In our last article, we explored the debate regarding trade policy in the developing world and what economists Ha-Joon Chang and Joe Studwell had to say on the matter. In short, both generally argued that developing countries should first engage in strategic protectionism so that their “infant industries” can mature until they’re competitive enough to compete in the global marketplace. But there’s a reason this is called a “debate” – the opposing viewpoint should not be neglected, and that is precisely the purpose of this article: to go through the criticisms raised at Studwell’s and Chang’s reasoning and advice.
Studwell’s Historical Analysis
Blogger Noah Smith, who has openly promoted Studwell’s How Asia Works, identified and documented what he considered “A few flaws in my favourite book about development” in a blog post here (he also uses Substack!). Smith talks about 3 specific points, the first of which is Studwell’s comparison of South Korea and Taiwan. As mentioned in our last article, one of the policy prescriptions outlined in How Asia Works is land reform, which essentially means distributing farmland among peasant farmers. Studwell believes that South Korea executed this with far superior proficiency and is why they rank ahead of Taiwan in per capita GDP rankings.
Here Smith differentiates nominal GDP and GDP based on purchasing power parity must be pointed out. While comparing countries’ nominal GDPs is done so through calculating exchange rates of those countries’ official currencies, purchasing power parity allows for economists to compare standards of living through the “basket of goods” approach (a constant set of consumer products and services used to determine the cost of living). Taiwan’s GDP (PPP) is and has been higher than that of South Korea’s for a long time now:
The GDP (PPP) metric works best when the countries' lifestyles are qualitatively similar, and that’s precisely why Smith recommends using it when examining the economies of Taiwan and South Korea. On these grounds, Noah Smith argues that, contrary to Studwell’s claims, Taiwan is and has been richer than South Korea.
The second point is Studwell’s unfair dismissal of Malaysia as a failure of industrial policy. Although South Korea’s Hyundai has been far more successful than Malaysia’s Proton (one of the country’s largest car brands), as Studwell thoroughly documented in his book, he almost totally ignores Malaysia’s success in electronics. Seeing as how How Asia Works was published in 2014:
Sure South Korea may exceed them in this area, but the fact that they’re comparable with the US (despite having less than a tenth of the population) and surpass Japan is no small feat. This achievement is likely what pushed Malaysia’s growth rate to impressive paces, surpassing that of South Korea’s in 2010. In Noah Smith’s eyes, Malaysia was in fact a development success.
The third and final point of contention Smith outlined in his post is in regards to Studwell’s contrast of Northeast vs Southeast Asian countries, with the former having advantages that the latter lacks, thereby resulting in the different growth outcomes. However, Southeast Asian countries have lately been catching up with their Northeastern neighbourhoods, which somewhat lends itself to the development theory outlined in Krugman, Fujita, and Venables’ The Spatial Economy; the essence is that countries have to “wait in line” for their “turn'' to develop. Despite its inconclusiveness, it seems to exhibit itself among Asian countries: Japan and Hong Kong and Singapore grew quickly, then Taiwan and South Korea, then China, now Vietnam and Indonesia.
What this means is that Southeastern Asian countries may not be a development failure per se, but are instead simply waiting their turn to experience rapid economic growth.
The Infant Industry Argument and Economic Theory
Let’s look at the market for a manufactured good in an undeveloped country:
Let’s break this down. We have the standard supply and demand curves, with P1 and D1 representing the “world price” of that good and what consumers would demand at that price. The problem is that producers don’t want to produce that much at that low of a price point, so a tariff gets implemented, thereby raising the good’s price to P2. At that price point, producers are willing to produce S2 but demand would fall to D2. This scenario is a deadweight loss because although producers and the government benefit, consumers are harmed because of the higher prices and the economy as a whole is as well because of the losses in efficiency (there’s a whole mathematical aspect in showing this, but we’re not going to get into that).
The only real scenario in which a protectionist policy would actually benefit a country is like so:
The supply curve shifts to the right in this one, and that allows for S2 to meet P1 along supply curve S1. In other words, consumers face the same free trade price as if there were no tariff, and thus experience no gain nor loss. This graph is supposed to model out the ideal infant industry scenario: domestic production is stimulated with a temporary import tariff, causing the domestic industry to improve its own productivity (the supply curve shifts from S to S1). Because of the shift, however, once the tariff is removed, the price returns to P1.
This is a pretty major assumption that is extremely difficult to get right, since rolling back the tariffs any sooner or longer will decrease the benefits outlined in the above scenario. Even implementing the tariffs is difficult; how is the government supposed to see in the future and know which industries will be its “winners” and which won’t?
And even granting all that, there’s no guarantee the country’s productivity improvement (assuming there is any) will be enough to result in a consumer welfare gain. Nonetheless, the final argument against tariff protection to political economy: industry interests will inevitably lobby hard against the revoking of industry protections and if they are successful in doing so, then they have little incentive to improve. If you’re a businessperson in a protected industry, you’d want to do as much as you can to make sure those protections remain for as long as possible. Doing so, however, could obviously lead to a net loss for the economy as a whole.
Conclusion
Economics is one of the few subjects in which 2 of its practitioners could be awarded the Nobel Prize even if they’re saying completely contradictory things. In a field with so much debate and dispute, it’s rare to find a consensus as strong as free trade. Its benefits are the most consistent matter on which economists find common ground.
While this goes without saying, it is important to note that a consensus alone doesn’t serve as a meaningful justification for any policy. Several important economic theories started out as heterodox and were only later incorporated into mainstream thought. Could Ha Joon-Chang and Joe Studwell be the next thinkers in this regard?
Econ IRL
Tax havens, that is, countries offering very low effective tax rates in order to attract foreign investors and businesses (specifically, their money), are notoriously difficult to study. Because of their secluded nature, collecting data on their usage is kind of at odds with their purpose and so greatly limits the amount available.
This week’s paper, however, capitalizes on the opportunity presented by an Ecuadorian policy of taxing outflows to limit currency flight. The simple tax led to government monitoring of inflows and outflows (which means potential research data!) as well as the increased cost of transacting with tax havens – if it left the country, then the money was taxed. Using the government outflow data as well as business-shareholder linkages, the author was able to identify businesses and individuals connected to various tax havens. Here are the main results:
The outflows tax led to a 66% decrease in the dividend payments to tax havens
Firms exposed to the new legislation decreased overall dividend payouts by 50%
On the other hand, exposed individuals increased their domestic income reporting by 40% and paid 55% more in personal income taxes
‘Till next time
SoBasically