NEO-CLASSICAL THEORY OF DEVELOPMENT, NEO-

LIBERALISM AND EXPERIENCE OF KENYA

Ms. Kathleen Fogelberg,

Graduate School of International Studies,
University of Denver,
Denver, CO 80208.

Prof. Kishore G. Kulkarni, Ph.D.,

Professor of Economics and Editor, Indian Journal of Economics and Business,
Campus Box 77, P. O. Box 173362,
Metropolitan State College of Denver,
Denver, CO 80217-3362.
E-mail: kulkarnk@mscd.edu

First draft of this paper was completed in June 2006. Please direct all
correspondence to the second author.

1
 NEO-CLASSICAL THEORY OF DEVELOPMENT, NEO-
LIBERALISM AND EXPERIENCE OF KENYA

INTRODUCTION:

Ever since the publication of Adam Smith’s The Wealth of Nations in 1776,

economists have tried to understand why some countries are wealthy and others are poor

(WHO, 1999). A range of theories of economic development have tried to explain the

process of development, from Walter W. Rostow’s linear modernization theory to the

neoclassical emphasis on free trade as the engine to growth. Theories have explored both

endogenous and exogenous factors contributing to, as well as hindering, growth.

Economic theories of growth pass in and out of fashion, depending on the political and

economic climate of the international arena.

One of the current popular theories of economic growth is that of market

fundamentalism, known as the neoclassical theory of development. According to this

theory, economic growth is directly related to free trade and countries should follow

policies of deregulation, privatization, and liberalization in order to achieve desired

economic growth (Addison, 2000). Underdevelopment is the result of too much

government intervention and poor resource distribution due to unfounded pricing

policies. The neo-classical theory is based on the idea that free markets will create

competitive environments in which producers will have incentives to engage in the global

marketplace (Schoepf, 2000). Often implemented under Structural Adjustment

Programs, or the re-named Poverty Reduction Strategies, from the World Bank or

International Monetary Fund, several characteristics appear throughout the different

2
approaches. One is conditionality of loans; certain policies and procedures must be

followed in order to ensure continued lending privileges. Moreover, governments must

privatize industries and services previously under their control, from airlines to health

care. The liberalization component requires that prices (interest rates, exchange rates,

wages, and commodity costs) be determined by market forces without any government

intervention or support. One final component deals with deregulating the country’s

economy by removing any barriers to global trade and investment. (Gershman, 2000).

Consistent with Heckscher-Ohlin’s theorem, which relies on the concept of factor

abundances, neo-liberal economists argue that open global trade networks will allow

developing countries to produce those goods with which they have a comparative

advantage. In labor-abundant developing countries, these goods are typically labor-

intensive with little or no added value in production.

While economic growth was one of the goals of these liberalizing policies, the

opposite has been true for must of the countries involved, especially the African countries

(Kim, 2000; Schoepf, 2000). They stated economic and social improvements that were

expected to follow the economic restructuring have not returned to many of the people

most affected by these reforms. For example, in Sub-Saharan Africa, the entire region

saw no increase in its per-capita incomes between 1965 and 1999, despite some

improvement in the 1990s (Goldin, 2001). Furthermore, although African countries did

show some positive improvement in health and education indicators (life expectancy and

literacy), the AIDS epidemic has reversed what progress on life expectancy had been

achieved. Life expectancy fell from 50 years in 1990 to 47 years in 1999, and several

countries have suffered double-digit declines in life expectancy (Goldin, 1999).

3
Although the idea that openness to international trade accelerates development may be

agreed upon by the vast majority of the economists, health situations are being created

and exacerbated by economic policies which do not include improved health as a

determinant and an end of economic development.

This paper will look at whether or not the neoclassical model of development is

the best option for Kenya, which is plagued by numerous devastating health problems.

Health is one phenomenon that is not going to be addressed by the market, and in a

country where major health issues are affecting productivity and growth, a market-based

approach may not be the most effective. A brief introduction to the theory of neoclassical

development will be followed by limits and critiques of this approach. Next, the effects

of the application of these policies to Kenya will be discussed, followed by concluding

remarks and recommendations.

Market-Driven Growth and Its Limitations

The theory of neoclassical (or neo-liberal) development became popular in the

1980s with the emergence of conservative governments throughout Western Europe and

the United States (Todaro, 2002). Furthermore, the failure of so many developing

countries to achieve higher standards of living led economists to develop new theories

about growth and underdevelopment. Neo-liberal economic theory has its roots in the

1950s as a reaction against Keynesian economic theory, which argued that an unregulated

capitalist economy was susceptible to severe Depressions and that government

intervention was necessary ( Shakow, 2000). The convergence of conservative

policymakers and economic theory in the 1980s elevated neo-liberalism to state doctrine

in the United States (Shakow, 2000). The United States and Britain have used their

4
power and influence to secure votes at the major International Financial Institutions

(IFIs), which are the most powerful institutions in the global political economy (Shakow,

2000).

The neoclassical theory offers a triple prescription for economic growth:

privatization, liberalization, and deregulation (Shakow, 2000). Privatization involves the

sale of state-owned enterprises, such as airlines, railroads, etc. It also requires the state to

reduce social service expenditures in areas of health, education, and sanitation. The

impetus for privatization is that states’ involvement in the economy creates inefficiencies

that the “invisible hand” of the market can correct. In the case of businesses, the idea is

that competition will create the most efficient methods of allocation. In the case of health

care, privatization leads to the imposition of user fees for services that were previously

paid for by the state. Furthermore, the transfer of these services from a not for profit

model to a for profit model leads to the exclusion of many from health care services.

According to neo-liberals, the liberalization of the economy attracts more

domestic and foreign investment, which increases the rate of capital accumulation

(Todaro, 2002). Capital accumulation is analogous to raising domestic savings rates,

which impacts capital-labor ratios and per capita incomes in positive ways (Todaro,

2002). Liberalization further requires reducing barriers, such as tariffs, quotas, and non-

tariff barriers, to the flow of free trade and investment. The elimination or large

reduction of government subsidies that keep the prices of certain goods down is another

component of liberalization. By cutting subsides and reducing the barriers to trade, the

market is allowed to determine prices, and neo-liberals argue that the prices are “right”

(Gershman, 2000). Prices will reflect the actual value of the goods without government

5
inefficiencies. Capital will hence flow to the areas of the economy that are the most

profitable and productive. Liberalizing the economy will integrate the national economy

with the global economy, and, in theory, this will raise social welfare by providing the

cheapest goods and services possible to consumers through imports while forcing

producers to be as competitive as possible. Deregulation of the economy entails a

reduction of the level of state control over goods, services, capital, and domestic labor

markets (Gershman, 2000).

These approaches are meant to ensure that state intervention in developing

economies with be reduced. By allowing the market to regulate the economy, privatizing

state-owned enterprises and services, promoting export expansion, creating a welcome

climate for foreign investment, and eliminating government controls on prices, neo-

liberals argue that economic efficiency will be stimulated, leading to economic growth

(Todaro, 2002). Inherent in this approach is the idea of “short term pain” for “long term

gain” (Schoepf, 2000). There are always winners and losers in the economy, and neo-

liberalism argued that the “trickle down” phenomenon would occur as countries followed

their policy prescriptions.

Thus, Neo-liberals argue that Keynesian policies, such as Import Substitution

Industrialization (ISI) render markets less effective that export focused development

strategies. ISI typically involves domestic protectionism for infant industries, as well as

state investment in infrastructure and social infrastructure (Shakow, 2000). Furthermore,

neo-liberals cite the experience of the Asian tigers as proof of their export-driven theory

of economic growth (Todaro, 2002). However, more careful analysis of the experience

6
of the Asian tigers has shown that they did not follow laissez-faire prescriptions of neo-

liberalism (Todaro, 2002).

In the 1980s and 1990s, these neo-liberal policies of growth provided the

ideological basis for the International Monetary Fund’s Structural Adjustment Programs

(SAPs). SAPs put the theories of neo-liberalism into practice with their strict

conditionality requirements on loans from the IFIs. Due to decreasing world prices for

primary exports, the oil crises in the 1970s, and continuing deteriorating terms of trade,

many countries were forced to adopt the stabilization policies of the IMF. Privatization,

liberalization, and deregulation were components of the loan packages, but devaluation of

the exchange rate and domestic anti-inflation program (which included control of bank

credit to raise interest rates, curbing government spending in the areas of social services,

control of the wage markets, and dismantling price controls) were also components of

SAPs. SAPs institutionalized neo-liberal theories and their effects on developing

economies are greatly contested.

Problems with Neo-liberalism in Developing Countries

The core of neo-liberalist theory states that less government control and more reliance on

the free market are the basic ingredients for development (Todaro, 2002). One of the

problems of applying models of growth based on developed countries experiences to

underdeveloped countries is that many LDC economies are “so different in structure and

organization from their Western counterparts that the behavioral assumptions and policy

precepts of traditional neoclassical theory are sometimes questionable and often

7
incorrect” (Todaro, 2002, p.131). Although neo-liberalism calls for free markets, there

are economic, social, political, and cultural structures in place in developed countries that

facilitate the application of the theory, and these are not necessarily the same in LDCs.

Furthermore, in LDCs, there are many externalities of production and consumption that

may or may not exists in developed economies to the same degree. The experience of

SAPs throughout the world has shown that the “invisible hand” succeeds at misreading

the majority of the population which enriching those who are already better off (Schoepf,

2000; Todaro, 2002). There is a tendency for capital to flow where it is already most

abundant, which further marginalizes people living in poverty.

At the core of neo-liberalism is reliance on the market. But some markets do not

operate on the same scale in LDCs, nor do they exhibit the same characteristics. By

assuming that market-led development in countries where markets are often imperfect,

consumers lack information, and greater uncertainty faces producers and consumers,

economists and policymakers are often ignoring other powerful ingredients to growth.

Since many goods have a social value that is not included in their market value, such as

education and health, they may be provided at a price below their cost. When

governments are responsible for providing social services, the idea of health or education

as a public good allows for expenditure into these sectors. However, when privatization

occurs and the private sector is responsible for providing these services, there is no

economic incentive to do so (Todaro, 2002). This may lead to a lot of people much

worse off than they were before.

Another major limit of the neo-liberal theories is their focus on economic growth

first, followed by human development. In countries of Sub-Saharan Africa, where

8
HIV/AIDS affects one out of every three people, focusing on increasing GDPs will not

have any major impacts on economic development. Economic growth is typically seen as

a precondition for real health improvements (Sachs, 2001). A growing body of empirical

evidence supports the notion that high prevalence of diseases such as HIV/AIDS and

malaria, coupled with a systemic lack of health care, is association with persistent and

large reductions of economic growth rates (Sachs, 2001). Health is an important tool and

strategy for economic development, not just a trickle down effect of economic

development. Healthy people are more productive, healthy children become productive

adults, and an overall healthy population can contribute to economic growth (Sachs,

2001). An in-depth study on the effects of malaria on country’s rates of economic growth

confirms these ideas about health and development (Gallup, 2001).

Countries that have eliminated malaria have considerably higher growth that those

still battling the disease. Another important observation is that the countries with

intensive malaria grew 1.3% less per person per year and a 10% reduction in malaria was

associated with 0.3% higher growth (Gallup, 2001). While malaria alone obviously does

not explain underdevelopment, the cumulative costs to society are having a real

detrimental effect on economic growth.

A Commission by the WHO on the impacts of investing in health as a strategy of

economic development determined that by saving eight million lives from preventable

deaths (e.g. tuberculosis, malaria, HIV/AIDS, childhood diseases, maternal mortality, and

smoking) would generate at least $360 billion annually by 2015-2020. These lives that

would be saved represent a much larger number of cumulative years of life saved

(Disability Adjusted Life Years, DALYs) as well as higher quality of life and

9
productivity for those individuals. (Sachs, 2001). The estimated 330 million DALYs

would be saved for eight million deaths prevented each year, which would directly

contribute to economic growth and poverty reduction. These 330 million DALYs are

estimated to worth approximately $180 billion per year “in direct economic savings by

2015; the world’s poorest people would live longer, healthier lives, and as a result, would

be able to earn more” (Sachs, 2001, 14).

We now turn to the case of Kenya to determine whether or not the neoclassical

model of growth applies to its situation.

Background on Kenya

Located in East Africa, Kenya is bisected by the equator, creating a variety of

climates and microclimates. The most productive zone is the Central Highlands, which

receives adequate rainfall and rich volcanic soils that create a rich agricultural

environment. Estimates of the population in 2000 were approximately thirty million

people (Todaro, 2002). Population growth is currently slowing, mostly due to the AIDS

pandemic sweeping through the country. Kenya gained independence from Britain in

1963 and there have only been three Presidents in this time period (Todaro, 2002).

Because of the arid climate in the north, almost eighty-five percent of the

population and the majority of the economic activity occupy the southern part of the

country (Todaro, 2002). Characteristic of many developing economies, most Kenyans

(77%) depend on agriculture for their livelihoods (Legovini, 2002). Maize is the

10
principal staple crop, while coffee and tea are the major export crops. Other exports

include coconut, cashews, sugarcane, sisal, bananas and pineapples (UNDP, 2003).

Post-independence Kenyan economic history can be divided into two time

periods: 1963 to the early 1980s was characterized by strong economic growth and

improvements in social outcomes; however, during the second period (1980s onward),

slow or negative growth and losses in social welfare reversed earlier successes. Post-

independence governments adopted Import Substitution Industrialization (ISI) strategies

towards growth, which promoted capital-intensive production and limited the number of

labor-intensive manufactures, such as garments and footwear that are found in other

LDCs (Legovini, 2002).

Between 1963 and 1970 the economy grew at an average of 5 percent per decade

and from 1970 to 1980 at 8 percent (See Figure 1)

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 Economic growth by decade

9.00
8.01
8.00
Constant GDP growth Constant GDP per capita growth
7.00

6.00
5.04

5.00
4.08 4.07

4.00

3.00

1.69 1.67
2.00

1.00 0.52

0.00
-0.79
-1.00
1970/63 1980/70 1990/80 2000/1990
Decade

FIGURE 1 (From: Legovini, 2002, p.29.)

These high growth rates during the early years of independence resulted from several

factors. In the agricultural sector, which we have already seen provides employment for

the majority of the population, the newly independent government distributed productive

land to small farmers and promoted the cultivation of tea, coffee, and hybridized maize

(Legovini, 2002). Rural incomes rose by five percent per year from 1974 to 1982 and

smallholders’ share of coffee and tea production rose to forty and seventy percent,

respectively (Legovini, 2002). Economic growth is inherent in poverty reduction, but to

really address the majority of the population, policies need to be addressed towards the

sectors that involve the majority of the poor people (HDR, 2001). Kenya’s early approach

12
to economic growth was pro-poor in that it focused on land redistribution and building

the small-scale percentage of agriculture.

Relatively stable prices for commodity goods provided foreign exchange, which

was reinvested into import substitution industries. The ISI approach created high barriers

to entry and disincentives to export growth (Legovini, 2002).

Growth by sector

12.00 Industrial growth Service growth Agricultural growth

10.61

10.00

7.61
8.00

6.26

% 6.00 5.23 5.33

4.90

3.95
3.66
4.00 3.26

2.44
1.77
2.00
0.68

0.00
1970/63 1980/70 1990/80 2000/1990
Decade

FIGURE 2 (From Legovini, 2002, p.30)

The expansionary economic policy of the first decade of independence allowed

for the 7% GDP growth during that decade (Todaro, 2002). Large public investments,

support of small-scale agriculture, and strengthening the industrial sector were some of

the reasons for this growth (See Figure 2). Furthermore, from the beginning of

independence, the Kenyan government made primary health care a priority based on the

idea that the combination of a sound health care delivery system, good nutrition, food

13
security, and an absence of morbidity and mortality will produce health people capable of

participating in their country’s economic and human development (HDR, 2001).

Kenya and Neo-liberal Development

While neo-liberal policies are not the only factor contributing to the decline of

economic growth in Kenya, they certainly had a role to play. Like other LDCs, climatic

crises, corruption, and the coffee crisis also contributed, but when the experience of

Kenya is compared with other countries who also attempted to follow the neoliberal path

to development, it is evident that neo-liberalism may not be the best policy for countries

lacking the structures necessary for neo-liberal development to occur.

Much of Kenya’s post-independent success, both in terms of economic and

human development, occurred in the first decades of independence. The growing

popularity of the neo-liberal path to development, coupled with deteriorating terms of

trade in the 1980s, led Kenya to join the neo-liberal bandwagon, at the expense of both its

economic and social well-being. Kenya received two loans from the International

Monetary Fund, one in 1988 and another in 1989 (IMF, 2001). In the 1984/88 and the

1983/93 Kenyan Development Plan periods, the government emphasized liberalizing the

economy, removing the promotion of rural development employment creation, and

agricultural expansion (HDR, 2001). This was in direct contrast to their earlier

supportive policies for rural agriculture, which as earlier stated employs up to seventy-

five percent of the labor force. Further reform in 1986 embodied all of the ideals of neo-

liberalism, and required increased reliance on market forces, a decline in the role of

government in economic affairs, and the creation of incentives for private investment

(HDR, 2001). The most recently implemented development plan (1997/2001)

14
emphasized the role of privatization in the country’s economic development (HDR,

2001).

Recent market-oriented policies that include financial, trade, and agricultural

market liberalization have yet to break the pattern of growth decline (Legovini, 2002). I

believe that the growing AIDS pandemic and other public health issues are directly

related to the stagnating growth in the country, and a more successful approach would

directly address investing in the health care sector. Where neo-liberal development has

had successes (developed countries), they have not also been plagued with such public

health emergencies as Kenya. The “invisible hand” of the market is not a viable option

given the extent of the AIDS crisis in Kenya. Following the prescriptions of neo-liberal

advocates, Kenya’s economy and population have suffered.

Deteriorating Economic Situation

During much of Kenya’s post-independence history, a strong export bias has

existed which led to the government reliance on ISI as a strategy to economic growth.

However, as Kenya has liberalized its economy, small-scale agriculture, which affects the

majority of the population, has suffered. Since the mid 1980s, the economic growth that

characterized the early post-independence years has been replaced with stagnation and

even negative growth during the 1990s (HDR, 2001). The 1990-2000 decade was

characterized by low economic growth, the impact of SAPs, and the donor aid freeze

(HDR, 2001). This translates to lower GDPs and more money being diverted to debt

repayment.

Agricultural growth fell from five percent in the 1970s to less than one percent in

the 1990s (Legovini, 2002). This decrease in agricultural productivity is exemplified by

15
the increasing rural-urban migration of peasants to Nairobi (Todaro, 2002). Industrial

output growth fell from eleven percent in the 1970s to two percent in the 1990s

(Legovini, 2002). All of these reductions are manifested in the decrease of Per Capita

Incomes (PCIs) in Kenya: in 1990, the PCI was 9% lower than it was in 1980; $380

compared to $410 (Todaro, 2002). Furthermore, the annual growth rate registered at a –

0.3% during the 1990s (Todaro, 2002). Deteriorating terms of trade (See Table 1) made

it more difficult to be a player in the global economy and had real impacts on income

levels.

Table 1: Balance of Trade (in Million Kenya Pounds)

1995 1996 1997 1998 1999 2000 2001

Exports 4,866.95 5,910.00 6,022.25 6,059.05 6,127.95 6726.35 7,379.5
Imports 7,758.22 8424.31 9,533.70 9,889.45 10,320.1 12,390.2 14,505.4
Balance -2,891.47 -2,514.31 -3,511.40 -3,830.4 -4,192.1 -5,663.9 -7,125.9
of Trade
From UNDP, 2003, pg. 5.

Deteriorating Social Situations

Another aspect of neo-liberal development involves the transfer of publicly

provided social services to private entities. This has had most profound health impacts in

Kenya. The increasing proportion of the budget allocated to debt repayment detracts

from investments into Kenya’s human capital, a vital component of economic growth

(Sachs, 2001). The gains achieved during the 1963-1980 period have been replaced with

a decrease in life expectancy and a greater burden on a defunct health sector. The

theoretical components of neo-liberalism put into practice in Kenya have had deleterious

effects on the health of the population, both through privatization of services and

16
liberalization, which has resulted in lower incomes for the poorest of the population

(HDR, 2001).

The effects of a decline in expenditure on social services from 20% in 1980 to

12.4% in 1997 are evident in the following indicators:

 Poverty incidence increase from 44.8% in 1992 to

52.3% in 1997
 Reduction in life expectancy from 59.5 years in 1989 to 51.3 years in
1999
 No improvements in the Infant Mortality Rate from 1989 to 1999
(66/1000)
 Increase in under five mortality from 89 in 1990 to 105 in 1998
 Immunization of infants (under 1 year old) decreased from 92% in
1990-1994 to 56% in 1995-1996
 Increase of HIV/AIDS infections to 13% (about 4 million), with some
areas as high as 30%
 80-90% of the HIV/AIDS infections are in the 15-49 age group
(Legovini, 2002; Todaro, 2002: HDR, 2001).

One of the major reasons for these downturns is the declining access to health

care. As earlier stated, when governments are responsible for providing social services,

the idea of health or education as a public good allows for expenditure into these sectors.

However, when privatization occurs and the private sector is responsible for providing

these services, there is no economic incentive to do so (Todaro, 2002). In addition, the

imposition of user fees and other externalities of accessing health care (transportation)

costs, missed wages at work, cost of medicines), leads to a greater percentage of the

population with less access to care.

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 Life expectancy and AIDS

65 20000
Life expectancy at birth, female (years)

Life expectancy at birth, male (years) 18000

60 Life expectancy at birth, total (years)

16000
Reported AIDS cases (WHO Epidemiological factsheet
2000)

14000
55

12000
Years

50 10000

8000

45
6000

4000
40

2000

35 0
1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

Year

FIGURE 3 (From Legovini, 2002, 55)

One cannot discuss the health, nor the economic, situation of Kenya without

discussing HIV/AIDS. As earlier stated, the AIDS pandemic has actually decreased life

expectancy in Kenya (See Figure 3).HIV/AIDS has been acknowledged as a threat to

economic growth by both the Kenyan government and the World Bank. However, the

ideologies behind growth still emphasize economic growth before human growth. There

is a growing body of academics that emphasize that health is a precondition to

development, not something that happens as a result of development. In fact, there is

hardly any empirical evidence that increased income leads to improved health, while

18
there is quite a bit of evidence that improved health leads to increased productivity

(Todaro, 2002; Sachs, 2001). HIV/AIDS affects family welfare, economic growth and

social services. Before death, family incomes are reduced as sick members reduce hours

of work or cannot work at all. A lack of public support means that families are often

responsible for the burden of what few treatment options are available. Growing

numbers of orphans will require social and economic resources by increasing the

dependency ratio. The extent of the AIDS epidemic in Kenya, on top of the weak health

infrastructure, need to be addressed alongside economic development to better people’s

lives.

Conclusion: The Kenyan Experience

Although neoclassical models of economic development are currently in fashion in

policymaking circles, the experience of developing countries, notably Kenya, decreases

the validity of this model in LDCs. What the neoclassical model is good at is ensuring

debt repayment and opening up borders for free trade. What it has not proven to be

successful at is increasing incomes for those who need it most and improving social

conditions.

Kenya at independence invested in small-scale agriculture, where the majority of

its population was employed and an import substitution strategy. In addition, their earlier

emphasis on health provided care to the majority of its population. However, when the

country adopted the policies and ideals embraced by neo-liberalism, their economy and

society took a turn for the worse. Neo-liberalism relies on the market for growth, but

19
when a large percentage of the population cannot participate in the economy because of

AIDS or other health problems, how much growth can be achieved? And who will be the

beneficiaries of this growth?

Decreasing terms of trade, a stagnant and lower per capita income, and declines in

the health of the population resulted from the neo-liberal policies embraced in the 1980s

and 1990s. A more effective model of growth for Kenya may prove to be a human

capital approach put into practice. Real investment into human capital is necessary in a

country where AIDS is somewhat responsible for declining productivity, and definitely

responsible for declines in life expectancies, which will inherently affect macroeconomic

growth and development.

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