Four—
The Role of Medium-Term Plans in Development

Chen Sun

1—
Introduction

The use of development planning to foster economic growth has been a general practice in almost all developing countries since World War II. It is perhaps pertinent, therefore, to enumerate at the beginning of this essay the major factors that are considered responsible for long-run economic growth. Economic growth means sustained increase in per capita output, which in the final analysis reflects continuing improvement in labor productivity.

Economists sometimes differentiate economic growth from economic development in that growth refers only to quantitative changes, while development involves not only quantitative but also qualitative changes, such as changes in industrial structure, economic institutions, and even the sociocultural environment. However, anything that grows changes. Without socioeconomic changes, economic growth could not be sustained for very long. This may be why certain economists, notably the late Simon Kuznets. use the term growth rather than development in dealing with the process of economic development (Kuznets 1966; see also Rostow I960).

Economic growth can be attributed to the following factors:

(1) A growing stock of knowledge from which continuous technical progress, in the form of more efficient methods of production, new products, or the ability to take advantage of other countries' advanced science and technology, can be made. Without technical progress, existing sources of growth would gradually be

exhausted, and the growth rate would decline and eventually approach zero. The economy would become stagnant.

(2) A group of people who have the spirit of entrepreneurship to take the initiatives and risks necessary to apply new technology to production. Without entrepreneurs, there would be no innovation, and the increasing stock of knowledge would not be relevant to economic development.

(3) A healthy, disciplined, and well-educated labor force willing to work and responsive to the incentive systems of the economy.

(4) A well-organized social, cultural, and institutional framework within which economic activities take place. In a centrally planned economy government authorities make major decisions on resource allocation. In a mixed-market economy it is the private sector that functions as the major engine of the economy in cooperation with the public sector. As Barend A. de Vries has correctly noted:

Without a viable private sector, government cannot (in most circumstances) stimulate or sustain economic growth. Conversely, without a reasonably efficient public sector capable of providing—at a manageable economic cost—the necessary infrastructure and an overall environment conducive to sound investment, the private sector is unlikely to make its full contribution to development. If government is inefficient and ineffective, or if it pursues policies that significantly distort private sector decision making, both the private sector and the overall prospects for economic development suffer, (de Vries 1981, 11–12)

(5) A constant flow of savings put aside from current production, and large enough in percentage of GNP to finance investment. A country cannot, however, save what it does not produce. A certain portion of what has been saved has to be exchanged, through international trade, for products consistent with domestic investment. Part of domestic investment could also be financed by foreign savings through trade deficits. A low saving ratio, under-development of international trade, and lack of sufficient foreign capital inflow can all cause bottlenecks limiting the economic growth of a country.

Each of these factors can be interfered with by government action, and could therefore be included in development planning. Important though all of these factors are to economic development, none has been a major subject of economic analysis, with the exception of savings and investment. Modern articulated comprehensive development planning

for mixed-market economies owes its origin to Keynesian economics, in which savings and investment play a key role.

This chapter consists of seven sections. Section 2 will trace the beginning of postwar comprehensive national economic plans and their later development. Types of plans, in terms of length, will also be discussed in this section. Section 3 deals with the objectives of planning in general and the relationship between growth and planning in particular. Section 4 is on resource mobilization and the allocation of resources between the public sector and the private sector and on determination of investment within the private sector. In section 5 education and research and development are discussed in connection with investment in human capital and technical progress. Section 6 is on price stability and income distribution. And the last section, section 7, contains concluding remarks.

2—
Development of Economic Planning

Economic plans may mean many different things. Broadly defined, an economic plan is a systematic arrangement of policy measures designed to achieve certain objectives or goals in connection with the economy as a whole or with a particular aspect of the economy. In this sense, one can hardly think of any economy that has not adopted economic plans of one kind or another as a device for improving economic situations. But the use of comprehensive national development plans to promote nationwide economic development came into existence and emerged in developing countries only after World War II. Development planning improved only gradually and has reached its present level of sophistication as a result of both accumulated experience and advances in economics and econometrics.

During the early postwar years economic plans in many developing countries were often just wish lists and collections of proposed investment projects. W. Arthur Lewis included in a development plan any or all of the following parts:

(1) a survey of current economic conditions;

(2) a list of proposed public expenditures;

(3) a discussion of likely developments in the private sector;

(4) a macroeconomic projection of the economy;

(5) a review of government policies. (Lewis 1966, 13)

They were gradually developed into a body of consistent goals to be obtained and policy measures to be adopted. Modern articulated comprehensive national development planning would not have been possible without the existence of macroeconomics and national income statistics.

In the 1950s and the early 1960s, when post-Keynesian growth theory was prevailing, the Harrod-Domar model was widely used in development planning to calculate the capital requirement necessary to achieve a certain rate of growth or to determine a growth target given the financial resources available for domestic investment. Following the development of neoclassical growth theory, the Harrod-Domar fixed coefficient production function was replaced by more general forms of production functions. Manpower planning was brought into the picture at least partly as a result of the emergence of the investment-in-human-capital thesis. Of course, there were other factors that also had something to do with the inclusion of manpower and education in development planning, for example: (1) in order to raise production as the unlimited-supply-of-labor stage ended, improvement in the quality of labor by way of education was required; and (2) as capital accumulated and became abundant, availability of skilled workers gradually became a limiting factor to further growth.

In 1961 the General Assembly of the United Nations designated the 1960s as the Development Decade and called upon member countries to accelerate programs not only in economic growth but also in social development. In response to this idea of socioeconomic development, UN experts promoted the inclusion of social considerations such as employment, education, health care, housing, social welfare, income distribution, and regional development into overall development planning; they emphasized the need for intersectional coordination and integration (United Nations 1963).

However, the integration of economic and social development planning has never been successful. This is because we know very little about the interrelationships between economic and social variables. Although certain social aspects have been included in development plans, they are in most cases formal and superficial, and only passively involve the redistribution aspect of development—at most, in the sense that the benefits of economic growth should be widespread through social programs. After all, economic development is, in the final analysis, a sociocultural process, and sociocultural behavior is difficult to plan. Thus the basic nature of economic development largely limits the effect that can be expected from development planning.

Development plans can be put into three categories in terms of length: long-term plans, medium-term plans, and short-term plans. A long-term plan is a perspective plan that covers a period of fifteen, twenty, or even twenty-five years—strictly speaking, more a projection

into the future than a plan for the future. It predicts certain major variables, such as population, labor force, and productivity in the distant future to serve as a background for the formulation of medium-term plans. Examples of long-term plans are the Soviet Union's 1960–80 twenty-year plan, and the French 1969–85 projection. Recently, the Republic of China on Taiwan completed a long-term projection into the year 2000, against which its 1986–1990 four-year medium-term plan was drafted.

The long-term plan is basically a supply-side plan. This is because, in the long run, economic growth is a result of increases in production capacity rather than in demand. And increases in production capacity involve improvement of the quantity and quality of the labor force, capital accumulation, and most important, technical progress, which reflects applications of advancing knowledge to actual production. Technical progress not only raises the productivity of labor and capital but also creates new products, offsetting the effect of the law of diminishing utility and opening up new dimensions for demand. Since knowledge concerning technical progress is limited, and is even more so as the period of observation extends, a long-term plan cannot be expected to be as comprehensive as a medium-term plan.

The duration of medium-term plans varies from three to seven years. Most countries adopt five-year plans, as have the Republic of Korea, India, and the Soviet Union. However, it is by no means necessary that a country always stick to the same duration in its medium-term planning. In the case of France, the first plan was for seven years (1947–53), but the following plans were for four years. Taiwan's medium-term plans have been four-year ones, except for a six-year plan in 1976–81. Medium-term plans are in operation in most developing countries. A complete medium-term plan consists of three basic components: objectives, projections, and policy measures. Objectives are the points we intend to reach with the help of certain policy measures; projections are the places we would arrive at without adopting any government policy. A medium-term plan consists of variables on both the supply side and the demand side. A key factor that connects supply and demand is investment, which is by definition an addition to the capital stock. Whenever net investment is not zero, the capital stock changes, and so does production capacity, or potential GNP.

The short-term plan is an annual plan, used for adjustment in order to keep development planning close to reality. It is also used to link economic plans to government budgets. A short-term plan is a plan on the

demand side simply because potential supply is fixed in the short run. However, investment and certain elements of government budget expenditure, such as those on social infrastructure, education, and research and development, do add to supply capacity. This change in production capacity will not, however, be shown in the current plan period.

The characteristics of development plans, and the ways in which government actions affect economies through planning, vary with different economic systems. Plans in centrally planned communist countries are basically controlling plans, whereas those in mixed-market economies are mostly indicative plans. A controlling plan gives orders to the various units of the different sectors of the economy. Its effect on the economy is direct and by command. An indicative plan only indicates intentions and recommends policies to fulfill them. Its effect on the economy, apart from the public sector, is indirect and through the influence of public policies on the private sector. In a mixed-market economy, some sectors—such as the government and public enterprises—can be controlled by plans and others can only be influenced by policy actions. The control over the public sector may be tight or loose, and the influence on the private sector may be heavy or light in different countries and in the same country at different stages of development. This is what makes development plans different from one another.

The four-year and six-year economic plans of Taiwan may be taken as examples of indicative plans. Taiwan started its first four-year medium-term plans in 1953. During the first two four-year plan periods, 1953–60, the fundamental development strategy was the so-called inward-looking, import-substituting policy. Certain consumer goods industries, notably textiles, were selected for development under the protection of foreign-exchange controls and high tariff duties to supply the domestic market. Government intentions for private industrial development were carried out mainly through selective allocation of financial resources at differential rates of interest. And, until 1965, when it was terminated, U.S. aid was one major source of financing.

Toward the end of the 1950s, when the domestic market was becoming saturated with primary import-substituting products, the government undertook a series of foreign trade and exchange reforms. In so doing, it changed the development strategy to an outward-looking, export-promoting policy. The New Taiwan dollar was devalued. Import controls were relaxed. Throughout the 1960s, industrial development very much followed market forces rather than government decisions, with the importing sector still considerably protected by high tariffs and

some import controls, and financial allocation in favor of exporting industries. In the mid 1960s export-processing zones were established to encourage development of the industries in which the economy possessed a comparative advantage.

The 1970s showed a reverting tendency toward more government intervention in private investment. The petrochemical intermediate products industry was established under government planning to supply the "downstream" industries. This is an example of so-called second-phase import substitution. Electronics and machinery were selected as "strategic" industries and enjoyed credit from banks with matching government funds to lower the interest rate. But the intervention was gradually reduced, and in the early 1980s the government eventually decided to liberalize the whole economy and go international.

3—
Objectives of Planning

The objectives that are commonly mentioned in medium-term development plans are:

(1) high growth rate in terms of GNP and per capita GNP;

(2) high level of employment or low rate of unemployment;

(3) a stable general price level;

(4) improvement in income distribution; and

(5) improvement in the balance of international payments.

The last is not on the same level as the first four objectives, which may be considered the ultimate ends, in the sense that they are not used as means to achieve other ends. They are ends in themselves so far as development planning is concerned. The reason that balance-of-payments improvement is included as one of the objectives is that developing countries are often troubled by balance-of-payments deficit problems in the course of development. Additional objectives, such as improvement in industrial structure, diversification of production or exports, and more balanced development among regions, are also often found in development plans.

These objectives are not necessarily consistent, and may, in fact, conflict with one another in many cases. For example, rapid growth in production and full employment may be contradictory; rapid growth and a stable price level are difficult to attain at the same time; and many economists believe that high rates of growth and equitable income distribution conflict with each other. This, of course, may be oversimplified. Some of the conflicts could be resolved, or at least reduced to a certain extent, by

incorporating appropriate policies into the plan. In the case of Taiwan, a high rate of growth, a low rate of unemployment, and improvement in the size distribution of income have all been achieved at the same time. The achievement may be at least partly attributable to two particular policies among its development plans:

(1) Method of production, in terms of labor/capital ratio, varies as relative prices (the wage rate and the interest rate) change over the course of development. To be specific, labor-intensive methods of production were encouraged when labor was an abundant factor in the economy, and only as labor gradually became scarce were more capital-intensive and technology-intensive production methods recommended in the 1970s and 1980s.

(2) Industries have been dispersed, helping factories to have easy access to labor (Ranis 1979, 222–24). This has not only raised the level of employment, and therefore reduced the rate of unemployment, but has also improved income distribution by way of raising labor's share of income in relation to capital's. This may also to some extent have been responsible for the price stability Taiwan was able to maintain prior to the early 1970s, since easy access to labor helped avoid an early labor shortage, which in turn prevented the wage rate from increasing excessively. But not every country has this kind of advantage. A prerequisite of the dispersion of industries is a well-developed system of transportation and communication.

If the objectives of planning are inconsistent in that the achievement of one may retard another, decisions must be made concerning the priorities of the objectives. Take the Republic of Korea and the Republic of China on Taiwan for example. In their respective development plans, Korea has assigned higher priority to growth, relative to price stability and equitable distribution, than has Taiwan.

Planning and Growth

While the priority system may differ in different countries and even at different times for the same country, economic growth is always the most important objective to be pursued in all development plans. At this point the following questions naturally arise: Does development planning really foster economic growth? If it does, then why. how, and to what extent does it do so? What are the factors that influence the effectiveness of a development plan?

Despite the prevalence of planning in almost all developing countries, economists have become skeptical about the effectiveness of economic planning on growth. After quoting Albert Waterston as saying that there have been many more failures than successes in the implementation of development plans in postwar planning history, and that the great majority of countries have failed to realize even modest output targets in their plans except for short periods, Michael Todaro concludes: "After more than two decades of experience with development planning in Third World countries, the results have been generally disappointing" (Todaro 1981, 459).

Another textbook writer, Clarence Zuvekas, even goes so far as to say:

The macroeconomic plans adopted by developing countries vary in complexity and technical soundness, but with few exceptions they have one common characteristic: their ineffectiveness. The acceleration of economic growth rates since 1960 has had little to do with the preparation of planning documents which prescribe the speed and direction of growth and identify the policy instruments that are to be used to achieve national economic objectives and growth. Indeed, economic growth has often proceeded in directions not foreseen by the plan, or if in accordance with the plan, would have occurred even without the plan. (Zuvekas 1979, 191)

However, neither the poor record of growth rates nor the wide divergence of growth performances from planned targets is by any means clear proof of the dysfunction of development planning in promoting economic growth. There are areas that have to do with economic growth, but in which very little can be done in medium-term planning, such as entrepreneurship and cultural variables. And there are other areas where planning does carry a certain influence, such as the mobilization of physical and human resources. Ineffectiveness may result either from a deficiency of the plan or from its poor implementation. The often-mentioned shortcomings of development planning include inappropriate theory and techniques, inadequate and inaccurate data, and lack of willingness or administrative capability for implementation.

Economic growth in terms of per capita output (as it was defined in the introductory section of this chapter) results from increases in employment as a percentage of population, and in labor productivity.

The increase in the employment ratio is limited first by the size of the labor force and then by the age structure of the population. The difference between employment and the labor force is unemployment. And the size of the labor force is determined by the participation ratio, given the number of the population beyond a certain age, say fifteen years of

age. Generally speaking, in a rapidly growing economy, the rate of increase in population first rises to a high level and then gradually dedines. As a result, the proportion of the population that is of working age first declines and then increases. Usually, the labor-participation ratio also increases as the economy grows. Therefore, in the course of development, there is a period of time when the potential supply of labor increases as a percentage of the total population. However, this tendency does not last very long before the structure of the population ages.

The increase in labor productivity is a combined result of a number of factors, such as improvement of the quality of the labor force, increase in the amount of capital per worker (in other words, the capital/labor ratio, or the capital intensity), and, most important, technical progress. The contribution of the increase in capital intensity to productivity improvement would decline gradually to zero at a given level of technology because of the law of diminishing returns. There would be no incentives for investment, and the net saving ratio would tall to zero. In the long run, then, technical progress is the only source of economic growth in terms of both per capita output and labor productivity.

Technical progress is a simplified concept involving a multiplicity of factors. First, there has to be a constant flow of new technology that can be applied to production—in the form of either new products or new methods of production. Then a group of innovative entrepreneurs must exist who will take risks to apply new technology to actual production, otherwise advancement in technology would not be relevant to economic growth. Quality of the labor force has to be continuously improved, as do the sociocultural conditions under which investment and production are taking place.

The role of development planning in promotion of economic growth is (1) to mobilize idle labor for production, (2) to promote domestic savings and to attract foreign capital for investment, (3) to provide education and training or otherwise invest in human capital in order to upgrade the quality of the labor force, (4) to encourage or undertake research and development in science and technology, and (5) to improve sociocultural conditions in order to facilitate investment and production, among other things.

4—
Resource Mobilization and Allocation

The mobilization of idle labor as a source of economic growth works only in the early stage of development, when there is large open and dis-

guised unemployment. Furthermore, additional savings will be required to finance the mobilized workers. The mobilization-of-idle-labor thesis has never played a major role in development planning. However, the mobilization of savings has always been central to development planning.

In most developing countries, savings generated from the private sector are rarely adequate to sustain even a moderate growth rate. Therefore, public-sector savings and savings by state-owned enterprises have been heavily relied upon to finance investment in social infrastructure, such as transportation, communications, irrigation systems, and electric power. But the record is not impressive in most cases. According to an early study by the secretariat of the Economic Commission for Asia and the Far East of the United Nations, while net domestic saving as a percentage of national income was less than 10 percent for selected ECAFE countries (with the exception of Japan [27.7 percent) and Burma [15.6 percent]) during the 1950s, public saving was less than halt of private saving in Burma, Taiwan, and Japan, less than one-fifth in India, and negative in South Korea. Public saving was equal to private saving in Ceylon and exceeded private saving in the Philippines, where net domestic saving was only 2.5 percent of national income. The same study reveals that the public sector was not able to generate enough saving to finance public investment in the period of 1950—60, with the exceptions of Ceylon and the Philippines. For four out of the eight selected countries, more than 60 percent was financed by external sources (United Nations 1962).

In a recent study Lin Wu-Lang reports that in most developing countries, net government saving (as a percentage of total current general government revenues) is generally less than 25 percent; that government net savings generally form not more than 3 or 4 percent of gross domestic product; and that within the public sector, public enterprises, instead of contributing to it, make large and growing claims on the government budget (Lin 1985).

In the early postwar years, when the saving ratios in most then underdeveloped countries were low and the public sector was sought as a major source of saving to finance investment, few came away with any significant results. In order to have a higher public-saving ratio, government revenues have to be increased relative to government expenditures. This, in turn, depends upon efficient administration and a sound and flexible system of taxation, both of which were lacking in underdeveloped countries. As development economists used to argue in the

late 1950s and early 1960s, an underdeveloped country was underdeveloped because the administration was underdeveloped, and so was the tax system.

Even if public-sector saving could be increased by an increase in government revenues, whether it would be a net increase to the economy as a whole or merely an increase at the expense of saving in the private sector, so that total saving of the economy would not increase, is still difficult to say. The effect of an increase in public saving by way of an increase in tax revenues and the profits of state-owned enterprises is twofold. On the positive side, through increasing public investment in social infrastructure, which would reduce costs of production and improve efficiency in the private sector, private investment would be encouraged. On the negative side, the increase in taxes might reduce private saving and weaken incentives to invest, therefore retarding economic growth. As a result, in the long run, increases in tax revenues might even decline rather than increase.

Alan Reynolds (1985) has demonstrated that in countries where average tax rates as a percentage of GDP were high. increases in real tax revenues over the seven-year period 1975–82 were generally low, and in many cases negative, while those countries where average tax rates were low nevertheless enjoyed rapid increases in real tax revenues. In promoting national saving to finance domestic investment in a developing market economy, behavior in the private sector is always of first importance.

In the early postwar years when development economics first emerged, many economists argued that an underdeveloped economy was underdeveloped because its saving ratio was inadequate to finance the high rate of investment required to sustain even a modest economic growth rate. The low saving ratio was a result of low per capita income, which in turn was owing to the low rate of economic growth. This process formed the so-called vicious circle of poverty that was so difficult for poor countries to break through.

Low saving ratios were a major characteristic of underdeveloped economies. Some people even went so far as to argue that there was a lack of thrift in underdeveloped countries—they simply would not save enough to get ahead. However, as T. W. Schultz has correctly pointed out, a stagnant poor economy fails to save enough to start growing not because of lack of thrift but because of lack of incentive (Schultz 1967, 28). At any given level of technology, capital will accumulate through investment until the marginal productivity of capital, and therefore its rate

of return, approaches zero, at which point there will be no incentive for investment. Net investment will fall to zero, and so follows net saving if there is no opportunity to invest abroad. (Investing abroad prevents saving from declining to zero even though there is no return on investment at home.) Technical progress raises the marginal productivity of capital and incentives to invest on the one hand and improves profits and ability to save on the other. A country is never too poor to save a small portion of its production, but lack of technical progress makes saving and investment economically unjustifiable.

So a low rate of saving may be a limiting factor to growth in the early stage of economic development, as in the 1950s and early 1960s in many developing countries. But once they have started growing as a result of technical progress, developing countries will generate their own savings to finance at least part of the investment required for sustaining growth. And in many developing countries saving has considerably increased as a percentage of GNP since the late 1960s. This may be a major reason why saving has gradually become a less favored subject in development economics. Generally speaking, the saving ratio increases as the economic growth rate increases, which provides incentives and improves the ability to save. But there are other factors that also affect saving and help explain individual differences in the saving ratio among countries.

Among all developing countries, Taiwan has generated the highest saving ratio in the past decade or so. Its gross national saving as a percentage of GNP has exceeded 30 percent annually since 1972, the only exception being 1975, when it dropped to 26.19 percent as a result of the first oil crisis. In comparing economic development in Taiwan and South Korea, Tibor Scitovsky summarizes the factors responsible for Taiwan's high household saving as follows:

The slightly faster growth of Taiwan's GNP; the slightly faster increase in the proportion of its labor force receiving part of its income in the form of bonuses; people's lesser spending and need to spend on education; the greater proportion of people saving up to establish independent businesses; the greater number of businessmen saving up to enlarge their already established independent businesses; and people's greater willingness to save especially for their old age, due partly to their greater affluence, and partly to the more secure and higher returns on their accumulated savings. (Scitovsky 1985, 249)

Savings can be encouraged by tax incentives, high interest rates, and price stability Price stability provides certainty and security in saving. Governments that adopted expansionary monetary and fiscal policies to

provide forced financing for investment often found only worsening inflation and a declining saving ratio in the long run. S. C. Tsiang (1984) criticizes the "misguided monetary policy," under the influence of Keynesian economics, of keeping interest rates low in order to stimulate investment and prevent cost-push inflation in the 1950s and 1960s for discouraging, rather than promoting, saving by the public. He argues that Taiwan was probably the first among the developing countries to abandon a low-interest rate policy to combat inflation and encourage saving, and was proven successful in the early 1950s and again in 1974.

In the past twenty years or so, Korea and Taiwan have achieved approximately the same average annual growth rate. However, since the early 1970s. Taiwan has been able to generate more than enough savings to finance its domestic investment, while Korea (though also high in saving ratio compared to many other developing countries) has had to depend heavily on capital inflow in order to maintain its rapid growth. The domestic saving-investment relationship has far-reaching effects on the foreign sector, and the difference between saving and investment at home always equals that between exports and imports. In recent years Taiwan has suffered from an increasing trade surplus, and Korea from trade deficits; both have their roots in saving-investment positions.

Determination of Investment

With regard to the allocation of resources available for investment, two questions are essential in development planning: one is how much of the resources should be allocated to investment in social infrastructure and how much to productive investment; and the other is to what extent should the productive investment be guided or intervened in by government policies. Whether investment in infrastructure should lead or follow productive investment has been an issue in development economics. The advantage of low infrastructure investment is that more resources can be available for productive investment, but the disadvantage is that inadequate infrastructure investment may become a bottleneck and therefore retard growth. The advantage of overinvestment in infrastructure is that it facilitates productive investment, but again, the disadvantage is that, in the face of limited resources, it may crowd out productive investment. Intelligent planning serves the purpose of maintaining balance between the two categories of investment, and makes sure that the growth rate is maximized. However, owing to both the large scale and the indivisibility of social infrastructure, exact balance is neither possible nor necessary. In this respect, the concept of balance applies only in the long run.

As for government guidance or intervention in productive investment, it can vary from complete control (in the form of state-owned enterprises) at one extreme to total determination by market forces at the other. Even in the private sector there are various degrees of government intervention. The choices made will depend upon the ideology of the economic system, the theories believed by the decision makers and planners, and the stage of development of the economy, among other things. In order to influence private investment, the government may use protective tariffs, import controls, foreign-exchange policies, credit allocations, differential interest rates, direct assistance, and privileges and persuasion of influential government officials. In Taiwan in the 1950s, private investments were directed to the area of import substitution in order to save foreign exchange and to meet domestic demand. In the 1960s investments in exporting industries were encouraged in order to take advantage of the world market. As can be imagined, relatively more government measures (compared to market forces) were adopted to serve the purposes of the 1950s than the 1960s. In recent years the government has decided to go international and to further liberalize the economy in order to enjoy the benefits of comparative advantage, and thus to improve the economic efficiency of resource allocation.

The rationale behind government intervention in private investment is that while the market or the price system could achieve static efficiency by maximizing current output with given production factors under ideal conditions, it would not automatically lead to technological advancement and structural improvement. In this respect, government must play a role. As Oskar Lange once remarked: "Consequently, the problem of development planning is one of assuring that there be sufficient productive investment, and then of directing that productive investment into such channels as will provide for the most rapid growth of the productive power of national economy" (Lange 1964, 804).

Investment resources have been directed to import-substituting industries or to exporting industries in different countries and at different time periods in the same country. In recent years emphasis has been given to high-technology industries in many middle-income developing countries. Judged by past performance, there have been successes as well as failures. Generally speaking, those countries that pursued export-promoting development strategies have proven more successful than others. And of all the successes, four resource-poor exportoriented developing economies with small domestic markets (Korea, Taiwan, Hong Kong, and Singapore) have emerged as outstanding. The

development of high-technology industries in developing countries has yet to be seen.

After reviewing more than three hundred plans, a World Bank report emphasizes the importance of consistency of development planning with the market and the price system, saying: "There is strong evidence to suggest that policies leading to high distortion in prices and incentives also lead to significant losses in growth and do not necessarily produce benefits in terms of equity" (Agarwala 1983, 13).

This report lists the following as policies that countries with relatively high growth rates have pursued:

• Avoiding appreciation of the real effective exchange rate

• Keeping the effective protection rate of manufacturing both low and even among products

• Avoiding the high taxation of agriculture by holding down producer prices

• Keeping interest rates positive and avoiding real wage increases not justified by rising productivity

• Applying cost-recovery principles in the pricing of infrastructure services

• Avoiding high and accelerating inflation

One common characteristic of these policies is that development incentives operate within the framework of the price system, not against it. Arnold Harberger advises:

• Make the tax system simple, easy to administer, and neutral and non-distorting with respect to resource allocation

• Avoid excessive income tax rates; high rates distort behavior and create disincentives to economic activity, while yielding little revenue

• Avoid excessive use of tax incentives to achieve particular objectives; excessive tax incentives too often direct scarce resources to less efficient investment

• Take advantage of international trade and modify tariff schedules in the direction of greater equality

• Let public enterprises operate like private interprises; when public enterprises and private enterprises compete, let their competition be governed by the same rules (Harberger 1984, 427–66)

Here again, the underlying principle is to be consistent with, and make use of, the market, not to distort it.

Government policy has universally been taken to provide the necessary incentives to channel investment resources to areas thought to be the most favorable to long-run growth. However, it should be kept in mind that economic growth is a sociocultural process that proceeds only gradually in terms of technological progress and improvements in industrial structure. The more ambitious the goal is, the larger the incentives offered will have to be. Too often in the history of the development of the Third World, government incentives have turned out to be so great that investments were induced in areas far from the reach of technology, and where little comparative advantage existed And yet the burden had to be shared, in one way or another, by the economy as a whole. Whether a developing country chooses to be more or less ambitious in its industrial policy to push its economy to the developed state is a matter not only of economic calculation, but also of political philosophy.

Both South Korea and Taiwan have adopted export-led, outward-looking development strategies in their development plans to take advantage of international trade and their comparative advantages in labor-intensive industries. Both have pursued industrial policies to guide and influence private investments in order to speed up improvement in industrial structure and technological progress. And in recent years, both have moved to more technology-intensive industries and have emphasized the development of high-tech industries. The government of the Republic of Korea seems to have been playing a more energetic and aggressive role than has the government of Taiwan in promoting industrial development. In Taiwan, business leaders, and many government officials as well, have always admired the strong leadership of the Korean government and the prompt, extensive, and often efficient policy measures that it has taken to promote development. However, despite the aggressiveness of the Korean government and all the efforts it has made to accelerate economic development, the performance of the Korean economy in terms of growth has been no better, if not worse, than that of Taiwan over the past years. And Taiwan has achieved a more stable price level, greater equality in income distribution, and stronger balance-of-payments positions than has Korea, and indeed, perhaps any other developing country. The difference lies in the fact that development planning and government policies have been less forceful in Taiwan than in Korea, and more room has been left for market forces to operate. Whether Korea has built up greater potential capability for future development is yet to be seen.

5—
Planning Education and R&D

Economists have long realized the importance of education to economic development. "The progress and diffusion of knowledge are constantly leading to the adoption of new processes and new machinery which economize human effort," Alfred Marshall pointed out in his Principles of Economics (1920, 222). In fact, a major theme of Marshall's book at the macro-level was, in modern language, the promotion of economic growth by way of the progress and diffusion of knowledge. Thanks to T. W. Schultz, "human capital" has been a useful concept for analyzing economic development since the early 1960s.

The stock of human capital accumulates through investment in education. In the simplest form of the production function, total production is a function of technical progress, the amount of (physical) capital stock, and the labor force. Education has to do not only with the labor force, but also with technical progress. The level of economic development that a country has attained very much reflects the general level of the education of its people. Education is a means to achieve economic development as well as development in other areas. It is also more than a means; it is an end in itself. As a means, education is an investment good, but as an end, it is a consumption good. The importance of education therefore goes beyond the scope of economic development.

But investment in education is limited by scarce resources, as is investment in social infrastructure. This is especially true in the early stages of development, when there is a serious capital shortage. Given the condition of capital shortage, education and productive investment compete for scarce resources. How to allocate limited resources between the two is a difficult decision to make.

Education planning may have three main objectives: (1) to provide the people with the general knowledge, the basic skills, and the discipline that are required for living in a modern society; (2) to supply the economy with an adequate labor force of the quality required for growth; and (3) to develop higher education and the pursuit of advanced studies in order to provide a growing number of highly qualified people and to build up an increasing stock of knowledge, both of which are necessary for a country's long-run development, economically and otherwise.

Whereas inadequate education retards economic growth, too much education draws resources from productive investment, which also reduces the growth rate. The structure of education in terms of levels of education and areas of discipline has a great deal to do with economic

growth. Too much emphasis on higher education at the expense of secondary and primary education does little to benefit growth. One can easily think of many formerly colonial developing countries that have quite a number of very well educated top people, but poorly educated or even illiterate general publics. These countries are characterized by slow growth and inequitable income distributions. The expensive investment in higher education seems to have contributed little to their economic development. This is understandable, because the structure of education was not consistent with the demand for labor. It is advisable for a developing country, in which national savings are inadequate to finance domestic investment, to plan its education in accordance with projected growth targets.

In planning education, it is important to keep in mind that economic development is a gradual process, and that an economy does not jump, but grows. Any country that has invested aggressively in higher education in its early stages of development, when the average qualification required of its workers is primary or at most secondary education, will find itself involved in a heavy cost that it can only expect to recover, with uncertain possibilities, in the very distant future.

In this regard, planning investment in education and planning investment in infrastructure are very similar, in that maintaining some kind of balance between education or infrastructural investment and productive investment is of utmost importance. A roughly balanced allocation of resources between education or infrastructure on the one hand and productive investment on the other is consistent with the basic principle of growth maximization.

In the case of Taiwan, the government has taken a gradual approach in educational development to correspond to its economic development. In the beginning, six years of free compulsory education were required as a minimum for all boys and girls of school age. Later the minimum requirement was extended to nine years, with the additional three years free from entrance examination, but not compulsory. Now, the government is talking about another extension to twelve years, with vocational education being the main stream at the senior high level. This new system is currently in the experimental stage. During the 1952–53 school year, only 33.8 percent of primary school graduates enrolled in junior high schools, 62.9 percent of junior high graduates enrolled in senior high schools, and 46.2 percent of regular senior high graduates enrolled in institutions of higher education. In 1985–86 the percentages increased to 99.4, 73.3, and 80.3 respectively (Taiwan 1986, 284).

As for the structure of secondary education, Taiwan has so far followed a 70:30 ratio between vocational senior high and regular senior high in terms of enrollment, on the grounds that vocational school graduates will go to work and regular senior high graduates will pursue higher education. However, as the economy becomes more and more sophisticated as a result of sustained development, the question of whether the country should produce more graduates from vocational senior high schools to take advantage of their technical skills, at the cost of a lack of general knowledge, or more from regular senior high schools to take advantage of their better basic knowledge and flexibility in adapting to changing technology deserves careful study.

When a country is getting rich and has more resources available for investment after a certain number of years of rapid growth, the time has come to consider allocating a higher percentage of resources to higher education. Too many college graduates may cause difficulties in employment at the beginning, but in the long run some people will create their own jobs and others will adjust by lowering their expectations and content themselves with positions that in the past would have been considered low for them. The general level of the society in terms of education and culture is upgraded in the process. There will be an increasing number of people considering an increasing proportion of education as a consumption good rather than an investment good. In this way, a country spreads its performance from the economic sphere to the sociocultural sphere and becomes, then and only then, a developed country.

Technical Progress

Education is the basic source of technical progress. However, as the final source of economic growth, technical progress does not necessarily have to come from research and development. In a developing country, whose general level of technology is low, new methods of production and new products can be learned and adopted rather easily from developed countries. In this sense, developing countries have the "advantage" of less development. Developed countries cannot do this; since they are at the top level of technology, almost everything new has to be developed by itself. It is natural, therefore, that the cost of technical progress is higher in developed than in developing countries. This "advantage" of less development helps explain why certain developing countries have performed better than developed countries in terms of economic growth in recent years.

Of course, a country cannot pick up technical progress from easy sources forever. Domestic capability for research and development has to be built up as the economy progresses. Enterprises in developing countries are often criticized for not doing, or not knowing how to do, research and development. And governments are often tempted to require enterprises in both the public and the private sectors to undertake R&D, or to allocate a certain percentage of total sales (or some other reference figure) for the purpose of R&D. However, if there are easy and inexpensive ways to make money, why should firms adopt expensive, uncertain, and sometimes even unnecessary ways, with which they may not be familiar? Businesses differ widely from one another. It is difficult for one general rule to apply to all firms as far as R&D is concerned. In planning technical progress and R&D, it may be useful to recall the basic principle of economics that incentive systems are always preferable to forceful, quantitative measures.

6—
Stability and Equity

It is often argued that price stability and economic growth conflict with each other, and that growth and equitable income distribution are also conflicting. Both arguments require clarification. The trade-off between the rate of growth and the rate of inflation is essentially a short-run relationship. In the long run, sacrificing price stability does not benefit economic growth. On the contrary, countries that suffered from serious inflation have seldom achieved significant performance in terms of growth. This is because in the long run, economic growth is a supplyside phenomenon, but inflation is mainly a demand-side monetary problem. In the short run, excessive demand causes both the price level and the growth rate to increase. But in the long run, economic growth results from real technical, economic, and sociocultural factors. Inflation discourages saving and productive investment and consequently is harmful to long-term economic growth.

Theoretically, development planning works better in the area of maintaining price stability than in other areas of development. All the government has to do is to manage the aggregate demand by means of monetary and fiscal policies so that it does not exceed the aggregate supply. But in reality it has been difficult for many developing countries to avoid budget deficits and rapid increases in the money supply. Therefore, this is not a problem of development planning, but rather a problem of implementation of the plans.

Whether rapid growth and equitable distribution of income conflict with each other depends on the definition of equity and on the government policies adopted to improve income distribution. Imposing high marginal rates on personal income tax as well as on corporate income tax in order to improve uneven distribution weakens incentives to work and to invest, thus reducing growth rates. In recent years, ideas regarding equitable distribution have been changing toward emphasizing improvement in the living standard of the people at the bottom of the distribution rather than taking away incomes from those at the top.

Taiwan adopted one particular industrial policy that has had a significant side effect on income distribution. Manufacturers were induced to establish their factories on industrial estates throughout the island, near the sources of the supply of labor, rather than concentrating in cities. This has the following advantages:

(1) There is easy access to workers, resulting in rapid increases in employment and growth without causing rapid increases in the wage rate.

(2) More people remain living in rural areas while taking jobs in nearby cities and the urban problems that often occur in the process of rapid industrialization are therefore reduced.

(3) The chances of cost-push inflation caused by large increases in the wage rate owing to rapid expansion in employment are reduced.

Taiwan was able to adopt this industrial policy because of its very well developed transportation and communication systems. Few areas on the island cannot be reached with modern means of transportation and communication. This has enabled Taiwan to achieve relatively balanced development between different regions and between urban and rural areas compared to many other developing countries. Since the main source of income of the rich is capital and that of the poor is labor, rapid increases in employment and in the real wage rate (as a result of rapid increases in labor productivity) have been the major factors that helped improve Taiwan's size distribution of income.

Social welfare programs have long been relied upon as a means of improving the well-being of the economically weak. Although strengthening social welfare programs is an increasing demand in developing countries, and many development plans have included social welfare schemes as an integral part, it is important to keep in mind that every dollar that goes to welfare could be used for productive purposes, and that the col-

lection of an additional dollar through progressive income tax, as is usually the case, reduces the incentives to work and to invest. So the key issue of planning in social welfare is how to allocate scarce resources between investment and welfare in order to balance growth and equity. For a rapidly growing economy, increases in the real wage rate and expansion of employment would help solve many of the poverty problems that would otherwise call for welfare programs.

Another thing about welfare that is important and worthy of note is the substitutability between government programs for social welfare and private responsibility. In a traditional society, the family is the basic unit of social security. The family serves the functions of health insurance, unemployment insurance, retirement, and old age care. The more a government does to provide social welfare, the less private responsibility will be. From the private point of view, it is nice to have a comprehensive social welfare system taking care of all anxieties. But the negative aspect is that incentives to save, invest, and work hard will be weakened.

So, while a social welfare system is important for helping to improve income distribution and provide social security, a critical consideration in the early stages of development is whether an additional dollar should go to productive investment or to equitable income distribution. When the economy becomes richer, a major consideration is the choice between incentives to saving, investment, and hard work on the one hand and social welfare and equity on the other. These, however, are questions more of value judgment than of economic calculation. As an economy progresses, welfare expenditures as a percentage of the GNP usually increase. Many developed countries have come to the point where the percentage is so high that people have begun to wonder whether it should be reduced in order to give more incentives to economic growth. This is not yet a relevant question for most developing countries.

7—
Concluding Remarks

Modern articulated comprehensive development planning for mixed-market economies owes its origin to Keynesian economics, which is fundamentally a theory of demand management. Although development of econometrics and growth modeling has helped make medium-term development plans more and more sophisticated, the basic framework of the plans is still demand-sided. But economic growth is in the long run a supply-side phenomenon. Planning affects long-run growth only when

factors on the supply side are affected. Although medium-term planning has been extended to cover manpower, education, and sociocultural, institutional, and even environmental aspects of development, the core of almost all medium-term plans remains an aggregate demand management model formulated with simultaneous equations consisting of only economic variables. An economically sound development plan may not help long-run growth very much if the factors responsible for growth are left unaffected. There are three major functions that an economically sound medium-term plan may have:

(1) Prediction of aggregate growth targets such as the GNP growth rate, the rate of saving and of investment, the government budget, and the balance of trade and balance of payments. However, econometric models constructed mainly from the demand side work better in the medium term than in the long run. In the very long run, investment and the stock of capital are insufficient to predict growth potential. In predicting growth potential in the very long run, economists are no better, though no worse either, than experts in science and technology.

(2) Evaluation of major investment projects. Projects that are technically feasible may not necessarily be economically justifiable. Developing countries that are too ambitious and apply advanced technology to production, ignoring comparative advantages and market conditions, often retard, rather than foster, economic growth.

(3) Coordination of macroeconomic policies to avoid inflation and conflicts of objectives.

Realizing that economic growth involves more factors than just economic variables such as saving, investment, and employment, development planning should also take into consideration education, science and technology, research and development, manpower, and social and cultural factors. Market forces should be respected. Flexibility in implementation of development plans should be provided in order to allow for changes in external conditions and inadequate knowledge on the part of the planners.

At its present level of sophistication, good (from a purely economic point of view) development planning still does not assure rapid economic growth. Even growth models of the highest standard, neatly designed at the forefront of the science of economics, may not help growth in the real world very much, since the final sources of growth are not

areas with which modern economics is accustomed to dealing. But without adequate planning, the growth rates realized will certainly be short of their potential.

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