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Busting Economic Myths: The Real Path to Prosperity
How High-Income Countries Truly Built Their Wealth
How do economic myths take hold? These are widely held beliefs that are completely false, such as government spending being like a household with a credit card. Or Homo Economicus. Or the idea that Donald Trump is a good businessman.
Another is that today’s high-income countries got rich by strict adherence to the neoliberal economic playbook: trade liberalisation and laissez-faire markets. For decades this was absolutely central to the way these countries thought about development – and the models they imposed on low-income countries: “here’s how we got rich, now you must do the same.”
But economic-myth-buster-in-chief Ha-Joon Chang has long argued that this reading of history is complete rubbish. His books have disputed the role free trade and liberalised markets played in the development of the West. Instead, he argues that these countries successfully employed a range of interventionist industrial policies – exactly the kind that Western-backed institutions like the World Bank, the IMF, and the World Trade Organisation have forbidden low-income countries from utilising. In Chang’s famous phrase, today’s rich countries kicked away the ladder to prosperity.
Despite Chang’s excellent work, the role of industrial policies in the rise of the West has been largely ignored. Don’t ask, don’t tell. But that’s now changing – and a great new paper from Réka Juhász & Claudia Steinwender rounds up the growing evidence base being developed by researchers around the world.
The authors explore the policies countries used in the late 18th and 19th centuries to catch up with the technological leader – Great Britain. They report that these policies were widespread: “From Bourbon France, through the early US republic to Meiji Japan, governments smuggled blueprints and machines, hired British engineers and subsidized the take-up of British technology in various ways.”
They report the success tariffs had in nurturing infant industries. The evidence isn’t always clear cut, but the trend that emerges is that countries that protected their infant firms from competition with dominant British firms tended to see stronger industrial development in these areas.
Infant industry protection worked best when it was accompanied by state-led active technology adoption. The French government went to great lengths to acquire British industrial technology, even going as far as to sponsor corporate espionage and lure technical experts across the channel, in defiance of British bans. The paper highlights research of state-led technology acquisition boosting growth in Meiji Japan as well.
The authors also point to an interesting natural experiment, analysed by Juhász in 2018. The experiment exploited the fact that the Napoleonic blockade against British trade wasn’t equally enforced in all areas in France. Juhász found that the parts of France that were better protected from competition, by a more robust blockade, expanded their mechanized spinning capacity. This fed through to increased value added per capita across industry in general – an effect which lasted around 50 years. Infant industry protection can work – even when it isn’t deliberate.
And countries heavily subsidised new infrastructure during this period, with the express intention of boosting industry. For example, Japan and Germany both supported the development of steam ships to increase their exports. The state-led provision of railways is another example.
So it’s clear that today’s rich countries were employing a host of policies to aid their industries during a key period in their development. It wasn’t all free markets and free trade. Yet the Western dominated IMF and World Bank spent decades attaching neoliberal conditions to loans, discouraging industrial policies and preaching free trade. Low-income countries were pushed to join the World Trade Organisation, where protective tariffs were largely outlawed.
And this so-called Washington Consensus turned out to be bad for the low-income countries themselves. One key study from the turn of the millennium found that for low-income countries working with the IMF, “Program participation lowers growth rates for as long as countries remain under a program.” Overall, the evidence is that trade liberalisation in particular is only beneficial for countries whose manufacturing and industrial sectors are already well developed. Many low-income countries opened up to international competition too soon and saw their domestic industries decimated.
Why, given the widespread use of industrial policies in Europe and the US during the industrial revolution, was the Washington Consensus so extreme in its free market prescriptions? The cynical explanation goes something like this. High-income countries looked across the world and saw untapped domestic markets into which their advanced businesses could expand. Firms at the technological frontier would have no problem competing with infant industries in low-income countries – as long as they didn’t face import tariffs. There was no downside, just expanded markets.
And it’s easy for cynics to poke holes in the trade theories used to maintain this status quo. The comparative advantage trade theory, which is econ 101, condemns low-income countries to stick to their current advantages – i.e., labour intensive and low productivity commodity exports – while rich countries keep the high productivity industries for themselves. It was only when countries like Taiwan decided this was nonsense and resolved to make semi-conductors whether or not it was their “comparative advantage” that the ladder to prosperity re-appeared.
There may be a fair bit of truth in this interpretation. But it’s important not to get carried away. Industrial policy is enjoying a global resurgence, and that’s good. Yet it doesn’t always work. We should know by now that there are no silver bullets in development. Juhász and Steinwender’s paper shows that results of industrial policies can be mixed, even when pursued by relatively sophisticated governments whose countries are on the up. Deploying them effectively today in stagnant economies with troublesome political climates is a big challenge – they can be snakes just as often as ladders.
And a world in which every country builds impregnable walls in perpetuity around domestic industries is a dystopia. A key question at the global level is how to build a system where the benefits of international trade and liberalised markets can be maximised, but that also empowers low-income countries to nurture their infant industries to maturity. A balance must be found between the extremes of the Washington Consensus and the dangers of giving states carte blanche to pursue crony capitalism.
But these important qualifications aside, it was wrong of rich countries to deny their low-income peers a proven route to prosperity – even if that route is more hazardous and complicated than we may like to believe. We are still learning more about when and how interventionist industrial policy can work. But sensible, well-executed policies – like the development of a business services sector in Rwanda – show what is possible.
The ladder should be given back - albeit perhaps with some guard rails attached and the acknowledgement that it won’t look the same everywhere. We should be doing all we can to help low-income countries build productive industries.
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