The Myth of Free Trade and the
Secret History of Capitalism
by Ha-Joon Chang
Bloomsbury Press, 2008, paperback
People in rich countries who preach
free market and free trade to poor countries in order to capture
larger shares of poor countries' markets and to preempt the emergence
of possible competitors.
In 1961, eight years after the end of its fratricidal war with
North Korea, South Korea's yearly income stood at $82 per person.
The average Korean earned less than half the average Ghanaian
citizen ($179).)The Korean War ... was one of the bloodiest in
human history, claiming four million lives in just over three
years (1950-3). Half of South Korea's manufacturing base and more
than 75% of its railways were destroyed in the conflict... A 1950s
internal report from USAID - the main US government aid agency
then, as now - called Korea a 'bottomless pit. At the time, the
country's main exports were tungsten, fish and other primary commodities.
Samsung, now one of the world's leading exporters of mobile phones,
semiconductors and computers, the company started out as an exporter
of fish, vegetables and fruit in 1938, seven years before Korea's
independence from Japanese colonial rule. Until the 1970s, its,
main lines of business were sugar refining and textiles that it
had set up in the mid-1950s.
The dictates of the free market: sound money (low inflation),
small government, private enterprise, free trade and friendliness
towards foreign investment.
The neo-liberal agenda has been pushed by an alliance of rich
country governments led by the ç US and mediated by the
'Unholy Trinity' of international economic organizations that
they largely control - the International Monetary Fund (IMF),
the World Bank and the World Trade Organisation (WTO). The rich
governments use their aid budgets and access to their home markets
as carrots to induce the developing countries to adopt neo-liberal
policies. This is sometimes to benefit specific firms that lobby,
but usually to create an environment in the developing country
concerned that is friendly to foreign goods and investment in
general. The IMF and the World Bank play their part by attaching
to their loans the condition that the recipient countries adopt
neoliberal policies. The WTO contributes by making trading rules
that favour free trade in areas where the rich countries are stronger
but not where they are weak (e.g., agriculture or textiles). These
governments and international organizations are supported by an
army of ideologues. Some of these people are highly trained academics
who should know the limits of their free-market economics but
tend to ignore them when it comes to giving policy advice (as
happened especially when they advised the former communist economies
in the 1990s. Together, these various bodies and individuals form
a powerful propaganda machine, a financial-intellectual complex
backed by money and power.
This neo-liberal establishment would have
us believe that, during its miracle years between the 1960s and
the 1980s, [South] Korea pursued a neo-liberal economic development
strategy. The reality, however, was very different indeed. What
Korea actually did during these decades was to nurture certain
new industries, selected by the government in consultation with
the private sector, through tariff protection, subsidies and other
forms of government support (e.g., overseas marketing information
services provided by the state export agency) until they 'grew
up' enough to withstand international competition. The government
owned all the banks, so it could direct the life blood of business
- credit. Some big projects were undertaken directly by q state-owned
enterprises - the steel maker, POSCO, being the best example -
although the country had a pragmatic, rather than ideological,
attitude to the issue of state ownership. If private enterprises
worked well, that was fine; if they did not invest in important
areas, the government had no qualms about setting up state-owned
enterprises (SOEs); and if some private enterprises were mismanaged,
the government often took them over, restructured them, and usually
sold them off again.
The Korean government also had absolute
control over scarce foreign exchange (violation of foreign exchange
controls could be punished with the death penalty). When combined
with a carefully designed list of priorities in the use of foreign
exchange, it ensured that hard-earned foreign currencies were
used for importing vital machinery and industrial inputs. The
Korean government heavily controlled foreign investment as well,
welcoming it with open arms in certain sectors while shutting
it out completely in others, according to the evolving, national
development plan. It also had a lax attitude towards foreign patents,
encouraging 'reverse engineering' and overlooking 'pirating' of
The popular impression of Korea as a free-trade
economy was created by its export success. But export success
does not require free trade, as Japan and China have also shown.
Korean exports in the earlier period - things like simple garments
and cheap electronics - were all means to earn the hard currencies
needed to pay for the advanced technologies and expensive machines
that were necessary for the new, more difficult industries, which
were protected through tariffs and subsidies. At the same time,
tariff protection and subsidies were not there to shield industries
from international competition forever, but to give them the time
to absorb new technologies and establish new organizational capabilities
until they could compete in the world market.
The Korean economic miracle was the result
of a clever and pragmatic mixture of market incentives and state
direction. The Korean government did not vanquish the market as
the communist states did. However, it did not have blind faith
in the free market either. While it took markets seriously, the
Korean strategy recognized that they often need to be corrected
through policy intervention.
Practically all of today's developed countries, including Britain
and the US, the supposed homes of the free market and free trade,
have become rich on the basis of policy recipes that go against
the orthodoxy of neo-liberal economics.
Today's rich countries used protection
and subsidies, while discriminating against foreign investors
- all anathema to today's economic orthodoxy and now severely
restricted by multilateral treaties, like the WTO Agreements,
and proscribed by aid donors and international financial organizations
(notably the IMF and the World Bank).
German economist Friedrick List in 1841
[I}t is a very common clever device that
when anyone has attained the summit of greatness, he kicks away
the ladder by which he has climbed up in order to deprive others
of the means of climbing up after him.
Today, there are certainly some people in the rich countries [Bad
Samaritans] who preach free market and-free trade to the poor
countries in order to capture larger shares of the latter's markets
and to preempt the emergence of possible competitors.
History is written by the victors and it is human nature to re-interpret
the past from the point of view of the present. As a result, the
rich countries have, over time, gradually, if often sub-consciously,
re-written their own histories to make them more consistent with
how they see themselves today, rather than as they really were.
Many Bad Samaritans are recommending free-trade,
free market policies in the poor countries in the honest but mistaken
belief that those are the routes their own countries took the
past to become rich. But they are in fact making the lives of
those whom they are trying to help more difficult.
Thomas Friedman, 'The Lexus and the Olive Tree'
Half the world seemed to be ... intent
on building a better Lexus, dedicated to modernizing, streamlining,
and privatizing their economies in order to thrive in the system
of globalization. And half of the world - sometimes half the same
country, sometimes half the same person - was still caught in
the fight over who owns which olive tree.
According to [Thomas] Friedman ['The Lexus and the Olive Tree'],
unless they fit themselves into a particular set of economic policies
that he calls the Golden Straitjacket, countries in the olive-tree
world will not be able to join the Lexus world. In describing
the Golden Straitjacket, he pretty much sums up today's neo-liberal
economic orthodoxy: in order to fit into it, a country needs to
privatize state-owned enterprises, maintain low inflation, reduce
the size of government bureaucracy, balance the budget (if not
running a surplus), liberalize trade, deregulate foreign investment,
deregulate capital markets, make their currency convertible, reduce
corruption and privatize pensions. According to him, this is the
only path to success in the new global economy. His Straitjacket
is the only gear suitable for the harsh but exhilarating game
of globalization. Friedman is categorical: 'Unfortunately, this
Golden Straitjacket is pretty much "one-size fits all"
. . . It is not always pretty or gentle or comfortable. But it's
here and it's the only model on the rack this historical season.'
However, the fact is that, had the Japanese
government followed the free-trade economists back in the early
1960s, there would have been no Lexus. Toyota today would, at
best, be a junior partner to some western car manufacturer, or
worse, have been wiped out. The same would have been true for
the entire Japanese economy. Had the country donned Friedman's
Golden Straitjacket early on, Japan would have remained the third-rate
industrial power that it was in the 1960s, with its income level
on a par with Chile, Argentina and South Africa - it was then
a country whose prime minister was insultingly dismissed as 'a
transistor-radio salesman' by the French president, Charles De
Gaulle. In other words, had they followed Friedman's advice, the
Japanese would now not be exporting the Lexus but still be fighting
over who owns which mulberry tree.
Hong Kong became a British colony after the Treaty of Nanking
in 1842, the result of the Opium War... The growing British taste
for tea had created a huge trade deficit with China. In a desperate
attempt to plug the gap, Britain started exporting opium produced
in India to China. The mere detail that selling opium was illegal
in China could not possibly be allowed to obstruct the noble cause
of balancing the books. When a Chinese official seized an illicit
cargo of opium in 1841, the British government used it as an excuse
to fix the problem once and for all by declaring war. China was
heavily defeated in the war and forced to sign the Treaty of Nanking,
which made China 'lease' Hong Kong to Britain and give up its
right to set its own tariffs.
So there it was - the self-proclaimed
leader of the 'liberal' world declaring war on another country
because the latter was getting in the way of its illegal trade
The countries under colonial rule and unequal treaties did very
poorly. Between 1870 and 1913, per capita income in Asia (excluding
Japan) grew at 0.4% per year, while that in Africa grew at 0.6%
per year." The corresponding figures were 1.3% for Western
Europe and 1.8% per year for the USA." It is particularly
interesting to note that the Latin American countries, which by
that time had regained tariff autonomy and were boasting some
of the highest tariffs in the world, grew as fast as the US did
during this period.
While they were imposing free trade on
weaker nations through colonialism and unequal treaties, rich
countries maintained rather high tariffs, especially industrial
tariffs, for themselves.
The history of the first globalization in the late 19th and early
20th centuries has been rewritten today in order to fit the current
neo-liberal orthodoxy. The history of protectionism in today's
rich countries is vastly underplayed, while the imperialist origin
of the high degree of global integration on the part of today's
developing countries is hardly ever mentioned.
During the 1960s and the 1970s, when they were pursuing the 'wrong'
policies of protectionism and state intervention, per capita income
in the developing countries grew by 3.0% annually... Since the
1980S, after they implemented neo-liberal policies, they grew
at only about half the speed seen in the 1960s and the 1970s (1.7%).
Growth failure has been particularly noticeable in Latin America
and Africa, where neo-liberal programmes were implemented more'
thoroughly than in Asia. In the 1960s and the 1970s, per capita
income in Latin America was growing at 3.1% per year, slightly
faster than the developing country average... Since the 1980s,
however, when the continent embraced neo-liberalism, Latin America
has been growing at less than one-third of the rate of the 'bad
old days' [1960s-1970s].
As for Africa, its per capita income grew relatively slowly even
in the 1960s and the 1970s (1-2% a year). But since the 1980s,
the region has seen a fall in living standards. This record is
a damning indictment of the neoliberal orthodoxy, because most
of the African economies have been practically run by the IMF
and the World Bank over the past quarter of a century.
As a result of neo-liberal policies, income inequality has increased
in most countries ... but growth has actually slowed down significantly.
Neo-liberal globalization has failed to deliver on all fronts
of economic life - growth, equality and stability. Despite his,
we are constantly told how neo-liberal globalization has brought
Chile's early experiment with neo-liberalism, led by the so-called
Chicago Boys (a group of Chilean economists trained at the University
of Chicago, one of the centres of neo-liberal economics), was
a disaster. It ended in a terrible financial crash in 1982, which
had to be resolved by the nationalization of the whole banking
sector. Thanks to this crash, the country recovered the pre-Pinochet
level of income only in the late 1980s.
The truth of post-1945 globalization is almost the polar opposite
of the official history. During the period of controlled globalization
underpinned by nationalistic policies between the 1950s and the
1970s, the world economy, especially in the developing world,
was growing faster, was more stable and had more equitable income
distribution than in the past two and a half decades of rapid
and uncontrolled neo-liberal globalization. Nevertheless, this
period is portrayed in the official history as a one of unmitigated
disaster of nationalistic policies, especially in developing countries.
This distortion of the historical record is peddled in order to
mask the failure of neo-liberal policies.
Much of what happens in the global economy is determined by the
rich countries, without even trying. They account for 80% of world
output, conduct 70% of international trade and make 70-90% (depending
on the year) of all foreign direct investments .
The IMF, the World Bank and the WTO (World Trade Organisation)
... are largely controlled by the rich countries ... so they devise
and implement Bad Samaritan policies that those countries want.
The IMF and the World Bank were originally set up in 1944 at a
conference between the Allied forces (essentially the US and Britain),
which worked out the shape of postwar international economic governance.
This conference was held in the New Hampshire resort of Bretton
Woods, so these agencies are sometimes collectively called the
Bretton Woods Institutions (BWIs). The IMF was set up to lend
money to countries in balance of payments crises so that they
can reduce their balance of payments deficits without having to
resort to deflation. The World Bank was set up to help the reconstruction
of war-torn countries in Europe and the economic development of
the post-colonial societies that were about to emerge - which
is why it is officially called the International Bank for Reconstruction
and Development. This was supposed to be done by financing projects
in infrastructure development (e.g., roads, bridges, dams).
Following the Third World debt crisis
of 1982, the roles of both the IMF and the World Bank changed
dramatically. They started to exert a much stronger policy influence
on developing countries through their joint operation of so-called
structural adjustment programmes (SAPs). These programmes covered
a much wider range of policies than what the Bretton Woods Institutions
had originally been mandated to do. The BWIs now got deeply involved
in virtually all areas of economic policy in the developing world.
They branched out into areas like government budgets, industrial
regulation, agricultural pricing, labour market regulation, privatization
and so on. In the 1990s, there was a further advance in this 'mission
creep' as they started attaching so-called governance conditionalities
to their loans. These involved intervention in hitherto unthinkable
areas, like democracy, government decentralization, central bank
independence and corporate governance.
This mission creep raises a serious issue.
The World Bank and the IMF initially started with rather limited
mandates. Subsequently, they argued that they have to intervene
in new areas outside their original mandates, as they, too, affect
economic performance, a failure in which has driven countries
to borrow money from them. However, on this reasoning, there is
no area of our life in which the BWIs cannot intervene. Everything
that goes on in a country has implications for its economic performance.
By this logic, the IMF and the World Bank should be able to impose
conditionalities on everything from fertility decisions, ethnic
integration and gender equality, to cultural values.
The Bad Samaritan rich nations often demand, as a condition for
their financial contribution to IMF packages, that the borrowing
country be made to adopt policies that have little to do with
fixing its economy but that serve the interests of the rich countries
lending the money.
Their [World Bank and IMF] governance
structure severely biases them towards the interests of the rich
countries. Their decisions are made basically according to the
share capital that a country has n other words, they have a one-dollar-one-vote
system. This means that the rich countries, which collectively
control 60% of the voting shares, have an absolute control over
their policies, while the US has a de facto veto in relation to
decisions in the 18 most important areas.
The World Bank's engagement with NGOs (non-governmental organizations)...
the impacts of such consultation are at best marginal. Moreover,
when increasing numbers of NGOs in developing countries are indirectly
funded by the World Bank, the value of such an exercise is becoming
The World Trade Organisation is an international organization
in whose running the developing countries have the greatest say.
Unlike the IMF or the World Bank, it is 'democratic' in the sense
of allowing one country one vote (of course, we can debate whether
giving China, with 1.3 billion people, and Luxembourg, with fewer
than half a million people, one vote each is really 'democratic').
And, unlike in the UN, where the five permanent members of the
Security Council have veto power, no country has a veto in the
WTO. Since they have the numerical advantage, the developing countries
count far more in the WTO than they do in the IMF or the World
Unfortunately, in practice, votes are
never taken, and the organization is essentially run by an oligarchy
comprising a small number of rich countries.
It is a law of competition that people who can do difficult things
which others cannot will earn more profit.
Britain remained a highly protectionist country until the mid-19th
century. In 1820, Britain's average tariff rate on manufacturing
imports was 45-55%, compared to 6-8% in the Low Countries, 8-12%
in Germany and Switzerland and around 20% in France.
Tariffs were however, not the only weapon
in the arsenal of British trade policy. When it came to its colonies,
Britain was quite happy to impose an outright ban on advanced
manufacturing activities that it did not want developed. [Prime
Minister Robert] Walpole banned the construction of new and slitting
steel mills in America, forcing the Americans to specialize in
low value-added pig and bar iron, rather than high value-added
Britain also banned exports from its colonies
that competed with its own products, home and abroad. 3 banned
cotton textile imports from India ('calicoes'), which were then
superior to the British ones. In 1699 it banned the export of
woollen cloth from its colonies to other countries (the Wool Act),
destroying the Irish woolen industry and stifling the emergence
of woollen manufacture in America.
Finally, policies were deployed to encourage
primary commodity production in the colonies. Walpole provided
export subsidies to (on the American side) and abolished import
taxes on (on the British side) raw materials produced in the American
colonies such as hemp, wood and timber. He wanted to make absolutely
sure that the colonists stuck to producing primary commodities
and never emerged as competitors to British manufacturers. Thus
they were compelled to leave the most profitable 'high-tech' industries
in the hands of Britain - which ensured that Britain would enjoy
the benefits of being on the cutting edge of world development.
Once British industries had become internationally competitive,
protection became less necessary and even counter-productive.
Protecting industries that do not need protection any more is
likely to make them complacent and inefficient(as Smith observed.)
Therefore, adopting free trade was now increasingly in Britain's
... By the end of the Napeolenic Wars
in 1815 ... British manufacturers were firmly established as the
most efficient in the world, except in a few limited areas where
countries like Belgium and Switzerland possessed technological
leads. British manufacturers correctly perceived that free trade
was now in their interest and started campaigning for it...
[David] Ricardo's theory ... says that, accepting their current
levels of technology as given, it is better for countries to specialize
in things that they are relatively better at.
His theory fails when a country wants
to acquire more advanced technologies so that it can do more difficult
things that few others can do - that is, when it wants to develop
its economy. It takes time and experience to absorb new technologies,
so technologically backward producers need a period of protection
from international competition during this period of learning.
Such protection is costly, because the country is giving up the
chance to import better and cheaper products. However, it is a
price that has to be paid if it wants to develop advanced industries.
Ricardo's theory is, thus seen, for those who accept the status
quo but not for those who want to change it.
Britain adopted free trade only when it had acquired a technological
lead over its competitors 'behind high and long-lasting tariff
Under British rule, America was given the full British colonial
treatment. It was naturally denied the use of tariffs to protect
its new industries. It was prohibited from exporting products
that competed with British products. It was given subsidies to
produce raw materials.
Moreover, outright restrictions were imposed
on what Americans could manufacture.
Once elected, [Abraham] Lincoln raised industrial tariffs to their
highest level so far in US history. The expenditure for the Civil
War was given as an excuse - in the same way in which the first
significant rise in US tariffs came about during the Anglo-American
War (1812-16). However, after the war, tariffs stayed at wartime
levels or above. Tariffs on manufactured imports remained at 40-50%
until the First World War, and were the highest of any country
in the world.
... Despite being the most protectionist
country in the world throughout the 19th century and right up
to the 1920s, the US was also the fastest growing economy.
... After the Second World War that the
US - with its industrial supremacy now unchallenged - liberalized
its trade and started championing the cause of free trade.
... Even when it shifted to freer (if
not absolutely free) trade, the US government promoted key industries
... namely, public funding of R&D. Between the 1950s and the
mid-1990s, US federal government funding accounted for 50-70%
of the country's total R&D funding, which is far above the
figure of around 20%, found in such 'government-led' countries
as Japan and Korea. Without federal government funding for R&D,
the US would not have been able to maintain its technological
lead over the rest of the world in key industries like computers,
semiconductors, life sciences, the internet and aerospace.
The two champions of free trade, Britain and the US, were not
only not free trade economies, but had been the two most protectionist
economies among rich countries - that is, until they each in succession
became the world's dominant industrial power.
Practically all of today's rich countries used nationalistic policies
(e.g., tariffs, subsidies, restrictions on foreign trade) to promote
their infant industries.
Free trade economists have to explain how free trade can be an
explanation for the economic success of today's rich countries,
when it simply had not been practised very much before they became
Roman Politician and philosopher Cicero
Not to know what has been transacted in
former times is to be always a child. If no use is made of the
labours of past ages, the world must remain always in the infancy
[There is a] gradual and subtle process in which history is re-written
to fit a country's present self-image. As a result, many rich
country people recommend free-trade, free-market policies in
the honest belief that these are policies that their own ancestors
used in order to make their countries rich. When the poor countries
protest that those policies hurt, those protests are dismissed
as being intellectually misguided or as serving the interests
of their corrupt leaders. It never occurs to those Bad Samaritans
that the policies they recommend are fundamentally at odds with
what history teaches us to be the best development policies.
Industries in developing countries will not survive if they are
exposed to international competition too early. They need time
to improve their capabilities by mastering advanced technologies
and building effective organizations. This is the essence of the
infant industry argument, first theorized by Alexander Hamilton,
first treasury secretary of the US, and used by generations of
policy-makers before and after him.
Belief in the virtue of free trade is so central to the neo-liberal
orthodoxy that it is effectively what defines a neo-liberal economist.
You may question (if not totally reject) any other element of
the neo-liberal agenda - open capital markets, strong patents
or even privatisation - and still stay in the neo-liberal church.
However, once you object to free trade, you are effectively inviting
During the past quarter of a century, most developing countries
have liberalized trade to a huge degree. They were first pushed
by the IMF and the World Bank in the aftermath of the Third World
debt crisis of 1982. There was a further decisive impetus towards
trade liberalization following the launch of the WTO in 1995.
During the last decade or so, bilateral and regional free trade
agreements (FTAs) have also proliferated. Unfortunately, during
this period, developing countries have not done well at all, despite
... massive trade liberalization.
The story of Mexico - poster boy of the free-trade camp - is particularly
telling. If any developing country can succeed with free trade,
it should be Mexico. It borders on the largest market in the world
(the US) and has had a free trade agreement with it since 1995
(the North American Free Trade Agreement or NAFTA). It also has
a large diaspora living in the US, which can provide important
informal business links. Unlike many other poorer developing countries,
it has a decent pool of skilled workers, competent managers and
relatively developed physical infrastructure (roads, ports and
Free trade economists argue that free
trade benefited Mexico by accelerating growth. Indeed, following
NAFTA, between 1994 and 2002, Mexico's per capita GDP grew at
1.8% per year, a big improvement over the 0.1% rate recorded between
1985 and 1995. But the decade before NAFTA was also a decade of
extensive trade liberalisation for Mexico, following its conversion
to neo-liberalism in the mid-1980s. So trade liberalization was
also responsible for the 0.1% growth rate. Wide-ranging trade
liberalization in the 1980s and the 1990s wiped out whole swathes
of Mexican industry that had been painstakingly built up during
the period of import substitution industrialization (ISI). The
result was, predictably, a slowdown in economic growth, lost jobs
and falls in wages (as better-paying manufacturing jobs disappeared).
Its agricultural sector was also hard hit by subsidized US products,
especially corn, the staple diet of most Mexicans. On top of that,
NAFTA's positive impact (in terms of increasing exports to the
US market) has run out of steam in the last few years. During
2001-2005, Mexico's growth performance has been miserable, with
an annual growth rate of per capita income at 0.3% (or a paltry
1.7% increase in total over five years). By contrast, during the
'bad old days' of ISI (1955-82), Mexico's per capita income had
grown much faster than during the NAFTA period - at an average
of 3.1% per year. Mexico is a particularly striking example of
the failure of premature wholesale trade liberalization.
Trade liberalization ... has increased the pressures on government
budgets, as it reduced tariff revenues. This has been a particularly
serious problem for the poorer countries. Because they lack tax
collection capabilities and because tariffs are the easiest tax
to collect, they rely heavily on tariffs (which sometimes account
for over 50% of total government revenue). As a result, the fiscal
adjustment that has had to be made following large-scale trade
liberalization has been huge in many developing countries - even
a recent IMF study shows that, in low-income countries that have
limited abilities to collect other taxes, less than 30% of the
revenue lost due to trade liberalization over the last 25 years
has been made up by other taxes. Moreover, lower levels of business
activity and higher unemployment resulting from trade liberalization
have also reduced income tax revenue. When countries were already
under considerable pressure from the IMF to reduce their budget
deficits, falling revenue meant severe cuts in spending, often
eating into vital areas like education, health and physical infrastructure,
damaging long-term growth.
What has happened during the past quarter of a century has been
a rapid, unplanned and blanket trade liberalization. Just to remind
the reader, during the 'bad old days' of protectionist import
substitution industrialization (ISI), developing countries used
to grow, on average, at double the rate that they are doing today
under free trade. Free trade simply isn't working for developing
In developed countries, the welfare state works as a mechanism
to partially compensate the losers from the trade adjustment process
through unemployment benefits, guarantees of health care and education,
and even guarantees of a minimum income. In some countries, such
as Sweden and other Scandinavian countries, there are also highly
effective retraining schemes for unemployed workers so that they
can be equipped with new skills. In most developing countries,
however, the welfare state is very weak and sometimes virtually
non-existent. As a result, the victims of trade adjustment in
these countries do not get even partially compensated for the
sacrifice that they have made for the rest of society.
As a result, the gains from trade liberalization
in poor countries are likely to be more unevenly distributed than
in rich countries. Especially when considering that many people
in developing countries are already very poor and close to the
subsistence level, largescale trade liberalization carried out
in a short period of time will mean that some people have their
livelihoods wrecked. In developed countries, unemployment due
to trade adjustment may not be a matter of life and death, but
in developing countries it often is.
In the long run, free trade is a policy that is likely to condemn
developing countries to specialize in sectors that offer low productivity
growth and thus low growth in living standards. This is why so
few countries have succeeded with free trade, while most successful
countries have used infant industry protection to one degree or
another. Low income that results from lack of economic development
severely restricts the freedom that the poor countries have in
deciding their future. Paradoxically, therefore, 'free' trade
policy reduces the 'freedom' of the developing countries that
... Never mind that free trade works neither
in practice nor in theory. Despite its abysmal record, the Bad
Samaritan rich countries have strongly promoted trade liberalization
in developing since the 1980s.
... In the 1980s ... the US, whose enlightened
approach to international trade with economically lesser nations
rapidly gave way to a system similar to 19th-century British 'free
trade imperialism This new direction was clearly expressed by
the then US president Ronald Reagan in 1986, as the Uruguay Round
of GATT talks was starting, when he called for new and more liberal
agreements with our trading ;partners - agreement under which
they would fully open their markets and treat American products
as they treat their own. Such agreement was realized through the
Uruguay Round of GATT trade talks, which started in the Uruguayan
city of Punta del Este in 1986 and was concluded in the Moroccan
city of Marrakech in 1994. The result was the World Trade Organisation
regime - a new international trade regime that was much more biased
against the developing countries than the GATT regime.
On the surface, the WTO simply created
a 'level playing field' among its member countries, requiring
that everyone plays by the same rule ... Critical to the process
was the adoption of the principle of a 'single undertaking', which
meant that all members had to sign up to all agreements. In the
GATT regime, countries could pick and choose the agreements that
they signed up to and many developing countries could stay out
of agreements that they did not want - for example, the agreement
restricting the use of subsidies. With the single undertaking,
all members had to abide by the same rules. All of them had to
reduce their tariffs. They were made to give up import quotas,
export subsidies (allowed only for the poorest countries) and
most domestic subsidies. But, when we look at the detail, we realize
that the field is not level at all.
To begin with, even though the rich countries
have low average protection, they tend to disproportionately protect
products that poor countries export, especially garments and textiles.
This means that, when exporting to a rich country market, poor
countries face higher, tariffs than other rich countries. An Oxfam
report points out that 'The overall import tax rate for the USA
is 1.6 per cent. That rate rises steeply for a large number of
developing countries: average import taxes range from around four
per cent for India and Peru, to seven per cent for Nicaragua,
and as much as 14-15 per cent for Bangladesh, Cambodia and Nepal."
As a result, in 2002, India paid more tariffs to the US government
than Britain did, despite the fact that the size of its economy
was less than one-third that of the UK. Even more strikingly,
in the same year, Bangladesh paid almost as much in tariffs to
the US government as France, despite the fact that the size of
its economy was only 3% that of France.
... The Uruguay Round resulted in all
countries, except for the poorest ones, reducing tariffs quite
a lot in proportional terms. But the developing countries ended
up reducing their tariffs a lot more in absolute terms, for the
simple reason that they started with higher tariffs. For example,
before the WTO agreement, India had an average tariffs.
... In addition, there were areas where
'levelling the playing field' meant a one-sided benefit to rich
countries. The most important example is the TRIPS (Trade-related
Intellectual Property Rights) agreement, which strengthened the
protection of patents and other intellectual property rights.
Unlike trade in goods and services, where everyone has something
to sell, this is an area where developed countries are almost
always sellers and developing countries buyers. Therefore, increasing
the protection for intellectual property rights means that the
cost is mainly borne by the developing nations.
In the name of 'levelling the playing field', the Bad Samaritan
rich nations have created a new international trading system that
is rigged in their favour. They are preventing the poorer countries
from using the tools of trade and industrial policies that they
had themselves so effectively used in the past in order to promote
their own economic development - not just tariffs and subsidies,
but also regulation of foreign investment and 'violation' of foreign
intellectual property rights.
It may be valuable for some developing countries to get access
to agricultural markets in developed economies.* But it is far
more important that we allow developing countries to use protection,
subsidies and regulation of foreign investment adequately in order
to develop their own economies, rather than giving them bigger
agricultural markets overseas. Especially if agricultural liberalization
by the rich countries can only be 'bought' by the developing countries
giving up their use of the tools of infant industry promotion,
the price is not worth paying. Developing countries should not
be forced to sell their future for small immediate gains.
South Korea is one of the world's industrial powerhouses, while
North Korea languishes in poverty. Much of this is thanks to the
fact that South Korea aggressively traded with the outside world
and actively absorbed foreign technologies while North Korea pursued
its doctrine of self-sufficiency. Through trade, South Korea learned
about the existence of better technologies and earned the foreign
currency that it needed in order to buy them.
... North Korea is technologically stuck
in the past, with 1940s Japanese and 1950s Soviet technologies,
while South Korea is one of the most technologically dynamic economies
in the world
... In the end, economic development is
about acquiring and mastering advanced technologies. In theory,
a country can develop such technologies on. its own, but such
a strategy of technological self-sufficiency quickly hits the
wall, as seen in the North Korean case. This is why all successful
cases of economic development have involved serious attempts to
get hold of and master advanced foreign technologies.
As South Korea shows, active participation in international trade
does not require free trade. Indeed, had South Korea pursued free
trade and not promoted infant industries, it would not have become
a major trading nation. It would still be exporting raw materials
(e.g., tungsten ore, fish, seaweed) or low-technology, low-price
products (e.g., textiles, garments, wigs made with human hair)
that used to be its main export items in the 1960s. The secret
of its success lay in a judicious mix of protection and open trade,
with the areas of protection constantly changing as new infant
industries were developed and old infant industries became internationally
competitive a way, this is not much of a 'secret As I have shown
in the earlier chapters) this is how almost all of today's rich
countries became rich and this is at the root of almost all recent
success stories in the developing world. Protection does not guarantee
development, but development without it is very difficult.
Free trade is not the best path to economic development. Trade
helps economic development only when the country employs a mixture
of protection and open trade, constantly adjusting it according
to its changing needs and capabilities. Trade is simply too important
for economic development to be left to free trade economists.
When economic prospects in a developing country are considered
good, too much foreign financial capital may enter. This can temporarily
raise asset prices (e.g., prices of stocks, real estate prices)
beyond their real value, creating asset bubbles. When things get
bad, often because of the bursting of the very same asset bubble,
foreign capital tends to leave all at the same time, making the
economic downturn even worse. Such 'herd behaviour' was most vividly
demonstrated in the 1997 Asian crises, when foreign capital flowed
out on a massive scale, despite the good long-term prospects of
the economies concerned (Korea, Hong Kong, Malaysia, Thailand
... the impact of herd behaviour by foreign
investors is much greater for the simple reason that developing
country financial markets are tiny relative to the amounts of
money sloshing around the international financial system.
... Developing countries have experienced
more frequent financial crises since many of them opened their
capital markets at the urge of the Bad Samaritans in the 1980s
and the 1990s.
In 1832, Andrew Jackson ... refused to renew the licence for the
quasi-central bank, the second Bank of the USA - the successor
to Hamilton's Bank of the USA. This was done on the grounds that
the foreign ownership share of the bank was too high -30%... Declaring
his decision, Jackson said: 'should the stock of the bank principally
pass into the hands of the subjects of a foreign country, and
we should unfortunately become involved in a war with that country,
what would be our condition? ... Controlling our currency, receiving
our public moneys, and holding thousands of our citizens in dependence,
it would be far more formidable and dangerous than the naval and
military power of the enemy. If we must have a bank ... it should
be purely American? If the president of a developing country said
something like this today, he would be branded a xenophobic dinosaur
and blackballed in the international community.
Gore Vidal, the American writer, once described the American economic
system as 'free enterprise for the poor and socialism for the
rich'. Macroeconomic policy on the global scale is a bit like
that. It is Keynesianism for the rich countries and monetarism
for the poor.
When the rich countries get into recession,
they usually relax monetary policy and increase budget deficits.
When the same thing happens in developing countries, the Bad Samaritans,
through the IMF, force them to raise interest rates to absurd
levels and balance their budgets, or even generate budget surplus
- even if these actions treble unemployment and spark riots in
In 1961, Zaire (now the Democratic Republic of the Congo) was
a desperately poor country with a per capita annual income of
$67. Mobutu Sese Seko came to power in a military coup in 1965
and ruled until 1997. He is estimated to have stolen at least
$15 billion during his 32-year rule.
In that same year, with a per capita annual income of only $49,
Indonesia was even poorer than Zaire. Mohamed Suharto came to
power in a military coup in 1966 and ruled until 1998. He is estimated
to have stolen at least $15 billion during his 32-year rule. Some
suggest the figure may even have been as high as $35 billion.
Unlike what neo-liberals say, market and democracy clash at a
fundamental level. Democracy runs on the principle of one man
(one person), one vote The market runs on the principle of one
dollar, one vote. Naturally, the former gives equal weight to
each person, regardless of the money she/he has. The latter gives
greater weight to richer people. Therefore, democratic decisions
usually subvert the logic of market.
In the long run, economic development brings democracy. But this
broad picture should not obscure the fact that some countries
have sustained democracy even when they were fairly poor, while
many others have not become democracies until they are very rich.
Without people actually fighting for it, democracy does not automatically
grow out of economic prosperity.
Investment in capability-building requires short-term sacrifices.
But that is not a reason not to do it, contrary to what free-trade
economists say. In fact, we often see individuals making short-term
sacrifices for a long-term increase in their capacities, and heartily
approve of them. Suppose a low-skilled worker quits his lowpaying
job and attends a training course to acquire new skills. If someone
were to say the worker is making a big mistake because he is now
not able to earn even the low wage he used to earn, most of us
would criticize that person for being short-sighted; an increase
in a person's future earning power justifies such short-term sacrifice.
Likewise, countries need to make short-term sacrifices if they
are to build up their long-term productive capabilities. If tariff
barriers or subsidies allow domestic firms to accumulate new abilities
- by buying better machinery, improving their organization and
training their workers - and become internationally competitive
in the process, the temporary reduction in the country's level
of consumption (because it is refusing to buy higher-quality,
lower-price foreign goods) may be totally justified.
This simple but powerful principle - sacrificing
the present to improve the future - is why the Americans refused
to practise free trade in the 19th century. It is why Finland
did not want foreign investment until recently. It is why the
Korean government set up steel mills in the late 1960s, despite
the objections of the World Bank. It is why the Swiss did not
issue patents and the Americans did not protect foreigners' copyrights
until the late 19th century.
... It took the US 130 years to develop
its economy enough to feel confident about doing away with tariffs.
Without such long time horizons, Japan might still be mainly exporting
silk, Britain wool and the US cotton.
Unfortunately, these are time frames that
are not compatible with the neo-liberal policies recommended by
the Bad Samaritans. Free trade demands that poor countries compete
immediately with more advanced foreign producers, leading to the
demise of firms before they can acquire new capabilities. A liberal
foreign investment policy, which allows superior foreign firms
into a developing country, will, in the long run, restrict the
range of capabilities accumulated in local firms, whether independent
or owned by foreign companies. Free capital markets, with their
pro-cyclical herd behaviour, make longterm projects vulnerable.
A high interest rate policy raises the 'price of future', so to
speak, making long-term investment unviable. No wonder neo-liberalism
makes economic development difficult - it takes the acquisition
of new productive capabilities difficult.
History has repeatedly shown that the single most important thin
that distinguishes rich countries from poor ones is basically
their higher capabilities in manufacturing, where productivity
is generally higher, and, more importantly, where productivity,
tends to grow faster than in agriculture or services.
Over the past quarter of a century, the Bad Samaritans have made
it increasingly difficult for developing countries to pursue the
'right' policies for their development. They have used the Unholy
Trinity of the IMF, the World Bank and the WTO, the regional multilateral
financial institutions, their aid budgets and bilateral and regional
free-trade or investment agreements in order to block them from
doing so. They argue that nationalist policies (like trade protection
and discrimination against foreign investors) should be banned,
or severely curtailed, not only because they are supposed to be
bad for the practising countries themselves but also because they
lead to 'unfair' competition.
... Global economic competition is a game
of unequal players. It pits against each other countries that
range from, as we development economists like to say, Switzerland
to Swaziland. Consequently, it is only fair that we 'tilt the
playing field' in favour of the weaker countries. In practice,
this means allowing them to protect and subsidize their producers
more vigorously and to put stricter regulations on foreign investment.*
These countries should also be allowed to protect intellectual
property rights less stringently so that they can more actively
'borrow' ideas from more advanced countries. Rich countries can
further help by transferring their technologies on favourable
terms; this will have the added benefit of making economic growth
in poor countries more compatible with the need to fight global
warming, as rich country technologies tend to be far more energy
John Maynard Keynes, when accused of inconsistency
"When the facts change, I change
my mind - what do you do, sir?"
Many Bad Samaritans go along with wrong policies for the simple
reason that it's easier to be a conformist. Why go around looking
for 'inconvenient truths' when you can just accept what most politicians
and newspapers say? Why bother to find out what is really going
on in poor countries when you can easily blame it on corruption,
laziness or the profligacy of their people? Why go out of your
way to check up on your own country's history when the 'official'
version suggests that it has always been the home of all virtues?
- free trade, creativity, democracy, prudence, you name it.