In the latest issue of the New York Review of Books I have a review (ungated here) of:
Leonard Mlodinow, The Drunkard’s Walk: How Randomness Rules Our Lives
Ha-Joon Chang, Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism.
The success of the East Asian Gang of Four—and now China—has exerted an irresistible lure to researchers of growth. Academic economists who were used to studying whether a politically difficult tax reform might make Americans better off by an amount equivalent to 0.1 percent of US GDP rushed into a field of inquiry that promises to explain how to increase your income seventeen times over. Theoretical breakthroughs in the late 1980s by Paul Romer (now at Stanford) and by Nobel laureate Robert Lucas helped inspire a remarkable effort by economists to find in the empirical data which factors reliably lead to growth. Yet hundreds of research articles later, we wound up at a surprising end point: we don’t know.
In 2007, the dean of growth research, Nobel laureate Robert Solow, said: “In real life it is very hard to move the permanent growth rate; and when it happens…the source can be a bit mysterious even after the fact.”
In view of this acknowledged ignorance, how can there still be so many writers who claim to know how to promote growth? The Drunkard’s Walk by Leonard Mlodinow offers a crucial insight. Humans are suckers for finding patterns where none really exist, like seeing the shapes of lions and giraffes in the clouds. It wasn’t that economists had no explanations of what causes growth. On the contrary, we had too many. One survey of the field counted no fewer than 145 separate factors that had been found to be associated with growth. But most of these patterns were spurious, because they failed to hold up when other researchers tried to replicate them. Economists can say something useful about economic success, but we have to clear away a lot of false overconfidence before we get to that point.
In Bad Samaritans, Ha-Joon Chang is both a critic and a purveyor of such overconfidence. He rightly criticizes those who have made overly strong growth rate effects for free trade and orthodox capitalism, but then he turns around and makes equally strong claims for protectionism and what he calls “heterodox” capitalism, which includes such features as government promotion of favored industries, state-owned enterprises, and heavy regulation of foreign direct investment.
Chang and almost everyone else, have also been suffering from a fallacy, what Mlodinow (following Nobel laureate Daniel Kahneman) calls the Law of Small Numbers. This is a sarcastic reference to the Law of Large Numbers, in which you can have a high degree of confidence in the average value of a sample if the sample includes a very large number of observations. The Law of Small Numbers is when you stop short of having ”enough” observations and show high confidence anyway. The Law of Small Numbers is our tendency to judge performance by too small a slice of experience.
Chang at one point suggests as evidence that free trade isn’t working the fact that Mexico had only 1.8 percent per capita growth from 1994 to 2002—the period following the enactment of the North American Free Trade Agreement. Chang also picks and chooses episodes in which it appeared heterodox policies were doing well. But economic growth is so volatile across and within countries that it takes a very long time to decide what policies are having a positive effect on growth, which lies behind the failure of both systematic growth evidence and anecdotal evidence a la Chang.
One way to escape from the Law of Small Numbers is to seek to explain levels of per capita income already attained today rather than rates of growth. The level of income you have reached today frees you from small numbers because it reflects the outcome of your entire previous growth experience. So let’s ask, who are the richest and the poorest countries now, and what is the difference between them?
The now-rich countries leaped ahead during a long period in which they were more free-trade and free-market (although Chang is correct they were far from perfectly laissez-faire) than the rest of the world. More important than the policies that Chang emphasizes, the now-rich countries had far better institutions and transport infrastructure that made free trade and free markets possible; the now poor countries historically always had a lot of “protection” through high transport costs and lousy infrastructure.
This big stylized fact just confirms the Western consensus around the basic concept of a state shaped by representative democracy, safeguarding individual rights and supplying crucial infrastructure such as transport, while rewarding entrepreneurship and technological creativity. Such common-sense ideas have stood the test of time over the very long run, both in their acceptance by the population in most economically successful societies (compared to their absence and rejection in unsuccessful economies) and in their pragmatic consequences for prosperity (as showed by the comparison to the poverty of states that lack most of the above conditions).
Despite Chang’s air of desperation about the experts getting it right (something shared by some of Chang’s free-market opponents), in the end, third-world growth seems to have been fairly expert-proof. Perhaps prosperity is not after all designed from above; perhaps it emerges from below, from the independent actions of many individuals who figure out their own paths.
21 Comments
“The now-rich countries leaped ahead during a long period in which they were more free-trade and free-market”
Shorter Bill Easterly: Everyone’s simplistic arguments are wrong except mine!
Apart from everything else you leave out, one glaring problem with this claim is that the ‘now-rich’ countries were already richer before any point you can credibly call them ‘free-trade and free-market’ (if indeed they ever actually merited those labels – it really is a bit much to acknowledge Chang’s very strong evidence on Western interventionism throughout the ‘free trade’ era and then completely ignore the implications). In Angus Maddison’s data on historical income levels, per capita GDP in Europe was already twice that of Africa’s in 1500.
It’s clear as day that the level and growth rate of income in Africa has through pretty much all of history been held back by a uniquely unhelpful natural geography. This clear has a major impact on infrastructure and transport costs, which you come fairly close to acknowledging. But I wonder why you can’t bring yourself to accept the huge impact of geography – is it because it makes it harder to construct a ‘bad guys’ narrative about African governments, or because it would involve agreeing with Jeffrey Sachs?
Near the end of the eighteenth century it was calculated that the living standards of a South Indian peasant were marginally better than those of his equivalents in the UK.
By the time the British left the Indian peasant was 26 times worse off than his British equivalent.
Rather a lot of that has to do with a deliberate colonial policy of looting and de-industrialization, forcing the Indians to buy British goods. Like the rest of the colonies India was ruled for the financial benefit of the UK.
“Humans are suckers for finding patterns where none really exist”…
Sounds far better for human survival/welfare than failing to find patterns where they exist.
I’ve just read the whole review. I haven’t got access to Dett’s article, but ‘free trade imperialism’ in India included such beauties as imposing a tax on indigenous salt so high that it became much cheaper to import vastly inferior salt from Cheshire.
Jim:
I fail to see why unhelpful geography is somehow incompatible with bad government. Indeed, it seems easy to argue that unhelpful geography may encourage bad government by discouraging the development of the institutional basis for good government.
Also, while it is true that medieval Europe (and Japan) were richer than Africa in 1500, it is also true that the really big take-off was around 1820.
Stephen Jones:
Surely, the big change was that in 1800 one is comparing peasants with agricultural labourers and by 1947 one is comparing peasants with industrial workers. It is true that India was ruled for British interests, but any notion that this explains British success does not really work. Having the longest running colonial empire did not do a lot for Portugal’s long term growth rate: never having had any seemed to do just fine for the Swiss.
There is also the always interesting question of why the British were able to rule India in the first place.
Great. I can agree with most of that. You start with “levels of per capita income already attained today rather than rates of growth”, then step back and “ask, who are the richest and the poorest countries now, and what is the difference between them?”. Hey presto, trade, markets, institutions (more detail needed here, such as priority sequencing, discipline, formality, hierarchy… basic stuff like that), infrastructure, representative democracy (eventually rather than as a precondition). If you read between the lines, the World Bank World Development Reports said all this during the wiser moments of the past two decades, no? But I’m far more skeptical about this part – “Perhaps prosperity is not after all designed from above; perhaps it emerges from below, from the independent actions of many individuals who figure out their own paths”. Yes, this is how things evolved over the centuries, and how they continue to evolve after society has reached a development threshold. But taking that approach at the outset in today’s developing world will mean the poor have a very long wait. In my experience what they want, need, and recognize initially is strong leadership that gets things done. There are faster paths, which unfortunately Hayek did not recognize or did not want to write about, that aim to set up the formal institutional structures upon which, or within which, spontaneous orders can subsequently thrive. Basically this involves ungating the path. That means expert knowledge (knowledge about all of the above) and a solid ideology to propagate that knowledge (for goodness sake don’t ask Chang to design this ideology), a ‘handful of heroes’ in the power structures of the state, and a plan to competitively emulate the standardized procedures of more or less successful tried and tested institutions found in the richest countries. Let’s not ask developing countries to repeat the grind of evolution.
I used to do a demo– mix up black beads with white beads and pour the mixture into a transparent jar. Then ask the class to explain the black and white blotchy ‘pattern’ that you see through the jar’s wall. All sorts of amazing new physical laws get discovered.
Dear Jim,
I am happy to consider whether my argument is too simplistic. However, please go back first and read the whole article in the NY Review of Books, which is an argument AGAINST being too simplistic.
Best, Bill
Whether laissez faire or government controlled, I don’t know what is best for development.
And I think the best approach is to be sceptical towards those people who claim to know the recipe.
However, talking of Asia, lots of government control does not seem to be a great success on the Korean peninsula, does it?
The Swiss were notoriously poor for a long period of their history. Why do you think so many of them had to seek employment as mercenaries?
What basically happened was that the British got richer whilst India stagnated under the British. But India stagnated because it was run for British needs. The infrastructure the British set up was for a colonial economy, not for the development of India.
Dear Bill
I must say I think you have written more than a handfull of BS lately, sometimes including Slavic tennis players of a certain gender.
It is heartwarming, then, to see you back at your best!
Your comparative advantage is definately in the more heavy academic discourse, please, for the future, you may leave the afore mentioned athletes and related issues to the tabloids.
Thank’s for that great post. I agree basically with the comment from LorenzoFromOz.
Lorenzo,
“I fail to see why unhelpful geography is somehow incompatible with bad government.”
To be clear, I think both institutions and geography have played a big part. Bill doesn’t.
Having now read Bill’s NY Times review of Chang alongside his equally useful review in the Financial Times of the book by Allan Beattie (ungated on Bill’s website) I understand his conclusion that the focus on growth recipes (and culture) can lead to dead ends – for every success there’s a failure, ‘law of small numbers’, etc. This seems really important. But, if economists can’t generate convincing answers, then, instead of giving up on expertise and – by possible implication – encouraging the third world to rediscover the wheel, maybe it’s time to revive non-quantitative theoretical logics of social science. Sociological big-picture breakthroughs in scientific analysis of development of the type pioneered by Weber, Parsons, Popper, and to some extent Hayek and Schumpeter might come back into style. It’s not that they abandon evidence, but rather that they successfully abstract from it. And by the by, in defense of Weber, what he said about religion seems so often to mislead instead of enlighten; it’s probably better to stick to his main body of writings dealing with universal-secular factors of capitalist development.
The problem of a policy-maker is that he or she always has N=1 cases. Every systematic argument has its outliers and no policy-makers can be sure whether his or her case is the one. Orthodox policies might have worked for Hong Kong, heterodox for South Korea. How do I know which may work here? The case studies may be more informative from the point of our policy-maker, because they get closer to what may work where questions than the large-N systematic evidence. They allow people to pull together their reform case and persuade other to give it a try. This is the experimentation you so much long for. The case studies have considerable political economy value even if they suffer from the Law of Small Numbers. You need both small- and big-N so why should you try to shoot down these arguments a priori?
Stephen Jones, your argument implies that your counter-factual is that India would have had substantial GDP growth per capita if it was not for the British-imposed colonial infrastructure. What is the evidence for this counter-factual? As evidence against, Ethiopia and Thailand mostly escaped imperalism (excepting Italy’s invasion of Ethiopia in the 1930s, and Japan’s occupation of Thailand in WWII), but both of those countries were poor during the 19th century, and Ethiopia particularly continues to be poor.
Of course perhaps India, in the absence of colonial interference, would have taken off and become very rich. But the cases of the non-colonised countries doesn’t make me think that India would most definitely have taken off.
Growth under the British was always under 1% per capita. Stunningly low. The British drove tens of millions of Indian peasants into misery, debt and even starvation, by overtaxing them even when there was nothing to pay with. In the eighteenth century Dhaka was one of the richest cities in the world, with a flourishing steel industry. The salt tax and the infamous ‘Hedge of India’ meant that millions of Indians suffered nutritional problems directly attributable to the British. In the year 1700 the Mughal Empire produced 25% of the world’s GDP. By the time the British had finished their depredations it was down to under 4%. It is not a question of India ‘taking off’ but of simply continuing a slow but satisfactory linear progression. The British deliberately destroyed that for the good of their own economy and the obscene luxury of the colonial rulers.
Stephen Jones, if the British destroyed Dhaka’s steel industry (in ways other than out-competing it) and starved to death millions of Indians then I strongly suspect they also harmed their own economy, not helped it. Millions of prosperous Indians would have meant a much larger market for British products, if the Indians in Dhaka could produce steel more efficiently than the Brits in Manchester then the Brits harmed their own economy by buying from less-efficient locals (of course freight rates, particularly pre-railways, could mean that effectively British steelmakers would be cheaper for British uses of steel, and Indian steelmakers for Indian uses of steel).
The British might have destroyed the Indian economy, but at best it would have been for the good of a few well-connected British political interests, not for the good of the British economy as a whole. For example, if British actions took place to destroy the local Indian steel injury in order to favour British steelmakers then Indian steel buyers would have had less money available to spend on non-steel products, and thus British sellers of non-steel goods would be worse off at least to the extent that British sellers of steel would have been better off, and deadweight losses imply the losses would be even higher than the transfer. Also British buyers of steel would be worse off, to the extent that they could have bought from the Indians, and thus also would have reduced purchasing power. (Note that in reality the Indians might have bought from the Americans or the Germans, or whoever, in which case the situation would have been that the Americans, or Germans, or whoever would have had more money available to spend on British goods).
It is noticeable that with the increase of the number of rich nations in the world, such as the rise in per-capita incomes of the USA, Germany and Japan, British per-capita incomes have gone up.
And quite frankly I’m not impressed with a country being one of the richest in the world in the 18th century, as the world was very poor back then.
British steel was industrial and would have been much cheaper than Indian steel made in the same way it had for hundreds of years, but your argument doesn’t hold water. You’re making the incredibly naive assumption that what is market efficient is necessarily good for all parties. In a non-colonial situation where the Brits minded their own business there can be no doubt they would produce cheaper steel but they Indians would produce their own more expensive variety, and the Indians would be the better off, because they would not need to lose output to pay for the British variety.
Textiles would be a better example. Take an Indian village that is basically self-sufficient,arranges its own water management, and spins its own cloth. Now the British gain nothing out of this. If the British allow entry of British cloth (and you’ve got to remember that the idea of colonies in the 19th century was to provide captive markets for the home country) then the cloth will be cheaper but now the village needs to pay for it, so instead of producing food it goes over to producing cash crops such as cotton which initially seem to provide a greater income but don’t provide security and end up by increasing misery.
Let’s take a non-Indian example; Thatcher’s political decision to allow Electricity companies to import cheaper East European coal and close down numerous coal mines in the UK. Sure the electricity company has lower costs, and can pass a proportion of that on to the consumer, but there are the additional costs of paying for thousands of unemployed miners, so that the total result was a financial loss.
Mike Davis has written about how the governor-general of India had to remind his subordinates that they were to work for the good of India, but not to forget that their primary purpose in India was to work for the good of Liverpool and Manchester.
If you really want details of British economic mismanagement in the Raj, then read Romesh Dutt, who described the process in detail over a hundred years ago.
I missed this; do you seriously think the British allowed goods from their competitors to enter the market?
I totally agree, tongue in cheek, that what is responsible for growth is free trade where you either get labor near free or raw materials near free or knowlege near free or capital near free.
The formula of the empires of past has been pursued by the Chinese, Koreans and Japanese in their 20th century growth paths except that the tradeoff (unlike the Africans) is giving near free labor for access to near free knowledge transfer.
Same thing for the Indian inroads into generic pharmaceuticals and IT. It comes from knowing that lots of money can be had from offering services a lot cheaper than the IBMs, EDSs and Price Waterhouse Coopers of the world.