|
post-autistic economics review In this issue: Forum on
Economic Reform In recent decades the alliance of neoclassical
economics and neoliberalism has hijacked the term - Erik S. Reinert - Matthew McCartney Symposium on Reorienting Economics (Part III) Dialogue on the reform
of economics with Tony Lawson’s Reorienting Economics as focal
point - Jeroen Van Bouwel - Bruce R. McFarling |
|
|
Development and Social
Goals: Balancing Aid and
Development to Prevent ‘Welfare Colonialism’[1] Erik
S. Reinert (The Other Canon
Foundation, Norway & Tallinn University of Technology, Estonia) This paper was prepared for the
High-Level United Nations Development Conference on Millennium Development
Goals, New York, March 14 and 15, 2005. ’…just as we may avoid widespread physical desolation by
rightly turning a stream near its source, so a timely dialectic in the
fundamental ideas of social philosophy may spare us untold social wreckage
and suffering.’ Herbert S. Foxwell,
Cambridge economist, 1899. Stating that creating economic development and employment always has
been the best social policy may appear to be a particularly silly statement.
However, today – with the Millennium Goals – the world community
is approaching the social problems in the poor countries in a way which in my
view makes this statement highly relevant. The Millennium Goals are noble
goals for a world which sorely needs action to solve pressing social
problems. Compared to how the world has solved problems of poverty over the
last 500 years, however, the Millennium Goals represent completely new
principles, the long term effects of which are, in my view, neither well
thought through nor well understood.
In this paper I shall attempt to explain why I do not think the
Millennium Goals represent a good social policy in the long run. The novelty in the Millennium Goal approach lies in the large emphasis
on foreign financing of domestic social goals rather than
developing/industrializing countries so they themselves, internally, can
solve their own problems of redistribution. Disaster relief used to be of a
temporary nature. Now, with the disastrous lack of economic development in
many countries, disaster relief finds a more permanent form in the Millennium
Goals. In countries where already more than 50 per cent of the government
budget is financed through foreign aid, huge additional resource transfers
are planned. One big question mark is to what extent this approach will put a
large group of nations permanently ‘on the dole’, a system
similar to the ‘welfare colonialism’ which will be discussed at
the end of the paper. The question is similar to that of starting foreign
wars: what is our exit strategy? Several UN Development Decades were only of limited success. In this
perspective the Millennium Goals may appear as the United Nations
institutions abandoning the project of developing the world poor, abandoning
the effort to treat the causes of
poverty and instead concentrating on an effort that to a large extent attacks
the symptoms of poverty. In this
paper I shall argue that in my view too much of the development effort has
been abandoned: to a considerable extent palliative
economics has taken the place of development
economics. Indeed the balance of
development economics – radically changing the productive structures of
poor countries – and palliative economics – easing the pains of
economic misery – is, in my view, the key issue, and I think we are
planning for a serious imbalance where the extremely high costs will be much
less important than the long term negative effects. There is little debate
around key issues. It is unfortunate that the Millennium Goals have acquired
the proverbial status of motherhood and apple pie, institutions that no one
in their right mind will speak against. I shall still make an attempt. How we used to deal with
problems of development
In terms of the number of nations and number of people lifted into
relative wealth, this re-industrialization plan was probably the most
successful development project in human history. The fundamental insight
behind the Marshall Plan was that economic activities were qualitatively
different, those of the countryside (which we could call diminishing returns
activities, or agriculture and raw materials) differed from those of the
cities (which we could call increasing returns activities, or industry). In
his famous June 1947 speech at Harvard, US Secretary of State George Marshall
(who was later to be awarded the Nobel Peace Price) stressed that ‘the
farmer has always produced the foodstuffs to exchange with the city dweller
for the other necessities of life’. This division of labour, i.e.
between increasing returns activities in the cities and the diminishing
returns activities in the countryside, was ‘at the present
time…threatened with breakdown’. He then made a remarkable
recognition of the cameralist and mercantilist
economic policy of previous centuries: ‘This division of labor is the basis of modern civilization’. Civilisation requires increasing
returns activities, something that economists and politicians from Antonio Serra (1613) to Alexander Hamilton, Abraham Lincoln and
Friedrich List had already been saying for a long time. The principles behind
the toolbox used by nations going from poverty to wealth through the creation
of ‘city activities’ (Appendix 1) have been surprisingly stable
from when they were first used by Henry VII of England starting in 1485 until
their use in Korea in the 1970s. I claim that many of today’s problems
are due to the conditionalities of the Washington
Institutions classifying the toolbox needed to create increasing returns
activities – a toolbox employed by all countries that developed after
Venice and Holland – as ‘illegal activities’. After World War II, the toolbox did not produce the same success in
every country. The most successful countries temporarily protected new
technologies for the world market under competition.(e.g. Korea). The least
successful permanently protected mature technologies for often small home
markets under limited or no competition (typically the small countries of
Latin America). However, the key fact here is that – from Mongolia to
Russia and Peru – this inefficient industrial sector produced higher real wages than these same
countries enjoy today when this structure has been considerably weakened[2]
(See Figure 1 http://www.btinternet.com/~pae_news
/ReinertFigure1.htm). For centuries it
was understood that having an ‘inefficient’ industrial (increasing
returns) sector produced higher real wages than no industrial sector at all,
and that this ‘business inefficient’ sector ought to be made more
efficient rather than being closed down.
In its most simple form this argument is born out of the inclusion of
both increasing and diminishing returns in trade theory, as the starting
points respectively of virtuous and vicious circles of growth or poverty. A
praxis ignoring these mechanisms may cause factor price polarization rather
than factor prize equalization. Increasing returns, virtuous circles, and
large economic diversity were first established as necessary elements for
wealth by Serra (1613), who specifically says these
mechanisms are not available in the agricultural sector. The principle thus
created was understood almost continuously – with brief interruptions
– up until and including the Marshall Plan, but was in practice
abandoned with the Washington Consensus. Deindustrialisation used to be
something one would impose on a vanquished enemy, like on France after the
Napoleonic War. Since the 1980s, ‘structural adjustment’ produced
this same effect in many poor countries. Ruling theory at the time said this
would not matter, to the contrary, a free trade shock would – in the
vision of first WTO Secretary General, Renato Ruggieri – unleash
‘the borderless economy's potential to equalise relations between
countries and regions’. In the 1930s, placing the gold standard (Keynes’
‘barbarous relic’) and budget balances as the untouchable core of
economic theory and practice locked the world into a sub-optimal equilibrium,
for a long time preventing Keynes’ policies to be carried out with the
approval of mainstream economics. In a similar way, placing free trade as the
ideological centrepiece of development policies – to which all other goals become subservient – since the
fall of the Berlin Wall has locked the non-industrialized countries into a
very sub-optimal equilibrium. In my view, rather than continuing world
policies based on the most simplistic version of mainstream trade theory, we
must again take the conflict between free trade and real wages in
non-industrialised countries seriously. A specialisation in diminishing
returns activities with increasing population pressures also has serious
environmental consequences.[3] In my opinion the poverty we can observe in so many countries in the
Third and former Second World is not caused by transitory problems, but by
permanent features of nations having different economic structures. When the
US started industrialising, few (although some) had the ambition for the
country to be as wealthy as England. They just wanted to create a less
efficient copy of the kind of production structure they could observe in
England. This required tariffs. Successful industrialisation under
protection, however, carries the seeds of its own destruction. By the 1880s
US economists – using the same arguments based on scale and technology
that were used to protect US industries in the 1820s – now argued for
free trade. The same tariff that for a while created manufacturing industry,
was now hurting the same industry.[4]
This is why List, the protectionist, was also the first visionary of global
free trade: when all countries had achieved a comparative advantage outside
the diminishing returns sector.[5]
The disagreement is not over the principle of free trade as such, only over
its timing. If one, instead of accepting Adam Smith as an icon of free trade and
laissez faire under any circumstances, reads what he says about economic
development at an early stage, one will find that he is very much in line
with classical development economics, where industrialization is the key
recommendation. In his early work, The Theory of Moral Sentiments (Smith
1759/1810), Adam Smith argued passionately for ‘the great system of
government’ which is helped by adding new manufactures. Interestingly,
Smith argued that new manufactures are to be promoted, neither to help
suppliers nor to help consumers, but in order to improve this ‘great
system of government’. In fact, it is possible to argue that Adam Smith was also a
misunderstood mercantilist, someone who firmly supported the mercantilist
policies of the past, but then argued that they were no longer necessary for
England. In other words, Adam Smith played the same role later played by Schoenhof (see above, footnote 3) in the United States.
He praises the Navigation Acts protecting English manufacturing and shipping
against Holland, arguing ‘they are as wise… as if they had all
been dictated by the most deliberate wisdom’ and holding them to be
‘perhaps, the wisest of all the commercial regulations of
England’ (Smith 1776/1976: I, 486-487). All in all, Smith described a
development that had become successfully self-sustained, a kind of
snowballing effect, originating in the wise protectionist measures of the
past. Only once did Smith use the term ‘invisible hand’ in the Wealth of Nations: when it sustained
the key import substitution goal of mercantilist policies, when the consumer
preferred domestic industry to foreign industry (Smith 1776/1976: 477). This
is when ‘the market’ had taken over the role previously played by
protective measures, and national manufacturing no longer needed such
protection. If one cared to look, Adam Smith also argued for tariff
protection at an early stage as a mandatory passage point to development as
did Friedrich List. Studying economic policy without discussing the context
is one of the destructive vices of economic practice. The praxis of economic development has been to assimilate and produce
less efficient ‘copies’ of the economic structure of wealthy
nations. The key features of the economic structure of wealthy nations have
been a large division of labour (a large number of different industries and
professions), an important increasing returns sector (industry and today also
knowledge–intensive services). This understanding was made into
economic theory by economists who codified what actually took place in
wealthy countries: Antonio Serra (1613), James Steuart (1767), Alexander Hamilton (1791) and Friedrich
List (1841). These principles are at times unlearned when the natural harmony
of physics-based economics totally takes over, as in France in the 1760s, in
Europe in the 1840s, and in the world in the 1990s. These periods come to an
end because of the great social cost they create. Physiocracy
in France created shortages and scarcity of bread, and started the process
that led to the French revolution.[6] The free trade euphoria of the 1840s met
its backlash in 1848 with revolutions in all large European countries, with
the exception of England and Russia. Every time Ricardo’s trade theory
is proven wrong when applied asymmetrically to increasing and diminishing
return industries[7],
Ricardo is proven right that the ‘natural’ wage level is
subsistence. The free trade euphoria of the 1990s has again backlashed and created widespread poverty, but this time
our response is wrong. We are too much attacking the symptoms rather than the
causes of the problem. The
situation today Today’s standard economics tends to see development as largely
being driven by accumulation, by investments in capital, physical and human.[8]
Standard economic theory which underlies today’s development policies
is normally unable to recognise qualitative differences between economic
activities. I have argued elsewhere that globalization in the periphery
therefore has had the effect of a Morgenthau Plan
in many of the world’s small and poor countries: ‘removing the
basis of modern civilization’. If we look at the list of today’s
failed or failing nations, we will find that they all fail George
Marshall’s test for what creates modern civilisation: They have very
weak manufacturing sectors, unable to create the virtuous exchange between
city activities and countryside activities that Marshall recognised. They
also have a very limited diversity in their economic base, a very limited
division of labour, and are specialised in diminishing returns activities. Historically, modern democracy was born in the nations where the
civilising trade between urban and rural areas had already been established,
in the Italian city states. A key feature of the most successful city states
was that power was not in the hands of the landowning (diminishing returns)
class. The scarcity of arable land made this easy in Venice and The Dutch
Republic, and the fact that the few islands of wealth in Europe also
geographically tended to be islands was not lost on the early economists. In
other areas this was only achieved through constant political fight. In
Florence, 40-odd landowning families had been banned from political life
already in the 13th century, enabling what we later in this paper
shall call Schumpeterian cronyism: political and economic interests
‘colluded’ in a way that created widespread wealth. Dependency on
raw materials would create feudalism and/or colonialism, neither of these
situations leading to political freedom. If we wish to establish genuine
democracies, we may also here at the moment be starting at the wrong end of
the problem, attacking symptoms rather than real causes of political freedom.
The US Civil War was essentially a war between landowners with vested
interest in agriculture and cheap labour (the South) and those with a vested
interest in industrialization, what the most visionary of the 19th
century US economists called ‘a high wage strategy’ (the North).
The history of Latin America is in many ways the history of a group of
countries where the South won the Civil War. The alternative paradigm, which we could broadly call evolutionary and
historical – which I refer to as The Other Canon of economics –
the key force in development is assimilation: learning to do what
more advanced countries are doing, ‘copying’ not only their
institutions, but more importantly their economic structure.[9]
In fact institutions like patents and protection, scientific academies and
universities were key elements in the strategy to change national economic
structures in order to assimilate that of the wealthier countries. In this
tradition, economic growth tends to be activity-specific, tied to
clusters of certain economic activities exhibiting increasing returns and
rapid technological progress. This process requires capital, but the
difficulty lies in transferring and mastering the skills and, above all, in
creating a viable market for the increasing returns activities in nations
where the absence of purchasing power and massive unemployment tend to go
hand in hand, each factor reinforcing the other in a deadlock. By generally
insisting on using models assuming full employment, the Washington
Institutions avoid facing a key factor in the mechanisms that lock nations
into poverty: the lack of formal employment. Historically, since 16th
century Holland and Venice, only nations with a healthy manufacturing sector
have achieved anything close to full employment combined with a lack of
sizable rural underemployment. Today’s reigning economic theory represents what Schumpeter
called ‘the pedestrian view that it is capital per se that propels the capitalist engine’: development is
seen as largely driven by the accumulation of capital, physical or human.
‘The premise of neo-classical theory is that, if the investments are
made, the acquisition and mastery of new ways of doing things is relatively
easy, even automatic’, as Richard Nelson says. Even more important, the
core thesis of standard economics, albeit seldom expressed, is that economic
structure is irrelevant, capital per se
will lead to economic development regardless of the economic structure into
which the investment is made. In the alternative Other Canon theory, economic
activities exhibit very different windows of opportunity as carriers of
economic growth. An intuitive example: Bill Gates is not likely to have
achieved his present economic success specializing in herding goats or
growing broccoli: the technological wave that created Microsoft is not
replicable in a company or country specialising in goat herding or growing
broccoli. In other words we have to get rid of what James Buchanan calls
‘the equality assumption’ in economic theory, probably the most
important and the least discussed assumption.[10]
The ability to absorb innovations and new knowledge – and consequently profitably
to absorb investments – at any time varies enormously from one
economic activity to another. The
problem: As a result of
seeing capital per se as the key to growth, loans are given to poor nations
which their productive/industrial structure is unable to absorb profitably.
Interest payments will often very fast exceed the rate of return on the
investments made. ‘Finance for Development’ may therefore take on
the characteristics of a pyramid game or a chain letter fraud: the only ones
to gain are those who started the scheme and are close to the door.[11]
Correspondingly on the human side: Investments in human capital are made
without corresponding change in the productive structure that creates a
demand for the skills acquired. As a result education may tend only to
promote emigration. In both cases Gunnar Myrdal’s ‘perverse backwashes’ of
economic development will be the result: more capital – both monetary
and human – will flow from the poor to the rich countries than the
other way around. My claim, based on the study of 500 years of
history’s laboratory, is that the main explanation for this lies in the
type of economic structure – locked into a vicious circle of lack of supply
and lack of demand and the absence of increasing returns – that
characterises poor nations. This circle cannot possibly be broken unless we
again listen to 500 years who speak in favour of the set of policies listed
in Appendix 1. Abraham Lincoln stands out as a proud representative of this
type of national economic strategy, and US industrial policy from 1820 until
1900 is the best example for the Third World to follow today until – as
the US was towards the end of the 19th century – these
nations are ready to participate fully in and benefit truly from
international trade. Recommendation: As
was the case with the Marshall Plan, financial funds must be matched with the
establishment of industrial and service sectors that profitably can absorb
both the physical and human investments. A diversification out of raw
material production is absolutely indispensable in order to create a basis
both for democratic stability and increased welfare. Initially these sectors will not be able to survive world market
competition. As this process always has required, since England’s
ascent to industrialization starting in 1485, this incipient
industrialisation needs special treatment of the kind the Marshall Plan
afforded after 1947. This requires interpreting the Bretton
Woods agreement as it was done in the post-WW II era, not as it is presently
interpreted. Part of the problem also lies in neo-classical economics’ poor
understanding of successful business. It is almost curiously amusing that at
the core of the economic theory behind capitalism is a situation of perfect
competition and equilibrium, a situation where no one makes any money to
speak of. In standard economics successful businessmen like Bill Boeing and
Bill Gates – who both contributed importantly to the wealth of Seattle
– are ‘rent-seekers’, generally an odious term. In fact it
is the poverty-stricken Third World that most closely corresponds to the
conditions assumed in international trade theory, diminishing returns and
perfect competition. The rich countries, whose export items are produced
under Schumpeterian dynamic imperfect competition, are ‘rent
seekers’ whose rents, spreading through society as higher wages and a
higher tax base, are what we call ‘economic development’. This
failure to understand development as Schumpeterian imperfect competition is
at the root of the present arguments against an industrial policy. Anything
which causes imperfect competition tends to be seen as
‘cronyism’. Keynes saw investments resulting from what he called ‘animal
spirits’. Without this ‘animal spirit’ – without the
initiative to invest in uncertain conditions – capital is sterile, both
in the world of Joseph Schumpeter and in that of Karl Marx, each representing
one side of the political spectrum. The motivating force behind this animal
spirit is to make profits, to break the equilibrium of perfect competition. From this businessman’s point of
view the very simple explanation for the lack of investments in poor
countries is the lack of profit opportunities. He does not invest because
he sees no opportunity to make profits outside the extraction of raw
materials. This lack of opportunities for profitable investments is largely
tied to the extremely low purchasing power and the very high unemployment
rate. Subsistence farmers do not represent profitable customers for most
producers of goods and services. Tariffs create incentives to move production
into the labour markets of the poor. Historically, this has been seen as a
conscious trade-off between the interest of man-the-consumer and
man-the-producer. The idea that industrialization would cause a rapid
increase in employment and wages that more than offset the temporary higher
cost of manufactured goods was at the core of the Prebisch
import-substitution industrialization, but also of US economic theory around
1820.[12] The idea that greater ‘openness’ in any way should improve
the situation of the poor countries is both counterintuitive and contrary to
historical experience. If anything, the first effect of sudden
‘openness’ in a backward society is likely to kill off what
little manufacturing activity that might exist, making the situation worse.[13]
In effect historical experience shows that opening up for free trade between
nations of very different levels of development tends first to destroy the
most efficient industries in the least efficient countries (The Vanek-Reinert Effect), from the unification of Italy in
the 19th century to the integration of Mongolia and Peru in the
1990s. Figure
1 visualizes how the highly successful export increases that followed the
opening up of the Peruvian economy were accompanied by falling real wages. In
Peru, as in many other Latin American countries, real wages peaked during the
period of ‘inefficient’ import substitution. The ports, airports,
roads, power stations, schools, hospitals, and service industries that were
created by this inefficient industrial sector, led by rent-seekers, were real and could not have been created
without the demand for labour and infrastructure that this inefficient
industrial sector generated.[14]
Economic theory must again open up to understanding synergies of this type,
where temporary ‘business inefficiency’ in certain sectors activates
more efficient activities and/or the upgrading of human capital in other
sectors, in the end leading to increased welfare. The timing of the opening of an economy is crucial. Opening up the
economy too late will seriously hamper growth. Opening up an economy too
early results in de-industrialization, falling wages[15]
and increasing social problems. An anonymous traveller who in 1786 observes
the effects of economic policy in different European countries reaches this
same conclusion: ‘Tariffs are as harmful to a country after
manufacturing industry has been established there, as they are useful to it
in order to introduce this industry’.[16]
In Southern Mexico we can observe the destructive sequence of
de-industrialization, de-agriculturalization[17]
and de-population. That large numbers of subsistence farmers should be made
‘uncompetitive’ by subsidized First World agriculture is a
relatively new, but alarming, trend that may persist even if the subsidies
are removed. There are around 650 million farmers in India, and a large
proportion of them are as ‘uncompetitive’ as their Mexican
colleagues if and when free trade opens up, but without the possibility to
migrate to the US. In the poorest countries today a trade-off exists between
maximizing international trade – which is what present policies achieve
– and maximizing human welfare (Figure 1).
In my view we must address this trade-off in a different way than trying to
compensate the losses of the poor countries through increased aid. More than five centuries of history – from England’s
ascent starting in 1485 – show that there is only one point where the
complex deadlock of vicious circles of poverty and underdevelopment can effectively
be attacked: by changing the productive structure of the poor and failing
states. This means increasing diversification away from the diminishing
returns sectors (traditional raw materials and agriculture) into an
increasing returns sector (technology intensive manufacturing), creating a
large division of labour and the synergies and social structures which emerge
from this structure. This is also the only way to make it possible for
subsistence agriculture to break away from its chains: creating an urban
market for their goods, which will induce specialization and innovation,
bring in new technologies and create alternative employment. Foreign markets
cannot play the same role, they break economies into advanced and backward
sectors and regions: the key to cohesive development is a national[18]
interplay between increasing and diminishing returns sectors. The arguments against
industrial policy: Malthusian vs. Schumpeterian cronyism. 2005: A Filipino sugar producer uses his political influence in order
to achieve import protection for his products. 2000: Major Daley in Chicago does not listen to the Chicago
economists, but provides subsidies to already wealthy high-tech investors
through an incubator. 1950s and 1960s: Swedish industrialist Marcus Wallenberg uses his
close political contacts with Labour Party Minister of Finance, Gunnar Sträng, to achieve
political support and favours in order to carry out his plans for companies
Volvo and Electrolux. 1877: Steel producers in the United States use their political clout
to achieve a 100 per cent duty on steel rails.[19]
1485: Industrialists use their political connections to King Henry VII
in order to achieve subsidies and an export duty on raw wool that will
increase the raw material prices for their competitors on the Continent,
slowly killing the wool industry elsewhere, e.g., in Florence. These are all blatant examples of crony capitalism, very far from the
nice perfect level playing field we are all supposed to prefer. These are all
rent seekers that purist economic theory tends to abhor. There is, however, a
crucial difference between the first example and the rest. The Filipino crony
differs from the other cronies in that he gets subsidies in a diminishing
returns raw material that competes under perfect competition on the world
market. He is a Malthusian crony leading his country down the path of
diminishing returns (in spite of technological change which counteracts
this). The others are Schumpeterian cronies, producing under what Schumpeter
calls historical increasing returns (a combination of both increasing returns
and fast technological change). If we couple this to trade theory we see that
the tilted playing fields providing Schumpeterian cronyism produce widely
different results than those of the Filipino crony. Bismarck used to say that there are two things whose production
process one should better not watch: sausages and government budgets. We
should probably add industrial policy to this group of aesthetically unpleasant
production processes. We can live without sausages, but not without
government budgets or industrial policy. And, as Keynes said, ‘the
worse the situation, the less laissez-faire works’. If we insist that
we cannot have industrial policy because moving away from perfect competition
will cause some cronies to get rich, we have totally misunderstood the nature
of capitalism. Capitalism is about getting away from perfect
competition; this is what people spend years at business schools
learning. Economic development is caused by structural change which breaks
equilibrium, creating rents. Insisting on the absence of rents is insisting
on a steady and stationary state. This is the reason why tariffs in many ways
are the least crony-friendly of the policy tools. However, there is still the
need to choose which activities to protect, which almost by definition will
create cronies. Abraham Lincoln protected the steel cronies, and he was very
proud of it. He saw that by paying a little more for steel[20],
he managed to create a huge steel industry with many jobs paying high wages
that also provided a base for government taxation. Economic development
strategy is about getting the public interests of the nation lined up with
the private vested interests of the capitalists. As stated above, the failure
of standard economics to understand the dynamics of the world of business is
a serious problem. This also leads to a failure to understand the economic
essence of colonialism. At its economic core colonialism is a technology
policy: the colonies were not allowed to have manufacturing industries. The
economic activities with high potential for economic growth and mechanization
were to remain in the metropolis, the diminishing returns activities went to
the colonies. The immense transfers that accompany The Millennium Goals process will
necessarily also lead to cronyism. Some people will get wealthy through this
initiative, and a huge aid industry-cum-lobby is working very actively.
Crony-free economics only exists in neo-classical models. My choice is that
we go for Schumpeterian cronyism more than aid-based cronyism, because in
this way we also make it possible for the poor countries to free themselves
from economic dependency. Is it because the apparent motivation of the businessman
is greed and avarice, while the apparent motivation of the aid lobby is
charity that the presently preferred solution tilts so heavily in favour of
charity rather than development? Again we may have unlearned our basic Adam
Smith: it is not by the charity of the baker, but by his greed that we get
our daily bread. We also seem to have unlearned the logic behind policy tools for
economic development. Patents and modern tariffs were created at about the
same time, in the late 1400s. It is crucial to understand that these
rent-seeking institutions were created by the very same understanding of the
process of economic development. To create protection and rents in order to
produce new knowledge (in the case of patents) and to make it possible to
move the new knowledge in order to produce with this new knowledge in new
geographic areas (the case of tariffs) are two aspects of the same
understanding of Schumpeterian economic dynamics. From the point of view of
those who think that perfect competition is the ideal economic situation,
both patents and tariffs represent legalized rent seeking in order to promote
goals that are not achievable under perfect competition. I suggest looking at this set of problems
as the poor countries might look at them. Why is the rent seeking and crony
argument not applied also against patents, only against tariffs and other
policy instruments used in poor countries? Why does the economic profession
accept legalized rent-seeking by pharmaceutical companies and by Bill Gates,
but abhor the rent-seeking of an industrialist who tries to set up a small
business in Lima, Peru? The poor countries may, with some justification, say
that the wealthy countries are establishing rules that legalize constructive
rent seeking in their own countries, but prohibit them in the poor countries.
Over time industrialization has proved as beneficial to mankind as many
highly protected drugs. The
Washington Consensus and sequential single issue management. By the time of what The New Yorker
appropriately called the ‘triumphalism’
following the fall of the Berlin Wall, neo-classical economics with its
variations had become the only game in town. The logic of the post-WW II
years that had built wealth along the belt bordering communism, from Norway
to Japan, was gone, and economics had fossilized into a war between two
utopias: the communist utopia that promised that each should give according
to ability and receive according to need, and the neo-classical utopia that
promised that under capitalism everyone would receive the same wages
world-wide (Paul Samuelson’s factor-price
equalization). Both of these theories, the communist planned economy and
neo-classical economics, were based on David Ricardo’s theories (1817).
Ricardo and his successors show a disregard for economic structure, for
technology and innovations, for entrepreneurship and leadership, and for the
fact that economic activities are qualitatively as different as carriers of
economic welfare. In both its communist and its liberalist forms Ricardian economics sees no need for a state (Marx’
‘withering away of the State’). However, neo-classical economics was, to
use Nicholas Kaldor’s term, an un-tested theory. Neo-classical
theory had provided an effective ideological shield during the Cold War, but
no nation had ever been built on this type of theoretical framework. In its
most extreme form, as it was practiced around 1990, the only predicament was
that nations should ‘get their prices right’ and economic growth
would follow automatically, disregarding economic structures. Because it is
so counterintuitive (why should stockbrokers and shoe-shine boys get the same
wages just by being put in different nations??), Paul Samuelson’s
theory of factor-price equalization had long been the pride of the economics
profession. Now, by 1990, policy recommendations were formulated as if this
‘law’ of factor-price equalization was comparable to the law of
gravity. This neglected not only important theoretical contributions pointing
elsewhere (Krugman, Grossman, Helpman,
Lucas, etc.), key insights of the founding father of neo-classical economics,
Alfred Marshall, were also neglected. Alfred Marshall not only describes
taxes on diminishing returns activities in order to subsidize increasing
returns activities as a good development policy, he also emphasizes the
importance for a nation to produce where most technical change is found, and
the role of synergies (industrial districts). These are the principles behind
all successful catching up since Henry VII started the industrialization of
England by taxing diminishing returns activities (an export tax on raw wool)
in order to subsidize industry manufacturing woolen
cloth. These elements, representing first successful practice and then sound
theory over more than 500 years, have disappeared from the policy space. In the 1990s, as the world economy failed
to deliver results corresponding to the crudest version of Samuelson’s
law of free trade, the search began for other explanations. This search was,
and still is, always based on the premises of neo-classical economics, the
search is for a factor which in
addition to neo-classical
economics would set free the magic of the market in providing factor-price
equalization with instant global free trade:
The vision of ‘the borderless
economy's potential to equalise relations between countries and
regions’ was based on the wrong theory. This theoretical fantasy
developed into a practical nightmare in many poor countries. None of the
sequential focuses on single issues will unleash a magic of factor-price
equalization under instant free trade; this never existed in history nor will
it ever exist. Economic growth is by the very nature of things an uneven
process, and only wise political intervention can even out the factor-price
polarizations which are the natural results of an unrestrained market. The latest fad in the sequence, attributing
poverty to a lack of entrepreneurship, comes across as being particularly
uninformed. As contrasted to most people in the wealthy countries who can
safely live within their mostly routine jobs, the poor of the world have to
prove their initiatives and entrepreneurship every day in order to ensure
physical survival for themselves and their families. The problem is that the sequence of
theoretical fads for policy fails to address the fundamental blind spots of
neo-classical economics: a) its inability to register qualitative
differences, including the different potentials of economic activities as
carriers of economic growth, b) its inability to register synergies and
linkages[21],
and c) its inability to cope with innovationists and novelties, and how
differently these are distributed among economic activities. Together, these blind spots of present-day
mainstream economics prevent many poor countries from developing. The
successful ones, like China and India, have, both for more than fifty years,
followed the recommendations of the Marshall Plan: creating a division of labour
between urban and rural activities. Learning is a key element in development,
but learning may spread in the economy also simply as falling prices to
foreign consumers. The key insight of Schumpeter’s student Hans Singer
was that learning and technological change in the production of raw
materials, particularly in the absence of a manufacturing sector, tend to
lower export prices rather than to increase the standard of living in the raw
material producing nation.[22]
Learning tends to create wealth to producers only when they are part of that
finely knit network that was once called ‘industrialism’: a
dynamic system of economic activities subject to increasing productivity
through technical change and a large division of labour. The absence of
increasing returns, dynamic imperfect competition, and synergies in the raw
material producing countries are all part of the mechanisms that perpetuate
poverty. Part of the explanation is also that only
‘industrialism’ gives the necessary critical mass and political
clout to create the countervailing power of labour unions. What the French
Regulation School economists call ‘fordism’,
that workers’ pay raise parallel to productivity improvements, was an
important part of industrialism. Further explorations along the mainstream
route taken since 1990 are in my view rapidly running into diminishing
returns. Huge resources are employed by well-intentioned governments along a
largely sterile path of inquiry, a main problem being that radically
different alternative theoretical approaches are not financed or explored. In
my opinion the only way to raise the standard of living in the poorest
countries of the world is to follow the only successful formula that ever
worked, from England in 1485 to Europe and the Asian Tigers in the 1960s and
70s and China today. This formula is included as Appendix 1. The best social
policy is to create development, not by the rich creating subsidized
reservations where the poor are kept, largely underemployed and
‘underproductive’. The Indian reservations in North America are
sad examples of a policy of the kind that subsidizes without changing
productive structures. In short, the Millennium Goals are in my view far too
much biased towards palliative economics rather than structural change,
towards treating the symptoms of poverty rather than its causes. I am not denying
they could be an unavoidable emergency measure under the present critical
conditions, but without confronting the deeper roots of the problem it is
simply poor social policy. Conclusion:
Are we creating ‘welfare colonialism’? Present policies
run a risk of creating serious imbalances between the efforts to create
development and the palliative efforts of aid. What we may be creating is a
system that could be described as ‘welfare colonialism’. This
term was coined by anthropologist Robert Paine to describe the economic
integration of the native population in Northern Canada. [23] The essential features of welfare
colonialism are: 1) The often observed colonial drain of the old days is
reversed, the net flow of funds is to the colony rather than to the mother
country, and 2) the native population is integrated in a way that radically
changes their previous livelihood, and 3) they are put on the dole. In Paine’s
view, welfare colonialism identifies welfare as the potential vehicle for a
stable internal ‘governing at a distance’ through the exercise of
a particularly subtle, ‘non-demonstrative’ and
dependency-generating form of neo-colonial social control that pre-empts
local autonomy through ‘well-intentioned’ and ‘generous’
– but ultimately ‘morally wrong’ – policies. Welfare
colonialism creates paralyzing dependencies on the ‘centre’ in a
peripheral population, a centre exerting control through incentives that
create total economic dependency, thus preventing political mobilization and
autonomy. The social conditions in which the native inhabitants of Arctic
North America find themselves today, show us that in their case the final
effect of massive transfer payments was to create a dystopia rather than a
utopia. We already see aid and transfers creating passivity and disincentives
to work in poor nations. My Haitian colleagues point to family transfer
payments from the United States creating disincentives to work for a going
rate of 30 US cents an hour in Haiti. A Brazilian research project on the highly
laudable Zero Hunger project, carried out at different government levels
(national, state and local) on different programs targeted to fight hunger,
concludes that to a large extent these projects are ineffective, since they
treat symptoms of poverty either by distributing food or by subsidizing food
prices, rather than creating situations where the poor are converted into
breadwinners.[24]
These are welfare colonialism type effects: results of treating symptoms
rather than causes of poverty. The idea of nations producing under increasing returns (industrialized
nations) paying an annual compensation to nations producing under constant or
diminishing returns (raw material producers) is not a new one. It is a
logical conclusion from standard trade theory once both increasing, constant,
and diminishing returns are included, and this recommendation – a
forerunner of the Millennium Strategy – is present already in a US
college textbook from the 1970s. [25]
Until very recently, however, the favoured option was to industrialize the
poor countries, even if it meant that for a long time these industries would
not be competitive on the world market. Making free trade the linchpin of the
world economic system – one to which all other considerations must yield
– has made a type of welfare colonialism appear as the only option. We
must compensate the poor for the welfare loss from free trade, seems to be
the underlying idea. The other option, to develop the poor world, is not
there because we do not wish to abolish free trade as the core of the world
economic order. However, the long term and cumulative effects of having
groups of nations specializing in pre-industrial economic structures will be
staggering. In my view the policies successfully followed between 1485 and
the 1960s are – in spite of their being decidedly out of fashion
– still the better alternative. There are also neo-classical tools that could be used with great
benefits. The Washington Institutions should stop using models assuming full
employment also in countries like Haiti, where only between 20 and 30 per of
the potential workforce have a job. By using shadow prices they will find
back to the original logic of the Bretton Woods
Institutions and their rules as they were interpreted in the 1950s and 60s,
making possible the reconstruction of Europe. This will mean that we temporarily must let the principle of
free trade yield to the principle of economic development and structural
change. Both after 1848 – in order to solve the perennial ‘social
question’ in Europe – and in 1947, political pressure from the
spectre of communism unleashed successful development practices. Few are
aware that Karl Marx stated that the only reason he was in favour of free
trade was that it hastened the revolution. In 1947, the free traders in
Washington had to yield to the political need for protectionist development
policy around the communist block. This Marshall Plan was a truly astonishing
success. It is perhaps a faint hope that today’s terrorist threat will
unleash a similar situation where free trade is temporarily abandoned in
order to create development as a political,
rather than as a social, goal. During the Enlightenment, civilization and democracy were understood,
through the analysis of people like Montesquieu and Voltaire, as products of
a specific type of economic structure. We find the origins of this
understanding already in Francis Bacon more than 100 years earlier: ‘There is
a startling difference between the life of men in the most civilised province
of Europe, and in the wildest and most barbarous districts of New India. This
difference comes not from the soil, not from climate, not from race, but from the arts.’[26] When German economist Johan Jacob Meyen in 1770 stated ‘It
is known that a primitive people does not improve their customs and
institutions later to find useful industries, but the other way
around’, he expressed something which could be considered common sense
at the time. We find the same idea – that civilisation is crated by industrialisation
– in the 19th century in thinkers across the whole political
spectrum from Abraham Lincoln to Karl Marx. Industrialisation ‘draws
all, even the most barbarian, nations into civilization’ as Marx puts
it. We ought to use our understanding of
successful policies in past history, which is the only laboratory economics
has, in order to create something brand new and adequate for solving today's
challenges. We should attempt to create something as brilliant and practical
as did the visions and accompanying policy recommendations of Alexander
Hamilton and Abraham Lincoln, but firmly grounded in an understanding of the
present technological and historical context. We ought to be as enlightened again in understanding the connection
between production and civilization, by moving our theoretical focus away
from trade and on to production. Compared to Meyen’s
statement above, our present understanding has reversed the arrows of
causality, and we therefore risk creating an increasing number of failed
states. We now ought to focus on how differently technological development
hits different economic activities, creating huge variations in the windows
of opportunity to innovate, and how this makes it possible for nations to
specialize in being poor and uneducated. We should focus more on core issues
like economies of scale, scope, speed and specialization, on avoiding the
negative effects of diminishing returns and lock-in effects, on the assimilation of knowledge rather than
the accumulation of capital, on changing the economic
structures of poor countries so they become more like those of the rich ones.
We should read not only Schumpeter on technical change, but also
Schumpeter’s essay on imperialism. Read not only Schumpeter on
‘creative destruction’, but also open our eyes and minds to the
type of ‘destructive destruction’ that can be observed. Appendix 1. ‘Mercantilist’ Economic Policies of the Generic
Developmental State.
…the
fundamental things apply, as time goes by. Sam, the pianist,
in ‘Casablanca’. 1. Observation of wealth synergies clustered
around increasing returns activities and continuous mechanization in general.
Recognition that ‘We are in the wrong business’. Conscious targeting,
support and protection of these increasing returns activities. 2. Temporary monopolies/patents/protection
given to targeted activities in a certain geographical area. 3. Recognizing development as a synergetic
phenomenon, and consequently the need for a diversified manufacturing sector
(‘maximizing the division of labor’, Serra 1613 + observations of the Dutch Republic and
Venice) 4. Empirical evidence accumulated showed that
the manufacturing sector solves three policy problems endemic to the Third
World in one go: increasing national added value (GDP), increasing
employment, and solving balance of payment problems. 5. Attraction of foreigners to work in the
targeted activities (historically religious prosecutions have been important) 6. Relative suppression of landed nobility
(from Henry VII to Korea). (Physiocracy as a
landowners’ rebellion against this policy) 7. Tax breaks for targeted activities. 8. Cheap credits for targeted activities. 9. Export bounties for targeted activities. 10. |