Ha-Joon Chang - Economics - The User's Guide

More recently, some development economists have emphasized the need to complement infant industry protection with investments in building an economy’s productive capabilities. [88] Important names include, in alphabetical order, Alice Amsden, Martin Fransman, Jorge Katz, Sanjaya Lall and Larry Westphal. Trade protection only creates the space within which a country’s firms can raise productivity, they argued. The actual raising of productivity requires deliberate investments in education, training and R&D.

A lot more than meets the eye: assessing the Developmentalist tradition

As I have pointed out earlier, the lack of a coherent, overarching theory is a crucial weakness of the Developmentalist tradition. Given the human tendency to be seduced by a theory that supposedly explains everything, this has put the tradition in seriously lower esteem in most people’s eyes than more coherent and self-confident schools, such as the Neoclassical school or the Marxist one.

The tradition is more vulnerable to the government failure argument than other economic schools that advocate an active role for the government. It recommends a particularly wide-ranging set of policies, which is more likely to stretch the administrative capabilities of the government.

Despite these weaknesses, the Developmentalist tradition deserves more attention. Its crucial weakness, namely its eclecticism, can actually be a strength. Given the complexity of the world, a more eclectic theory may be better at explaining it. The success of Singapore’s unique combination of free-market policies and socialist policies, which we encountered in Chapter 3, is a case in point. Moreover, its impressive track record in generating real world changes suggests that there is a lot more to it than meets the eye.

One-sentence summary: No one knows enough, so leave everyone alone .

Oranges are not the only fruit: different types of free-market economics

Not all Neoclassical economists are free-market economists. Nor are all free-market economists Neoclassical. The adherents of the Austrian school are even more ardent supporters of the free market than most followers of the Neoclassical school.

The Austrian school was started by Carl Menger (1840–1921) in the late nineteenth century. Ludwig von Mises (1881–1973) and Friedrich von Hayek (1899–1992) extended the school’s influence beyond its homeland. It gained international attention during the so-called Calculation Debate in the 1920s and the 1930s, in which it battled the Marxists on the feasibility of central planning. [89] On this debate, see D. Lavoie, Rivalry and Central Planning: The Socialist Calculation Debate Reconsidered (Cambridge: Cambridge University Press, 1985). In 1944, Hayek published an extremely influential popular book, The Road to Serfdom , which passionately warned against the danger of government intervention leading to the loss of fundamental individual liberty.

The Austrian school is these days in the same laissez-faire camp with the free-market wing (today the majority) of the Neoclassical school, producing similar, if somewhat more extreme, policy conclusions. However, methodologically it is very different from the Neoclassical school. The alliance between the two groups is due more to their politics than economics.

Complexity and limited rationality: the Austrian defence of the free market

While emphasizing the importance of individuals, the Austrian school does not believe that individuals are atomistic rational beings, as assumed in Neoclassical economics. It sees human rationality as severely limited. It argues that rational behaviour is only possible because we humans voluntarily, if subconsciously, limit our choices by unquestioningly accepting social norms – ‘custom and tradition stand between instinct and reason’, Hayek intoned. For example, by assuming that most people will respect moral codes, we can devote our mental energy to calculating the costs and the benefits of a potential market transaction, rather than to calculating the odds of being cheated.

The Austrian school also argues that the world is highly complex and uncertain. As its members pointed out in the Calculation Debate, it is impossible for anyone – even the all-powerful central planning authority of a socialist country that can demand any information it wants from anyone – to acquire all the information needed to run a complex economy. It is only through the spontaneous orderof the competitive market that the diverse and ever-changing plans of numerous economic actors, responding to unpredictable and complex shifts of the world, can be reconciled with each other.

Thus, the Austrians say that the free market is the best economic system not because we are perfectly rational and know everything (or at least can know everything that we need to know), as in Neoclassical theories, but exactly because we are not very rational and because there are so many things in the world that are inherently ‘unknowable’. This defence of the free market is a lot more realistic than the Neoclassical one, based on the assumption of absurd degrees of human rationality and on the unrealistic belief in the ‘knowability’ of the world.

Spontaneous vs. constructed order: limits to the Austrian argument

The Austrian school is absolutely right in saying that we may be better off relying on the spontaneous order of the market because our ability to deliberately create order is limited. But capitalism is full of deliberately ‘constructed orders’, such as the limited liability company, the central bank or intellectual property laws, which did not exist until the late nineteenth century. The diversity of institutional arrangements – and the resulting differences in economic performances – between different capitalist economies is also in large part the result of deliberate construction, rather than spontaneous emergence, of order. [90] Herbert Simon, the founder of the Behaviouralist school, has pointed out that modern capitalism is better described as an ‘organization’ economy than as a market economy. These days, most economic actions happen within organizations – predominantly firms but also governments and other organizations – rather than through markets. See Chapter 5 for further discussion.

Moreover, the market itself is a constructed (rather than spontaneous) order. It is based on deliberately designed rules and regulations that prohibit certain things, discourage others and encourage still others. This point can be more clearly seen when we recall that the boundaries of the market have been repeatedly drawn and redrawn through deliberate political decisions – a fact that the Austrian school fails to, or even refuses to, accept. Many once-legal objects of market exchange – slaves, child labour, certain narcotics – have been withdrawn from the market. At the same time, many formerly unmarketable things have become marketable due to political decisions. ‘Commons’, the grazing lands that were collectively owned by communities and therefore could not be bought and sold, became private land through the Enclosure in Britain between the sixteenth and eighteenth centuries. The market for carbon emission permits was created only in the 1990s. [91] The idea that ‘permits to pollute’ can be bought and sold may still sound alien to many non-economists. But the market for these permits is already a thriving one, with an estimated value of trade in 2007 at $64 billion. By calling the market a spontaneous order, the Austrians are seriously misrepresenting the nature of the capitalist economy.

The Austrian position against government intervention is too extreme. Their view is that any government intervention other than the provision of law and order, especially protection of private property, will launch the society on to a slippery slope down to socialism – a view most explicitly advanced in Hayek’s The Road to Serfdom . This is not theoretically convincing; nor has it been borne out by history. There is a huge gradation in the ways market and the state combine across countries and within countries. Chocolate bars in the US are provided in a much more market-oriented way than is primary school education. South Korea may rely more on market solutions than Britain does in the provision of health care, but the case is the reverse in water or railways. If the ‘slippery slope’ existed, we wouldn’t have these kinds of diversity.