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Gospel of the rich

Print edition : Oct 24, 2008 T+T-

Reinert uses the historical experiences of the rich countries of Europe, as also of the U.S., to critique the contemporary dogma of free trade.

ERIC REINERTS book is best described as a counterpoint to the dominant Anglo-American doctrine of globalisation, popularised and propagated by the International Monetary Fund (IMF) and the World Bank, that the route to the prosperity of nations is free trade and hence opening up their boundaries to international trade is what countries that desire material progress should do.

The author, for many years a development consultant in Latin America, Africa and Asia, is now Professor of Technology, Governance and Development Strategies at Tallin University of Technology, Estonia. He places before the readers what may be called a Continental perspective, relying largely on the writings of European scholars who, long before Adam Smith wrote his famous book Wealth of Nations, studied how European centres and countries had broken away from centuries of low-level economic performance and become rich. Reinert uses these historical experiences of the rich countries of Europe, as also of England and subsequently of the United States, to critique the contemporary dogma of free trade, said to be premised on the writings of Adam Smith in the late 18th century and of David Ricardo in the early 19th century. His approach, therefore, is both historical and theoretical.

Take any country that is considered rich today, says Reinert, and examine how it got rich, and you will find that it was not free trade that made it rich. On the contrary, the present-day rich countries got rich by appropriately regulating trade with other countries. The clearest example is none other than the U S.. The American War of Independence, after all, was directed against the attempt of Great Britain to retain the American settlements as its colonies, supplying raw materials (cotton, primarily) to feed Britains rising industries. And from the time the colonies declared themselves to be the independent United States of America late in the 18th century until the end of the Second World War about the middle of the 20th century, America protected its economic interests and growth by strong tariff walls. So, would not it be right to say that it was not free trade but protected or regulated trade that made America rich? And, this is crucial too, once America became rich and powerful, it started preaching the gospel of free trade while still protecting some of its vulnerable economic segments.

Actually, in this America was doing exactly what Great Britain itself did earlier. If the Corn Laws allowing the free flow of corn into the island marked the beginning of the free trade regime, it happened only in 1848, long after Adam Smiths Wealth of Nations was published (1776) and even many years after Ricardo put forward his theory of international trade based on the principle of comparative advantage (1817). By 1848, Great Britain had emerged as the richest country of that period.

And, of course, it is widely recognised that European countries industrialised themselves by effectively protecting themselves against Great Britain and that the theoretical rationale for it was provided by Friedrich Lists Infant Industry Argument.

This historical evidence shows that rich countries became rich by restricting trade, but they started peddling the doctrine of free trade after they became rich. So Reinerts counter doctrine is that free trade may be good for the rich and the powerful, but it will only keep poor countries poor. However, this is not Reinerts main argument. His thesis is that countries can become rich only by shifting out of nature-related primary economic activities (agriculture, fishing and so on) into technology-driven industrial activities, and protective trade is a necessary enabling condition for this transition or transformation.

Why is this so? Here Reinert falls back on standard economic theory. Economic activities based on natural resources are subject to diminishing returns, and thus increasing costs, but industrial activities can benefit by increasing returns to scale and the decreasing costs that result from them.

A general conclusion that Reinert arrives at is that economic development is activity-specific and he demonstrates this by going back into history again. Historically, the first to become rich were not countries, but cities. And it happened long before Adam Smith wrote Wealth of Nations, and indeed, even before national sentiments became significant factors in the determination of economic activities. The period is the early 16th century when the widely prevalent socio-economic order was feudalism and the predominant economic activity was agriculture and pasturing, both land-related. In 1500, points out Reinert, the city of Venice (in the territory known as Italy) and the cities of Holland were centres noted for wealth primarily because they had very large and diversified manufacturing and craft sectors. The cities of Holland had invented a process of preserving fish as early as the 14th century, which enabled them to have monopoly over fish trade in the neighbourhood and overseas. Wealth had been created and maintained behind huge barriers to entry created by superior knowledge, says Reinert, by possessing a large variety of manufacturing activities that created systemic synergies, by market power, by low costs created through innovations and increasing returns These same factors, applied on a larger territorial area, enabled England to become a wealthy country a few centuries later. Other countries followed the same formula and got rich subsequently.

The general lesson that Reinert draws from these historical examples is that todays poor countries can get rid of poverty only by getting out of primary activities and taking up industrialisation. Industries become creators of wealth because they rely on increasing returns to scale which reduce costs, they open up scope for innovation and technical progress, and they lead to diversity of economic activities which enables realisation of systemic synergies. The net result will be to raise labour productivity and hence real wages. In sum, structural transformation resulting from industrialisation is the only way for todays poor countries to become rich.

How is this to be achieved? Reinerts prescription for poor countries is: Dont do what rich countries ask you to do; do what they did. Rich countries (as also international institutions which reflect and defend their economic interests) now tell poor countries that this is the age of globalisation and that in that context the best way to become rich is through global trade, which implies opening up their borders to let commodities and capital from the rest of the world to come in freely. They will invoke David Ricardo who proved (so it will be argued) that if each country specialises in the production of goods in which it has comparative advantage and enters into global trade on that basis, all countries will benefit.

Dont do this, Reinert warns poor countries, especially those in Africa. He tells them that the colonialism of the past has reduced them to producers of primary goods, even just a single primary good (be it copper or coco), and the advice that they now receive from the rich countries is to continue the same pattern. Premature opening up, says Reinert, will lead them into primitivisation and the perpetuation of poverty. Primitivisation occurs when a labour market no longer has the core city activities and human beings are retained or forced back into diminishing returns activities, he points out.

Reinert cites Mangolia as a glaring case. In the Cold War period of 50 years until the early 1990s, Mangolia had slowly but successfully built a diversified industrial sector, bringing down the share of agriculture in the national product from 60 per cent in 1940 to about 16 per cent in the mid-1980s. But soon after the Cold War ended, in 1991, Mangolia was advised to accept the World Bank-IMF reforms and open up its economy, which it did. And half a century of industry-building was virtually annihilated over a period of only four years from 1991 to 1995. Large-scale unemployment followed and many people were forced to return to their ancestral nomadic way of living: nomadic pastoralism, where the country, with vast areas of land, had its natural advantage, its external experts pointed out. But, says Reinert: The nomadic economy, however, was unable to sustain the same population density as the industrial system, and the outcome was a combined ecological, economic and human catastrophe by 2000.

The Mangolian example shows the fallacy of applying the theoretical model of David Ricardos principle of comparative advantage to real-life situations without taking note of its simplifying assumptions. The model that Ricardo had used of England and Portugal specialising in the production of goods where each had its comparative advantage, cloth in the former and wine in the latter, was built on a number of abstract assumptions, one of the crucial ones being that labour is just a qualityless quantity. Can it be applied to a world where workers in one country are engaged in software production while those in another are herding animals, is Reinerts question. To put it differently, does it make a difference whether a country specialises in computer chips or banana chips?

The point is that todays rich countries have reached a high level of productivity through industrialisation, technological upgradation and higher levels of knowledge, all leading to much higher real wages compared with the rest of the world. At the same time, in the poor countries much of the labour force, with restricted skills, is made to depend on activities that are technologically dead ends. The asymmetry can be summed by stating that rich countries have come to specialise in man-made comparative advantage, while poor countries have been left behind in nature-made comparative advantage. Under these conditions free trade can only lead to a perpetuation of the gap at best. A widening of the gap is more likely because of the dynamic conditions in the former.

Reinert is not recommending autarchy as the solution. But he is pointing out that globalisation has become the new process of colonisation, and that a colonys role has always been to produce raw materials. He is asking the poor countries to do what the rich countries did in their early stages and continue to do even now to restrict trade in the national interest. His own country, Norway, had a protectionist regime until 1960 with total prohibition on the import of clothing combined with severe restrictions on the transfer of funds out of the country until 1956. He suggests that poor countries, particularly those in Africa, should take lessons from the historical examples of China, South Korea and India, which followed a largely closed economy policy initially to diversify their economies and build up enough of a base to sustain the growth of non-primary economic activities before opening up to the rest of the world.

That, surely, is an oversimplified policy prescription. How many of the poor countries of the early 21st century have the policy options that some countries of the mid 20th century poor, but with continental economies had to face the rest of the world? The real problem that most poor African countries face today is that because of their colonial past they have become so precariously dependent on international trade even for the livelihood of their people. They cannot exercise the option of delinking themselves from international trade. Even the rich countries are aware of this as can be seen by the many attempts, including the Millennium Development Goals and the Monterrey commitments, to transfer some resources from the rich to the poorest countries. Reinert is right in characterising such aid as welfare colonialism because the rich countries through trade take away more than what they pass on as aid. He is also right in saying that the free trade that the rich countries now propagate is one where they set the rules.

That being the case, it is surprising that Reinerts treatment of global trade is little more than anecdotal. He makes only passing references to the World Trade Organisation (WTO) and has hardly anything to say on how a trade regime that is fair to the poor countries can be brought about that will enable them to bring about the structural transformation that he so eloquently recommends. He also does not consider the role of finance capital, controlled by large oligopolistic multinational corporations, in actually setting the terms of the so-called free trade. Hence it is too facile to suggest that poor countries of today should emulate the strategies of a distant past.

In spite of these limitations, those interested in development strategies will find it helpful to go through Reinerts writing because it calls for reviewing many familiar propositions and their underlying presuppositions and draws the attention of the readers to a rich literature on development issues