Governments role in development

It is easy to miss the major issues of developing economies from the comfort of the UK. One of them is the argument about the role government should play.

On one side of the argument are those who believe markets should drive development. There should be free trade, stable inflation and minimal government intervention.

On the other side of the argument are those who say that LDC's have not got the capital needed to provide the infrastructure that markets need (roads, power, education and health services for example). Therefore governments must take the lead by providing this.

But a third position takes this argument further. LDC's don't have the experienced entrepreneurs and necessary business skills to allow markets to allow development at the desired rate. Further they argue that the distribution of income that markets would cause will be far too unequal and this also requires intervention. In short the view is that the government must be responsible for the development process and most parts of the economy.

India is a country that has largely taken the third view. Indian industries are heavily subsidised, measures to even out the distribution of income are significant and prices are controlled. This has worked quite well for India, although their advantage as English speakers cannot be understated.

However now the policy is reaching its limits. The widespread involvement of government has stifled private enterprise, prevented the development of some industries and led to a corruption that diverts well intended funds from worthwhile projects.

So the time has come to reform and 'get the prices right' to allow India to unlock its potential. It's not going to be easy.

The Age reports on the next stage which includes the introduction of VAT (GST).

Regulating market failure

Market failure occurs in many ways. One of the less well covered is the 'Tragedy of the commons'.

Nobody used to own the fish in the sea and so fishermen could catch them without paying for them. This led to chronic overfishing and so declining fish stocks. This is really a case of 'lack of information' and failing to take account of externalities. The fishermen maximise profits according to their private costs which do not include any cost of fish themselves.

The way to regulate this is not easy. With the Commons on land the answer was to enclose them and confer property rights on individuals. The farmers then consider the full costs of the land (well nearly, most ignore the effects of intensive farming on the environment) and farm it sensibly.

It was not possible to confer private property rights on the sea, but in the last forty years EU governments have established government control of the sea for 200 nautical miles offshore.

The solution taken by the EU to the problem of fish stocks is quotas. Each fishing boat is allowed to catch so much a year and can only fish for so many days each month. In this way fewer fish are taken and stocks should recover. Of course the fishermen earn less and some leave the industry. Others are compensated by the higher fish price as supply in the markets fall.

So that's easy then! Problem solved?  Except fish stocks have not recovered. Every year they seem to decline, or at least not improve. Every year the fishermen complain they will never survive and need higher quotas (obviously stupid as fish will then run out and they all lose their livelihood). And each year each EU government tries to negotiate their fisherman's quota higher.

Overall this is an example of an attempt to correct market failure that has turned into a classic example of government failure. It does have some sense. Hayek would applaud it for using the rule of law to enforce a solution that attempts to be fair. Others would point out that the lower quotas raise fish prices and so use the market to reallocate resources more fairly.

However the obvious point is that after 40 years of fishing quotas the policy has not worked. This is because the quotas chosen were wrong (due to imperfect information, 'accidental' fishing AND cheating). The other obvious solution is to offer tradeable fishing permits to operators of vessels. Price the fish accordingly and the fishermen won't try to overfish. A tax is another possible solution, but much more expensive to administer (as each catch must be weighted and taxed, permits could apply to boat capacity per day).

The annual quota negotiation has just finished. The BBC cover the story below.

The BBC covers the story here

Meddling in markets

For some reason governments can't help interfering in agricultural markets. And most of the time they make things worse, an example of government failure.

Thailand are the latest government to distort a food market. They are offering a premium of about 50% to rice farmers to buy up rice in unlimited amounts. The claimed motive for this policy is to raise the income of farmers who are amongst the lowest paid in the country.

But such policies, however well intentioned, distort the market. This effectively raises the price in the local market, (see the diagram above) but will inevitably lead a situation of excess supply in Thailand and a distortion of the international market.

As a major rice exporter changes to the local market will inevitably lead to changes in the international price. Why would a Thai farmer sell on the open market when the government will pay more? So the supply of Thai rice to the international market will fall, forcing up the world price and causing problems for the poor of other nations.

There is also the question of what to do with the rice the government buys. Some schemes stockpile food in years of surplus to release in lean years. Doing so helps moderate price fluctuations and smooth out farm incomes. However the Thai floods mean production is actually down this year so its not the time to start buying up stocks.

The EU pursued a disastrous agricultural policy from the 1950's to the mid 2000's where they paid farmers far to high a price for food. This caused an inefficient over production in Europe and reduced the incomes of farmers in LDC's where the market would produce the food most cheaply and efficiently. The solution for the EU was to move to direct income payments, simply giving money to the farmers and so avoiding the incentive to them to produce ever more unwanted food.

Businessweek report the Thai policy here