Thursday, June 5, 2008

The Myth of Free Trade by Ha-Joon Chang

Bad Samaritans: The Myth of Free Trade and the
Secret History of Capitalism
by Ha-Joon Chang

The concept of free trade, as promoted by today’s economic superpowers, is a set of principles based on unfettered capitalism (e.g. no tariffs or government subsidies) with a few notable exceptions (e.g. subsidies for agriculture, intellectual property rights). Promoted as beneficial to the world community at large, free trade simultaneously promises to lift developing nations out of poverty and give the greatest number of human beings the greatest number of goods, at the lowest possible cost. Ha-Joon Chang, a distinguished economics professor at the University of Cambridge, challenges these notions. Instead of examining them from a theoretical perspective, he reviews actual trade history to provide an empirical framework for discussion.

He begins his review with his own native South Korea which achieved a level of economic growth in forty years that it took the United States a century and a half and Great Britain two centuries to achieve. He asks if this was a result of practicing the principles of free trade and concludes that it was not. The South Korean government methodically selected key industries and nurtured them through a combination of tariffs, outright import bans, and subsidies. They heavily controlled foreign investment, welcoming it in certain areas and shutting it out in others. Some critical industries that would not be immediately profitable were undertaken as state-owned enterprises, the steel maker, POSCO, being the best example.

Chang then reviews the British and American experience and finds a similar history. Britain imposed high tariffs on wool for many years, while developing a woolen industry that could compete against the Low Countries. The United States imposed high tariffs on British cotton textiles in order to develop its own textile industry. In fact, this was the primary source of tension between the North and the South in the run-up to the Civil War.

As producers of raw cotton, it was understandable that the South would want to purchase cotton cloth at the best possible price. The 40 to 50% tariffs that the United States imposed on all manufactured goods, from that period through the First World War, was seen as an imposition on a region that was primarily agricultural. Yet in order to grow and prosper as a nation, the United States needed to protect our new industries until they reached a point where they could compete on the world stage. There was no stronger advocate for this than Alexander Hamilton, our first Secretary of the Treasury, whose ideas in “Report on the Subject of Manufactures” became the foundation of our economic prosperity.

There appear to be only two areas within the free trade framework that government intervention is encouraged: agricultural subsidies and intellectual property rights. The United States heavily subsidizes agriculture and the result is that our food products are available in other countries at lower prices than locally grown foods. For example, after the implementation of NAFTA, low cost corn from the United States reached the Mexican market, resulting in many Mexican corn farmers going out of business. This was not only devastating to individual farmers. It put the entire country in a difficult position since it became dependent upon another country for the staple of its diet.

In the area of Intellectual Property Rights, particularly as granted to pharmaceutical companies, Chang shows where such policies often result in scarcity, rather than abundance, of goods. When a local economy is prevented from creating a cheaper generic alternative, many go without badly needed medicines, simply because they cannot afford them. Recent changes in patent laws have extended the life of patents, 97% of which are held by rich countries, making economic development in poorer countries that much more difficult. Interlocking patents make it hard to generate medicines and other innovations that are founded on previously patented knowledge. Chang dispels the myth that without a strong profit motive, advances in medicine would not occur, pointing out that much research is done in university settings for reasons having to do with scientific curiosity and the desire to do something beneficial for mankind.

On another front, and as part of the free trade framework, the giants of world finance, the World Bank and International Monetary Fund, favor private enterprise over state owned at all times, and these preferences are usually part of the terms of business. Chang looks at the criticisms leveled against state owned enterprises, which he calls the “principle agent problem, the free rider problem, and the soft budget constraint.” He shows through actual examples that these problems are not exclusive to state owned enterprises, and that there are poorly run and well run state, as well as private, enterprises. He shows that even in countries such as France, many successful companies from Renault to Rhone-Poulenc began as state-owned, the most powerful reason being that some critical industries need to be nurtured for years, before they can become profitable.

The strength of the book is that it does not rely on hypothesis and conjecture regarding the result of free trade, but rather examines actual trade history. Chang’ concludes that the notion of a “level playing field” is unfair when the players themselves are unequal. He certainly supports the idea of international trade, and in fact, blames the lack of it for North Korea’s dismal economic performance, since 1950. However, as was the case in South Korea, Britain, the United States, and the vast majority of prosperous nations, he strongly believes that countries must be allowed to integrate into the world economy on their own terms.

What is lacking here is any discussion of the impact of free trade on the citizens of wealthier countries. Chang does not address the concerns of displaced workers in a nation that has been losing its manufacturing base, nor does he give possible remedies for those concerns. That, perhaps, is the subject of another book.

Louellyn Lambros