RIETI Report December 2006

Markets and Economic Development for Poverty Reduction

U2 lead singer Bono recently came to Tokyo for a talk with Prime Minister Shinzo Abe. But the topic of discussion was not music; it was official development assistance (ODA). Bono, well-known for his activism on issues such as poverty and AIDS, wanted to remind Mr. Abe of Japan's promise before and during the 2005 G8 summit in Scotland to boost its aid to Africa along with its overall ODA. Bono bestowed a pair of his trademark Giorgio Armani sunglasses on Mr. Abe who promptly tried them on; a look which Bono dubbed "very cool." The profits for products such as the Armani sunglasses go partly to AIDS programs as part of Bono's "Red" campaign. The singer praised Japan for its aid-giving generosity in the 1990s and efforts to tackle infectious diseases in Africa, and said he hoped the country would continue to take a global lead in that area. Mr. Abe in turn vowed to continue Japan's efforts to help the developing world.

However, aid money does not necessarily contribute to the improvement of poverty-stricken areas. Effective policies need to be developed and implemented. According to RIETI Faculty Fellow SAWADA Yasuyuki, no policy can be designed without an accurate understanding of markets. This month RIETI Report features Dr. Sawada's recent lecture on the causes of market failure, the relationship between communities and markets in developing countries, and how to design policies to overcome market failure.

RIETI Featured Fellow

Dr. Sawada is an Associate Professor in the Graduate School of Economics at the University of Tokyo. From 1999-2003 he served as an Associate Professor in the university's Department of Advanced Social and International Studies. Prior to teaching at the University of Tokyo, Dr. Sawada served as a visiting researcher in the Pakistan Institute of Development Economics and as a consultant in the Development Research Group of the World Bank. He received his B.A. and Ph.D. in Economics from Keio University and Stanford University respectively. He also earned M.A. degrees in Economics, International Relations, and International Development Policy from Osaka University, the University of Tokyo, and Stanford University respectively. Dr. Sawada's areas of expertise are theoretical and empirical analyses of developing economies and he has conducted extensive field surveys in South and Southeast Asia. His recent publications include: Shijo to keizai-hatten: Tojokoku ni okeru hinkon-sakugen ni mukete [Markets and economic development for poverty reduction in developing countries], Toyo Keizai, 2006 (co-edited with Tetsushi Sonobe); "Do Community Managed Schools Work?: An Evaluation of El Salvador's EDUCO Program," World Bank Economic Review Vol. 13, No. 3, 1999 (with Emmanuel Jimenez); "Secondary Market Efficiency of LDC Bank Loans and International Private Lending, 1985-1993," Journal of International Money and Finance, Vol. 20, No. 4, 2001; and "Exchange Rate Misalignment: A New Test of Long-Run PPP Based on Cross-Country Data," Applied Financial Economics Vol. 16, 2006 (with Pan A. Yotopoulos); and "The Determinants of Credit Access and Its Impacts on Micro and Small Enterprises: The Case of Garment Producers in Kenya," Economic Development and Cultural Change Vol. 54, No. 4, 2006 (with John Akoten and Keijiro Otsuka).

METI Journal, December 2006
Markets and Economic Development for Poverty Reduction in Developing Countries

SAWADA Yasuyuki
Faculty Fellow, RIETI / Associate Professor, Graduate School of Economics, The University of Tokyo

Importance of understanding "market failure"

Market economy refers to a world comprised of and based upon transactions. However, as evident from a series of business scandals such as the fabrication and use of earthquake-resistance data and the Snow Brand Milk Products Co. poisoning incident, only a fine line separates legitimate business transactions from fraudulence and cheating. Even in developed countries, government authorities find it difficult to crack down on these types of unlawful acts. Their counterparts in developing countries can find the situation beyond their control. Nevertheless, the market economy is somehow functioning in developing countries. In our research (Yasuyuki Sawada and Tetsushi Sonobe, eds., Shijo to keizai-hatten: Tojokoku ni okeru hinkon-sakugen ni mukete [Markets and economic development for poverty reduction in developing countries], Toyo Keizai, 2006), we have sought to identify institutional factors which allow the market to function effectively.

Actors in the market economy - companies, merchants, farmers, and so forth - constantly make efforts and devise ways to fulfill transactions, of which the effective and efficient ones become customary and evolve into grassroots institutions. Supported by such efforts and the ingenuity of private-sector actors and the institutions, the market economy has been managing to function in developing countries even where government authorities are less reliable. If we lose sight of this picture, we will never be able to realize successful economic structural reform or create a truly effective social safety net.

When we look back on the stream of ideas on international development to date, we can see a lack of understanding of markets throughout the course of history - from the era of structural adjustment and liberalization in the 1980s, through the 1990s when emphasis was placed on a non-market-oriented safety net, and to the current approach of prioritizing poverty reduction as seen in the United Nations Millennium Development Goals (MDGs) adopted in 2000. Without a sound understanding of markets, no policies will be designed.

In economics, a situation in which the market is not functioning properly is referred to as "market failure." Economic policies are meant to correct market failure so as to improve economic welfare. The first step toward that end is to accurately understand where problems come from and how private-sector actors are responding to them. However, it appears economists at various international institutions such as the International Monetary Fund (IMF) and the World Bank as well as those working at Japanese aid agencies are rather oblivious to the importance of understanding the actual state of market failure.

Cases of successful overcoming of market failure in developing countries

What is a market? What are the characteristics of a market that is destined to fail? And what institutional policies are needed to overcome the failure? To find answers to these questions, we have collected, for the purpose of this research, a series of case studies accumulated by researchers of development economics and those specializing in economic history of Japan.

In this research, it is assumed that merchants play an important role because they are the driving force of market formation and possess some characteristics of the Schumpeterian entrepreneur. In the early stage of development, communities also play an important role. A community, a group that is bound by trusting relationships based on very close and intense personal interactions, has a remarkable ability to reduce transaction costs. Apart from traditional communities such as farm villages, subcontracting arrangements between major manufacturers and their parts suppliers and personal relationships in a company can be defined as a quasi-community while industrial agglomeration is also an important concept.

Stating the conclusion first, although the market does not function properly in transactions involving laborers, goods, and money, a wide variety of transaction participants such as farmers, merchants, and entrepreneurs in developing countries, including pre-war Japan, have been contributing to the smooth processing of transactions by utilizing implicit contracts based on family ties, kinship, territorial connections, camaraderie, ethnic ties, and community rules, thereby helping overcome any existent market failure. Specific cases of this are introduced in the following. (continued...)

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EVENTS INFORMATION

Brown Bag Lunch Seminars

All BBLs run 12:15 - 13:45, unless otherwise stated.

01/17
Speaker: TAKESADA Hideshi, Director, Library, The National Institute for Defense Studies (NIDS)
Topic: "North Korean Nuclear Issues" (in Japanese)

01/19
Speaker: OSAWA Machiko, Professor, Department of Studies on Contemporary Society, Faculty of Integrated Arts and Social Sciences, Japan Women's University
Topic: "Towards Work-Life Balance Society" (in Japanese)

01/22
Speaker: TANAKA Hitoshi, Senior Fellow, Japan Center for International Exchange
Topic: "Japan's Diplomacy" (in Japanese)

02/01
Speaker: SANBONMATSU Susumu, Consulting Fellow, RIETI / Researcher, Organization for Small & Medium Enterprises and Regional Innovation, JAPAN / Visiting Professor, Hitotsubashi University
Topic: TBA (in Japanese)

02/06
Speaker: KOMATSU Masayuki, Executive Director, Fisheries Research Agency (FRA) Topic: TBA (in Japanese)

For a complete list of past and upcoming BBL Seminars, http://www.rieti.go.jp/en/events/bbl/index.html


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This month's featured article

Markets and Economic Development for Poverty Reduction

SAWADA YasuyukiFaculty Fellow, RIETI

Event Information

For a complete list of past and upcoming event information.

Symposiums

Workshops

BBL Seminars

Fellow titles and links in the text are as of the date of publication.

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RIETI Report is published monthly.