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Issue 136 , July 2007
Protecting the global poor
by Ha-Joon Chang

Almost all rich countries got wealthy by protecting infant industries
and limiting foreign investment. But these countries are now denying
poor ones the same chance to grow by forcing free-trade rules on them
before they are strong enough

Ha-Joon Chang's book Bad Samaritans-Rich Nations, Poor Policies and
the Threat to the Developing World is published by Random House on 5th
July


Once upon a time, the leading car-maker of a developing country
exported its first passenger cars to the US. Until then, the company
had only made poor copies of cars made by richer countries. The car
was just a cheap subcompact ("four wheels and an ashtray") but it was
a big moment for the country and its exporters felt proud.

Unfortunately, the car failed. Most people thought it looked lousy,
and were reluctant to spend serious money on a family car that came
from a place where only second-rate products were made. The car had to
be withdrawn from the US. This disaster led to a major debate among
the country's citizens. Many argued that the company should have stuck
to its original business of making simple textile machinery. After
all, the country's biggest export item was silk. If the company could
not make decent cars after 25 years of trying, there was no future for
it. The government had given the car-maker every chance. It had
ensured high profits for it through high tariffs and tough controls on
foreign investment. Less than ten years earlier, it had even given
public money to save the company from bankruptcy. So, the critics
argued, foreign cars should now be let in freely and foreign
car-makers, who had been kicked out 20 years before, allowed back
again. Others disagreed. They argued that no country had ever got
anywhere without developing "serious" industries like car production.
They just needed more time.

The year was 1958 and the country was Japan. The company was Toyota,
and the car was called the Toyopet. Toyota started out as a
manufacturer of textile machinery and moved into car production in
1933. The Japanese government kicked out General Motors and Ford in
1939, and bailed out Toyota with money from the central bank in 1949.
Today, Japanese cars are considered as "natural" as Scottish salmon or
French wine, but less than 50 years ago, most people, including many
Japanese, thought the Japanese car industry simply should not exist.

 Half a century after the Toyopet debacle, Toyota's luxury brand Lexus
has become an icon of globalisation, thanks to the American journalist
Thomas Friedman's book The Lexus and the Olive Tree. The book owes its
title to an epiphany that Friedman had in Japan in 1992. He had paid a
visit to a Lexus factory, which deeply impressed him. On the bullet
train back to Tokyo, he read yet another newspaper article about the
troubles in the middle east, where he had been a correspondent. Then
it hit him. He realised that "half the world seemed to be. intent on
building a better Lexus, dedicated to modernising, streamlining and
privatising their economies in order to thrive in the system of
globalisation. And half of the world-sometimes half the same country,
sometimes half the same person-was still caught up in the fight over
who owns which olive tree."

According to Friedman, countries in the olive-tree world will not be
able to join the Lexus world unless they fit themselves into a
particular set of economic policies he calls "the golden
straitjacket." In describing the golden straitjacket, Friedman pretty
much sums up today's neoliberal orthodoxy: countries should privatise
state-owned enterprises, maintain low inflation, reduce the size of
government, balance the budget, liberalise trade, deregulate foreign
investment and capital markets, make the currency convertible, reduce
corruption and privatise pensions. The golden straitjacket, Friedman
argues, is the only clothing suitable for the harsh but exhilarating
game of globalisation.

However, 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 a western car
manufacturer and Japan would have remained the third-rate industrial
power it was in the 1960s-on the same level as Chile, Argentina and
South Africa.

Had it just been Japan that became rich through the heretical policies
of protection, subsidies and the restriction of foreign investment,
the free-market champions might be able to dismiss it as the exception
that proves the rule. But Japan is no exception. 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 contradict today's orthodoxy.

In 1721, Robert Walpole, the first British prime minister, launched an
industrial programme that protected and nurtured British manufacturers
against superior competitors in the Low Countries, then the centre of
European manufacturing. Walpole declared that "nothing so much
contributes to promote the public wellbeing as the exportation of
manufactured goods and the importation of foreign raw material."
Between Walpole's time and the 1840s, when Britain started to reduce
its tariffs (although it did not move to free trade until the 1860s),
Britain's average industrial tariff rate was in the region of 40-50
per cent, compared with 20 per cent and 10 per cent in France and
Germany respectively.

The US followed the British example. In fact, the first systematic
argument that new industries in relatively backward economies need
protection before they can compete with their foreign rivals-known as
the "infant industry" argument-was developed by the first US treasury
secretary, Alexander Hamilton. In 1789, Hamilton proposed a series of
measures to achieve the industrialisation of his country, including
protective tariffs, subsidies, import liberalisation of industrial
inputs (so it wasn't blanket protection for everything), patents for
inventions and the development of the banking system.

Hamilton was perfectly aware of the potential pitfalls of infant
industry protection, and cautioned against taking these policies too
far. He knew that just as some parents are overprotective, governments
can cosset infant industries too much. And in the way that some
children manipulate their parents into supporting them beyond
childhood, there are industries that prolong government protection
through clever lobbying. But the existence of dysfunctional families
is hardly an argument against parenting itself. Likewise, the examples
of bad protectionism merely tell us that the policy needs to be used
wisely.

In recommending an infant industry programme for his young country,
Hamilton, an impudent 35-year-old finance minister with only a liberal
arts degree from a then second-rate college (King's College of New
York, now Columbia University) was openly ignoring the advice of the
world's most famous economist, Adam Smith. Like most European
economists at the time, Smith advised the Americans not to develop
manufacturing. He argued that any attempt to "stop the importation of
European manufactures" would "obstruct. the progress of their country
towards real wealth and greatness."

Many Americans-notably Thomas Jefferson, secretary of state at the
time and Hamilton's arch-enemy-disagreed with Hamilton. They argued
that it was better to import high-quality manufactured products from
Europe with the proceeds that the country earned from agricultural
exports than to try to produce second-rate manufactured goods. As a
result, congress only half-heartedly accepted Hamilton's
recommendations-raising the average tariff rate from 5 per cent to
12.5 per cent.

In 1804, Hamilton was killed in a duel by the then vice-president
Aaron Burr. Had he lived for another decade or so, he would have seen
his programme adopted in full. Following the Anglo-American war in
1812, the US started shifting to a protectionist policy; by the 1820s,
its average industrial tariff had risen to 40 per cent. By the 1830s,
America's average industrial tariff rate was the highest in the world
and, except for a few brief periods, remained so until the second
world war, at which point its manufacturing supremacy was absolute.

Britain and the US were not the only practitioners of infant industry
protection. Virtually all of today's rich countries used policy
measures to protect and nurture their infant industries. Even when the
overall level of protection was relatively low, some strategic sectors
could get very high protection. For example, in the late 19th and
early 20th centuries, Germany, while maintaining a relatively moderate
average industrial tariff rate (5-15 per cent), accorded strong
protection to industries like iron and steel. During the same period,
Sweden provided high protection to its emerging engineering
industries, although its average tariff rate was 15-20 per cent. In
the first half of the 20th century, Belgium maintained moderate levels
of overall protection but heavily protected key textile sectors and
the iron industry.

Tariffs were not the only tool of trade policy used by rich countries.
When deemed necessary for the protection of infant industries, they
banned imports or imposed import quotas. They also gave export
subsidies-sometimes to all exports (Japan and Korea) but often to
specific items (in the 18th century, Britain gave export subsidies to
gunpowder, sailcloth, refined sugar and silk). Some of them also gave
a rebate on the tariffs paid on the imported industrial inputs used
for manufacturing export goods, in order to encourage such exports.
Many believe that this measure was invented in Japan in the 1950s, but
it was in fact invented in Britain in the 17th century.

It is not just in the realm of trade that the historical records of
today's rich countries burst the bindings of Friedman's golden
straitjacket. The history of controls on foreign investment tells a
similar story. In the 19th century, the US placed restrictions on
foreign investment in banking, shipping, mining and logging. The
restrictions were particularly severe in banking; throughout the 19th
century, non-resident shareholders could not even vote in a
shareholders' meeting and only American citizens could become
directors in a national (as opposed to state) bank.

Some countries went further than the US. Japan closed off most
industries to foreign investment and imposed 49 per cent ownership
ceilings on the others until the 1970s. Korea basically followed this
model until it was forced to liberalise after the 1997 financial
crisis. Between the 1930s and the 1980s, Finland officially classified
all firms with more than 20 per cent foreign ownership as "dangerous
enterprises." It was not that these countries were against foreign
companies per se-after all, Korea actively courted foreign investment
in export processing zones. They restricted foreign investors because
they believed-rightly in my view-that there is nothing like learning
how to do something yourself, even if it takes more time and effort.

The wealthy nations of today may support the privatisation of
state-owned enterprises in developing countries, but many of them
built their industries through state ownership. At the beginning of
their industrialisation, Germany and Japan set up state-owned
enterprises in key industries-textiles, steel and shipbuilding. In
France, the reader may be surprised to learn that many household
names-like Renault (cars), Alcatel (telecoms equipment), Thomson
(electronics) and Elf Aquitaine (oil and gas)-have been state-owned
enterprises. Finland, Austria and Norway also developed their
industries through extensive state ownership after the second world
war. Taiwan has achieved its economic "miracle" with a state sector
more than one-and-a-half times the size of the international average,
while Singapore's state sector is one of the largest in the world, and
includes world-class companies like Singapore Airlines.

Of course, there were exceptions. The Netherlands and pre-first world
war Switzerland did not adopt many tariffs or subsidies. But they did
deviate from today's free-market orthodoxy in another, very important
way-they refused to protect patents. Switzerland did not have patents
until 1888 and did not protect chemical inventions until 1907. The
Netherlands abolished its 1817 patent law in 1869, on the grounds that
patents created artificial monopolies that went against the principle
of free competition. It did not reintroduce a patent law until 1912,
by which time Philips was firmly established as a leading producer of
lightbulbs, whose production technology it "borrowed" from Thomas
Edison.

Even countries that did have patent laws were lax about protecting
intellectual property (IP) rights-especially those of foreigners. In
most countries, including Britain, Austria, France and the US,
patenting of imported inventions was explicitly allowed in the 19th
century.

Despite this history of protection, subsidy and state ownership, the
rich countries have been recommending to, or even forcing upon,
developing countries policies that go directly against their own
historical experience. For the past 25 years, rich countries have
imposed trade liberalisation on many developing countries through IMF
and World Bank loan conditions, as well as the conditions attached to
their direct aid. The World Trade Organisation (WTO) does allow some
tariff protection, especially for the poorest developing countries,
but most developing countries have had to significantly reduce tariffs
and other trade restrictions. Most subsidies have been banned by the
WTO-except, of course, the ones that rich countries still use, such as
on agriculture, and research and development. And while, of course, no
poor country is obliged to accept foreign inward investment (and most
receive none or very little) the IMF and the World Bank are always
lobbying for more liberal foreign investment rules. The WTO has also
tightened IP laws, asking all but the poorest developing countries to
comply with US standards-which even many Americans consider excessive.

Why are they doing this? In 1841, Friedrich List, a German economist,
criticised Britain for preaching free trade to other countries when
she had achieved her economic supremacy through tariffs and subsidies.
He accused the British of "kicking away the ladder" that they had
climbed to reach the world's top economic position. Today, there are
certainly some people in rich countries who preach free trade to poor
countries in order to capture larger shares of the latter's markets
and to pre-empt the emergence of possible competitors. They are
saying, "Do as we say, not as we did," and act as bad samaritans,
taking advantage of others in trouble. But what is more worrying is
that many of today's free traders do not realise that they are hurting
the developing countries with their policies. History is written by
the victors, and it is human nature to reinterpret the past from the
point of view of the present. As a result, the rich countries have
gradually, if often sub-consciously, rewritten their own histories to
make them more consistent with how they see themselves today, rather
than as they really were.

But the truth is that free traders make the lives of those whom they
are trying to help more difficult. The evidence for this is
everywhere. Despite adopting supposedly "good" policies, like liberal
foreign trade and investment and strong patent protection, many
developing countries have actually been performing rather badly over
the last two and a half decades. The annual per capita growth rate of
the developing world has halved in this period, compared to the "bad
old days" of protectionism and government intervention in the 1960s
and the 1970s. Even this modest rate has been achieved only because
the average includes China and India-two fast-growing giants, which
have gradually liberalised their economies but have resolutely refused
to put on Thomas Friedman's golden straitjacket.

Growth failure has been particularly noticeable in Latin America and
Africa, where orthodox neoliberal programmes were implemented more
thoroughly than in Asia. In the 1960s and the 1970s, per capita income
in Latin America grew at 3.1 per cent a year, slightly faster than the
developing-country average. Brazil especially was growing almost as
fast as the east Asian "miracle" economies. Since the 1980s, however,
when the continent embraced neoliberalism, Latin America has been
growing at less than a third of this rate. Even if we discount the
1980s as a decade of adjustment and look at the 1990s, we find that
per capita income in the region grew at around half the rate of the
"bad old days" (3.1 per cent vs 1.7 per cent). Between 2000 and 2005,
the region has done even worse; it virtually stood still, with per
capita income growing at only 0.6 per cent a year. As for Africa, its
per capita income grew relatively slowly even in the 1960s and the
1970s (1-2 per cent a year). But since the 1980s, the region has seen
a fall in living standards. There are, of course, many reasons for
this failure, but it is nonetheless 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.

In pushing for free-market policies that make life more difficult for
poor countries, the bad samaritans frequently deploy the rhetoric of
the "level playing field." They argue that developing countries should
not be allowed to use extra policy tools for protection, subsidies and
regulation, as these constitute unfair competition. Who can disagree?

Well, we all should, if we want to build an international system that
promotes economic development. A level playing field leads to unfair
competition when the players are unequal. Most sports have strict
separation by age and gender, while boxing, wrestling and
weightlifting have weight classes, which are often divided very
finely. How is it that we think a bout between people with more than a
couple of kilos' weight difference is unfair, and yet we accept that
the US and Honduras should compete economically on equal terms?

Global economic competition is a game of unequal players. It pits
against each other countries that range from 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 subsidise their producers more vigorously, and to put
stricter regulations on foreign investment. These countries should
also be allowed to protect IP rights less stringently, so that they
can "borrow" ideas from richer countries. 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-efficient.

I am not against markets, international trade or globalisation. And I
acknowledge that WTO agreements contain "special and differential
treatment" provisions which give poor country members certain rights,
and which permit rich countries to treat developing countries more
favourably than other rich WTO members. But these provisions are
limited and generally just give poor countries longer time periods to
liberalise their economic rules. The default position remains blind
faith in indiscriminate free trade.

The best way to illustrate my general point is to look at my own
native Korea-or, rather, to contrast the two bits that used to be one
country until 1948. It is hard to believe today, but northern Korea
used to be richer than the south. Japan developed the north
industrially when it ruled the country from 1910-45. Even after the
Japanese left, North Korea's industrial legacy enabled it to maintain
its economic lead over South Korea well into the 1960s.

Today, 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
to buy them. In its own way, North Korea has managed some
technological feats. For example, it figured out a way to mass-produce
vinalon, a synthetic fibre made out of limestone and anthracite, which
has allowed it to be self-sufficient in clothing. But, overall, 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 mastering advanced
technologies. In theory, a country can develop such technologies on
its own, but 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
advanced foreign technologies. But in order to be able to import
technologies from developed countries, developing nations need foreign
currency to pay for them. Some of this foreign currency may be
provided through foreign aid, but most has to be earned through
exports. Without trade, therefore, there will be little technological
progress and thus little economic development.

But there is a huge difference between saying that trade is essential
for economic development and saying that free trade is best. It is
this sleight of hand that free-trade economists have so effectively
deployed against their opponents-if you are against free trade, they
imply, you must be against trade itself, and so against economic
progress.

As South Korea-together with Britain, the US, Japan, Taiwan and many
others-shows, active participation in international trade does not
require free trade. In the early stages of their development, these
countries typically had tariff rates in the region of 30-50 per cent.
Likewise, the Korean experience shows that actively absorbing foreign
technologies does not require a liberal foreign investment policy.

Indeed, had South Korea donned Friedman's golden straitjacket in the
1960s, it would still be exporting raw materials like tungsten ore and
seaweed. The secret of its success lay in a mix of protection and open
trade, of government regulation and free(ish) market, of active
courting of foreign investment and draconian regulation of it, and of
private enterprise and state control-with the areas of protection
constantly changing as new infant industries were developed and old
ones became internationally competitive. This is how almost all of
today's rich countries became rich, and it is at the root of almost
all recent success stories in the developing world.

Therefore, if they are genuinely to help developing countries develop
through trade, wealthy countries need to accept asymmetric
protectionism, as they used to between the 1950s and the 1970s. The
global economic system should support the efforts of developing
countries by allowing them to use more freely the tools of infant
industry promotion-such as tariff protection, subsidies, foreign
investment regulation and weak IP rights.

There are huge benefits from global integration if it is done in the
right way, at the right speed. But if poor countries open up
prematurely, the result will be negative. Globalisation is too
important to be left to free-trade economists, whose policy advice has
so ill served the developing world in the past 25 years.