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State strategy and policy choice in economic development: A game theory approach

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State strategy and policy choice in economic development: A game theory approach

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Content STATE STRATEGY AND POLICY CHOICE IN ECONOMIC
DEVELOPMENT: A GAME THEORY APPROACH
by
Carmen Sue Barker Lemay
A Thesis Presented to the
FACULTY OF THE GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillment of the
Requirements for the Degree
MASTER OF ARTS
(Economics)
December 1992
Copyright 1992 Carmen Sue Barker Lemay
U M I Number: EP44942
All rights reserved
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U N IV E R S IT Y P A R K
L O S A N G E L E S . C A L IF O R N IA 9 0 0 0 7
This thesis, written by
under the direction of hMu Thesis Committee,
and approved by all its members, has been pre
sented to and accepted by the Dean of The
Graduate School, in partial fulfillment of the
requirements for the degree of
to
H2.
373 $ " CsSS
Dean
Date November 3 0 , 1992
THESIS COMMITTEE
Chairman
TABLE OF CONTENTS
INTRODUCTION
Why study zones?
Why employ a critical policy analysis?
Employing a game model
v v u y v i u p u j y a v i m u u a x u u ^ s i s i v »
Employing a game model 6
CHAPTER 1 MODELING THE ZONE EXPERIENCE
Introduction 9
Players/Strategies/Actions/Payoffs 10
Assumptions & Limitations of Game Theory 11
Agents: Their Interests and Influence on Zone Policy 12
CHAPTER 2 THE LAISSEZ FAIRE STRATEGY & THE ZONE GAME
Introduction 16
Players' Actions 17
Power and Information Assymetries 17
The Role of Commitment 20
Decision making Tree and Associated Payoffs 21
Equilibrium and Solution Concept 25
Outcomes 26
CHAPTER 3 THE RENT-SEEKING STRATEGY AND THE ZONE GAME
Introduction 28
Players'Actions 28
Power and Information Assymetries 29
Decision making Tree and Associated Payoffs 29
Equilibrium and Solution Concept 33
Outcomes 33
CHAPTER 4 THE DEVELOPMENTAL STRATEGY AND THE ZONE GAME
Introduction 35
Players' Actions 36
Power and Information Assymetries 37
The Role of Commitment 38
Decision making Tree and Associated Payoffs 38
Equilibrium and Solution Concept 40
Outcomes 41
CHAPTER 5 CONCLUSIONS 42
BIBLIOGRAPHY 44
APPENDIX 50
LIST OF TABLES
DIAGRAM 2.1 DECISION MAKING TREE WITH A LAISSEZ FAIRE
STRATEGY 22
TABLE 2.1 PAYOFF MATRIX 23
DIAGRAM 3.1 DECISION MAKING TREE WITH A RENT-SEEKING
STRATEGY 31
TABLE 3.1 PAYOFF MATRIX 32
DIAGRAM 4 1 DECISION MAKING TREE WITH A DEVELOPMENTAL
STRATEGY 39
TABLE 4.1 PAYOFF MATRIX 39
TABLE 5.1 COMPARISON OF THREE STRATEGIES 42
ABSTRACT
Taking a cue from the recent writings on the newly industrialized
countries (NICs) and the discussion of the developmental state, this work
attempts to evaluate a state's role in the market in the process of creating
; and sustaining an export processing zone. Rather than the simple cost-
benefit analyses of previous zone studies, this work employs a game
framework to evaluate the interactions of influential agents in the zone
context and to assess the costs and benefits accruing from players'
interdependent actions. Of particular interest is how a zone policy
enhances the legitimacy, international reputation, accumulation and
distribution activities, and autonomy of the host-country state.
This work identifies three different state strategies toward foreign
investment and evaluates the outcomes of a zone game given these
strategies. The laissez faire state takes a hands-off approach to the zone
thereby allowing firms maximum freedom to pursue their interests. When
rent-seeking, state officials intervene in the market and extract side
payments from economic players thereby distorting market outcomes.
Finally the developmental state acts to augment market relations and
enhance the ability of zone firms to transfer technology to the host-country
through selective intervention.
INTRODUCTION
A notably common policy utilized over the last thirty-odd years to influence
the movement of foreign direct investment has been the creation of an export
processing zone. A territory of land distinguished by preferential treatment of
foreign investors, an export processing zone lures foreign investors for their
resources, namely capital and technology, which the host country finds scarce. At
the same time, the host country can offer the firm cheap labor relative to that
found in their home country. Therefore, each can offer the other something of
value.
Within the zone the state essentially offers the multinational company two
of the three requirements for production: land, including the infrastructure
necessary for modern production facilities; and labor— inexpensive, educated and
controlled through legislation either outlawing or severely restricting union
activity. In most cases the firm provides the capital it needs, however in a few
select cases the state provides finance capital as well. More often the host-country
state assists with the provision of capital saving measures— in the form of tax
holidays, exemptions from duties and free trade agreements.
WHY STUDY ZONES?
The policy of creating export processing zones to attract foreign
investment enjoys worldwide popularity. The modem version of the export
processing zone appeared in Ireland during the 1950s (Vittal 1977:1). Later the
developing countries of Taiwan, South Korea, Brazil, Mexico, and many others
1
introduced export processing zones. Seventy-nines zones were in operation in 25
countries by 1975. Then by 1986 a total of 176 zones operated in 47 countries
(Kreye 1987:6).
The proliferation of the policy continues despite a widely available
empirical record that suggests that zones rarely meet their economic objectives,
and in many cases create other distortions in the host country. The large number
of zones, and the discrepancy between outcome and expectation of the policy has
fostered many zone studies (Crane 1991; Kreye 1987; Warr 1983,1986,1987;
Kelly 1987; Maex 1983). So why does the author embark on yet another study of
this policy?
The interest of the EPZ lies essentially in its physical, social
and economic segregation from the rest of the country. This
segregation, coupled with the presence of good
infrastructure and a favorable administrative environment,
has been one of the keys to the success of EPZs. At the
same time it raises a number of complex questions as to
their effective benefits to the host country, their contribution
to social development and their role in the process of
technological innovation and industrial growth.
(UNCTC/ILO 1988:7)
The above statement and the two that follow represent the ambiguous
conclusions found in works that attempt to evaluate the zone experience.
One of the keys to success for an EPZ is its exclusive
preoccupation with exports and employment promotion; a
simultaneous focus on regional development, social policy
or the promotion of technological development is likely to
detract from its main task and hamper its development.
2
As a physical, economic and even social enclave in the host
country, the EPZ is perhaps the most achieved mechanism
fo r preventing the development o f technological linkages
between the foreign firms in the EPZ and the enterprises in
the host country. (UNCTC/ILO 1988:118, emphasis added)
In those cases where EPZs have been evaluated as economically
successful, they remain problematic. It is this "successful yet troublesome"
designation that will be explored in this study. The existing approaches to
evaluating EPZs create a dichotomy between economic and social costs and
benefits, that when employed separately offer incomplete and often misleading
information on zones. What is needed is a method to integrate both economic and
social impacts of a zone policy and a process to evaluate whether those agents
with interests in a zone got what they wanted and the effect of these outcomes on
the host country.
Many believe that establishing export processing zones expedites economic
development in less developed countries. Export promotion takes a smaller
investment of capital and yields a quicker return than investment in domestic heavy
industry or the development of human capital (Vittal 1977:5). Nonetheless, the
relative underdevelopment of the periphery, including the lack of infrastructure,
trained labor, technological capacity, and access to world markets makes it difficult
for domestic firms to break into the world market. Therefore, it is considered
prudent to attract foreign interests to acquire the technology and know-how to
make the export-drive a success. However, it is often the case that foreign
investors do not receive the call from developing countries with great enthusiasm
3
because of the aforementioned conditions. Therefore, the peripheral state is
obligated to "offer a suitable package of investment incentives" to attract foreign
investment (Vittal 1977:1). The development of export processing zones is one
way that the developing world has employed in hopes of securing foreign
investment.
Whereas various bodies of the United Nations once encouraged the
development of export processing zones as a popular policy option, "these bodies
now conclude that EPZs are of limited utility in industrialization" (Crane 1990:10).
EPZs are troubling precisely because, "the competition to attract industry to
[zones]...has resulted in under-utilization of the infrastructure created to receive it,
leading to the waste of already scarce resources" (Basil and Germidis 1984:9).
Although literature on the pros and cons of the zone policy proliferates,
much of the literature fails to put the policy in its broader context in order to
interpret the outcomes Therefore, these studies have not been able to identify
either the activities that support the success of the policy, or those that detract
from zone efforts. This work emphasizes the state's approach to foreign
investment, including the joint gains anticipated by such investment and the policy
environment created to influence foreign investment within a zone.
It starts with the state not because a priori the state has the sole interest in
the zone or takes action isolated from other agents. Rather it takes this approach
because recent literature investigating the success of the Newly Industrialized
Countries (NICs) of Taiwan, South Korea, Singapore and Hong Kong points to
the importance of the state's market-augmenting role in promoting and sustaining
economic development (Deyo 1987; Haggard 1990; Gereffi and Wyman 1990;
4
Koo and Kim 1992; Lubeck 1992; Castells 1992). This literature gives rise to two
questions: first, does the state's relationship with the market change zone
outcomes? and second, what factors determine the state's choice of strategy and
then persuade a state to change strategies?
WHY EMPLOY A CRITICAL POLITICAL-ECONOMIC ANALYSIS?
To answer these questions, this study merges two methods: critical policy
analysis and the technique of fonnal modeling as found in game theory. Critical
policy analysis
encourages dialogue and criticism by disseminating
information and questions, counteracts noise emanating
from or circulating within bureaucracies, offers suggestions
for action, and exposes unwarranted exerci se of political
power. (Bobrow and Dryzek 1987:176)
Applying a critical policy analysis means clearly defining the costs and benefits of a
policy accruing to all segments of the population given a keen sense of the culture,
politics, and history of the area or group in question. Through application to
social problems, critical policy analysis seeks to empower those of little influence
so that they may be a more effective voice in democratic decision making and
development efforts. The social problem identified herein is the high cost of
public funds used to subsidize multinational production in the export processing
zones of developing countries.
While many existing zone studies have adequately identified the costs of a
zone policy, all seem to have miss certain social/political gains. This work would
5
suggest that previous works have not taken a critical look at the objectives of state
managers and the requirements of state organizations therefore they have not
identified the gains that the state realizes from investment in the zone.
EMPLOYING A GAME MODEL
Political economy is "mapping economic constraints through the choices
and institutions facing political actors" (Haggard 1992:631). Policy is conducted
within this realm of choices and constraints, in an environment of competing
interests vying to improve their position in the marketplace These interactions
between domestic agents, the state and representatives of the multinational
companies at the level of the international economy provide the level of analysis
for this study of a policy of creating and sustaining an export-processing zone.
Bargaining between dominant groups and their representative agents
characterizes the policy process. Game theory can offer an insight into the
bargaining process by offering a model of negotiation. Characterizing the
interactions of agents as a game is useful in that it 1) formalizes agents’ interests
and actions in the policy process, 2) suggests changes in the relative strength of
agents over time, and 3) offers a means by which to map the options open to them
and to evaluate the payoffs associated with these actions.
Game theory is a technique of mapping the set of possible actions open to a
player and the payoffs assigned to these actions. It "is concerned with the actions
of individuals who are conscious that their actions affect each other" (Rasmusen
1989.16). An agent is an individual who has an interest in the outcome of the
policy but is unable to influence the outcome directly A player is an agent actively
6
involved in the policy process Each player can affect the others' actions. A
strategy set includes possible courses of action and their associated payoffs. A
game tree traces the actors' strategy set. Payoffs constitute a player's preferences.
These can be ordinal (rank) or suggest utility through a comparison of absolute
value. Payoffs must be independently determined from the outcome of the game if
they are to have any meaning.
Determining payoffs offers an exercise in political economy, as it involves
understanding players' preferences in a historical perspective, as well as the
political, economic, and social context in which actions gain value. Furthermore,
as many agents get excluded from any particular game; and overall the most
powerful agents participate much more frequently in the bargaining process,
gaming models can mimic the real world of social structural constraints facing
agents and the exclusivity of the policy making process.
Modeling actions within a game framework assumes that players act
"rationally." Striving to achieve preferred ends, players rank alternatives based on
their goals and interests, and then choose the highest ranking alternatives. The
assumption of rationality does not imply in any way that the resulting actions best
serve societal interests, or that one player's choices are better than any others.
Rather it assumes individual self-maximizing behavior in absence of centralized
authoritative institutions. Within the conditions of the game, players can assess
their interests and rank courses of actions based on their desire to have these
interests fulfilled.
Using a game framework, this work will offer three models of the actions
of state managers and state organizations conducted in the context of bargaining
7
with other players in an export-processing zone game. It will suggest three
different state strategies: 1) laissez faire, letting the market lead while maintaining
a hands-off approach by the state, 2) rent-seeking, extracting side payments for
the benefit of state managers, and finally, 3) developmental, selective state
intervention to overcome market failures and to lead the market. These three
strategies represent real-life responses to foreign direct investment but may not
exhaust the possibilities.
OUTLINE OF CHAPTERS
In chapter 1 the particulars of the game model are introduced. This sets
the stage for modeling the state strategies in chapters 2-4. Each chapter explores
the ways in which the zone game is affected, an explanation of the benefits and
costs involved, and the conditions associated with the selection of the particular
strategy. Finally chapter 5 draws some conclusions from the exercise and suggests
applications for this type of model.
8
CHAPTER 1 MODELING THE ZONE EXPERIENCE
INTRODUCTION
To understand the relations between the parties interested in the export
processing zone it is necessary to employ a method that can adequately capture the
many and varied interactions between these agents. Gaming models provide
conceptual tools that reveal the interdependence among players' decisions and
suggest the likely outcomes of such interactions (Schelling 1984:240)
A game involves a multi-person decision problem (Gibbons 1992:xi), in
which players devise strategies and take actions to maximize their own self-interest
given their understanding of the other players' likely moves. These models
encompass the idea of bargaining as found in the new dependency literature, that
recognizes that political economic outcomes vary and no one player holds infinite
power (Newfarmer 1985:17).
While developing country states depend on MNCs for job creation, the
transfer of technology, and the creation of foreign exchange, MNCs rely on host-
country states as well. The state defends property rights, guarantees the free
circulation of production factors, and maintains social control. It also builds
infrastructure, and reproduces the labor force (Martinelli 1975:429). Therefore,
state and MNC interactions reveal an interdependence that a game model can
capture. In this sense the game's outcome is not pre-determined in that despite the
power of a multinational corporation, the host-country state does make real policy
choices given global and domestic factors.
9
The relative strength of players changes over time thereby affecting the
outcome of the game. Perhaps more telling, certain agents become players in the
game, and some get excluded altogether. Both the relative power of the players
and the composition of the game change. In this way, gaming models mimic the
real world of social structural constraints facing agents and the exclusivity of the
policy making process (Bennett and Sharpe 1985:81). Given the wide range of
interests in an export processing zone, the zone policy potentially attracts a large
number of players: the state, domestic firms, MNCs and the popular sector. An
evaluation of the roster of players and their relative strengths follows.
PLAYERS, STRATEGIES, ACTIONS AND PAYOFFS
Game models allow for the formalization of players' interests and actions in
the policy process. This offers some means by which to map the strategies that
players choose and to evaluate the payoffs of their subsequent actions. A strategy
offers a rule of behavior in a repeated game (Kalai 1990:136), while a payoff
constitutes the expected utility of a given action (Rasmusen 1989:24). Payoffs
must be independently determined from the outcome of the game if they are to
have any meaning. Determining payoffs is truly an exercise in political economy,
as it involves understanding players' preferences in historical context.
Payoffs not only involve monetary rewards, but also include anything the
agent values. For example, firms measure payoffs in monetary terms, that is in an
action's ability to enhance profits, noted herein as (+) for profit enhancing, or (-)
for profit reducing. Meanwhile state managers prefer activities that will enhance
the state's legitimacy, increase state autonomy from competing sources of power,
10
offer opportunities for the state to accumulate and distribute resources, and accrue
recognition in the international arena.
An equilibrium "is a strategy combination consisting of a best strategy for
each of the N players in the game” where best is defined by the modeler based on
all strategy combinations and their payoffs (Rasmusen 1989:26-27).
ASSUMPTIONS AND LIMITATIONS OF GAME THEORY
Game theory assumes goal-seeking behavior in absence of centralized
authoritative institutions. In other words, the structural constraints of society
although very real, are not deterministic. The assumption of rationality suggests
strategic decision making, not superior outcomes. Each player develops a strategy
which s/he believes will lead to her/his own desired outcomes takes action in line
with the strategy. Players reveal their preferences when repeatedly confronted
with comparable choices. The values of players, their preferences, beliefs and
definition of self, are all exogenous to the model and may change over time.
Therefore, players behavior must be closely monitored.
Unexpected events may occur at the same time as the players' actions, and
as a result alter the outcome of the game. These events may change the players'
strategies altogether, forcing the game from its original equilibrium and pushing
players to find a new equilibrium. A shift in strategy may also reveal a tension
between the expected returns from a given action and the actual payoffs.
11
AGENTS: THEIR INTERESTS AND INFLUENCE ON THE ZONE
POLICY
The State
State managers invest significant amounts of state funds in the development
and provision of infrastructure in the zone and hope to realize an expanded
economy in return. Such growth provides the means for accumulation and
distribution and thus legitimates the state. This keeps the ruling party in power
and the state managers working.
At the same time the zone enhances the state's international reputation by
suggesting to the world that the host country state will accommodate foreign
investors. Their comprehensive development strategy: including the position taken
on foreign investment, and the degree to which the other developing countries are
competing for foreign investment affects state managers' bargaining practices
(Encamation and Wells 1986:77).
Furthermore, the growing number of zones in the world creates a situation
in which zones compete against one another for foreign investment . All other
things being equal, with each additional zone in the world the bargaining position
of state managers vis-a-vis incoming or veteran zone firms weakens. State
managers must continually reestablish their country's comparative advantage and
cannot risk scrapping incentives (Guisinger 1986:166). State managers turn to
economic zones because the developing economy faces the ever pressing problem
of job creation. Unless state managers have an alternative to the employment that
the zone firms offer, they need to offer and maintain an incentive package
attractive to foreign firms.
12
Furthermore, cutting back on any state program is potentially a source of
delegitimation for state managers and state institutions (Wright 1978:157).
Nowhere is this more evident than in a zone. Because of the concentrated nature
of the state's investment, the zone assumes a high profile amidst development
efforts. Any visible lack of activity within the zone questions the appropriateness
of the state's initial commitment of resources and infrastructure development. The
zone's high level of visibility, and its ability to absorb large numbers of workers
becomes a liability if at any time state managers desire to reduce the zone subsidy.
Domestic Firms
The domestic private sector desires to increase its productive activities and
thereby increase profitability. When domestic producers can link their activities
with those of zone firms and supply inputs that zone firms need, there is the
potential for domestic producers to benefit from the establishment of a zone. Two
kinds of domestic firms must be distinguished. Small and medium-sized firms, and
large conglomerates.
Small and medium-sized firms generally lack technical sophistication and
capital resources. Therefore, they face great obstacles to linking with the large,
and relatively more technology and capital intensive foreign firms. Furthermore,
they lack the informational resources necessary to link with multinational firms
producing within zones.
Although domestic firms are not prohibited from locating inside the
zone."...the advantages and incentives offered to industries located in the [export-
processing zone] are generally much greater than those provided for domestic
13
industry (Basile and Germidis 1984:40). The size of lots and production facilities
are often too big, mid, therefore, too expensive to meet the needs of the generally
small and medium-sized domestic producers (Fong 1990:85).
Large domestic export-based manufacturing firms lobby state officials to
receive incentives similar to those offered to multinational firms. They desire
either to have the same production incentives offered to them, or they want
legislation mandating domestic content requirements for goods produced in the
zone (Jomo 1986:214). When this is unsuccessful, lobbying against the policy
itself or those who promote it, is one alternative. Large domestic firms often
object to the policy privileges extended to the multinationals in the zone.
The Popular Sector
The popular sector's interest in the establishment and continuity of the zone
is in its ability to provide employment. This group supports the zone policy in two
ways: first, by providing labor to the zone and second, supporting those elected
officials who align themselves with the policy. In democratic nations the popular
sector indirectly affects the zone policy by forcing their elected officials to be
accountable for the results of the zone.
The zone absorbs excess labor power from the rural villages. Rural
residents desire zone jobs despite long hours and low pay. A job opening in a zone
firm typically amasses many interested applicants. The lack of alternative
employment opportunities for this group of unskilled laborers makes zone
employment attractive. Multinational firms' preference for the "nimble fingers" and
low-wage labor power of females creates the demand, while money income and
14
"bright lights" bring a pool of young women workers to the zone (Andors 1988;
Ong 1989). Despite the large number of zone workers, labor as an organized
group wields little direct impact on the policy process, as the result of laws
restricting workers' activities Labor's exclusion from the policy process acts to
perpetuate a strategy centered on the use of low-cost labor manufacturing goods
for export (Deyo 1989:4).
Multinational Corporations
Multinational corporations benefit from the creation and maintenance of an
export processing zone due to its relatively low wage bill, tax holidays and
freedom from import duties, which lower costs of production and maintain firm
"competitiveness" within the world market. Furthermore, it stands to benefit from
the provision of infrastructure in the zone. All such inducements assist in profit
maximization.
CONCLUSIONS
Familiar with the potential players in a zone game, it is now time to explore
the various strategies toward foreign investors that states implement and evaluate
the slate of players, their actions and the outcomes of the game.
15
CHAPTER 2 THE LAISSEZ FAIRE STRATEGY AND THE
ZONE GAME
I
I .
INTRODUCTION
Under laissez faire, the state essentially abdicates power to the private
sector which it believes is the appropriate conduit of economic growth and change.
The private sector creates the jobs, products, and taxable revenues that will
presumably grow the economy. Frequently in developing countries a bi-polarity
* exists in the structure of production activities a result of the colonial experience.
On the one hand, a few very large, monopoly producers account for a large
portion of the economies output and income but employ a relatively few number of
individuals. On the other hand a large number of very small, generally family-
owned companies, each produce very little contributing a minuscule amount to the
economy, employ the vast number of workers.
As a result, if conditions in a developing country call for the creation of a
large number of jobs, or the acquisition of foreign exchange and/or advanced
technologies, state managers often bypass domestic producers and instead turn
their attention to wooing foreign investors with incentives and the provision of
infrastructure necessary for production. Under this strategy, however the state
seeks little more involvement. By welcoming investors the state relies on the
private sector to lead the economy. The private sector creates the jobs, products,
and taxable revenues that will presumably grow the economy.
PLAYERS’ ACTIONS
Initially state managers and representatives of foreign firms conduct
negotiations to get the zone up and running. After initially establishing the
conditions for MNC production in the zone, state managers step back and use
state organizations solely for zone maintenance. The state attempts to maximize
its expected return such that
E(R) = g + a + a/d + ir + o,
where E(R) = expected return, g = legitimacy, a = autonomy, a/d -
accumulation/distribution, ir = international recognition and o = an error term.
The E(o) = 0. The additive nature of this function is merely suggestive of how
state managers go about evaluating the expected payoffs of their actions. To reach
its objectives, the state sees that any reasonable demands of foreign firms get met.
However, the state's role remains limited in a laissez faire strategy.
Firms attempt to maximize expected profit such that
E(p) = QP - LW - kR + u
where E (p) = expected profit, QP = total revenue, LW = labor costs, kR = costs
of other factor inputs, and u = the error term. The E(i>) = 0
POWER AND INFORMATIONAL ASYMMETRIES
State managers as the initiators of the game can set the parameters
according to their objectives, as well as veto entrance to the zone of any particular
firm based on its perceived lack of contribution to these objectives. Given the
desire to attract foreign investment to the zone, the bargaining position of state
depends on the importance of the particular industry and the degree of competition
17
the host country state faces with other developing countries for the investment
(Encamation and Wells 1986:77).
The bargaining process between the representatives of foreign firms and
state managers' results in a certain distribution of gains Organizational capacity,
economic and political resources, as well as bargaining strategies affect this
outcome (Haggard 1990:220-21). Over time, one would expect, however, that
they could offer less favorable terms to the MNC and thereby enhance their own
gains. This greatly depends on the nature of zone industries and to what extent the
development strategy relies on zone firms for employment creation. For example,
in high technology manufacturing industries, Doner notes that rapid technological
change makes it difficult for the host country to acquire the expertise necessary to
produce for export without the MNC (Doner 1991:7).
The bargaining power of state managers is weak when they attempt to
attract uncommitted foreign investment (Crane 1990:18; Doner 1991). In the
context of this game this suggests that the player who moves last, in this case the
firm, gains some leverage by the ability to take an action that worsens the payoffs
for the state. On the other hand, the relationship between MNCs and the host
country state is a mutually dependent one. The zone firms rely on state
organizations to defend property rights and to guarantee the free circulation of
production factors. The state also reproduces the labor force, creates
infrastructure, and maintains economic and social control (Martinelli 1975:429).
18
State managers use state organizations to favor the growth of zone activity.
Quite often however, these individuals lack information on the firm's true cost of
production, or its profit margin, therefore, they must rely on the firm to provide a
signal on the value of the subsidies to its production activities. However, because
ultimately the host-country state's incentive package will affect firm profitability, it
is in the interest of the firm to offer information to state managers that
overestimates the cost of doing business in the host country in hopes of
maintaining or securing the best possible package of incentives. This asymmetry of
information weakens the bargaining position of the host-country state, and
proceeds to increase the cost of the zone policy.
The other way in which power is differentiated in this context is the
altogether exclusion of some potential players from the zone game. State
managers and state organizations could offer similar incentives to domestic firms.
However, these firms would be unlikely to produce large numbers ofjobs, secure
foreign exchange or develop high-tech goods and processes in the short-term, due
either to their small size or monopoly power as noted above.
At the same time, the production processes of the average domestic firm
and the zone firms are so very different— one labor-intensive, capital poor and
technologically unsophisticated, the other capital-intensive and technologically
sophisticated. As a result of these disparities, these firms are unlikely to interact.
Data on existing zones suggests that the multiplier from zone production is small
as forward and backward linkages are negligible. In these instance zone firms
become the consumers of scarce state resources, rather than producers stimulating
the local economy (Kreye 1987:15; MPPP 1986:60; Warr 1987:238).
19
THE ROLE OF COMMITMENTS
Getting the firm to commit is a tricky business for the host-country state.
In negotiations with state managers, it is in the best interest of the firm to try to
extract and maintain the maximum level of subsidy. The most effective way for the
firm to do this is to exercise the threat of their departure. MNCs use the threat of
packing up shop to further enhance their bargaining positions (Vernon 1981:54-
55). Due to their ability to "exit," MNCs have an advantage in any zone game.
For example, if state managers propose to eliminate any subsidies to multinational
companies, the multinational may threaten to move operations to a ’ ’ more
hospitable" environment. State managers have little way of knowing how credible
this threat is, therefore, they must assess the cost of such a departure on their
future actions.
This is a game known as "stag hunt" in which an actor may prefer
cooperation, but employs threats of non cooperation to impress upon the other the
value of cooperation (Conybeare 1984; 17-18). The structural characteristics of
export-oriented manufacturing make the threat realistic (Haggard 1990:222).
These producers tend to be relatively small and mobile with their assets resulting in
low relocation costs (Doner 1991:7-8).
At any given time, the number of firms for which locating in developing
countries is a cost-efifective move is likely to be less than the number of zone
opportunities. Therefore, there is swift competition among sellers, to present their
zones as the highest quality product, or as a better deal than the competition. This
competition favors the buyers. After state managers offer their generous
incentives to a zone firm, they rely on the commitment of the firm to maintain its
20
production activities in the zone. However, the state has no power to force the
firm to remain or to make new demands on the firm as the state precommits to
making few interventions in the market.
DECISION MAKING TREE AND ASSOCIATED PAYOFFS
Given the state's initial investment in the zone, with a laissez faire strategy
only one other point in the history of the zone calls for state intervention. That is
at the point, typically five to ten years after the commencement of a zone when tax
holidays and other incentives expire. State managers must determine at this time
whether to extend the holidays and other incentives, or suspend such subsidies to
multinational firms. State managers necessarily consider the impact of their actions
on the MNCs, because they depend on the MNCs for the aforementioned political-
economic benefits. Given the host-country state's decision, multinational firms
must determine whether production remains profitable or not, and then whether to
maintain production levels in the zone, or to decrease their investment.
Given the political-economic context, state managers choose either to
Continue to subsidize foreign production activities in the zone, or to suspend
subsidies. Diagram 2.1 displays these choices. The state moves first, with firms
following. Four possible outcomes exist: node #1 the state continues subsidies
while the foreign firm continues to produce; node #2 the state continues subsidies,
nevertheless, the firm decreases its level of investment; node #3 the state
discontinues subsidies but the firm continues to produce; finally, node #4 the state
discontinues subsidies and the firm reacts by decreasing the level of investment.
21
The later may mean totally divesting from the given country and moving to a more
"hospitable'* climate.
Diagram 2.1 Decision making Tree with a Laissez Faire Strategy
Firm
State (+)^Node §i
Firm
State
Node #3
If the state continues to support the zone with subsidies, it hopes to sustain
or enhance the four factors of its objective function: legitimacy, international
recognition, accumulation and distribution and autonomy from domestic sources of
influence. Given that subsidies are forthcoming, the firm then decides on its level
of production based on its calculation of expected profit. However, the state
might choose to suspend subsidies to the zone for any number of reasons. This
action suggests that the ex post calculation of benefits from the zone did not
warrant such subsidies or perhaps the state can no longer afford the subsidies.
Table 2.1 maps the payoffs associated with the four strategies All other
things being equal, if both players maintain the status quo— that is the state
continues to subsidize production and the MNC continues to produce— then
22
presumably both players will benefit. With continued subsidy of the zone activities
ceteris paribus, employment will remain the same or increase. Therefore, the
state's accumulated resources remain unchanged thereby allowing it to distribute as
it sees fit. The state's international reputation for providing an atmosphere
conducive to private accumulation remains secure as well. Meanwhile, state
managers can take credit for keeping the people employed and expanding output
of export commodities, thereby maintaining the legitimacy state organizations. No
reduction in state autonomy results. This is the outcome associated with node #1
(extend/produce).
Table 2.1 Payoff Matrix
State/Firm Produce Contract
Extend #1 (2,2) #2(4,1)
Suspend #3 (1,4) #4(3,3)
Ranked payoffs to (State, Firm) where 1 equals first preference.
Node #2 (extend/contract) considers the case when the state continues to
subsidize firms, and yet firms cut back on their level of investment despite the
incentives. Reduced firm activity and rising unemployment hampers state
accumulation. Therefore, state managers have fewer resources to distribute to an
increasingly needy populace. The foolishness of wasting resources on firms whose
labor pool is shrinking does not threaten state legitimacy, however, if state
managers can impress upon the people that zone firms and not state organizations
have reneged on their obligation to produce in the zone.
23
Meanwhile, because state managers and state organizations continue to
support the private accumulation process, the state's international reputation
remains in good standing. Likewise, state autonomy may increase by the declining
influence of contracting zone firms. However, in a situation of rising
unemployment, labor may take to mobilizing, making demands upon state
organizations, thereby reducing its autonomy from domestic agents. For simplicity
we assume that these two conditions balance each other out, and the net effect on
state autonomy is, therefore, zero.
At node #3 (suspend/produce), state managers choose to end subsidies to
the zone, but zone firms maintain their level of investment. With the end of
subsidies such as tax holidays, the state will begin to receive revenues that it can
then channel to other sectors. This has the potential of increasing legitimacy of
state organizations. However, the state's international reputation suffers as the
state moves away from accepted rules of the international market game whereby
states assist in the private accumulation process. State autonomy increases as the
suspension of subsidies distances the state from the interests of foreign capital. At
the same time, the newly acquired resources get distributed through the patron-
client network, thereby buying-off influential domestic agents and increasing
autonomy further.
At node #4 (suspend/contract) state managers choose to suspend subsidies
and the firm reacts with decreased investment. The potential cost to the state
becomes quite large if the firm goes so far as to relocate its production in another
country. In the case of firm contraction or relocation, state organizations
experience constraints on accumulation and distribution similar to that at node #2
24
(extend/contract). Unlike that experience, however, state managers have not
simply thrown resources into the wind.
Corresponding with the decrease in subsidies, the contraction of zone
activity will negatively affect the state's distributional efforts. As a result the
potential loss of legitimacy is severe, as state actions may appear to be the cause of
the economic contraction. Whereas at node #2 (extend/contract) state managers
could blame the firm for the contraction and present their own actions as in the
national interest, at node #4 (suspend/contract), this is not the case. Like node #2
(extend/contract), however state autonomy remains unchanged as the decrease in
foreign firm influence equals an increase in domestic influence as groups become
mobilized by poor economic conditions
EQUILIBRIUM AND SOLUTION CONCEPT
Given this analysis of the actions taken by players and the various payoffs,
the state prefers node #3 (suspend/produce). In this case the state discontinues
subsidies and yet production and employment in the zone continues. As a result of
their actions, state managers enhance accumulation and distribution amongst state
organizations, and secure legitimacy and autonomy from both foreign and
domestic agents. However, if state managers cannot guarantee the continuation of
firm production in the zone without the subsidies, then choosing this path may be
too risky.
Likewise, if the blow to its international reputation experienced in this case
is so profound as to slow future investment or the ability to secure foreign loans,
25
then this path is undesirable. The second best option for the state is node #1
(extend/produce) where present payoffs persist.
The firm prefers node #2 (suspend/contract). The willingness of the host-
country state to offer subsidies and workers' desire for zone employment creates
an ideal environment in which to keep costs down. Cutting operating expenses
with a limited contraction boosts profitability in the short run. This position is an
unstable one, however, as presumably state managers would catch on to the firm's
activities and suspend subsidies in the future
The equilibrium occurs at node #1, the point at which the state provides
subsidies and the firm continues to produce. This node is a second-best strategy
for each player. However, if we assume that conflict is costly this provides the
best possible course of action they can sustain in the game.
OUTCOMES
Both host-country state and investing firms would like to maximize their
individual self-interests in this game Their preferences lead them to different
outcomes, however, and the terms of laissez faire do not promote cooperation
between players. The laissez faire game can be considered a non-cooperative
game with conflict.
Free market outcomes favor neither the transfer of technology nor the
provision of large amounts of foreign exchange to the host country treasury. This
game, played in the context of a zone policy, favors the extraction of wealth from
the host country to the MNCs home countries through the repatriation of profit.
26
Increased state intervention may improve the outcomes The two games that
follow characterize a different level of state intervention.
27
CHAPTER 3 A RENT-SEEKING STRATEGY AND THE ZONE
GAME
INTRODUCTION
Rent-seeking behavior suggests that the state intervenes in the market
creating a regulatory environment of "quantitative controls in which state officials
can appropriate surplus" (Blomqvist and Mohammad 1986:161). Rent-seeking
behavior is a rational response by state managers to political-structural conditions.
However, there is a great deal of uncertainty and risk associated with rent-seeking
behavior due to its unofficial nature. Such uncertainty increases costs to those
engaged in this type of activity, but for the individual or firm involved such
behavior could result in wealth enhancement or monopoly profits.
PLAYERS’ ACTIONS
This game is the exclusive abode of state managers and representatives of
large foreign and domestic firms. The need to make side payments to receive
serious attention from the state, adds yet another burden on small, capital-poor
domestic producers. Because they cannot pay the price, they cannot become
serious players in the game.
State managers desire to maximize their expected return such that
E(R) = g + a + a/d + ir + sp + o,
where E(R) = expected return, g= legitimacy, a = autonomy, a/d =
accumulation/distribution, ir = international recognition, sp = side payments and t>
- an error term. E(u) = 0. Side payments become a reward for having the power
to grant special favors to private firms.
28
Firms prefer to maximize profits while minimizing these payments as they
see them as a burden on their ability to make profits. Therefore, the firm again
wishes to maximize expected profit such that
E(p) = QP - LW - kR + u
However, each firm must weigh the value of producing in a particular zone at any
given time and the extent to which such payments allow production activities to
continue or infer other types of benefits (Macrae 1982:679). With side payments,
then the firm's calculation of expected profits becomes
E(p) = QP - LW - kR - sp + u,
where the additional term reveals the cost of the side payment to the firm.
POWER AND INFORMATION ASYMMETRIES
State managers can never know with any precision the value of the tax
holidays and other production incentives given to the zone firms. Therefore, if
state managers seek side payments from zone firms, the amount of the payment is
necessarily negotiable. Likewise any given firm cannot know whether other firms
are indulging in this type of behavior, or what they are willing to pay to the host
country state. Therefore, the value of side payments will be very fluid and not
easily identifiable.
DECISION MAKING TREE AND ASSOCIATED PAYOFFS
The decision making tree includes conditional activities. Diagram 3.1
suggests that the state extends tax holidays and other incentives to firms if side
payments are forthcoming. After the provision of side payments, the firm will
29
continue to enjoy the aforementioned subsidies thus lowering its cost of doing
business, given that the value of the subsidy is greater than the amount of the side
payment. The firm then chooses either to expand (+), or contract (-) its activities.
To earn rent on zone activities, the state must create a scarcity condition.
One way may be to restrict entry into the zone by offering a limited number of
production licenses that all zone firms would hold, or a limited number of
opportunities to take up the state-offered incentives. If the value of the license to
a given firm #1 is X, then a reasonable side payment to make to state officials to
assure that the firm gets sufficient consideration in the licensing process equals
something less than X. If, the payment does not significantly reduce the firm's
utility, such that
(Uf l - X ) > U P )
where U p is the utility of a firm without side payments. In this case state
managers will continue to receive side payments.
If state managers exhibit rent-seeking behavior and no side payments
appear, all subsidies stop, leaving the firm to conduct its affairs without the state's
assistance in the form o f capital saving measures. The firm must determine the
value of the subsidies to its profit-making activities. If the firm is in a position in
which it does not need the inducements to produce in the zone, then it can refuse
to indulge state managers.
30
Diagram 3.1 Decision making Tree with a Rent Seeking Strategy
Firm
State (-H^Node #1
Firm (- ^ * Node
(+)
Node
Node
State x ^ < e ‘
In contrast to the game within a laissez faire strategy, this game involves
conditional actions on the part of the state. The state signals to firms the conditions
under which they will extend subsidies to the zone. Firms must then initiate the
payment of rents in order to influence the state toward continued subsidy of the
zone. In the previous game, no present activity of firms could affect state decision
making as to whether to continue subsidies. Rather state managers made decisions
based on the past performance of the zone and the amount of resources available
to state organizations.
Under a rent-seeking strategy, however, if state managers exhibit rent-
seeking behavior and no side payments appear, all subsidies stop, leaving the firm
to conduct its affairs without the state's assistance in the form of capital saving
measures. The firm must determine the value of the subsidies to its profit-making
31
activities. If the firm is in the position that it does not need the inducements to
produce in the zone, then it can refuse to indulge state managers.
Under what conditions would rent-seeking behavior flourish, given that a
large number of competitive sellers exist, presumably not all requiring such
payments? State managers could extract a rent if the product, in this case the
zone, had some unique attribute. This could mean offering significantly lower
production costs than in other zones, a better educated or more highly skilled
workforce, access to a very promising domestic market, or access to a rich
resource base for the development of export products. Any one, or a combination
of these measures might differentiate a zone from others, thus allowing for the
possibility of rent-seeking behavior by state officials.
Table 3.1 Payoff Matrix
State \ Firm Side payment No Side payment
Seeks
Arrangements
#1 (2,2) #2 (4,3)
No Arrangements #3 (1,4) #4(3,1)
Ranked payoffs to (State, Firm) where 1 equals first preference.
If state managers believe that firms will unilaterally attempt to make side
payments, it won't be necessary to overtly seek such arrangements. Seeking
behavior implies the expenditure of state resources which state managers would
rather preserve. At the same time, seeking side payments is risky. If state
managers get caught seeking or receiving side payments, the popular sector might
lose confidence in them, causing delegitimation. In taking side payments state
32
managers and state organizations begin a new relationship with firms, and thereby
lose some autonomy.
EQUILIBRIUM AND SOLUTION CONCEPT
If the likelihood of getting caught remains small or the penalties
insignificant, state managers prefer to operate at node #3 as shown in Table 3.1.
This node represents state managers not expending resources in rent-seeking
activities, yet nonetheless receiving side payments from motivated private interests.
The firm prefers to operate at node #4, not having to use its resources to
make side payments to state managers. Nonetheless, if the firm thinks that state
managers remain open to such arrangements and that other firms may be making
such payments, then if it desires consideration as a key player in the zone, it had
best make the payment. On the other hand, if state managers appear uninterested
in such activities, it had best keep its money in tow lest it offends the host-country
officials.
The equilibrium occurs at node #1 where state managers seek
arrangements and side payments are forthcoming. This solution occurs because it
provides a second-best strategy for both players.
OUTCOMES
The increasing number of zones limits the use of a rent-seeking strategy.
Only in those situations where state managers can persuasively argue that they
offer a different product, that is a zone with significantly different characteristics
from other zones, are they able to extract side payments from firms. The rent-
33
seeking strategy perpetuates a cooperative game with conflict that serves the
short-term interests of a small elite in the host country, while shifting the
distribution of income from investment to consumption goods. For the country
a whole this proves welfare reducing as a significant loss in tax revenues and
increasing inequality between individuals results (Macrae 1982:685.)
CHAPTER 4 A DEVELOPMENTAL STRATEGY AND THE
ZONE GAME
INTRODUCTION
The developmental state is distinguished by its willingness to augment
market rationality by reducing risk and uncertainty for producers, while generating
jobs and income in the economy (Castells 1992; Lubeck 1992:178). State
managers and state organizations actively collect and disseminate information in an
attempt to foster linkage between domestic producers and firms in the zone.
Focusing on long-run gains, state managers commit fiscal resources to the
provision of high quality education and training opportunities for the citizenry, the
establishment of consulting and technological sendee centers for both domestic
and foreign firms, and the provision of infrastructure. There is an ongoing effort
to upgrade the economy to higher value-added production through both human
and capital improvements.
State managers attempt to restrict firm entrance to only those firm s likely
to transfer technology and/or skills to local producers and workers. In line with
this objective, those firms more likely to transfer technology often receive a better
package of incentives than other firms. State managers make these distinctions by
seeking information on potential investors. Wade characterizes the activities of the
Taiwanese state as developmental because it "identified gaps in industries then
helped to find foreign companies willing to share the needed technology, and
negotiated with them on the terms" (Wade 1990:240).
35
PLAYERS’ ACTIONS
The players in the developmental game include the state, foreign firms and
large domestic firms as in the two previous games. However, state managers and
state organizations effectively lower the cost of participation for small and
medium-sized domestic firms by providing them with needed information on the
production activities of foreign producers. As the state steps in to enhance their
ability to interact with zone firms, a large number of domestic producers thereby
become an integral part of this game.
To pursue its developmental course, the state must tap some existing
resources. These resources may come from foreign assistance, or revenues earned
from the sale of a valued commodity or service on the world market. Given this
minimum level of accumulation, the state can focus its energies on distributing
resources and opportunities across the economy. By definition a developmental
state has secured a level of autonomy from both domestic and international sources
of influence. Therefore, it is not necessary in this game for the state to expend
resources to secure autonomy and international recognition. The state desires to
maximize its expected gains such that
E(R) = g + a/d + o,
where expected return equals legitimacy and accumulation and distribution and an
error term. E(o) = 0. The state will find satisfying its interests easier if it can
convey the idea that legitimacy equals economic growth and consumption— that is
that g = a/d. In that case,
E(R) = 2a/d + o
36
As long as the state is able to maintain autonomy from domestic and international
interests it should be possible to secure legitimacy through the accumulation and
distribution of resources in this fashion.
Firms, both domestic and foreign, maintain their interest in profit-making
with the production and distribution of their products and services. Domestic
producers desire to increase demand for their products through sales to zone firms.
Both groups of players seek to maximize expected profit such that
E(p) = QP-LW-kR + o
In this case, however, with the increase in factor productivity the firms realize a
greater QP than in the previous games. Therefore, E (p) is greater in this game.
POWER AND INFORMATION ASYMMETRIES
In the developmental game State managers and state organizations know
firm types and capabilities because a pre-commitment exists to finding out such
information. However, both foreign and domestic firms face informational
problems. The firm is unaware of domestic producers' capabilities, while domestic
producers' are unaware of what they might produce as zone inputs. The state's
role then becomes clear--to bridge these informational chasms. The developmental
state is both willing and able to do so. Neither zone firms nor domestic producers
object to such state activities because it has the potential of enhancing their profit-
making abilities
37
THE ROLE OF COMMITMENT
Given firms' suspicions about intervention by state organizations, state
managers must reassure firms that their activities will not impede profit-making nor
do they imply any rent-seeking behavior. Resides reassuring firms on these issues,
the managers’ objective of developing indigenous technologies must not be
perceived as an attempt to nationalize MNCs. If managers fail to properly signal
their commitment to private profit-making, zone investors will quickly pull up shop
and go elsewhere. Similarly, domestic firms will not show great enthusiasm for
investing either.
DECISION MAKING TREE AND ASSOCIATED PAYOFFS
Diagram 4.1 exemplifies the developmental game. The game begins in the
same manner as the previous two. The host-country state creates the zone
infrastructure and capital-saving measures. After the initial period, however, this
game becomes rather more complicated because under the developmental strategy
the state conducts developmental activities noted by (D), rather than merely
subsidizing the zone. Attempting to induce the transfer of technology and skills
from zone firms to domestic firms and workers, the state offers additional
incentives to firms or selectively targets existing incentives. Zone firms then act by
either involving themselves in the transfer of technology (T), or not.
In this game it is assumed that the state has made a pre-commitment to
developmental objectives. The state goes about its developmental activities,
anticipating that firms will respond. Existing zone firms will either expand or
contract and new firms may be enticed to begin production in the zone.
38
Diagram 4.1 Decision making Tree with a Developmental Strategy
DFIRM
S t a t e
MNC
MNC
Incentives
No Incentives
Node #1
Node #2
Node §3
Node #4
Node #5
Node #6
Node 07
Node 08
This game also differs from the two previous games in that an additional
player has been added noted by the participation of domestic firms. These firms
will either produce in consort with zone firms (P), or they will not (NP). Laid out
in the following table, the eight possible outcomes of these activities are noted with
the rank of the expected payoff to the players.
Table 4.1 Payoff Matrix
#1 #2 #3 #4 #5 #6 #7 #8
State 2 4 8 7 1 3 6 5
MNC 3 4 1 2 7 8 5 6
Dfirm 2 7 8 6 1 3 5 4
39
The rankings in Table 4.1 are based on a few assumptions. It is assumed
that state managers value technology transfer. This assumption fits well the
original arguments for a zone. Second, it is assumed that technology transfer
imposes some costs on the MNCs. On the other hand, domestic production if
coordinated with MNC efforts lowers MNC costs. Finally, by producing in
conjunction with zone firms the domestic firm increases its total revenue.
Given the proper incentives, MNC investors will likely find it profitable to
upgrade to more technologically sophisticated processes and higher value-added
lines of production (node #1). Under these conditions domestic producers often
find it possible to integrate their activities with those of zone producers, or may
even absorb foreign firms' previous activities as these firms now move into more
technologically sophisticated processes. Finally, as the state improves the quality
of capital and labor inputs, more firms invest. Therefore, the number of ancillary
services that firms consume increase opening up many other types of opportunities
for domestic producers.
EQUILIBRIUM AND SOLUTION CONCEPT
Node 5, Node 3 and Node 5 comprise the individual maximizing strategies
for the three players: state, MNCs and domestic firms respectively. However,
Node #1 offers an equilibrium— a second-best strategy for the state and domestic
firms, and a third-best strategy for the MNC. This equilibrium proves welfare
maximizing in the long-run as productivity increases while costs decrease for the
private sector, and the state enhances its ability to accumulate and distribute.
40
When repeated the developmental game becomes cooperative and without conflict
as players strive to jointly maximize their interests at node #1.
OUTCOMES
The developmental game differs significantly from the previous two games
in that new players enter the game and the state takes a much more active role in
coordinating activities of economic agents. The inclusion of domestic producers
provides for a more dynamic economic growth scenario than in either of the
previous two games. However, the inclusion of domestic firms in the game may
lessen the autonomy of the state in the long run, particularly as their economic
strength increases.
41
CHAPTER 5 CONCLUSIONS
The three strategies elaborated above reflect the state's response to
dynamic shifts in the political economic environment. A state could employ any
one of these strategies for a time, then due to an exogenous shock find itself out of
equilibrium. Therefore, the state will employ a new strategy to regain in
equilibrium. The zone game associated with each strategy suggests a different
complement of players, and changes in the information and power of the respective
players.
Table 5.1 summarizes the discussion in the preceding chapters. The items
marked in bold distinguish long-run costs or benefits. The developmental strategy
facilitates technology transfer and in this way sets the course for a more dynamic
economy in the long-run. The provision of infrastructure and the development of
human capital also enhances the long-run profitability for firms thereby providing
resources for reinvestment and the provision of state programs.
Table 5.1 Comparison of three Strategies
Costs Benefits Net Gain
Laissez Faire a/d, E(p), g a, ir
.
Rent-Seeking g, a, ir, E(p) a/d
.
Develop
mental
g, a, a/d, ir E(p), g, a/d, ir E(p), a/d
42
Whereas the rent-seeking strategy clearly diverts resources into non-productive
activities, the developmental strategy harnesses those very resources and employs
them in market-augmenting ways. The laissez faire strategy offers profit-making
opportunities for zone firms, nevertheless, the state's lack of effort to act as a
liaison between multinational corporations and domestic firms results in lower
long-run gains for the host-country.
The three strategies elaborated above reflect a dynamic process involving
the evolution of power and social/structural conditions. External shocks to the
domestic political economy create a situation in which the expected and actual
returns to the original strategy differ. Such shocks are apparent when E(u)>0. In
this case, the entire character of the game changes as the expected gains from
given actions change unpredictably. Players then begin to create another strategy
which will maximize their expected benefits in light of the new social/structural
conditions.
43
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APPENDIX
Legitimacy (I) implies that the state secures its mandate from a critical mass
of the popular sector— that they have agreed to work under the existing economic
system, and support the state's efforts to maintain the system. Meanwhile, the
state gains international recognition (ir) by operating within the rules of the world
capitalist system. This involves being open to the forces of international capital and
honoring property rights and international financial and trade agreements.
The accumulation and distribution (a/d) of resources is crucial for state
survival (Camoy 1984:134). Without operating resources, agents of the
executive, parliament and the military bodies would be unable to carry out the
various tasks assigned them. At the same time, distribution secures legitimacy. In
stratified societies, patron-client relations facilitate distributional activities. In
patron-client relations, parties of unequal status, wealth O r influence come together
in the exchange of goods or services, with "the patron frequently controlling scarce
resources needed for the client's survival" (Flynn 1974:142).
The need for state autonomy (a) from dominant forces in society arises
from the contradictory roles of the democratic state. To both legitimate its
existence and maintain its ability to distribute and accumulate, the state must
represent itself as looking out for the interests of capital as well as looking out for
the broader interests of the population. Some level of autonomy offers officials the
ability to make and implement decisions without always being accountable to
organized groups.
50

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Creator Lemay, Carmen Sue Barker (author)

Core Title State strategy and policy choice in economic development: A game theory approach

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