Laissez-faire free trade

Here are some excerpts from the 2008 book
In the Jaws of the Dragon:
America’s Fate in the Coming Era of Chinese Dominance

by Eamonn Fingleton.
The emphasis is added.

Chapter 2
“Don’t Worry, Be Happy”

Section 2.7
The Truth About Laissez-Faire

As we have noted, thanks to their faith in American economic dogma,
many American policymakers have been lulled into a false sense of security
about recent economic trends.
They have been assured that
America’s trade deficits will automatically prove self-correcting,
if only policymakers would leave everything to free markets.
Equally, they have been persuaded that
Beijing’s current highly interventionist economic strategy
will prove self-defeating.
Chastened Chinese leaders, it is argued,
will embrace laissez-faire quickly enough
once they discover the error of their ways.

The assurances about American trade deficits
can be disposed of in a few sentences.
The idea that the deficits will prove self-correcting
has been a standard shibboleth of Washington discourse since the 1970s.
While reasonable people
might have been persuaded to give this view the benefit of the doubt
thirty years ago,
they can hardly be expected to continue to do so today.

Of course, in recent years many defenders of the Washington view
have shifted ground to argue that
even if the deficits do not prove self-correcting,
we need not worry.
The deficits-don’t-matter view
has been prominently championed by Vice President Dick Cheney
as well as by many other influential neoconservative thinkers.
(In Ron Suskind’s The Price of Loyalty [2004],
former U.S. Treasury Secretary Paul O’Neill
quotes Cheney saying at a cabinet meeting in 2002,
“Reagan proved deficits don’t matter.”)
Yet those who argue that deficits don’t matter
no longer have a leg to stand on.

The reality is that every dollar America spends in projecting power abroad—
indeed every dollar it spends on defense—
has to be borrowed abroad.
Not only that, much of the money comes from its main power rival, China.
To say the least, America’s attempts to pursue an independent foreign policy
will be subject increasingly to a veto in Beijing.
In any case, it is the sheerest of wishful thinking to imagine that
the United States can long remain a world power
if all it has to sell the world, besides wheat[, beef,] and oranges
is treasury bonds.

More generally, it should be noted that
laissez-faire has proved a disappointment
almost everywhere it has been tried.
The fact is that in the last four decades [1968–2008]
those advanced nations that have been most faithful to laissez-faire—
the United States and Britain—
have been notable for economic mediocrity, if not downright dysfunction.
Their currencies have on balance fallen precipitately,
their trade positions have spun out of control, and
they have lost the advanced manufacturing industries
that provide a bedrock of well-paid secure jobs
to support broad-based prosperity

[and prevent the trade deficit from spinning totally out of control].

The problems with Western economic dogma have long been particularly clear
in the automobile industry.
The nations that have believed in open markets
have largely lost their car industries:
the United States and Britain are the two obvious examples.

On the other hand
those nations that have most avidly protected their car markets
have seen their car industries boom.
The principal examples are Japan
which has boosted its world market share four-fold since 1970,
and South Korea which has achieved a phenomenal twenty-fold increase.
It is worth noting that, as of 2007,
South Korea was described by DaimlerChrysler as
“the most closed market in the industrialized world.”

All the empirical evidence suggests that
a laissez-faire approach to trade no longer works,
at least not for large nations like the United States and Britain,
not to mention Japan and South Korea.
(Full disclosure:
open markets have worked a lot better in leveling up
small, previously poor economies like Ireland and Finland—
but that is another matter.)

After decades of denying any problems,
American economic scholars are now finally beginning to ask
what is wrong with laissez-faire.
Thus, the Nobel Prize-winning economist Paul Samuelson
has made some “heretical” public comments
questioning the standard case for free trade.
Meanwhile, in their book
Global Trade and Conflicting National Interests (2000),
Ralph Gomory and William Baumol have shown—
with the sort of rigorous mathematical models
that doctrinaire economists insist on—
that in certain circumstances
outsourcing can be a net negative.

Among other top economic thinkers who have recently publicly questioned the orthodoxy are
Alan Blinder, a Princeton professor and former vice-chairman of the Federal Reserve;
Lawrence Summers, the Harvard professor who served as Treasury Secretary in the Clinton [42] administration; and
the Berkeley-based Nobel Prize winner George Akerlof.

The basic problem is that
laissez-faire is an old dogma
born in the very different economic conditions of Europe two centuries ago.

Although the theory’s early enunciators, Adam Smith and David Ricardo,
stated their case as timelessly applicable,
and this is how it continues to be interpreted today
(at least in the English-speaking world),
they failed to anticipate the dramatic economic changes we have seen
in the last [half century].

A fundamental flaw in the Smith-Ricardo model is that it is static,
whereas the real world is dynamic.

The model concerns itself merely with the allocation of resources
at just one moment in time.
It considers the capital and labor available to society at that moment
and predicts that
these resources are likely to serve most efficiently in satisfying consumers’ needs
if all economic actors—investors, managers, workers, and consumers—
are allowed full freedom to maximize their individual positions.

While this theory was helpful in times gone by
(and it is still useful in analyzing countless narrowly focused economic problems today),
it has become more and more misleading as a guide to
the workings of today’s highly complex modern global economy.
A key point never considered by Smith and Ricardo is that,
as we have already pointed out [§1.6],
a nation like China can use authoritarian controls to achieve
a preternaturally high savings rate.
Suitably channeled into fast-growth industries,
the resulting capital can power a fast rate of growth in real wages.
Thus the promise to consumers is that
their involuntary early sacrifices will result in
a much more prosperous old age.
It is a promise that has been honored in one East Asian nation after another.

Part of the reason the strategy works is that poor nations start with
many easy opportunities for “technology catch-up.”
That is, by investing in standard production technologies
already widely used in richer countries,
they can generate massive increases in productivity.
[Anybody care to try that in an African nation, or in Haiti?]


Laissez-faire theory is crucially flawed
in a different sense in that
it makes no allowance for the possibility that
nations can manipulate technological progress
to benefit themselves at the expense of others.

Laissez-faire theory is based on the assumption that
breakthroughs in production technology, if they occur at all,
will accrue to all producers equally.
Although this assumption was broadly realistic two centuries ago
(when most of the know-how to compete at the leading edge
either was already in the public domain
or could readily be acquired by dint of
rudimentary industrial espionage),
it is completely mistaken today.

After all,
leading-edge corporations these days spend ever larger sums each year
to achieve proprietary improvements in their production technologies
and thus establish a decisive lead over their competitors.

For a nation like China
that wants to boost its technological position at the expense of its rivals,
the course is obvious:
  1. Extort technologies from rival nations.
    In this regard Beijing’s control of access to the Chinese market
    is a huge bargaining chip:
    foreign corporations are simply told that
    if they want a fair shot at the Chinese market
    they must transfer more and more technology to China.
    Key American corporations such as Intel, Microsoft, and General Motors
    have meekly complied.
    One of the more spectacular beneficiaries of this strategy has been
    China’s fast-rising aerospace industry.
    By adroit bargaining,
    Beijing has pressured both Boeing and Airbus
    to transfer key production technologies.
    [In that situation, pressure was clearly more significant than bargaining.]
    Thanks in large measure to such transfers,
    Beijing is planning to launch a full-size commercial airliner by 2020.

  2. Fund research and development.
    This strategy has played little part so far in China’s rise,
    but it will become increasingly important
    as Chinese industry becomes more technologically advanced.
    Here again Japan has set an important example.
    Thanks to considerable help from their national government,
    Japanese corporations spend nearly $100G a year
    on research and development.
    Most such research is devoted to improving production processes
    with the aim of
    making Japanese factories ever more competitive.

  3. Prevent Chinese industry’s key technologies
    from leaking abroad.

    For now Chinese industry does not have many technologies to guard,
    but this strategy will become increasingly relevant in future years.
    What is clear is that
    the governments of the more advanced nations of East Asia
    have long carefully guarded their key technologies from leaking abroad.
    Japan and South Korea have been the two prime examples.

As China climbs the technology ladder
the impact on other nations’ economies will become ever greater.
This is because at the leading edge of technological progress,
global competition is increasingly characterized by
a winner-take-all syndrome.
A nation that achieves a narrow competitive edge
in making, for example, a new type of advanced microchip
can at a stroke wipe out its competitors worldwide.
The rewards therefore will increasingly accrue to nations like China
that take a highly focused national approach to technological competition.

Part of the problem, argues the Washington-based trade expert Patrick Mulloy,
is that

the interests of American corporations
are increasingly at odds with
those of the American nation.

In a personal addendum to
the 2006 report of the United States–China Economic and Security Review Commission,
Mulloy, who served as a top Commerce Department official
in the Clinton [42] administration, commented:
The interests of the U.S.-based multinational corporations,
which have done so much to influence our current policies toward China,
are often not aligned with the broader interests of our nation.
This is not because they have malevolent intent.
It is a systemic problem for which
we must develop a public policy response.
Those corporations, as they are charged to do in our economic system,
are focused on “shareholder value.”

They are not charged to consider the larger impact of their decisions
on the American economy and workers,
and the impetus they give to China’s growing
international, political, and military strength.

[Twas not always so, as Clyde Prestowitz points out
in chapter 7 of The Betrayal of American Prosperity,
where he notes that prior to the 1970s
the corporate value system was focused on all stakeholders,
not merely the shareholders.]

While we do not have space for a full discussion of
the problems with laissez-faire in modern conditions,
let’s simply note that economic planning chiefs in Beijing
do not necessarily “shoot themselves in the foot”
when they assume a strongly assertive role in steering China’s economic development.
While laissez-faire advocates are right in arguing that
government intervention has often proved counterproductive
in, for instance, Latin America,
the lesson of East Asia is that,
in the hands of intelligent, patriotic, and well-organized officials,
government intervention has proved on balance a strongly positive force.

As we will now see, few instances of market intervention
have been more rationally based than
the strongly pro-manufacturing bias of Chinese industrial policy.

Labels: , ,