Critical Appraisal of Market-led Economic Approaches: Reality vs

Perceptions
Written by Siyaduma Biniza
1

Neoclassical economics is a predominant orthodox position of economics and this form of
understanding the social reality and its method of analysis has extended its influence in
debates where heterodox positions have managed to claim the space. One such area of
economics is industrial policy. Industrial policy, even though this is a heterodox
prescription, has been influenced by mainstream economic views in its methodology which
has had an impact on the framing of the debates and the conception of industrial policy.
In this essay I examine the theoretical foundations to some of the debates on industrial
policy, the assumptions, the proposed theoretical mechanisms and their validity. Then I
consider the case of South Africas automotive industry and the Motor Industry
Development Plan before making conclusions about the impact of neoliberal economics on
the key debate and our understanding of the role of the state.
In this paper, I argue that market-led approaches to development and growth have not
broken from the methodological tradition of neoclassical economics even though they
purport to be critiques that undermine the assumptions of neoclassical economics. This
has resulted in a narrow understanding of the role of the state. And the influence of
neoliberal economics has also affected the conception and purview of industrial in such a
way that industrial policy has been reduced to trade policy and co-ordinating investment.
The dominant economic paradigm, neoclassical economics, is largely the result of an
academic evolution known as the Marginalist and Formalist Revolution. Significant
contributors in this revolution are Walras, Jevons and Menger whose work contributed
towards the de-historicising, de-politicising and de-socialising economics; and the
introduction of methodological individualism and mathematisation of economics (Milonakis
& Fine, 2009; Blaug, 2003). Consequently economics evolved from the methodologically
holistic and inductive conceptual underpinnings of political economy and became
deductive, mathematical and underpinned by a foundational principle known as
methodological individualism. Methodological individualism is the assertion of the pre-
eminence of the agent over the structure in defining society and human behaviour;
making the structure, such as society, an aggregation of individuals (Milonakis & Fine,
2007). This revolution also resulted in an academic distinction of the economic and non-
economic. The non-economic refers to historic, political and social considerations which
do not impact the rational decisions of the self-interested-utility-maximising individual
who is only concerned with expected utility according to neoclassical economics (Fine,
2010).

1
Corporate Strategy and Industrial Development Research Programme, University of the
Witwatersrand, Johannesburg, South Africa and masters fellow at the Public Affairs Research
Institute and Economic Research Southern Africa.


siyaduma.biniza@students.wits.ac.za www.Scribd.com/siyabiniza | www.Linkedin.com/in/siyabiniza
As a result, the economic is solely concerned with individual behaviour and choices which
are defined as individualistic-utility-maximising. A consequence of this, as contributed by
Walras, neoclassical economics asserts the existence of perfectly competitive markets
which clear since the actors are rational, individualistic-utility-maximising agents with full
information which is supposed to result in the most efficient outcome (Milonakis & Fine,
2009). In simple terms, individuals can find anything they want in the markets and all
goods that are demanded will be met by concomitant supply. But this precludes inefficient
market outcomes, market failure and non-existence of markets which is common feature
of economics. And various ways are deployed to use the economic and non-economic in
explaining market failure. Therefore, it is argued that information imperfections hinder
perfect functioning of markets thus explaining market failures (Stiglitz, 2002). On the
other hand, as might be clear from the economic and non-economic distinction,
neoclassical economics cannot explain the existence of the non-economic which is lumped
up and given the description of as institutions which are aimed at assisting markets
function perfectly by reducing transaction costs (North, 1993).
Efficient outcomes of markets depend on various assumptions about individual behaviour
and the nature of market which depends on perfect information according to neoclassical
economics (Varian, 2010). Therefore it is argued that informational asymmetries mean
that markets are no longer perfectly competitive which means information is important to
understanding inefficient outcomes of markets (Stiglitz, 2002; Stigler, 1961). The
implication of this is that equilibrium can exist even if it is not efficient so markets do not
always clear or that market do not always exist (Akerlof, 1970). This is therefore a critique
of the mainstream neoclassical theory which makes the neoclassic-type markets an ideal.
Another critique of neoclassical economics is that markets are not perfectly competitive,
and that when markets have high transaction costs institutions become important to
restore markets and ensure they function as perfectly competitive as possible. The
implication of this is that whenever there are transaction costs institutions, or the non-
economic, will make rational sense because they reduce transaction costs allowing for
perfect functioning of markets (Coase, 1960).
Theoretical Challenge: Methodological Acquiescence to the Critiqued Subject
Institutional and the informational critiques of mainstream neoclassical theory are not
opposed to the methodological foundations of neoclassical economics even though both
argue for the significance of the non-economic which has been excised in neoclassical
economics. Even though the theory about informational imperfections can be understood
as a critique of neoclassical economics assumption of perfect information and its
implications, it is not a methodological shift but a mechanistic shift from neoclassical.
Moreover, the theory does not shed much light on how the non-economic plays a role
except that it is important for the economic. On the other hand the institutional approach
has been criticised for being a form of economics imperialism (Fine, 2000) because it
simply explains the non-economic in economic terms. The central argument is that the
existence and functioning of institutions is defined by the rational decision-making of
individuals in order to facilitate market mechanisms or remedy market failures. This
makes economics the central preoccupation of even the non-economic because the non-
economic is only explained in relation to the economic.
With regards to policy these criticism introduce a role for the state albeit a narrow role in
matters pertaining to the economy and ensuring perfect functioning of markets.
Therefore, the state has a role in reducing information asymmetries in order to allow for
Pareto efficient outcomes or to allow for the existence of markets that would otherwise
be non-existent (Stiglitz, 2002). The alternative is that the objective of the state is by
default the reduction of transaction costs and aiding in the perfect functioning of markets.
Nevertheless this common policy proposal is very different from that of neoclassical
economics which asserts that the state would either be obsolete or even detrimental
according to various strands of neoclassical economics (Pollin, 1998).
Policy Limitation: A Narrow Role for the State as Assisting Market Perfection
The role of the state in economic growth and development is a highly contentious area of
economics and international development. Efficiency the state is a major point of
contention and its development can be summarised into four eras, namely: the pro-state
interventionism era in the 1950s and 1960s, the Washington Consensus era which was
dominated by a preference of market-orientated policies and diminishing of state
intervention in the economy during the 1980s and 1990s, the re-emergence of the state in
the post-Washington Consensus era which sought to introduce effective state intervention
in the mid-1990s, and the developmental state which emerged in the 1980s and re-
emerged post-1997 (Fritz & Menocal, 2006). This shows the changing perception of the
role of the state and the gradual move from anti-state-interventionism towards effective
state interventionism.
Fine (2011) makes a distinction between old and contemporary development economics.
Old development economics was concerned with transformation of the economy from
traditional forms of production into modern forms of production (Hunt, 1989). In this
regard the modernist and structuralist schools were at opposing ends of the debate about
how the state could aid the economy by modernising it. Despite nuanced differences in
how development was said to occur, the central notion was that industrialisation is
important for development because it leads to the kind of transformation that is needed
for economic growth and development. Given unequal structural relationships an unequal
development amongst countries, structuralists recommended state interventions that
sought to undermine the structural relations between countries and promoted import
sustitution industrialisation as a mechanism of growth and development (Hunt, 1989). Thus
the role of industrial policy was to protect local industries from external competition to
assist in their development as was first pioneered by List (Fine, 2013). But investment was
seen as key to this transformation and key to economic growth in general.
There are a number of theorists who can be classified as part of old development
economics who focus on the impact of investment. Rostow (1953) focuses on the take-off
period, which is the period before a country reaches a point where economic growth is
automatic. He focuses on three stages of growth; the first long period, sets up the pre-
conditions for take-off, then there is the take-off itself and the second long period, where
growth is normal and fairly automatic. The take-off period is characterised by productive
investment, development of some substantial manufacturing sectors, a high growth rate
and the emergence of social, political and institutional frameworks (Rostow, 1956, p.
164). Rostow (1953: pp. 165-166) emphasises savings, productivity and structures that
encourage high marginal rates of saving and investment as important for takeoff. Lewis
focuses on the notion of unlimited supply of labour for the purposes of development and
like Rostow he also emphasises the importance of saving and investment (Hunt, 1989, p.
87). He also indicates the need for government institutions which is something that
reached its height in the Keynesian era.
The Keynesian model included government institutions as a response to market
imperfections and the notion of uncertainty. Keynesians argue that savings are a function
of income and that investments depend on expectations under uncertainty rather than
savings as the neoclassical economics frameworks would assert (Forstater, 2000).
Moreover, under imperfectly competitive conditions, even though the co-ordination
problem between investment and savings can be solved; involuntary unemployment would
still persist due to trade union bargaining influence (Amendola et al., 2004). Therefore
unemployment is a natural feature of capitalism because investment decisions are made
under uncertainty and also due to labour market conditions that drive up the cost of
labour. So Keynesians argue that markets do not return to full employment by themselves,
as the neoclassical assertions, and that unemployment is a characteristic phenomenon of
capitalism which requires the state in order to achieve full employment (Wray, 2011).
Thus, unemployment is a natural feature of capitalism due to uncertainty and business
cycle which necessitates government intervention to stimulate demand during slumps and
eliminate unemployment (Forstater, 2000).
Therefore, old development economics was focused on the role of the state in co-
ordinating investment to overcome market failures due to uncertainty. The central notion
was that capitalism is prone to failures which result in unequal development, due to
politically maintained and economically functional structural relationships or due to
inherent uncertainty. However, more recent development economics in the form of the
developmental state theory sought to emphasise both what was necessary for the state to
co-ordinate investment as well as to what end the state ought co-ordinate investment
towards (Fine, 2013). This was a concern of many post-colonial states.
Many post-colonial states have been driven by various interests, such as nationalism or
survival, to pursue high economic growth as a strategy for development. But the approach
to development has been driven by the intervention of governments and anomalous
fluidity between the military and public service, which is uncommon and sometimes
frowned upon in the developed world (Leftwich, 2000). Nevertheless, the results have
been mixed with resounding success in some East Asian economies that was unexplainable
and unexpected under the orthodox view of economic determinants of development; and
many failures in Africa and Latin America. This then led to the developmental state
concept, which sought to explain this Asian Miracle, and the emergence of the
developmental state theory as an attempt to formalise ideal conditions for development.
Policy Implication: The Falsely Perceived Policy Difference from the Mainstream
The developmental state theory asserts a particular list of characteristics that are integral
for a developmental state. These characteristics include: a strong politically-willed and
technocratic elite that can intervene in the market and co-ordinate private economic
interests in favour of national development goals, a civil society that can be subjugated
and a technocratic bureaucracy that can design and implement policies successfully
(Gainsborough, 2009). This requires a certain level of state autonomy from private
economic interests. But the developmental state should not just seek autonomy from the
private sector and civil society. Instead, the state needs to exercise embedded
autonomy to harness a mutually beneficial relation between private and public sectors to
ensure development (Meyns & Musamba, 2010: 13).
The idea of embedded autonomy asserts the necessity of interconnectedness between the
state and private sector to ensure a two-way flow of ideas and learning that benefits both
the state and private sector; and ultimately civil society through the provision of public
goods. Moreover, the relationship between the state and private sector should be such
that the state can insulate its nationalist interests from being veered by the dominant
economic interests of the private sector; whilst allowing the state to consolidate both
public and private interests in pursuit of development (Meyns & Musamba, 2010).
Although the developmental state discourse offers a useful theoretical focus on the
bureaucracy and elites in relation to development by offering prescriptions that emphasise
importance of an embedded autonomous and technocratic bureaucracy (Evans, 2008); the
discourse overlooks the current institutional contexts of developmental states and due
its restricted focus on developmental state successes the discourse cannot say much about
analysing failures or attempts at being a developmental state (Evans, 2008, p. 5; Fine,
2013, p. 9). Therefore industrial policy has become a highly contentious issue in
development economics.
In this regard, the South African automotive industry presents an interesting example of
strong industrial policy to support the industry despite what is often characterised as a
neoliberal economic environment. South Africa has successfully liberalised the automotive
sectors whilst offering a system of incentives aimed at promoting exports. However, this is
not with contradiction because the incentives have resulted in automotive assemblers
offsetting local content requirements with export volumes that could sustain stead
imports of automotive components instead of investing in domestic production and relying
less on domestic sourcing (Black, 2001; Masondo, 2003; AIEC, 2011).
The MIDP is a system of export incentives designed for domestic car and components
producers which enables substantial employment to about 33 000 workers in car
production and 47 000 in components and tyre production (Vickers, 2002). The MIDPs
success offers invaluable lessons because the MIDP has succeeded in attracting export-
orientated foreign investment which has had the most significant direct impact on
employment by providing new opportunities and operations that have integrated domestic
producers into global supply chains (Thomas et al., 2006; Vickers, 2002). However, there
are some challenges which relate to sustainability of the practice of off-setting local
content with exports under a regime of phasing down domestic tariff protection (Black,
2001; Zalk, 2013).
Policy Implication: Narrow Conception and Limited Purview of Industrial Policy
The case of South Africa is an apt example of the impact of neoclassical economics on
industrial policy. Industrial policy has reduced to trade policy or co-ordination of
investment in some economic sectors (Fine, 2011). As can be seen with this example, the
South African state has succeeded in co-ordinating investment to create some jobs and
increase exports. However, the sustainability of the industrial comes to question due to
the dominance of foreign capital in the industry and the sustainability of the practice of
increasing exports in order to reduce the cost of imported inputs through industrial policy
incentives in the context of increasing trade liberalisation and competition from foreign
automotive producers (Barnes & Black, 2013). Thus the objectives of industrial policy have
been reduced trade policy and co-ordination of investment.
In the South African automotive industry industrial policy was conceived narrowly as a way
to assist market functioning even though there was the hope that the MIDP would reduce
domestic producers and incentivise increased scales of production through its tariff regime
this has not occurred (Black, 2001; Black & Roberts, 2008). This highlights to the fact that
industrial policy was narrowly conceived without any consideration about skills, labour
markets and regulating finance which is an impact of neoliberalism (Fine, 2011).
Critical Appraisal of Market-led Economic Approaches: Reality vs Perceptions
Although these various theorisations of the state, from information theoretical and
institutional approaches, from old to new development economics question, undermine
and reject the assumptions of neoclassical economics they still promote the pre-eminence
of market-led models of growth. In addition, the theories have taken on the same
methodological foundation which has limited their conception of alternative solutions to
the problems they highlight. Moreover the different theorisations take for granted the
validity of this distinction between state and market. However, this distinction is neither
clearly distinct nor is it sufficiently problematized.
For example, the tacit acceptance of this distinction overlooks the fact that the
organisational power of the government hinders us from actually discovering the state by
limiting understanding political practice (Abrams, 1988, p. 61). Instead the state and
markets are taken as given as the basis for distinguishing aim that the state and market
compete against or co-ordinate towards, i.e. economic growth but with varying definitions
of what the aim is as it relates to development. Nevertheless, the impact of neoliberalism
can be felt in the conception of economics and development and upon closer inspection
the critiques of neoclassical economics have not completely disassociated and created any
methodological shift from the mainstream view.
The discourse on the state and development has been dominated by a conflation of the
separate matters of development, which relates to attainment of human potential, and
economic growth which relates to production growth and accumulation (Herring, 1999).
Consequently many case studies of attempts at the developmental state have been
classified exclusively according to their economic performance due to this conflation. But
this conflation has been challenged with the introduction of the human development
index, which is a measure that tries to consider both developmental and economic aspects
of state development. Despite this, the conflation is a persistent feature of the discourse
and it has influenced the way we analyse the success or failure of states attempts at
development. However, market-led approaches have brought about a new understanding
of the states relation to development and economic growth.
In the tradition of international development, development is primarily achieved through
the markets with the state as the primary driver or deterrent to the efficient functioning
of markets in order to promote development (Todaro & Smith, 2003). In other words, the
state has a deterministic role in development. Hence, in the context of market failure the
state is seen as the primary institution that can ensure the recovery of markets (Stiglitz,
2002); or a under kleptocratic authority the state is understood as being inimical to
development.
In this paper, I have argued that market-led approaches to development and growth have
not broken from the methodological tradition of neoclassical economics even though they
purport to be critiques that undermine the assumptions of neoclassical economics. This
has resulted in a narrow understanding of the role of the state. And the influence of
neoliberal economics has also affected the conception and purview of industrial in such a
way that industrial policy has been reduced to trade policy and co-ordinating investment.
However, even though this perceived shift from neoclassical economics and its
assumptions has had little changes in the methods employed and the policy
recommendation, the shift in views on the role of the state have led to the state being
understood as having a deterministic role in the direction of economic growth and
development.




















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