links for 2007-07-16
I Write to Jay Carney at Time Magazine...

DeLong Smackdown Watch: Dani Rodrik Strikes Back

The learned and thoughtful Dani Rodrik has a good response. He writes:

Dani Rodrik's weblog: What's different about international trade?: UPDATE: Brad DeLong does not express my views accurately. He writes:...

Dani Rodrik's country whose "labor force that is producing at low levels of productivity" is doing so because it has lousy political institutions: it lacks the "constitution... judiciary, nation-wide financial regulation, and free flow of labor" that have underpinned economic growth in the rich post-industrial core. The poor country is poor because its government is incompetent, and corrupt...

No, the argument that poor countries are and remain poor because their governments are incompetent and corrupt is one of the absurd reductionisms of the day which I do not believe in and have written against. The point I made was that a poor country would have the real prospect of converging in living standards with rich countries if international economic integration were near-total (involving free labor mobility, truly integrated capital markets, and a transnational set of regulatory, legal and political institutions that underpin this integration). In the absence of these, trade liberalization does not get you there. You are in a second-best world and you need to think appropriately. The idea that developing countries cannot employ industrial policy in such a world to good effect is downright silly.

Here is a thought experiment: does anyone really believe that China would have grown as fast as it did if it had removed all its tariffs and trade restrictions in 1978, instead of liberalizing strategically and sequentially--first in agriculture, than in industry, then on the export side, and only later in the 1990s on the import liberalization side?  There are many reasons why the Chinese strategy worked, but one of them is that it protected employment while industrial capabilities were being built up.

I would put the story of China since 1978 differently than Dani would, I think...

First, I would start with the proposition that the Chinese government from, say, 1955 (the start of the reenserfment of the peasantry) to 1978 was massively, massively incompetent and massively, massively corrupt. And its massive, massive incompetence and massive, massive corruption were so the reasons that China was then so very, very poor. If you don't start there--if you denounce that fact as "absurd reductionism"--you can't make any sense of the story.

The fact that China's government had been so bad before 1978 meant that there were enormous problems and enormous opportunities for a government that was both competent and (relatively) benevolent--in the sense of wanting to see the economy grow rapidly if that could be accomplished without endangering its hold on power. And in 1978 China had its first piece of great good luck in a long, long time--perhaps the first time some important chance broke right for China since the end of the Sung dynasty. China acquired as its paramount ruler one of the most devious and effective politicians of this or indeed any age, a man who was quite possibly the greatest human hero of the twentieth century: Deng Xiaoping. Deng sought to maintain the Communist Party oligarchy's control over China's politics while also seeking a better life for China's people, and he is guided by two principles: (i) be pragmatic ("what matters is not whether the cat is red or white, what matters is whether the cat catches mice), and (ii) be cautious ("cross the river by feeling for the stones at the bottom of the ford with your feet").

The Chinese economy as of 1978 had two main features: (i) a peasantry whose agricultural production was half of what it should have been because the peasants were serfs on communes working for lords who were party bosses, and (ii) a value-subtracting Soviet-style heavy-industrial sector. Freeing up the peasantry to work for themselves on their own land and sell their produce on markets promised to instantly double agricultural output and living standards--hence liberalizing agriculture first was a no-brainer: it promises only gains.

Immediately opening up the industrial sector to international trade, however, would have led to (a) a rapid rise in imports of foreign-manufactured industrial goods, (b) a rapid rise in exports of agricultural products to pay for those imports, (c) mass urban unemployment as the value-subtracting Soviet-style heavy industries found that they could not compete and closed, and (d) riots and revolution as the now-unemployed urban manufacturing workers overthrew the government. Hence Deng Xiaoping kept China closed in the early years, and used tax revenue from the productive countryside to keep the Soviet-style industrial sector running--value-subtracting as it was--while another, alternative industrial base was gradually built up, a market-oriented sector in which local party bosses had an important and very profitable stake. And then they were off and running.

The key elements of the situation of China in 1978 relevant to the theory of the second best from the standpoint of the Communist Party oligarchy are (i) the threat to the regime from mass urban unemployment, (ii) the fact that the economically-rational closing-down of the Soviet-style industrial base would have generated such mass urban unemployment, (iii) the need to start up exports that took advantage of China's extraordinarily low wages in order to earn foreign exchange to purchase technology-bearing capital and other goods from abroad, (iv) the need to find a supply of entrepreneurship somewhere to start up the market-sector manufacturing industries needed for development, (v) the need to find a way to protect the growing market industrial sector from predatory local party bosses, and (vi) a central government that actually sought not the enrichment of its functionaries but the prosperity of its people as its highest priority. Given (vi), realying on township and village enterprises for industrial development took care of (v), drawing on Taiwan and Hong Kong gave China a leg up on (iv), and (i) and (ii) were dealt with by protecting and subsidizing the Soviet-style industrial sector for a long, long time.

The price was retardation of (iii). IIRC, Manchuria, Shandong, Wuhan, and Shanghai were China's industrial centers in 1978. Guangzhou (with Shenzhen leading the pack), Shanghai, and Zhejiang are its industrial centers today because those were the first areas where SEZs were opened to international trade. A lot of human resources and infrastructural capital was wasted becuase Deng Xiaoping did not dare risk the political consequences of the economic process of shifting resources out of the old Soviet-style industrial sector. I think he was right--from his perspective at least--to initially limit market manufacturing to the south. However, the logic is not economic but political.

Note that the success of the strategy that was in fact adopted hinged on element (vi): Deng Xiaoping's power and status as paramount leader, and the wisdom exercised by him and his team, and their goal of making the Chinese rich. Dani Rodrik's praise of policies that "protected employment while industrial capabilities were being built up" strikes an echo of Juan Peron's development strategy in Argentina in 1950--keep the descamisados employed and the price of beef low. It was a strategy that sounded good to many at the time (including Raul Prebisch). It was was justified in economic terms by assertions about market failures and the second best. And it turned into a complete and total disaster.