My first post on 23 Things They Don’t Tell You About Capitalism addressed Ha Joon Chang’s dubious debating tactics when discussing ‘free market economics’. I turn now to some of Chang’s more specific critiques of economic liberalism to illustrate these tactics in greater detail.
Summarising his work in Kicking Away the Ladder and Bad Samaritans Chang tries to debunk the claim that free trade and open markets are the key to prosperity in developing countries. He claims that historically free trade was rarely if ever practiced by developed nations such as Britain and the USA. To the extent that they prescribe free trade for today’s developing nations, therefore, free market economists and their political supporters are guilty of a ‘do as I say, not as I did’ hypocrisy. What the developing world needs is the freedom to pursue the protectionist industrial policies that Chang himself favours. The economic success stories of East Asia owe their prosperity to high levels of state intervention and not to ‘neo-liberalism’.
To put it mildly, Chang misrepresents free market economics and offers a highly selective view of the evidence on trade, markets and development. First, few if any free market economists have ever claimed that Britain or the US were historical paragons of free trade. At most they have suggested that relative to previous historical eras nineteenth century Britain and the US benefited from a broad package of market-oriented policies of which free trade (especially in Britain, though less so in the United States) was a part. Similarly, they have been foremost in attacking the residual protectionism that exists in the developed world today – notably the European Union Common Agricultural Policy and equivalent schemes in the US. While Chang has every right to suggest that free market economists are in error the charge of hypocrisy is disingenuous because these economists have been critical of protectionism whenever and wherever practiced. Arguably, rich country politicians who preach free trade while refusing to reform domestic protection may be guilty of hypocrisy – but this is not a charge that can be directed against free market economists themselves.
Second, Chang misrepresents the place of free trade in the overall package of institutions and policies supported by free market economics. The classical liberal case has never been that international trade is the engine of development per se but that free trade offers an extension of the benefits provided by domestic market oriented policies – such as improvements in the security of property rights, largely private ownership of industry and a broad reliance on competition rather than central planning. Free trade can extend the benefits of these policies and may be especially important for smaller countries that have very limited scope for internal trade. Recognising this perspective is crucial when separating correlation from causation in understanding development outcomes. The fact that Britain and especially the USA had protection in place during industrialisation does not imply that it was the protection that caused the growth. Rather, the negative effect of protection may have been more than offset by other policies – such as improved security of property rights, low taxes, low government spending, and strong internal competition. Thus, though it pursued an external policy that was often highly protectionist, nineteenth century America also benefited from the creation of an enormous internal free trade zone where the free movement of goods, labour and capital enabled gains from trade across a massive territorial area.
Significantly, Chang fails to acquaint his readers with any of the empirical literature that has sought to decipher the causal role of protection in development relative to other factors. Douglas Irwin and Stephen Broadberry, in particular, have questioned the role of tariffs by showing convincingly that the sectors of the US economy that were supposed to benefit most from ‘infant industry’ protection did not in fact experience strong growth. Thus, at the time the US overtook Britain in the nineteenth century it did so largely by increasing labour productivity in the service sector – and not through gains in protected sectors of manufacturing industry. Similarly, high growth in Argentina and Canada in the late nineteenth century was largely due to growth outside the specific industries which were supposed to benefit from import tariffs. Protection in Britain meanwhile – notably the Corn Laws, actually slowed the industrialisation process by preventing the transfer of resources out of agriculture and into industry. *
Chang cites a number of small countries (such as Finland) that had elements of state intervention during the nineteenth century but succeeded nonetheless. Again however, he makes no effort to put this evidence in a broader context of other policies. Typically, Chang seizes on any evidence of state intervention however small to claim that it must have been the intervention that did the developmental heavy lifting. Interestingly, he does not apply the same criteria when accounting for declining economic growth in Europe and the United States over the last thirty years. During this period there has been privatisation of state-owned industries and liberalisation of labour markets – but these trends have been accompanied by substantial government spending and significant increases in regulation elsewhere (see on this blog ‘ America’s Thirty Year Experiment with ‘Radical Economic De-Regulation). Nonetheless, Chang asserts that the ‘dominance’ of free market economics must be to blame for recent ills. On planet Chang, state intervention no matter how extensive cannot be considered a legitimate explanation for declining economic performance. Reading Chang’s book one is left with the impression that Europe and the United States during the Victorian era were models of Keynesian interventionism, even though they had government expenditures between 5 and 10% of GDP, minimal regulation and virtually non-existent welfare states. Europe and America of today by contrast are depicted as practitioners of rampant laissez faire – even though government spending runs at between 40 and 60% of GDP alongside constantly escalating regulation.
Chang’s analysis of East Asian development is no more impressive. Though it is true that South Korea and Taiwan pursued protectionist policies during the 1960s and 1970s and experienced strong growth their performance was eclipsed by that of Hong Kong and Singapore which operated much closer to a free trade model. China post 1978 meanwhile, though it is far from a laissez faire economy has undergone one of the most significant economic liberalisations in world history – a liberalisation that has promoted unprecedented economic growth. Not surprisingly, Chang is quick to claim that the continuing existence of industrial policies and active government involvement in the financial sector are the cause of this growth. Yet, as Jasheng Huang has shown, the growth that started the Chinese economic boom had little to do with any such policies – it was the result of a huge boost in agricultural productivity following Deng’s massive programme of rural privatisation in the early 1980s. More recently, residual government controls in industry and finance have thwarted the Chinese industrial sector. Insofar as the Chinese have developed successful industrial companies (such as Lenovo) these have been Chinese in name alone. Nearly all such companies although operating in China are formally owned and registered in Hong Kong where they have access to one of the most liberal capital markets anywhere in the world. Far from China’s system of financial controls being the cause of their success it has been the ability of entrepreneurial start-ups to exit from these restrictions and to re-enter China on the more liberal terms granted to ‘foreign investors’ that has been critical. **
Perhaps the worst misrepresentation of free market economics in 23 Things They Don’t Tell You About Capitalism occurs in chapter 15 where Chang claims that ‘they’ – the ‘free market economists’ – attribute lack of development in poorer countries to the absence of entrepreneurial spirit. I know of no free market economist who has ever made such claims. From Peter Bauer in the past to William Easterly in the present free market economists have argued that entrepreneurship is a universal aspect of the human condition. What matters is whether social and political institutions channel this entrepreneurship towards voluntary exchange and positive sum games or whether institutions encourage entrepreneurs to engage in rent-seeking activity focused on the predatory transfer of wealth. The primary obstacle to the poor in much of the developing world is the absence of secure title to property and a maize of regulatory restrictions which limit access to markets, confine people to the ‘informal sector’ and which benefit predatory elites that monopolise access to the legally recognised economy. Chang offers no account of how these obstacles would be addressed by his protectionist/ high regulation agenda. Were developing countries to follow his advice they would be destined to a future that would institutionalise crony capitalism on a truly massive scale – the very sort of crony capitalism that is now disfiguring much of the developed world as well.
* Broadberry, S. (1998) How Did the United States and Germany Overtake Britain? A Sectoral Analysis of Comparative Productivity Levels, 1870-1990, Journal of Economic History, 58: 375-407.
Irwin, D. (2000) Did Late Nineteenth Century US Tariffs Promote Infant Industries? Evidence from the Tinplate Industry, Journal of Economic History, 335-360.
Irwin, D. (2000) Interpreting the Tariff-Growth Correlation of the Late Nineteenth Century, American Economic Review, 165-169.
** Huang, J. (2008) Capitalism with Chinese Characteristics, Cambridge: Cambridge University Press.