Michael Pettis writes a history of
industrial policy and implications for Chinese development.
It was... the post-War Japanese development model, itself
based on Japan’s experience of economic development during and after the
Meiji restoration, that became the standard for policymakers throughout
East Asia and China. I think of China’s growth model as merely a more
muscular version of the Japanese or East Asian growth model, which
is itself partly based on the American experience.
There were three key elements of the American System. ...Michael Lind, in one of his economic histories of the United States, described them as:
· infant industry tariffs
· internal [infrastructure investment] 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.
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.
While most academic US economists and the commodity-producing South
embraced free trade, Alexander Hamilton and his followers, mainly in the
northeast, did not (in fact differing views over free trade as well as
over slavery and state rights were at the heart of the North-South
conflict that led eventually to the Civil War).
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, ...Hamilton believed that comparative
advantage was not static and could be forced to change [to increase productivity of a country]... 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. 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).
This the US did... 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).
Note: I'm not sure where Pettis got the above idea that Haiti was so wealthy before its revolution, but I suspect that Pettis is not counting the Hatian slaves as people in this measurement. That was the usual practice in slave societies. Pettis continues:
...rather than ...embrace protection ...there is one
very important caveat. Many countries have protected their infant
industries, and often for many decades, and yet very few have made the
transition to developed country status. Understanding why protection
“works” in some cases and not in others might have very important
implications for China. ...I suspect ...domestic competition [may help explain successful infant industry strategies].
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.
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... 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.
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 [loans] and ...government approvals.
They were able to invest in an industry they knew little about, ...because they knew they could extract economic rent. This clearly
is not a good use of protection.
The lessons for China, if I am right, are that China should forego
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 [in]
which, ...China fares
very, very poorly.
There is nothing wrong with protecting domestic industry, but the
point is to create an incentive structure that forces increasing
efficiency behind barriers of protection. 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. ...Friedrich
Engels, [Karl Marx's best friend, criticized protectionism saying,] “the worst of protection is
that when you once have got it you cannot easily get rid of it.”
Internal improvements
The second element of the American System was internal improvement,
which today we would ...call infrastructure spending. Proponents
of the American System demanded that the national and state governments
design, finance and construct canals, bridges, ports, railroads, toll
roads, [schools], and a wide variety of communication and transportation facilities
that would allow businesses to operate more efficiently and profitably.
In some cases these projects were paid for directly (tolls, for
example) and in other cases they were paid for tax revenues generated by
higher levels of economic activity.
It is easy to make a case for state involvement in infrastructure
investment. The ...benefits ...are likely to be diffused throughout
the economy, making it hard for any individual company to justify
absorbing the costs of investment. In this case the state should fund
infrastructure investment and pay for it through the higher taxes
generated by greater economic activity.
For me the interesting question, especially in the Chinese context,
is not whether the state should build infrastructure but rather how much
it should build. In fact this is one of the greatest sources of
confusion in the whole China debate. Most China bulls implicitly assume
that infrastructure spending is always good and the optimal amount of
infrastructure is more or less the same for every country, which is what
allows them to compare China’s per capita capital stock with that of
the US and Japan and conclude that China still has a huge amount of
investing to do because its capital stock per capita is so much lower.
But this is completely wrong, and even nonsensical. Infrastructure
investment is like any other investment in that it is only economically
justified if the total economic value created by the investment exceeds
the total economic cost associated with that investment If a country
spends more on infrastructure than the resulting increase in
productivity, more infrastructure makes it poorer, not richer.
Pettis' third point, a sound financial system, seems to be in place. China has done better so far than most of the West. I would expect that China will have a financial crisis eventually too, but so far so good for them. And the US did not have a sound financial system before the Great Depression and the US still developed well, so China is better off than the US was. And the biggest financial problems since the 1970s has been caused by rapid capital flight out of countries. China has capital controls and is less vulnerable to this kind of problem than most of the world.
