Most Dishonest Wall Street Journal Editorial Ever
The Past Week in "Shrillblog": July 13, 2007

Don Boudreaux vs. Dani Rodrik on Industrial Policy: I Call This One for Don--I Think It's a Knockout

In the ring, Dani Rodrik stumbles into a knockout punch from Don Boudreaux:

Don Boudreaux:

Cafe Hayek: "Faith" In Free Trade?: I don't want here to rehearse debates over the meaning of the term "faith."  I would say that I have no "faith" in free trade; rather, the evidence and the theory of free trade are powerful enough to convince me that it is practically superior to any form of protectionism if the goal is widespread prosperity.  Faith is required when neither evidence nor theory support whatever proposition you choose to (or happen to) believe.  Even if Rodrik is correct about the errors and oversights of traditional trade theory and evidence, it is an unjustified smear to say that those who accept these as the basis for supporting a policy of free trade do so as a matter of "faith."

But my problem with Rodrik's position runs even more deeply.  If it's true that theory and evidence in favor of protectionism are sufficiently strong to warrant economists abandoning their conclusion that free-trade policy is generally sound, then why shouldn't economists -- led by Dani Rodrik -- also start exploring the potential benefits of intra-national protectionism?  Surely a scholar not benighted with the free-trade "faith" ought to take seriously the possibility that, say, Tennesseeans could be made wealthier if their government in Nashville restricts their ability to trade with people in Kentucky, Texas, Rhode Island, and other states?...

I suspect that if someone proposed to Dani Rodrik that he explore the wealth-creating potential of state-level protectionism, he would refuse.  He would likely (and correctly) say that it's ridiculous on its face to suppose that such protectionism would make the people of Tennessee as a group wealthier over time.  If my suspicion is correct, then to what would Rodrik himself attribute his out-of-hand dismissal of the notion that Tennessee tariffs might well make Tennesseeans richer?  Would he realize to his chagrin that he is a benighted, faith-based non-scholar?  Or would he instead understand that the case for an extensive, market-driven division of labor is so strong -- and that the political border that separates Tennessee from other states is so economically meaningless -- that it would be as pointless for a serious economist to explore the economic potential of Tennessee protectionism as it would be for a serious oncologist to try to cure a patient of cancer by bleeding that patient with leeches.

Dani Rodrik:

Let me confirm Boudreaux's suspicion that I would indeed be against imposing intra-state trade restrictions in general (or to be more precise, that I would have a strong presumption against them). So the question he asks is an important one. Why then do I not take an equally strong position against trade restrictions in international trade?

The answer is that the... two situations are alike only in the limiting (and counterfactual) case where government-imposed tariffs are the only transaction costs blocking economic exchange across international borders. In reality, national borders demarcate political and legal jurisdictions, which means that there remain plenty of transaction costs which block economic convergence. Capital flows are hindered by sovereign risk and the absence of international regulation and lender-of-last resort functions, which create the kind of syndromes that I often discuss in this blog. Labor mobility is severely restricted. And differences in regulatory regimes impose severe transaction costs (estimated by Jim Anderson and Eric van Wincoop to be of the order of 40% in tariff equivalents) on international trade. In the presence of these transaction costs, free trade in goods (in the sense of zero import tariffs) is in general incapable of achieving rapid economic growth and economic convergence in poorer nations of the world. If you do not believe this, just ask the Mexicans.

Within this U.S., economic convergence is achieved because there is a common constitution, a federal judiciary, nation-wide financial regulation, and free flow of labor. This ensures that a lagging region (such as the South until recently) catches up by a combination of capital coming in and labor moving out. Neither of these channels are operative in a world economy that is divided into nation-states. Removing restrictions on international trade in goods, services, and capital simply does not do it. Trade ends up being too small, and capital flows in the wrong direction (from poor to rich countries)....

Now, there is still the question of how trade restrictions may help in the kind of imperfectly integrated world economy I have discussed. I think the answer is that when you are stuck with a labor force that is producing at low levels of productivity, there exists a bunch of arguments having to do with learning and (domestic) market failures under which subsidization of tradable activities could speed up your economic growth. There also exists a bunch of historical and current instances where the evidence seems to have lined up with these theoretical presumptions. That is why I am not a free trade fundamentalist and believe that there are circumstances under which trade restrictions may serve a valuable function...

The knockout punch, of course, is that 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.

And yet Dani wants--in this situation--to enhance and extend the role and powers of the poor-country government by asking it to implement an active protectionist industrial policy because "there exists a bunch of arguments having to do with learning and (domestic) market failures under which subsidization of tradable activities could speed up your economic growth."

As Lant Pritchett put it once: "there is nothing as catastrophic as state-led development led by an anti-developmental state." Any argument to commit a government to an active protectionist industrial policy must be accompanied by arguments about why the government will be capable and effective in this role when it has not been capable and effective in its primary roles of establishing property rights, providing tolerable administration of justice, building infrastructure, and providing education.

So I score this for Don: a knockout.