Interview with Joe Studwell by Sam Roggeveen, Editor, The Interpreter, Lowy Institute for International Policy, July 11, 2013
This interview originally appeared as a three-part series published on July 11 (Part I), July 12 (Part II), and July 16 (Part III) on Lowy Institute's blog, The Interpreter
Last month
Marginal Revolution blogger Tyler Cowen described Joe Studwell's
How Asia Works: Success and Failure in the World's Most Dynamic Region as 'perhaps my favourite economics book of the year'.
I decided to see for myself what the fuss was about, and I must say I have rarely had my economic preconceptions so thoroughly tested. This book challenges a lot of free market notions I had taken for granted, and as this interview progresses, I will try to tease out some of those ideas with Studwell.
SR:
How Asia Works is a bold assault on what we might call the neo-liberal consensus about what makes economies grow. You argue that protectionism and industry policy are actually important policy tools for countries at an early stage of development, and that Asian governments have adopted this model with varying degrees of success.
This is an almost heretical thought in the Western economic debate, and I suspect a lot of readers of this site would dismiss it out of hand. So what are some of the key facets of Asia’s economic development you would point to that prove your case?
JS: The distinction I make is between the 'economics of learning' and 'the economics of efficiency'. Poor countries lack technological capacity and have low quality human capital. This is why they need to target investible funds at a learning process and such a learning process requires nurturing and protection as well as competition.
It was ever thus. Anyone who disagrees is simply historically ignorant. The history of British, American, German, and indeed Australian development is the history of government policies that nurtured globally competitive firms, whether those policies were Britain's Navigation Acts, the average 40% tariff applied in the US in the 19th century, German export subsidies of the late 19th and early 20th centuries, or Australia's own long history of tariff protection and industry subsidy.
Those 'infant industry' policies allow learning to take place and produce more competitive firms, especially when subsidy is predicated on exports, or what I call 'export discipline', as has very much been the case in the fastest growth stories in Japan, ROK, Taiwan and now China. The capacity to export into the global market tells governments of development countries if they are getting an acceptable return on their subsidies to domestic firms.
However, the economics of learning only get you so far. There comes a point when an economy is close to the global technological frontier and it is much harder, if not impossible, to run cost-effective industrial policy. It is then necessary to enter the world of Adam Smith or (to put things in Australian terms) Colin Clark. It is no surprise that Smith produced his ideas in the late 18th century, when Britain was close to global technological dominance but the British consumer was getting screwed every day by oligopolies and monopolies set up in the infant industry era. Britain needed to be more efficient, more focused on short-run profit, more fair to the consumer. And that was what gradually happened in the 19th century.
Colin Clark made similar points in Australia in the early 1960s and was fortunate that Labor Party politicians were receptive to his arguments about the need for deregulation so that Australia could continue to progress on its development path (I was going to say to the promised land of Kath and Kim, but I'll leave that out).
Anyhow, the basic point is that it is a stages game, and there are different solutions for different stages of development. This, of course, is horribly problematic for modern economics because everything is supposed to fit in the same spreadsheet — there are no stages. And behind this problem is the other one that so many contemporary economists are really just (drug-less) hippies, whose every statement begins with 'Imagine!': 'Imagine that there are large numbers of participants in every transaction, imagine that information is perfectly dispersed...Dude, you'd get a perfect price function. Pass the dooby!'
So I have a number of issues with the economics profession as it is presently constructed. But economics offers us powerful analytical tools and there are also some very smart, historically literate economists. In the book I quote Charles Kindleberger's question about whether there really can be only one kind of economics. My answer, as stated above, is that, at a minimum, there is an economics of development and an economics of efficiency and what we really need to understand is where and how they meet in the middle. (But please don't ask for the answer to this question because I don't know and it is the subject of my next book.)
SR:
Asia is home to some of the great cautionary tales of industry policy: Malaysia’s national car brand, Proton, and Indonesia’s aircraft manufacturer IPTN come to mind. So what is it that distinguishes those failed efforts from success stories such as Hyundai?
And how do you get around the argument that, even where state-backed companies succeed in the long term, they still represent a misallocation of resources and an attempt to pick winners? Why wouldn’t these governments have been better off creating favourable tax and regulatory conditions for industry to flourish, rather than backing specific industries themselves?
JS: This is a number of different questions. First, what makes industrial policy cost-effective? The answer to this in east Asia has been what I term 'export discipline', or the conditioning of subsidy (in all its myriad forms) on a significant level of exports at the firm level. In essence, export discipline solves an information problem. If you give subsidy to entrepreneurs they are amazingly good at taking the money and pretending to do what you want in terms of developing globally competitive firms that carry an economy forward, but not actually doing so.
Most obviously they tend to concentrate on services, which employ and 'upgrade' relatively few people, avoid adding value through manufacturing by importing components of manufactured goods or even finished manufactured goods, and they tend to limit the competition they face by sticking to the domestic market. They then take the cash flows from subsidised domestic activity and invest it on a portfolio basis in more advanced and competitive economies.
This is the story of what my last book dubbed 'godfathers' — the oligarchs who dominate economies from south-east Asia, to Russia, to Latin America (KS Li, Ambramovich, Carlos Slim, if you want three examples). In essence these entrepreneurs outplay the state in its efforts to foster economic development based on technological learning and broad-based improvement of human capital.
When you have export discipline, the game changes. First, export discipline is almost inevitably bound up with a focus on manufacturing because manufactures are way more freely traded in the world than services (services are only 19% of world trade and have been stuck at that level for a quarter century). So entrepreneurs manufacture because manufactures are readily exportable.
Then comes the information bit. The capacity to export tells the state whether firms it subsidises and otherwise supports are globally competitive. Domestic financial institutions benefit from the same information feedback. Of course you can sell at a loss for a while, but not long if you have to export, say, 30% of your output, because it will bankrupt your firm. As a result, the capacity of the entrepreneur to deceive the state is undermined. He or she faces the horrible reality that in order to feed their insatiable desire for wealth and recognition (those 'animal spirits') they have to knuckle down, actually make stuff, and sell it in the viciously competitive world market.
Hyundai is a good example because founder Chung Ju Yung was himself a godfather, bribing his way to construction contracts under Syngman Rhee in the 1950s. Then came Park Chung Hee's coup in May 1961. Park brought in so much export discipline that firms had to file their export returns to the government on a monthly basis. Suddenly Chung became a big fan of manufacturing for export and had to get rich that way.
In Southeast Asia, industrialisation programs like Proton and IPTN did not face export discipline. As a result the state's return on industrial policy was very poor. Was it zero, however? I think not. There has been some industrial learning in Malaysia and, to a lesser extent, in Indonesia. So I doubt they would have been better off without Mahathir or Habibie, the main people who drove those programs. However, the performance was lousy by the standards of Japan, ROK, Taiwan and China and I talk in a lot more detail in the book about exactly why. After the Asian financial crisis, when the IMF went in to Indonesia and dismantled/emasculated its industrialisation strategy, it made things worse. If you look at IPTN, on which the Indonesians spent billions training engineers, designers and so on, many of the key people went off in the late 90s and 2000s to work in places like the US or Germany. Indonesia's learning-oriented subsidy ended up going to the world's richest nations (that's why we have black humour).
On the inevitability of misallocation of resources in industrial policy, the answer is 'yes'. There is a lot of waste in industrial policy. But the waste is at an acceptable level when you are far behind the technological frontier because you can see where you need to go. Steel, chemicals, plastics, construction materials, etc — you have to learn to make this stuff just like everybody before you. You have to fill your society with tacit, value-adding knowledge. Critically, manufacturing is the way to learn because people learn on the job, in factories, generating the capital to pay for their education. It is affordable in the way that more schooling for everybody would not be because school is just a sunk cost until you leave and get a job. (Indians — don't get me started — only think about learning through investment in formal education and have no real manufacturing strategy, which is why they are relatively so much poorer than the Chinese.)
On 'picking winners', this is a term of abuse coined by neo-liberal economists in Europe in the 1970s (I have never managed to identify first use of the term) when they were beginning to criticise the industrial policies that made a country like Italy grow 5-6% for a quarter century after World War II. It is a term of abuse because, as far as I can see, successful industrial policy has never been about picking winners. It is about culling losers, which is very different. Culling losers means cutting off state support to subsidised firms that are failing to make the grade, judged by profit & loss and export performance. There is a period of culling losers going on in China right now, so you can watch live!
On 'favourable tax and regulatory environments', development requires these, but the objective remains that of learning, as I have said, not efficiency expressed in terms of short-run returns. That comes later. I think that perhaps the answer you want to this question is the following statement: if you can show me a country, other than anomalous offshore financial centres/trading entrepots, which has developed to the first rank through policies of free trade from the get-go, then tell me which country it is. (Certainly not yours or mine...)
Reading through the first part of this answer, I realise that I simplified and exaggerated considerably to make a point. Perhaps too much so. But people need to read the book!
Can we talk about the cricket rugby now?
SR:
In your previous answer you took a swipe at the IMF for its behaviour towards Indonesia during the currency crisis, so I wonder if you could say some more about the role of international institutions.
I notice that Michael Pettis, in his Amazon review of your book, says the merits of industry policy are so obvious as to be not worth debating. The fact it is debated 'suggests to me how unreal academic economics has become and how divorced from historical understanding.'
But it's not just academic economics, clearly. It's also the policy advisers in the IMF and World Bank (and perhaps even the NGOs?) who push a pure free market line. How do you account for the fact that these institutions seemingly continue to ignore the evidence of successful industry policy? And how have Asian governments dealt with advice from the IMF, World Bank and others? Do they just ignore it?
JS: The story of the international institutions is a complex one, so I'd like to try to reflect that complexity. I would also like to say that I am not an expert in the history of these institutions and mostly know them from the work I have seen them doing in east Asia.
The first point is to consider the origins of the IMF, the institution that is best known for going in to countries after financial crises occur and agreeing (forcing?) and overseeing reform 'programs'. The IMF was created at the end of the Second World War and gained its early crisis experience in the 1970s in already quite mature western European countries after the Bretton Woods fixed exchange rate regime broke down. The IMF played an important role cajoling countries that had employed what I earlier called the 'economics of development' or 'economics of learning' in order to get back on their feet after the Second World War towards what I called the 'economics of efficiency'.
Continues on the next page
