Sunday 26 July 2009

The myth of Free Trade

The Myth of Free Trade
HA-Joon Chang
South Korea
President Park launched the ambitious Heavy and Chemical Industrialization (HCI) in 1973. the first steel mill, the first modern shipyard and the first locally designed cars (made mostly from imported parts rolled off the production lines. Park’s apparently delusional goal of $ 1000 per capita income by 1981 was actually achieved five years before the time. Korea became one of the most innovative nation, actually one of the top five in terms of the patents granted annually by the US Patent office.
The country’s obsession with economic development was reflected in education. They learned that it was their duty to report anyone smoking foreign cigarettes.
For most economists, the reason for Korea’s spectacular success has been its adoption of the free market, low inflation, small government, private enterprise, free trade, friendliness towards foreign investment; neo-liberal economics, which is an updated version of the liberal economics of the 18th century CE economist John Adams. It first emerged in 1960s and gradually became the dominant thought in the Western world.
18th and 19th CE economists believed that unlimited competition was the best way, because it forced every one to perform with maximum efficiency. Government intervention was harmful as it reduced competition restricting entry of competitors. And despite a whole series of disappointing results of the policies applied in LDCs, the agenda of deregulation, privatization and open international trade and investment has remained the same since the 1980s.
The agenda has been pushed on LDCs by an unholy alliance of rich countries led by the US and the ‘Unholy Trinity’ of IMF, WB and WTO. The rich governments use their ‘aid’ and access to their home markets to induce LDCs to adopt neo-liberal policies. WTO makes rules which favor trade in areas in which rich countries are strong, but not where they are weak (Textiles and Agriculture).. These groups and governments are supported by ideologues, some of whom are highly trained academics, who know the limits of free trade but chose to ignore them, when it is in the interest of rich country corporations, as they did when they advised the former communist countries in the 1990s. the governments and international body combine form a propaganda machine backed by money and power.
During the ‘miracle’ years, Korea did not follow neo-liberal policies but nurtured new industries in a consultative partnership with the private sector supported by tariff and subsidy protection, marketing information supplied by the government export industry until they ‘grew up’ to stand international competition. Some big projects like Steel POSCO were undertaken directly by the state.
The government had absolute control over foreign exchange, violation of controls could be punished with death penalty. The government heavily controlled foreign investment as well, welcoming it with open arms in certain areas, and shutting it out in others. It also had a ‘permissive’ attitude towards patents, allowing ‘reverse engineering’.
The popular impression that it was due to free trade was created by Korea’s export success, but as shown by Japan and China, export success does not require free trade. Tariffs and subsidies were not there to shield industries forever. The Korean miracle was the result of a clever and pragmatic combination of market incentives and state control.
Practically all of the DCs of today, including the US and Britain, became rich on the basis of regulated markets. They used protection and subsidies, while discriminating against foreign investors.
In 1841, a German economist Friedrich List criticized Britain for preaching free trade to other countries, while keeping high tariffs and subsidies at home, accusing it of ‘kicking away the ladder’ after climbing to the top of the world’s economic position. Today rich countries preach free trade to poor ones in order to capture a large share in their markets and pre-empt emergence of competitors. The history of capitalism has been rewritten that most of the people in rich countries do not perceive the historical double standards in recommending free trade to poor countries. History is written by victors and they reinterpret the past for their own interest, in the same way as people write of renaissance Italy, a country which did not exist until 1871, or include the French speaking Norman conqueror kings in the list of ‘English’ kings.
The ‘historical’ facts that Britain and the US are homes of free trade are wrong.
For starters:
-Free trade reduces freedom of choice of poor countries
-Keeping certain foreign companies is good for them
-long term investment is better
-Some of the best firms are owned and run by the state.
-Borrowing ideas from foreigners is essential
-Low inflation and austerity may actually be harmful for economic development.
-corruption exists because of too much free market.
-Free market and democracy are not natural partners.
-Countries people are lazy, because they are poor not the other way round.
Chap 1: Myths of Globalization
Once upon a time, the leading car maker of a LDC exported its first passenger car to the USA. To most people, it looked lousy. The car was withdrawn from the US market. People thought that the company should have stuck to making simple textile machinery. The home country had had given the car maker every opportunity to succeed, high tariffs, Draconian controls over foreign investment in the car industry, even public money to save it from bankruptcy. Critics argued that foreign car companies kicked out 20 years ago should be allowed back in.
The year was 1968, the country was Japan, the company was Toyota, the car was Toyopet. The company started ad textile machinery producer and moved into cars in 1933. the government had kicked out GM and Ford and had bailed out Toyota in 1949.
50 years ago, most people, including Japanese thought the Japanese car industry was not viable. 50 years on Lexus has become an icon of globalization. According to Freedman, unless the LDCs fit themselves into a particular set of economic policies, they would stay in the Olive tree world (1)privatize, low inflation, reduce government, balance budget, liberalize trade, deregulate foreign investment, capital markets, make currency convertible, reduce corruption, privatize pensions (2).
Had the Japanese government followed the free trade economists in the 1960s, there would have been no Lexus. Toyota would, at best. Be a minor partner of to a Western car manufacturer, and the same would have been the fate of the entire Japanese economy. Japan would have remained a third rate economic power it was in the 1960s, a country whose PM was insultingly dismissed by De Gaulle as a ‘transistor-radio salesman (5-He asked LBJ, then Kennedy’s VP ‘what have you come to learn”).
According to the official history of Globalization, it has progressed over the last 300 hundreds years; Britain adopted free market and free trade in the 18th century CE, well ahead of others, By the middle of the 19th century CE, the success of the policies had become so obvious that other countries started liberalizing trade and adopting free market policies. The liberal world order perfected by Britain around 1870 CE, was based on laissez-faire at home, low barriers to international flow of goods, capital and labor, macroeconomic stability assured by sound money and balanced budgets
After WW I, things started going wrong. In 1930, in response to economic instability, the US began raising trade barriers, enacted the Smoot-Hawley tariffs, other countries like Germany and Japan, unwisely followed, created cartel which promoted fascism and aggression. In 1932, hitherto the champion of free trade threw in the towel and reintroduced tariffs. The resulting contraction and instability of economy, and the WW II, destroyed what was left of the first liberal order.
Post WW II, the economy was reorganized on liberal lines, this time under American hegemony, but state intervention and protectionism persisted in LDCs and communist countries.
Fortunately anti-liberal policies were cast aside across the world since the 1980s. by 1970s, the import substitution industrialization (ISI) in LDCs based on tariffs, protectionism, regulation and subsidies, was too obvious a failure to ignore.
After the 1982 third world debt crisis, many LDCs abandoned the illiberal policies and embraced ne0-liberalism. The crowning glory of the policy was the collapse of communism in 1989.
The policy changes were made all the more necessary due to the hugely fast pace of transport and communication technologies. The possibility of entering mutually beneficial economic partnerships with faraway countries, though trade and investment.
Reflecting the enveloping global economic integration, the governance system has been upgraded, GATT to WTO in 1995 which pushes for liberalization in foreign investment and intellectual property rights (not deregulation, but more regulation). Globalized world economy is compared to the ‘golden age’ of 1870-1930, and Renato Ruggiero, the first director general of the WTO, talked of eradicating poverty in early 21st century CE (I suppose 2008-9 crisis is a foretaste of the good times to come).
Globalization: the Real History.
Democratic elections in Hong Kong had only been allowed in 1994, 152 years after the British seized it, yet when the British governor Christopher Patten, handed it back to China on June 30, 1997, they loudly worried about the fate of democracy.
The growing British taste for tea had created a huge trade deficit with China. The British started exporting opium to China where, incidentally it was illegal to do so, but a little detail like that has never worried imperialists. The Chinese government seized an illicit cargo of opium in 1941, the British declared war. China defeated and had to sign the humiliating Treaty of Nanking, ‘lease’ Hong Kong, and surrender its right to set up its own tariffs, and accept the imposed 3-5% tariff rate.. The first episode of globalization, the free movement of goods, people and money inducted under British hegemony between 1870 and 1913, was possible due to British arms, and not by market forces (9).
The fact that they forced ‘free’ trade down other countries throats by colonialism and unequal treaties, is hardly mentioned in pro-globalization books. Even Niall Ferguson, the British historian, who honestly notes the many misdeeds of the British in his book, Empire, fights shy of blaming his people, saying that it was arguably the cheapest way of assuring free trade, which ‘benefited’ every one. But between 1870 and 1913, per capita income in Asia (excluding Japan) grew by 0.4% per year and that of at 0.6% (11), while the Latin American countries which had regained tariff autonomy and imposed some of the highest tariffs in the world grew as fast as the US did in the period (13).
Rich countries maintained high tariffs while forcing free trade and discriminatory treaties on the poor ones. Britain was the most protectionist state in till mid 19th century CE. Low tariffs did obtain, zero in Britain, briefly in the eighties and free trade did exist, but briefly in Europe, but from 1880s, tariffs went up again, to protect their agriculture from the new world and to promote their emerging heavy and chemical industries (14).Britain reintroduced tariffs in 1932, in response to the decline in its economic supremacy.
The rich countries did lower their tariffs between 1950s and 1970s, but even during this period they used policies to promote their own industry and economic development by subsidies in R&D , state owned enterprises, guidance of banking credits and capital controls US gives billions to large scale farms ($3 billion to 25,000 farmers in 2008). When they started imposing neo-lib policies in real earnest their growth rate fell from 3.2% a year in 1960s to 0970s, to 2.1% in the next two decades (15).
Post war era is described as that of disasters for LDCs, due to ‘wrong’ policies, they suppressed agriculture, mineral extraction and labor intensive manufacturing and indulged in aping industrialized countries, like Indonesia producing subsidized jet aeroplanes. The LDCs won the right to ‘asymmetric protection’ in 1964 GATT, was compared to the proverbial rope to hang with by Jeffery Sachs and Andrew Warner (16). Gustvo Franco, president of the Brazilian Central bank (1997-99) went further to undo forty years of stupidity” and the choice was “to be neo-liberal of neo-idiotic (17- find if he went to Chicago).
During the period of ‘wrong’ policies, LDCs per capita income grew by 3% annually (18).According to Professor Ajit Singh, it was the period of industrial revolution in the third World” (19). After they adopted neo-liberal policies in the 1980s, they grew only at 1.7%. Growth slowed in the rich countries but much less so (3.2 to 2.1%). Growth failures were much worse in Latin America and Africa, where neo-liberal policies were imposed more thoroughly than in Asia. Latin America grew at half the rate of bad old days in 1990s (1.7 vs. 3.1%) and has been at 0.6% in 2000 and 2005 ((21).
Africa grew slowly ( 1-2%) even in 1960s and 1970s, but since 1980s, its living standards have fallen further.
Accelerating growth, even at the cost of inequality was the proclaimed goal. The latter was achieved, but latter has not. Economic instability has markedly increased, thus making a triad of failures of neo-liberalism in=growth, equality and stability.
The only successes have been the ‘miracle’ economies of East Asia-Taiwan, Singapore, which combined state enterprises with control on foreign investment and foreign ownership and capital flow.
China and India, more recent entrants to the ranks of success, show the wisdom of strategic, rather than unconditional integration with global economy, based on national priorities as the US did in mid-19th Century CE, and Japan did in mid- 20th century CE, followed by South Korea. China used high tariffs to the 1990s. It has opened up a bit more lately, but it still imposes ceiling on foreign ownership and local content requirements.
India’s growth acceleration began in the 1980s, well before the ‘open policies’ of 1990s (23). Its average manufacturing tariffs remained above 30% (now 25%) well above neo-liberal standards. I has imposed severe restrictions on FDI and local content requirements.
Chile adopted the neo-liberal policies under the direction of ‘Chicago boys’ even before the US and the UK did, after the 8/11/1973 coup, which killed thousands jailed many more, and threw a lot more into destitution, did grow, but not at the rate Asian Tigers did (24).
Chile’s early experiments with neo-liberal policies enunciated by Friedman and led by his acolytes resulted in the 1982 financial crash when the whole banking sector had to be nationalized and the country only regained pre coup level of income only in 1985 (25). The country only started doing well only when the country provided help in overseas marketing and R&D (26), and used capital controls in 1990s. the country has lost a lot of industries in the last three decades and has become highly dependent on natural resources.
The official history post 1945 globalization is illusory. During the period of controlled integration with world economy in 1950s to 1970s, the world economy grew faster especially in third world countries.
Who is Running the World Economy:
Rich countries account for 80% of world output, 70% of international trade, and 70-90% of all FDI. (27). They, therefore, determine what happens in global economy, even without trying. They induce LDCs to adopt particular policies by making them a condition for foreign aid or preferential trade agreements. Even more important are the actions of the ‘Unholy Trinity’ (UHT)-the IMF, the WB and the WTO, all controlled by and obliged to follow the policies and directives of the rich countries.
The WB and the IMF, were set up in 1944 at a conference between the allied forces, dominated by the US and the UK, at Bretton Woods in New Hampshire, USA, the latter to lend money to countries suffering from balance of payment crises to reduce balance of payment deficit with out resorting to deflation. The former was to help reconstruct the war devastated economies of Europe and the colonist ravaged economies of the newly independent countries, that is why its official designation is International Bank for Reconstruction and Development, to be done by financing infrastructure development.
The roles of both changed following the third world Crisis of 1982. They started exerting a much stronger policy influence (bullying) on the LDCs, through their joint program called Structural Adjustment programs (SAPs). Exceeding their Bretton Woods mandates, they got deeply involved in virtually all areas of economic policies of the LDCs-government budgets, industrial regulation, agricultural pricing, labor market regulation and privatization etc. in the 1990s the ‘mission creep’ advanced further and they started attaching conditionalities to the loans like democracy, decentralization, central bank independence and corporate governance.
The UHTs argued that they had to exceed their original mandate into areas, which had driven the countries to ask for loans. The logical extension of the argument is that the UHT could interfere with all aspects of national life-fertility, ethnic integration and cultural values. The only relevant conditionalities are the ones related to the repayment of the loan.
Rich countries demand as a condition of funding IMF that it include conditions in its loan packages which have little to do with improving the recipient’s economy, but everything to do with donor’s interests like the US and Japan tried to get south Korea to adopt-lifting of trade barriers to specific Japanese and US products, open up capital markets so that foreign firms could have majority shares in Korean enterprises, expand direct participation in banks/financial services, engage in hostile take over-all the conditions Korea had rejected , was forced to accept in its weakened condition after the East Asian crisis (28)
IMF and WB persist in pushing failed policies, as they are controlled by the rich countries, they being run on one dollar one vote system-according to the share capital of each country. Rich countries control 60% of the votes, and the US had de facto veto (29).
The governance structure allows imposition of packages considered universally valid, and not carefully designed plans according to the particular conditions obtaining in the recipient country-with predictably poor results.
IMF facing mounting criticism undertook cosmetic changes like calling SASs, poverty Reduction and Growth Facility program, though the World Bank has engaged in discussions with NGOs. But increasing number of NGOs in the LDCs are financially dependent on handouts from the WB, so they try to say what WB wants to hear.
Most Laces lack the intellectual resources to argue against the UHT’s trained economists holding enormous financial clout. Further, the UHT have adopted the Henry ford dictum on diversity “a customer could have a car painted any color…so long as it was black”. The Laces are forced to appoint former UHT officials to key economic posts to curry favor with the UHT.
The WTO is nothing but a tool to pry open LDC markets and further the interests of MNCs. But WTO is democratic, no country has a veto-but only in name. Votes are seldom taken. In the various ministerial meetings-Geneva 1998, Seattle 1999, Doha 2001, Cancun 2003-were held in the so called Green room, by invitation only, and in the 1999 Seattle meeting, some uninvited delegates, who tried to muscle into the green room, were thrown out by official strongmen.(page 37). They can, in any case , get their way without these ‘gangster’ techniques, by using the influence of the UHT and ‘regional institutions like Asian Development bank (ADB), Inter American Development Bank (IDB0, African Development Bank (AFDB), and the European Bank for Reconstruction and development (EBRD).
Poor countries can send only a handful of delegates. The meetings number more than a dozen per day, so they have to miss most. The US, on the other hand, had dozens of people working in TRIPPS alone.
The Bad guys are Winning.
Margaret Thatcher (called milk snatcher, when she stopped the supply of milk to school children at lunch time, during her tenure as education secretary under PM Edward Heath) invented the argument “TINA, there is no alternative”. This stems from a defective understanding of the forces driving globalization and a distortion of history to fit the theory.
There is nothing inevitable about globalization, because it is driven by capitalist forces. If technology were the determining factor, it would be impossible to explain why the world was much less globalized in 1970s than in it was in 1870s.

Chap 2: How the Rich Countries Become Rich.
It is not well known that Daniel Defoe he also worked as spy for both leading parties, the Tory and the Whig), the author of such classics as Robinson Crusoe and Moll Flanders, also wrote a book on economics called A Plan of the English Commerce (1728), in which he describes how the Tudor monarchs especially Henry VII and Elizabeth I, used protectionism, subsidies, distribution of monopoly rights, government sponsored industrial espionage and other means of government intervention to develop England’s woolen manufacturing industry. The book shatters the impression that Britain succeeded because it took to free trade and free market before others did. By defying the given wisdom that his country was an efficient raw wool producer and exporter and should remain so, Henry VII introduced policies, which transformed Britain into a leading manufacturing nation.
Robert Walpole was notorious for his venality and is said to have changed it an art form. He juggled titles, government offices and perks to maintain his power base, so he could remain PM for 21 years (1721-42) (11). He enhanced the creditworthiness of the government by creating a ‘sinking fund’ to repay the debts, left behind by the ‘south Sea Bubble” (the South Sea company was set up in 1711, by Robert Harley, Defoe’s first spymaster, who was granted exclusive trading rights in Spanish South America. With deliberately spread rumors of the potential value of the trade Its stocks rose by ten times in seven months between January and august 1720, started falling and by early 1721, was back where it had started.
Prior to Walpole, the British aimed to capture trade through colonization and the Navigation Act, which mandated that all trade with Britain be conducted in British ships (US requires all foreign aid to use US ships, manufactories and farms). Walpole introduced measures to promote manufacturing-export of finished goods and import of raw material (12). The policies are similar to the ones adopted by Japan, Korea and Taiwan, post WW II.
Britain remained highly protectionist till mid-19th century CE, its tariff on manufactured imports was 45-55%, compared to 6-8% in Low countries, 8-12 in Germany and Switzerland and 20% in France (17). Walpole banned the construction of rolling and slitting steel mills in America. Britain also banned cotton textile imports from India, which were superior to the British (popular reality/myth, the hands of Dacca Muslin weavers were chopped off. It was so fine, reputedly, one could pass yards of it through a wedding ring). In 1969, it banned the export of woolen cloth from its colonies, destroying the Irish wool industry.
Walpole provided export subsidies, on the American side, to raw material and abolished import taxes , on the British side, to promote production of raw material, and make sure that colonies stuck o producing commodities, and never emerge as competitors to British industry(18).
Adam Smith vehemently attacked Walpole’s ‘mercantile system’, in his “Wealth of the Nations”, published in 1776. (But he did praise the Navigation Act).
But once British industry became internationally competitive, protection became unnecessary, even counter productive, as they would become complacent/inefficient, as Adam smith pointed out. The British traders also campaigned for free trade, except in export of textile machinery, which could help foreign competitors.
Ricardo came up with the theory of comparative advantage, which is still in vogue as free trade theory. Ricardo, in a brilliant inversion of the previously held observation that foreign trade makes sense only when a country can make something more cheaply than its trading partner, offered that although this country is more efficient in producing everything than the other, it can still gain by specializing in things in which it has the greatest cost advantage over its trading partner. Conversely, a country that has no cost advantage, can gain from trade, if it specializes in products in which it has the least cost advantage, thus providing the free traders of the 19th century CE with a powerful argument that free trade benefits every country.
It takes time and experience to absorb new technologies, so technologically backward producers need a period of protection from international competition.
The big change in British policy came in 1846, when the Corn Laws were repealed, and tariffs on many manufacturing goods were abolished. Neo-cons take that as a victory for Adam smith and Ricardo (19), and Jaghdish Bhagwati of Columbia university calls it a historic transition (20).
By opening its domestic market wider, Britain only wanted to lure its competitors back into agriculture. Britain adopted free trade only when it had acquired a technological lead over its competitors.(24).
America:
Under British rule, it was denied the use of tariffs to protect its new industries, and prohibited from exporting products that competed with British products, outright restricted placed on what they could manufacture, but were given subsidies to produce raw materials. Adam Smith advised Americans not to develop manufacturing (26).
Thomas Jefferson, among many Americans, agreed. The leader of fierce opposition to this stance was Alexander Hamilton (first treasury secretary in 1789,at age33), who argued that the country needed to develop industries and use protection and subsidies. In 1791, he submitted a “Report on the subject of Manufactures” on the issue to the congress.
The practice of protecting infant industry had existed before, but it was Hamilton who gave it a name. It was further developed by Freidrich List. The US followed the blue print, Hamilton provided for US economic policy, till end of WW II.
The trade policy established by 1820s, remained a source of tension in US politics for three decades. The Southern agrarian States wanted to reduce the industrial tariff constantly, while the Northern states wanted to keep them high or even raising them further.
Abraham Lincoln, the 16th president is known as the great emancipator of slaves, but if anything, he was a greater protector of manufacturing industry.
What won the election for Lincoln was the formation of the Republican party, an invention of the mid-19th century, and actually younger than the democratic party.
Abolitionists had a strong presence in some states, especially Massachusetts, but the mainstream Northern view was not abolitionist. Many people, who favored abolition, thought blacks were racially 8inferior, and opposed giving them full citizenship and a vote. Lincoln himself wrote “if I could save the Union without freeing any slave, I would do it…” (33).
Once elected, Lincoln raised tariffs to their highest level in US history (35). Tariffs on manufactured imports were the highest in the world, at 40-50%, and remained so till WW I.
Despite being the most protectionist country through the 19th century to 1920s, it remained the fastest growing economy. It was only after the WW II, with its industrial supremacy well established, that the US liberalized its trade. But it never had a zero tariff like Britain from 1860-1932, and has used non-tariff protection more aggressively (41). Further, the US provided 50-70% funding of R&D from mid-1950s to mid-1990s, 20% higher even than ‘government led’ Japan and Korea.
None of the currently wealthy countries, with the exception of Spain in the 1930s, has been as protectionist as Britain and the US. The equation of protectionism and fascism is belied by the fact that its tariff during the period remained at about 20%.
Japan, in the very early days of its industrial development, practiced free tr4ade as it was forced to do so by unequal treaties imposed on it in 1853, which kept the tariff to less than 5% till 1911, when it regained tariff autonomy, but it kept the rate at no higher than 30%Post WW II, the US liberalized its trade and France with 30% looked ‘bad’. But Netherlands and Germany had only 7%. Belgium, Japan, Italy Austria and Finland were only slightly higher (44) (But the tariff rate alone does not tell the whole story. Germany kept a low rate in late 09th and early 20th century, but gave heavy protection to iron and steel. US subsidizes agriculture heavily).
In certain cases, in addition to subsidies, they lured skilled workers from abroad.
After WW II, state efforts to promote industry were intensified in most rich countries. After 1945, France, acknowledging that its hands off policy had led to economic decline and defeat in two WWs, it launched indicative, to distinguish it from communists compulsory planning, and nationalized key industries, and channeled investment through state owned banks.
In Japan, the legendary Ministry of International Trade and Industry (MITI), orchestrated the now famous industrial development program. Tariffs were not particularly high, but imports were tightly controlled, and exports were promoted to maximize the supply of foreign currency to buy technology. It also heavily regulated foreign investment by MNCs, and a maximum of 49% ownership was allowed, and had required technology transfer and local content requirement.
Finland, Norway, Italy and Austria used the same strategies, France and Japan did.
Lessons From History:
Cicero “Not to know what has been transacted in former times is to be always be a child…” Rich countries have ‘kicked away the ladder’, by forcing the free market, free trade policies on poor countries. Even more important than ‘kicking the ladder,’ is historical amnesia. The policy is at odds with the historic best development policies. In June, 1947, the US abandoned its policy of weakening the German economy, and launched the Marshall plan, announced by George Marshall, the secretary of state in his address to the Harvard University on June 05, 1947. It was started in 1948, and ended in 1951, and channeled $ 13 billion, equivalent to $ 130 billion, now. By financing essential imports, it helped kick start the war ravaged European economies. Through GATT, set up in 1947, the rich countries helped developing countries to protect and subsidize their products (The motivation was Russian advance, and that France, Italy and Greece were on the verge of communist takeover).
As a result, the rich countries had their ‘golden Period of Capitalism’ (1950-73). Growth in Europe was 1.3% in Liberal age went up to 4.1%, in the US from 1.8 to 2.5%, and in Japan from 1.5 to 8.1%, and also offered low income disparity and economic stability. The LDCs also did well, growing 3%, twice as much as in the liberal age (1870-1913) and the neo-liberal since 1980s.

Chap 3: My six year old son.
Millions of children of his age already have jobs. The more competition my son faces and as soon as possible, he will be better prepared for his future.
This is precisely the inverted logic free trade economists use to justify rapid, large scale trade liberalization in LDCs. Industries in LDCs will not surviving they are exposed to international competition too early. Subsidizing my son till the age of 40, would be as bad as making him work at the age of six.
Free Trade Not Working..
Unilateral trade liberalization is not ‘concession’. It is self interest. Reciprocal trade liberalization enhances the gains (1). Belief in the virtue of free trade is so central to the neo-lib orthodoxy, that it effectively defines a neo-lib economist.
Pushed by the IMF, and WB in the aftermath of the 1982 debt crisis, , most LDCs have, during the past quarter of a century, liberalized trade to a huge degree. The formation of WTO in 1995 gave it further impetus. During the last decade bilateral agreements and regional free trade agreements (FTAs) have also proliferated, but during the period, LDCs have not done well at all.
Wide ranging trade liberalization in the 1980s and the 1990s wiped out whole swathes of Mexican industry built up painstakingly during the period of import substitute industrialization. The result was a slow down in economic growth, lost jobs, falls in wages and its agricultural sector was hard hit by subsidized US products especially corn, which is the staple diet of Mexicans. NAFTA benefits of increased exports to the US have run out. During 2001-2005, has been miserable-1.7% in total over five years (4), and had grown by 3.1% per year in pre-NAFTA days.
Among other examples, in ivory coast, after the 40% tariff cuts in 1986, the chemical, textile, shoe and automobile industries virtually collapsed, and unemployment soared. In Zimbabwe, after liberalization in the 1990s, unemployment went up from 10% to 20% (6).
Other problems created by liberalization included pressures on national budgets as it reduced tariff revenues, especially in the LDCs, as they have limited capacity to collect taxes (7&8). Lower levels of business activity and higher unemployment have adversely affected the tax base. Falling revenues led to cuts in education, health and infra structure spending, damaging long term growth.
India and China undertook gradual trade liberalization in 1980s and benefited from it.
Poor Theory:
Modern free trade argument is based on the Heckscher-Ohlin-Samuelson (HOS theory named after the first two Swedish economists and the third American economist), which derives from David Ricardo’s theory, but differs from it in that, it assumes that ‘comparative advantage’ arises from international differences in the relative endowment of ‘factors of production’ (capital and labor) , rather than international differences in technology as in Ricardian theory (9).
According to both theories, every country has an advantage in some products, as it is by definition, relatively better at producing some things than others are. Guatemala, though less efficient than Germany in producing toys as well as automobiles, should specialize in toys as their production requires more labor than capital which it does not have, and Germany in automobiles, which require more capital of which it has plenty, than labor which it has less of. The more a country conforms to its underlying pattern of comparative advantage, the more it can consume. The countries should leave things as they are; under developed countries should remain under developed.
The conclusion depends upon the assumption that productive resources can move freely across economic activities. Capital and labor released from one activity can immediately and without cost be absorbed by other activities. This is known as the assumption of ‘perfect factor mobility’. If a steel mill shuts down due to reduction of tariff duty and consequent import, the resources-workers, buildings and blast furnaces- will be employed by another industry, say computer industry. In actual fact, factors of production can not take any form as it becomes necessary. Unless retrained, the steel workers will remain unemployed, or at best end up working in low skill jobs, at lower pay, thus wasting their skills. It will also induce them to accept lower paid jobs, if they find them in steel related work.
Most free trade adherents accept that that there would be winners and losers, but they contend that winners gain more than what is lost by losers, the winners can make up the losses of the losers and keep something for themselves wonder why would they want to), this is known as the ‘compensation principle’.
The problem with this argument is that trade liberalization does not necessarily or even often, bring overall gain. Then compensation is not automatically worked through the market.
In welfare states, the government works as a mechanism to partially compensate the losers. In Scandinavian countries have highly effective retraining schemes. In LDCs, the welfare mechanism is very weak to the point of virtual non-existence.
Gains from liberalization in LDCs, if any, are very unevenly distributed.
But the more serious problem with the theory is that it is all about short term efficiency, and not about long term development. Historically trade liberalization has been the outcome, not the cause of development. Paradoxically, the free trade policy restricts the freedom of LDCs to develop, and that is precisely the idea.
The International trading System.
In sharp contrast to its attitude in post WW II, when it was competing for hegemony with the USSR, and despite its abysmal record, the US and other DCs have, since 1880s, continued to push free trade down the throats of LDCs, in a manner reminiscent of 19th century CE, British free trade imperialism. In 1986, Reagan called for ‘new and more liberal agreements’ (10), eventually resulting through GATT talks, in the 1994 WTO, which was much more biased against LDCs than GATT was.
In contrast to GATT in which countries could pick and choose, the critical principle in WTO was the ‘single undertaking’ under which all members had to sign up to all agreements. The agreement to reduce subsides meant that all members had to reduce tariffs and they had to give up import quotas, export subsidies and most domestic subsidies.
LDCs tend to disproportionately protect products that poor countries produce like garments and textiles. Poor countries when exporting to rich countries face higher tariffs than other rich countries do, while exporting similar goods. OXFAM report “overall import tax for the USA is 1.6%…rises steeply for… LDCs, to 4% for India and Peru, 7% for Nicaragua, to 14-15% for Bangladesh, Cambodia and Nepal (11). BD paid as much in tariffs to the US as France, whose economy is 30 times its size, did (12).
The Uruguay round resulted in the LDCs reducing their tariffs a lot more in absolute terms, as they started at a higher rate-India cut from 71% to 32%, the US cut from 7% to 3%. In India’s case an item that had cost $ 171 would now cost $ 132, a significant drop (23%), where as for the US consumers would pay $ 1.3 in stead of $107, hardly noticeable (4%).
The most important example is TRIPS Trade Related Intellectual Property Rights), the items covered- DCs are almost always the sellers and the cost is borne by LDCs. Another is TRIMS (Trade Related Investment Measures), which restricts WTO member countries from regulating foreign investors. LDCs receive, not make foreign investments and are not compensated by national firms investing in other countries.
The exceptions favored the rich countries, as in agriculture, and R&D, which are used by the rich countries, to the detriment of the poor ones. The rich give $100 billion subsidy to farmers, the US gave $ 4 billion to 25,000 peanut farmers and EU subsidizes Finland’s beet farmers so they can produce sugar from it (13). R&D is another big subsidy which increases productivity. LDCs do not have any R&D to speak of, to take advantage of this exception. In the name of redressing regional imbalances, they subsidies firms to relocate into depressed areas. That may help the depressed Mid-West in the US, but not the poor farmer in BD.
The DCs are preventing LDCs from using the tools of trade and industrial policies, which they themselves had used so effectively to promote their own development in a not too remote past.
Industry for Agriculture.
The rich countries have been pushing for further liberalization by LDC economies over and above what was accepted in TRIMS, through the OECD in 1998, and WTO in 2003 (15), but the move was thwarted both times.
NAMA (non-agricultural market access) was launched in Doha in 2001 WTO. The US, in 12/02, raised the stakes by asking for abolition of all industrial tariffs by 2015. and if the rich countries have their way, tariffs in the poor countries could fall from 10 to 70% to 5-105 of the times of unequal treaties of the 19th/early 20th centuries CE. In return the rich countries will reduce their agricultural tariff and subsidies (India and other LDCs rejected it in ? year). But many LDCs are in fact net agricultural importers. (page 79, if details felt necessary).
Agricultural liberalization would not come free. The poor countries would have to reduce industrial tariffs and abandon ‘permissive’ attitudes on TRIPS, which will hamper their development.
The obstacles of ideology:
The Japanese had developed the North part of Korea under their rule from 1910 to 1945 CE, and maintained its lead over the South till 1960s.
The North followed the path of ‘self sufficiency’, while the South learned of better technologies, and earned the foreign currency in trade , to buy them. The North, though, was able to achieve some technological feats, developed mass production of Vinalon, invented by a Korean scientist in 1939. Though not a comfortable fabric, it made North Koreans self sufficient in clothes.
In the final analysis, economic development is about acquiring and using advanced technologies. Without trade, there will be little foreign currency to buy technology and little economic development.
South Korea showed that free trade is not necessary for participation in international trade. And protection does not guarantee development, but is very difficult without it. Free trade is not the best path to development.

Chap 4: Finland.
After gaining independence from Russia in 1918 CE, Finland tried its best to keep foreigners out. It is strange that such excessively self-conscious country has suddenly become an icon of Globalization.
The question is if foreign capital is essential? Foreign capital flows into LDCs in three forms-1 grants, which on paper are gifts, but have strings attached, for example US aid requires that US products be bought, US experts hired, US ships be used and naturally US ports employing US dock workers handle everything. On top of that economic and political concession are extracted-votes in the UN, ‘security’ pacts, exclusive use of raw material at cheap rates and so on. 2 Debts bank loans and bonds (4- LDCs pay several times as much in interest to financial institutions in DCs every year as the ‘aid’ they receive). 3 Investment-portfolio equity-share ownership, which seeks financial return and managerial influence and FDI which seeks control over management (5).
Aid that is not primarily motivated by geo-politics, does not work (6). Debts and portfolio equity are volatile (7), but bank loans are much more so. In 1968 CE, total net loan to LDCs was $ 50.00 billion. Following the financial crises-Asia 1997, Russia and Brazil 1998, Argentina in 2002, it nose dived into negative for four years (-6.5 billion). By 2005, it was 30% higher than that in 1998, to $ 67 billion (8-9). And worse, they come and go at the wrong time. When the economic prospects look good, they flow in, temporarily raising asset price beyond their real value creating asset bubbles. When things get worse, often because of the bursting of the same bubbles, all the money flows out at the same time. Such ‘herd behavior’ was demonstrated in the Asian 1997 crisis (10).
This ‘pro-cyclical behavior affects domestic investors too, they often use insider information to leave before foreigners do. But foreign herd behavior is more devastating because the LDC markets are tiny relative to the money circulating in the international financial system. Indian stock market, the largest of LDC markets, is one thirtieth of the US market (11).
LDCs have, therefore, suffered more frequent financial crises since they opened their capital markets in the 1980s and 0990s. Between 1955-1971, when global finance had not been liberalized, LDCs suffered no banking crises, 16 currency crises and one ‘twin’ crisis. Between 1973-1997, in contrast, they had 17 banking crises, 57 currency crises, and 21 ‘twin’ crises (13), not counting the major crises after 1998-Brazil, Russia and Argentina being the most prominent. That makes even ardent globalizers like Jagdish Bhagwati of Columbia U, being wary of “the perils of gung-ho international financial capitalism” (14), forcing even IMF to change its stance(15-16).
FDI behavior is in sharp contrast to that of debt and portfolio equity, is more stable. It was $ 169 billion into LDCs in 1997, and even after the financial turmoil, it was still $ 172 billion in per year between 1998-2002 (18). But FDI has limitations and problems. When a country has open capital market, FDI can be made ‘liquid’ and shipped out rather quickly. An IMF publication points out that a FDI investor can borrow from domestic banks, change the money into foreign currency and send it out or the parent co of the FDI investor may recall the inter company loan it has given to FDI investor (21).
So FDI is, after all, not that stable, but can, in fact affect the position of the host country’s foreign exchange position, it can generate additional demands on it for importing inputs, contracting foreign loans etc. that is why many countries have imposed controls on foreign exchange earnings and spending by foreign companies (23).
FDI allows MNCs to indulge in ‘transfer pricing’, the practice when the subsidiaries of MNCs are over/undercharging each other relative to the corporate (lowest) taxes in the countries, they are operating in. A Christian Aid report is astounding. Under-priced exports like TV antenna from China at $0.40, rocket launchers from Bolivia at $ 40.00, US bulldozers at $528.00 and overpriced items like German hacksaw blades at $5,485 each, Japanese tweezers at $4,896, and French wrenches at $1,098 (24). Proliferation of tax havens, where there is little or no corporation tax, has made it possible for MNCs to shit most of their profits to a paper company registered in such a place.
Even with the technologies and management skills that FDI brings, the evidence that it is overall beneficial to LDCs is ambiguous (25). FDI can be broadly categorized into a) Micro-chip by Intel in Costa Rica or Volkswagen in China, called ‘green field’ investment and b) most FDI buys into an existing local company, called ‘brown field’ investment (26). The latter accounts for over half of FDI since the nineties, and in 2001, it was 80% of the total (27). It does not add to production facilities as GM buying Daewoo of South Korea. FDI may even destroy existing productive capability by ‘asset stripping’ as the Spanish airline Iberia did to some Latin American airlines in 1990s, by swapping its old planes for the new ones owned by the Latin American airlines, driving the latter to bankruptcy due to poor service capacity and higher maintenance costs of the older planes.
But there are beneficial ‘spill over effects’ of FDI, bringing new technology, hiring locals and management skills which may be adopted by local companies and knowledge of overseas market. But the spill over may not happen. MNCs often set up ‘enclave’ facility where all inputs are imported and locals are offered only non-skill learning jobs (29), that is why governments have tried imposing performance requirements such as technology transfer and local content etc. (30)
A critical impact of FDI is on domestic competitors, which can be destroyed because they have not had time to ‘grow up’. The productive capacity of the country, in the long run, would become lower. And MNCs do not, as a rule, transfer their most valuable technology outside their home country. LDCs would be quite within their rights and quite reasonably ban or strictly regulate FDI (31).
Foreign ownership more dangerous than military power:
“It will be a happy day for us…the US will cease to be an exploiting ground for European bankers…” (US Banker’s Magazine in 1884 (32). In 1832, Andrew Jackson, now a hero to free marketers, refused to renew the license of the second Bank of the USA, on the grounds that the foreign ownership of the bank was 30% (34). “…controlling our currency, receiving our public moneys…If we must have a bank…it should be purely American” (35).
The US central government strongly regulated foreign investment (39). The 1997 Federal Alien Property act prohibited ownership of land by aliens (41).
Some states were even more hostile to foreign investment. NY state instituted a law in 1880s that banned foreign banks from engaging in ‘banking business’ (44).
Despite its restriction, the US was the largest recipient of foreign investments in the 19th and early 20tn centuries CE, as regulation of MNCs has not kept massive investment from China.
Japan had even more draconian laws, and paid only lip service in recent statements, a classic example of selective historical memory (47).
Largely due to EPZs, South Korea and Taiwan are regarded as pioneers of pro-FDI policy, but outside the EPZs they imposed restrictive policies. Korea was the least FDI dependent countries till 1990s (48).
The UK, France and Germany were not as restrictive of FDI, as the US, Japan or Finland, as till WW II, they were mostly making, rather than receiving FDI. After WW II, when they started receiving it, they imposed portfolio requirements mainly through foreign exchange controls. (remember, one could nor take out pounds from Britain, above a certain amount in 1960s and 1970s).
When Nissan established a UK plant in 1981, it was forced to procure 60% of value added locally, to rise with time to 80%, and the government put pressure on GM and ford to achieve a better balance of trade (51).
Singapore and Ireland have done well with FDI, but the former had always a very targeted approach, and the latter started prospering genuinely, only when it shifted from an indiscriminate to focused approach to FDI (page 96).
Is the world borderless?
Rich countries, in spite of all the evidence to the contrary, have been trying to outlaw practically all regulation. They have been pushing foot it in GATTS, WTO. Bilateral and regional free trade agreements (FTAs) and bilateral trade agreements (BTAs) to restrict the ability of the LDCs to regulate FDI.
Rich countries argue that globalization has created a borderless world. Firms are more mobile, are not attached to home countries and do not have a nationality anymore. Most large firms produce less than a third of their product abroad (Nestle is among a few exceptions, producing less than 5% in home country-Switzerland), and the Japanese produce less than 10% (54). Location of core activities is to other DCs (55). Top decision makers are still based in the home country and are home nationals. Among the exceptions again, is Carlos Ghosn, the Lebanese-Brazilian, who runs Renault and Nissan. In 1998, Daimler-Benz took over Chrysler. Though in equal number to begin with, Germans soon vastly outnumbered the Americans in top management.
If the MNCs have become truly borderless, why do the DCs insist on getting LDCs to sign agreements that restrict their ability to regulate FDI.
Some MNCs requiring movable equipment and low level of skills like garments, shoes and stuffed toys have more mobility, other industries requiring immobile inputs-mineral resources and skilled labor, big domestic market like China or a supplier network such as sub-contracting network in Thailand and Malaysia for Japanese car makers, are not quite so mobile. In any case regulation is not that important in determining in determining the level of the inflow of FDI. China, for all the regulations is getting about 10% of the world FDI, because of the huge market, good labor force and infrastructure (56).
Foreign investment follows, rather than causes economic growth. Countries have to show growth before MNCs would get interested in them.
Foreign investment, especially FDI, can be a very useful tool for development, but that depends upon the kind of investment and how it is regulated by the host country. Accepting foreign investment unconditionally can be a hindrance to long term development, as MNCs remain national firms with international operations, and unlikely to let their subsidiaries to engage in higher level activities, and their very presence can prevent the emergence of national firms. Their potential benefits depend upon ‘spill over’ effects, which require national policy intervention, but many such tools have been outlawed by the rich countries, for instance local content requirement.
It took Nokia of Finland to make any profits from its electronic subsidiary, which is the biggest mobile phone manufacturer in the world. If Finland had liberalized FDI too early, Nokia would at best be a subsidiary of some MNC.
Chap 5 Is Public Enterprise Bad?
John Kenneth Galbraith, once said “under capitalism, man exploits man, under communism, it is just the opposite”. What he was expressing was the profound disappointment, about the failure of communism to build an egalitarian society.
Since the 19th century, the key goal of communism has been to abolish the private ownership of means of production. They saw private ownership as the ultimate source of distributive injustice of capitalism and also saw it as a cause of inefficiency. Too many capitalists invested in producing the same thing, as they were not cognizant of the plans of their competitors. Eventually there was overproduction, some enterprises became bankrupt, some machines went into scrap heaps and workers were laid off. The waste would disappear with central planning.
Unfortunately centrally planned economy based on state ownership performed very poorly, with no competition, killed off economic dynamism, bred conformism, red tape and corruption.
But it is not true that state owned enterprises (SOEs) do work. The idea is based on concept that people do not fully take care of things that are not theirs. Ownership gives two rights, first to dispose it off and second to claim profits from it, and it is known as the right to ‘residual claim’ as it is what is left after the owner has paid for raw material, labor and other inputs.
By definition, SOEs are collectively owned by all the citizens, who hire professional managers to run them. The hired managers do not care about profits as they are on a fixed salary. The principals, that is the citizens, can make the managers interested by linking their salary with profits. But that is notoriously difficult to do, as there is a big gap in the information between the principals and the agents. This difficulty is called ‘principal-agent problem’, the resulting reduction in profits is called ‘agency cost’. Further citizens, though theatrically owners, do not have any incentive to take care of their ‘property’. The problem is that the extra profit accruing out of monitoring the managers is shared by all the citizens, while the cost is only borne by the monitor/citizens in terms of time and energy.
Being part of the government, SOEs are usually able to obtain additional finances from the government, if they sustain losses. This is called ‘soft budget’ problem and ‘sick enterprises’ of India are given as examples.
State Vs Private:
The objections to state ownership apply to large private enterprise as well Most of them are managed by hired managers, as the shore ownership is widely dispersed. They have the same principal-agent, agency cost, free rider and soft budget problems. (the 2008/2009 financial debacle-huge bail outs). The British nationalized rolls Royce (1971 Conservatives, British Steel 1967, British Leyland, British Aerospace under Labor in 1977). State owned companies are not totally immune to market forces. Managers are sacked there too for bad performance (3).
Success Stories of State Ownership:
Singapore Airlines: 57% share is owned by the Ministry of Finance which owns Temasek holding company. The so called Government Linked companies (CLGs) run shipping, engineering, banking and semiconductor firms (5). Singapore’s SOE sector is twice as large as that of South Korea (6), that of Korea twice again as large as that of Argentina and five times larger than that of Philippines (7). Yet in both Argentina and Philippines , state ownership is blamed for failures. Korea’s steel maker POSCO was a stunning success while state owned. With in ten years of starting in 1973, it became one of the most efficient in the world and now its largest.
‘The Three People’s Principles’ of Sun Yat Sen, the founder of China’s Nationalist party included state ownership of key industries. Both Taiwan and China have scored successes by following the principles.
In Europe, Austria, Finland, France and Norway achieved notable successes with SOEs after WW II. In France Renault (cars), Alcatel telecom), St Gobain glass) and many others achieved success as SOEs (13). Brazil’s Petrobras (oil), Embraer (regional jets-15).
We don’t hear about the successes of SOEs, as the media controlled by private money, investigates only failures. The rise of neo-liberalism during the past three decades or so had made state ownership so unpopular in the public mind that SOEs shy away from exposure. Few know that the state of Saxony in Germany is the largest shareholder (18.6%).of Volkswagen.
Under certain circumstances, state ownership is definitely superior to definitely superior to private ownership, for example when private shies away from a venture with prospects of long term success, because they want profit ‘yesterday’.
Capital market failures are more common in the earlier stages of development, so countries resort to state enterprise. Under Frederick the great (1740-86), Prussia set up ‘model’ factories (16).Meiji Japanese state did that in the late 19th century CE (17). The state works better in the case of ‘natural monopoly’ like electricity, water, gas, railways and phones, the unit cost goes down as the number of customers increases (p 113). The producer can charge whatever it wants, as the customers have no choice. Private owners exploit the customers and it also produces ‘social loss, called ‘allocative deadweight loss’ which even a monopoly supplier can appropriate, so it is more economical for the government to take over.
If left to private ownership, people living in remote areas may be denied access to essential services like post, water and transport.
Regulation/subsidy are often more difficult to manage than SOEs especially in LDCs, where tax revenues required for subsidies are not sufficient and even difficult to collect. Regulation is difficult even in DCs, which have sophisticated regulators. The British rail privatization in 1993, ended up in de facto rail tracks in 2002 and the deregulation of electricity in CA resulted in blackout of 2001.rich country enterprises like Maynilad Water Services, a French -Filipino consortium took over the water supply for half of Manila in 1997. The deal was hailed by the WB. Having obtained several tariff hikes, not permitted under the contract, it walked out when the regulators disallowed another increase in 2002 (19).
The critical divide is not between state and private ownership, but between concentrated and dispersed ownership.
The problems of privatization start with the choice of enterprises to sell. It is a bad idea to sell monopolies or essential services. Another is that the government would want to sell the worst performing one, and they have the fewest buyers, so the government has to invest more in them and restructure them to make them attractive (Pakistan Steel Mill), but if the performance can be improved, why sell at all? (20). The third is to sell at the right price. If it sells them too cheaply, the government is violating the trust by transferring public wealth to a private buyer. If it is taken outside the country, national wealth is lost. It can happen both with the buyer based abroad and with citizens when the capital market is open as happened in the Russian oligarch plunder under Yeltsin, post privatization.
Privatization must be done at the right scale and the right time. Selling too many together has a ‘fire sale’ effect. It happened in Asian countries after the 1997 crisis. It is a bad idea to set rigid deadline as the IMF insists and privatize regardless of market conditions, which nay be bad.
Right buyers are important, the ones who have the ability to improve long term productivity.
State enterprises are often sold off cheap in return for bribes, as massive state assets were transferred to Russian oligarchs in return for funding Yeltsin’s election faltering campaign. It can be done ‘legally’ too when government insiders get it done for a heavy consultant’s fee. A corrupt government will not suddenly change its ways when privatizing. Privatization does not necessarily reduce corruption, as private firms are corrupt too (2008-09 Bernie Madoff and others).
Replacing inefficient polit5ically restrained state monopolies with inefficient politically insensitive sensitive private as happened in the sale of Cochabamba water system in Bolivia to Bette of the USA in 1999, resulted in tripling of rates, riots and renationalization (21).Argentina partially privatized some roads in 1990and gave contractors the right to collect tolls, the contractors raised earthen barriers on non-toll roads to force motorists to use their roads to drive to popular beach resorts. That caused lively protests too (22) and the contractors resorted to parking a fleet of phony squad cars to give an appearance of police presence. Privatization of the Mexican state telephone company, TELMEX in 1989 was derided by the WB as a measure to tax consumers and distributing the gains to foreign shareholders and the government (23).
Other things being equal, there is a greater need for SOEs in LDCs than in DCs.
Chap 6: Is it Wrong to Borrow Ideas?
Computer software is very easy to duplicate. The entertainment and pharmaceutical industries have the same problem. This handful of industries have been leading the campaign for TRIPS (Trade Related Intellectual Property rights) in WTO to widen the scope, the duration and protection for IPRs (Intellectual property rights) to an unprecedented extent, making it more difficult for LDCs to acquire knowledge and technology for development.
Many African and Asian countries are suffering from HIV epidemics. The drugs cost $10-12,000 per patient per year. That is ten times the average income of the people in the countries, and 30-40 times the income in the poorest countries. Some countries have been importing ‘copy’ drugs from India and Thailand, which cost 2-5 % of the patented ones.
The countries have not been doing anything illegal. All patent laws, including the most pro-industry laws of the USA, provide for restricting the rights of patentees when they clash with the public interest, when the governments may cancel patents. In 2001 anthrax scare, , the US government used this provision to threaten the producers with compulsory licensing to get an 80% discount in the price of Cipro (3).
Still 41 drug companies banded together and took the South African government to court in 2001. There was a public uproar and the companies had to withdraw the suit.
The drug industry asserted that “without TRIPS, the private sector will not invest hundreds of millions of dollars…to develop new vaccines…” (4). It is only a half truth. We have not had to ‘bribe’ clever people to invent. 13 members of the Royal society of the UK wrote an open letter to the Financial Times “ Patents are only one means…Scientific curiosity, coupled with the desire to benefit humanity, has been of far greater importance through history (5).
In the US in 2000, 57% of drug research funding came from the US government, private charities and universities and 43% from the drug industry (6). A slight weakening of patent rights, selling at lower price in poorer countries and a shorter patent life would have little impact on new research.
Patenting is important for pharmaceutical, chemical and soft ware industry because copying is so easy (7). In other industries, it is not so, and innovation gives imitation lag time, reputational advantage and head start in ‘learning curves’ (8). This was the argument against patents in the 19th century CE (9). The patent lobby is using scare tactics when it says that there will be no new inventions with out patents.
We need to get the balance right between the interests of the patentees and the rest of the society. Patents, by definition, create monopolies, with costs to society. Monopoly also creates social loss by allowing the producer to maximize his profits by producing less than a socially desirable quantity. Patents also result in unnecessary duplication of research among competitors, which is socially wasteful. In the mid-19th century CE, the Economist of Britain, a bastion of free market objected to the patent system because its costs would be higher than its benefits (11).
The most detrimental aspect lies in its potential to block knowledge into technologically backward countries.
The technological race between the LDCs trying to acquire knowledge and DCs trying to prevent them from getting it has always been at the heart of economic development.
The race started to take a new dimension in the 18th century CE, with the emergence of modern technology which offered greater potential for productivity. The leader in the race was Britain. It set up legal barriers to stop technology outflows. Other countries, in Europe and the US had to violate these laws to acquire British technology.
The race was started by John law (1671-1729), the legendary Scottish financier-economist, who also was a minister of finance of France for about a year. He made huge killings on currency speculation, set up and merged banks and trading companies, getting monopolies for them. It led to the so called Mississippi bubble, three times larger than the contemporary South Sea bubble. Law was also an incredible gambler and advocated the use of paper money. He also recruited hundreds of skilled workers from Britain to upgrade France’s technology (14). Their importance was greater in earlier times, as they embodied a lot of technology.
Reacting to Law’s attempts to poach workers and a similar attempt by Russia, Britain introduced a ban in 1917,on the migration of workers (15), with penalties like loss of citizenship, land and assets. It was known as suborning law..
With time, machines became more complex and it became increasingly more important to acquire key machinery, and Britain banned the export of ‘tools and utensils’ in 1750, in wool and silk industries. In 1785, it banned export of different types of machinery (16).
Other countries in Europe got hold of British technology, legally through apprenticeships and factory tours, and ‘illegally’ by flouting the British law and luring skilled British workers. They also employed spies. France in 1750s hired John Holker, a Manchester textile finisher, as inspector general of foreign manufactures (18). They smuggled machines too.
By the end of the 18th century CE, ‘disembodied knowledge’ separate from workers and machines became increasingly important. A lot, though not all, knowledge could be written down in scientific language, and could be understood by trained people. Now it became important to protect ideas. The British ban on emigration of workers was lifted in 1825, and that on machinery in 1842. Patent laws became the key to restrict the spread of inventions.
The first patent law was introduced in Venice in 1474 to grant ten year’s privilege to inventors of ‘new arts and machines’. It was used by some German states and Britain in the 16th and 17th centuries CE (19).It spread very quickly from late 18th century CE to France in 1791, the US in 1793 and Austria in 1794 (20). Copyright law was first introduced in Britain in 1709, and trade marl law again in Britain in 1862, like patent laws were adopted by most of the today’s rich countries in the second half of the 19th century CE. Paris convention on patents and trademarks 1863 (21) and Berne convention on copyrights (1886) followed.
When Einstein published three papers on physics in 1905 (annus mirabilis of modern physics), he was an assistant technical examiner in the Swiss Patent Office (23). Switzerland did not grant patents for chemical inventions till 1907 ( no patents of any kinds till 1888), and they did it then under threats of sanctions from Germany, but it was far cry from today’s TRIPS and they did not grant patents to chemical substances (as opposed to the process) till 1978.
Netherlands abolished its 1817 patent laws in 1869, to reintroduce them only in 1912. Taking advantage of the absence of a patent law Philips, a Dutch electronics company, started as a producer of light bulbs on the patents ‘borrowed’ from Thomas Edison and ended up as a household name (26).
But other countries, which are rich today, were also bad at protecting foreigner’s intellectual rights. Laws were generally very lax. In the US, till 1936 over haul of its laws, patents were granted with out any proof of originality. In most countries in Europe and the US, patenting of imported inventions was allowed (28).
There was also extensive counterfeiting of trade marks in the 19th century CE, as was done in the 20th century by Japan, Korea and Taiwan and being done by China in the 21st century CE.(29- p 133).
Copyrights were frequently violated: the US did not protect foreigner’s copy right in its 1790 law. It only signed the Berne convention in 1886 in 1891 (it had been a net importer of copyright materials and only protected American authors). Till 1988, it did not recognize copyrights on materials printed outside the US.
Counterfeiting was not invented in Asia.
In 1998, the US extended the US Copyright Term Extension Act extended the period from the 1976 act of ‘the life of the author plus fifty years’ to ‘life of the author plus seventy years’ for a work of corporate authorship. Originally it had been fourteen years, extendable for another fourteen, under the act of 1790. It was called Mickey mouse act as Disney was heading the lobby in anticipation of Mickey’s 75th birthday in 2003, and it was to be applied retrospectively. So it should be obvious that extending the patent of existing work does not create new knowledge (32).
The US pharmaceutical industry has successfully lobbied for extension of de facto patents by up to eight years.
During 1850-75, the average life of patents in 60 countries was 13 years. It was extended to 16-17 years between 1900-1975. the US played a leading role in extending it to 20 years by enshrining it in the TRIPS agreement, the average for 60 countries being 19 years in 2004 (33). Lengthening the term means that the society is paying more for new knowledge.
Chemical substances, as opposed to processes, should not be patented, as the persons who have extracted them, have not done anything original. They could not be patented in rich countries till the 1970s. and in Spain and Canada till early 1990s (34). Before TRIPS, most LDCs did not give protection to pharmaceutical products (35).India and Brazil has actually abolished the ones they once had (36).
Since the 1980s, the hurdle for patents has been significantly lowered in the US. Professors Adam Jaffe and Josh Lerner point out that the Smucker’s food company’s sealed crust less sandwiches’ and ‘bread refreshing method (toasting stale bread), and the method of swinging on a swing ‘’invented by a five year old girl were patented (37). The US patents grew by 1% a year between 1930 and 1982 and by 5.75 between 1983 and 2002. Traditional knowledge, well known especially in the LDCs, but not legally patented is vulnerable. Two Indian researchers in the University of Mississippi were granted patents for the medicinal use of turmeric, known in India for thousands of years. It was cancelled only because of the challenge in US courts by New Delhi based council for Agriculture Research.
The IPR system has become an obstacle, rather than a spur to innovation.
Interlocking Patents:
Ideas are the most important inputs in producing new ideas. If other people own ideas you need to develop your own ideas, you may not use them without paying for them. That makes it very expensive and what is far worse, you run the risk of being sued by your competitors, who may own ideas closely related to your own. You not only waste money on law suits, but also are kept from developing the technology under contention. So patents are a hindrance rather than a spur, as was the case in US industry of Sewing Machines in the 19th century CE, aero planes in early 20th century CE and semi-conductors, mid-20th century CE. Some companies came up with an innovative idea-‘patent pool’ under which all related industries could cross license relevant patents. In case of Wright Brothers and Glenn Curtiss (aero planes) and Texas Instruments and Fairchild (semi-conductors) the US government had to step in.
In 2000, scientists led by Ingo Potrykus of Switzerland and Peter Beyer of Germany developed genetically engineered ‘gold rice’ which contained extra beta carotene, which turns into vitamin A when digested and which ordinary rice is deficient in. 124 million people in 118 poor countries suffer from vitamin A deficiency (VAD), which causes 1-2 million deaths, half a million cases of blindness and millions of cases of debilitating eye diseases like xerophthalmia every year (45).
The two scientists caused an uproar by selling the technology to sold to Pharma firm Syngenta (previously Astra-Zeneca-46). Syngenta had indirectly funded the research through the EU. But they negotiated with Syngenta to allow farmers making less than $10,000 a year to grow the rice free-to their credit.
But the current situation is that you can not just develop a technology in a laboratory alone. You need an army of lawyers to negotiate the hazards of interlocking patents.
The Rules and LDCs:
The political and economic weakness of LDCs vis-à-vis DCs constrains the former from using the public interest provision. 97% of all patents and nearly all copyrights and trademarks are owned by DCs. The WB estimates that following TRIPS, LDCs will pay an extra $45 billion a year for technology licenses. It has made higher education that uses foreign books, much more costly. To comply with TRIPS each LDC has to spend money building up and implementing a new IPR system-with armies of inspectors, scientists, attorneys and judges.
Martin wolf, a British financial journalist, and a dyed in the wool globalizer concedes that IPR is “a rent extraction device” for the DCs, with devastating effect on the ability of LDCs to educate their people, adopt designs for own use and deal with severe challenges of public health” (48).

Chap 7: Can Financial Prudence Go Too Far
IMF is much feared by the LDCs, as it plays the role of gatekeeper, controlling their access to international finance. When the LDCs get in a balance of payment crisis, it is critical to sign an agreement with IMF, which involves an ever expanding conditions on economic policy like liberalization, even adopting new company laws, but the more onerous are the conditions concerning macro-economic policies.. It is a guarantee that the country will mend its ways, and adopt a set of non-profligate policies to ensure repayment of debt. IMF does not have much money of its own, but after the agreement, other lenders like the WB and DCs and their banks and private lenders, offer loans.
Macro-economic policies concern monetary and fiscal policies are intended to alter the behavior of the whole economy, as distinct from the change in behavior of individual economic actors (1). This counter-intuitive idea that the whole economy may behave differently from the sum total of its parts comes from John Maynard Keynes. He argued that what seems rational for individuals, may not be so for the entire economy. For example in a downturn, firms see the demand for their products fall, and workers lose their jobs, so both will try to reduce spending. But the combined effect of such acts reduces the demand further, enhancing the chance of bankruptcy and redundancy for every one. So the government can not use the plans of individual actors. It should increase spending to offset the reduced spending of firms and workers. In an upturn, it should reduce spending and increase taxes, to prevent demand from outstripping supply.
Until the 1970s, the trend therefore was to adopt macroeconomic policies, which will diminish the magnitude of swings in the level of economic activity, known as the business cycle. But since the rise of ‘monetarist neo-liberal economy’ since the 1980s, the focus has changed. The monetarists are so called because that process rise when too much money is chasing a given quantity of goods and services. Their contention is that keeping inflation low (price stability) is the key to prosperity, so monetary discipline should be the highest goal of macroeconomic policy.
The rich countries emphasize the need for discipline even more for LDCs, that they do not have self control to live within their means, they print money and borrow with out a care (2). But the macro-economic policies advocated by IMF have produced the exact opposite effect.
Neo-liberals:
See inflation as public enemy number 1, the lower it is, the better. It is argued that inflation is a stealth tax. Milton Friedman, the late Guru of monetarism “inflation is one form of taxation, that can be imposed without legislation” (5). Neo-liberals argue that it is bad for economic growth (6). It goes like this: investment is essential for growth, investors do not like uncertainty, so economy must be kept stable, which means keeping price flat, which requires low inflation. This line of argument had strong appeal for Latin American countries, where hyperinflation combined with collapse in economic growth in the 1980s led to disaster in Argentina, Bolivia, Brazil, Nicaragua and Peru.
The central bank should not increase the money supply over and above what is necessary to support real growth, and the country should not live beyond its means. The central bank should pursue price stability above all else. New Zealand indexed the bank governor’s salary in inverse ratio to the rate of inflation (7). The best way to protect central banks from succumbing to political considerations, is to make them independent of the government. IMF made this a condition of agreement with Korea in its currency crisis of 1997. Further budget deficits would cause inflation by creating more demands than the country can meet (8). In the late 1990s, it however became obvious, that they were caused by over-borrowing by the private sector and consumers. So now BIS (Bank for International Settlements, the club of central banks based in Basel, Switzerland).) emphasizes ‘prudential regulation’ of finance houses, the so called capital adequacy ratio.
Inflation is of Different Kinds:
During the 1960s and 1970s, inflation in Brazil was 42%, yet it was one 9f the fastest growing economies in the world, its per capita income rose 4.5% a year during the two decades. Between 1996-2005, with adoption of neo-liberal policies, the inflation rate went down to 7.1%, but the growth rate was only 1.3% per year.
During its miracle years, when its economy was growing at 7% a year in per capita terms, Korea had inflation rates of 20 to 17.4% in the 1960s and 19.8% in the 1980s.
This is not to say that all inflation is good. When prices rise very fast, they mess up the very basis of rational economic calculation. In Argentina, a carton of milk cost I peso in January 1977. In 1991, it cost a billion pesos. Inflation between 1977 and 1991 ran at 330% per year (what was the reason?). 1989-1990, it ran at 20,266% (12).
But it is a leap of faith to say that hyperinflation is bad and in saying that it should stay at 1-3% as neo-liberals want for the economy to do well. Examples of Brazil and Korea prove that.
Moderate inflation may even be compatible, or even be beneficial to rapid growth and job creation. Inflation does hurt people on fixed income (16) and the financial industry, whose income derives from financial assets, since they are outside the labor market.
The Cost of Price Stability:
The African National congress, on inheriting power from the Apartheid Regime in 1994, embraced IMF ordained macro-economic policy, ostensibly, in order not to scare the investors away. (Make sure have it from Naomi Klein). Interest rates were kept high between 1990s and early 2000s, to keep price stability-the real interest rates were 10-12%. Inflation was kept down to 6.3% a year (17). Given that an average non-financial firm in South Africa has a profit rate of less than 6%, few firms could borrow to invest at 10-12% interest rate. Investment rate fell from 20-25% (was over 30% in 1980s) to 15% (19).
Given that redistribution was precluded by the agreements between the ANC and the Apartheid regime, the only way to reduce the huge gap in the living standards between the racial groups, is to generate rapid growth and create jobs. The official unemployment rate runs at 26-28%, one of the highest in the world, a growth rate of 1.8% annually is not going to do it. Mercifully, the leaders are trying to get out of the stranglehold of IMF/Apartheid regime, and have brought the interest rate down to 8% but that is still too high.
In most countries, non-financial sector makes 3-7% profit, so if the interest rate is higher, it makes more sense to put money in the bank. In the LDCs, firms have little accumulated capital (it having been stolen and robbed by colonial powers and post colonial finance imperialists), making borrowing difficult means little or no investment, little growth and few jobs. This is what happened in South Africa, Brazil and numerous LDCs, when they followed IMF policies.
DCs, while preaching high interest rates and discipline, resort to lax monetary policies, when they need to generate growth, income and jobs.
Post WW II growth boom, real interest rates in DCs were low or even negative. Between 1960 and 1973, when all the DCs achieved high investment and growth, real interest rates were-2.6% in Germany, 1.8% in France, 1.5% in the USA (low in post 2008-09 crisis), 1.4% in Sweden, and less than 1% in Switzerland (21).
Lower investment, slow growth and job creation that goes along with tight monetary policy, is not a big problem for DCs with high standards of living, but is a disaster for LDCs, with few jobs and high unemployment.
Given the risks of a tight monetary policy, an independent central bank is the last thing a LDC needs. Central bankers are anything but non-partisan technocrats. They listen very carefully to their kin, the financial sector, and implement policies to help them, even at the cist of industry and the working class. Further, their independence raises the important issue of democratic accountability. They have to be supervised by elected bodies, to be responsive to popular will as happens in the US (23).
Gordon brown, long serving finance minister (later PM) of Britain emphasized prudence in fiscal management, which is a central theme in neo-liberal macroeconomic policy. The government budget may need to be balanced, but should be over business cycle, rather than every year. As Keynes would have it, over the business cycle the government acts as a counterweight to the behavior of the private sector, engages in deficit spending during…downturns, and …budget surplus during…upturns.
For an LDC it may make economic sense to run a budget deficit in the medium term, to ‘borrow’ from future generations to invest and accelerate economic growth.
But IMF remains obsessed. In the agreement in December 1997, Korea was required to run a budget surplus equivalent to 1% of GDP, while a huge exodus of foreign capital was pushing the country into deep recession, it should have been allowed to increase budget deficits. The economy nose dived.(24). In a worse example of Indonesia the same year, the government was ordered to cut spending especially food subsidies, together with the interest rate of 80%, it led to an avalanche of corporate bankruptcy, mass unemployment and foods riots. It saw a huge 16% fall in output in 1998. No DC finance minister would raise interest rates and run budget surplus during a downturn, as when dot.com bubble burst and 9/11 came along, even the republicans, disciples of George Friedman, resorted to deficit spending, monetary policy of unprecedented laxity (US, trillions of dollars given away in the 2008-09 downturn). The budget deficit in 2003 and 2004 was equivalent to 4% GDP. During 1991-95, budget deficit of Sweden, the UK, Netherlands and Germany was respectively 8%, 5.6%, 3.3% and 3% of GDP (26).
The other problem that DCs create for LDCs is the so called BIS capital adequacy ratio. It ordains that bank’s lending change in line with changes in its capital base. Banks are able to increase their loans in good times, when prices of its assets go up. This feeds into the boom, overheating the economy. During a downturn, the asset base shrinks, forcing them to call loans, which pushes the economy further down. If all the banks were to follow it, the business cycle will be greatly magnified and will hurt the banks in the long run.
Keynesianism for the Rich, monetarism for the Poor:
Gore Vidal on the American economic system “ Free enterprise for the poor, and socialism for the rich”.

During the financial crisis of 1997, IMF allowed South Korea to run a budget deficit of only 0.8% of GDP, but when Sweden had a similar crisis due its poor management of opening up of capital markets in the early 1990s, its budget deficits were allowed to run to 8% of DGP, 10 times that of South Korea.
When LDC people talk of belt tightening (South Korean women campaigned for eating less0 they were ridiculed as simpletons. Financial times correspondent in Korea pontificated that the country could go into deeper recession (makes sense, capitalists in the West are fat, cutting down on food would give a big boost to economy, while people in the East are not gluttons, taking a bit of bread away from them would make them so feeble. They would not be able to work to increase the profits of MNCs). They contended that LDCs should not adopt policies suitable for ‘grown up’ DCs.

Does Corruption Hurt Economic Development:
Corruption is a violation of trust by vested in officeholders, by the stakeholders (the public in case of government and shareholders in case of corporations, members in the case of trade unions and donors in case of NGOs).
The economy of Zaire under Mobuto and Haiti under Duvalier was ruined by rampant corruption. But Indonesia did well in spite of corruption, and Italy, Japan, Korea, Taiwan and China did even better despite ingrained and widespread and often massive corruption.
Corruption is as old as human beings (it should be called the second oldest profession). The public life in all the currently rich countries was deeply corrupt. The sale of office in Britain and France was a common practice till the 18th century CE (6). Robert Walpole, the British PM when accused of corruption in the parliament in 1730, freely admitted that he had acquired great estates “having held some of the most lucrative offices for nearly twenty years, what could any one expect unless it was crime to great estates by great office” (recent expense padding scandals among the members of the British parliament, including the speaker. In the USA, instances are too many to be gone into). In the USA the spoils system allocating public office to party loyalists, regardless of qualities became entrenched in the early 19th century CE(8). In Britain, they had to pass the Corrupt and Illegal Practices Act in 1883. Awarding aliens citizenship without due process, so they could vote ‘ with no more solemnity…,as is displayed in converting swine into pork…(NY Tribune 1868-9).
A bribe is a transfer of wealth from one person to another. It does not necessarily have negative effects on economic efficiency and growth. If a government official takes a bribe from a capitalist and invests it in another project, that is at least as productive as if the capitalist had done it for his project. But if the officers indulges in conspicuous consumption, that would be a waste.
A critical issue is whether the ‘dirty’ money stays in the country or goes into a Swiss account. In Zaire, it went to Switzerland, in Indonesia, it mostly stayed in the country, creating jobs and income. But corruption can distort government decisions, whether the ill gotten wealth stays in the country or not. It may allow a less efficient producer to get the license, for example, a steel mill.







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