Tilt the playing field of the world economy

I have a six-year-old son. His name is Jin-Gyu. He lives off me, yet he is quite capable of making a living. After all, millions of children of his age already have jobs in poor countries.

Jin-Gyu needs to be exposed to competition if he is to become a more productive person. Thinking about it, the more competition he is exposed to and the sooner this is done, the better it is for his future development. I should make him quit school and get a job.

I can hear you say I must be mad. Myopic. Cruel. If I drive Jin-Gyu into the labour market now, you point out, he may become a savvy shoeshine boy or a prosperous street hawker, but he will never become a brain surgeon or a nuclear physicist. You argue that, even from a purely materialistic viewpoint, I would be wiser to invest in his education and share the returns later than gloat over the money I save by not sending him to school.

Yet this absurd line of argument is in essence how free-trade economists justify rapid, large-scale trade liberalisation in developing countries. They claim that developing country producers need to be exposed to maximum competition, so that they have maximum incentive to raise productivity. The earlier the exposure, the argument goes, the better it is for economic development.

However, just as children need to be nurtured before they can compete in high-productivity jobs, industries in developing countries should be sheltered from superior foreign producers before they “grow up”. They need to be given protection, subsidies, and other assistance while they master advanced technologies and build effective organisations.

This argument is known as the infant industry argument. What is little known is that it was first theorised by none other than the first finance minister (treasury secretary) of the USA - Alexander Hamilton, whose portrait now adorns the $US10 bill.

Initially few Americans were convinced by Hamilton’s argument. After all, Adam Smith, the father of economics, had already advised Americans against artificially developing manufacturing industries. However, over time people saw sense in Hamilton’s argument and the US shifted to protectionism after the Anglo-American War (1812-6). By the 1830s, its industrial tariff rate, at 40-50 per cent, was the highest in the world and remained so until World War II.

The US may have invented the theory of infant industry protection, but the practice had existed long before . The first big success story was, surprisingly, Britain - the supposed birthplace of free trade. In fact, Hamilton’s program was in many ways a copy of Robert Walpole’s enormously successful 1721 industrial development program, based on high (among world’s highest) tariffs and subsidies, that had propelled Britain into its economic supremacy.

Britain and the US may have been the most ardent - and most successful - users of tariffs, but most of today’s rich countries deployed tariff protection for extended periods in order to promote their infant industries.

Many of them also actively used government subsidies and public enterprises to promote new industries. Japan and many European countries have given numerous subsidies to strategic industries. The US has publicly financed the highest share of research and development in the world. Singapore, despite its free-market image, has one of the largest public enterprise sectors in the world, producing about 30 per cent of the national income. Public enterprises were also crucial in France, Finland, Austria, Norway, and Taiwan.

When they needed to protect their nascent producers, most of today’s rich countries restricted foreign investment. In the 19th century, the US strictly regulated foreign investment in banking, shipping, mining, and logging. Japan and Korea severely restricted foreign investment in manufacturing. Between the 1930s and the 1980s, Finland officially classified all firms with more than 20 per cent foreign ownership as “dangerous enterprises”.

While (exceptionally) practising free trade, the Netherlands and Switzerland refused to protect patents until the early 20th century. In the 19th century, most countries, including Britain, France, and the US, explicitly allowed patenting of imported inventions. The US refused to protect foreigners’ copyrights until 1891. Germany mass-produced counterfeit “made in England” goods in the 19th century.

Despite this history, since the 1980s the “Bad Samaritan” rich countries have imposed upon developing countries policies that are almost the exact opposite of what they used in the past. But by condemning tariffs, subsidies, public enterprises, regulation of foreign investment and permissive intellectual property rights it is like these countries “kicking away the ladder” they used to climb to the top - often against the advice of the then richer countries.

The rich countries argue that they are merely trying to ensure fair play by “levelling the playing field”. But a level playing field leads to unfair competition when the players are unequal. When one team in a football game is, say, the Brazilian national team and the other team is made up of my 11-year-old daughter Yuna’s friends, it is only fair that the girls attack downhill. Indeed, in most sports, unequal players are simply not allowed to compete against each other - through gender division, age groups, and weight classes. In a world of highly unequal productive capabilities, there is nothing unfair about “asymmetric protection”.

But, the reader may wonder, didn’t the developing countries already try protectionism and miserably fail? That is a common myth, but the truth of the matter is that these countries have grown significantly more slowly in the “brave new world” of neo-liberal policies, compared to the “bad old days” of protectionism and regulation in the 1960s and the 1970s (see table). And that’s despite the dramatic growth acceleration in the two giants, China and India, which have partially liberalised their economies but refuse to fully embrace neo-liberalism.

Annual per capita GDP growth rates

Source: World Bank, United Nations

Growth has failed particularly badly in Latin America and Sub-Saharan Africa, where neo-liberal reforms have been implemented most thoroughly. In the “bad old days”, per capita income in Latin America grew at an impressive 3.1 per cent per year. In the “brave new world”, it has been growing at a paltry 0.5 per cent. In Sub-Saharan Africa, per capita income grew at 1.6 per cent a year during 1960-80, but since then the region has seen a fall in living standards (by 0.3 per cent a year).

Both the history of rich countries and the recent records of developing countries point to the same conclusion. Economic development requires tariffs, regulation of foreign investment, permissive intellectual property laws, and other policies that help their producers accumulate productive capabilities. Given this, the international economic playing field should be tilted in favour of the poorer countries by giving them greater freedom to use these policies.

Tilting the playing field is not just a matter of fairness. It is about helping the developing countries grow faster. Because faster growth in developing countries means more trade and investment opportunities, it is also in the self-interest of the rich countries.