Why Poor Countries Still Struggle to Catch Up: How Neoliberal Ideology Reshaped Development Theory, 1950–Present
This blog post is based on the course on Political Economy of Development at the LSE designed by Prof Elliott Green and Dr Mahvish Shami and a public lecture at the LSE by Ha-Joon Chang on the 5th of October 2025
I included some passages in italics for those who do not have much background economics…feel free to skip those if you do.
We used to think that poor countries would eventually catch up with the rich ones.
Nevertheless, since the Industrial Revolution, we can see that the opposite is true and poor countries today are lagging further behind than ever.
Why do poor countries stay poor and what can be done to change it. I spent the past 9 days exploring the last 7 decades of development theory to give you an update on where we stand right now in answering this question.
The Early Thinkers - Linear Model
One of the earliest models modeling how economic growth is achieved was the Harrod–Domar model which argued that output equals consumption and savings (which are identical with investments) => when savings and investment rise, output grows.
In everyday language the H&D model says: ‘If you are a farmer and sell eggs for 1000$ this month and you spend 950$ for fancy farmer clothes and parties, you will be able to save 50$, buy one more chicken and next month make 1100. The less you party, => the more you save => the more you invest =>the more you make => the more you make next month’ (tell your governments).
Mathematically speaking: Y(output) = C(consumption) + S (savings)
A somewhat logical conclusion follows: If poor countries saved too little, they would be trapped in poverty; foreign aid could fill the “financing gap” and spark growth. The foreign aid schemes today still often reflect this theory.
In 1954 Arthur Lewis added nuance with his Dual-Sector Model. Developing economies, he wrote, had vast “surplus labour” in low-productivity agriculture. Moving those workers into industry, where labour is more productive, would generate self-sustaining growth.
In other words: You can only make a certain amount of money through selling corn. On the other hand if you make cars and innovate, the possibilities are endless.
Notice that this is one of the first models that take into account the ‘structure’ of an economy.
Industrialization = Restructuring of the Economy
We established that structure (ratio of industry vs agriculture etc.) matters for long term economic growth. In the 1950s and 60s, Latin American economists like Raúl Prebisch and Hans Singer pinpointed an even deeper structural problem. The terms of trade between raw materials and manufactured goods were deteriorating; exporters of coffee and copper would always lose to industrial powers that exported cars and ships.
Imagine I produce cotton in Pakistan, sell it to you and you make shirts from it in the US. I extract the value from the crop and sell you raw material. You add value to this raw material and sell it for much more than it cost you to make it. Not only that but Prebisch and Singer also found out that when consumers get richer, they spend more money for more luxurious or sophisticated goods.
However, you in the US don’t need that much more cotton to add a collar to their shirt and sell it for 50% higher price(price elasticity). For this reason, countries selling cotton earn less and less for the same amount of exports, while countries selling luxury shirts keep earning more.
What can be done to fix this? Prebisch's idea was for developing countries to protect their infant industries by raising tariffs.
Imagine my friend in Pakistan comes and says ‘I have a few sewing machines at home. Give me your cotton and I will make shirts here’. His shirts will be 30% more expensive than those in the US because she doesn’t yet have the same advanced machines they have.
‘But why would anyone buy a 30% more expensive shirt from a domestic company when they can buy it from a larger US-based producer and pay 30% less?’ This is where the state comes in and says to the US company ‘if you want to sell your shirts in pakistan, you have to pay us 30% every time you sell one’ this equalizes the conditions for both companies and compensates for the domestic company’s smaller size.
Through this tariff policy, these smaller companies get protected until they are large enough, capturing the value added in manufactured products in the developing country.
The P&S theory was hugely influential and translated into policymaking mainly in South America through so called Import-Substitution Industrialization (ISI)
The proposed ISI had the goal to protect infant industries through tariffs, credit subsidies, and state planning so that these developing countries could develop their own industries instead of staying exporters of raw materials.
As Ali Allawi (2024) shows, ISI worked initially. Latin America’s growth averaged 6% through the 1960s as factories and car plants were built. Nevertheless, by the 1970s the model hit its limits: small domestic markets, lack of competition, overvalued currencies, and weak export capacity created inefficiency, slowing down their growth. When the oil crisis hit in the 1970s, these countries found themselves in debt and subsequently in sovereign defaults.
However, there was an important caveat to the story that was suppressed by ideological pressures at the time. ISI’s failure was not inevitable. It suffered from political capture, protected firms stopped innovating, and governments became dependent on rents.
Structuralism’s insight, that states must create new industries, was right; its execution, as Allawi argues, overreached the state’s capability.
The Neoliberal Revolution
The crisis of the 1970s shifted the discourse in the very liberal direction towards what is know as the Chicago-school (or neoliberal) revolution. The argument of Milton Friedman and others was essentially: Governments obviously distort incentives and increase risk of states themselves going bankrupt and so let the market regulate itself. The result was a wave of “market-friendly” reforms, privatization, liberalization, and open capital accounts coming with all the problems I recently covered in my last blogpost on Rodrik’s Globalization Paradox.
The Developmental State
While South America was trying to recover from a deep crisis blamed on protectionist policies, East Asia broke every neoliberal rule and massively succeeded. South Korea and Taiwan protected industries but tied support to export performance. Firms received cheap credit only if they met targets; failure to perform meant losing access to finance.
The two main differences between the industrial policy measures in the south american vs asian case are the following.
Protection vs. conditional protection
Imagine two children wanting to become athletes. One’s parents praise her no matter how she plays; the other’s only show affection when she trains hard. Of course, both would make pretty awful parents, but it’s easy to guess which child becomes the better athlete. Similarly conditional protection means the government protecting industries conditionally on their delivery of promised results. This makes the companies stay innovative without domestic competition.
Taiwan’s and Korea’s focus on export in the second phase of their industrialization process
In the second phase of the industrialization (basically going from manufacturing shirts to manufacturing cars and semiconductors), Taiwan and Korea focused on export which boosted these industries and brought economic growth. South American countries instead kept focusing on their domestic economies and ‘choked’ their economies as described above.
As Robert Wade (2018) shows, the system in Korea and Taiwan was rooted in capable, meritocratic bureaucracies, combined state discipline and market pressure. To paraphrase Wade ‘these states were “embedded but autonomous”: close enough to firms to understand their needs, but strong enough to resist capture’.
East Asia’s success is a story of countries who ignored ideological noise of their time and instead bet on expertise in institutional design and economic policy; states that could plan, learn, and enforce discipline.
Rethinking Industrial Policy for the 21st Century
By the 2000s, economists began to move beyond the false market–state dichotomy. Justin Yifu Lin (2011) proposed the idea of the New Structural Economics (NSE). Every country, he argued, should develop along its latent comparative advantage, industries consistent with its endowments of labour, land, and capital, but use the state to overcome coordination failures. Governments should “facilitate rather than defy” the market, helping firms upgrade step by step from textiles to electronics.
Building on Lin, Ha-Joon Chang and Antonio Andreoni (2020) redefined industrial policy as risk management. Development requires “anticipatory” and “insurance” functions: anticipating future constraints and insuring firms against risks they cannot bear alone (safety net). The goal is no longer to protect firms indefinitely but to create an environment where they can innovate and compete globally.
Both Lin and Chang see the state as a strategic partner, not planner, not spectator, whose role is to organize learning and share risk in the face of uncertainty.
Why Strong Institutions Are Needed?
In order for the state to be a strategic partner it must be reliable and not corrupt. It is obvious that countries only grow when states have the capacity to invest, discipline, and learn
ISI failed where politics turned protection into patronage
Market reforms failed where politics could not cushion social shocks
East Asia succeeded where egalitarian reforms and capable bureaucracies aligned state and business incentives
As You Jong-Sung (2015) shows, equality and good governance are not moral luxuries, they are conditions for effective industrial policy. Without them, every model collapses into corruption or chaos.
From Planning to Learning
Today’s stands towards structural economics is slowly changing to the better and combines lessons from all eras outlined here. Growth depends on markets to allocate resources, but also on states to coordinate, insure, and learn. The best-performing economies practice a kind of strategic pragmatism: protect when necessary, liberalize when ready, and constantly adapt.
As Chang reminds us, every rich nation once used industrial policy; only after succeeding did they preach free markets (Kicking Away the Ladder). The role of today's academia should be to ignore ideological pressures and look at industrial policy through an empirical lens in order to give nuanced and well informed policy advice.
Bibliography
Allawi, A. A. (2024). Rich World, Poor World: The Struggle to Escape Poverty. Yale University Press.
Chang, H.-J. & Andreoni, A. (2020). “Industrial Policy in the 21st Century.” Development and Change, 51(2).
Lin, J. Y. (2011). “New Structural Economics: A Framework for Rethinking Development.” World Bank Research Observer, 26(2).
Wade, R. (2018). “The Developmental State: Dead or Alive?” Development and Change, 49(2).
You, J.-S. (2015). Democracy, Inequality, and Corruption: Korea, Taiwan and the Philippines Compared. Cambridge University Press
