How Rich Countries Got Rich …and Why Poor Countries Stay Poor - review
Introduction
Erik Reinert’s book, “How Rich Countries got Rich …and Why Poor Countries Stay Poor” is a polemical take on international trade theory. He notes that today’s wealthy countries developed by way of economic theory that today would be considered highly unorthodox. He uses this observation to build a convincing case that the advice given to poor countries is not helpful for them, and traces out what he calls the “other Canon” of economic advice which more closely mirrors economic policies that were successful in the past. In conventional trade theory, it is claimed that free trade is a driver of economic growth. Reinert pushes back on this claim and says that trade is a corollary, not a cause, of economic growth. Instead of trade, it is “increasing returns activities” that drive economic growth. For example, manufacturing rather than agriculture will boost a country’s economy - and if a country only has agriculture, free trade will not create the wealth that they so desire. Finally, he addresses a controversial element of stimulating these “increasing returns activities” - protectionism. This will take a little unpacking, so we will break it up into sections.
Increasing and diminishing returns activities
The two most significant historical examples of increasing and diminishing returns activities are agriculture (diminishing returns) and manufacturing (increasing returns). A farmer will naturally farm the best land first, and subsequent farming on poorer quality land will yield lower returns. In contrast, we have increasing returns to investment in manufacturing. Let’s imagine I have a spoon factory and one machine ($500,000 and $20,000 respectively). Adding a machine moves my fixed costs from $520,000 to $540,000 - not much in the grand scheme of things - but with this change my output doubles. This is an example of increasing returns to investment, because a comparatively small additional investment yields big returns. Additionally, the more spoons I make, the more I will learn about how to make better spoons. It is important to note that these days, we do not have to solely rely on environmentally degrading manufacturing to boost the economies of poorer countries. There are now many other increasing returns activities, such as telecommunications networks, creative media, R&D, software, financial platforms, consulting and digital goods.
Positive spill-over effects of increasing returns activities
Another mechanism Reinert highlights is the effect of manufacturing on other sectors. This is important for government policy, because governments must be strategic in which industries they support and how they support them. Supporting “increasing returns activities” has spillover effects which create a rising tide, lifting the boats of even those engaged in diminishing returns activities like agriculture, as well as neutral services like hairdressing. The way this works is that increased wages in the manufacturing sector can be spent on a wider variety and better quality of food, and more services like more frequent haircuts. In economic language demand is boosted in the economy generally. If a government were to invest in agriculture directly, however, wages would not even increase proportionally to the extra investment, and the previously described spillover of increasing returns would not happen.
Trade should not liberalise too quickly
Reinert claims that free trade is not the driver of wealth; rather, increasing returns activities are. It’s worth looking at his negative case now with some more nuance - why not free trade? When we take a bird’s eye view of the book, we see that Reinert is not against free trade - indeed, he says that countries should ultimately be oriented towards eventually trading freely with other countries. However, this free trade is not the starting point for wealth creation. In fact, he argues that if a country opens up too quickly to the world market, its potential for wealth creation will be lost. Instead, it must open up at the right speed, otherwise its local industries will be unable to compete with the highly efficient international offerings, and will quickly die. This is what Friedrich List advocated around 1840 in a book he published. Ignoring his warnings, Europe proceeded on a course of rapid free market policy, which so distressed List that he committed suicide. In the light of that event, Europe’s ship arighted and so averted enormous misery. However, perhaps in the absence of such a persuasive event, or in our post-Cold-War triumphalism, our international institutions have gone back to a pre-List era of “shock therapy”, rapid privatisation, thrusting poor economies into the world market, only to see their industries collapse at the same speed.
Dynamic protectionism
Reinert’s solution is “dynamic protectionism”. This is the kind that was exercised, for example, in South Korea from the time of its birth. Taxes are levied on imports (i.e. tariffs are used) in order to “protect” local industries. Subsidies are used for the same purpose. However, this is called dynamic because it is a temporary measure. It is intended for supporting selected industries to eventually enter the world market, not to supply the same stagnant products to a local market in perpetuity. It is reserved for strategic industries that are growing and conditional on growth targets being met. Other accompanying strategies should be used - partnering with international technology providers in such a way that domestic companies can learn at the greatest possible rate and thereby have control over their inputs. Finally, the dynamic nature implies a timeline. At the start, companies might be inefficient or brand new. A policy of “import substitution” can be used whereby anything the country thinks it can create itself, is protected. As the domestic industry for this product expands, the government may allow trade with countries at a similar level of development - but not yet the world market. When the product is competitive enough, then tariffs, embargoes and subsidies can be removed. In terms of the products chosen to protect, initially simple products will be chosen which have technology that can be accessibly learned, mastered and controlled domestically. As time goes on, there will be opportunities to leapfrog from one industry/product to another, more complex one.This process continues until the country is fostering the incorporation of relatively advanced technologies in service of sophisticated products and services. This jumping from one product to a more complex one is called the “Flying Geese” model.
Inefficiencies of protectionism
Critics of protectionism do not often focus on best practice, as demonstrated in Korea and Japan, but on various countries in Latin America. These countries often engage in permanent rather than dynamic protectionism, are lax when it comes to consequences for poorly performing companies, never intend to re-integrate with the world market, etc. These are all behaviours we might associate with corrupt institutions (a characteristic of many poorer countries). A question we should ask, therefore, is: at what point do we cease to recommend protectionism? At what point do we consider a country too corrupt to be able to handle such a process? A further question might be: what if a country fails to launch? What if its products fail to become competitive enough to enter the world market. A turning point for me in reconsidering protectionism was reading Reinert’s argument that a product does not have to be the most efficient in the world to improve local wages through increasing returns. This gives confidence to try this strategy even if there is some level of imperfection in the process - if we believe there is likely to be some forward movement anyway. However, an element that is largely absent from Reinert’s book is that of institutions. Good institutions must be somehow pursued in parallel to the economic strategy of dynamic protectionism.
Conclusion
In sum, Reinert’s book is an essential corrective to the convenient doctrine of free trade espoused by international financial institutions like the World Bank and the International Monetary Fund. Like a spiral staircase into a conspiratorial basement, you will find yourself embarking on the same ideas over and over again - but each time with a little extra detail. You will find yourself arguing with economists. You may be left with a sense of righteous frustration at the antics of world powers, who always recommend free trade as a universal strategy since it gives them a bigger market for their production. England told America that free trade was the answer. America ignored their suspicious advice and protected their industries. Years later, America now doles out the same advice to an increasingly hostile audience, who do not want it any more than America did before the origins of their prosperity. Free market economics thrives because it works - in America and for Americans. For this Christian country and their clean, perfect economic theory, Jesus’ words seem appropriate:
“Woe to you, scribes and Pharisees, hypocrites! You are like whitewashed tombs, which appear beautiful on the outside, but inside are full of the bones of the dead and every kind of impurity.”
For everyone else, this book might be a breath of fresh air.
