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Review by Martin Wolf
Published: July 21 2007 01:24 | Last updated: July 21 2007 01:24
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
Vintage, 287 pp., $14.95 (paper)
Berrett-Koehler, 290 pp., $24.95
Yale University Press,260 pp., $16.00 (paper)
Donald Davis was not concerned about imports in the late 1960s, when he started out as CEO of the Stanley Works, the country's leading manufacturer of hand tools. By the early 1980s, the challenge of competing against inexpensive tools made in Taiwan, Korea, and China had swept most of Davis's other concerns aside. His first response was a plan to streamline management, reducing the company's white-collar ranks through attrition. An old-school CEO who had been with Stanley most of his adult life, Davis considered layoffs a last resort. But by the time he stepped down as CEO in 1987, hundreds of factory workers had lost their jobs on his orders.
His successor, Richard Ayers, had the advantage of knowing what he was in for. An industrial engineer by training, Ayers mapped out a long-term strategy that called for layoffs, plant closings, and outsourcing: sledgehammer and crowbar production was moved to Mexico; socket wrench production to Taiwan. But the company also invested in making its domestic operations more efficient, and Ayers took special care to preserve jobs and facilities in New Britain, Connecticut, where Stanley had been a major employer for more than a century. By the mid-1990s, revenues had stabilized, profits were up, and Ayers could reasonably tell himself that his "evolutionary" approach had worked.
Wall Street, however, was not impressed. Securities analysts, comparing the jobs eliminated by Ayers with the layoff numbers at other old-line companies—Scott Paper (11,000), Sears (50,000), General Motors (94,000)— suggested that Stanley's key problem might be leadership rather than imports. At age fifty-five, according to Louis Uchitelle's The Disposable American, Ayers concluded that he did "not have the stomach" for any more job-cutting.
When Ayers retired, Stanley's directors turned to an outsider. The new CEO, John Trani, approached the import question with a clear mind. In his seven years as CEO, he shifted virtually all tool production to East Asia and Mexico, closed forty-three of Stanley's remaining eighty-three plants, cut the payroll from 19,000 to 13,500, and reduced its presence in New Britain to, in Uchitelle's words, "a collection of mostly empty factory buildings and reproachful former workers."
Through the story of the three Stanley CEOs, Uchitelle traces a mental journey taken by a great many top managers over the past few decades, and it would be hard to find a better distillation of the new mindset than his brief account of an interview with Trani in November 2004 (just a few days before he, too, retired, with an $8 million bonus and a $1.3 million-a-year pension). "Layoffs and plant closings," Trani says, "are not such a rare event anymore that one generally makes a big deal out of them." Scarcely mentioning the laid-off workers, he acknowledges no hesitation, no regret—in fact, no alternatives. The story, as he tells it, comes down to the difference between successful leaders, who "look at reality as it exists," and unsuccessful ones, who make the mistake of "hoping for it to change."
Trani came to Stanley from General Electric. In his attitude toward layoffs he resembled his former boss, Jack Welch, who had pushed more than a hundred thousand workers off the GE payroll. Welch's combative style has gone out of fashion lately; in fact, Uchitelle had something to do with that. A longtime reporter for The New York Times, he was largely responsible for "The Downsizing of America," an attention-getting series of Times articles on the mass layoffs of the early and mid-1990s. Those articles helped inspire a backlash. Few CEOs, questioned now about layoffs, would permit themselves to boast, as Trani did, of "taking out" workers—as in, "We took out 23 percent of the people" at Best Access, one of the companies Stanley acquired. In his actions if not his affect, however, Trani speaks for a school of management that remains ascendant. He drove Stanley down the path of a great and continuing migration—away from the postwar view of the corporation, whose success rested on a secure workforce and a strong local economy, toward what Greg LeRoy, in The Great American Jobs Scam, calls the "rootless corporation," which defines success by financial measures alone, making it possible to "save" a company by destroying much of what it was.
"The Downsizing of America" came out in March 1996—not the best moment, in hindsight, for a 40,000-word lament on the theme of growing economic insecurity. Inflation and unemployment were falling. The stock market was rising. In Silicon Valley, Washington, D.C., and other centers of optimism, influential commentators were turning out books and articles intended to explain why, unlike previous good times, these could be expected to last virtually forever. Even many of Uchitelle's journalistic peers thought the Times had been too intent on telling an old, downbeat story to notice the new story of America's astonishing resurgence. In The Disposable American, Uchitelle makes it plain that he is writing about a long-term change—one that neither began nor ended in the 1990s, and one that transcends even the wrenching adjustment of an economy moving from manufacturing toward information and service. "The permanent separation of people from their jobs, abruptly and against their wishes," he asserts, has become "standard management practice."
It's a fair statement. Over the past quarter-century, the victims (and potential victims) of layoffs have come to include managers, professionals, and workers in such growth industries as banking and telecommunications. Hardly any company is too successful nowadays to consider a large-scale cutback in jobs. Early last year, Intel was showering cash on its shareholders in the form of dividends and share buybacks after reporting record 2005 profits of $12.1 billion (partly thanks to a custom-made tax break known as the American Jobs Creation Act). None of that kept CEO Paul Otellini from announcing, several months ago, plans to eliminate 10,500 jobs—10 percent of Intel's total—in order to become a "more agile and efficient" company.
The modern layoff is frequently a hidden layoff, entered in the personnel records as a buyout, an early retirement, or the severing of relations with someone deemed a contractor rather than an employee. Procter and Gamble has unloaded some 20,000 employees since 1993, Uchitelle says, while scarcely registering a blip on the Bureau of Labor Statistics' count of involuntarily displaced workers. With all their omissions, however, even the official data suggest a sharp decline in job security. In 1978, a middle-aged American male could expect to remain with the same employer for eleven years, according to BLS figures. Now it's 7.5 years. Over that same period, the average duration of unemployment has lengthened from thirteen to almost twenty weeks. The long-term economic damage that people suffer has grown, too. If you factor in the impact of foregone pay raises in the old job and lower wages in the new one, according to the Princeton University economist Henry S. Farber, the typical laid-off college graduate now suffers a 30 percent loss of income, up from 10 percent in the early 1980s.
Uchitelle sees Jack Welch as a pivotal figure. Before he came along, a CEO was expected to manage the existing enterprise. Welch enlarged the job description: lifting a page from the corporate raider's playbook, he promised to manage the shareholders' capital as well, by maintaining a steady lookout for more profitable places to put it. There is a case to be made for his approach. It may be better for a company—better even for its workers, and for the economy—to have layoffs spread over time rather than deferred until a moment of crisis. What today's managers like to call a "flexible workforce" has arguably helped American corporations seize opportunities they would have missed if the US had the kind of employment protection that exists in, say, France. Uchitelle is not dogmatic on these points. He simply wants it acknowledged that we are going through something more than a few bumps on the road to "a new equilibrium at the high end of innovation and production." Permanent disequilibrium, he argues, would be a more accurate picture of where we're headed.
Uchitelle's harsh view of the new workplace order sets him at odds not only with corporate leaders but with economic advisers to the last four presidents. Layoffs, he reminds us, were a hot issue in the 1992 presidential campaign. Although Ross Perot's "great sucking sound" is better remembered, Bill Clinton also came down hard on companies that closed factories where Americans made "a decent standard of living" while opening "sweatshops to pay starvation wages in another country." Candidate Clinton wanted corporations to spend at least 1.5 percent of their earnings on "continued education and training." (Companies that made such a commitment were less likely to let employees go, research showed.)
But once he became President Clinton—and as the budget deficit moved to the center of his thinking—continued education and training got a new name and spin. Now the Clintonites began to speak of "lifetime learning," which was more exhortation than policy and directed mainly at employees, not employers. Americans who had lost their jobs or who sensed their skills becoming outmoded were told that they could take charge of their careers, go back to school, and emerge retooled and "reempowered."
While the policy experts may have believed some of this, it bore little relation to the experience of laid-off workers around the country, according to Uchitelle. There were many retraining programs, but scarcely any actual retraining, he says, largely because few appropriate jobs were waiting to be filled even in the surging economy of the late 1990s. The first order of business in many retraining programs was to defuse anger and lower expectations—a process known in the trade, he reports, as "housebreaking." In The Disposable American, Uchitelle describes an Indianapolis program created largely for United Airlines mechanics who lost their jobs when the company bailed out of an advanced maintenance shop for narrow-body jets. The mechanics show up looking for tips about companies that might be hiring or new careers beckoning. What they receive, mostly, is airy wisdom about attitude, interpersonal relations, and the inner self; at least one classful gets free copies of the global best seller Who Moved My Cheese?, which warns those in economic distress not to be led into indignation or dismay by the overly complex human brain. Far better, the book suggests, to adopt the existential pragmatism of mice: No cheese in that corner? Check out this corner.
Uchitelle is a fine reporter. In The Disposable American, he follows several of United's mechanics as they head out into the world of the downsized. After twenty-five years in the airline industry, Ben Nunnally, a specialist in delicate wingskin repairs, becomes a window-washer. Erin Breen goes back to college, gets an engineering degree, and winds up as a janitor in the Indianapolis public schools. Tim Dewey, who has been through one layoff already, resolves to go into business for himself rather than run the risk of a third. With his wife and children, he moves to the Florida panhandle to run a water taxi service, impulsively charging the $54,000 purchase price on three credit cards. He spends five months "hawking boat rides to passing tourists," as Uchitelle puts it, before the business goes bust and the family goes bankrupt. A few hard knocks later, he grabs a chance to return to his old line of work for $17 an hour (half his United pay) as an employee of one of the non-union subcontractors he and his former coworkers had scorned.
As well-paid blue-collar workers, union members, and, for the most part, males without college degrees, United's mechanics were out on a limb. But Uchitelle finds much the same pattern of downward mobility among women, white-collar workers, professionals, and executives. The "vast majority of laid-off workers never get back to where they were," he writes. Moreover, he finds, being laid off is a "fundamental in-the-bones blow to ego and self-worth." People are "cut loose from their moorings and rarely achieve in their next jobs a new and satisfactory sense of themselves."
"The Downsizing of America" was criticized for treating the postwar era as the natural order of the US economy. The relatively secure employment of the 1950s, 1960s, and 1970s was historically exceptional, Uchitelle acknowledges, and it was secure mainly for Americans fortunate enough to land full-time jobs with major corporations or professional firms. Nevertheless, he regards the ideal as one to cherish and build on. To Uchitelle, the labor practices that others now celebrate as bold and unprecedented look a lot like those of the nineteenth-century robber barons. We should hold today's corporate leaders to a higher standard, he argues, because they know better —or, at any rate, because more is now known about what stable employment means to mental and physical health.
Resentment and self-castigation are recurring themes in The Disposable American. Persuaded to accept a buyout package after twenty-five years at Procter and Gamble, Elizabeth Nash seems unable to find any source of self-confidence other than the scraps of contract work that her former employer throws her way. "It vindicates that I have value," she says. Some people, of course, have more of what it takes to hop from job to job and stay afloat emotionally as well as financially. Among the United mechanics, Uchitelle cites Craig Imperio, who after moving to Georgia and taking a job with Pratt & Whitney, the engine maker, networks around the clock, plays golf with his superiors, and earns a promotion to quality engineer. (Even then, his $50,000-a-year salary remains about $20,000 short of what he made in Indianapolis as a mechanic.) Imperio's brand of resilience could become more widespread as time passes and freelancing becomes an increasingly common way of life. But in the here and now, Uchitelle reasonably insists, lifetime learning is a delusion—and a cruel one, providing cover for layoff-prone companies and setting unrealistically high expectations for layoff victims, who then blame themselves when their experiences fall short.
Layoffs can be unavoidable, Uchitelle acknowledges. His quarrel is with corporate leaders who do not seek to avoid them—and with those, in the corporate world and elsewhere, who count the cost purely in material terms. In conversations with layoff victims, Uchitelle emphasizes the systemic nature of the problem. People tend to "agree perfunctorily," he writes, before going "right back to describing their own devaluing experiences, and why it was somehow their fault or their particular bad luck." Even when thousands of jobs are eliminated at once, few can depersonalize the experience.
Uchitelle resists the temptation to spell out an anti-layoff program. His caution arises partly out of a temperamental inclination to let his reporting speak for itself, and partly out of a bleak assessment of the political world's readiness to entertain the measures he would be tempted to propose. His policy recommendations really boil down to one: when we think about layoffs, we should consider the full range of consequences, and, above all, the emotional and psychological ones, which are, he says, "deep, consistent, and ignored in the political debate."
Ignored and, as he shows, compounded—and not just by callous rhetoric. United could abandon its Indianapolis center with impunity, turning its back on a spectacularly efficient facility, because it would not have to continue making mortgage and maintenance payments of $37.5 million a year. That responsibility passed to the taxpayers of Indiana and Indianapolis under the terms of a 1991 agreement in which United had received the land and $320 million in cash—more than half the facility's total cost. The city and state had done this in the name of "economic development," a seedy business that is briefly discussed in The Disposable American and thoroughly dissected in Greg LeRoy's The Great American Jobs Scam.
The economic development story goes back to the 1930s when a group of southern governors set out to capture some of the manufacturing business of the North by offering cheap capital on top of the traditional lure of cheap labor. In more recent decades, the practice has gone national, and the private sector has taken firm control. To work their will with job-hungry public officials, corporations now routinely deploy teams of lobbyists, site consultants, and other hirelings. The formula rarely fails: drop word of a planned expansion or relocation; create the illusion of a wide-ranging search; overstate the company's own investment and the number of jobs involved; hire fancy experts to talk about the economic ripple effects; walk off with huge subsidies and tax concessions.
Among the southeastern states, North Carolina once had a reputation for refusing to play the economic development game; its relatively prosperous economy was founded on infrastructure, education, and public investment. Nevertheless, the state was easy prey for Dell Computer when, in 1994, the company dangled the prospect of a factory in the Piedmont Triad area. So anxious was the administration of Governor Mike Easley to land the prize that state officials became stooges in Dell's efforts to pit one North Carolina community against another. The company eventually wangled $37 million in tax incentives out of Winston-Salem and Forsythe County, on top of a $267 million subsidy from the state; the total far exceeded the cost of the plant property, and construction combined. After the deal was made, leaked documents revealed a negotiating process that resembled an organized-crime shakedown. "[I'm] not wowed here," Dell's chief emissary complained at one point, adding that a twenty-year income-tax exemption was "my line in the sand." A few weeks later, he was threatening to pull out "unless I can get that income tax resolved."
Was Dell really prepared to go elsewhere? Most companies, LeRoy shows, enter the process with their minds made up. Site selection experts, when they are not off helping companies stage their elaborate "searches," acknowledge that business fundamentals, such as access to key customers and suppliers, generally carry more weight than subsidies do. But while the game may have little to do with where companies decide to locate, it has everything to do with the taxes they pay. LeRoy puts the national cost of these deals at $50 billion a year; they go a long way, he says, toward explaining a sharp decline in corporate taxes as a share of state revenues— from 9.7 percent in 1980 to about 5 percent today. The falloff in some states has been even more precipitous. Corporations paid a third of all taxes in Arkansas as recently as the 1970s; by 2002, the figure was 2 percent.
Beyond the injury to city, county, and state treasuries—and the services they fund—the economic development process "demeans" and "degrades" public officials, LeRoy writes. He means not only the officials who participate, but also those who are cut out of the process—such as the school board members who get "no say in property tax abatements that will corrode their budget" or the revenue director whose "sober advice is upstaged by the frothy projections of an economist rented by the Chamber of Commerce." The rules are designed to bestow the biggest rewards on the companies least likely to show any true attachment to workers or communities. New businesses are subsidized at the expense of existing ones. Big-box retailers gain while independent merchants lose. Commercial and social life is pulled away from Main Streets and downtowns toward malls and strips. Local and state leaders have been known to grovel before telemarketing firms, gambling casinos, and the operators of private prisons.
LeRoy is an activist. His organization, Good Jobs First, has worked with unions, environmentalists, and citizen watchdog groups to resist the giveaways. But realism often compels them to aim for modest goals, such as job-quality guarantees with "clawback" provisions calling for the recovery of taxpayer funds if a company fails to deliver. LeRoy foresees a long campaign of organizing and consciousness-raising before it is even worth talking about more sweeping reforms.
That is about how Uchitelle sizes things up, too, and it is a conclusion shared by John C. Bogle, author of The Battle for the Soul of Capitalism. Bogle has been an investor and innovator in financial management for close to fifty years. He was railing against the chicanery and high fees of the mutual fund industry before Eliot Spitzer had been to law school. Vanguard Management, which Bogle founded in 1972, became the biggest company in the field by keeping commissions low and transactions infrequent—and advertising it. Bogle went on to invent the index fund; while innumerable others claimed the ability to beat the market, he merely offered to approximate the market year after year. That proved to be a better deal for most clients, as he had theorized.
After a heart transplant ten years ago, Bogle retired to a life of full-time hell-raising. The Battle for the Soul of Capitalism is his response to the recent corporate scandals—Enron, MCI WorldCom, and Tyco among them. Not being a prosecutor, though, Bogle fails to see much difference between the acts that sent Jeffrey Skilling, Bernard Ebbers, and Dennis Kozlowski to prison and a host of more common and accepted forms of executive self-enrichment—for example by playing around with employee pension funds in order to inflate company profits and bonuses. At Verizon, Bogle notes, bonuses for the year 2001 were based on profits of $389 million, which rested, in turn, on a supposed $1.8 billion in pension-fund gains.
By the time the company reported those numbers, however, the stock market bubble had burst, making it clear that Verizon's pension funds had actually lost money that year; as it turned out, they had lost a staggering $3.1 billion, obliterating all the claimed profit and then some. Verizon, moreover, was only one of 1,570 companies—"an enormous part of the giant barrel of corporate capitalism"—required to restate corporate earnings for one or more of the years 2000–2004; and "I have not heard of a single instance," Bogle adds, "in which...bonuses have been recalculated and the overpayments returned to the stockholders."
Since the publication of Bogle's book, executives and directors of more than 250 companies have come under suspicion of profiting from fraudulently timed stock option grants. The whistle was blown by Erik Lie, a professor of finance at the University of Iowa. Through statistical analysis, he established a pattern that could not be explained by chance, thus giving new meaning to the term "probable cause." His 2005 paper "On the Timing of CEO Stock Option Awards," prompted investigations by The Wall Street Journal and eventually the Justice Department and the Securities and Exchange Commission; their objective, however, was to prove what Bogle might consider a minor point, for, in his mind, stock options were a scam to begin with. In the overheated market of the late 1990s, he shows, options—backdated or not—brought windfall gains to virtually all executives, including some who were leading their companies to ruin while concealing the evidence from (among others) the eventual purchasers of their stock.
Viewing these evils through a shareholder-rights lens, Bogle attributes them to a triumph of "managers' capitalism" over "owners' capitalism." But while he offers plenty of evidence to justify his low opinion of "our imperial chief executives" with "their jet planes...their pension plans, their club dues, their Park Avenue apartments," his argument ranges well beyond the territory suggested by the manager/ owner framework. In almost all their recent misdeeds, he demonstrates, self-serving executives have been abetted by self-serving directors, securities analysts, auditors, lenders, investment bankers, and others. And while shareholders have suffered in case after case, many could be said to have brought their losses on themselves by being just as fixated on market trends—and just as oblivious to business realities—as anyone else in the equation. To Bogle's dismay, few of today's shareholders have much appetite for the rights he asserts on their behalf (over the election and removal of corporate directors, for example); most seem content with the only right that today's executives would willingly grant them —the so-called "right of exit," which gets exercised nowadays with promiscuous frequency, in Bogle's judgment. Twenty years ago, the annual rate of share turnover was about 25 percent; by 2004, he says, it was 150 percent. That kind of manic buying and selling, Bogle convincingly argues, generates wildly irrational levels of market volatility and endless opportunities for insiders to play the market for short-term gain.
Institutional investors now control approximately two thirds of all publicly traded stock in the US. Bogle has for years been trying to mobilize these giants into a new community of owners, capable of restraining corporate avarice and opportunism. Except for a few unions and public pension funds, he has found few takers. Not a single "mutual fund firm, pension manager, bank, or insurance company," he writes, "has ever sponsored a proxy resolution that was opposed by the board of directors."
"Managers' capitalism," then, is Bogle's shorthand for a system of rules, practices, and standards of behavior designed to bring quick and sure rewards to a few at long-term cost to many. Executives are not the only suspects here, and shareholders are not the only victims.[*] Often, Bogle observes, workers and shareholders get defrauded together. That is obviously true when managers cook the books; it can also be true when they cook up dramatic "restructuring" plans entailing mass layoffs. As Uchitelle points out, these plans often generate smaller-than-anticipated savings and bigger-than-anticipated costs—in morale and trust, especially. The point of many recent layoffs has been to free up capital for the repayment of debt incurred in mergers and acquisitions; those deals have a notably bad track record of their own. To understand why so many mergers continue to occur—$3.79 trillion worth in 2006—Bogle suggests that we consider the consequences for the executives who arrange them: not just the bonuses and the increased pay and power, but the ability to "take huge writeoffs—largely ignored by market participants —and create 'cookie jar' reserves"—paper assets created through mergers —"available at the beck and call of management to inflate future earnings on demand."
From their different vantage points, Uchitelle, LeRoy, and Bogle are writing about the breakdown of what some have called the postwar social contract, and about the rise of a new "money power" more daunting, in some ways, than that of the late 1800s and early 1900s. To gain their political ends, the robber barons and monopolists of the Gilded Age were content with corrupting officials and buying elections. Their modern counterparts have taken things a big step further, erecting a loose network of think tanks, corporate spokespeople, and friendly press commentators to shape the way Americans think about the economy. Much as corporate marketing directs our aspirations disproportionately toward commercial goods and services, the new communications apparatus wants us to believe that our economic wellbeing depends almost entirely on the so-called free market—a euphemism for letting the private sector set its own rules. The success of this great effort can be measured in the remarkable fact that, despite the corporate scandals and the social damage that these authors explore; despite three decades of deregulation and privatization and tax-and-benefit-slashing with, as the clearest single result, the relentless rise of economic inequality to levels so extreme that since 2001 "the economy" has racked up five straight years of impressive growth without producing any measurable income gains for most Americans—even now, discussions of solutions or alternatives can be stopped almost dead in their tracks by mention of the word government.
The rules, procedures, and understandings of the postwar social contract were designed for a world in which practical forces kept businesses anchored in geographical place, reinforcing the sense of obligation that many corporate leaders felt toward workers and communities. That being said, those arrangements were spectacularly successful in creating a broad, accessible, and secure middle class, and in bringing unprecedented transparency and fairness to the hazardous relations between individuals (whether customers, workers, neighbors, or shareholders) and corporations.
In addition to being good for the society at large, the postwar social contract turned out to be very good for American business. (No matter what they may say about the role of government, today's corporate chieftains and financiers—the scalawags and the rest—owe their fortunes in no small part to the legacy of trust in the financial markets created by the securities regulations of the New Deal era and onward.) Economically and in other ways, then, the future will depend on our ability to find more durable means toward the same ends; and while none of these books lays out a blueprint, taken together, they suggest a few operating principles.
The economic policy of the United States has in recent memory been directed almost entirely toward the goal of growth, and treated, accordingly, as the preserve of experts and corporate and financial insiders. Policy initiated outside this preserve has been limited, for the most part, to a set of narrowly defined issues (such as health care, retirement security, pollution, etc.) considered fit for democratic deliberation. This compartmentalized approach, we now know, is guaranteed to be an exercise in damage control, requiring obsessive vigilance and leaving a trail of frustration. Instead of trying to prod or seduce companies into doing what they cannot justify from a profit standpoint, we should be trying to bring everyday corporate thinking into rough alignment with the goals of society as a whole.
That will mean, as Bogle says, finding efficient ways to check the speculative excesses of today's financial markets and cut down on the tremendous amount of energy and human as well as economic resources that go into the pursuit of what he calls "aggressive financial targets" at the expense of "character, integrity, enthusiasm, conviction, and passion." It will also mean (in exchange for the privileges and rewards of incorporation and access to regulated financial markets) coming up with mechanisms to recognize the stakeholder status of longtime employees and local communities, and— as we are just beginning to do on environmental issues—bringing some of the intangible concerns of work life and community and social wealth onto the corporate balance sheet.
Devising workable policies in service of these aims; forging new approaches into a coherent and convincing program; looking for strategic ways to loosen the hold that the free-market mythology still has on us—that is the great challenge of this fluid moment in our national story. It is a project filled with difficulties, and, as yet, not so obvious potential. The injuries examined by these books are felt, to one degree or another, by most Americans. A countermovement might eventually be as broad as the harm, reaching across some of the lines that have defined American politics, unconstructively, since the 1970s; such a movement could, in time, draw support from inside as well as outside the business world, since, as Bogle so plainly shows, many corporate decisions reflexively attributed by supporters and critics alike to a "bottom-line mentality" in fact serve what he calls "the wrong bottom line"—one that not only shortchanges investors but tramples on many of the impulses that people naturally bring to the work of creating and building businesses.
Most Americans are troubled by the culture of dealmaking and financial engineering and insider self-enrichment that Bogle deplores; by the callous treatment of workers and work life that Uchitelle describes; by the erosion of communities and community institutions that LeRoy examines. Not very far below the political surface, most of us feel some version of the same vexed ambivalence toward corporate America—dazzled by the conveniences and comforts it delivers, yet resentful of the tradeoffs that it continually demands; few Americans would be anything but grateful if our corporations and financial institutions could develop some respect for our non-material and non-individualistic selves. It is hard to imagine such a fundamental transformation of these giant institutions. It is even harder to imagine a better world in which they remain essentially what they are.
[*] In fairness to managers—the honest and dutiful ones, that is—long-term thinking becomes a tricky business when you're operating in a stock market so focused on the short term that a penny-a-share shortfall in earnings can whack a few hundred million dollars off your company's market value between one day and the next.
Kornai's Choice
http://www.economicprincipals.com/issues/07.05.20.html
One of the most striking features of the years after the collapse of communism has been the general lack of interest on the part of Americans, at least, in what the former communists have to say about their lives, their experiences, their societies. We make exceptions, of course, for defectors, those who wholeheartedly adopted our point of view: most conspicuously, Alexander Solzhenitsyn (at least for a time). Otherwise, without the full confession of error, it is assumed that the experience they accumulated in all those years of living under central planning is of very little value. No matter who they are, we figure, they only need to take lessons from us.
There is an obvious exception to this rule at the moment, of course. It is "The Lives of Others," a German drama about the corruption of everyday life by the Stasi secret police in the DDR, the old East Germany. The film won an Academy Award earlier this year (although even here a Hollywood remake is being discussed.) Another, considerably more illuminating testimony is to be found in Janos Kornai's newly-published memoirs, By Force of Thought: Irregular Memoirs of an Intellectual Journey.
Kornai is a famous Hungarian dissenter who, having been hit by the Marxist meatball as a youth (the phrase is that of R. Crumb, coined to describe the many similar conversion experiences among the young in the West of the 1960s), who then broke with the Communist party, who stayed home after the 1956 Hungarian revolt was crushed by the Russians, taught himself economics, and managed to build a formidable reputation among economists in the West as an expert on the mechanics of socialist systems.
Kornai embraced communism after the Russian Army chased the Nazis out of his country in 1945. The Germans had murdered his lawyer father and older brother the year before. Thus cruelly tumbled from a comfortable haute bourgeois childhood, the 17-year-old changed his name from Kornhauser (which sounded German and Jewish); and traded what had been an "open and flexible" view of the world for a mechanical Spenglerian mindset, in which "the fresh energy and raw barbaric force of the communist movement heralded the coming of a new age."
He joined the Communist Party, read Das Kapital with a friend, annotating every page, and, in due course, got a job on what, under the communists, rapidly became the country's main newspaper. Of Marx, he writes, "The young man who at 14 to 16 had feverishly sought enlightenment in a hundred types of reading now found it radiating like sunshine from those thousand pages."
The newspaper education was a good one. Kornai rose swiftly, vaulting ahead of more experienced men (two main criteria governed advancement, he says, Party loyalty and ability). He worked hard, wrote fluently, convinced that he had the inside track on history. The death of Stalin was the crucial watershed; almost immediately, Russia's new rulers recognized the chaos that Stalinist directives had produced, called their Hungarian franchisees to Moscow, and loosened up a bit. "I was not among those who had suffered in the period before June, and I did not feel the time had come to breathe a sigh of relief," Kornai writes of the "New Course" that Hungarian communism sought to adopt after Stalin's death. But many others did, and in the course of the next two years, Kornai paid attention to them.
He met an old editor of his paper who had been imprisoned during a purge in 1951 and beaten at the direction of a friend with whom Kornai had joined the Party; after that, he started paying attention to the number of political prisoners in his little country (40,000 in a nation of ten million in 1953).He read the British journalist Isaac Deutscher's biography of Stalin, and various Yugoslav writers on economic topics.(Tito, having been thrown out of the international Communist party by Stalin, had already begun to decentralize.) He defied the party boss who told him to attribute electricity shortages and service cuts to "objective circumstances" rather than poor state planning.
And then, in October 1954, he joined a memorable two-day meeting of Party members at his newspaper at which a couple of dozen staffers endorsed the "New Course" and openly criticized the regime. Inevitably, word of the newspaper rebellion leaked out. Other organizations followed suit. Self-determination was in the air.
Alas, it's hard to loosen by degrees. The Communist Hungarian government reacted. The first three rebellious newsmen were fired in December; Kornai and several others (including his wife) were let go a few months later, after a humiliating "self-criticism."
"My mental state in those months was one of disillusionment, bitterness and horror," he writes in By Force of Thought. "My earlier blind faith was dispelled once and for all. My eyes had been opened wide to what was happening. Stomach-turning lies, infamous slanders, hypocritical arguments, sly use of real and false reports compiled by informers, threats and blackmail, and mental torture and humiliation of opponents were among the 'normal' weapons used in Communist factional fighting. .... I wanted to get as far as I could from this pollution."
Already his first newspaper editor, his old friend Miklós Gimes, had told him, "Politics is not for you. You would do better if you became a researcher; it would suit you better." Kornai earlier had wangled admission to Budapest's Institute of Economics as a result. Now he took advantage of it, becoming a full-time student. From the start, his work as a scholar displayed a strong empirical bent: countless interviews with managers in light industry. What were the problems with which they dealt? In little more than a year, he had written a dissertation: Overcentralization in Economic Administration. It contained none of the usual Marxist jargon, just a steady parade of facts about bottlenecks, plan bargaining, mismatched incentives of all sorts. Within the Institute, it was well received -- enough to win Kornai an appointment as a research fellow, with a salary and a bonus to boot.
But first there would be a public defense. It was held September 24, 1956 -- barely a month before the outbreak of the Hungarian revolt against Russian rule. Word of the event had got around town, naturally; some two hundred persons showed up for what the cognoscenti described as "a choice political morsel." Newspapers carried news of the highly favorable debate. No wonder, then, that Kornai was enlisted a month later to write the economic section of the speech Imre Nagy would give as new prime minister. That night Hungarian security police shot unarmed demonstrators at the state radio station. The next morning he started to work on a draft.
It was the last time Kornai would dabble in politics. Ten days later, Soviet tanks rolled into Budapest. His friend and former editor Gimes, having started an illicit newspaper (Kornai declined to participate) was hunted down by police (after hiding for a few days in Kornai's mother's apartment) and later hanged. So was prime minister Nagy. Kornai was interrogated repeatedly, though never tortured. He did not turn on his friend, though he buckled in small degrees in other situations. (The passages in which he reconstructs his calculus in these matters are among the most moving in the book.)
Nor did he take the opportunity to leave Hungary for the West, as did some 200,000 to 250,000 others, including his closest friend. Instead, between times, he studied his German edition of Paul Samuelson's Foundation of Economic Analysis. As Soviet tanks shut down the city, he had decided both to remain in Hungary, and to become part of the economics profession of the West, even while declining to emigrate.
A year later, towards the end of 1957, blackballed at Budapest's Karl Marx University of Economics, he was quietly dismissed from his job at the Institute.
That was the nadir. Starting in 1958, Kornai found jobs that permitted him to carry on his work, first with the Light Industry Planning Board, then with the Textile Industry Research Institute. He remarried, the economist Zsuzsa Dániel, whom he met while he worked on mathematical models at the National Planning Office. On Oxford economist John Hicks' recommendation, Overcentralization was translated into English. It appeared in 1959, to glowing reviews. Who had the nerve to write so candidly about the Communist world from the inside?
As early as 1958, London School of Economics professor Ely Devons had invited him to teach there. Only in 1962 was he permitted to lecture in East Germany, Poland and Czechoslovakia. Edmund Malinvaud succeeded in winning him permission to travel to the West -- to England -- in 1963, where he met Tjalling Koopmans, who would become his long-time friend. Kenneth Arrow invited him to Stanford in 1968, and thereafter he was relatively free to work abroad, in Cambridge, at Yale, Princeton, Stockholm University, the Institute for Advanced Study in Princeton. But it was not until 1986, when he accepted an offer from Harvard University that permitted him to split his time between Cambridge and Budapest, that he finally became a full professor at a university.
Until then, Kornai had had relatively few doctoral students of his own, the mathematical frontier having steadily moved on since he learned linear programming from Samuelson, Robert Solow and Robert Dorfman's text. But at last there was time to excavate an idea that had been implicit in his work for years -- the "soft budget constraint," meaning the socialist practice of routinely plowing resources into failing enterprises even when they routinely exceeded their budgets, year after year (as opposed to the "hard" constraint of bankruptcy.) Kornai first employed the phrase in 1979, but not until he acquired a Swedish co-author (and not long thereafter, a son-in-law), Jörgen Weibull, did the pair undertake mathematical modeling of what by then they were calling "paternalism." With Ágnes Matits, a young Hungarian collaborator, Kornai then sought to empirically document the phenomenon in socialist economies.
Meanwhile, Richard Quandt at Princeton had begun formal modeling of the propensity to bail out failing enterprises -- what he called "the Kornai effect." Soon Eric Maskin and Mathais Dewatripont at Harvard had cast the familiar phenomenon of "too big to fail" in game-theoretic terms. Yet when Kornai sent a literary summary to the American Economic Review in 1984, it was rejected.
Kyklos, an international journal noted for publishing original approaches, immediately accepted it without revision, and at last Kornai had a famous paper, perhaps the most frequently cited of all his papers.
It is sometimes said that Kornai's reputation rests on four books. Overcentralization (1959), Anti-Equilibrium (1971), The Economics of Shortage (1980), and The Socialist System (1992). It is held against him that he failed to foresee the collapse. "Kornai's tragedy is that by the time he finished explaining why the socialist system did not work, it had disappeared," wrote Robert Skidelsky in the current New York Review of Books. In fact, The Road to a Free Economy (1990) is in some ways Kornai's best and most important book, and the real tragedy is that the gradualist approach to privatization that he advocated in it was almost universally ignored in Eastern Europe and Russia.
The patching and darning of socialism had to end, wrote Kornai. There could be no more wistful longing for "a third way." Socialist economies would have to change completely. But the accelerated privatization schemes of Western reformers were misguided, he argued. Vouchers, mutual fund distributions and other "big-bang" schemes conveyed the impression "that Daddy state has unexpectedly passed away and left us, his orphaned children, to distribute the patrimony equitably.... The point is not to hand out the property, but rather to place it into the hands of a really better owner."
In the end, Hungary preferred the slow sequence of events recommended by the book, while Russia tried to convert to democracy and capitalism overnight. The rest is history.
Kornai was in Cambridge, Mass., last week in connection with the publication of his book. At one point, he gave a seminar to a circle of old friends. Here is how his old friend (and fellow Hungarian), Harvard economist Francis Bator concluded his introductory remarks:
"Some might think a blemish Kornai's choice, as he puts it in the book, 'not [to] indulge in heroic, illegal forms of struggle against the communist system...[instead] to contribute to renewal through...scholarly activity.' Not so. If you want your bold ideas to affect the real world, you have sometimes to restrain your impulse to be bold. It is the courageous tradeoff of a quintessentially autonomous man."
http://www.paecon.net/PAEReview/development/Chang15.htm
post-autistic economics review
Issue no. 15, 1 September 2002
article 3
Kicking Away the Ladder:
How the Economic and Intellectual Histories of Capitalism Have Been
Re-Written to
Justify Neo-Liberal Capitalism
Ha-Joon Chang (Cambridge University, UK)
© Copyright 2002 Ha-Joon Chang
There is currently great pressure on developing countries to adopt a set of “good policies” and “good institutions” – such as liberalisation of trade and investment and strong patent law – to foster their economic development.
When some developing countries show reluctance in adopting them, the proponents of this recipe often find it difficult to understand these countries’ stupidity in not accepting such a tried and tested recipe for development. After all, they argue, these are the policies and the institutions that the developed countries had used in the past in order to become rich. Their belief in their own recommendation is so absolute that in
their view it has to be imposed on the developing countries through strong bilateral and multilateral external pressures, even when these countries don’t want them.
Naturally, there have been heated debates on whether these recommended policies and institutions are appropriate for developing countries. However, curiously, even many of those who are sceptical of the applicability of these policies and institutions to the developing countries take it for granted that these were the policies and the institutions that were used by the developed countries when they themselves were developing countries.
Contrary to the conventional wisdom, the historical fact is that the rich countries did not develop on the basis of the policies and the institutions that they now recommend to, and often force upon, the developing countries. Unfortunately, this fact is little known these days because the “official historians” of capitalism have been very successful in re-writing its history.
Almost all of today’s rich countries used tariff protection and subsidies to develop their industries. Interestingly, Britain and the USA, the two countries that are supposed to have reached the summit of the world economy through their free-market, free-trade policy, are actually the ones that had most aggressively used protection and subsidies.
Contrary to the popular myth, Britain had been an aggressive user, and in certain areas a pioneer, of activist policies intended to promote its industries. Such policies, although limited in scope, date back from the
14th century (Edward III) and the 15th century (Henry VII) in relation to woollen manufacturing, the leading industry of the time. England then was an exporter of raw wool to the Low Countries, and Henry VII for example tried to change this by taxing raw wool exports and poaching skilled workers from the Low Countries.
Particularly between the trade policy reform of its first Prime Minister Robert Walpole in 1721 and its adoption of free trade around 1860, Britain used very dirigiste trade and industrial policies, involving measures very
similar to what countries like Japan and Korea later used in order to develop their industries. During this period, it protected its industries a lot more heavily than did France, the supposed dirigiste counterpoint to its
free-trade, free-market system. Given this history, argued Friedrich List, the leading German economist of the mid-19th century, Britain preaching free trade to less advanced countries like Germany and the USA was like someone trying to “kick away the ladder” with which he had climbed to the top.
List was not alone in seeing the matter in this light. Many American thinkers shared this view. Indeed, it was American thinkers like Alexander Hamilton, the first Treasury Secretary of the USA, and the (now-forgotten)
economist Daniel Raymond, who first systematically developed the infant industry argument. Indeed, List, who is commonly known as the father of the infant industry argument, in fact started out as a free-trader (he was an ardent supporter of German customs union – Zollverein) and learnt about this argument during his exile in the USA during the 1820s
Little known today, the intellectual interaction between the USA and Germany during the 19th century did not end there. The German Historical School – represented by people like Wilhelm Roscher, Bruno Hildebrand, Karl Knies, Gustav Schmoller, and Werner Sombart – attracted a lot of American economists in the late 19th century. The patron saint of American Neoclassical economics, John Bates Clark, in whose name the most prestigious award for young (under 40) American economists is given today, went to Germany in 1873 and studied the German Historical School under Roscher and Knies, although he gradually drifted away from it. Richard Ely, one of the leading American economists of the time, also studied under Knies and
influenced the American Institutionalist School through his disciple, John Commons. Ely was one of the founding fathers of the American Economic Association; to this day, the biggest public lecture at the Association’s annual meeting is given in Ely’s name, although few of the present AEA members would know who he was.
Between the Civil War and the Second World War, the USA was literally the most heavily protected economy in the world. In this context, it is important to note that the American Civil War was fought on the issue of
tariff as much as, if not more, on the issue of slavery. Of the two major issues that divided the North and the South, the South had actually more to fear on the tariff front than on the slavery front. Abraham Lincoln was a
well-known protectionist who cut his political teeth under the charismatic politician Henry Clay in the Whig Party, which advocated the “American System” based on infrastructural development and protectionism (thus named on recognition that free trade is for the British interest). One of Lincoln’s top economic advisors was the famous protectionist economist, Henry Carey, who once was described as “the only American economist of importance” by Marx and Engels in the early 1850s but has now been almost completely air-brushed out of the history of American economic thought. On the other hand, Lincoln thought that African Americans were racially inferior and that slave emancipation was an idealistic proposal with no prospect of immediate implementation – he is said to have emancipated the slaves in 1862 as a strategic move to win the War rather than out of some moral conviction.
In protecting their industries, the Americans were going against the advice of such prominent economists as Adam Smith and Jean Baptiste Say, who saw the country’s future in agriculture. However, the Americans knew exactly what the game was. They knew that Britain reached the top through protection
and subsidies and therefore that they needed to do the same if they were going to get anywhere. Criticising the British preaching of free trade to his country, Ulysses Grant, the Civil War hero and the US President between 1868-1876, retorted that “within 200 years, when America has gotten out of protection all that it can offer, it too will adopt free trade”. When his country later reached the top after the Second World War, it too started “kicking away the ladder” by preaching and forcing free trade to the less developed countries.
The UK and the USA may be the more dramatic examples, but almost all the rest of the developed world today used tariffs, subsidies and other means to promote their industries in the earlier stages of their development. Cases like Germany, Japan, and Korea are well known in this respect. But even
Sweden, which later came to represent the “small open economy” to many economists had also strategically used tariffs, subsidies, cartels, and state support for R&D to develop key industries, especially textile, steel,
and engineering.
There were some exceptions like the Netherlands and Switzerland that have maintained free trade since the late 18th century. However, these were countries that were already on the frontier of technological development by the 18th centuries and therefore did not need much protection. Also, it should be noted that the Netherlands deployed an impressive range of interventionist measures up till the 17th century in order to build up its maritime and commercial supremacy. Moreover, Switzerland did not have a patent law until 1907, flying directly against the emphasis that today’s orthodoxy puts on the protection of intellectual property rights (see below). More interestingly, the Netherlands abolished its 1817 patent law in 1869 on the ground that patents are politically-created monopolies inconsistent with its free-market principles – a position that seems to elude most of today’s free-market economists – and did not introduce another patent law until 1912.
The story is similar in relation to institutional development. In the earlier stages of their development, today’s developed countries did not even have such “basic” institutions as professional civil service, central
bank, and patent law. It was only after the Pendleton Act in 1883 that the US federal government started recruiting its employees through a competitive process. The central bank, an institution dear to the heart of today’s free-market economists, did not exist in most of today’s rich countries until the early 20th century – not least because the free-market economists of the day condemned it as a mechanism for unjustly bailing out imprudent borrowers. The US central bank (the Federal Reserve Board) was set up only
in 1913 and the Italian central bank did not even have a note issue monopoly until 1926. Many countries allowed patenting of foreign invention until the late 19th century. As I mentioned above, Switzerland and the Netherlands refused to introduce a patent law despite international pressure until 1907
and 1912 respectively, thus freely “stole” technologies from abroad. The examples can go on.
One important conclusion that emerges from the history of institutional development is that it took the developed countries a long time to develop institutions in their earlier days of development. Institutions typically took decades, and sometimes generations, to develop. Just to give one example, the need for central banking was perceived at least in some circles from at least the 17th century, but the first “real” central bank, the Bank of England, was instituted only in 1844, some two centuries later.
Another important point emerges is that the levels of institutional development in today’s developed countries in the earlier period were much lower than those in today’s developing countries. For example, measured by
the (admittedly highly imperfect) income level, in 1820, the UK was at a somewhat higher level of development than that of India today, but it did not even have many of the most “basic” institutions that India has today. It did not have universal suffrage (it did not even have universal male suffrage), a central bank, income tax, generalised limited liability, a generalised bankruptcy law, a professional bureaucracy, meaningful securities regulations, and even minimal labour regulations (except for a couple of minimal and hardly-enforced regulations on child labour).
If the policies and institutions that the rich countries are recommending to the poor countries are not the ones that they themselves used when they were developing, what is going on? We can only conclude that the rich countries are trying to kick away the ladder that allowed them to climb where they are. It is no coincidence that economic development has become more difficult during the last two decades when the developed countries started turning on the pressure on the developing countries to adopt the so-called “global standard” policies and institutions.
During this period, the average annual per capita income growth rate for the developing countries has been halved from 3% in the previous two decades (1960-80) to 1.5%. In particular, Latin America virtually stopped growing, while Sub-Saharan Africa and most ex-Communist countries have experienced a
fall in absolute income. Economic instability has increased markedly, as manifested in the dozens of financial crises we have witnessed over the last decade alone. Income inequality has been growing in many developing countries and poverty has increased, rather than decreased, in a significant number of them.
What can be done to change this?
First, the historical facts about the historical experiences of the developed countries should be more widely publicised. This is not just a matter of “getting history right”, but also of allowing the developing countries to make more informed choices.
Second, the conditions attached to bilateral and multilateral financial assistance to developing countries should be radically changed. It should be accepted that the orthodox recipe is not working, and also that there can be no “best practice” policies that everyone should use.
Third, the WTO rules should be re-written so that the developing countries can more actively use tariffs and subsidies for industrial development. They should also be allowed to have less stringent patent laws and other intellectual property rights laws.
Fourth, improvements in institutions should be encouraged, but this should not be equated with imposing a fixed set of (in practice, today’s – not even yesterday’s – Anglo-American) institutions on all countries. Special care has to be taken in order not to demand excessively rapid upgrading of institutions by the developing countries, especially given that they already have quite developed institutions when compared to today’s developed countries at comparable stages of development, and given that establishing and running new institutions is costly.
By being allowed to adopt policies and institutions that are more suitable to their conditions, the developing countries will be able to develop faster. This will also benefit the developed countries in the long run, as
it will increase their trade and investment opportunities. That the developed countries cannot see this is the tragedy of our time.
Ha-Joon Chang (hjc1001@econ.cam.ac.uk) teaches in the Faculty of Economics, University of Cambridge. This article is based on his new book, Kicking Away the Ladder – Development Strategy in Historical Perspective, which was published by Anthem Press, London, on 10 June 2002.
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Ha-Joon Chang, “Kicking Away the Ladder”, post-autistic economics review,
issue no. 15, September 4, 2002, article 3.
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http://www.thenation.com/doc/20070430/greider
by WILLIAM GREIDER
[from the April 30, 2007 issue]
The church of global free trade, which rules American politics with infallible pretensions, may have finally met its Martin Luther. An unlikely dissenter has come forward with a revised understanding of globalization that argues for thorough reformation. This man knows the global trading system from the inside because he is a respected veteran of multinational business. His ideas contain an explosive message: that what established authorities teach Americans about global trade is simply wrong--disastrously wrong for the United States.
Martin Luther was a rebellious priest challenging the dictates of a corrupt church hierarchy. Ralph Gomory, on the other hand, is a gentle-spoken technologist, trained as a mathematician and largely apolitical. He does not set out to overthrow the establishment but to correct its deeper fallacies. For many years Gomory was a senior vice president at IBM. He helped manage IBM's expanding global presence as jobs and high-tech production were being dispersed around the world.
The experience still haunts him. He decided, in retirement, that he would dig deeper into the contradictions. Now president of the Alfred P. Sloan Foundation, he knew something was missing in the "pure trade theory" taught by economists. If free trade is a win-win proposition, Gomory asked himself, then why did America keep losing?
The explanations he has developed sound like pure heresy to devout free traders. But oddly enough, Gomory's analysis is a good fit with what many ordinary workers and uncredentialed critics (myself included) have been arguing for some years. An important difference is that Gomory's critique is thoroughly grounded in the orthodox terms and logic of conventional economics. That makes it much harder to dismiss. Given his career at IBM, nobody is going to call Ralph Gomory a "protectionist."
He did not nail his "theses" to the door of the Harvard economics department. Instead, he wrote a slender book--Global Trade and Conflicting National Interests--in collaboration with respected economist William Baumol, former president of the American Economic Association. Published seven years ago, the book languished in academic obscurity and until recently was ignored by Washington policy circles.
I asked Gomory if his former colleagues from the corporate world quarrel with his provocative message. "Most of them have never heard it," he said. "It's a pretty new message." He has discussed his reform ideas with some CEOs, "who said, Well, maybe we could do that. Others couldn't have disagreed more strongly."
Now Gomory is attempting to re-educate the politicians in Congress. He has gained greater visibility lately because he has been joined by a group of similarly concerned corporate executives called the Horizon Project. Its leader, Leo Hindery, former CEO of the largest US cable company and a player in Democratic politics, shares Gomory's foreboding about the destructive impact of globalization on American prosperity. Huge losses are ahead--10 million jobs or more--and Hindery fears time is running out on reform.
"We want to be a counter to the Hamilton Project," Hindery explains. "They have a sense of stasis that is more benign than I have. I don't think this is all going to work out." The Hamilton policy group was launched last year by former Treasury Secretary Robert Rubin to make sure the laissez-faire trade doctrine known as Rubinomics continues to dominate the Democratic Party. "We're never going to have the status of Bob Rubin," Hindery concedes. "But we're not chopped liver either. We have respectable business careers. You can't tell Ralph Gomory that he is 'smoke and mirrors,' because he wrote the book."
Gomory's critique has great political potential because it provides what the opponents of corporate-led globalization have generally lacked: a comprehensive intellectual platform for arguing that the US approach to globalization must be transformed to defend the national interest. Still, it will take politicians of courage to embrace his ideas and act on them. Gomory's political solutions are as heretical as his economic analysis.
At IBM back in the 1980s, Gomory watched in awe as Japan and other Asian nations captured high-tech industrial sectors in which US companies held commanding advantage. IBM invented the disk drive, then dropped out of the disk-drive business, unable to compete profitably. Gomory marveled at Singapore, a tiny city-state, as it lured American manufacturers with low-wage labor, capital subsidies and tax breaks. The US companies turned Singapore into a global center for semiconductor production.
"It was an unforgettable transformation," Gomory remembers. "And it was pretty frightening.
"The offer that many Asian countries will give to American companies is essentially this: 'Come over here and enhance our GDP. If you are here our people will be building disk drives, for example, instead of something less productive. In return, we'll help you with the investment, with taxes, maybe even with wages. We'll make sure you make a profit.' This works for both sides: the American company gets profits, the host country gets GDP. However, there is another effect beyond the benefits for those two parties--high-value-added jobs leave the U.S."
China and India, he observes, are now doing this on a large scale. Microsoft and Google opened rival research centers in Beijing. Intel announced a new, $2.5 billion semiconductor plant that will make it one of China's largest foreign investors. China's industrial transformation is no longer about making shirts and shoes, as some free-trade cheerleaders still seem to believe. It is about capturing the most advanced processes and products.
The multinationals' overseas deployment of capital and technology, Gomory explains, is the core of how some very poor developing nations are able to ratchet up their technological prowess, take over advanced industrial sectors and rapidly expand their share in global trade--all with the help of US companies and finance, as they roam the world in search of better returns.
The Gomory-Baumol book describes this as "a divergence of interests" between multinational firms and their home country. "This overseas investment decision may then prove to be very good for that multinational firm," they write. "But there remains the question: Is the decision good for its own country?" In many cases, yes. If the firm is locating low-skilled industrial production in a very poor country, Americans get cheaper goods, trade expands for both sides and the result is "mutual gain." But the trading partners enter a "zone of conflict" if the poor nation develops greater capabilities and assumes the production of more advanced goods. Then, the authors explain, "the newly developing partner becomes harmful to the more industrialized country." The firm's self-interested success "can constitute an actual loss of national income for the company's home country."
American multinationals, as principal actors in this transfer of wealth-generating productive capacity, are distinctively free to make the decisions for themselves without interference from government. They want profit and future consumer markets. Their home country wants to maintain a highly productive high-wage economy. Without recognizing it, the two are pulling in opposite directions--the "divergence of interests" most US politicians ignore, evidently believing church doctrine over visible reality.
The Gomory-Baumol book explains the dynamics with charts and equations for economists to study. For the rest of us, it is easier to follow Gomory's personal explanation of changing fortunes among trading nations. "What made America much wealthier than the Asian nations in the first place?" Gomory asks. "We invested alongside our workers. Our workers dug ditches with backhoes. The workers in underdeveloped countries dug ditches with shovels. We had great big plants with a few people in them, which is the same thing. We knew how, through technology and investment, to make our workers highly productive. It wasn't that they went to better schools, then or now, and I don't know how much schooling it takes to run a backhoe.
"The situation today is that the companies have discovered that using modern technology they can do all that overseas and pay less for labor and then import product and services back into the United States. So what we're doing now is competing shovel to shovel. The people in many countries are being equipped with as good a shovel or backhoe as our people have. Very often we are helping them make the transition. We're making it person-to-person competition, which it never was before and which we cannot win. Because their people will be paid a third, a quarter of what our people are paid. And it's unreasonable to think you can educate our people so well that they can produce four times as much in the United States."
As this shift of productive assets progresses, the downward pressure on US wages will thus continue and intensify. Free-trade believers insist US workers can defend themselves by getting better educated, but Gomory suggests these believers simply don't understand the economics. "Better education can only help," he explains. "The question is where do you put your technology and knowledge and investment? These other countries understand that. They have understood the following divergence: What countries want and what companies want are different."
The implication is this: If nothing changes in how globalization currently works, Americans will be increasingly exposed to downward pressure on incomes and living standards. "Yes," says Gomory. "There are many ways to look at it, all of which reach the same conclusion."
I ask Gomory what he would say to those who believe this is a just outcome: Americans become less rich, others in the world become less poor. That might be "a reasonable personal choice," he agrees. "But that isn't what the people in this country are being told. No one has said to us: 'You're probably a little too rich and these other folks are a little too poor. Why don't we even it out?' Instead, what we usually hear is: 'It's going to be good for everyone. In the long run we're going to get richer with globalization.'"
Gomory and Baumol are elaborating a fundamental point sure to make many economists (and political leaders) sputter and choke. Contrary to dogma, the losses from trade are not confined to the "localized pain" felt by displaced workers who lose jobs and wages. In time, the accumulating loss of a country's productive base can injure the broader national interest--that is, everyone's economic well-being.
"Our objective," Baumol told a policy conference last summer, "is to show how outsourcing can indeed reduce the share of benefits of trade, not only for those who lose their jobs and suffer a direct reduction in wages but can wind up making the average American worse off than he or she would have been."
The conventional win-win assurances, they explain, are facile generalizations that ignore the complexity of the trading system--the myriad differences in country-to-country relationships and the vast realm of government actions and policy interventions designed to shape the outcomes. "Many of our 'dismal science' colleagues speak unguardedly as though they believe free trade cannot fail, no matter what," Baumol said.
Some nations, in other words, do indeed become "losers." Gomory fears the United States is now one of them--starting to go downhill. When he and Baumol wrote their book, they figured US trade relations with China and India produced "mutual gain" for both ends. The United States got cheaper goods, China and India got jobs and a start at industrialization. But the rapid improvements in those two nations during the past decade, Gomory thinks, are putting the United States in the bind where their gain becomes our loss.
Essentially, the terms of trade have changed as more and more value-added production has shifted from the United States to its poorer trading partners. America, he explains, becomes increasingly dependent, buying from abroad more and more of what its citizens consume and producing relatively less at home. US incomes stagnate as the high-wage jobs disappear and US exports become a smaller share of the world total.
The persistent offshoring of domestic production is leading to a perverse consequence: The United States finds itself paying more for imports. The production that originally moved offshore to get low-wage labor and cheaper goods is now claiming a larger and larger share of national income, as the growing trade deficits literally subtract from US domestic growth. "All the stuff you were already importing from them becomes more expensive," Gomory explains. "That's why you can start going downhill--because you pay more for what you were previously getting." Put another way, one hour of US work no longer buys as many hours of Chinese work as it once did. China can suppress its domestic wages to keep selling more of its stuff, but that does not alter the fundamental imbalance in productive strength.
The US predicament is vividly reflected in the nation's swollen trade deficits, now running at nearly 7 percent of GDP every year. The country consumes more than it produces. It borrows heavily from trading partners, led by China, to pay for its "excess" consumption. This allows America to dodge--temporarily--a reckoning with its weakened condition, that is, falling living standards. But that will eventually occur, when Americans are compelled to reduce their consumption and pay off the overdue bills. Postponement will deepen the ultimate injury because, meanwhile, the trading partners will gain greater industrial capabilities, while US productive strength weakens further.
Americans can choose to blame China or disloyal multinationals, but the problem is grounded in US politics. The solution can be found only in Washington. China and other developing nations are pursuing national self-interest and doing what the system allows. In a way, so are the US multinationals. "I want to stress it's a system problem," Gomory says. "The directors are doing the job they're sworn to do. It's a system that says the companies have to have a sole focus on maximizing profit."
Gomory's proposed solution would change two big things (and many lesser ones). First, the US government must intervene unilaterally to cap the nation's swollen trade deficit and force it to shrink until balanced trade is achieved with our trading partners. The mechanics for doing this are allowed under WTO rules, though the emergency action has never been invoked by a wealthy nation, much less the global system's putative leader. Capping US trade deficits would have wrenching consequences at home and abroad but could force other nations to consider reforms in how the trading system now functions. That could include international rights for workers, which Gomory favors.
Second, government must impose national policy direction on the behavior of US multinationals, directly influencing their investment decisions. Gomory thinks this can be done most effectively through the tax code. A reformed corporate income tax would penalize those firms that keep moving high-wage jobs and value-added production offshore while rewarding those that are investing in redeveloping the home country's economy.
US companies are not only free of national supervision but actively encouraged to offshore production by government policy and tax breaks. Other advanced economies have sophisticated national industrial policies, plus political and cultural pressures, that guide and discipline their multinationals, forcing them to adhere more closely to the national interest.
Neither of Gomory's fundamental policy reforms--balancing trade or imposing discipline on US multinationals--can work without the other. Both have to be done more or less at once. If the government taxed US multinational behavior without also capping imports, the firms would just head out the door. "That won't work," Gomory explains, "because you will say to the companies, 'This is how we're going to measure you.' And the corporations will say, 'Oh, no, you're not. I'm going overseas. I'm going to make my product over there and I'll send it back into the United States.' But if you insist on balanced trade, then the amount that's shipped in has to equal the amount that's shipped out by companies. If no companies do that, then nothing can be shipped in either. If you balance trade, you are going to develop internal companies that work the way you want." Public investment in new technologies and industries, I would add, may not achieve much either, if there is no guarantee that the companies will locate their new production in the United States.
Essentially, Gomory proposes to alter the profit incentives of US multinationals. If the government adds rules of behavior and enforces them through the tax code, companies will be compelled to seek profit in a different way--by adhering to the national interest and terms set by the US government. Other nations do this in various ways. Only the United States imagines the national interest doesn't require it.
In recent months Gomory and Leo Hindery of the Horizon Project have been calling on Congress with these big ideas and getting respectful audiences. The two met with some thirty Democratic senators and Congressional staffers from both parties. Senator Byron Dorgan, with co-sponsors like Sherrod Brown, Russell Feingold and even Hillary Clinton, has introduced several bills to confront the trade deficits.
Gomory's concept for multinational taxation is a tougher sell amid Washington lobbyists because it goes right to the bottom line of major US corporations. On the other hand, this proposal has stronger intuitive appeal for citizens, who reasonably ask why multinationals are allowed to undercut the national interest when they enjoy all the benefits of being "American" companies.
Hindery's group is advocating Congressional action to arrange a "national summit" on trade, where all these questions can be thrashed out. The political system has never really had an honest, open debate on globalization in the past thirty years. The dogmatic church of free trade--"free trade good, no trade bad"--wouldn't allow it. As more politicians grasp the meaning of Gomory's analysis, they should start demanding equal time for the heretics.
Gomory's vision of reformation actually goes beyond the trading system and America's economic deterioration. He wants to re-create an understanding of the corporation's obligations to society, the social perspective that flourished for a time in the last century but is now nearly extinct. The old idea was that the corporation is a trust, not only for shareholders but for the benefit of the country, the employees and the people who use the product. "That attitude was the attitude I grew up on in IBM," Gomory explains. "That's the way we thought--good for the country, good for the people, good for the shareholders--and I hope we will get back to it.... We should measure corporations by their impact on all their constituencies.
"So in my utopian dream, we decide what we want from the corporations and that's how they make a profit--by doing those things. Failing that, I would settle for the general realization of this divergence and let people argue it out."
Some older CEOs and board members at least listen to him sympathetically. "They have grandchildren," he says. "They wonder too what's going to happen to our grandchildren. You can't get a vote around the corporate board table about, Is this good for the grandchildren? But you can talk to them and they'll worry about it and say, Well, maybe we need to do something."
Political aspects of the Reaganomics
Given all of these economic consequences of the 1st
With respect to these questions, there might be following two answers: the first is related with Republican Party’s clever political strategy during the election period. From a political perspective,
“Republicans held the symbolic high ground that the Democratic Party had once own in national politics – the party of growth and prosperity. On the contrary, Democratic presidential candidate proposed painful remedies – a major tax increase and substantial budget reductions to restore fiscal order.” (610)
From historical perspective, the historic positions of the two dominant political parties were reversed for the first time in political history during the 1984 election. “The Democratic Party felt trapped by its past government deficit policy, still tarnished by the inflationary anxieties experienced under
In the meantime, the president’s party had effectively abandoned the old Republican orthodoxy that the Democrats started to attempt to mimic. From 1984 election, Republicans started to appeal their rhetorical loyalty to the idea of a balanced budget and fiscal order.
Of course, however, the conservative party had adopted the opposite in actual policy – an economy driven by increased federal spending (mainly for military subsidies) and increased debt (mainly from tax cuts), the most serious fiscal deficit policy ever attempted in peacetime. The old Republican complaint that deficit spending ultimately led to ruinous inflation was conveniently discarded in the presence of Republican federal deficits.
Secondly,
But from the benefits of hindsight, the
Nonetheless, what most ordinary citizens knew from their own lives appeared to match what the President told them. “The anxiety of price inflation was gone. Most important of all real disposable income per capita was rising throughout the campaign year at an extraordinary pace. In 1980, when
Theoretical implication of the 1980s
From theoretical perspectives, economic policies adopted under the
However, unlike the forward-looking expectations of “supply side economics,” it was “demand side” which pulled and induced the investment. Even under the dire circumstances, it was not capitalist or entrepreneurs but ordinary households and consumers who spent their money leading entrepreneurs to expand their production facilities. In this sense, Keynesian notion of “effective demand” has remained effective even under the dominance of “supply side economics” in economic policy area.
Furthermore,
However, apart from the question related with adequate quantity of money (how can we know and to what extent is the overall quantity of money necessary in a given condition?), his explanation missed the significant role of the velocity of money. If the velocity of money changes due to various reasons, his argument that the Fed should focus on the overall quantity of money, instead of trying to regulate real interest rates, would lead us in the wrong direction.
In sum,
Concluding remarks
It seems necessary for me to conclude this review essay by introducing the merits of this book. The first virtue that I would like to mention is its style and structure. It is written and organized in plain English. Even those readers with basic level of English proficiency would not find any serious difficulties in understanding the main contents of the author’s arguments. Even though it seemed to be somewhat thick compared to ordinary paperbacks at first glance (717 pages for main contents and total 798 pages including reference, appendix and index), the way of writing was easy to follow and even exciting. It took a week for me to finish reading the book.
Second, the book is well organized. The book consists of four major parts, each of which mainly deals with the Fed’s institutional characteristics (“Part one: secrets of the temple”), its history and traditional roles (“Part two: the money question”), the Fed’s monetary policies in 1980s and their repercussions (“Part three: the liquidation”) and finally evaluations of the Fed’s economic policies in socio-political perspectives (“Part four: the restoration of capital”). Every chapter is closely connected with each other.
Third, this book is based on wide range of references, data analysis and intensive interviews. As you can see, the author spent for about 5 years to gather basic data and references. He also conducted in-dept interviews with former Fed chairman and many government officials in order to represent policy debates and economic climates around the Fed and the White House at the time. The author’s honest and meticulous descriptions of the affairs offer enough information about the Fed and
Fourth, this book contains wide range of knowledge about the
In sum, this book will be a very helpful guide for those who want to understand the history of US economic affairs – how does it develop and where will it go. Instead of doing laborious work for myself, I would like to finish this essay by citing the following precise praises for the potential readers: “startling and revelatory as well as probing and incisive. It is not only a major journalistic achievement but a major public service, for it is an immensely valuable addition to our understanding of the hidden forces that shape our lives.” – Robert A. Caro; “I expect this book to shake up
* Reference for this review
Krugman, P. 1990. The Age of Diminished Expectations – U.S Economic Policy in the 1990s,
------------. 1994. Peddling Prosperity – Economic Sense and Nonsense in the Age of Diminished Expectations,
* Further reading list about the history and roles of the Fed and the
Greider, W. 1992. Who Will Tell the People – The Betrayal of American Democracy,
Rothbard, M. 2002. A History of Money and Banking in the United States – The Colonial Era to World War Ⅱ, Alabama: Ludwig von Mises Institutes (deals with the history of the US central bank system from the perspective of Austrian school of economics)
Stiglitz, J. 2003. The Roaring Nineties – A New History of the World’s Most Prosperous Decade,
Global consequences Ⅰ – in the name of ‘glory’ of the strong dollar
Until now, we focused on
First of all, it would not be so difficult to understand that the world economy has started to enter into the same economic recession due to the Fed’s contractionary money policy. The underlying logic was simple: once the richest market in the world declined, exporters around the world started to lose their customers. When the ordinary wage earners in the North America started to suffer from their losses of jobs and reduced incomes due to higher interest rates, it was natural for export-driven “developmental economies” in the
Even in these circumstances, however, central banks of other industrial nations had no other options but to raise their interest rates too allowing the depression of their own domestic markets. If they resisted raising interest rates in their own countries whatever the reasons, huge amount of money invested on their domestic capital account would flight into the U.S financial market for the short term arbitrage causing abrupt withdrawal and financial disorder in the domestic financial market.
It is not purely theoretical; newly elected socialist president of
Secondly, there was another aspect the Fed’s monetary policy had. It was more indirect process but surely exacerbated by the Fed’s high interest rate policy. The higher interest rates available in the
From then on, an international bank or a corporations or private investor who wished to buy dollar assets would have to pay with more francs or pounds or yen. “From July 1980 to September 1981, the dollar appreciated by 36 percent in its international exchange value with the German mark. In 1979, the yen had traded at less than 200 yen to the dollar. By 1983 the ratio was 235 yen to the dollar.”(414)
This rapid appreciation of the dollars in turn “drove away foreign buyers of American products, just as high interest rates drove away the domestic customers from goods and services. It made US exports more expensive for overseas customers proportionately, and at the same time made foreign imports cheaper in American marketplace.”
In extreme case, for example, American farmers who have previously produced their grains and corn much more cheaply in
In the meantime, “foreign producers of auto, steel, machine tools, computer chips and a long list of other manufactured products grabbed a larger and larger share of the American domestic market. US import of manufactured goods rose by 66 percent over four years’ time and
In a sense, this process can be described as an exploitation of producers for the interest of consumers, which every mainstream economic textbook cites as an example of the benefits of free trade. However, since American consumers are consisted of owners of farms and agricultural workers, owners of small scale of factories and industrial workers, the process of cost and benefit analysis will be highly complicated; Those who were engaged in farming and middle scale manufacture industries would lose their lands, factories and jobs due to expensive money borrowing. Those who barely succeeded in maintaining their factories and farm would now finally lose their lands and factories due to the rapid appreciation of their national currency.
During these periods, “hundreds of thousands, perhaps millions of US jobs were extinguished by the strong dollar. The
But what damaged American production was rewarding for American finance, especially for the major banks active in international markets. The rising dollars meant that the value of their overseas dollars was rising too. It also meant that market demand was growing for the commodity that American financial institutions traded –
Admittedly, the
Given this unique balance of power controlling the international value of the dollar, it is still mysterious why the then US Treasury did not intervene with international exchange market, allowing the rapid appreciation of the dollars. The author of the book,
Global consequences Ⅱ - the
However, the most serious impacts of the Fed’s economic policy on global economy were on the less developed countries (LDCs) in the Third World, whose economies largely depended on the
First of all, their economic output and real incomes fell disastrously as much as 10 percent in some instances, as their export markets dried up and the price of raw material commodity such as copper and rubber price began to fall sharply. “What was to become a severe recession for Americans was catastrophe for the citizens of these poorer countries in Africa and Latin America and
At the same time, the debt burdens of the LDCs expanded dangerously. The worldwide spike in interest rates had raised the cost of the debt, the hundreds of billions in outstanding loans previously borrowed from the banks of Europe and
In a sense, the debt crisis had its origins in the Fed’s policy failure itself. In the late 70s and early 80s, the Fed and other
The Fed’s failures of regulation are now turning its direction to the
The first challenge originated from
In theory at least, the debt crisis might have been avoided if the Fed had not chosen such an abrupt approach to decelerating price inflation. The LDCs were heavily dependent on credit. But the Fed had drastically raised the cost of their borrowing while simultaneously depressed their sales and incomes. “If the world economy had not been pushed down so far, if interest rates had not been forced so high, these debtor nations might have survived the contraction. As it was, they had no time to adjust and really no alternative but to keep borrowing more, just as weakened American corporations had to increase their borrowing to survive the recession.”(521)
In this respect, whether there were no alternative to the Fed’s aggressive anti-inflation policy seemed to be relevant. The Fed tightened money to curb the inflation. “The general public agreed that double-digit inflation must be curbed somehow, but if the question was examined carefully, it was not at all clear that a deep recession induced by the Fed’s monetary policy was the best way. The 1981 inflation, for instance, was driven by escalating prices in oil and agriculture. In this case, the price inflation might have been contained by temporal price controls and other aggressive government policies.”(394)
The cost and benefit analysis
The Fed imposed the most severe discipline on the
Despite various problems, however, this policy worked. “The GNP contracted in real terms by more than $82 billion from its peak, and since 1979 the country had accumulated as much as $600 billion in lost economic output. The excess supply of goods, the declining incomes, and the surplus labor had worked to force down their wages and commodity prices. Overall price inflation fell dramatically from above 13 percent to less than 4 percent by 1983.”(507)
Even though the Fed succeeded in its anti-inflation campaign, the cost was tremendously high. We can analyze this cost in its effects on the transformation of the
First, the Fed’s tight money policy affect unevenly on various industrial sectors. As we already mentioned, those who borrowed huge amount of money to expand their lands and production facilities had to face dire circumstances in which their debt burdens increased substantially in a short notice. Those who borrowed money to buy house and car had to suffer from both their reduced incomes and increased interest payment at the same time. Some of farmers and small scale manufacturers went bankrupt losing everything. Some households had to lose their real estates, and suffer from credit (mortgage and loans interest) payment for a long time.
However, there was another manufacturing industry which gained the monopolist profit. Apart from financial investors, the military industry was a major winner under the Reagan-Volcker’s strategy. The production of armaments was an important special case among manufacturing sectors. “The defense companies and their allied support industries enjoyed two special advantages under
Second, the Fed’s stabilization of money was also an underlying cause driving the frenzy of corporate take-over battles in the 1980s. “The Fed deplored the practice and even introduced regulations to curb the use of the junk bond used to finance many of the corporate buy outs. Nonetheless so long as monetary policy maintained such high real returns for financial investments and simultaneously depressed the return from real assets, smart investors would naturally seek ways to get their capital out of one and into the other.” (661)
Third, there is another issue related with household’s consumption patterns. In the age of inflation, it was wise decision for ordinary consumers to buy houses and cars with mortgage or credit whatever the interest rate might be. If the inflation continues, buying something today is a good deal because the credit interest rate will be undermined by high inflationary pressures. From this era on, the ordinary Americans’ consumption pattern would be a good source for boastful strong consumer power.
However, this pattern did not change even after their real incomes were reduced substantially because even under these circumstances people had to buy something to live. But the behind logic became different. While American consumers tried to buy today during the inflationary era because it was a good deal, this time they do the same thing because they could not accept the new reality of their reduced status. “By going deeper into debt, they kept spending and hoped that their prospects improved. Millions of families borrowed money to spend during and since
From now on, previously praised strong American consumer powers now started to turn out to be a castle in the air. The
The
Secondly, the retreat from home buying was more fundamental to the American standard of living. During the 1980s, a lot of young couples were priced out of the housing market by high mortgage interest rates or by reduced personal incomes that were too depressed to support a mortgage. For the first time in forty years, the percentage of American families that owned their own house actually decreased during the Reagan Presidency. “The rate of homeownership among Americans had increased steadily from 44 percent in 1940 to 66 percent by 1980. Starting in 1981, homeownership began to decline for the first time since World War II. By 1984, it was down to 64.5 percent. By 1986, it fell to 63.9 percent.” (654)
Finally, the Reaganomics had detrimental effects on income distributions. The 1981 tax legislation proved to be regressive in a more fundamental way. It became the pretext for a vast redistribution of incomes, flowing upward on the income ladder, through another powerful channel – interest rates. The largest benefits in reduced tax burden went to the wealthiest taxpayers, and the tax relief became proportionately smaller and smaller for families that were less well off.
According to the US Census, “only families on the top 20 percent of the economic ladder enjoyed real increases in their after-tax household incomes from 1980 to 1983. The others, the bottom 80 percent actually lost. The highest fifth, families earning $38,000 or more, gained an average of $1,480 per household in real income, and the top 5 percent, earning more than $60,000, gained an average of $3,320. Families in the middle lost about $560 and the working poor lost about $250.”(401)
Apart from these analyses, the author argues that the Fed strategy may have left larger consequences for the
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