Institutions and market development: Capacity building for economic and social transition
by Denis Rondinelli
Preface
This report is part of a series of working papers published under the ILO's Action Programme on Privatization, Restructuring and Economic Democracy for use by governments, workers' organizations, employers' organizations, development agencies, consultants, academics and managers. The ILO is particularly interested in the social aspects of privatization, structural adjustment and economic transformation at national level. However, it is also concerned with global trends and appropriate national responses to globalization and with helping all stakeholders to better understand and assess the economic, political and cultural conditions and the institutional capacities which can lead to successful economic transformation. Experience has indicated that, in the areas of privatization and economic transformation in the context of the rapidly evolving world economy, countries that manage their transformation processes strategically and participatively -- and simultaneously adjust, adapt, democratize and strengthen their institutions -- are more successful.
In this period of major economic and social transition, the International Labour Organization is focusing attention on the impact of globalization and economic transformation as they affect national and enterprise employment levels and the quality of jobs in the short and long term; working conditions, wages and income differentials; and the access, availability and quality of services provided by privatized enterprises and consumer prices, especially with respect to economically vulnerable groups in society. The ILO is also concerned with national and enterprise productivity levels in countries undergoing widespread privatization; improvement of national industrial relations as economies transform and as more economic activities are carried out by private enterprises; and respect for international labour standards in industries and sectors being privatized or affected by economic transformation. Moreover, it is giving increased emphasis to promoting the positive effects of privatization and broader economic transformation on the development of economic democracy and of small enterprises and increasing private sector participation.
During the coming century global trade and investment will continue to be key factors affecting the wealth of nations. Countries seeking to maintain their economic growth, increase employment and raise their standards of living and social equity will have to base their national economic development strategies on improving their abilities to engage successfully in international trade and investment in participatory and democratic fashion. To do this efficiently and equitably many countries will need to restructure their governments, private sectors and civil societies in ways that facilitate and expand global economic transactions while enhancing participation and social equity. This report intends to make an intellectual contribution to how to carry out such processes.
The role of government will change drastically from controlling, directing and intervening in the economy to supporting and facilitating productive economic activities, providing adequate infrastructure and social overhead capital, creating and maintaining a competitive business climate, assuring fair market access, protecting the interests of workers and consumers and providing for the health, safety and security of all its citizens.
Business and industry too will have to restructure and reorganize to compete effectively in world markets. Small, medium and large businesses will all be buffeted by global economic forces. They will have to become more productive and more competitive in order to contribute to national economic growth, create quality jobs, provide higher incomes and raise overall standards of living. In a world in which the functions of government are being redefined, the private sector will be expected to take on more social responsibility in such wide ranging areas as education, training and other aspects of human resource development, health care, child care, environmental pollution prevention and clean-up and social security.
These changes in government and the private sector will also require fundamental institutional transformation in civil society. All of the social institutions in countries seeking to adjust their economies effectively and equitably to the requirements of international trade and investment and globalization will have to redefine their functions and operations. New demands will be made on educational institutions, health-care organizations, trade unions, employers' and industry associations, the media, consumers' groups and civic and social organizations to play new roles in developing an effective, efficient and equitable market economy.
This report provides a comprehensive and integrated overview of the policy and institutional challenges facing industrial, transitional and developing countries in the years ahead. It examines the policy adjustments that are essential for market development and the economic, business and social support institutions that allow markets to operate efficiently and equitably. It describes the political and governmental reforms that are needed to make public sector institutions more efficient and effective and allow them to provide the support required by the private sector in a competitive market system. It also focuses on social transformation and human resources development policies that allow the benefits of market competition to be distributed equitably and identifies the institutions of civil society that can contribute to market development, social progress and higher standards of living. Finally, it provides guidelines for managing the policy reform and institutional development processes themselves in this period of rapid global economic change.
The report underscores the importance of institutional capacity building in the development of efficient and equitable market economies. Institutional capacity building is viewed as a process through which individuals and organizations in any country strengthen their abilities to mobilize the resources necessary to overcome economic and social problems to achieve a better standard of living as generally defined in that society. Institutions can include both sustainable organizations and widely accepted rules of behaviour. Institutional development is viewed as being at the heart of economic and social transformation. National programmes of institutional capacity building for economic and social transition should involve four management functions: (i) the identification of appropriate strategies for capacity building in the core institutions of society, government, the private sector and non-governmental and civic organizations; (ii) the creation of appropriate conditions for institutional capacity building for economic and social transition; (iii) the development of feasible policy interventions to strengthen institutional capacity in public, private and non-governmental organizations for economic and social transition; and (iv) the determination of appropriate pacing and sequencing for such policy and institutional reform implementation.
The report provides broad guidelines for the management of institutional capacity building. It also provides an overview of lessons of experience and indicative recommendations in the preceding areas. The report was prepared by Dennis Rondinelli and it expands on a previous book published by the International Labour Office: Policies and institutions for managing privatization: International experience by D. Rondinelli and M. Iacono.
Max Iacono
Action Programme Coordinator
Privatization, Restructuring and Economic Democracy
Contents
Preface
About the author
1. Institutional and policy reforms in an emerging global economy
2. Economic policies and institutions
3. Political reforms and government institutions
4. Private enterprise: The foundation of market economies
5. Social policies and institutions of civil society
6. Institution building and market development: Management
About the author
Dennis A. Rondinelli is the Glaxo Distinguished International Professor of Management at the Kenan-Flagler Business School and Director of the Center for Global Business Research, Kenan Institute of Private Enterprise, University of North Carolina at Chapel Hill.
Dr. Rondinelli is a teacher, researcher and advisor on international management, international economic development policy and private enterprise development. He has done applied research on economic reform policy, privatization, the environmental industry, urban and regional development, business opportunities in emerging market economies, employment generation policies in developing countries, international trade and investment and programme and project management for economic development. He has carried out research in Asia, Central Europe, Latin America and Africa. He has authored or edited 15 books and published more than 150 monographs, book chapters and articles in scholarly and professional journals.
In addition, Dr. Rondinelli has served as an advisor, consultant, or expert to the US State Department's Agency for International Development, the World Bank, the Asian Development Bank, the Canadian International Development Agency, the International Labour Office, the United Nations Development Programme and to private corporations. During the 1970s, Dr. Rondinelli was decorated by the Government of the Republic of Viet Nam for service as an advisor to the Ministry of Rural Development and for the ethnic minorities development programme. In 1989, he received the Julio Lleras Order of Merit for outstanding service to the Central Mortgage Bank of the Republic of Colombia.
Prior to joining the University of North Carolina, Dr. Rondinelli was Principal Research Scientist and Senior Policy Analyst in the Office of International Programmes at the Research Triangle Institute. He was also a professor at the Maxwell School of Citizenship and Public Affairs at Syracuse University and has held faculty positions at the Owen Graduate School of Management at Vanderbilt University and at the University of Wisconsin, Milwaukee. He also served as a Senior Fellow at the Technology and Development Institute of the East-West Center in Honolulu.
Dr. Rondinelli received his undergraduate degree from Rutgers University and his Ph.D. from Cornell University.
1. Institutional and policy reforms in an emerging global economy
Introduction
The early years of the twenty-first century will be a period of profound economic and social transition for all countries. Rapid changes in the world economy that are pushing inexorably toward global integration will require governments around the world to rethink their strategies of economic development and job creation and to establish new institutions through which to build economically viable and socially equitable societies. The final decades of the twentieth century brought momentous political, economic and social changes that will continue to redefine the fundamental concepts of national economic and social development.
During the next century global trade and investment will be the key factors affecting the wealth of nations. The International Labour Organization's (ILO) enterprise strategy points out that "globalization has emerged as one of the most powerful forces shaping the competitive environment. The growth of cross-border interdependence on markets and factors of production (including labour) is making national boundaries more permeable and geographic distance no longer constitutes a barrier to, or a safeguard against, competition".(1) Countries seeking to maintain their economic growth, increase employment and raise their standards of living will have to base their national economic development strategies on improving their abilities to engage successfully in international trade and investment. They will need to restructure their governments, private sectors and civil societies in ways that facilitate and expand global economic transactions.
National and local economic development will come from improvements in the capacity of businesses and governments to engage effectively in international competition and cooperation. For nations, the ability to engage successfully in international economic transactions -- exporting, importing and foreign direct investment -- will depend on their success in creating a strong domestic market economy that is efficient and productive in mobilizing resources to attract, develop and support businesses and industries that are internationally competitive. The ILO's enterprise strategy notes that "fewer formal sector firms are able to remain exclusively oriented toward local or national markets and most are linked into complex and dynamic global networks".(2)
Those nations that can engage successfully in international economic transactions will grow and prosper; those that cannot will stagnate and decline. The ability of a nation's businesses and industries to engage successfully in international competition and cooperation will not only determine rates of national economic growth, but also of job creation, income generation and wealth creation that will fundamentally affect standards of living. The wealth of cities and regions as well as of nations will depend on their ability to create an economic and political climate that allows their businesses and industries to compete successfully in international markets.
The basis of national economic development is shifting quickly from mass production industries relying on low-wage labour and cheap raw materials and energy to a technology- and knowledge-based system of production and services. Such a system will require better educated and higher skilled workers, modern infrastructure and flexible and responsive public and private organizations. This shift to a technology- and knowledge-based system of production and services will provide higher incomes to those workers and managers who have the skills and knowledge to participate effectively. The ILO recognizes that unemployment problems in developing countries are inextricably linked to slow rates of economic growth and job creation. In its preparatory reports for the World Summit on Social Development, the ILO recognized that globalization will bring both benefits and adversities, especially in the poorer developing countries. But the reports emphasized that "... disturbing as these changes are, it is clearly better to be affected by them than to be left out. ... For all it negative side-effects, exposure to this highly competitive environment is essential for increased growth, efficiency and sustained job creation". (3)
Because of the necessity for nations to participate in trade and investment in a complex and uncertain world economy, central government economic planning will be even less effective in the twenty-first century than it was in the past. Global competitiveness will require countries at all stages of economic development to develop a market system in which resources can be allocated efficiently and in which investors and consumers can react accurately to market signals. Government's role will change drastically from controlling, directing and intervening in the economy to supporting and facilitating productive economic activities, providing adequate infrastructure and social overhead capital, creating and maintaining a competitive business climate, assuring fair market access, protecting the interests of workers and consumers and providing for the health, safety and security of its citizens.
At the same time, the relentless integration of the world economy will weaken the role of nation states in international economic transactions and increase the importance of both supranational and subnational regions. The proliferation of regional trade agreements among nations and the growing importance of metropolitan areas as locations for global corporations presage this trend. Transnational corporations (TNCs) will also play an increasingly important role in transforming economic interactions from "shallow integration" based on trade, to "deep integration" based on extensive and complex networks of worldwide business relationships. The ILO's enterprise strategy recognizes that transnational enterprises "are at the centre of global expansion, account for a significant volume of investment and value-adding activities and play a direct role in employment creation in their own operations by stimulating employment in related enterprises and by their catalytic effect on host country enterprises".(4) The ILO strategy also points out that transnational enterprises play a crucial role in the diffusion of technology and skills and in facilitating "the creation of a modern small scale business sector and [providing]] additional avenues of job creation".
In this emerging global economy, governments will have to find more effective ways of forging mutually beneficial alliances with the private sector not only to promote and support business competitiveness, but also to deliver efficiently a growing array of services needed by citizens and corporations. Governments will have to help create and manage effectively a worldwide logistics system through which businesses interact. National and local governments in many countries are already seeking more effective ways of providing services and infrastructure through public-private partnerships or through the private sector.
Businesses and industries too will have to restructure and reorganize to compete effectively in world markets. Small, medium and large businesses will all be buffeted by global economic forces. They will have to become more productive and more competitive in order to contribute to national economic growth, create jobs, provide higher incomes and raise overall standards of living. In a world in which the functions of government are being redefined, the private sector will be expected to take on more social responsibility -- in such wide-ranging areas as education, training and other aspects of human resource development, health care, child care, environmental pollution prevention and cleanup and social security. In order to earn the profits and returns to perform these social functions satisfactorily, businesses and industries must be able to compete internationally. As they do, more of the world's productive capacity and job creating potential will be found in transnational companies with headquarters based in one country and with branches, subsidiaries, divisions and joint ventures in other countries. The supply and distribution systems of many transnational firms will be spread over the globe. Joint ventures and international strategic alliances will become increasingly more important as companies seek to develop and market their products and services in countries with diverse economic, cultural, political and social characteristics.
Changes in the world economy during the 1990s required businesses and corporations of all sizes to adopt "agile business practices" and during the next century they will have to become even more agile to remain competitive. They must become more responsive to diverse customer needs, more flexible in their management processes and organizational structures, more adept at interacting with worldwide networks of suppliers, distributors and customers, more capable of modifying, redesigning and diversifying their product and service lines quickly and more able to deliver high-quality, reasonably priced, customized products rapidly to customers around the world. Just-in-time inventory systems, rapid restructuring of production and distribution systems and speed-to-market delivery will be the hallmarks of successful manufacturing and service industries in coming years. These agile business practices will require more companies to become "virtual corporations" able to draw on the skills and talents of managers and workers located in cities and countries around the world. They will have to obtain supplies and raw materials globally, use advanced telecommunications systems to respond quickly to customers' needs and distribute their goods quickly to wherever customers are located.
These changes in government and the private sector will also require fundamental institutional transformations in civil society. All of the social institutions in countries seeking to adjust their economies to the requirements of international trade and investment will have to redefine their functions and operations. New demands will be made on educational institutions, health care organizations, trade unions, employers' and industry associations, the media, consumers' groups and civic and social organizations to play new roles in developing an effective and efficient market economy and in strengthening their country's capacity for international trade and investment.
The ILO points out in its enterprise strategy that "growing global competition, communications networks, rapid investment flows and technological change are altering the competitive rules in most business sectors". Increasingly, the strategy notes "competitive advantage is based on a highly skilled and flexible workforce able to apply the latest technology while responding rapidly to market changes".(5)
In this period of economic and social transition, the International Labour Organization is focusing attention on the impacts of globalization and economic transformation as they affect national and enterprise employment levels and the quality of jobs in the short and long term; working conditions, wages and income differentials of those employed in privatized enterprises and those who remain in state enterprises; and the access, availability and quality of services provided by privatized enterprises and consumer prices, especially with respect to economically vulnerable groups in society. The ILO is also concerned with national and enterprise productivity levels in countries undergoing widespread privatization; improvement of national industrial relations as economies transform and as more economic activities are carried out by private enterprises; and respect for international labour standards in industries and sectors being privatized or affected by privatization. Moreover, it is giving increased emphasis to promoting the positive effects of privatization on the development of economic democracy and of small enterprises and increasing private sector participation in decisions regarding improvements to the business environment.(6)
The chapters that follow provide an overview of the policy and institutional challenges facing industrial, transitional and developing countries in the years ahead. Chapter 2 examines the macro-economic policy adjustments that are essential for market development and the economic and business support institutions that allow markets to operate efficiently. Chapter 3 describes the political and governmental reforms that are needed to make public sector institutions more efficient and effective and that allow them to provide the support required by the private sector in a competitive market system. Chapter 4 focuses on social transformation and human resource development policies that allow the benefits of market competition to be distributed equitably and identifies the institutions of civil society that can contribute to market development, social progress and higher standards of living. Chapter 5 examines the changing roles and requirements of private sector development and the contribution of small and large businesses and of domestic and transnational enterprises to national economic growth and social development. Chapter 6 offers a synthesis of lessons learned from experience over the past two decades with market development and guidelines for managing policy reform and institutional development in a period of rapid global economic change.
Market development and institutional capacity
During the 1990s the emergence of market systems in countries where the government had long played the dominant role in economic activities crystallized the challenges facing all countries in developing their market economies in the twenty-first century. The extensive economic and political reforms that took place in Central and Eastern Europe, the former Soviet Union, the Balkan and Baltic States and in Asian countries such as China, Mongolia and Viet Nam, often overshadowed the less dramatic but no less significant transformations that are also occurring in many other countries. In order to become more competitive in the world economy, governments in former socialist and many developing countries are privatizing their state-owned enterprises. And to do so, they must reform their economic policies and redefine the relationships among public, private and non-governmental organizations in economic activities and processes of governance.(7)
Since the early 1980s international assistance organizations and most governments around the world have focused their attention on macroeconomic policy reforms as the key to creating and revitalizing markets for international competition. But one of the most important lessons to emerge from that experience is that economic reforms alone are neither sufficient to create a market economy nor adequate to sustain market development.(8) In Central and Eastern Europe it has become clearer that developing the institutional capacity to produce and distribute goods and services and to engage in international trade is far more important than reformers initially acknowledged.(9) And, reflecting on the Asian Development Bank's experience, two of its leading economists concluded that "in terms of sequencing reforms, fiscal and monetary policies are less important in the near term and medium term than the standard policy prescriptions would make them appear".(10) They insist that "institutional reforms and price reforms are more important in the early stages".
Whether the changes that are essential to the success of privatization come through the radical "shock therapy" reforms such as those adopted in Poland or through the more gradual transition to economic liberalization and private enterprise development that were tried in Hungary, China and Viet Nam, the experiences are yielding a better understanding of the types of institutional capacity that must be developed in any country that seeks to establish or sustain a market economy and to increase its international trade and investment. In their attempts to transform their economies and polities, government and business leaders in most of the former socialist countries, having made major macroeconomic adjustments, still face the daunting challenges of building the institutional capacity to implement economic reforms and expand the private sector. But governments in the industrialized nations face equally formidable challenges in restructuring their economies to meet the new demands of international competitiveness. Governments in developing countries must move rapidly to reform their political, economic and social systems, create more effective institutions of civil society and strengthen private enterprises so that they can participate in international economic transactions.
Institutional capacity building is the process through which individuals and organizations in any country strengthen their abilities to mobilize the resources needed to overcome economic and social problems and to pursue economic opportunities in order to achieve a better standard of living as generally defined in that society. Institutions include both sustainable organizations and widely accepted rules of behaviour. Governments that are privatizing their state enterprises, international agencies that are providing aid, or transnational companies that are operating in emerging markets cannot achieve their goals unless they understand the challenges of institutional development. Institutional development is at the heart of economic transformation and market development because, as the economist James Buchanan has pointed out, "a market is not competitive by assumption or by construction" it only becomes competitive "and competitive rules come to be established as institutions emerge" to shape attitudes and behaviour.(11)
This book provides a framework for assessing the changes needed to create an appropriate policy environment and institutional structure for market development in the emerging global economy. It identifies these policies and institutions by: first, assessing the weaknesses and deficiencies in former non-market socialist systems and in developing and industrial economies; second, examining the lessons of experience with the transition to market economies; and third, identifying those factors that account for the success of established market economies in sustaining economic and social development and democratic governance for more than 300 years. This does not imply that emerging market economies must necessarily follow the same patterns set by older Western market democracies, for they too face challenges of transition. It does yield, however, some general conclusions about the factors that seem to account for the vitality of their market systems and that may be necessary for success in international economic competition and cooperation.
The imperative of market development
The need for policy reform and institutional development has arisen during the last quarter of the twentieth century for many of the reasons outlined above. The requirements for policy and institutional reform will vary among countries in the future, however, depending on their degree of market development. Industrial countries with established market economies face challenges far different than those in transition from centrally planned socialist economies to market systems and both have different needs than developing countries with weak market economies.
Market development needs in industrial nations
Established market economies in industrialized nations face challenges different from but just as important as those of transitional and developing countries. North American, European and Asian industrial countries have fought a constant battle since the early 1980s for price stability and economic growth.(12) Exchange rate pressures and cyclical downturns required industrial nations to adjust their fiscal and monetary policies. Governments and businesses in all of the established market economies have had to make policy adjustments to increase their capacities to engage successfully in international trade and investment, correct serious fiscal imbalances and reduce unemployment. At the same time they have had to struggle to keep productivity high and inflation in check.
Beginning in the mid-1960s, the economies of many Western industrial countries came under strong government control.(13) Government intervention in industrial economies made it difficult for private enterprises to respond effectively to changing international trends and it created rigidities that undermined the ability of their markets to operate efficiently. Economic stagnation in countries such as Australia and New Zealand resulted from pervasive intervention by government in the operation of the market after the Second World War. Reliance on import-substitution policies and labour-intensive manufacturing and the transfer of revenues from natural resource exploitation to subsidize and protect manufacturing enterprises that could not produce and compete effectively in domestic markets that were too small to provide economies of scale weakened both countries' ability to grow and compete.
In the United States, stagnation and decline in real wages and salaries began in the late 1960s and low levels of productivity and economic growth during the 1970s and early 1980s were exacerbated by low savings rates, increasing federal budget deficits and rising wage and non-wage labour costs. In Canada, economic problems became more severe during the 1980s and early 1990s because productivity growth was declining and unemployment was increasing for many of the same reasons that the economy became stagnant in the United States. Canada suffered from pervasive regulation of economic activities, distortions in monetary and fiscal policy and in labour markets, high levels of inflation and deterioration in federal and provincial finances. Strong government intervention in economic activities made it more difficult for Canadian industries to compete effectively in international markets and to provide employment at home.
Western European countries also suffered from structural problems that adversely affected their economies. Germany began to lose some of its economic dynamism and the economy plunged into recession in the late 1980s and early 1990s. The debt burdens of integrating the formerly socialist East German States into a unified market economy drained investment capital and accelerated inflation. France's economy also suffered from the effects of strong government intervention, especially high levels of structural unemployment. Italy experienced severe economic problems arising from inflexibility in its labour markets, low levels of productivity in the private sector, severe regional disparities in income and wealth, wide variations in regional productivity, high levels of public debt and inefficient public services. Much of the government's contracting and procurement took place through noncompetitive means.
The continuing challenges for governments and the private sector in advanced market economies are with sustaining reasonable economic growth, expanding international trade, reducing unemployment and maintaining their standards of living.
Creating market economies in transitional countries
Although important policy and institutional reforms were enacted in many Western industrial countries during the 1980s and early 1990s, the most visible and complex challenges arose in developing countries and in former socialist economies. It is clear in retrospect that the collapse of central planning regimes in Eastern Europe at the end of the 1980s and the weakening of interventionist governments in Asia and Latin America earlier came not so much from indigenous political revolutions as from the steady deterioration of their economies. The passing of communism as a viable system of governance can be attributed primarily to the failure of those regimes relying on central planning and control to stimulate and sustain economic growth and to achieve an acceptable standard of living for the majority of their citizens.
The types of capacity building in which transitional countries are now engaged were shaped initially by the need to overcome the deficiencies of central planning. The inability of central planning to promote economic development became evident in the 1980s, but it is now clear that socialist governments could not efficiently or effectively guide national economies or the operations of SOEs in countries such as Poland, Hungary, Czechoslovakia, the Soviet Union, or China.(14) The characteristics of centrally planned systems provide some insights into the problems most post-socialist regimes now seek to remedy. Charles Lindblom concisely summarizes the characteristics of centrally planned systems as those with: (1) a strong concentration of political power and authority in the hands of a single ruler or a small group of party leaders; (2) political leaders committed to achieving collective goals determined largely by ideological criteria;( 3) state ownership of all or most of the productive assets in society; (4) centralized organization and direction of the economy by the ruling party or government; (5) use of a wide range of controls (including coercion) to assure conformance to planned goals and targets; (6) suppression of individual political freedoms and social pluralism; (7) use of a privileged mobilizing organization -- such a political party -- to guide society toward collective goals; and (8) the substitution of formal organization (large, complex and hierarchical party or government bureaucracies) for other forms of social coordination.(15)
The inability of central planning authorities to comprehend and calculate the myriad interactions and interdependencies in the economy quickly undermined their capacity to control it in any meaningful way. Thus, in most socialist countries scarce resources were allocated neither by efficient market signals nor by competent technical analysis and planning. Kornai points out that in place of market signals, resource allocations were made in centrally planned economies through a set of nonprice signals emanating primarily from the national economic plan, but also from frequent bureaucratic directives, the exchange of information horizontally among authorities on the same hierarchical level, breakdowns and catastrophes and grumbles or protests from subordinate bureaucratic units as requirements became unrealistic or intolerable.(16)
Nowhere were the deficiencies of central planning and control more visible than in the management of the SOEs that dominated the economies of socialist countries. State enterprises were run much like government agencies, with little concern for profits and losses or for operating within hard budget constraints. Losses were regularly subsidized by the government. The primary objective of state enterprise managers in the Soviet Union, Eastern Europe, China and Viet Nam was to meet centrally established production targets. They paid little or no attention to the quality of the goods they produced or to the costs of production. State enterprises in nearly all centrally planned systems were vertically integrated, retained large surplus labour forces, compensated their workers with low wages and social benefits, hoarded materials and inputs and accumulated large inventories in the face of chronic shortages of supplies. There was virtually no incentive for workers to increase their productivity or for managers to develop skills in marketing, quality control, product development and finance or for either workers or managers to make their enterprises more competitive in the domestic economy.
Although the immediate task of post-socialist governments was to abolish the central planning apparatus and to reduce the State's control over production enterprises, the complex challenges of implementing economic reforms and of developing the private sector also helped define the capacities needed to complete the transition to a market system. The difficulties that both emerging and established market economies face in market development can be attributed to a combination of adverse external conditions; internal economic, political, bureaucratic and structural obstacles remaining from the old system; and inadequate institutional capacity to carry out new tasks.
Strengthening markets in developing countries
Developing countries face many of the same problems plaguing transitional economies.(17) Those developing countries with recent high growth rates must make complex economic adjustments to prevent overheating, inflation and adverse effects of sudden declines in capital flows. Less robust developing economies suffer from over-regulation, slow privatization and trade restrictions. They face difficult challenges in reforming fiscal and monetary policies, liberalizing trade, increasing domestic savings and developing private enterprise. Many of the developing countries that have experienced strong economic growth, including Chile, China, the Republic of Korea, Malaysia and Thailand will have to invest heavily in physical infrastructure and relieve productive capacity constraints. Some of these countries are also experiencing labour shortages and labour market constraints. Developing countries with moderate growth rates in Latin America and South Asia must accelerate the pace of macroeconomic reform and trade liberalization, continue to privatize state-owned enterprises and reduce fiscal deficits while increasing savings. Countries such as Egypt, Pakistan and Turkey must find ways of maintaining capital inflows and increasing investment rates.
The large number of developing countries that have experienced slow economic growth, especially in sub-Saharan Africa and Central America, must restructure their economies to produce higher value-added products and services and become more outward-oriented. They face substantial challenges in diversifying their exports from primary commodities and raw materials, achieving economic stability, adjusting exchange rates, commercializing agriculture and building manufacturing and services industries. They have little choice but to develop a market system to alleviate poverty and raise living standards through job creation. They must implement effective and affordable social assistance, basic education, health and small business development programmes in order to maintain political stability and attract foreign direct investment in both labour- and technology- intensive industries and improve labour and managerial skills in order to participate in international trade and investment.
The shortage of human capital and especially of skilled labour and managerial talent remains a serious bottleneck to expanding exports and attracting foreign investment for many developing countries. Capital inflows will be essential to make the investments that will be needed to create and extend basic infrastructure and services. Without efficient infrastructure systems neither domestic nor foreign trade is possible. Many of the poorest developing countries suffer from political and social instability, weak private sectors and high levels of corruption in government that undermine the confidence of foreign and domestic investors and increase political risk. Institutions of civil society that support the efficient and equitable operation of the market either do not exist or remain weak.
Thus, in established industrial countries, emerging market economies and developing countries, structural adjustment and institution-building have become permanent requirements for sustaining economic progress. They are also essential for creating an economic environment conducive to privatization, private enterprise development and international economic competitiveness.
The changing bases of economic and social development
The global changes described earlier are relentlessly integrating the world economy. The businesses and industries that are the primary engines of job generation and wealth creation in all countries must increasingly operate across national borders. These global changes mean that nations will no longer be able to grow merely by producing goods and services for domestic markets. In the twenty-first century, the economic vitality of nations will depend on the capacity of their political, civic and business leaders to adjust quickly and continuously to globalization of trade and investment. Integration of the world economy and the rapid changes in conditions of international economic competition are creating a new set of forces that is changing the ways nations interact and firms compete. They will, in turn, determine the conditions that nations and regions must provide in order for businesses and industries to participate successfully in international trade and investment.
The ability of national economies to grow will depend on the ability of the leaders of national and local governments, non-government organizations (NGOs), institutions of civil society and businesses and industries to adjust rapidly to complex international social, political and economic changes. Countries are reshaping their economies in creative and innovative ways to meet emerging global conditions. Policy and institutional reforms will be essential not only to support their existing industries, but also to attract new investment by domestic- and foreign-based transnational corporations. In order to compete effectively in international trade and investment, transnational companies -- and especially those in high-technology industries and information services -- will use new criteria for choosing the countries in which they locate or expand. <
Growing importance of trade and investment
The basic forces integrating the world economy and pacing national economic growth are international trade and investment. These pressures for economic integration have been reinforced during the past two decades by developments in technology and information exchange, changes in market structures and the emergence of transnational corporations, all as the result of growing world trade and investment. These forces -- reinforced by increasing international mobility of factors of production, changes in the nature and scope of economic competition and cooperation and shifting attitudes of both transnational corporations and government leaders concerning international business -- have all created new modes of economic integration.
Since the 1960s, world trade has provided an important source of economic growth for established market economies and, by the 1980s, became a driving force for economic growth in developing countries with competitive market systems. The value of world merchandise exports doubled from a little more than $2 trillion in 1980 to a little more than $4 trillion in 1994.(19) In addition, the value of world exports of commercial services increased from $402 billion in 1980 to nearly $1.1 trillion in 1994. Even in developing countries, although they engaged in a smaller volume of trade, the value of their exports more than doubled during the same time period.
1. Export-driven growth The growth of many developing countries has been closely associated with the shift from inward-looking protectionist development strategies to outward export-oriented liberal trade strategies. Those countries that have diversified their exports and opened their economies to imports and investment have grown faster than countries that continued to export only basic commodities and raw materials or that maintained protectionist policies. Between 1960 and the early 1990s, for example, countries with small volumes of exports or exports of primary materials and commodities had average GDP growth rates of only about 2.8 per cent compared to countries exporting manufactured goods with 7.0 per cent growth rates, or exporting services with 4.5 per cent growth rates, or exporting diversified products and services with 4.9 per cent growth rates.(20)
Developing countries that have been successful in moving from non-oil commodity exports to diversified manufacturing and services exports had the highest sustained GDP growth between 1960 and 1990. Thailand, for example, which reduced its share of non-oil primary commodities from 97 per cent to 35 per cent had a GDP average growth of 7.3 per cent a year over the 30-year period. Cyprus reduced its share of commodity exports from 84 per cent to 43 per cent and experienced a 7 per cent average annual GDP growth rate. Malaysia achieved a 6.8 average annual GDP growth rate over three decades as it reduced its share of commodity exports from 89 to 28 per cent. Brazil and Pakistan were also successful in diversifying their exports and achieved 6.1 per cent and 5.9 per cent average annual GDP growth rates respectively.
World exports of manufactured goods alone increased from $189 billion in 1970 to $2.1 trillion by 1990. All regions of the world saw growth in manufactured exports, although at drastically different rates. The manufactured exports of industrial market economies grew from about $160 billion to $1.6 trillion between 1970 and 1990 while Eastern European countries and the former Soviet Union saw increases from $18 billion to $91 billion. Developing market countries increased their manufactured exports from $10.5 billion to $344 billion.(21)
Economically competitive countries were able to accelerate economic growth through trade and investment because exports generate employment and increase productivity. Higher productivity comes from shifting resource allocation from less to more productive sectors as industries and firms attempt to compete more effectively in world markets, by requiring improvements in technical efficiency and by lifting scale efficiency.
2. Foreign direct investmentParticipation in foreign direct investment has also become a vital source of economic advancement and global economic integration. As noted earlier, both the stock and flows of foreign direct investment have increased substantially since the late 1970s. Between 1988 and 1993 alone the inward flow of foreign direct investment increased from $1.2 trillion to nearly $2 trillion. By the early 1990s, the sales of foreign affiliates of transnational corporations surpassed exports as the primary means of transferring goods and services across national borders.
For many developing and transitional countries, foreign direct investment helps develop their domestic and export manufacturing industries. Foreign direct investment in developing and transitional market economies can provide foreign exchange and tax revenues, change regional and personal income generation, modernize social institutions and change social values.(22) Foreign direct investment brings technical know-how, foreign capital and imports as well as export marketing capability and a network of supply and distribution channels.(23) The United Nations Conference on Trade and Development points out that "as the competitive advantage of resource-intensive, low-cost, low-skill activities declines, countries must be able to attract higher value FDI. If they fail to do so, they will pay the price in terms of slower economic growth".(24)
Integration of world economy
Freer international trade, financial transactions and investment across national borders is accelerating the integration of the global economy and intensifying national competition and cooperation. According to the United Nations Conference on Trade and Development, international economic integration is increasing at two levels.(25) At the microeconomic level, international integration intensifies as enterprises expand across national borders either through equity investments (mergers, acquisitions or "greenfield" investments) or through non-equity linkages (strategic alliances) that integrate the activities of independent firms. The cross-border acquisitions in such industries as telecommunications, for example, have been substantial. Between 1975 and 1990 alone international acquisitions of telecommunications companies increased in value from $399 million to $16.5 billion. During the 1980s, the growth of strategic alliances between the United States and European companies, European and Japanese companies and United States and Japanese companies in the automobile industry increased by more than 200 per cent, in biotechnology and new materials by more than 83 per cent and in information technology by more than 300 per cent.(26)
At the macro-economic level, international economic integration results from the weakening of trade barriers and the freer flow of goods, services and factors of production. Freer trade has been enhanced by GATT and the World Trade Organization and the formation of regional trade associations and bilateral trade agreements. In addition, economic interaction is moving from "shallow integration" based on simple trade linkages to "deep integration" shaped by worldwide production-based linkages through transnational corporations.
Regionalization of world trade
The integration of the world economy is weakening the role of the nation state in international economic transactions and increasing the importance of both supranational and subnational regions in trade and investment. Since the late 1970s countries have been expanding their international trade by forming regional trade alliances ranging from customs unions and free trade areas to economic communities. These regional trade agreements usually reduce or eliminate tariffs, provide preferential trade and investment conditions and allow the freer flow of capital, goods, services and people among member countries. The Southern Africa Customs Union (SACU), the Arab Common Market (ACM), the Association of Southeast Asian Nations (ASEAN), the North America Free Trade Agreement (NAFTA), the Australia-New Zealand Closer Economic Trade (ANCERTA), the Latin American Integration Association (LAIA), Central American Common Market (CACM), the European Free Trade Association (EFTA) and the European Community (EC) are among the growing number of regional trade associations into which the world's trading countries have divided themselves. An increasing number of countries are applying for membership in these regional trade pacts and others are forming new ones. Since 1970 nearly all of these trade pacts have seen their share intra-bloc trade increase.(27)
Although global economic integration and supranational trade agreements are allowing more industries to become "footloose" in location, subnational regions and metropolitan areas will also remain important locations for firms engaged in international trade and investment. Urban regions (cities and metropolitan areas) have historically been the centers of social and cultural activities that promote national economic growth. For these reasons, those cities and metropolitan areas that can strengthen business conditions that improve the international competitiveness of their industries and firms will continue to be catalysts for national economic and social progress, incubators of technological innovation and sources of national wealth.
Urban regions allow enterprises more easily and efficiently to create, mobilize and utilize all of the factors of production. Cities create economies of scale by concentrating organizations in close physical proximity that provide the infrastructure, land, labour and capital that internationally competitive enterprises need to increase their world market shares. Urban institutions also generate, produce and distribute technologies that add value to manufacturing and services and that keep industries at the cutting edge of technological development. Increasing integration of the global economy will not only affect growth rates of metropolitan areas but will alter the structure of their economies. Foreign direct investment will flow to and exports will flow from those metropolitan areas that openly seek them by creating a physical environment, a quality of life and a sense of community in which technologically-trained and globally-oriented managers and workers can flourish.
Mobility of factors of production
The expansion of world trade and investment results from and contributes to the increasing global mobility of factors of production. Since the 1959s all of the factors of production -- labour, capital, ownership of land and technology -- have begun to move more rapidly and easily across national borders. Although capital has always been mobile, the scale of the transfer has significantly increased with the expansion of foreign direct investment (FDI). Capital flows across national borders have accelerated through direct investment, medium and long-term foreign private borrowing, short-term borrowing and domestic outflows, private grants and official bilateral and multilateral foreign aid. Between 1988 and 1993 alone, the stock of outward foreign direct investment nearly doubled from $1.1 trillion to 2.1 trillion and of inward foreign direct investment from $1.2 trillion to $1.9 trillion. The cross-border bank deposits of non-banks increased from $75 billion in the early 1970s to $1.6 trillion in the early 1990s. Cross-border bank credit to non-banks grew from $54 billion to $1.7 trillion during the same period. World sales of foreign affiliates of transnational corporations more than doubled from $2.4 trillion in 1982 to $5.5 trillion in 1990.(28) The International Finance Corporation reports that between 1985 and 1994 alone, world market capitalizations increased from $4.6 trillion to more than $5.1 trillion and that world value traded on stock markets increased from $1.6 trillion in 1984 to $9.6 trillion in 1994.(29)
Workers now also move more freely among nations or are transferred within transnational firms or through contracts for large projects in foreign countries. Employment in transnational corporations grew from about 40 million people in 1975 to more than 73 million in 1992. Managers are rotated among international branches and divisions or contract their services to transnational corporations. Modern management practices are taught worldwide. Land is bought and sold across national borders, giving foreign companies an important economic role in local communities.
Importance of services in the economy
All countries undergo a structural transformation in their economies as they diversify from agriculture and low-wage industrial production toward higher-technology manufacturing and services. The United Nations Department of Economic and Social Development points out that "the new world economy is increasingly a services economy and it is being recognized as such. Services will come to be, in terms of shares of GDP and employment, the largest sector in most economies and the dominant sector in all developed economies".(30) In most established market economies in North America and Europe services now contribute well over 70 per cent of GDP. In upper-middle income developing countries agriculture now contributes less than 9 per cent of GDP, industry contributes about 40 per cent and services contribute about 51 per cent. Agriculture's share of GDP is only about 21 per cent in middle-income developing countries while industry's is about 37 per cent and services have increased to about 50 per cent. Even in low- income developing countries services account for about 35 per cent of GDP.(31)
Rapid technological changes, especially in computers and telecommunications make services more tradeable in international markets. As a result, services are playing a more important role in the exports of the more technologically-advanced countries and in world exports. World exports of commercial services increased from $413 billion in the early 1980s to $890 billion by the early 1990s.(32) World exports of nonfactor services -- shipping, passenger services, other transportation, travel, royalties and fees and other private services -- grew by about 5.8 per cent annually between 1980 and 1990 from $1.6 trillion to $2.9 trillion.(33) Services now account for about 50 per cent of the world stock of foreign direct investment and 50 per cent to 55 per cent of annual flows of foreign direct investment.
Driving force of technology
Technology -- reflected in new production techniques, products, communication, transportation and energy systems -- has also been a driving force in creating global markets for the past two decades and will create a strong base for national and industrial competitive advantage in the future. Technological development has significant impacts on national economic growth. Technology can reduce costs by replacing old products with low long-term income and price elasticity with those of higher income potential and by increasing the productivity of other factors of production. In addition, technology can improve a nation's export performance by changing the composition of exports away from basic commodities toward manufactured goods and by increasing the volume and improving the quality of industrial products.
New technologies both enhance factor mobility and create new varieties of products. New technologies also change the relative costs of production and distribution and the comparative advantages of both corporations and metropolitan areas. In so doing, they also increase the gains from trade. The process of technological change continues to enhance specialization, leading to stronger economic linkages and further international integration. Technological innovation is also accelerating all other aspects of global economic integration. Technologically-driven growth will not only require countries to expand their transport and communications infrastructure as speed and agility become more crucial factors in competition, but also to provide educational opportunities that will prepare their citizens to work in technology-driven and transnational companies.
Nations that seek to develop economically and socially in the twenty-first century must consider three interrelated strategies for promoting technological change: (1) developing fundamental research capability for understanding scientific principles underlying technological processes and making technological discoveries; (2) developing the institutional structures for transforming scientific principles and discoveries into engineering applications and methods of production; and (3) developing the processes for making technological innovations commercially viable and transferrable.(34) Even those countries that choose a strategy of simply transferring and adapting technologies developed elsewhere must build the institutional capacities to select appropriate technologies, adapt them to local needs and conditions and integrate them with existing machinery and equipment. Moreover, successful technology adaptation requires new skills and work behaviors in the receiving country, new infrastructure to absorb technology effectively and organizational changes to use the technology efficiently.
Emergence of knowledge industries
A related factor reshaping the world economy and the basis of national economic and social development is the emergence of knowledge industries. The global mobility of factors of production and the driving force of technology are altering the structure and the location of employment, the use of technologies, the patterns of trade and investment and the economic opportunities in and among countries. New technologies create information and make having it more important. By accelerating the flow of information they further stimulate technological development. The techniques of information flow permit rapid exchange of data across national borders, making collaborators and competitors abroad aware of new processes and products. The mere flow of information, therefore, increases the similarity of behavior among enterprises in different countries having access to it and thereby intensifies competition.
For most countries, these forces will shift the basis of competition from low-wage heavy manufacturing or smokestack industries to "knowledge" industries and technology-based services. In order to keep their industries internationally competitive, countries will have to strengthen international information, education and service functions.
Crucial role of market size
Yet another factor shaping the emerging global economy is the crucial role of market size. The new conditions of international trade and investment will require countries and especially those of small physical size or population, to continue to develop markets that extend beyond national and regional borders. Two aspects of market development signal the emergence of worldwide markets in many sectors. The first is the need for increasing market size to reach economies of scale and specialization; the second is the growing similarity of tastes and demands for a variety of consumer and industrial products. The size of markets is both a stimulus and a constraint to economic growth. Small national markets mean that the economic growth of countries depends on their ability to penetrate markets abroad.
Growing similarity in production capabilities
The increasing mobility of production factors means that there is a potentially greater similarity of production capabilities around the world as nations attract or lose competitive advantage. Whether or not countries gain or lose economically will depend on policies that allocate resources effectively to those activities that contribute to the competitiveness of their businesses and industries. To the extent that factor mobility narrows comparative advantages, the structure of production worldwide becomes more similar and it becomes feasible for enterprises to produce almost any item in a number of different locations. In the future, income differences among and within countries will be based on the productivity of labour and management in using similar production factors. Greater progress will occur in countries that can attract investment in high value-added industrial and service sectors with international markets.
The need for agile business practices
In order to cope with the rapidly changing trends in the international economy, transnational manufacturing and service corporations must organize and operate in a more fluid manner, become more attuned to the changing and diverse needs of their customers and be able to organize in more flexible ways their systems of suppliers, distributors, workers and managers. They must expand their capacities to use high-speed telecommunications and transport networks to collect and disseminate information and to obtain inputs and distribute products and services. Although the costs of production are crucial in a global economy, labour costs alone are becoming far less important than overall cost efficiency. Competitiveness increasingly depends on an enterprise's ability to produce high-quality goods, to deliver them rapidly and to service them quickly and conveniently. This requires not only agile manufacturing systems that use decentralized plants and networks, but "virtual organizations" in which teams of managers and workers are combined to achieve specific and temporary goals and then reformed into new structures as new opportunities arise.(35) Speed-to-market requires manufacturing companies to adopt concurrent engineering in which all aspects of a product's development are planned simultaneously rather than waiting for research and development phases to end before testing them with customers and developing marketing and service strategies. Cross-functional teams representing engineering and design, marketing, purchasing, distribution and service departments and customer representatives -- some of whom are scattered widely in different cities or countries -- must be part of the product development process.(36)
Agile and flexible corporations must be able to use decentralized structures and be willing to empower teams and units to make decisions and carry them out, adjusting as they learn more about the business environment, customer needs and the characteristics of logistics systems.(37) Agile and flexible corporations must not only be able to manage their own internal operations effectively, but to coordinate the entire "value chain"of suppliers and distributors on which they depend. Virtual organizations are not constrained by requirements of geographical space or location in cities in the same way as mass production facilities. Virtual corporations connect components of a production-distribution system in many locations that have the physical and geographical characteristics most appropriate for that component's efficient operation.(38) Agile and flexible enterprises involved in global transactions must have a global presence in order to attain economies of scope. They require workers with the education and skill levels to participate effectively in agile manufacturing practices, just-in-time inventory programmes and total-quality-management systems.
Need for global strategic alliances
The trend toward market expansion requires nations and firms to form international strategic alliances in order to compete through cooperation. For industries and firms inter-corporate networks lead to a type of specialization that is substantially different from that of trading. Each party to the alliance or network brings a particular talent that is merged with that of the others to produce a new technology, product, or service, or to provide a similar one at less cost or higher quality. More importantly, alliances may open access to new international markets that would be difficult or impossible for any single alliance member to penetrate on its own.
Globally competitive firms will have to enter into international strategic alliances more aggressively in the future for six major reasons: (1) to learn -- that is, to acquire knowledge about how to enter foreign markets most effectively, develop technology and products that are suitable for those markets and manage their operations overseas; (2) to take advantage of partners' specialization advantages -- especially in developing supplier and distributor activities in foreign markets and in obtaining resources and infrastructure that the home country firm does not have in the host country; (3) to leverage resources -- by fully integrating firm operations with partners that can provide missing elements of production and distribution; (4) to create linkages -- that is, to develop closer relationships with suppliers and customers; (5) to leap over existing constraints -- by pursuing radically new business opportunities in foreign markets; and (6) to "lock out" the competition -- by forming partnerships with the strongest firms in foreign markets.(39) The need for internationally competitive firms to join strategic alliances means that nations must provide conditions that are conducive not only for trade and investment, but also for their industries and firms to engage successfully in global business interactions.
All of these trends toward globalization of the economy will require nations to adapt in new ways to the needs of international competition and cooperation in the future. The efforts of virtually all countries to open their economies to international trade and investment is increasing the importance of urban regions as centers of international economic transactions. As noted earlier, transnational companies are attempting to become more flexible and responsive to global business trends by adopting "agile" manufacturing practices, customer-driven production and service strategies, just-in-time inventory systems and speed-to-market delivery of goods and services. Companies engaged in international transactions are locating in those metropolitan areas that have services and facilities to support global interactions and are moving out of cities that do not. Improvements in telecommunications, air transport and information technology have made distance to suppliers and markets less critical for high technology- and information-based industries. The most dynamic and competitive cities and regions in the future, therefore, are likely to be those that support competent and well-trained labour forces, offer modern and efficient infrastructure and superior telecommunications linkages, provide an attractive quality of life and promote the innovation, creativity and flexibility in public and private institutions that will allow local economies to restructure and adapt to rapidly changing international conditions.
Conclusions
All of these trends are pushing nations inexorably toward trade and investment as a foundation for national economic growth and social development. The Director-General of the International Labour Organization emphasizes that "there can be no question of stopping or slowing down the trends towards a globalized economy, which opens up new possibilities for renewed economic growth and for job creation. Rather it is necessary to adapt our policies and our institutions to this new reality".(40) But for differences of scale and extent, all countries will have to open up significantly to trade and investment in the twenty-first century in order to sustain economic vitality because no country will find its internal market large enough to elicit the variety and scale of production necessary to be competitive. The linkage of economies through the flow of goods, capital, labour and technology means that national economic growth in one country will be tied to that in others. These linkages will alter the ability of each country to act independently in providing higher levels of employment, in changing the nature of employment, or in relocating economic activities. Countries will have to be a part of the open world economy in order to compete and grow successfully. This increasing economic integration will impose new requirements and conditions on nations to remain competitive locations for global businesses.
In his now classic book, The competitive advantage of nations, Michael Porter observes that national competitiveness is measured by two sets of indicators: "(1) the presence of substantial and sustained exports to a wide array of other nations and/or (2) significant outbound foreign investment based on skills and assets created in the home country."(41) He notes that the competitive advantage of nations is determined by the strength of their factor endowments, their demand conditions, the competitiveness of firm strategies, structures and rivalries in major industries and the strength and diversity of related and supporting industries. Similar characteristics determine the international competitiveness of regions and metropolitan areas. A competitive region has strong factor endowments, provides large markets for domestic and foreign goods and services, has strong core industries and related commercial and service sectors and provides public services, infrastructure and an overall quality of life that attracts and supports enterprises that can compete in global trade and investment with the leading international firms. Although the economic growth of countries will depend in the future on the ability of their industries to engage effectively in international commerce, Porter and others note that many of the factors that enhance or inhibit the competitiveness of industries are highly localized. Sub-national regions (States, provinces, cities, districts) must be able to provide economic, social, physical and administrative conditions that are conducive to the efficient, effective and profitable operation of their industries in international markets. In the twenty-first century, regions and metropolitan areas as well as nations will also have to create a "business climate" that gives its enterprises a competitive edge in exporting and that attracts and promotes foreign direct investment. Regions must also facilitate strategic alliances among firms for economic cooperation.
The ability of nations to participate effectively in global trade and investment in the future will depend on the ability of governments and the private sector to create favorable conditions for private enterprises to engage more effectively in international competition and cooperation. National economic policies and international trade agreements can facilitate exporting, importing and foreign direct investment, but cities and metropolitan areas provide the direct and immediate business climate in which internationally competitive enterprises must operate. Local business conditions can be as crucial to the international competitiveness of industries and enterprises as national economic and trade policies. The determinants of international competitiveness for nations, regions and enterprises are being shaped by rapid, pervasive and fundamental changes in the global economy. These global changes affect the way nations interact with each other and that enterprises compete.
These conditions imply -- and the World competitiveness report explicitly identifies -- specific institutional factors that contribute to a country's international competitiveness.(42) They include: (1) domestic economic strength-- the strength of the domestic economy overall; (2) internationalization -- extent to which the country participates in international trade and investment flows; (3) government -- extent to which public policies are conducive to competitiveness; (4) finance -- performance of capital markets and quality of financial services; (5) infrastructure -- extent to which resources and systems are adequate to serve the basic needs of the private sector; (6) management -- extent to which enterprises are managed in an innovative, profitable and responsible manner; (7) science and technology -- scientific and technological capacity, together with the success of basic and applied research; and (8) people -- availability and qualifications of human resources. Each of these sets of factors contributes to the ability of firms and industries to compete and cooperate effectively with others in international markets.
International assistance organizations such as the International Monetary Fund and the World Bank have focused their efforts on convincing leaders in emerging market and developing countries to adopt structural adjustment policies to overcome the problems described earlier, but much of their effort has been focused on economic reforms. Reform leaders in both transitional economies and industrial nations have quickly discovered, however, that no matter how much economic changes are needed, they alone cannot achieve their goals. Reformers must be prepared to cope with the complexities of both economic and political restructuring while at the same time developing new organizations and institutions that support the private sector's participation in emerging market systems. As the Czech Republic's prime minister and leading economic reformer Vaclav Klaus pointed out, "in such a fundamental change of the whole society there can be no pure economic solution".(43) These conclusions apply as well in industrialized nations and developing countries.
Figure 1-2 summarizes the types of policy reforms that must be made and the institutional capacities that must be strengthened to support market development and international competitiveness. First, macroeconomic policies are needed to create an environment conducive to market transactions. Governments must enact structural adjustment and stabilization policies to curb inflation, liberalize trade and deregulate the economy. But at the same time, they must help establish a complex network of institutions through which market transactions take place. These include financial and legal institutions, an education system that can prepare graduates to work effectively in a market economy, efficiently operating labour markets, a system of property rights and effective distribution systems. Market development also requires the expansion of foreign trade and investment, the promotion of small and medium-sized enterprises, the restructuring of large companies and investment by multinational companies in domestic industries. In many transitional countries, non-governmental organizations -- civic groups, labour organizations, business and professional associations, the news media and foundations -- that form civil society must be recreated or strengthened. The success of the economic and political reforms as well as the survival and expansion of privatized enterprises depends ultimately on human development, that is, on the expansion of the pool of entrepreneurs, of market-oriented business managers, of a merchant and trading class and of skilled technical and support workers. All of these changes often have to be initiated quickly in order to create a momentum that will allow a market economy to come into being as well as to survive the dislocations and hardships inevitably accompanying traumatic political, economic and social reforms.
Evidence supporting the need to develop these institutional capacities in transitional and developing countries comes not only from their own experiences but also from those of Western market economies. Industrialized countries succeeded in achieving economic progress over the past 300 years precisely because they were able to establish an economic and political environment conducive to private enterprise development; this is, one that encouraged the emergence of a diverse set of institutions and organizations to carry out economic activities and supported the development of skilled human resources to innovate and adapt to change.(44) The creation of this institutional capacity and human resource base further encouraged the diffusion of authority, the widespread use of experimentation to find appropriate technology and effective means of production and marketing and the discovery of new ways of organizing economic enterprises. Moreover, the economies of Western market democracies developed because, as Rosenberg and Birdzell point out, many organizations could provide "incentives which combined ample rewards for success, defined as the widespread economic use of the results of experiment, with a risk of severe penalties for failing to experiment". In sum, progress in economic development was based on three factors -- autonomy, experimentation and diversity -- that resulted from and contributed to institutional development.
Thus, the deficiencies of former socialist regimes, the challenges facing reformers in emerging market and developing economies and the experience of Western market democracies all point to a set of policy reforms and institutional capacities depicted in Figure 1-2 that are essential for social and economic transition, market development and successful privatization.(45)
References
1. International Labour Organization, "An ILO Enterprise Strategy," Draft report, (Geneva: ILO, 1995): 2.
2. Ibid.,p. 2.
3. International Labour Organization, "Contribution of the International Labour Organization to the first substantive session of the Preparatory Committee for the World Summit for Social Development," (Geneva: ILO, 1994): pp. 6-7.
4. ILO, "An ILO Enterprise Strategy," p. 2.
5. Ibid., p. 3.
6. Max Iacono, "Action programme on Privatization," ILO Memorandum (Geneva: International Labour Office, 1995): 1-2.
7. See Dennis A. Rondinelli, "Capacity Building in Emerging Market Economies: The Second Wave of Reform," Business & the Contemporary World, Vol. VI, No. 3 (1994): 153-167.
8. Joseph Prokopenko, "Management Implications of Structural Adjustment," Management Development Programme Working Paper, Geneva: International Labour Office, 1991.
9. See Dennis A. Rondinelli (ed.) Privatization and Economic Reform in Central Europe: The Changing Business Climate, Westport, Conn.: Quorum Books, 1994.
10. Pradumma B. Rana and J. Malcolm Dowling, Jr., "Big Bang's Bust," The International Economy, Vol.VII, No. 5 (1993): 40-43 and 701-702; quote at p. 702.
11. James Buchanan, What Should Economists Do? (Indianapolis, Indiana: Liberty Press, 1979): quote at p. 29.
12. For a description of these issues see International Monetary Fund, World Economic Outlook, Washington, DC: IMF, 1995.
13. For a detailed assessment of the problems of European, North American and Asian-Pacific countries see Organization for Economic Cooperation and Development, Assessing Structural Reforms: Lessons for the Future, Paris: OECD, 1994.
14. See, for example, Dennis A. Rondinelli and Martin R. Fellenz, "Privatization and Private Enterprise Development in Hungary: An Assessment of Market Reform Policies," Business & the Contemporary World, Vol. 5, No. 4 (1993): 75-88; and Dennis A. Rondinelli, "Private Enterprise Development and the Transition to a Market Economy in the Czech and Slovak Republics," in Perry L. Patterson (ed.) Capitalist Goals, Socialist Past: The Rise of the Private Sector in Command Economies, (Boulder, Colorado: Westview Press, 1993): 89-115.
15. See Charles E. Lindblom, Politics and Markets: The World's Political-Economic Systems, (New York: Basic Books, 1977): Chapter 18.
16. Janos Kornai, The Socialist System: The Political Economy of Communism, (Princeton, N.J.: Princeton University Press, 1992): 157-159.
17. International Monetary Fund, World Economic Outlook 1995, (Washington, DC: IMF, 1995): 35-51.
18. This section draws heavily from Jack N. Berhman and Dennis A. Rondinelli, "Urban Development Policies in a Globalizing Economy: Creating Competitive Advantage in the Post-Cost War Era," in William Crotty (ed.) Post Cold War Policy, Vol. I: The Social and Domestic Context, (Chicago: Nelson-Hall, 1995): pp. 209-230.
19. Unsigned article, "World Trade Growth in 1994 Highest in Almost Two Decades," press release No. 8, Geneva: World Trade Organization, 1995.
20. World Bank, Global Economic Prospects and the Developing Countries 1994, Washington: World Bank, 1994.
21. United Nations Industrial Development Organization, Industry and Development Global Report 1993/1994, Vienna, Austria: UNIDO, 1993.
22. K. Billerbeck and Y. Yasugi, "Private Direct Foreign Investment in Developing Countries, World Bank Staff Working Paper No. 348, Washington, DC: World Bank, 1979.
23. See United Nations Industrial Development Organization, Industry and Development Global Report 1993/94, Vienna, Austria: UNIDO, 1993.
24. United Nations Conference on Trade and Development, World Investment Report 1993, ST/CTC/156/ (New York: United Nations, 1993): quote at p. 84.
25. United Nations Conference on Trade and Development, World Investment Report 1993,pp. 160-161.
26. United Nations Department of Economic and Social Development, World Investment Report 1992, (New York: United Nations, 1992); pp. 138-139.
27. United Nations Department of Economic and Social Information and Policy, World Economic Survey 1993, (New York: United Nations, 1993): pp. 81-82.
28. United Nations Conference on Trade and Development, World Investment Report 1994, UNCTAD/DTCI/10, New York: UNCTAD, 1995.
29. International Finance Corporation, Emerging Stock Markets Factbook 1995, Washington, DC:IFC, 1995.
30. United Nations Department of Economic and Social Development, World Investment Report 1992, ST/CTC/130, (New York: United Nations, 1992); quote at p. 105.
31. World Bank, World Development Report 1992, Washington, DC: World Bank, 1992.
32. General Agreement on Tariffs and Trade, International Trade 91-92, Geneva: GATT, 1993.
33. United Nations Department of Economic and Social Information and Policy Analysis, World Economic Survey 1993, New York: United Nations, 1993.
34. United Nations Economic and Social Commission for Asia and the Pacific, Restructuring the Developing Economies of Asia and the Pacific in the 1990s, New York: United Nations, 1990.
35. See Steven L. Goldman, Roger N. Nagel and Kenneth Preiss, Agile Competitors and Virtual Organizations, New York: Van Nostrand Reinhold, 1994.
36. See Otis Port and John Cary, "This is What the U.S. Must do to Stay Competitive," Business Week, (December 16, 1991): 92-93; Otis Port, "Moving Past the Assembly Line: 'Agile' Manufacturing Systems May Bring U.S. Revival," Business Week, (October 23, 1992): 177, 180.
37. See Robert H. Hayes and Gary P. Pisano, "Beyond World-Class: The New Manufacturing Strategy," Harvard Business Review, (January-February 1994): 77-86; Shlomo Maital, "A 'Made in America' System," Across the Board, (April 1994): 45-46; Samuel E. Bleeker, "The Virtual Organization," The Futurist, (March-April 1994): 9-14.
38. A.D. MacCormack, L.J. Newman III and D.B. Rosenfield, "The New Dynamics of Global Manufacturing Site Location," Sloan Management Review, (Summer 1994): 69-80.
39. Stephen B. Preece, "Incorporating International Strategic Alliances into Overall Firm Strategy: A Typology of Six Managerial Objectives," The International Executive, Vol. 37, No. 3 (1995): 261-277.
40. International Labour Organization, World Employment 1995, Geneva: ILO, 1995.
41. Michael E. Porter, The Competitive Advantage of Nations, New York: Free Press, 1990); quote at p. 19.
42. World Economic Forum and IMD, World Competitiveness Report 1994, Lausanne, Switzerland: IMD, 1994.
43. Vaclav Klaus, "The Ten Commandments Revisited," The International Economy, Vol. VII, No. 5 (1993): 36-39 and 70; quote at p. 36.
44. Nathan Rosenberg and L.E. Birdzell, Jr., How the West Grew Rich: The Economic Transformation of the Industrial World, New York: Basic Books, 1986.
45. See the experiences described in Dwight H. Perkins and Michael Roemer (eds.) Reforming Economic Systems in Developing Countries, Cambridge, Mass.: Harvard University Press, 1991; and in Vittorio Corbo, Fabrizio Coricelli and Jan Bossak (eds.) Reforming Central and Eastern European Economies: Initial Results and Challenges, Washington, D.C.: World Bank, 1991.