Financial Times chief economist Martin Wolf has come out swinging against his pet peeve term "neoliberal" while reviewing two recent books that suggest "mercantilist" measures are more or less required in order for nations to develop. One of the authors in question is Ha-Joon Chang from Cambridge. You may have read Ha-Joon Chang's older book Kicking Away the Ladder, whose basic thesis is that there are few if any countries which have successfully developed without first resorting to using trade barriers and the like to spur development. Only after some measure of development is achieved with the help of these barriers can the "ladder" of trade barriers be "kicked away." According to Chang, it is unfortunate that the WTO looks down upon the use of such measures nowadays, making development a difficult task for countries looking to better their economic fortunes. The second book reviewed here by Erik Reinert pretty much makes a similar point as Wolf discusses.
Wolf rightly comments that some countries never reach the point of being able to kick away the ladder for they are either unwilling or unable to do so to begin with. And, the passage of time does little to improve matters. Hence, the Chang argument is in many ways similar to the "infant industry" argument. While some infants do grow up enough to become viable competitors in their own right, many do not (like the famous case of Proton Cars Malaysia). Indicators of progress and timetables for the gradual withdrawal of heavy state support are likely welcome features from Wolf's point of view. UPDATE: BBC Radio 4 has an audio interview of Chang. And, there is an article in Prospect by Chang which summarizes his book's points.
In the summer of 1972, as a “young professional” at the World Bank, I went on a mission to South Korea. It was my first experience of something extraordinary: a country that was developing at a breathtaking rate. The country had already enjoyed a decade of economic growth at close to 10 per cent a year. It continued to grow at close to that rate for another quarter of a century.
What struck me about Korea was the determination of its policy-makers to sustain rapid industrialisation. I saw the construction from scratch of the vast Hyundai shipyard at Ulsan that was soon to join the first rank of ship-builders. That bet itself demonstrated something even more remarkable: Koreans’ belief in their country’s ability to achieve global competitiveness.
For the Koreans, exports were both a tool of development and a test of its success. How different this was from east Africa and India, on which I was to work for the following five years. India was almost as sealed from the world economy as it was possible to be. Its annual growth in income per head had fallen in the 1970s to about 1 per cent a year, while industrial productivity seemed to be declining, despite its desperately low level.
The contrast between South Korea’s success and India’s failure was striking. Both used protection and other tools of industrial policy. Yet the orientation of India’s policies was inward-looking and anti-competitive, while that of South Korea was the opposite. In the literature on development and trade, the Korean strategy came to be called “export promotion”, because its economy did not have an overall bias towards the home market.
The contrast between South Korea and India raised the biggest questions in economics: why have some countries succeeded with development and others failed? Why has Korea jumped from poverty to prosperity in a lifetime? Why did India do badly then, but much better recently?
The broad question is the one Erik Reinert states in his title: How Rich Countries Got Rich... and Why Poor Countries Stay Poor. Reinert is a Norwegian professor who now teaches at Tallinn, Estonia. Ha-Joon Chang, a well-known Korean development economist, teaches at Cambridge. But both give strikingly similar answers to this question.
Both state that the priority in development is rapid and sustained growth. Only industrialisation can deliver such growth, because industry is the only sector in which rapid and sustained rises in productivity are feasible. Furthermore, to industrialise, countries must upgrade their technological and managerial capabilities, which can be achieved only if they are able to nurture infant sectors. That requires protection, they both argue, as has been the case in every successful economy of the past half-millennium.
Tragically, they argue, the “neo-liberal hegemony” - the broad consensus [of liberalization, privatization, and deregulation] on liberal trade and freer markets of the past quarter century - has deprived countries of these valuable tools. The result has been a development disaster, particularly in Latin America and Africa, where the International Monetary Fund and the World Bank have run amuck. The World Trade Organisation and a host of one-sided so-called free trade agreements further constrain the ability of developing countries to adopt sensible policies. This, they agree, is a huge contrast to the era of the Marshall Plan in postwar Europe and the more permissive attitudes towards development policy taken by the US between the 1950s and early 1980s [which enabled the maintenance of barriers].
While the two books are rooted in a similar world view, their style and tone are different. Reinert’s book, while no less enraged, is more academic. He is fighting an intellectual war with neo-classical economics, the academic orthodoxy since the 19th century. He considers himself “heterodox” and presents an alternative “other canon”.
In place of a priori reasoning, this emphasises practical experience; instead of the theory of comparative advantage in trade invented by the 19th-century theorist David Ricardo, it points to the success of protection against imports since the Renaissance. Reinert argues that, for poor countries, specialisation in line with comparative advantage means specialising in poverty. As Friedrich List, the 19th-century German economist, argued, what a country makes matters. Protection is the solution; free trade is suitable only for countries at the same level of development.
So, in respect of Africa - surely the most important and urgent case for treatment - Reinert recommends internal free trade and external barriers to trade, in place of what he condemns as the mere “palliative economics” of millennium development goals, bed-nets and ever more aid.
Chang’s book Bad Samaritans is shorter and more punchily written. He considers how people who want to help developing countries but instead are hurting them, constrain policy options for developing countries. Among these constraints are limits on their ability to regulate inward direct investment, an undue obsession with privatisation, restrictions on access to intellectual property, exaggerated attention to financial stability, excessive emphasis on corruption and lack of democracy and, last but not least, undue stress on the importance of culture.
Unlike much of the writing produced by opponents of contemporary globalisation, these are serious books by serious people. They deserve to be read.
Moreover, I agree with both authors that the goal has to be faster economic growth. I sympathise with the view that the assumptions of conventional economics ignore the evolutionary character of a dynamic economy. I agree, too, that industrialisation is the principal route to growth. I agree, finally, that some policies that now affect developing countries are dangerous: restrictions on easy access to intellectual property are perhaps the most important.
Yet I also have some important disagreements. Reinert, for example, argues that contemporary neo-liberals believe in “factor-price equalisation” - the theory that free trade would make wages and returns to capital the same everywhere. In fact, those taught the theory always understood that the implication is the opposite: it shows how many unlikely conditions need to hold before these results hold true.
What neo-liberals - if I may use that ugly term - did believe is that new opportunities were at last opening up for developing countries to export manufactures and a range of relatively sophisticated services competitively. Indeed, about 80 per cent of exports from developing countries are now manufactures.
Admittedly, this success has recently been dominated by China. But China is as populous as sub-Saharan Africa and Latin America combined. The exports of manufactures would, it was hoped, build up the virtuous circle of growth and industrialisation in which Reinert believes, operating on a world scale from the start. That is, of course, what China is now achieving.
This brings me to my most fundamental disagreement: the lessons of history. Reinert argues: “US industrial policy from 1820 to 1900 is probably the best example for Third World countries to follow today until these countries are ready to benefit from international trade.” From the emphasis Chang puts on 19th-century examples, he agrees.
Yet this example makes no sense for most, if not all, contemporary developing countries. The technological gap between the UK and the US in the 19th century was trivial by comparison with that between, say, the US and Ethiopia today. Even so it took more than half a century for the US to close it.
The US was also a vast continental country, capable of attracting a huge immigrant workforce, much of it educated, and so generate a domestic market large enough to exhaust the economies of scale offered by the technology of the time, while still permitting strong domestic competition. That proved not to be the case even for India, a giant among developing countries. This is, to put it mildly, hardly a model for Ethiopia, let alone Chad.
Few (I would argue, no) contemporary developing countries are big or technologically sophisticated enough to make a decent job of the 19th-century protectionist model. The big successes of recent decades - from Hong Kong to China, South Korea to Ireland, Singapore to Taiwan, Japan to Finland - were not all free traders (though some were). Some also relied heavily on foreign direct investment (China, Ireland and Singapore), while others resisted it (Japan and South Korea).
Yet all used the world economy - and therefore trade - as a central part of their development success. These were, then, cases of outward-looking, infant-industry promotion far more than protection. Indeed, this was precisely what most observant economists learnt from the contrast between the performance of South Korea and India. Apparently similar tools can be used in various ways, with very different results. Both the overall aim and the details of policy make a huge difference.
Moreover, both these books lack a serious discussion of what very late catch-up countries ought to do. Reinert recommends free trade inside Africa or Latin America, with high barriers to trade against outsiders. But this sort of preferential trading agreement among developing countries is a way to transfer income from the most backward to the least backward economies in the region.
Worse, the higher the protection the larger (and so more politically objectionable) is the transfer of income. This is why only those preferential agreements with low external barriers tend to survive. But these do not deliver the greater protection Reinert wants. Higher barriers, even if desirable, would be politically possible only if members also moved towards a single labour market, which is impossible.
What then is left is protection by individual countries. But, to use just one example, Ghana’s national income is about the same as that of a London borough. A policy of import substitution there would be as rational as for Southwark.
Across-the-board import substitution in a country such as Ghana is a recipe for creating a host of small-scale, uncompetitive, rent-extracting monopolies. Obviously, an industrial policy with any hope of success must be both selective and build towards world markets, to obtain scale. What, then, are the chances that often malignantly corrupt, incompetent and ill-informed governments will make sensible choices? Little, I would argue.
South Korea and Taiwan were exceptional cases. The argument that success will follow the overthrow of the neo-liberal consensus and the return of protection is nonsense. But the authors are right that those who argued that free trade alone is the answer were wrong. There are no magic potions for development. Developmental states can work. Many fail. But some may succeed.
Above all, developing countries should be allowed to try, and so learn from their own mistakes. Countries should be warned of the difficulties of following South Korea’s example, but allowed to do so if they wish.
Big and relatively successful developing countries, such as China and India, must participate in and be bound by global rules. They cannot be free riders. But the bulk of developing countries should be allowed to choose their own policies. Almost all will need to attract inward foreign direct investment. A few might still manage without it.
Chang is right that some of the constraints imposed upon developing countries, notably on intellectual property, are unconscionable. Most should enjoy the benefit of open markets from the rich, but be allowed to pursue their own paths, from laissez-faire to its opposite. They will make many mistakes. So be it. That is what sovereignty means.