11 Responses to “The growth of nations”

Comments

1. L. Alan Winters: Martin’s review of these books hits all the right notes. He notes Reinert’s advocacy of the nineteenth century model and Chang also frequently makes this argument. Such advocacy needs to be supported by at least a little evidence that the parallels hold for the twenety-first century - after all we do not generally advocate nineteenth century medicine or engineering. One failed parallel is that growth rates then were much slower than governments and their people expect these days. The following data (from Angus Maddison)compare growth in China since 1978 with the most successful industrialisations of large countries in the past. Both the world economy and world leaders now perform far better than they did then.

   Annual growth rates over periods of history:
   1700-1820 world 0.5%, UK 1.0%
   1820-1870 world 0.9%, UK 2.1%, USA 4.2%
   1870-1913 world 2.1%, USA 3.9%
   1978-2004 world 3.1%, China 7.5%
   alternative view of China:
   1978-2004 world 3.3%, China 9.6% (World Bank)

   Source: L Alan Winters and Shahid Yusuf, 2007, Dancing with Giants: China, India and the World Economy, World Bank, Washington and IPS, Singapore.

   Posted by: L Alan Winters | July 24th, 2007 at 4:07 pm | Report this comment
   

2. Arvind Panagariya (guest commenter): Martin Wolf is to be congratulated for his incisive “two-in-one” review of “How Rich Countries Got Rich…and Why Poor Countries Stay Poor” by Erik S. Reinert and “Bad Samaritans: Rich Nations, Poor Policies and the Threat to the Developing World” by Ha-Joon Chang. Wolf gives the authors a fair hearing but rejects their core arguments favoring protection in one form or the other. Indeed, Wolf is gentler to the authors than their poorly conceived arguments warrant.

   Thus, consider the recommendation by Reinert that countries in Africa (or Latin America) must practice free trade among themselves with high barriers to trade against outsiders. Wolf offers devastating conceptual criticisms of such an approach. But since Reinert prefers practical experience to a priori reasoning, let us ask whether the last sixty years of history offers a single example of a developing country achieving sustained rapid growth under the strategy advocated by him. The answer is a resounding no.

   Virtually every developing country that has achieved sustained rapid growth in the last sixty years has done so while rapidly expanding its trade on a largely non-discriminatory basis, with the bulk of the trade expansion accounted for by developed country trading partners. It is delusional to think that an African country can rely on other African countries as engines of growth.

   Both Reinert and Chang rely on the experience of South Korea among others to advocate infant industry protection. But they misread the Korea economic history. During 1963-72, Korea had registered the average annual growth rate of 9.5 per cent. With rare exceptions, its policies during this period were industry-neutral. The so-called Heavy and Chemical Industry (HCI) drive to which the proponents of infant-industry protection like to allude did not begin until the early 1970s. And the growth rate during the following decade, 1973-82, actually fell to 7.2 percent.

   Additionally, various policy measures forced on Korea to sustain the HCI drive culminated in a macroeconomic crisis in the late 1970s. The crisis led Korea to finally abandon the HCI drive and undertake systematic liberalisation in the early 1980s. These measures eventually restored Korea to the higher growth path with the growth rate returning to 9.9 per cent during 1983-90.

   If infant industry protection is supposed to be as good as these authors advocate, one must explain why India did so poorly during the 1960s and 1970s. During the 1950s and early 1960s, India and South Korea had both grown at the annual average rate of 4 per cent. In the early 1960s, Korea abandoned the import-substitution policy in favour of outward orientation and accelerated to near-double digit rate. After a brief, failed experiment with liberalisation in the mid 1960s, India turned progressively protectionist and interventionist. It tried to promote the production of every conceivable product by banning its imports. During 1965-81, India grew a paltry 3.2 per cent per annum.

   Critics of free-trade advocates like to argue that free trade alone is not the answer to the development problem. This is like knocking down a straw man: few free-trade advocates argue that free trade by itself is enough to launch a country into high-growth orbit. My own forthcoming book India: An Emerging Giant (OUP, NY) is 500-pages long precisely because it carefully spells out the reforms needed in various areas to achieve and sustain a double-digit growth in India. If free trade was all that was required, I could have finished the book in less than hundred pages! But like other advocates of free trade, I am aware that an outward-oriented trade policy regime by itself is not sufficient to guarantee sustained rapid growth. I am also aware, however, that outward-oriented policy regime is usually necessary so that I do devote considerable space to explaining the case for it.

   (Arvind Panagariya is a professor at Columbia University)

   Posted by: Arvind Panagariya | July 25th, 2007 at 1:32 pm | Report this comment
   

3. Anne Krueger: In the 1950s and 1960s, economists and policy makers thought that industrialization was “the key” to economic growth. While I agree that rapid economic growth should surely be a major objective of economic policy in poor countries, that does not necessarily imply that industrialization is the only way to achieve it; more importantly, focusing on industrialization as a policy objective is almost certainly wrong. Mechanization and increasing productivity in all sectors usually leads to more rapid growth of industry than of other sectors, but that is the outcome of appropriate policy. While it is highly likely that growth of agricultural productivity – a necessary part of overall economic growth – will shift returns to induce movement of workers to industrial (and service) activities, a focus on industrialization as an instrument, rather than an outcome, can lead to low growth if not stagnation.

   Further, as Reinert and Chang apparently do, economists and policy makers regarded trade protection as a major policy instrument for achieving rapid growth through industrialization. Much sad experience has shown that not to be the case. Many countries adopted policies of “import-substitution”, protecting new industries (indefinitely) with import prohibitions or very high walls of protection. There is enough experience to show why that strategy does not work. Martin Wolf’s arguments are valid, but there is much more.

   It was not neoclassical economic theory, but primarily the failures of the “import-substitution” strategies that resulted in unsatisfactorily low growth rates. In country after country, high-cost domestic monopolies or duopolies were developed in industry after industry. They achieved little total factor productivity growth, and remained high cost behind high walls of protection. Over time, growth rates slowed as each wave of new industries was more capital-using and higher-cost than the last one. But once established, politicians could not or did not reduce protection and the political power of the industrialists increased. Interestingly, there was little growth in employment, as most producers chose capital-intensive techniques of productin.

   It is certainly true that an outward orientation in trade policy will not by itself lead to a satisfactory growth performance. But an outward orientation will, if policy makers are committed to it, lead to policy decisions regarding infrastructure, low tariffs (to enable imports of needed inputs), relatively flexible labor markets, and other spheres of economic activity that are conducive to growth.

   I would also note that some countries, pre-China, grew rapidly through opening up their economies. Martin Wolf notes the cases of Korea and Taiwan, whose spectacular growth preceded the Chinese. While it is certainly true that Korea did not abandon all protection during the rapid growth years (l960 to 1990), tariff rates were dropped substantially, quantitative restrictions were abandoned, and the degree of protection to import-competing producers was no greater than the incentives for exporters. And, it is important to note, export incentives were uniform and applicable to all who exported. In that regard, it is also questionable whether 19th century protectionism caused success (in the U.S.) or whether success occurred in spite of protection.

   Finally, free trade agreements (or customs unions) among a group of countries with similar factor endowments and commodity prices have been tried and have been found wanting. While there are certainly parts of the international economic system that are not as conducive to poor countries’ rapid growth as they might be, the answer ought to be to recognize the potentially powerful support a rapidly growing international economy can provide for a poor country, and to support those changes in the WTO that will further improve the functioning of the international economy. Even if the current international economy is not ideally organized, it offers a far better hope for poor countries than would an autarkic world or one in which most trade was conducted among preferential trading blocs.

   Posted by: Anne Krueger | July 30th, 2007 at 10:19 am | Report this comment
   

4. Martin Wolf: I would like to thank Alan Winters, Arvind Panagariya and Anne Krueger for stiffening my spine. I agree with virtually everything they say.

   I agree, of course, on the importance of outward orientation for success in development, on the irrelevance of US experience in the 19th century to contemporary development, on the folly of preferential trade agreements among developing countries and on the diminishing returns to import substitution.

   That said, I think it is also important for those on “our side” of the argument – the right side, of course – to recognise some of the difficulties.

   First, industrialisation has indeed been the only successful route to mass prosperity. The reason is that this is the sector characterised by increasing returns and so to high rates of growth of productivity. High productivity in manufacturing then raises real wages everywhere else. Moreover, those increasing returns are in substantial part externalities: they are the result of positive feedback effects not taken into account by individual industrialists. At the same time, industrialisation cannot work without a great deal of competitive pressure. That is the reason why the import substitution route is ultimately unsuccessful. So, as Anne Krueger remarks, a country does not industrialise successfully by focusing only on industry and certainly not by focusing on a protected home market. But it may well still be interested in policies that promote efficient industrialisation.

   Second, world-class businesses do not normally come from nowhere. I recognise that some businesses have emerged in developing countries without any initial push from government: Indian software seems to be a good recent example. But that was not the case for Toyota, Hyundai or Samsung. Is it plausible that Japan and South Korea would have been able to produce world-class manufacturing companies without initial government help? Should countries just rely on inward foreign direct investment, instead?

   Third, virtually all the big successes have been countries that started off labour-abundant and began with labour-intensive manufactured exports. India seems to be starting with labour-intensive services, instead. But what should we say about countries with good resource endowments and relatively high initial wages? How should they best start off a true development process?

   Finally, we need to admit that, along with the huge recent successes from progressive liberalisation (notably China and India), there have been some disappointments. I am thinking of Brazil and Mexico here. What lessons should sensible people learn from these experiences?

   I recognise the extreme importance of not going back to the failed import substitution policies of the past – a point to which I intend to turn to in future columns. But we do know that free trade is not enough. So let’s consider a few of the things needed in addition.

   Posted by: Martin Wolf | July 30th, 2007 at 5:23 pm | Report this comment
   

5. Edmund Phelps: Martin Wolf’s July 21/22 review of two books on development was thought-provoking. It made me wonder, what may we economists reasonably say to the underdeveloped aspiring to embark on economic development?

   My antennae picked up Martin’s growing feeling that economic culture is awfully important. A few years ago I would not have known whether to believe in the importance of culture or not. However, research of mine a year ago (written up for the Venice conference of CESifo/Center on Capitalism and Society in July 2006 and available at www.earth.columbia.edu/ccs) found that various cultural values (the value of competition, the value of work) and especially various workplace attitudes (toward initiative, taking orders, accepting responsibility, etc.) are surprisingly significant in explaining differences in economic performance among OECD countries. But I agree that economic culture is mutable and perhaps can be molded for the better. Maybe globalisation will pull up attitudes where they are wanting.

   I appreciated the authors’ willingness to tackle big questions. But we should not let pass their argument that manufacturing is always the better bet - because productivity growth will be mainlyin that sector, as it always has. This argument overlooks that some countries are going to produce services and, along an equilibrium trajectory, the relative price appreciation occurring in the services sector will exactly compensate for the lack or deficiency of productivity growth in those areas. If some people didn’t think that, there would be no capital invested in services.

   The neoclassical prescription is to forget about the question of the best industrial directions to take and leave that to the magic of the market: It will work out in short order what a country’s comparative advantages are. This strikes me as way too deterministic and mechanistic. I have discussed in a couple of papers a theory of Chinese development in which that China will be transferring technologies in the areas where the West leaped ahead in previous decades while exporting garments and other goods where the West advanced little. (One message was that as China comes nearer and nearer to the “frontier,” wages there will be rising to such heights that its exports of those manufactures will be disappearing - in the end, replicating the US more or less.) The message pertinent here is that a China’s comparative advantages of
   the current moment lie where the West has to date made few technical gains. More broadly, a country’s comparative advantages are entirely artificial and, in particular, depend greatly on the history of innovation overseas.

   But, going deeper, it’s immediately clear that a country - its “market,” if it is given the task - has to think about the directions of the economic advances abroad over a long future. Those prospects will, to take one example, weigh heavily on what values the market decided to put on the various sorts of business assets - commercial space, equipment, employees of various types, etc. There isn’t any objective answer. Perfect foresight is not an answer, since there is none. So people are going to have to think where it is best to invest, acquire skills, gain knowledge. There is no deus ex machina to make those calculations for a country.

   Last point: When a country innovates — creating or at any rate adopting NEW goods and/or NEW methods - it may (with luck) be CREATING a comparative advantage that it did not have before. (I was stimulated by the paper of Dani Rodrik and Ricardo Hausmann around 2003 in which they urge Brazil to find its comparative advantages the way one might urge someone to find his inner self.) A Brazilian film maker contemplating making a new movie for the world market does not stop to ask whether it is a manufacture or a service. So it would seem that we have found the solution to development: let everyone who cares to innovate for the global marketplace in whatever directions appear to have the best prospects of financial gain and personal growth.

   The trouble is that the people of a country might lack savvy about markets in countries unlike their own. Their backwardness is holding them back from development. So maybe the two authors are right: Manufacturing - presumably of a traditional, standardised, sure-fire kind - will be done will be done by the seriously underdeveloped and as long as that is the best they can do they will remain underdeveloped. The developed world can send money and experts over to the underdeveloped countries to raise their efficiency and maybe their technological practice to a higher level; and that would reduce disease. But unless and until people in a country have an experienced sense or gifted intuition of what might be good to invest in, it will stay underdeveloped.

   Posted by: Edmund Phelps | August 2nd, 2007 at 8:35 am | Report this comment
   

6. Ha-Joon Chang: I am delighted that Martin has taken my book seriously despite our differences and written a considered review. However, I am saddened by the fact that his presentation of my argument in relation to trade has left an unfortunate room for misunderstanding.

   Let me first of all make it clear that I do not advocate “across-the-board import substitution”, as Martin seems to imply at places. I don’t think he meant it, but the result was to create a mistaken impression of my argument, as evidenced by the comments by Alan Winters, Arvind Panagariya, and Anne Krueger. I go to a great length in the book to explain why trade is essential for economic development. I daresay that I am even more pro-trade than those mentioned above. But that is not the same as saying that free trade is the best way to promote trade and economic development.

   Country after successful country, from the 18th-century Britain to the late-20th-century South Korea and Taiwan, have first used various policy measures (trade protection included in most, although not all, cases) to create the space in which their producers can build up their productive capabilities before they can compete with better producers from abroad, either in the domestic market or in the export market In some cases the protection was brief, while in others it was long – the Japanese car industry needed nearly four decades of protection and subsidies before it could successfully compete in the world market (but then those were totally worth it for everyone, not just the Japanese, because those policies eventually created the most efficient and environment-friendly car industry in the world). But the intention behind successful protectionism was always to fully join the world economy.

   There is huge difference between “across-the-board import substitution” that was practised in some countries and the kind of purposeful (although not necessarily less protectionist, if you just look at things like average tariff rates) protectionism that I advocate. I feel like a man being accused of promoting a copious consumption of vodka when all I have done is to recommend moderate amount of red wine as a part of balanced diet.

   Not all protectionist countries have succeeded. Many have done poorly. However, I present evidence, in the book and in my academic writings, that most countries that have succeeded used protectionism to one degree or another. Typically, countries have liberalised trade after, rather than before, they became rich. Most countries that adopted free trade prematurely have failed. And I am not talking only of the poorest countries. There are many middle-income countries that had similar experience – Mexico and Brazil in the recent period being the best examples that Martin himself cites in his response to comments by other people. Today’s developing countries had pitiful growth records (if they grew at all) when they were practising free trade under colonialism and unequal treaties for a century until the Second World War. In the recent period, developing countries in Latin America and Sub-Saharan Africa grew much faster during the “bad old days” of protectionism than they have in the last two decade of neo-liberal policies, including free trade. Per capita income in Latin America grew at 3.1 per cent in the “bad old days” of the 1960s and the 1970s. In the “brave new world” of neo-liberalism between 1980 and 2004, it grew at 0.5 per cent. Even if we leave out the 1980s as the decade of adjustment, growth rate in Latin America was only about 1.5 per cent between 1990 and 2005. Moreover, growth rate in Latin America has fallen recently (growth rate in 2000-2005 was only 0.6 per cent), when the continent should be finally reaping the gains from the reforms (that have lasted for nearly two decades in some countries).

   When discussing the (alleged irrelevance of) lessons of history, Martin pays almost exclusive attention to the US case. This is understandable, as the fact that the country used to be the most protectionist in the world for over a century until the Second World War is such a shock, given its role as the standard bearer of free trade in the recent past. Martin, as Anne Krueger does in her comment, argues that the US was an exception that grew ‘despite’ protectionism. I do not agree with this interpretation, but even if it were the case, how does he propose to explain the fact that virtually all of today’s rich countries, and not just the US, have protectionist past? Perhaps the US succeeded despite protectionism because of its large market, but then how about Taiwan or Finland that had tiny markets? If large-scale, high-quality immigration offset the ill-effects of protectionism in the US, how about countries like Sweden or Germany that were losing qualified people and practising protectionism in the late-19th century? It may be possible to dismiss the US as an “exception”, but if there are another two dozen countries that have to be dismissed as “exceptions”, then the theory has simply too many holes (the exercise reminds me of the pre-Copernican practice of drawing “epi-circles” in order to square evidence with geo-centrism).

   I agree with Martin that I do not say much on what very poor economies should do. I see it as a shortcoming of my work. However, let me remind Martin that South Korea’s per capita income in 1961, at $82, was less than half that of Ghana ($179) and the country was described as a “bottomless pit” by the USAID in the late 1950s. If Korea could do it, why not other countries? I agree that the challenges facing the poorest countries today may be bigger than the ones faced by Korea in the 1960s. But one important reason for that is the intolerance for those “nationalistic” policies used by Korea in the past, on the part of the rich countries and multilateral institutions. My plea in the book is that this has to change and countries should be allowed to choose what they need and want, as such choice usually produce better results, as I have pointed out earlier. Martin summarised this argument at the end of his review much better than I can, so I will not elaborate on this point.

   As for the comments of Alan Winters and Arvind Panagaryia, I hope they had at least the decency of reading the book (or at least reading the review more carefully, for Martin does give me a fair hearing except in the area of trade) if they were to denounce it with strong languages (”ill-conceived”, said Arvind, and Alan likens my argument to ‘nineteenth-century’ medicine). For I don’t recognize my work in their caricaturisation of my argument as solely trade-focused and based on some outdated model and no empirical evidence.

   Alan’s assertion that my argument is not serious because it is based on the “nineteenth century model” is very unfortunate. If he read the book, he cannot possibly accuse me of advocating a nineteenth century model – for my discussion is right up to today’s practice, such as huge R&D subsidies that the US gives to its industries to harsh regulation of foreign direct investment by Japan and Finland until the 1980s. If there is an idea in this debate that is “nineteenth-century”, it is Alan’s implicit belief that human knowledge progresses linearly. This idea has proven problematic even in natural sciences, but no philosopher of science would take it seriously these days when it comes to social sciences. The interesting thing is that Alan would be actually in greater trouble if human knowledge progressed linearly and therefore newer theories were always better – for protectionist theories are newer than free trade theories. Finally, I think it is wrong to dismiss one’s opponent’s theory by labelling them with negative words (‘nineteenth-century’). How would Alan feel if I described him and his colleagues as “defenders of free-trade theory that was so strongly advocated by American slave-owners and opium-trafficking British imperialists”?

   Arvind’s argument that the failure of Heavy and Chemical Industrialisation (HCI) in Korea proves the wisdom of free trade may have cut some ice when Ian Little first said it in the early 1980s, when many of the HCI industries were in trouble (teething problems complicated by world recession), but it is a hollow argument today. Let’s get some facts straight. Korea did go through a bad patch in the late 1970s and the early 1980s, but it was in part due to the Second Oil Shock and the ensuing world recession, not just because of the HCI programme. Moreover, Korea did not abandon the HCI programme after the shock, as Arvind suggests. It re-organised and closed some of the firms that had little hope of doing well, but it kept supporting the good ones. Finally, if the HCI programme was a failure, how does Arvind explain that most of the leading industries of the 1980s onwards – steel, shipbuilding, automobile, electronics – have been the ones that had been set up and promoted through HCI, often against the advice of free-trade economists? (This is in fact a question that Ian Little himself could not answer when I put it to him in the early 1990s).

   As for Arvind’s invocation of the Indian case as the proof that infant industry protection is not good, I have no problem in admitting that not all protectionist policies are going to be successful and that India’s protectionism especially until the 1970s was not well managed. Whatever the strategy is, there are going to be failures. All I am showing in the book is that, contrary to the conventional wisdom, protectionist strategy has a much higher chance of success than free-trade strategy. Invoking the Indian example to dismiss the infant industry argument is like arguing for the abolition of parenting because there is a man in his fifties who is still living off his parents.

   Anne’s languages are gentler than those of Alan’s and Arvind’s but the substantive disagreement is no less. She says that while Korea “did not abandon all protection during the rapid growth years (1960 to 1990), tariff rates were dropped substantially, quantitative restrictions were abandoned, and the degree of protection to import-competing producers was no greater than the incentives for exporters”. This kind of characterisation has already been discredited by the early 1990s among those who work on East Asia. Let me remind her some of the evidence. Average tariff rates, at 20-30 per cent, were still quite high during the period. Moreover, the average conceals very high variation – the country had zero tariffs for some products while others had tariff rates around 100 per cent (so going against her advice for ‘non-discriminatory’ policies). Quantitative restrictions were widespread – there were a lot more explicit QRs than Anne and her people acknowledge, and many QRs were not very visible because they were practised through domestic laws (for example, laws governing the state-owned railway companies). Most importantly, Korea practised strict foreign exchange rationing by the government until the 1980s, so tariff figures do not give us the real picture of protectionism across sectors. There were many items whose tariffs were relatively low on paper but which simply could not be imported (so facing an effective tariff rate of infinity) because they were far down the government priority list.

   Finally, I can only agree with most of the things that Edmund Phelps said in his comment. His view on economic development is, although expressed in a slightly different language, exactly the same as mine. As he puts succinctly, I believe that “a country’s comparative advantages are entirely artificial”. In other words, economies develop in the particular ways they do because someone somewhere makes a conscious decision to “invest acquire skills, and gain knowledge” in particular areas. In the same way in which business managers often go deliberately against market signals in making such decision (Nokia ran losses in its electronics business for 17 years), governments can, and often should, go against market signals. Of course, if that is done to permanently insulate a country from international market forces, it would lead to a disaster like North Korea, but as far as the final aim is to fully join the world economy, protecting the car industry for 40 years (as Japan did until the 1970s) or setting up a state-owned steel monopoly against the advice of the World Bank (as Korea did in the early 1970s) may be justified.

   Reading the comments by Alan, Anne, and Arvind, I feel like this. I am a man whose book recommending the Mediterranean diet has been reviewed by a well-known anti-fat dietician, who unintentionally misrepresented me as praising beneficial qualities of all fats, when I had only praised olive oil. This was bad enough, but then a few other anti-fat dieticians read the review, go into a Pavlovian reaction on seeing the word, “fat”, and accuse me of promoting excessive consumption of all fats, brandishing American obesity figures and Scottish heart-attack statistics. I regretfully have come to conclusion that I was absolutely right to say what I said at the end of chapter three in the book – “Trade is simply too important for economic development to be left to free trade economists”.

   (Ha-Joon Chang teaches in Cambridge and is the author of Bad Samaritans)

   Posted by: Ha-Joon Chang | August 3rd, 2007 at 3:23 am | Report this comment
   

7. An economists scorn

   A post I submitted to the Financial Times Economists Forum in response to a debate about Martin Wolfs review of several books on development economics and Dani Rodriks comments on his own blog:
   The policy makers entrusted to manage…

   Posted by: Willful Blindness | August 7th, 2007 at 7:12 am | Report this comment
   

8. Martin Wolf: I thank Ned Phelps for his insightful comments on my review essay and on the issues raised for economic development. I have the following reactions.

   First, the case for manufacturing is not just about productivity growth. It is essentially about increasing returns that are themselves the results of externalities. I think the same is probably also true of high technology services. These increasing returns are shown by the famous “residual” in growth accounting – the difference between the results of pure factor accumulation and the growth of output. As Ned knows very well, most growth is driven by the residual. It is the product of the creation and use of new knowledge, which is itself largely the unanticipated result of previous production. This is why there is a case for policies that encourage the emergence of clusters of production.

   Second, I don’t agree that a country’s comparative advantage is entirely artificial, in the sense that it can be created deliberately, without any constraint. It would be difficult, for example, to turn Chad into a successful ship-builder (since it is land-locked). It would be difficult to turn Singapore into one of the world’s largest producers of motor cars, because it is too small. And so forth. I have long been struck by how far today’s comparative advantage even of highly advanced countries, such as the UK, are the product of a long history. Once upon a time, the UK had a strong comparative advantage in ship-building and textiles. Could anything have been done to retain this? I doubt it.

   Third, Ned does not discuss how far governments can successfully help markets find a successful pattern of comparative advantage (one compatible with long-term growth). The question is, in essence, how to get to the knowledge frontier – where knowledge is something very broad indeed – when the frontier today is so vastly further from the position of underdevelopment than it was 100 or even 50 years ago. It seems to me that the presence of foreign direct investment is one way to learn, since employment in businesses that are on the frontier must be one of the best ways of learning how to get there. That is one of many reasons why I believe that the sort of industrial self-sufficiency practiced two generations ago by the Japanese is no longer sensible for developing countries.

   Posted by: Martin Wolf | August 7th, 2007 at 8:30 am | Report this comment
   

9. Martin Wolf: I thank Ha-Joon Chang for his lengthy and courteous response to my review essay. I am also sorry he thinks I misrepresented his views on trade. That was certainly not my intention. My aim was to analyse the arguments contained in two books that, while similar in many respects, have differences in emphasis. Reinert seems to be a little more protectionist than Ha-Joon. I apologise if I failed to make this difference between the two of them clearer.

   As I said in my column, the favourable reference to the example of the US came from Eric Reinert, whom I quoted. I then added that “from the emphasis Chang puts on 19th-century examples, he agrees”. It still seems to me that Ha-Joon’s references to the protectionist policies of the 19th century (repeated in his response) suggest that he does indeed consider these policies to be a possible model.

   Of course, since all those countries did trade quite heavily and all did break out into competitive exports of manufactures, this does not suggest they were hostile to trade in the right circumstances. But nothing I wrote (I hope) suggested that Ha-Joon himself believes trade to be irrelevant.

   Indeed, nobody with deep knowledge of the South Korean case (such as Ha-Joon) could believe that. That was the point of my introduction: it is not protection that has made the difference to performance, but, as the stark contrast between Indian and South Korean growth in the 1960s and 1970s showed, the contrasting ability to make intelligent policy interventions which exploit opportunities to trade. South Korea and Taiwan both achieved that to an impressive degree.

   The difficulty with evaluating Ha-Joon’s position on what policies poor countries should now follow is that he is, as he himself admits in his response to me, far more focused on what they should be allowed to do than on what they should do. This seems to me to be a lacuna in his book.

   Again, I did pick up on one specific policy suggestion, from prof Reinert, that for inward-looking regional trade blocs. I do not say that Ha-Joon is in favour of such a policy. To be honest, I don’t know what his view on it would be.

   I then went on to consider the options for a country like Ghana. I stated that across-the-board import substitution would be silly. I am glad that Ha-Joon agrees. So what is left is some form of selective industrial policies. These, presumably, are what Ha-Joon would recommend. I would love to know what those policies should consist of in this case and why one should suppose that they would work.

   Ha-Joon’s answer is that if South Korea could do it, why not Ghana? My response – one he would reject – is that the two countries are very different. South Korea was the larger part of a country with a long history, a strong national identity and the legacy of a traditional agrarian state, with a literate ruling elite and strong state institutions. The jump from this to a modern bureaucracy directing a developmental state was relatively small.

   Furthermore, South Korea had a strong comparative advantage in labour-intensive manufactures on which to build. Again, almost all of Africa lacks that. Finally, South Korea could follow quite closely the example of Japan – a country with quite similar characteristics. Ghana lacks such a model, too.

   I worked on east Africa shortly after I worked on South Korea. The differences seemed to me to be enormous, as indeed they proved. After all, Ghana did practice protectionism for a long time. The results were not, to put it mildly, similar to those of South Korea.

   I do not wish to respond to all of what Ha-Joon says elsewhere, not least because much of it is directed to the comments of others. Let them respond if they wish, but let me add the following points.

   First, protection has, historically, been a more common policy than free trade. It is simply the natural policy for any country to follow. It is, for this reason, almost impossible to discover any rich country that was not protectionist when it was not on the frontier of development. But it is also almost impossible to discover a poor country that has not been protectionist for some time. It is hard to draw conclusions in favour of protection from these facts. This does not mean – let me stress this – that the practice of free trade guarantees development. The evidence does not support this proposition, as Ha-Joon notes.

   Second, in evaluating successful cases of protectionist infant-industry policy, one has to be careful to avoid the trap of survivor bias. How many countries tried to start a car industry off behind protection over the past century and how many succeeded? I don’t know the answer to this question. But it cannot be answered by pointing to Toyota.

   Third, I agree with Ha-Joon that the recent experience of Latin America is disturbing. But can it be ascribed to free trade (as opposed to many other mistakes and misfortunes)? Brazil’s tariff barriers to imports of manufactures are higher than China’s. This is hardly a case of free trade run wild! Ha-Joon might respond that Brazil has been very open to inward direct investment. But so has China been. Moreover, Brazil was quite reliant on inward FDI even in its high-growth phase of 40 years or so ago.

   Fourth, it is really hard to dismiss the experience of China and India, because they are two-fifths of the world. Both are liberalising fast. Both have grown faster as they liberalised. Both are still very poor countries. China is also very dependent on inward FDI. On Ha-Joon’s logic these two countries should be developmental disasters. Evidently, they are not.

   Fifth, there were four great successes in post-war east Asia in the 1960s-1980s: Hong Kong, Singapore, South Korea and Taiwan. Two followed free trade and two did not. Yes, the two that followed free trade were small city states. What follows from that? Of course, Singapore also had an interventionist government. But this argument is not about laissez faire, but free trade.

   Sixth, Ireland has been the most successful country in Europe in the past 15 years. It is essentially a free-trading state dependent on inward FDI. Similar policies are being followed by the Baltic states, with substantial success. Ha-Joon would have to predict that the new entrants to the EU will fail, since they are so far behind and cannot compete on level terms. We shall see. But I would strongly doubt that this is what is going to happen.

   Seventh and most important, we have to get away from this Punch-and-Judy show over trade policy. The logical position for Ha-Joon to take is that there is simply a case for active policy. I agree that with a reasonably competent, honest and development-minded government, that is true. (These are not universal, alas!) Where I disagree is over whether trade policy is the best active policy – and particularly whether high protectionist barriers against imports are the best policy.

   I do not see how the overall experience of the past half century supports that proposition, any more than that it supports arguments against use of foreign direct investment. By the way, if protectionist barriers were so helpful one would find that land-locked countries do particularly well. Being land-locked is, after all, natural protection.

   A last short comment on Ha-Joon’s response to Alan Winters: Reinert, in fact, goes out of his way to show that the protectionist theory is older than free-trade theory. Of course, we might not today call the ideas of the mercantilists a “theory”, but surely Ha-Joon would agree that mathematical formalism is not the only way to create a theory.

   Thanks for the engagement. It has been extremely enjoyable.

   Posted by: Martin Wolf | August 7th, 2007 at 12:10 pm | Report this comment
   

10. Ha-Joon Chang: I am grateful for Martin’s sincere engagement with my arguments.

    As Martin correctly notes, I am not against international trade. All I am saying is that free trade is unlikely to be the best way to promote economic development (nor trade itself, in the long run). To make this point, I could do a lot worse than citing myself (chapter 3): “In the end, economic development is about acquiring and mastering advanced technologies. … [I] order to be able to import technologies from developed countries, developing nations need foreign currency to do pay for them … 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. But 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 …. It is this sleight of hand that free trade economists have so effectively deployed in cowing their opponents – if you are against free trade, they insinuate, you must be against progress.”

    I am not saying that free trade can never work. The Netherlands, Switzerland (until the First World War), Hong Kong, and Singapore succeeded with free trade. But there are far more countries that have succeeded with protectionism – Britain in the 18th century, the US, Sweden and Germany in the 19th century, and France, Finland, Norway, Austria, Japan, Korea, and Taiwan in the 20th century. More importantly, even the free-trade success stories went against today’s orthodox recipe in other respects. The Netherlands and Switzerland refused to grant patents until the early 20th centuries, while Hong Kong mass-produced counterfeit products. Singapore has had one of the largest state-owned enterprise sectors in the capitalist world and used a lot of industrial policy, not least in relation to FDI. Even in Hong Kong, which comes the closest to the laissez-faire ideal, all land is publicly owned.

    Similar arguments can be made in relation to other policy areas. Take the case of FDI, which Martin thinks I am against. As Martin points out, Ireland, Singapore, and China have succeeded by welcoming FDI. However, Latin American countries did not succeed despite welcoming FDI, and countries like 19th-century US, Japan, Finland, Korea, and Taiwan succeeded with policies that severely restricted FDI. Once again, I could do worse than citing myself (chapter 4) in summing up my position on FDI: “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 kinds of investment made and how the host country government regulates it.”
    Martin is right to caution against what he calls the ‘survivor bias’ in evaluating the success of infant industry promotion. But I am not saying that all countries that try infant industry promotion will succeed. All I am saying is that, once the ‘first movers’ are in place, it is almost impossible to break into advanced industries like automobile without an infant industry programme, What I am talking about is, if you like, the batting average. There may be only a handful of car-makers that have developed under protectionism and subsidies (the Japanese and the Korean ones), but there is none that have developed under free trade.

    My point is this. Contrary to what we are led to believe by the orthodoxy, heterodox policies have played key roles in all development success stories – protectionism, government subsidies, restrictions on FDI, state ownership of industries, lax protection of intellectual property rights, macroeconomic policy that permits moderate inflation, and so on. Few countries used all of these policies, but all used at least some of them. Given this, it is wrong of the orthodoxy to preach that there is only one recipe for success – neo-liberalism. It is even worse for it to try to institutionalise such policy package through international agreements and loan/aid conditionalities.

    As it should be clear from his review and response to my comments, Martin agrees with me that state activism can work, if dispensed in the right doses by a competent government. Where we differ is that he sees the chance of success for infant industry programme as being much lower than I suggest. This is largely because he is more pessimistic than I am about the chance of countries overcoming the constraints of history and geography, which brings me back to the comparison of South Korea and Ghana.

    As a nationalistic Korean, I can only thank Martin for thinking so highly of my own country, but I think he is overly positive about its historical legacy. In the 1950s, many people thought that Korea wasn’t developing well because of its Confucian culture. Only two generations before the Korean ‘miracle’ (in 1911) Beatrice Webb, the Fabian leader, described my ancestors as “12 millions of dirty, degraded, sullen, lazy and religionless savages who slouch about in dirty white garments of the most inept kind and who live in filthy mudhuts” (cited in chapter 9). I would be the last one to dismiss the importance of historical legacy, but my point is that, in the long run, things like culture and national identity can be changed – partly, although not entirely, through conscious effort. After all, if you go back far enough in history, all countries had incompetent and corrupt government, ‘lazy’ and ‘dishonest’ people, fractious and fuzzy national identity, and poor institutions. The successful countries are the ones that have somehow found a way to change these things, rather than the ones that never had such constraints.

    To conclude, I am delighted that Martin and I have found so many points to agree upon. I have learned a lot from the exchange. I am still a little frustrated that some of my finer points are not getting through, but then I am the one who has the duty to make these points understood. After all I have an unusual position that does not neatly fit in the traditional Punch-and-Judy divide. I will keep trying.

    Posted by: Ha-Joon Chang | August 9th, 2007 at 4:22 am | Report this comment
    

11. Martin Wolf: I thank Ha-Joon for his reply. I believe we have exhausted this round of exchanges, but thank him for the depth of his contributions. I, too, have enjoyed them.

    Posted by: Martin Wolf | August 9th, 2007 at 10:05 am | Report this comment
    

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