Enterprise Capital in Emerging Markets

By Smith, Roy C. | Independent Review, Summer 2007 | Go to article overview

Enterprise Capital in Emerging Markets


Smith, Roy C., Independent Review


Economic growth in developing economies has long been considered dependent on trade, direct and portfolio investment, and foreign aid, including loans from the World Bank and the International Monetary Fund (IMF), which were set up after World War II to fund reconstruction and development and to maintain an orderly international financial system. The postwar reconstruction of the European and Japanese economics proved successful, and it was hoped that similar approaches would enable the countries of the Third World to bring their economies up to Western standards, thereby reducing the likelihood that they would seek economic success by aligning themselves with the Communist countries. Aside from the rapid economic progress of a few, relatively small Asian countries (the so-called "Asian Tigers"--Hong Kong, Singapore, Taiwan, and South Korea--all of which had strong incentives to stay closely allied to the United States), however, the postwar period until the 1990s produced few cases of developing countries that greatly improved their economic conditions relative to the developed world.

Until the 1990s, trade in developing countries was still largely in commodities, foreign direct investment was limited, and foreign portfolio investment was scarce, although banks were beginning to make significant loans to affiliates of Western companies located in developing countries and to the governments of these countries. Foreign aid and technical assistance were regarded as essential to economic development, although they came with political strings or financing conditions that were sometimes hard to live with. It was evident that economic development in the Third World was extremely hard to achieve, despite considerable efforts. This difficulty was attributed in part to the prevalence of corrupt, authoritarian governments, whose retention of power depended on their maintenance of the economic status quo, and in part to the distortions of political and economic relations caused by the struggle between East and West in the Cold War. In that struggle, most developing countries preferred to be in the middle, where they could play one side against the other. Although doing so brought in financial and military aid, it did little or nothing to speed economic growth. For the most part, the lack of substantial economic development reflected an inadequate system of private enterprise and an absence of the conditions needed to attract foreign capital. Since 1990, however, great progress has been achieved in attracting enterprise capital to the private sectors of a number of developing countries, whose economic growth rates have soared as a result. Ironically, several of these countries are former socialist societies that have adopted market-driven economic systems that are incentive compatible and lubricated by fluid capital flows from abroad.

The New World Order

Changes began after the removal of the Berlin Wall in 1989, which symbolized the end of Soviet-style communism. That system essentially imploded under the weight of economic mismanagement, Cold War arms-race pressures, and the obvious, contrasting economic success of the market economies in the West. After the wall came down, the rest of Soviet eastern Europe and the Soviet Union itself dissolved bloodlessly into a cluster of independent states seeking economic development and willing to try Western measures to achieve it. Meanwhile, India, whose government had struggled to resist any aspects of foreign "imperialism" and to remain neutral in the Cold War, began in the early 1990s to adopt similar policy changes to enable its economy to exceed the "Hindu rate of growth" (an average annual growth rate of 3.5 percent from 1950 to 1990) to which its socialistic political system had confined it since the country's independence in 1947. A decade earlier in Communist China, Premier Deng Xiaoping, beginning with his "Four Modernizations" policy, had introduced measures to create a "socialist market economy" (or "socialism with Chinese characteristics") that brought about fundamental market-opening reforms to decommunize the economy and to permit and encourage private enterprise, foreign direct investment, and private investment in stock markets.

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