A Review of William Easterly’s “The Elusive Quest for Growth”
by Julian Dautremont-Smith
In “The Elusive Quest for Growth,” William Easterly methodically explains that previous approaches to development — such as “closing the financing gap,†education, population control, structural adjustment lending, and debt forgiveness — have all failed because they fail to take into account the truism that people respond to incentives. Easterly goes on to argue that in order to promote growth, governments should act to avoid “high inflation, high black market premiums, high budget deficits, strongly negative real interest rates, restrictions on free trade, excessive red tape, . . . inadequate public services,†corruption, and polarization in the form of class warfare or ethnic conflict. [1]
Although the book is not primarily about free trade, on the back cover of the paperback edition, Paul Romer of Stanford Universityâ€TMs Graduate School of Business suggests that “[e]very college student who protests against free trade . . . should read this extraordinary book.†Given the prominent placement of this quote, I feel justified in reviewing this book from the perspective of a college student who has protested free trade and remains entirely unconvinced of the merits of free trade after having read the book in its entirety. I argue that the evidence that free trade is good for growth is weak, and indeed there is significant evidence suggesting that free trade is in fact not good for growth.
In making his case for free trade, Easterly presents the theoretical arguments on both sides of the free trade debate. According to Easterly, those opposed to free trade argue that since the price of primary commodities trends downward over the long run, countries should put up barriers to manufactured imports and thus spur the development of their own industries. Further, free trade opponents believe in the “infant industry†argument — i.e., that there is a learning curve to developing industry and, therefore, allowing manufactured imports would stifle newer domestic industry before it had a chance to compete fairly. In contrast, free trade advocates believe that “[f]ree trade allows economies to specialize in what they are best at doing, exporting those things and importing the things they are not good at producing.†Moreover, “[i]nterference with trade distorts prices so that inefficient producers will get subsidized†and this “could affect growth because inefficient resource use lowers the rate of return to investing in the future.†Easterly then tries to settle the debate by presenting a series of six empirical studies that he claims show a clear relationship between openness and economic growth. [2]
Unfortunately, it is not quite so simple. A comprehensive study by Rodriguez and Rodrik discredits every one of the studies Easterly cites. [3] Easterly notes the existence of this study but responds to only a small part of their analysis and fails to address the larger questions they raise. According to Easterly, Rodriguez and Rodrik “argue that many of these measures do not really capture trade interventions and that they are not robust to changes in the sample period or other control variables.†In response, he maintains that “few variables in the research on growth capture exactly a specific policy or are robust to all possible control variables.†[4] This may be true, but it mischaracterizes Rodriguez and Rodrikâ€TMs primary argument and is an insufficient response to their study. Although the problems with each individual study are different, Rodriguez and Rodrik show that “the indicators of ‘opennessâ€TM used by researchers are poor measures of trade barriers or are highly correlated with other sources of bad economic performance†and often, “the methods used to ascertain the link between trade policy and growth have serious shortcomings.†[5] As Rodrik explains in a later paper:
[w]e argued that authors in this literature have used inappropriate indicators of trade policy, selected to systematically bias the results in favor of showing a statistically and quantitatively significant link between trade liberalization and growth. Our complaint was not about the fragility of the results — it was about the use of patently inappropriate measures and methods. . . . Non-robustness and fragility in cross-national regressions is something we probably have to live with. But inappropriate and misleading methods are something we can dispense with. [6]
Thus, the problem is not that measures of openness do not “capture exactly a specific policy,†but rather that they are poor indicators of barriers to trade in general or are otherwise inappropriate.
Moreover, there is substantial evidence that free trade does not lead to growth and that protectionism can. For instance, “[t]he United States, Germany, France, and Japan all became wealthy and powerful nations behind the barriers of protectionism,†while “East Asia built its export industry by protecting its markets and banks from foreign competition and requiring investors to buy local products and build local know-how.†[7] Such practices are now discouraged or are illegal under current trade rules. Indeed, Ha-Joon Chang, noting that “[i]t was only after [Britain and the United States] achieved their industrial supremacy that they started practicing free trade and laissez-faire policies,†accuses developed countries of attempting to “kick away the ladder†that they had used to promote development. [8] The statement by Ulysses S. Grant, U.S. president from 1869-1877, that “within 200 years, when America has gotten out of protection all that it can offer, it too will adopt free trade,†lends at least anecdotal support to this argument. [9]
According to Dollar and Kraay, two prominent free trade proponents, “the current wave of globalization, which started around 1980, has actually promoted economic equality and reduced poverty.†[10] However, if this is so, it seems that, all other things being equal, we would expect to see higher growth during the past 20 years of liberalized trade (1980-2000) than in the previous 20 years (1960-1980). Instead, Weisbrot, Naiman, and Kim show that “[e]ighty-nine countries — 77%, or more than three-fourths — saw their per capita rate of growth fall by at least five percentage points from the period 1960-1980 to the period 1980-2000. Only 14 countries — 13% — saw their per capita rate of growth rise by that much from 1960-1980 to 1980-2000.†Along the same lines, “[i]n Latin America, GDP per capita grew by 75% from 1960-1980, whereas from 1980-1998 it has risen only 6%†and “[f]or sub-Saharan Africa, GDP per capita grew by 36% in the first period, while it has since fallen by 15%.†[11] Likewise, Rosenberg points out that, “[e]xcluding China, the growth rate of poor countries was 2 percent a year lower in the 1990s than in the 1970s, when closed economies were the norm and the world was in a recession brought on in part by oil-price shocks.†[12]
Easterly is also on shaky ground when he suggests that dependence upon primary commodity exports is no worse for growth than manufactured exports. The United Nations Conference on Trade and Development (UNCTAD) documents “a close association between the incidence of extreme poverty and dependence on exports of primary commodities†as well as “a close link between commodity dependence and the build-up of an excessive external debt burden†among the least developed countries (LDCs). [13] In fact, “in LDCs whose major exports are non-oil primary commodities, the share of the population living in extreme poverty increased from 63 percent during 1981-1983 to 69 percent during 1997-1999.†[14] It is thus not overly surprising for UNCTAD to argue that “[t]he current form of integration . . . is not supporting sustained economic growth and poverty reduction†and “[i]ndeed, for many LDCs, external trade and finance relationships are an integral part of the poverty trap.†[15]
There are additional reasons on a theoretical level to be skeptical of free trade. First, as Weisbrot and Baker explain, “tariff revenue accounts for 10-20 percent of government revenue†in many developing countries and thus “[i]f tariffs are reduced or eliminated, these countries will have to impose large increases in other taxes in order to keep their budgets in line.†[16] Therefore, “it is possible that the taxes that are raised to offset the lost tariff revenue would be more distortionary than the tariffs, in which case the country would lose by cutting its tariffs.†[17] Indeed, “[i]t is relatively easy to tax goods that are brought into the country at a border crossing, port, or airport†but “most other types of taxes — income taxes, payroll taxes, or sales taxes — require an extensive tax collection system, including administration and enforcement, that can collect taxes from a large number of businesses, or an even larger number of individuals, scattered throughout the country,†that most developing countries lack. [18] Furthermore, “[i]n countries that have poor transportation and communications systems, as well as serious problems with corruption, it can be even more difficult to devise an alternative to tariffs that can be as effective in raising revenue.†[19] In the end, “a tariff may actually be the most efficient form of tax, since an alternative form of taxation would be very expensive to administer and enforce.†[20] According to Weisbrot and Baker, “[t]he distortionary effect of these tax increases, as well as the costs and problems associated with collecting taxes from other sources, are generally ignored in economic models that project gains from eliminating trade barriers.†[21]
A second theoretical cost of trade liberalization that is often ignored in trade models is the transitional displacement of workers. For example, most trade models “imply a large movement of workers out of agriculture in developing countries†and “also will imply a loss of jobs in many domestic industries that will not be able to compete internationally in the absence of protection.†[22] These workers are generally assumed to “find new employment in the sectors that expand as a result of trade liberalization.†[23] While “[t]his may be an accurate description of a long-run process that happens over decades . . . it does not fit neatly with the way economies work over relatively shorter periods, such as an individualâ€TMs working lifetime.†[24] “In reality, this process can involve very long periods of adjustment†and “[t]herefore, it is reasonable for [developing countries] to opt to limit the pace at which workers are displaced from agriculture and other traditional sectors, in spite of the economic gains that trade models indicate will result from this displacement.†[25]
The comparative advantage of many developing countries is in cheap labor. Hence, as countries compete for foreign investment, it has the unfortunate impact of placing a downward pressure on wages and can set off a “race to the bottom.†This implies that countries who begin to develop and where workers demand higher wages will lose foreign investment to other less developed countries. A fair analogy would be to imagine a large number of people in a hole. As soon as one begins to climb out, the others pull him/her down and ultimately no one goes anywhere. An example of this principle in action is the shift in investment from Indonesia to Vietnam and China because of “Indonesiaâ€TMs newly empowered labour unions†and “[e]xcessively labour-friendly laws and higher wages.†[26]
I do not wish to imply that protectionism is necessarily good. Indeed, tariffs can often be administered in a corrupt way and can be detrimental to growth. However, free trade negotiations are also “soiled with the footprints of special interests†as one commentator puts it. [27] I have tried to show that there is scanty empirical evidence in favor of free trade and much evidence against it. Therefore, this college protestor of free trade sees no reason to change his views after having read Easterlyâ€TMs arguments. I do however, support Easterlyâ€TMs focus on incentives, but agree with Claire Melamed that:
[w]hat all success stories in trade policy and development have in common is that governments managed markets to ensure that the incentive structure faced by the private sector reflected development goals. A closed system with no incentives has not been shown to be particularly helpful in achieving economic growth and poverty reduction. Likewise, an open system where incentives are left entirely to market forces has not had conspicuous success in fostering growth or poverty reduction. [28]
- Julian Dautremont-Smith, USA
Footnotes
[1] William Easterly, The Elusive Quest for Growth (Cambridge, MA: MIT Press, 2002).
[2] Ibid., 229-231.
[3] Francisco RodrÃguez and Dani Rodrik, “Trade Policy and Economic Growth: A Skepticâ€TMs Guide to the Cross-National Evidence,†May 2000; http://ksghome.harvard.edu/ .drodrik.academic.ksg/skepti1299.pdf.
[4] Easterly, 231.
[5] RodrÃguez and Dani Rodrik, 4.
[6] Dani Rodrik, “Comments on ‘Trade, Growth, and Poverty,â€TM by D. Dollar and A. Kraay,†October 2000; http://www.globkom.net/rapporter/rodrik.pdf.
[7] Tina Rosenberg, “The Free-Trade Fix,†The New York Times Magazine, August 18, 2002; http://www.nytimes.com/2002/08/18/magazine/18GLOBAL.html?pagewanted=all&position=bottom.
[8] Ha-Joon Chang, “Kicking away the ladder: an unofficial history of capitalism, especially in Britain and the United States,†Challenge, Sept/Oct 2002, Vol. 45, No. 5, pp. 63-97.
[9] Ha-Joon Chang, “History debunks the free trade myth,†The Guardian (London), June 24, 2002; http://www.guardian.co.uk/Archive/Article/0,4273,4447095,00.html.
[10] David Dollar and Aart Kraay, “Spreading the Wealth,†Foreign Affairs, January / February 2002; http://www.foreignaffairs.org/articles/Dollar0102.html.
[11] Mark Weisbrot, Robert Naiman, and Joyce Kim, “The Emperor Has No Growth: Declining Economic Growth Rates in the Era of Globalization,†Center for Economic and Policy Research, November 27, 2000; http://www.cepr.net/IMF/The_Emperor_Has_No_Growth.htm.
[12] Rosenberg.
[13] United Nations Conference on Trade and Development, The Least Developed Countries Report 2002, (New York: United Nations, 2002).
[14] Ibid.
[15] Ibid.
[16] Mark Weisbrot and Dean Baker, “The Relative Impact of Trade Liberalization on Developing Countries,†Center for Economic and Policy Research, June 11, 2002; http://www.cepr.net/relative_impact_of_trade_liberal.htm.
[17] Ibid.
[18] Ibid.
[19] Ibid.
[20] Ibid.
[21] Ibid.
[22] Ibid.
[23] Ibid.
[24] Ibid.
[25] Ibid.
[26] Sadanand Dhume and Maureen Tkacik, “Just Quit It,†Far Eastern Economic Review, September 12, 2002; http://www.feer.com/articles/2002/0209_12/p046money.html.
[27] Rosenberg.
[28] Claire Melamed, “What Works? Trade, Policy and Development,†Christian Aid, July 2002
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