Economic Development - State Intervention

Author: Geoff Riley Last updated: Sunday 23 September, 2012

Introduction There are several examples of countries that have built development policies where the public / state sector is given a greater and growing role in sustaining economic growth and rising national wealth. Brazil The Brazilian government has established development programmes where active state intervention is seen as crucial to achieving inclusive growth. In 2009 the former President Lula da Silva was quoted as saying:

If the global financial crisis put any development model on trial, it was the free-market or neoliberal model, which emphasizes a small state, deregulation, private ownership, and low taxes. Few developing countries consider themselves to have fully adopted that model.
Some elements of their programme include: Direct intervention in the currency markets to prevent the Brazilian Real from appreciating and making Brazilian industries uncompetitive in world markets Strong regulatory control of their banking system and controls on capital flows in and out of Brazil A targeted industrial policy picking likely winners in emerging industries and subsidising them) Conditional cash transfer policies as part of their welfare system Ha Joon Chang

Development used to be about the transformation of the productive structure and the capabilities that support it, and the resulting transformation of social structure (e.g., oil-rich countries, Germany after WWII) Now, development is about poverty reduction, provision of basic needs, individual betterment, and the sustenance of the existing production structure
South Korea South Korea is one of the most notable development success stories of recent times it has made impressive progress in escaping the middle income trap and becoming a highly successful member of the OECD. Their development policies have moved away from the standard Washington Consensus model.

Ha Joon Chang from Cambridge University has written extensively about the South Korean development model. Ha Joon Chang is known as a heterodox economist who challenges conventional views on policy for example in the areas of trade, macro policy and industrial policies. His main argument is that the South Korean development miracle was achieved under policies that combined the market with a high degree of government involvement. Indeed he argues that there is no such thing as the free market and that most countries including the USA and the UK relief heavily on active state intervention and industrial policies when they were in their fast-development stages. From South Koreas experience he picks out some of the following features: Bolivia Bolivia has chosen a development path that involves partial re-nationalization of businesses / industries that had formerly been privatized. The aim is to keep in government hands the revenues and profits from extracting natural resources. Nationalization has taken place in hydrocarbons, electricity generation and transmission, telecommunications and smelting. In December 2012 for example, Bolivia nationalized two electricity distribution companies owned by Spanish utility Iberdrola. The danger is that ad hoc nationalization of assets will frighten off future private sector foreign investment because of the high risks of state appropriation of private wealth. Argentina State Interventionism and Protectionism to achieve Growth Extensive use of selective industrial policy actively looking for growth potential industries Combining protectionism with export subsidies especially in the early stages of growth Tough regulations on foreign direct investment moving away from the free flow of capital Active but selective use of state-owned enterprises

Argentinean President Cristina Fernandez leads a left-wing government prepared to use unorthodox policies and frequent use of state-intervention to achieve economic and political goals. Argentina is a relatively isolated country because of her politics although it has been accepted into the Group of 20 leading economies. Here are some examples of state intervention in Argentina they represent aninward-looking growth and development strategy. Argentina has a managed floating exchange rate policy designed to keep the peso competitive There is high state spending on subsidies including energy supplies to households. A conditional cash transfer programme for low-income households, similar to Brazils Bolsa Familia aims to cut extreme poverty The government nationalised private pension funds in 2008 The central bank funds state borrowing for example there is the use of billions of dollars in Central Bank reserves to service interest payments on the National Debt In 2011, the government introduced currency controls to stop capital flight The government decides on annual corn and wheat export quotas In 2012, Argentina shocked European businesses and governments by seizing shares of the Spanish firm Repsol that were held in the Argentine energy company YPF A new law limits land sales to foreigners A 15% tax on the use by Argentinean citizens of credit cards in foreign countries Commercial banks are obliged by law to lend to local businesses at favourable rates with a negative real interest rate Argentina now requires importing businesses to sell something anything to foreigners worth as much as what they buy from them. The state is forcing Argentinean insurance companies to invest some of their funds in production and infrastructure projects to boost sluggish economic growth. Resource Nationalism and Development The Rise of Resource Nationalism Resource nationalism has become a contagion impacting the mining & metals industry across the globe. The industry needs to become more engaged in the analysis and management of this risk which can place a heavy burden on existing operations and influence future decisions on where to invest. Andy Miller, Global Tax Leader Mining & Metals, Ernst & Young Examples of Resource Nationalism in Action South Africa (Coal and Platinum) 50% windfall tax on super profits 50% capital-gains tax on sale of prospecting rights

Ghana (Diamond and Gold) 35% company tax 10% windfall tax on super-profits 5% royalties on output

Australia (Iron Ore, Nickel, Coal) Government plan to implement a Mineral Resource Rent Tax (MRRT) on iron ore and coal. Set to raise $8bn a year.

Peru Copper Use it or Lose it - With a fall in commodity prices companies tend to have lower capital expenditure which can lead to a revoking of their license Since the financial crisis of 2008 many countries have struggled to maintain manageable budget deficits as their economies contract. With revenue down from reduced economic activity and increasing expenditure on items such as social welfare, governments around the world are either tightening their belts or finding new sources of revenue. In a number of producer nations, concerns over Dutch disease or two-speed economies have led to plans to tax resource extraction more heavily, and provide tax relief or subsidies to other sectors. The Dutch Disease refers to the fact that once countries start to export oil or other natural resources their exchange rate appreciates making other exports uncompetitive and imports cheaper. At the same time there is gravitation towards the natural resource industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports. Those that have natural endowments such as minerals and other commodities have been continually assessing how they can acquire more revenue from these resources. This could be done by various means taxes, royalties or full-scale state-ownership however they need to be vigilant in that significant charges to overseas companies might inhibit foreign direct investment (FDI) which is crucial to many countries that have plentiful natural resources. Furthermore the initial capital investment in mining, etc., is usually substantial and governments have to be careful not to implement drastic revenue-making means that curtail further investment. This is especially common when you consider the volatility of commodity prices and the cyclical nature of the mining sector. In 2011 accountants Ernst & Young identified at least 25 countries that increased or intended to increase government revenue by taxing those companies involved in the commodity industry. On average at recent commodity prices these increases have raised the average effective tax rate by approximately 5%. According to their research, nationalism

places a large cost burden on mining and metals companies and can influence the decision of where to invest in a particular country. Today Governments are searching for new ways to extract more out of foreign-owned firms that are doing very well financially from what lies beneath the soil. Those countries that are prepared to implementhigher rents and taxes on overseas mine companies run the risk of the loss or the reduction in some long-term investments. Although existing mines are not mobile the level of extraction, reinvestment, and expansions are and the temptation to divert resources to another country are highly plausible when you consider the mobility of capital resources. A lot of this depends on high commodity prices which encourage the exploration of potential sources of commodities. However, with lower prices and increasing government fiscal demands there is the possibility that capital investment will be fleeting.

Source: Mark Johnston, EconoMax, March 2012