A continuing reply to Michael Pettis Post on the Chinese economic model:
There were three key elements of the American System. Historian Michael Lind, in one of his economic histories of the United States, described them as:
· infant industry tariffs
· internal improvements, and
· a sound system of national finance
These three elements are at the heart, explicitly or implicitly, of every variation of the investment-led development model adopted by number of countries in the last century – including Germany in the 1930s, the USSR in the early Cold War period, Brazil during the Brazilian miracle, South Korea after the Korean War, Japan before 1990, and China today, to name just the most important and obvious cases. For this reason I think it makes sense to discuss each of them in a little more detail.
***I agree, but look at the list: Germany 1930s... hmmmmm... Soviet Union, Japan, Brazil... this list recommends the system?***
Infant industry tariffs
The “infant industry” argument is fairly well known. I believe Alexander Hamilton was the first person to use the phrase, and the reasoning behind his thinking was straightforward. American manufacturing could not compete with the far superior British, and according to the then- (and now) fashionable economic theories based on Adam Smith and David Ricardo, the implications for trade policy were obvious. Americans should specialize in areas where they were economically superior to the British – agriculture, for the most part – and economic policy should consist of converting US agriculture to the production of cash crops – tobacco, rice, sugar, wheat and, most importantly, cotton – maximizing that production and exchanging them for cheaper and superior British manufactured items.
In this way, as Ricardo brilliantly proved, and assuming a static distribution of comparative advantages, with each country specializing in its comparative advantage, global production would be maximized and through trade both the British and the Americans would be better off.
***There are a couple of fatal flaws.
1. Mr Hamilton just KNOWS which industries to pick? And by picking winners and losers, Mr Hamilton would NEVER starve a new technology, as yet unseen? Mr Pettis might do well to consider J B Say.
And should they pick wrong, we’d never go to war to fix the mistake?
Recall what Reagan said: If it moves, tax it. If it keeps moving regulate it. If it stops moving, subsidize it. It’s funny becuase it is true. In practice Hamiltonians are about misallocation and malinvestment.
And comparative advantage is a nice theory, but has never occurred in human action, for the very reason that at the moment hamiltonians begin managing the economy, it is tariffs, regulations and subsidies, not comparative advantage, that rules.***
Hamilton was convinced that it was important for the US to develop its own manufacturing base because, as he explained in his Congressional report in 1791, he believed that productivity growth was likely to be much higher in manufacturing than in agriculture or mineral extraction. Contrary to David Ricardo, in other words, Hamilton believed that comparative advantage was not static and could be forced to change in ways that benefitted less productive countries. What is more, he thought manufacturing could employ a greater variety of people and was not subject to seasonal fluctuations or fluctuations in access to minerals.
Given much higher British efficiency and productivity, which translated into much lower prices even with higher transportation costs, how could Americans compete? They could do it the same way the British did to compete with the superior Dutch a century earlier. The US had to impose tariffs and other measures to raise the cost of foreign manufacturers sufficiently to allow their American counterparts to undersell them in the US market.
*** Undersell? Or charge too much? A great system for the industrialized North, which forced Southern growers to buy overpriced USA goods with revenues from sales of cotton to France, instead of cheaper French goods. The result was the US Civil war, 700,000 americans dead, and the South destroyed. And slavery permanently enshrined in the US Constitution. Mr. Pettis’ historical sketch here is tendentious.***
In addition Americans had to acquire as much British technological expertise and capacity as possible (which usually happened, I should add, in the form of intellectual property theft).
***How is “stealing British ideas” intellectual property theft when USA and the UK had no treaty on IPR? UK IPR had absolutely no validity in USA. How could any treaty even be written when the USA IPR premise of “inventor owns patent” was at variance from the UK “first to patent.” Then there is the problem of what we understand as patents didn’t show up in the UK until about 1850. This assertion is a complete mess.***
This the US did, and in fact I believe every country that has managed the transition from underdeveloped to developed country status (with, perhaps, the exception of one or two trading entrepôts like Singapore and Hong Kong, although even this is debatable), including Germany, Japan, and Korea, has done it behind high explicit or implicit trade tariffs and stolen intellectual property. The idea that countries get rich under conditions of free trade has very little historical support, and it is far more likely that rich countries discover the benefits of free trade only after they get rich, while poor countries that embrace free trade too eagerly (think of Colombia and Chile in the late 19th century, who were stellar students of economic orthodoxy) almost never get rich unless, like Haiti in the 18th Century or Kuwait today, they are massive exporters of a very valuable commodity (sugar, in the case of Haiti, which was the richest country in the world per capita during a good part of the late 18th Century).
***If we limit our view to only one century, as Pettis does here, and a century that saw human destruction never seen before in history, then ... well, it still does not make sense. If limited to his time frame, the cost is not worth the widespread use of cell phones, or whatever benefit all this brought us.***
... I suspect the difference between the countries that saw such rapid productivity growth behind infant industry protection that they were eventually able to compete on their own, and those that didn’t, may have had to do with the structure of domestic competition.
Specifically, it is not enough to protect industry from foreign competition. There must be a spur to domestic innovation, and this spur is probably competition that leads to advances in productivity and management organization. I would argue, for example, that countries that protected domestic industry but allowed their domestic markets to be captured and dominated by national champions were never likely to develop in the way the United States in the 19th Century.
*** OK, but this is not new. Five families control all industry in Mexico, and to assure their steady stream. USSR centrally planned down to the number of toothbrushes. Toothbrush shortage. In USA, design an electric toothbrush, do well, and the oligarchy takes a cut. And then offers more credit to lend on a fractional reserve basis. In the modern societies, people are relatively free to do as they want, and if successful, the state takes a % for the oligarchy. This mimics, or more likely mocks, freedom. So far so good.***
I would also argue that companies that receive substantial subsidies from the state also fail to develop in the necessary way because rather than force management to improve economic efficiency as a way of overcoming their domestic rivals, these countries encourage managers to compete by trying to gain greater access to those subsidies. Why innovate when it is far more profitable to demand greater subsidies, especially when subsidized companies can easily put innovative companies out of business? Last April, for example, I wrote about plans by Wuhan Iron & Steel, China’s fourth-largest steel producer, to invest $4.7 billion in the pork production industry.
***Like Monsanto, a chemical company that sells seeds. And odd, after the Wuhan move, we find...
The Ministry of Agriculture has launched an urgent investigation into the deaths of more than 3,000 pigs whose carcasses ended up in East China's Huangpu River.
| Cha Siu Huang Po |
Coincidence? The problem is once started, there is no rational limit to the activity.
***
The company’s management argued that they could compete with traditional agro-businesses not because steel makers were somehow more efficient than farmers, but rather because their size and clout made it easier for them to get cheap capital and to get government approvals. They were able to invest in an industry they knew little about, in other words, because they knew they could extract economic rent. This clearly is not a good use of protection.
***No, but it is a rational use of state power and central banking, and the model of US capitalism. It is why “food” is cheap in USA. ***
The lessons for China, if I am right, are that China should forgo the idea of nurturing national champions and should instead encourage brutal domestic competition. Beijing should also eliminate subsidies to production, the most important being cheap and unlimited credit, because senior managers of Chinese companies rationally spend more time on increasing access to these subsidies than on innovation, a subject on which, in spite of the almost absurd hype of recent years, China fares very, very poorly.
*** And would Mr. Pettis recommend this for the UK and USA too? I would go further. The state should get out of industrial planning, and let “brutal competition” flower both domestic and foreign.***
There is nothing wrong with protecting domestic industry,
***If you do not mind genocide, wars, disease, destruction, widows and orphans, starvation, boy bands, etc. Otherwise, it works out ok for the grantors and grantees.***
but the point is to create an incentive structure that forces increasing efficiency behind barriers of protection.
*** We have that, it is called the free market. Why give an impossible task to a tiny group that cannot possibly effect any good?***
The difficulty, of course, is that trade barriers and other forms of subsidy and protection can become highly addictive, and the beneficiaries, especially if they are national champions, can become politically very powerful. In that case they are likely to work actively both to maintain protection and to limit efficiency-enhancing domestic competition. It was Friedrich Engels, not often seen as a champion of capitalist competition, writing to Edward Bernstein in 1881, who said that “the worst of protection is that when you once have got it you cannot easily get rid of it.”
***Well, there is a devastiig answer to mercantilism, such as Pettis recommends: unilateral free markets. If you drop domestic subsidies and protections, and give foreign producers free range in your markets, they are soon brought to their knees. Japan enjoys relatively unilateral free trade in autos with USA. It is crushing Japan. Hong Kong has unilateral free trade. Hong Kong rocks.
What bothers me about Hamiltonianism is that is rules for crybaby billionaires. Their "needs" crowd out the innovation that would make USA the envy of the world, instead of the desperate murder-for-oil and screw-pal militarism which is attendant to Hamiltonianism. Let Americans trade freely, and we'll lead the world to peace and prosperity.***
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