological change: the “Industrialization Consensus”, as I have called it, to borrow from the contrasting term which came to be called the “Washington Consensus”.

In terms of macroeconomic issues, a major topic was how export fluctuations were a major source of periodic balance of payments crises in developing countries. Given their strong dependence on the imports of machinery, equipment and many intermediate goods, the availability of foreign exchange was also seen by some classical development economists as a long-term constraint to growth (balance of payments constraint on growth. The strong role of external trade in the macroeconomic dynamics of developing countries, and the subsidiary role of domestic demand, the issue most underscored by the Keynesian revolution, is that I have come to be called “balance of payments dominance”, gain in contrast with the concept of fiscal dominance that has played a central role in the macroeconomic literature.

The 1960s and 1970s led to three significant changes.

1. a) The world economy started to offer developing countries increasing opportunities to export manufactures. This led to an increasing differentiation between those countries that were able to benefit from that trend and those that continued to depend on exports of primary goods.
   b) Rise of a new brand of orthodox economics critical of state intervention. It included a strong criticism of import substitution. It was also critical of other forms of state intervention – e.g., in the financial sector, against what this school referred to as “financial repression”. The orthodox views were codified in what came to be known as the “Washington consensus”.
   c)The third trend was the return – for the developing countries particularly in the 1970s – of private international capital flows, which had collapsed with the Great Depression in the 1930s. However, the volatility of those flows became a problem of its own and implied a return to boom-bust financial cycles and associated crises, starting with the Latin American debt crisis of the 1980s. Such volatility became therefore a central element of the “balance of payments dominance” that affects developing countries.

The first and third were part of a “globalization” process, which offered very unequal opportunities to different groups of developing countries, with successful manufacturing exporters from East Asia leading the process but other countries experiencing slower growth, including processes of “premature de-industrialization”. Globalization also generated crises that involved a large number of countries: the 1997 East Asian crisis that spread to large parts of the developing world; and the North Atlantic financial crisis of 2008-09; the COVID-19 crisis, which was perhaps the most global, but its origins are not economic, and was followed by the current crisis.

The international division of labor and the terms of trade debate

In Prebish’s “center-periphery” system, and the views Hans Singer, a major characteristic of the world economy was the tendency of the terms of trade of commodities – and thus of developing countries – to experience a long-term decline. This represented a major break with the views of classical economics (David Ricardo, in particular), according to which the laws of diminishing returns in primary production and the increasing returns in manufacturing implied that the terms of trade of primary goods would show a long-term improvement vis-à-vis manufactures.

The Prebisch-Singer Hypothesis, as it came to be called, can be understood as involving two different theoretical variants.

The first drew on the negative impact that the low income elasticity of demand for primary commodities – and particularly, agricultural goods – had on the terms of trade of developing countries.

The second – and, in my view, a more interesting one – was based on the asymmetric functioning of factor markets in the developed vs. developing countries: the fact that the second group of countries faced a labor surplus – what in Arthur Lewis terminology came to be known as an “unlimited supply of labor”.

The fundamental difference between the two variants was that, in the first case, the downward pressure was reflected directly in the barter terms of trade, whereas, in the second, it was generated through factor markets – the factorial terms of trade – and only indirectly, through the effects of production costs on commodity prices.

Another important difference is that the first variant applied only to primary commodities, whereas the second should affect all goods and services produced in developing countries. Singer posed it very clearly in 1998: the terms of trade between standardized manufactures produced by developing countries would also tend to deteriorate relative to the innovative products of developed countries. This meant that, even though developing countries could industrialize and produce manufactures, the fact that these products were standardized meant that they did not create new economic rents. Instead, the rents associated with innovations were captured by developed countries’ entrepreneurs.

The concept of labor surplus fitted well the complementary terms-of-trade theory of Arthus Lewis, according to which the international terms of trade were determined by relative wages in developing versus developed countries, which were determined, in turn, by the levels of productivity in the production of food (or of subsistence goods in general) in the two groups of countries.

As pointed out, according to the second variant, the trend in the terms of trade was not associated with the types of goods produced but rather with the structural characteristics of the countries that produced them. The North-South models developed in the 1980s, by Ronald Findlay and Lance Taylor, among others, formalized this analysis. A common feature of these models was that, due to differences in economic structures, wage increases in the North were proportional to the rise in productivity, while the unlimited supply of labor implied that real wages were not affected by technological change, which was then “exported” to the rest of the world through lower prices.

The expansion of world trade also offered since the 1960s opportunities for the diversification of primary good exports towards goods of higher income elasticity of demand and value added. This included manufactured goods, as well as an array of perishables – fruit, vegetables, and flowers – the development of which required special transportation and handling.

On top of the now well-established view on the features of the center-periphery system, the literature identified since the 1980s the risks of “Dutch-disease” effects of commodity booms and, in particular, the de-industrialization processes that they could generate. Latin America is the best example of this process. But it also limits the industrialization of Sub-Saharan Africa.

In relation to the empirical validity of the P-S Hypothesis, the literature written up to the end of the 1970s was ambivalent. A breakthrough was a World Bank 1988 paper by Enzo Grilli and Maw Cheng Yang, who showed that there was indeed evidence of a long-term deterioration in real non-oil commodity prices through the twentieth century. This paper became a milestone in the debate.

The later empirical literature has reinforced this conclusion, although indicating also that that the adverse trend of the commodity terms of trade was a feature of the twentieth century (particularly after World War I), not of the nineteenth or the twenty-first centuries. In turn, the adverse trend in the twentieth century is largely explained by two major downward shifts: one after World War I and the other in the 1980s. In both cases, these adverse shifts represent the delayed effects of sharp slowdowns in world economic growth. An additional conclusion is that the adverse price trend in the twentieth century was particularly strong for tropical agricultural goods. This literature also showed that, beyond short-term fluctuations, there are long-term cycles of commodity prices (as long as 30 years).

In Part 2 – From the Industrialization Consensus to market reforms, and to a revival of industrial (production sector) policies.