[book] Bad Samaritans 2015-01-22

Bad Samaritans – The Myth of Free Trade and the Secret History of Capitalism (Ha-Joon Chang, 2013)

Base Ideas

A mixture of economic theory, history and contemporary evidence is deployed to turn much of the conventional wisdom about development on its head.

Introduction — Are the Bad Samaritans winning?

Margaret Thatcher, the British prime minister who spearheaded the neo-liberal counter-revolution, once famously dismissed her critics saying that ‘There is no alternative’. The spirit of this argument – known as TINA – permeates the way globalization is portrayed by the Bad Samaritans.

The Bad Samaritans like to present globalization as an inevitable result of relentless developments in the technologies of communication and transportation. Going against this historical tide only produces disasters, it is argued, as evidenced by the collapse of the world economy during the inter-war period and by the failures of state-led industrialization in the developing countries in the 1960s and the 1970s.

TINA conclusion stems from a fundamentally defective understanding of the forces driving globalization and a distortion of history to fit the theory. Free trade was often imposed on, rather than chosen by, weaker countries. Most countries that had the choice did not choose free trade for more than brief periods. Virtually all successful economies, developed and developing, got where they are through selective, strategic integration with the world economy, rather than through unconditional global integration. The performance of the developing countries was much better when they had a large amount of policy autonomy during the ‘bad old days’ of state-led industrialization than when they were totally deprived of it during the first globalization (in the era of colonial rule and unequal treaties) or when they had much less policy autonomy (as in the past quarter of a century).

There is nothing inevitable about globalization, because it is driven more by politics (that is, human will and decision) than technology, as the Bad Samaritans claim. If it were technology that determined the extent of globalization, it would be impossible to explain how the world was much less globalized in the 1970s (when we had all the modern technologies of transport and communication except the internet) than in the 1870s (when we relied on steamships and wired telegraphy). Technology only defines the outer boundaries of globalization. Exactly what shape it takes depends on what we do with national policies and what international agreements we make. If that is the case, the TINA thesis is wrong. There is an alternative, or rather there are many alternatives, to the neo-liberal globalization that is happening today.

Trade => Economic Development

In the end, economic development is about acquiring and mastering advanced technologies. In theory, a country can develop such technologies on its own, but such a strategy of technological self-sufficiency quickly hits the wall. This is why all successful cases of economic development have involved serious attempts to get hold of and master advanced foreign technologies.

But to import technologies from developed countries, developing nations need foreign currency to pay for them – whether they want to buy directly (e.g., technology licences, technology consultancy services) or indirectly (e.g., better machines). Some of the necessary foreign currency may be provided through gifts from rich countries (foreign aid), but most has to be earned through exports. Without trade, therefore, there will be little technological progress and thus little economic development.

There is a huge difference between saying that trade is essential for economic development and saying that free trade is best (or, at least, that freer trade is better) for economic development.

“…worse than being exploited by capital…”

Like Joan Robinson, a former Cambridge economics professor and arguably the most famous female economist in history, I believe that the only thing that is worse than being exploited by capital is not being exploited by capital. Foreign investment, especially foreign direct investment, can be a very useful tool for economic development. But how useful it is depends on the kind of investiment made an how the host country government regulates it.

Foreign finantial investiment brings more danger than benefits, as even neo-liberals acknowledge these days. It often bring benefits in the short run, but is the long run that counts when it comes to economic development.

State-owned Enterprises

The picture regarding the management of SOE is complex. There are good state-owned enterprises, and there are bad state-owned enterprises. Even for a similar problem, public ownership may be the right solution in one context and not in another. Many problems that dog SOEs also affect large private-sector firms with dispersed ownership. Privatization sometimes works well, but can be a recipe for disaster, especially in developing countries that lack the necessary regulatory capabilities. Even when privatization is the right solution, it may be difficult to get it right in practice. But there are some general lessons that we can draw from economic theories and real life examples.

Enterprises in industries that are natural monopolies, industries that involve large investment and high risk and enterprises that provide essential services should be kept as SOEs, unless the government has very high tax-raising and/or regulatory capabilities.

Other things being equal, there is a greater need for SOEs in the developing countries than in the developed countries, as they have underdeveloped capital markets and weak regulatory and taxation capabilities. SOE performance can often be improved without privatization:

Getting the balance right

Criticizing the IPR regime as it exists today is not the same as arguing for the wholesale abolition of intellectual property itself. Patents, copyrights and trademarks do serve useful purposes. But the fact that some protection of intellectual property rights is beneficial, or even necessary, does not mean that more of it is always better. Some minimum amount of protection of intellectual property rights may be essential in creating incentives for knowledge creation. Some more of it may bring more benefits than costs. But too much of it may create more costs than benefits so that it ends up harming the economy.

So the real question is not whether IPR protection is good or bad in principle. It is how we get the balance right between the need to encourage people to produce new knowledge and the need to ensure that the costs from the resulting monopoly do not exceed the benefits that the new knowledge brings about. In order to do that, we need to weaken the degree of IPR protection prevailing today – by shortening the period of protection, by raising the originality bar, and by making compulsory licensing and parallel imports easier.

Macroeconomic policies and Keneysianism

Macroeconomic policies – monetary policy and fiscal policy – are intended to change the behaviour of the whole economy (as distinct from the sum total of the behaviours of the individual economic actors that make it up). The counter-intuitive idea that the whole economy may behave differently from the sum total of its parts comes from the famous Cambridge economist John Maynard Keynes.

Keynes argued that what is rational for individual actors may not be rational for the entire economy. For example, during an economic downturn, firms see the demand for their products fall, while workers face increased chances of redundancy and wage cuts. In this situation, it is prudent for individual firms and workers to reduce their spending. But if all economic actors reduced their expenditure, they will all be worse off, for the combined effect of such actions is a lower aggregate demand, which, in turn, further increases everyone’s chances of bankruptcy and redundancy. Therefore, Keynes argued, the government, whose job it is to manage the whole economy, cannot simply use scaled-up versions of action plans that are rational for individual economic agents. It should always deliberately do the opposite of what other economic actors do. In an economic downturn, therefore, it should increase its spending to counter the tendency of the private sector firms and workers to reduce their spending. In an economic upturn, it should reduce its expenditure and increase taxes, so that it can prevent demand from outstripping supply.

Kenesianism for the rich, monetarism for the poor

When the rich countries get into recession, they usually relax monetary policy and increase budget deficits. When the same thing happens in developing countries, the Bad Samaritans, through the IMF, force them to raise interest rates to absurd levels and balance their budgets, or even generate budget surplus – even if these actions treble unemployment and spark riots in the streets.

The Bad Samaritans have imposed macroeconomic policies on developing countries that seriously hamper their ability to invest, grow and create jobs in the long run. The categorical – and simplistic – denunciation of ‘living beyond one’s means’ has made it impossible for them to ‘borrow to invest’ in order to accelerate economic growth. If we categorically denounce people for living beyond their means, we should, amongst other things, condemn young people for borrowing to invest in their career development or in their children’s education. That cannot be right. Living beyond one’s means may or may not be right; it all depends on the stage of development that the country is in and the use to which the borrowed money is put.

Politics and economic development

Corruption and lack of democracy are big problems in many developing countries. But the relationships between them and economic development are far more complex than suggested. The failure to think through the complexity of the corruption issue is, for example, why so many developing country politicians who come to power on an anti-corruption platform not only fail to clean up the system but often end up being ousted or even jailed for corruption themselves. When it comes to democracy, the neo-liberal view that democracy promotes a free market, which, in turn, promotes economic development, is highly problematic.

Deregulation of the economy in general, and the introduction of greater market forces in the management of the government more specifically, has often increased, rather than reduced, corruption. By forcing trade liberalization, the Bad Samaritans have also inadvertently encouraged corruption; the resulting fall in government revenue has depressed public salaries and thus encouraged petty corruption.

Having once dismissed political factors as minor details that should not get in the way of good economics, neo-liberals have recently become very interested in them. The reason is obvious – their economic programme for developing countries as implemented by the Unholy Trinity of the IMF, World Bank and WTO has had spectacular failures (just think of Argentina in the 1990s) and very few successes. Because it is unthinkable to the Bad Samaritans that free trade, privatization and the rest of their policies could be wrong, the ‘explanation’ for policy failure is increasingly found in non-policy factors, such as politics and culture.

Reinventing culture

At a given point in time, a particular culture may produce people with particular behavioural traits that are more conducive to achieving certain social goals, including economic development, than other cultures. At this abstract level, the proposition seems uncontroversial.

But when we try to apply this general principle to actual cases, it proves elusive. It is very difficult to define what the culture of a nation is. Things are complicated further by the fact that very different cultural traditions may co-exist in a single country. All cultures have multiple characteristics, some positive and others negative for economic development. So, it is not possible, nor useful, to ‘explain’ a country’s economic success or failure in terms of its culture.

Even though certain behavioural traits may be better for economic development, a country does not need a ‘cultural revolution’ before it can develop. Though culture and economic development influence each other, the causality is far stronger from the latter to the former; economic development to a large extent creates a culture that it needs. Changes in economic structure change the way people live and interact with one another, which, in turn, changes the way they understand the world and behave. Many of the behavioural traits that are supposed to ‘explain’ economic development (e.g., hard work, time-keeping, frugality) are actually its consequences, rather than its causes.

The fact that culture can be deliberately changed – through economic policies, institution building and ideological campaigns – gives us hope. No country is condemned to underdevelopment because of its culture. But at the same time we must not forget that culture cannot be reinvented at will – the failure to create the ‘new man’ under communism is a good proof of that. The cultural ‘reformer’ still has to work with existing cultural attitudes and symbols.

In the end

Why manufacturing matters

Having accepted that increasing capabilities is important, where exactly should a country invest in order to increase them? Industry – or, more precisely, manufacturing industry – is my answer. It is also the answer that would have been given by generations of successful engineers of economic development from Robert Walpole onwards, had they been asked the same question.

Of course, this is not to say that it is impossible to become rich by relying on natural resources. But one has to have a huge stock of natural resources in order to be able to base high living standards solely on them – and few countries are so fortunate. Moreover, natural resources can run out or, worse, wealth based on natural resources can be rapidly eroded.

History has repeatedly shown that the single most important thing that distinguishes rich countries from poor ones is basically their higher capabilities in manufacturing, where productivity is generally higher, and, more importantly, where productivity tends to (although does not always) grow faster than in agriculture or services. Walpole knew this nearly 300 years ago, when he asked George I to say in the British Parliament: ‘nothing so much contributes to promote the public well-being as the exportation of manufactured goods and the importation of foreign raw material’. In the US, Alexander Hamilton knew it when he defied the world’s then most famous economist, Adam Smith, and argued that his country should promote ‘infant industries’. Many developing countries pursued import substitution ‘industrialization’ in the mid-20th century precisely for this reason. Contrary to the advice of the Bad Samaritans, poor countries should deliberately promote manufacturing industries.

Of course, today there are those who challenge this view on the grounds that we are now living in a post-industrial era and that selling services is therefore the way to go. Some of them even argue that developing countries can, and really should, skip industrialization and move directly to the service economy. In particular, many people in India, encouraged by that country’s recent success in service outsourcing, seem to be quite taken by this idea.

There are certainly some services that have high productivity and considerable scope for further productivity growth – banking and other financial services, management consulting, technical consulting and IT support come to mind. But most other services have low productivity and, more importantly, have little scope for productivity growth due to their very nature (how much more ‘efficient’ can a hairdresser, a nurse or a call centre telephonist become without diluting the quality of their services?). Moreover, the most important sources of demand for those high-productivity services are manufacturing firms. So, without a strong manufacturing sector, it is impossible to develop high-productivity services. This is why no country has become rich solely on the basis of its service sector.