Bill Totten's Weblog

Friday, February 15, 2008

Unfree Global Markets

Only Protection Can Build Developing Economies

by Ha-Joon Chang

Le Monde diplomatique (August 2003)

The World Trade Organisation is run as an oligarchy of the developed countries, which do not even bother to pretend to be democratic. The excluded and abused underdeveloped countries could force a change, or even the end of the world's free trade order as we have come to know it. This would be a blessing to the world's poor, who have been further impoverished since the end of protected economies in the early 1980s.

Free-traders have achieved crucial victories in the past twenty years. Since the debt crisis in 1982 and the resulting IMF-World Bank structural adjustment programmes, many developing countries have radically liberalised their trade. The collapse of communism in 1991 opened up a vast area of the world to free trade. During the 1990s a number of important regional agreements, such as the North America Free Trade Agreement (Nafta), were signed. And in 1995 the conclusion of the Uruguay Round talks of the General Agreement on Trade and Tariffs (Gatt) led to the birth of the World Trade Organisation (WTO). The WTO is not yet a full-blown free trade agreement, as it still allows some tariffs, but it has shifted the world towards free trade by reducing tariffs and banning trade-related subsidies.

However impressive these achievements, the free-traders (mostly developed countries) are not content. In the WTO they exert continuous pressure to reduce tariffs even further and faster than agreed, and to expand its jurisdiction into areas that were not in the original mandate (such as foreign investment and competition law). In terms of regional agreement, there is a strong push to create an area that will cover almost all the Western hemisphere - the free trade area of the Americas (FTAA). In pushing for further liberalisation, the free-traders believe that history is on their side. They argue that free trade is how all developed countries have become rich, and criticise the developing countries for refusing to adopt this successful formula for economic development.

This is far from the truth. When they were developing countries, those countries now developed followed few of the policies they now recommend to others, and especially free trade. And nowhere is this discrepancy between historical reality and myth greater than in Britain and the United States, the two countries supposed to have reached the summit of the world economy through free markets and free trade. Britain is far from a paragon of free trade. It was an aggressive follower, and in certain areas a pioneer, of dirigiste [state-controlled] policies to protect and promote strategic industries. These policies, though limited in scope, date back to the 14th century (Edward III) and 15th century (Henry VII) and relate to wool manufacturing, which was the leading industry of the era. England was an exporter of raw wool to the Low Countries, and British monarchs tried to promote wool manufacturing instead by, among other things, protecting the domestic manufacturers, taxing raw wool exports and poaching skilled workers from the Low Countries {1}.

Between the 1721 trade policy reform of Robert Walpole, Britain's first prime minister, and the repeal of the Corn Law in 1846 {2}, Britain implemented a most aggressive trade policy. It used tariff protection, export subsidies, import tariff rebates on inputs used for exporting, export quality control by the state - policies that are now associated with Japan and other East Asian countries. It is a little known fact that during this period Britain protected its industries much more heavily than other European countries, especially France, thought of as its dirigiste counterpoint.

Britain moved significantly, though not completely, to free trade with the repeal of the Corn Law. This is now regarded as the ultimate victory of liberal economic doctrine over wrong-headed mercantilism, but historians familiar with the period see it actually as an act of "free trade imperialism" intended to "halt the move to industrialisation on the continent by enlarging the market for agricultural produce and primary materials" {3}. This is exactly how many key leaders of the campaign to repeal the Corn Law, such as the politician Richard Cobden and John Bowring of the Board of Trade, saw their campaign {4}.

Britain's technological lead, which enabled this shift to a free trade regime, had been achieved "behind high and long-lasting tariff barriers", as the economic historian Paul Bairoch put it {5}. For this reason Friedrich List, the 19th-century German economist who is (mistakenly) known as the father of the modern "infant industry" argument - the view that underdeveloped countries cannot develop new industries without state intervention, especially tariff protection - argued that the British appeal for free trade was selfish. He wrote: "It is a very common clever device that when anyone has attained the summit of greatness, he kicks away the ladder by which he has climbed up, to deprive others of the means of climbing up after him ... Any nation which by protective duties and restrictions on navigation has raised her manufacturing power and her navigation to such a degree of development that no other nation can sustain free competition with her, can do nothing wiser than to throw away these ladders of her greatness, to preach to other nations the benefits of free trade, and to declare in penitent tones that she has hitherto wandered in the paths of error, and has now for the first time succeeded in discovering the truth" {6}.

If Britain was the first country with a major infant industry strategy, its most ardent user was the US - Bairoch called it "the mother country and bastion of modern protectionism" {7}. The first systematic arguments for infant industry protection were developed by American thinkers, in particular Alexander Hamilton, the first Treasury Secretary of the US, and the now-forgotten economist Daniel Raymond. Friedrich List, the supposed father of the argument, first learned about it during his exile in the US in the 1820s. Many 19th-century US politicians clearly understood that free trade theory was unsuited to their country, even though this meant going against the advice of great economists such as Adam Smith and Jean Baptiste Say, who thought that the US should not protect manufacturing industries, and specialise in agriculture {8}.

Between the 1830s and the end of the second world war, the US had one of the highest average tariff rates on manufacturing imports in the world. Since it had an exceptionally high degree of natural protection due to the high costs of transporting goods to the US at least until the 1870s, we can say that US industries were the most protected in the world until 1945. Even the Smoot-Hawley Tariff of 1930 increased the degree of protection in the US economy only marginally. The average tariff rate for manufactured goods after this bill was 48%, still within the upper region of the range of the average rates that had prevailed in the US since the Civil War. It is only in relation to the brief liberal interlude of 1913-29 that the 1930 tariff bill can be interpreted as increasing protectionism, though not by much - from 37% in 1925 to 48% in 1931.

The Civil War was fought over the issue of tariffs just as much as slavery. The South had more to fear over tariffs than over slavery. Abraham Lincoln was an economic protectionist who began in politics under the charismatic politician Henry Clay {9} in the Whig party, which advocated the "American system", based on infrastructure development and protectionism - so named in recognition of the fact that free trade was in the British interest. Lincoln thought blacks were racially inferior and slave emancipation an idealistic proposal with no prospect of immediate implementation. In response to a newspaper editorial urging immediate slave emancipation early in the war, he wrote: "If I could save the Union without freeing any slave, I would do it; and if I could save it by freeing all the slaves, I would do it; and if I could do it by freeing some and leaving others alone, I would also do that" {10}. He is said to have emancipated the slaves in 1862 as a strategic move to win the war rather than out of moral conviction.

It was only after the second world war, with US industrial supremacy unchallenged, that the US liberalised its trade (although not as unequivocally as Britain had done in the mid-19th century) and championed free trade - again proving List's ladder metaphor right. Ulysses S Grant, the war hero who was president of the US from 1869 to 1877, said: "For centuries England has relied on protection, has carried it to extremes and has obtained satisfactory results from it. There is no doubt that it is to this system that it owes its present strength. After two centuries, England has found it convenient to adopt free trade because it thinks that protection can no longer offer it anything. Very well then, gentlemen, my knowledge of our country leads me to believe that within 200 years, when America has gotten out of protection all that it can offer, it too will adopt free trade" {11}.

Britain and the US may be dramatic examples, but the history of other developed countries is similar. When they were trying to catch up with the more developed countries, almost all used tariff protection, subsidies, and other policy tools to promote their industries. Britain and the US, the supposed homes of free trade, used tariff protection most aggressively, not countries like France, Germany or Japan that are usually associated with state activism. During the 19th and the early 20th centuries industrial tariffs were relatively low in France and Germany at fifteen to twenty percent, and that of Japan was bound below five percent until 1911 by a series of unequal treaties, which it had been forced to sign upon opening to the world in 1853. During the same period the US and Britain, until the 1860s, boasted average industrial tariff rates of forty to fifty percent.

The exceptions are Switzerland and the Netherlands, countries that were already on the frontier of technological development by the 18th century and not much protection. The Netherlands had an impressive range of interventionist measures until the 17th century to build up its maritime and commercial supremacy. Switzerland did not have a patent law until 1907, (which directly contravenes today's orthodoxy about the protection of intellectual property rights). The Netherlands abolished its 1817 patent law in 1869 on the ground that patents were politically created monopolies inconsistent with its free-market principles - a position that eludes most contemporary free-trade economists when they support the pro-patent Trips (trade- related intellectual property rights) agreement of the WTO - and did not introduce a patent law again until 1912.

Tariff protection was in many countries a key component of their development strategies, but it was not the only, or most important, one. There were export subsidies, tariff rebates on inputs used for exports, conferral of monopoly rights, cartel arrangements, directed credits, investment planning, manpower planning, research and development supports, and the promotion of institutions to allow public-private cooperation. All of these are commonly thought to have been invented by Japan and other East Asian countries after the second world war, or at least by Germany in the late 19th century, but many of them have in fact a long history. Despite sharing the same underlying principles, there was a considerable diversity among developed countries in the exact mix of trade and industrial policy tools. This suggests that there is no one-size-fits-all model for industrial development.

Those few neoliberal economists who are aware of past protectionism argue that protectionist policies may have had some (but, they stress, not many) positive impacts in the past but they can only do harm in a globalised world. They argue that the superiority of free trade is proven by the growth record of two decades of trade liberalisation being superior to that of the preceding few decades, when protectionism was the norm.

But if free trade is so good, we would expect economic growth to have accelerated over the past two decades, given that there has been so much liberalisation. Yet during the bad old days of the 1960s and 1970s, when there was more protection, the world economy was in fact growing much faster than now - world per capita income was growing at about three percent a year, while during the past twenty years it has grown at only about two percent. Per capita income growth in the developed countries slowed from 3.2% to 2.2% between 1960 and 1980 and 1980 and 1999, while in the developing countries it went from three percent to 1.5%. Without the strong growth during the past two decades in China and India, neither of which has followed the neoliberal recipe, the rate would have been even lower.

This average growth rate does not fully convey the magnitude of crisis that many developing countries have experienced since 1982. Economic growth evaporated in Latin America, with the annual growth rate of per capita income crashing from 3.1% during 1960-80 to 0.6% during 1980-99. The crisis has been even deeper in other regions. Per capita income has shrunk in the Middle East and North Africa (at an annual rate of -0.2%) and in sub-Saharan Africa (-0.7%) during the past twenty years, whereas it grew at 2.5% and two percent during 1960-80. Since the start of their transition to capitalism, most former communist countries have experienced the fastest falls in living standards in modern history, and many have not yet recovered even half the per capita income level under communism.

The neoliberal experiment has failed to deliver on its key promise, accelerated growth, in whose name we were told to sacrifice everything else, from equity to the environment. Despite this failure the neoliberal view on free trade continues to be dominant thanks to a formidable economic- political- ideological machinery, comparable in its scale and power only to the Vatican during the Middle Ages in Europe. Through their hold on the governments of the most influential developed countries, especially the US and the UK, neoliberals have an enormous influence in setting the political agenda of key international agencies - especially the IMF, the World Bank and the WTO. Through their influence in mainstream media all over the world, neoliberals have been able to underplay, or even suppress, unfavourable information, including those dismal growth figures. Through their dominance in key economics departments, especially in the US and UK, which lead the world, neoliberals can make sure that almost no dissenting economists are ever hired in respectable departments.

In the developing countries the stranglehold of neoliberalism has been even greater. The continued crisis makes it necessary for many developing country governments to follow the policies of the IMF, the World Bank and key donor governments, on whose support they are dependent, even if these policies perpetuate the crisis that makes dependence inevitable. Powerful interests in these countries benefit from neoliberal policies - for example, exporters of primary products or those who provide professional services to foreign firms. Alternative policy proposals are few, as most thinkers have lost the self-confidence to challenge the orthodoxy and others have defected to it to make a living: not a surprising outcome when an IMF or World Bank consultancy fee can be as great as several years' academic salary in most developing countries. With this dominance of the political and intellectual agenda, neoliberals have been able to dismiss critics as softies afraid of creating short-term inequality in return for long-term greater wealth for everyone, or as economic innumerates who do not understand what is going on. Serious debates are avoided and dissenters ignored, reinforcing neoliberal dominance.

What is the future of free trade? Despite what the free-traders argue, there are many good reasons to believe that free trade between countries with very different productivity levels may benefit the poorer countries in the short term by providing them with bigger export markets, but it is likely to harm long-term development by locking them up in low-productivity activities. Clever policy-makers of countries trying to catch up with more developed countries, from Robert Walpole and Alexander Hamilton in the 18th century down to the Japanese and the Korean bureaucrats of the 1960s and 1970s, understood this all too well when they rejected free trade.

Free trade agreements that involve countries with vastly different levels of productivity are unlikely to succeed long-term, because over time poorer countries will realise that they are not helping development. Free trade agreements that bind countries at similar levels of development, such as the Mercosur (common market of the south), which includes Brazil, Argentina, Uruguay, and Paraguay, and the Association of South East Asian Nations (Asean) {12}, have greater possibility of success than those that try to bind countries at different levels, such as the FTAA. Friedrich List saw no contradiction in supporting the German customs union (zollverein) while arguing for infant industry protection, as he believed that the German states were sufficiently similar in levels of development that a free trade agreement would eventually benefit all the countries involved. The only way to make a free trade agreement between countries at different levels of development work is a deep integration like the European Union, which allows significant fiscal transfers from richer countries and movement of labour from poorer ones. But this can work only if the poor economies are few and small relative to the rich ones, as otherwise it will make the richer countries feel that the agreement is too costly. This is why the enlargement of the EU is likely to stop before it reaches big, relatively poor countries such as Turkey and Ukraine.

What about the WTO? It is not yet a free trade agreement as it still gives some scope for industrial protection by developing countries. But there is now a strong push towards further reduction in industrial tariffs, exemplified by the recent US proposals in effect to abolish all tariffs by 2015. If this succeeds, the potential of the WTO to thwart the effort of developing countries will be even greater than that of the proposed FTAA or even Nafta (for Mexico), as it involves countries with even bigger productivity gaps than the regional agreements. The WTO may not be a free trade agreement in the conventional sense, but it constrains policy areas that conventional agreements do not cover, such as intellectual property rights, control over foreign investment and government procurement procedures. The WTO can make economic development of poorer member countries even more difficult than conventional free trade agreements, which only restrict the use of tariffs and quotas.

For now most developing countries want to stay in the WTO as a second, or even third, best option, as it allows them to have some voice in the running of world trade (as the organisation is one-country-one-vote, at least in theory). It also gives them some protection from bilateral pressures for liberalisation from developed countries, especially the US, which is more willing to use such pressures than other developed countries. But there is increasing dissatisfaction among the developing countries, which may lead to change: while it is ostensibly democratic, the WTO is in fact run as an oligarchy of the developed countries. Powerful countries have the implicit power to coax and threaten weaker countries, but that is a common problem with any democracy of agents with unequal powers. However, in the WTO powerful countries do not even bother with the charade of democracy, as can be seen in the Green Room meetings, to which the representatives of developing countries are not invited and from which they may be barred if they show up. The result has been a policy agenda (and implementation) grossly biased towards the interests of powerful countries.

If the WTO increasingly deprives the developing countries of vital policy tools while imposing the interests of powerful countries on them, they may leave en masse. Or they may put to use the democratic decision-making structure of the WTO to the full and try to renegotiate its basic parameters. If this happens, powerful countries, especially the unilateralist US, may decide to leave the WTO rather than risking a defeat in the vote. Either way, it will mean the end of the free trade order as we know it. That may not be a bad thing, given its recent dismal record.


{1} In a now-almost-forgotten book, A Plan of the English Commerce (1728), Daniel Defoe, merchant, politician, and the author of Robinson Crusoe, describes how the Tudor monarchs, especially Henry VII (1485-1509) and Elizabeth I (1558-1603), transformed England from a country that relied chiefly on the export of raw wool into the most formidable wool manufacturing nation in the world through deliberate state intervention.

{2} These laws, voted in 1815 by a parliament under the influence of the land-owning aristocracy, in spite of the opposition of industrialists and the urban middle classes, imposed very high tariffs on wheat imports.

{3} Charles Kindleberger, "Germany's Overtaking of England, 1806 to 1914" in Economic Response: Comparative Studies in Trade, Finance, and Growth, Harvard University Press, Cambridge, Massachusetts, 1978.

{4} Cobden argued that: "The factory system would, in all probability, not have taken place in America and Germany. It most certainly could not have flourished, as it has done, both in these states, and in France, Belgium, and Switzerland, through the fostering bounties which the high-priced food of the British artisan has offered to the cheaper fed manufacturer of those countries", The Political Writings of Richard Cobden, 1868, as cited in Erik Reinert, "Raw Materials in the History of Economic Policy" in G Cook, editor, The Economics and Politics of International Trade, Volume 2, Routledge, London, 1998.

{5} Paul Bairoch, Economics and World History - Myths and Paradoxes, Wheatsheaf, Brighton, 1993.

{6} Friedrich List, The National System of Political Economy, Longmans, Green, and Co, London, 1885.

{7} Paul Bairoch, op cit.

{8} Adam Smith: "Were the Americans, either by combination or by any other sort of violence, to stop the importation of European manufactures, and, by thus giving a monopoly to such of their own countrymen as could manufacture the like goods, divert any considerable part of their capital into this employment, they would retard instead of accelerating the further increase in the value of their annual produce, and would obstruct instead of promoting the progress of their country towards real wealth and greatness". An Inquiry into the Nature and Causes of the Wealth of Nations, 1776, Random House, New York, 1937.

{9} Henry Clay was a leading force in the American Colonisation Society; he conceived the idea of founding a national home in Africa for freed slaves, from which Liberia derived its name in 1820.

{10} John Garraty and Mark Carnes, The American Nation - A History of the United States, 10th edition, Addison Wesley Longman, New York, 2000.

{11} Ulysses S Grant, cited in AG Frank, Capitalism and Underdevelopment in Latin America, Monthly Review Press, New York, 1967.

{12} The ten members of Asean are Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. Only Singapore is a truly developed country (Brunei's wealth is solely based on oil) and it is too small to dominate regional trade.

Ha-Joon Chang teaches at the faculty of economics and politics, University of Cambridge, United Kingdom. He is author of Kicking Away the Ladder: Development Strategy in Historical Perspective (Anthem Press, London, 2002).

Bill Totten


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