Dani Rodrik's Globalization Paradox

Upon a recommendation by the always well-inspired Caroline, I recently read Dani Rodrik’s 2012 The Globalization Paradox. In it, Rodrik makes the case for a pragmatic trade policy. Governments should not accept free trade as an end in itself, he writes. Instead, they should use tariffs as a means to develop their country and renounce free trade when needed. This argument is exactly the one made by Friedrich List, a German-American economist of the first half of the 19th century, whose National System of Political Economy is a great critique of Adam Smith’s theses [1].

In 2013, one year after The Globalization Paradox was published, Joe Studwell made the same points in a case study of Taiwan, South Korea, Malaysia, the Philippines and China, in How Asia Works. Countries that did well (South Korea, Taiwan and China), he writes, are those where the government followed a pattern of giving land to the poor masses to cultivate, then fostering an export-oriented industry while keeping financial institutions in check. Giving a free hand to private entrepreneurs and deregulating trade and finance only led to money being allocated to easy businesses that do nothing for development, such as telecoms and banking. Only by keeping entrepreneurs on a short leash can a government ensure that a countries develops shipyards, car industries and computers, Studwell writes.

Listian economics works

The appeal of such theories is obvious for one main reason: It works. Listian economics is probably the only school of though which is based in reality from the beginning. List opens his National System of Political Economy with a lengthy analysis of how the trade policies of different nations helped them succeed or fail. Countries that ditched free trade in favor of infant industry protectionism often outperformed their neighbors, as List predicted. England in the 18th century, the United States, Germany and Japan in the 19th century, South Korea, Taiwan and China in the 20th are only some examples.

When I was a student of economics, from 2003 to 2008, Listian ideas were taboo. On French campuses, Karl Marx was just being replaced by John Maynard Keynes as the economist of reference. In Germany and England, Friedrich Hayek and Milton Friedman were de rigueur. There, criticism of free trade was equated with backward lefticism and seen as the grossest mistake one could make. Rodrik perfectly highlights this overconfidence economists as a group had in neo-classical economics back in the 2000’s in The Globalization Paradox and sees it as one of the main causes of the 2008 financial meltdown.

Me and most of my friends saw that neo-classical economics, which rely in large part on mathematical models to describe reality, were most of the time off the mark. This approach, where models are built before data points from the real world are collected, is best exemplified in this Laffer curve in the Wall Street Journal in 2004. Instead, we were in awe of the neo-Austrian school of thought, which cares little for mathematical models and instead analyzes most social problems by atomizing them down to the individual and the choices they make. In term of policy, Austrian economics advocate for large amounts of freedom for individuals (within strict moral and practical boundaries). This includes the right to trade with whomever one wants, across borders if need be.

Nations vs. individuals

This is the point on which Rodrik and List’s arguments are weakest. High tariffs are probably good for the local industry, but they increase costs for consumers. How can a government justify that its citizens must buy products of inferior quality at higher prices? List and Rodrik easily get around the argument by talking about “nations” and not “citizens” [2]. For List, development is measured by the ability of a nation to produce wealth, not by wealth in itself. Industry is more important than consumer goods, as a strong industry will always let a country produce consumer goods at a later point in time.

A nation might be better off in the long run by having a protectionist policy. But in the short run, entrepreneurs benefit by getting richer and normal citizens suffer by having to buy inferior wares. If Europe were to stop importing Chinese textiles so that local tycoons can sell more expensive and low-quality T-shirts, Europeans would probably complain, and rightly so. Using the nation as the main unit of reference makes it easy to see individuals as disposable units. But to anyone who values each individual, such arguments are unacceptable [3].

Austrian economics would dictate that citizens must make the choice themselves between locally-produced goods that benefit their neighbors (who might be employed in the fabrication process of said goods and services) and goods that might be cheaper but benefit people farther away. It is obvious that everyone under a well-run administration is better off in the long run by buying locally-manufactured goods. If companies that contribute to the tax base of your government make more money, your government has more tax resources to spend on public services. Research in human psychology has shown time and again that our brains are very bad at making trade-offs in time (we discount the future much more than we should), so there is a strong case for tariffs, even if one is to use an individualistic – and not national – framework [4].

Such an argument makes one very important assumption: that locally produced goods and services translate in higher tax revenues for the government, which uses them to improve the population’s standards of living. In Europe today, to take this assumption seriously borders on insanity. Profits are routinely channeled to tax heavens and high-level government officials display a high propensity for corruption. In the end, it makes little difference if I buy a Chinese-made Xiaomi or a Nokia N9 (the last smartphone to have been manufactured in Europe). Forcing us to buy Nokia or Alcatel phones would probably do little for the global European good, but it would be a very real hassle for Europeans. (It would also create a thriving black market for iPhones and Samsungs.)

A question of visions

For protectionist trade policies to make sense in an individualistic framework, it is essential that the government offers a convincing vision of a better future to the whole population. These visions must produce fast and visible results. In South Korea, for instance, it was land redistribution at first and high levels of growth thereafter. In other words, the government must make it very clear that current sacrifices will be rewarded by higher standards of living in the future. A charismatic leader often helps in the process, as well as a good reason. There, survival is a good choice. Rodrik mentions this as an aside in The Globalization Paradox when he writes that South Korea’s development drive was pushed by a need to fend off a North Korean attack (the same applies to Taiwan’s and China).

Rodrik sees that context is crucial in the choice of an economic policy (and therefore a trade policy) but he fails to use context to explain the rise of the free trade ideology. Not once in his book does he mention the fall of the Soviet Union as one of the causes of the deregulation of trade and finance in the 1990’s. That Reagan and Thatcher (and the French socialists who pushed for free trade in the 1980’s) were in power in 1991 might have been an example of correlation not implying causation, but it was a powerful argument for more deregulation. It was only normal, after all, that countries whose political elite had just been defeated trusted the policies of the victors.

It’s all about trusting the government

Provided that the government offers a convincing vision, can a protectionist trade policy be compatible with the ideas of the Austrian school? After all, it would be easy for European governments to break away from free trade by imposing a carbon tax on all incoming goods. This would benefit European industries and probably receive support from European citizens. It all comes down to a favorite of Austrian economists: trust in the government.

Individuals might honestly think that they will be better off in the future and enthusiastically follow their government’s protectionist policies. But when the future arrives, they might realize that the government had other plans. Neither Rodrik nor Studwell mentions the suicide rate in South Korea, for instance [5]. Contrary to many media reports, what puts Korea on top of global suicide rates rankings is not pressure at school (which exists in many countries), but old, rural peasants who ingest fertilizers when they realize that the social benefits enjoyed by the rest of the population thanks to their own sacrifices in the 1970’s will never reach them [6]. One should be careful to examine their fate before jumping to conclusions regarding the success of that country’s economic policies.

Should individuals have the right to buy products from anywhere on earth, or should restrictions and tariffs be put in place, as Rodrik suggests? I don’t know. What is certain is that policy makers and journalists should not embrace Listian ideas as uncritically as they embraced neo-classical ones in the 2000’s.

Notes

1. Amazingly, Rodrik does not mention List once, either in the text of the book or in the notes.

2. In The Globalization Paradox, Rodrik talks of “nation” 147 times and “citizen” 9 times only.

3. Rodrik’s careless attitude to individuals’ preferences is most obvious in his policy recommendations. He advocates for more freedom of movement for workers and argues that European countries should increase their workforce by 3% through work visas. About 80,000 migrants enter Germany annually (net migration). This represents 0.2% of the workforce (but not all migrants are working age). 3% would mean 1.2 million people. Needless to say, the xenophobic sentiment in Europe these days would make such a policy impossible to enact. Rodrik is aware of this, but justifies his idea by arguing that free-trade was unpopular, too. Replacing an unpopular policy with another is hardly compatible with the democratic ideals Rodrik supports his critique of free trade with.

4. Contrary to what many say, Hayek was very much in favor of large-scale safety nets. However, he based his argument on moral values, not human psychology or utilitarianism. See this page for the full quotes on social services from The Road to Serfdom.

5. Studwell does mention it as an aside once, but never as part of his analysis.

6. 2009 data from WHO shows that one in 1,000 Koreans above 75 commits suicide every year.


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