Political Economist

Bridging the gap between rich and poor countries should be as high a priority for the International Monetary Fund as helping to solve the world’s financial imbalances, Dominique Strauss Kahn, the probable next managing director of the IMF told the Financial Times.

The former French finance minister, who is on a world tour to win support for his candidacy to head the IMF, said that “going south of the Equator” would matter just as much as going “east to the Pacific” – a reference to deep concerns about the growing trade gap between China and the developed world. Mr Strauss Kahn will fly to Mozambique on Sunday to meet African finance ministers and then over the following two weeks to Mexico, Argentina, South Africa, Brazil, Saudi Arabia, Egypt, China, South Korea, Japan, India and Russia in what he freely described as a “campaign” among the largest developing countries to get the job.

Asked whether Europe should continue to maintain its stranglehold on the top IMF job as the US does with the World Bank, Mr Strauss Kahn said he supported an open process and would welcome candidates from other parts of the world if they threw their hats into the ring before the closing date at the end of August.

“It is entirely legitimate for any country that is a member of the IMF to promote one of their nationals as a candidate,” he told the FT in his first interview since being proposed for the job.

“But of course that does not mean that a European cannot also be a candidate,” he added.

On Friday the Bush administration formally endorsed Mr Strauss Kahn’s candidacy following his meeting with Hank Paulson, the US treasury secretary.

Mr Strauss Kahn on Friday also met Bob Zoellick, the new president of the World Bank, who moved into the job following the unexpected resignation of Paul Wolfowitz last month.

He said his top priorities would be to address both financial and equity imbalances in the world economy and to improve the governance structure and quota system of the IMF to better reflect the growing weight of developing countries in the world economy.

He said he believed the IMF could “adapt” to make itself more relevant to the challenges of globalisation.

“I believe strongly in multilateralism,” he said.

“I think that at this time of globalisation we need more multilaleralism – not less,” adding that he believed the US had recently become “more committed to “multilateralism”.

He said that the “integration” of poor countries into the global economy would be a top priority if he got the job.

Brazil on Friday claimed victory in its latest assault on US cotton subsidies at the World Trade Organisation, underscoring warnings by the Bush administration that the subsidy-laden farm bill under consideration by Congress risks triggering a wave of trade disputes.

Brazil said a confidential interim ruling by a WTO panel had gone in its favour.

The panel, due to issue its final decision in September, was set up last year to judge whether the US had fully complied with a 2005 WTO appeal verdict condemning several subsidy programmes for cotton farmers.

In response to that verdict, the US scrapped or amended programmes considered to be illegal export subsidies. However, Brazil says this left untouched some of the most trade-distorting subsidies, such as marketing loans and counter-cyclical payments that compensate farmers for low prices.

The US House of Representatives was set to vote late on Friday on a controversial $256bn, five-year farm bill that eliminates subsidies for farmers with more than $1m in adjusted gross income but continues to give generous subsidies in key areas including corn, cotton, soya beans and rice.

The bill was approved by the House agricultural committee on July 19.

The Bush administration has threatened to veto the legislation, saying it leaves the US vulnerable to WTO challenges similar to the case brought by Brazil over support for cotton farmers.

Pedro Camargo Neto, ex-secretary of production and trade at the Brazilian Ministry of Agriculture, dismissed the likelihood of Brazil bringing further cases, such as against soy, sugar and rice, where it would be more difficult to prove damages.

The Brazil ruling should embolden other countries, such as Mexico and Uruguay, to seek redress over rice subsidies.

A US trade official confirmed on Friday that the WTO panel had found that the changes made by the US “were insufficient to bring the challenged measures into conformity with US WTO obligations . . . we are very disappointed with these results”.

Brazil and its allies have pressed for big reductions in US and European Union farm support in the Doha global trade round.

The latest draft text by the chair of the Doha round’s agricultural negotiations calls specifically for deeper and faster-than-average cuts in cotton subsidies in developed countries.

Critics say such subsidies hurt not only Brazil but also millions of poor West African cotton farmers.

Still, with a successful conclusion to the round uncertain, the WTO’s dispute mechanism is increasingly seen as an alternative if ponderous route to the same end.

In 2005, Brazil, Thailand and Australia won another landmark case against EU sugar subsidies and this year Canada and Brazil have each filed new complaints alleging US overspending on trade-distorting farm aid.

In the summer of 1972, as a “young professional” at the World Bank, I went on a mission to South Korea. It was my first experience of something extraordinary: a country that was developing at a breathtaking rate. The country had already enjoyed a decade of economic growth at close to 10 per cent a year. It continued to grow at close to that rate for another quarter of a century.

What struck me about Korea was the determination of its policy-makers to sustain rapid industrialisation. I saw the construction from scratch of the vast Hyundai shipyard at Ulsan that was soon to join the first rank of ship-builders. That bet itself demonstrated something even more remarkable: Koreans’ belief in their country’s ability to achieve global competitiveness.

For the Koreans, exports were both a tool of development and a test of its success. How different this was from east Africa and India, on which I was to work for the following five years. India was almost as sealed from the world economy as it was possible to be. Its annual growth in income per head had fallen in the 1970s to about 1 per cent a year, while industrial productivity seemed to be declining, despite its desperately low level.

The contrast between South Korea’s success and India’s failure was striking. Both used protection and other tools of industrial policy. Yet the orientation of India’s policies was inward-looking and anti-competitive, while that of South Korea was the opposite. In the literature on development and trade, the Korean strategy came to be called “export promotion”, because its economy did not have an overall bias towards the home market.

The contrast between South Korea and India raised the biggest questions in economics: why have some countries succeeded with development and others failed? Why has Korea jumped from poverty to prosperity in a lifetime? Why did India do badly then, but much better recently?

The broad question is the one Erik Reinert states in his title: How Rich Countries Got Rich... and Why Poor Countries Stay Poor. Reinert is a Norwegian professor who now teaches at Tallinn, Estonia. Ha-Joon Chang, a well-known Korean development economist, teaches at Cambridge. But both give strikingly similar answers to this question.

Both state that the priority in development is rapid and sustained growth. Only industrialisation can deliver such growth, because industry is the only sector in which rapid and sustained rises in productivity are feasible. Furthermore, to industrialise, countries must upgrade their technological and managerial capabilities, which can be achieved only if they are able to nurture infant sectors. That requires protection, they both argue, as has been the case in every successful economy of the past half-millennium.

Tragically, they argue, the “neo-liberal hegemony” - the broad consensus on liberal trade and freer markets of the past quarter century - has deprived countries of these valuable tools. The result has been a development disaster, particularly in Latin America and Africa, where the International Monetary Fund and the World Bank have run amuck. The World Trade Organisation and a host of one-sided so-called free trade agreements further constrain the ability of developing countries to adopt sensible policies. This, they agree, is a huge contrast to the era of the Marshall Plan in postwar Europe and the more permissive attitudes towards development policy taken by the US between the 1950s and early 1980s.

While the two books are rooted in a similar world view, their style and tone are different. Reinert’s book, while no less enraged, is more academic. He is fighting an intellectual war with neo-classical economics, the academic orthodoxy since the 19th century. He considers himself “heterodox” and presents an alternative “other canon”.

In place of a priori reasoning, this emphasises practical experience; instead of the theory of comparative advantage in trade invented by the 19th-century theorist David Ricardo, it points to the success of protection against imports since the Renaissance. Reinert argues that, for poor countries, specialisation in line with comparative advantage means specialising in poverty. As Friedrich List, the 19th-century German economist, argued, what a country makes matters. Protection is the solution; free trade is suitable only for countries at the same level of development.

So, in respect of Africa - surely the most important and urgent case for treatment - Reinert recommends internal free trade and external barriers to trade, in place of what he condemns as the mere “palliative economics” of millennium development goals, bed-nets and ever more aid.

Chang’s book Bad Samaritans is shorter and more punchily written. He considers how people who want to help developing countries but instead are hurting them, constrain policy options for developing countries. Among these constraints are limits on their ability to regulate inward direct investment, an undue obsession with privatisation, restrictions on access to intellectual property, exaggerated attention to financial stability, excessive emphasis on corruption and lack of democracy and, last but not least, undue stress on the importance of culture.

Unlike much of the writing produced by opponents of contemporary globalisation, these are serious books by serious people. They deserve to be read.

Moreover, I agree with both authors that the goal has to be faster economic growth. I sympathise with the view that the assumptions of conventional economics ignore the evolutionary character of a dynamic economy. I agree, too, that industrialisation is the principal route to growth. I agree, finally, that some policies that now affect developing countries are dangerous: restrictions on easy access to intellectual property are perhaps the most important.

Yet I also have some important disagreements. Reinert, for example, argues that contemporary neo-liberals believe in “factor-price equalisation” - the theory that free trade would make wages and returns to capital the same everywhere. In fact, those taught the theory always understood that the implication is the opposite: it shows how many unlikely conditions need to hold before these results hold true.

What neo-liberals - if I may use that ugly term - did believe is that new opportunities were at last opening up for developing countries to export manufactures and a range of relatively sophisticated services competitively. Indeed, about 80 per cent of exports from developing countries are now manufactures.

Admittedly, this success has recently been dominated by China. But China is as populous as sub-Saharan Africa and Latin America combined. The exports of manufactures would, it was hoped, build up the virtuous circle of growth and industrialisation in which Reinert believes, operating on a world scale from the start. That is, of course, what China is now achieving.

This brings me to my most fundamental disagreement: the lessons of history. Reinert argues: “US industrial policy from 1820 to 1900 is probably the best example for Third World countries to follow today until these countries are ready to benefit from international trade.” From the emphasis Chang puts on 19th-century examples, he agrees.

Yet this example makes no sense for most, if not all, contemporary developing countries. The technological gap between the UK and the US in the 19th century was trivial by comparison with that between, say, the US and Ethiopia today. Even so it took more than half a century for the US to close it.

The US was also a vast continental country, capable of attracting a huge immigrant workforce, much of it educated, and so generate a domestic market large enough to exhaust the economies of scale offered by the technology of the time, while still permitting strong domestic competition. That proved not to be the case even for India, a giant among developing countries. This is, to put it mildly, hardly a model for Ethiopia, let alone Chad.

Few (I would argue, no) contemporary developing countries are big or technologically sophisticated enough to make a decent job of the 19th-century protectionist model. The big successes of recent decades - from Hong Kong to China, South Korea to Ireland, Singapore to Taiwan, Japan to Finland - were not all free traders (though some were). Some also relied heavily on foreign direct investment (China, Ireland and Singapore), while others resisted it (Japan and South Korea).

Yet all used the world economy - and therefore trade - as a central part of their development success. These were, then, cases of outward-looking, infant-industry promotion far more than protection. Indeed, this was precisely what most observant economists learnt from the contrast between the performance of South Korea and India. Apparently similar tools can be used in various ways, with very different results. Both the overall aim and the details of policy make a huge difference.

Moreover, both these books lack a serious discussion of what very late catch-up countries ought to do. Reinert recommends free trade inside Africa or Latin America, with high barriers to trade against outsiders. But this sort of preferential trading agreement among developing countries is a way to transfer income from the most backward to the least backward economies in the region.

Worse, the higher the protection the larger (and so more politically objectionable) is the transfer of income. This is why only those preferential agreements with low external barriers tend to survive. But these do not deliver the greater protection Reinert wants. Higher barriers, even if desirable, would be politically possible only if members also moved towards a single labour market, which is impossible.

What then is left is protection by individual countries. But, to use just one example, Ghana’s national income is about the same as that of a London borough. A policy of import substitution there would be as rational as for Southwark.

Across-the-board import substitution in a country such as Ghana is a recipe for creating a host of small-scale, uncompetitive, rent-extracting monopolies. Obviously, an industrial policy with any hope of success must be both selective and build towards world markets, to obtain scale. What, then, are the chances that often malignantly corrupt, incompetent and ill-informed governments will make sensible choices? Little, I would argue.

South Korea and Taiwan were exceptional cases. The argument that success will follow the overthrow of the neo-liberal consensus and the return of protection is nonsense. But the authors are right that those who argued that free trade alone is the answer were wrong. There are no magic potions for development. Developmental states can work. Many fail. But some may succeed.

Above all, developing countries should be allowed to try, and so learn from their own mistakes. Countries should be warned of the difficulties of following South Korea’s example, but allowed to do so if they wish.

Big and relatively successful developing countries, such as China and India, must participate in and be bound by global rules. They cannot be free riders. But the bulk of developing countries should be allowed to choose their own policies. Almost all will need to attract inward foreign direct investment. A few might still manage without it.

Chang is right that some of the constraints imposed upon developing countries, notably on intellectual property, are unconscionable. Most should enjoy the benefit of open markets from the rich, but be allowed to pursue their own paths, from laissez-faire to its opposite. They will make many mistakes. So be it. That is what sovereignty means.

Martin Wolf is the FT’s chief economics commentator.

How Rich Countries Got Rich...and Why Poor Countries Stay Poorby Erik S. Reinert
Constable & Robinson £25, 320 pages
FT bookshop price: £20

Bad Samaritans: Rich Nations, Poor Policies and the Threat to the Developing World
by Ha-Joon Chang
Random House £18.99, 288 pages
FT bookshop price: £15.19