PLANNING PARADIGM
Planning vs the Market and the Role of Govt.
Dang T. Tran, Chair and Professor, Department of Economics & Statistics, College of Business & Economics California State University, Los Angeles 1/1/2011 2:28:15 AM
Let's discuss the prerequites of a planning system at first. In a planning system, an ideal structure is set up as follows:
1. Long-term perspective planning.
2. Medium-term plans.
3. Sector programs and projects.
4. Policy framework.
5. Annual planning and the budget.
6. Plan for the private sector and the working of the financial infrastructure.
7. Planning in the individual states
or provinces.
8. Problems of implementation in some critical areas.
9. Plan evaluation.
In a long-term perspective of 15-25 years, broad national long-term objectives are laid out, such as to advance from $300 per capita GDP to $2,000 in about 25 years or to lower poverty rate in rural areas from 40% to 20% in 15 years, or to raise manufacturing ratio in GDP from 10% to 20% in 15 years. They represent the aspirations of the country to achieve better material life in a set time period given the resource constraints. A set of broad guidelines for a 10-15-year period outlines a development strategy, pointing to broader objectives and priorities, and reflecting the broad structural changes that are necessary in this period. These objectives will be implemented in successive medium-term plans of 4-7 years (mostly 5-year 
plans but the number of years depends on the elected President’s term in office). They provide an overall economic framework consistent with the guidelines, to help maintaining some internal and external balance in the economy. The medium plans could contain plans, policies, and programs in selected sectors and an elaboration of financial requirements. They could provide some measures for mobilizing resources; estimates of saving and investment, exports and imports, current and capital government expenditures; forecasts of financial resources; an elaboration of fiscal and credit policy; and measures to develop proper financial institutions. The medium plans spell out details in what to be done, what to be produced, how much to be produced, and how they are to be produced, given the resources available. The plans would include projections of real GDP growth and growth of various sectoral outputs. Output targets of most essential commodities such as food, electricity, construction, infrastructure (physical, financial, and institutional), education, exports, and imports are given. It is here that sector programs and projects are needed to meet the targets. A list of projects with appropriate feasibility studies has to be made and funding methods must be analyzed.
To implement the five-year plans, annual plans are designed in such a way that there is a link between material production requirements and monetary and fiscal policies. The government has to adopt a consistent stabilization policy and a macroeconomic environment conducive to production programs to achieve the annual targets. There are many difficulties in implementing the projects, but annual planning itself is an appropriate mechanism for ensuring proper implementation. In many developing countries, the government plays an important role as it establishes and owns many corporations. In many cases, these corporations are privatized to promote efficiency and to relieve the public’s financial burden. Infrastructure projects (such as roads, highways, transportation systems, fuel, water and power, communication systems, schools, health care systems, etc.), which have enormous social benefits but low private benefits, have to be undertaken by the government. Their funding comes from the budget which necessarily involves either domestic tax revenue, bond issuing, foreign aid, foreign loans and debt servicing. The budgetary decisions should reflect the annual plans. The five-year plans could call for foreign investment in certain industries if domestic sectors lack technological or financial capability.
A crucial element in planning is the question of resources. They refer to not only finance, but also manpower, key materials, and institutions. The question should address training of personnel at different management levels, forecasts of imports and exports of some key commodities, and administrative and institutional reforms which include passing of necessary legislation to facilitate the efficient working of the labor and product markets.
The five-year plans also discuss the role played by the private sector in implementing the plans and how the government is going to help it attaining its own plans. They outline how the government is to carry out sectoral dialogue with the private sector and what sort of arrangements necessary to ensure that the relationship between the two is undertaken in an orderly and informed manner, and that decisions resulted from this dialogue are expedited.
An important aspect of development is to strengthen the efficiency of financial infrastructure to mobilize savings and lending to those investors who need them. There may be a need of both quantitative expansion and qualitative improvement in the lending operations. There should be a close link between financial institutions’ policy and government operations, between government’s credit policy and policies of financial institutions.
In a large economic system with political federation like India, there is a need for better planning and coordination of various development activities at the state or provincial level. Better information can be provided through the state plans or regional plans. An administrative office could be set up to provide whatever help to states with regard to their implementing the five-year plans and annual plans.
Plans’ evaluation is relatively easy since projections and targets are clearly specified in the plans. The main question is to find out where the problems reside. The most difficult problems frequently are in the project implementation. The first serious obstacle is created by lack of clear objectives and purposes and by missing baseline data for measuring achievement. Then, there is a problem of insufficient project appraisals and technical studies. This leads to delay and overspending. Finally, there is an imperfect coordination between various government units to follow the plans, particularly between agencies responsible for macroeconomic policies and those implementing the sectoral programs and projects at the micro level.
Difficulties Associated with a Planning System
It goes without saying that the system outlined above to be successful requires an enormous amount of skilled manpower and an efficient administrative structure, both of which are wanting in most developing countries. An extreme case in which prices of thousands of products were set by the government, as in the Soviet Union before its collapse in 1989, shows the impossibility of totally planning and controlling a diversified economy. It is well-known fact that quantitative planning in Soviet Union, in which there was no place for the market to work, led to corruption, inefficiency, waste, and consumer dissatisfaction.1
A planning system mentioned in the first section doesn’t have to be close to the Soviet model. However, the prerequisites for even a less-than-total planning system are still hard to meet. This has been shown by the abandonment of the planning system in the developing world. Many of them now only follow a general guideline system without a detailed plan suggested above. Let’s us cite a number of overriding difficulties.
As is well-known, a worthy development plan now puts less emphasis on growth but more on human development, i.e. development refers now to not only the development of countries but also development of persons. Economic growth as measured by real GDP growth is just one among many development indicators. It measures growth in living standards. But there are others such as longevity (a proxy for health and nutrition) which measures life expectancy, and education measured by the number of school years. The three measures of living standards, longevity, and education are included in the United Nations Human Development Index (HDI). We could rank the countries in terms of how high or low in HDI. The trouble is that this HDI is still inadequate. It does not include unemployment, poverty, and income distribution. It has been observed that there is no necessary connection between GDP growth and improvement on unemployment, or on poverty, or on income distribution.
Many countries with fast economic growth also have higher unemployment rate and poverty rate. As to income distribution, it tends to increase during the first phase of economic development and decrease during the later phase. For instance, the gaps between the richest 20% of the population and the poorest 20% in Brazil, India, Indonesia, Mexico, Thailand have risen during 1980s and 1990s. It is expected that once the GDP per capita passes the per-capita income threshold of the developed countries, these measures will decline to the level comparable to those of the more-developed countries. However, some segments of the society might not realize this trend and become impatient in the face of economic growth. For instance, the younger generation in Korea now grows restless and demands a more equal distribution of income. Thus, despite the general validity of the inverted Kuznets curve of Gini coefficient in relation to per- capita GDP, for some country, to prevent social instability, care must be taken to address the distribution question in the early phase of economic growth.
A planning system whose goals are broader than simple GDP growth faces more uncertainty as it has to deal with more variables which are not easily measured. These variables may not be purely economic but social or political in nature such as health care, education, income distribution, or even freedom. Once we define development not simply as economic development but also as human development, the problems of planning envisaged in the first section become intractable. Thus, the more we are concerned about non-economic objectives, the less the planning system becomes manageable.
Benefits of a Market System and the Role of Government
It has been generally acknowledged that, during the past fifty years, the socialist model of development has been a total failure.2 A system driven by dominating egalitarian principles offers no incentives for people to work and to produce to their utmost capacity. A minimal production incentive yields minimal output. On the other hand, a system which rewards efficiency and diligence and punishes inefficiency and indolence will generate ample output and creativity. To work hard is an individual decision based on the freedom of choice which must be motivated by appropriate material rewards. The market system provides the best motivating system as regards to work, entrepreneurship, risk-taking, production, and innovation. An economically free market economy with open trade stimulates the development of technological capabilities and innovations which engender industrialization and growth in manufactures exports. The same one with institutions that protect private property, promote transparency in government, and ensure individual liberty, works better than the one with the state planning. This does not preclude the necessary government intervention in the case of market failures or protection of infant industries, or adopting necessary policies that would promote human development. What we mean by “working better” we mean the achievement of the goals laid out in the second section, namely the development not only of countries but also of persons and their creative talents. In the following, we list the major areas that the government can do to boost the economy.
Free market system implies open trade system which facilitates growth. Many Korean economists now regret that Korea did not open its ports sooner to expand trade when it first embarked on industrialization process during 1960s.
Most jobs are created by the private sector rather than by the government sector. Within the private sector, small businesses offer more employment than the large firms. Thus the government should make it easy to open a new business. In China today it takes a few days to open a business. In Hong Kong which ranks first in the Economic Freedom of the World Index, it takes about five hours. In India, in the past, it might take years to expand a business. This red tape and bureaucracy slow down employment growth and breed graft and corruption. Microfinance should be promoted and given aid by the government to foster independent self-employed businesses.
In general, there are two fundamental problems associated with underdevelopment: insufficient knowledge about technology (know-how) and about attributes. Examples of technical knowledge are computer chip fabrication, business management techniques, software engineering, accountancy, and nutrition. Knowledge about attributes, such as the quality of a product, the diligence of a worker, or the creditworthiness of a firm or a borrower, is crucial to effective markets. Information is the lifeblood of markets. Incomplete knowledge of attributes lead to market failures and impede efficiency and growth. Developing countries can reduce insufficient knowledge of attributes by establishing standards and certification through the governments, private organizations, laws, or social norms. Development requires an institutional transformation that improves information flows and creates incentives for work and enterprising effort, innovation, saving, and investment.
The government can close the knowledge gaps between the less-developed countries (LDCs) and the more-developed countries (MDCs) by (i) absorbing knowledge through universal basic education and tertiary technical education; (ii) acquiring knowledge through open trading system, foreign investment and foreign licensing; (iii) communicating knowledge to the economic agents by using communications technology as well as through increased competition, private sector provision, and appropriate regulation.
Technical knowledge can be raised by “learning to learn” new technologies. A developing country needs to build learning capability by investing in new skills, technical information, organization methods, and international connections. This costly learning process is part of the development of technological capabilities at the firm level and the national level. Technological capability is defined in terms of physical investment (plants and equipments), human capital (education and training), and technological effort (e.g. facilities to promote research and development). At the firm level, capabilities should focus on investment (identify, prepare, design, obtain technology for, construct, equip, and staff plants), production (process optimization, quality control, operation, maintenance, inventory control), and linkages (procurement of inputs and raw materials, absorbing/providing technology from/to input suppliers, subcontractors, consultants, service firms, etc.). At the national level, the government should provide appropriate macroeconomic incentives (interest rates, exchange rates, development funds, etc.), incentives to promote healthy domestic and international competition, incentives to foster flexible and efficient factor markets. It is the interplay between appropriate incentive structure, capabilities, and institutions that determines the industrialization success.
The government plays a critical role in reducing the uncertainty created by lack of rules. The government should provide a framework of clear-cut general rules for doing business as well as resolving conflict in a free-market setting. It should not favor any industry by special subsidies, tariffs, quotas, or other non-tariffs barriers. Nevertheless, in its early phase of economic development, a LDC may protect infant and strategic industries to be developed based on its resource endowments. Coordination failure induced by externalities calls for government intervention to organize private entrepreneurs into investments that they might not otherwise have made.
More importantly, the government may take the lead in providing technological development. The best example is given by Korea which is the most technologically capable among the East Asian newly-industrializing countries (NICs). Korea followed the footstep of Japan by fostering giant local private firms, the chaebol, which were given the mission of spearheading the industrialization drive, just as the Japanese counterparts, the keiretsu, once were. Korea selectively encouraged activities and firms via credit allocation and subsidization. It provided technology financing in the form of both grants and subsidized loans which were directed by the government to specific activities or firms. Just as Japan in the old days, foreign direct investment in Korea was severely restricted and only permitted when it was the sole way of obtaining the technology or gaining access to world markets. Thus it relies primarily on capital-goods imports and technology licensing to acquire technology. The other successful model among the NICs as opposed to the Korea-Japan model is Taiwan’s in which medium-size and small firms were promoted by the government. However, both Korea and Taiwan adopted the Japan's "guided capitalism" in which the government played a dominating role. The government laid down the rules of the games and firms competed within the rules. Just as there was a close cooperation between industry, banking, and government sectors in Japan, the same was found in Korea and Taiwan.
Finally, the government should be proactive in providing an institutional and macroeconomic environment conducive to human development. The institutional environment comprises of both soft and hard infrastructure. The hard infrastructure includes roads, railways, seaports, airports, communications network, educational institutions, and basic health care systems. The soft infrastructure covers formal and informal institutions such as a fair legal system, a moral system, a democratic political system, and a social system which ensures mobility among different groups. In addition, the government should protect freedom and democracy and consolidate them with considerable citizen participation; it should ensure property rights and enhance human capital. The macroeconomic environment should exhibit stable price, output, employment, and disciplined fiscal and monetary policies. All of these aim at supporting a quality of life for citizens. In this overall environment setting, the policy conduct should be carried out with transparency and integrity. Correct strategies and policies are essential to development success.3
New Role for the Planning Commission
From the discussion above on the difficulties of a planning system that has non-economic goals, it can be seen that the main problems lie in the implementation at the micro level and coordination at the policy level. The implementation could be successful for certain goals such as health and education as in the case of socialist Cuba. However, its exclusive emphasis on health and education requires an enormous commitment by the government at the expense of other goals. Ninety-nine percent of the Cuban labor force is employed by the government. This means that the government is able to put a tight control on the population. But without freedom it is hard to stimulate innovations and entrepreneurship. Cuban leaders now realize that without the private sector, it is impossible to develop the country. As a result, the government plans to lay off seventy percent of its workers. It demonstrates once again that even a die-hard socialist system will eventually crack under the weight of excessive government control. Traditionally, the LDCs have invested a disproportionally large amount of spending on education but a relatively small amount in health care. The government may try to balance this by increasing the expenditure on health care. These two services generate large enough externalities to justify the government intervention. However, let the market take care of goods-producing sectors unless some of them are classified as infant industries needed to be protected from international competition.
Given this framework, there is little role for a planning commission initially charged with supervision of a traditional planning system. Its continued existence is justified by its new function of laying out the long-terms goals and strategies for the nation. Based on this, they will provide studies and suggest appropriate policies to achieve these goals without any detailed five-year or annual plans. An illustration will suffice. For India, domestic consumption is more important for its economic growth than China which relies more on exports. The question for interest rate policy is whether interest rate should be low to encourage consumption and/or investment. Thus a study should be made on elasticities of consumption and investment with respect to change in interest rate. Recently, Korea faced a decline in exports due to the global recession, it needed to boost either domestic consumption or investment. Studies by all Korean research institutes indicated that interest elasticities of consumption were near zero while domestic investment was more elastic with respect to interest rate. The Korean Central Bank ultimately decided to lower main interest rate to near zero percent to encourage investment. This strategy worked by raising investment thereby preventing Korea from suffering a great recession as many other nations did.
Since there is no planning per se, the name of Planning Commission is no longer appropriate. Now, it plays more of a role of an advisory council (say, National Advisory Council) but with a power greater than any Ministry because, after some debates, whatever it proposes the Ministries and the Central Bank should implement.
End-notes and Additional Thinking
1 Tran, Dang T., Vietnam: Socialist Economic Development, 1955-1992, Country Studies Series No. 12, International Center for Economic Growth, San Francisco, April 1994.
2 An example of the failure of a typical socialist model, see Tran, Dang T., "Lessons From the Socialist Experiment in Vietnam," The Social Engineer, 4, No. 1, January 1995, 8-15.
3 For more detailed analysis of what the LDCs should do to promote growth, see Tran, Dang T., “Globalization and Growth of Developing Countries”, in Khi V. Thai, Dianne Rahm, and Jerrell D. Coggburn, Eds, Handbook of Globalization and the Environment, Boca Raton, Florida: CRC Press, 2007, 491-525.
(Dang T. Tran is Department Chair and Professor of Economics & Statistics at California State University, Los Angeles, U.S.A. He holds a Ph.D. (1977) and M.A. (1976 ) in Economics from the Maxwell School of Citizenship and Public Affairs, Syracuse University, New York, and a B.Ec. (Hons.) (1968) from University of Western Australia, Australia. Having taught at Utica College of Syracuse University and the University of Baltimore, Baltimore, Maryland, he has published extensively in various professional journals such as Journal of Regional Science, Eastern Economic Journal, Applied Economics, and Economia Internazionale/International Economics. He is an Associate Editor of Indian Journal of Economics & Business and on Editorial Board of Asian-African Journal of Economics and Econometrics. He was Chief Economist for Ministry of Planning and Development of the Government of South Vietnam. He also has consulted for the World Bank.
The views expressed in the write-up are personal and do not re?ect the official policy or position of the organization.)
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