Chapter 5Chapter 5: Markets and States1.Markets and Market FailuresAfrican Economic ReformsI. Markets and Market FailuresArguments for MarketsI. Areas of Market FailureII. Market Pessimists & Market OptimistsMarket OptimismImplementing Market ReformsStabilization of the Macro-economyIMF Stabilization ProgramsStructural Adjustment Program (SAP) by the World BankTiming of Market ReformsCredibility of ReformsThe Washington ConsensusThe ten Components of the Washington ConsensusThe ten Components of the Washington Consensus contd.The future Economic ReformsChapter 5 A Brief SummaryChapter 5 Summary Contd.End Chapter 5Chapter 5States andMarketsNorton Media LibraryDwight H. PerkinsSteven RadeletDavid L. LindauerChapter 5: Markets and States•1.Markets and Market Failures •2.Market Pessimists and Market Optimists •3. Implementing Market Reforms •4,Stabilization of the Macroeconomy •5. Structural Adjustment –Adjusting Prices –Ensuring Competition –Privatization –Creating Market-Supporting Institutions •6.Timing Market-Enhancing Reforms •7.The Credibility of Reforms •8.The Washington Consensus1.Markets and Market Failures•At Independence many African countries has a promising future due to low population and rich resource base.•Ghana became the first to gain independence 1957 from Britain with leadership of Kwame Nkrumah•Nkrumah introduced central control on the economy and abolished some traditional institutions such as Ashanti and led to a serious of coups until 1983 when Lt. Rawlings took power and introduced Ghana’s Recovery Program supported by the World Bank and the IMF toward macroeconomic stability , economic growth and poverty reductionAfrican Economic Reforms•The 1980s were called the “lost decade” of Africa. These was also applied to Latin America due to state driven excessive control on the economies •Ghana led the way in economic reforms followed by others. Later the collapse of the Berlin Wall in 1989 enable many African countries make reforms along market system.•The end of the cold war and demise of the former Soviet Union led to fall of African dictators such as in Ethiopia, and Somalia, etcI. Markets and Market Failures•Market economics well developed in Introductory Principles of Economics (Microeconomics & Macroeconomics)•Markets under certain conditions provide the “invisible hand” to the economy •The Power of Markets in organizing national economies have been proved in successful market EconomiesArguments for Markets•1.Allocate resources efficiently. Under competitive economy economic welfare is maximized under free working markets•2.Market system is more flexible and able to adjust to business cycles than government control•3.Market promote competition which motivate consumers and producers guided by enlightened self interest.•4.Reliance in Markets disperses economic and political power and therefore consistent with democracy.I. Areas of Market FailureMarkets can fail due to numerous reasons•1.Monopoly or oligopoly control..•2..Presence of Externalities ( Positive Spill Over effects)- such as public education, etc•3. Negative Externalities (negative spill over effects- such as pollution•4. Markets may not facilitate change in economic structure- Infant Industry argument at early stages •5. Missing or underdeveloped Institutions rules/laws•6. Macroeconomic Imbalances•7.Misguided National Goals promoted by autocratic governments especially in Dictatorship. examplesII. Market Pessimists & Market OptimistsSome Roots of Market Pessimism:•“Great Depression of the 1930 & 1940’s when war led blocked trade barriers •Arguments for intervention and control•(balanced growth, big push arguments)•Forced structural transformation of economies by States justified by Lewis theory of labor surplus- the Soviet Union was the model 1950 &60’s,•Marxist, Leninist, Mao ideologies of central control and direction of the economies..Market OptimismIntellectual basis for Market Optimism•Economic Theory provides the basis for market supremacy.•Powerful theories by the Chicago School of Economists such as Friedman, Schultz, etc •The historic collapse of the Soviet Union in 1991 and the end of the Cold War•East Asian Miracle of Asian Tigers such Singapore, South Korea, Taiwan, Malaysia, etc.•(See BOX 5.1 Decline of state control over time)Implementing Market Reforms•Due to regulations and control that led to rent seeking that diverted investors and entrepreneurs to unproductive activity and corruption, it became necessary to promote markets and the private sector•The World Bank and IMF helped to countries economic reforms: structural adjustment and stabilization reforms.Stabilization of the Macro-economy•Stabilization refers to correcting imbalances in budgets, & money supply aimed at controlling inflation.•It also means the need to devalue the currency or exchange rate to avoid currency controls.•With inflation and uncertainty investors divert resources from productive activities such as transfers to overseas, etcIMF Stabilization Programs There are five such remedies•1.Reducing government budget deficit via higher taxes, reduce spending, financing by borrowing which crowds out private investment.•2.Restrictions on central credit-control of money supply•3.Adjust exchange rate via devaluation to stimulate exports.•4.Remove price controls on consumer goods including food prices•5.Restrain wage increases since wages greater than productivity increase costs and contributes to inflation•Case of Bolivia stabilization program Box 5.2. 1985-86Structural Adjustment Program (SAP) by the World Bank•Trade reform- opening the economy to trade•Adjusting Prices” Getting Prices Right”•Promoting market competition•Fostering Privatization•Creating Market Support Institutions (Legal system, financial system, well define property rights rules that promote long term investment and productivity.Timing of Market Reforms•Faster reform- shock therapy often recommended by the IMF. This may work under new regimes- Russian & Eastern Europe case.•Graduate reform-based on sequencing of reforms- China and Vietnam•China began with household responsibility system in the rural sector (Box 5-3 A case of China reform 1999-2001) •Attempted reforms in Africa with varying results;•(Uganda, Kenya, Ghana, Mozambique, and Tanzania)Credibility of Reforms•How do we evaluate and monitor