Africa Tries Free Trade

Or, more accurately, a customs union.

With all the proposals for hundreds of billions of dollars in new government spending and new taxes in the United States in recent days, there hasn’t been much good economic news.

Alexander C. R. Hammond, of the Institute of Economic Affairs (IEA) and of African Liberty, writes about it in “Africa Tries Free Trade,” Reason, April 2021. He writes:

On January 1, the long-awaited African Continental Free Trade Area (AfCFTA) came into effect. Aside from the economic benefits that the arrangement will bring to the continent, Africa’s newfound support for free trade and liberalization marks a clear rejection of the socialist ideology that has tormented African politics for decades.

In recent decades Africa has been the sick puppy of the six heavily populated continents. A glance at the Economic Freedom of the World map of economic freedom shows why. Over half of the 50+ African countries are in the least-economically-free quartile of the world’s 190+ countries. Not a single African country is in the top quartile. Hammond calls Nigeria, South Africa, and Egypt “regional economic powerhouses,” but of the three, only Nigeria is in the second-from-the-top quartile, South African is in the second-from-the-bottom quartile, and Egypt is in the bottom quartile.

One of the five measures of economic freedom is freedom to trade internationally. With AfCFTA, this will increase for many African countries.

This agreement is like NAFTA and its successor, USMCA: it’s a customs union. The idea is to have low or zero tariffs between and among members of the group, but a common tariff rate on imports from outside. Nevertheless it’s a big, if slow, step toward freer trade.

Hammond writes:

Within 5–10 years, the AfCFTA will ensure that 90 percent of tariffs on goods traded between member states will be abolished. Within 13 years, 97 percent of all tariffs will be removed. By 2035, the World Bank has predicted, this enormous liberalization effort will boost Africa’s gross domestic product by $450 billion, increase wages for both skilled and unskilled workers by 10 percent, and lift more than 30 million people out of extreme poverty, defined as living on less than $1.90 per day. According to the same estimates, by 2035, the AfCFTA will see more than 68 million people rise out of moderate poverty, defined as living on $1.90–$5.50 per day. The “countries with the highest initial poverty rates,” the World Bank says, will see the “biggest improvements.”

Given Africa’s flirtation with socialism and protectionism from the 1960s through at least the 1980s, this is a welcome development.

For more on Customs Unions, see Douglas A. Irwin, “International Trade Agreements,” in David R. Henderson, ed., The Concise Encyclopedia of Economics.

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An Ordoliberalism Primer on Project Syndicate

On Project Syndicate, Lars Feld, Peter Jungen, and Ludger Schuknecht have a long article on Ordoliberalism and its enduring influence. The article is important, not least because two of the authors, Feld and Schuknecht, had important responsibilities in the recent past: Schuknecht was chief economist of the German Ministry of Finance, Feld was until the end of February chairman of the German Council of Economic Experts. I am not sure that either of them actually had much responsibility in shaping public policies, but their appointments certainly signaled, if not a real commitment, at least a degree of respect for the Ordoliberal tradition by Mrs Merkel’s Christian Democratic Party.

The article is rich in information and gives, for once, a sensible definition of what the label “social market economy” stands for:

The “social” element of the social market economy, then, is not about state ownership or state direction, as under socialism. Instead, it refers to a rules-based economy in which social interests are properly accounted for.

The authors argue that though Ordoliberalism originated in specific circumstances and the German “social market economy” was built “under unique conditions – namely, out of the ruins of the most devastating and destructive period in human history- “it is well suited for any country that is committed to pursuing patient, secure economic development.” To provide readers with a glimpse of the kind of choices that were made after WWII, the authors use an anecdote that Larry White also quotes in his The Clash of Economic Ideas:

The postwar German Wirtschaftswunder (economic miracle) was born. By unleashing the market to revitalize a moribund economy, German policymakers pursued a course that may seem obvious today but certainly didn’t at the time.
Ironically, those who were most skeptical of the ordoliberal reforms included representatives of the US, the world’s leading market economy. Though what is apocryphal and real are now impossible to reconstruct, there is an anecdote that General Lucius D. Clay, the military governor of the US-controlled zone, summoned Erhard and told him that he must not alter the rules of price administration:
“Mr. General, I have not altered the rules, I have lifted them,” Erhard replied.
“Professor Erhard, all my advisers tell me that a market economy in Germany will never work.”
“Don’t worry,” Erhard assured him, “all my advisers are telling me the same.”

The article ends with some examples of the lasting influence exerted by Ordoliberalism over public policy:

Ordoliberal thinking has also strongly influenced what one might call Europe’s “financial constitution.” It was the German Bundesbank that provided the model for the European Central Bank and other independent central banks across the Union. Likewise, the Maastricht deficit and debt rules that laid the foundation for the euro were a clear reflection of ordoliberal thinking. And the same can be said of the German deficit rule – the “debt brake” that allowed Germany to reduce its public debt after the global financial crisis and thus be well prepared to handle the fiscal challenges of the pandemic.
Ordoliberalism’s central tenets also underpin the European Stability Mechanism – which adheres to the IMF’s principle of conditional financial support to ensure solidarity within the EU – and the EU Treaty’s requirement of “subsidiarity,” or decentralized decision-making.

(…) policymaking in Germany is not a perfect incarnation of ordoliberalism. Political compromises have had to be made in the face of diverging interests. The state’s continued ownership stake in Volkswagen and a few other companies comes to mind. But these examples are exceptions to an otherwise private-sector-driven growth and innovation model.
Germany thus stands in stark contrast to countries that have engaged in “industrial policy,” aiming to identify the most promising industries to promote. This reflects the conviction that successful innovation policy does not pretend to know what the future will bring. Instead, it maintains institutional openness to ideas that no one today could even imagine. Indeed, no government could have foreseen that mRNA technology developed by a German startup (BioNTech) to fight cancer would be used to create a vaccine against the coronavirus in record-breaking time.
Finally, in fostering more green innovation, Europe has deployed rules- and market-based emissions trading schemes as the foundation of its decarbonization strategy. This, too, represents another win for ordoliberal thinking. It shows that the social market economy remains the framework for tackling our most pressing challenges today.
The social market economy model endures because it supports consumer interests before those of producers, just as it positions citizens, rather than the state, as the true sovereigns. At its heart is a commitment to constitutional and system-level thinking, not piecemeal, discretionary policymaking.

I wonder how much of this is holding in the Covid19 world. I suspect that Feld, Jungen and Schuknecht would agree that monetary policy in the Eurozone is no longer sticking with a “monetary constitution”-like approach. It seems to me that fostering green innovation requires precisely some kind of “industrial policy”, wherever it is happening, with some pretty strong convictions about what successful innovation policy should hold in store. The “debt brake” in Germany is gone because of the pandemic: will it ever be back?

Feld, Jungen, and Schuknecht’s piece is a good antidote against the prevailing rhetoric. We certainly need a better, more widespread understanding of the success of Ordoliberalism. But we also need some ideas to go back to rules, after all the discretionary measures taken because of the pandemic.

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Why Human Space Exploration Matters

Unity proves elusive, but Americans who cannot seem to agree on much else— from Trumpian and traditionalist conservatives on the right, to certain libertarians, to liberals and progressive social justice advocates— do seem to agree on at least one big policy thing: space does not matter much, and other things matter much more than space. Cue the familiar disagreements on what those “other things” are. But the first part undoubtedly stands. Broadly speaking, the principals guiding our politics today—and, it would seem, the median journalist and current events commentator on Twitter— could not care less about whether humans make progress in space, or whether we as a species ever develop the technologies required to allow human inhabitation of other planets and celestial bodies at scale. (Transitory enthusiasm for the recent Perseverance landing does not, to my mind, negate this judgement.) The voting masses, by and large, seem to share in their leaders’ lack of real and urgent concern in this regard. Other crises have consumed us, and space seems—as in fact it is—so remote from our cares.

As a result, our discourse doesn’t much dwell on the desirability, not to mention the possible necessity, of advancing human space exploration capabilities.

I view this as an unfortunate collective oversight.

While the yields to space exploration and the development of spaceflight technology may appear minimal in the immediate future, shifting our perspective to the longer term renders the human situation vis a viz space exploration extremely clear: if humans want to survive in perpetuity, we need to establish ourselves on other planets in addition to Earth. It is as simple as that. And yet we are not doing all that much to make that happen.

To be clear, I’m long on Earth, too, and hope that technological improvements will continue to allow our species to get “more from less” right here on the third rock from the sun, enabling us to keep occupying the planet that saw us evolve into consciousness. I like to imagine that the distant future on Earth has the potential to be an extremely pleasant one, as advances in our scientific understanding and bio-technical praxis should hopefully allow our descendants to clean up any of the remaining messes previous generations will have left behind (e.g., nuclear and industrial waste, high amounts of atmospheric carbon, other lingering nasties) and stable-state free societies will hopefully allow all persons (or very nearly all persons) to live free and meaningful lives in productive community and exchange with their fellows. As the previous qualification highlights, the trickiest problems here on Earth and extending to wherever humans end up in the spacefaring age will still be social and political, and their successful resolution will depend more on the future state of our governing arts than our hard sciences.

But regarding the negative events that could very well happen to Earth I think we all need to be equally clear: life might not make it here. There is no guarantee that it will, and in the very long run, with the expansion and subsequent death of our sun, we know with near certainty that it will not. Consider just a few possible extinction-level events that could strike even earlier: large meteors, supervolcanic eruptions, drastic climactic disruption of the “Snowball Earth” variety. As SpaceX founder and Tesla CEO Elon Musk recently observed on the Joe Rogan Experience podcast, “A species that does not become multiplanetary is simply waiting around until there is some extinction event, either self-inflicted or external.”

This statement, applied to the human species, is obviously true on its face. As doomsday events go a giant asteroid might be more shocking, since we (people living today) have never experienced one before while concerned atomic scientists warn us about the nuclear bomb all the time, but the odds that we blow ourselves up are still there. Slim, but there. It’s more plausible that a severe nuclear war and the nuclear winter it would likely trigger would leave the human population greatly reduced as opposed to completely extinct, but then the question becomes: why is that a risk we would want to take? The bomb is here to stay for now, but there is no reason that 100% of known life in the universe needs to stay here on Earth to keep it company, waiting around for something even more destructive to show up.

While we’re on that happy subject: Do you have any good intuitions about our collective chances against hostile, or simply arrogant or domineering, technologically-advanced extraterrestrial lifeforms, if and/or when they decide to pay us a visit on our home turf?

These scary situation sketches will suffice. At bottom, the core reason I am a believer in the need to make life—and not just human life—multiplanetary is the same basic reason I would never counsel a friend to keep all their money and valuables in one place: diversification is good. Wisdom and experience suggest we store precious resources in multiple safe(ish) places. Diversification limits our exposure to risk, and increases our resilience when bad things do happen. One reserve gets hit, two or three others survive, and you probably feel that the effort to spread things out was worth it.

What I’m saying here has strong undercurrents of common sense, yet our approach to the human population itself—the universal store and font of “human capital”—does not currently prioritize diversification to the degree our technological capabilities would allow. The distribution of the human population, and of almost all human knowledge and works, is overwhelmingly local. (Let us set to one side the possibility that aliens somewhere maintain an archive of captured human information.) Establishing outposts at least as large as those we maintain in Antarctica on the Moon and Mars, or other more suitable sites, by the end of this century would be a great first step toward genuinely diversifying the physical locations of the most precious resources known to us: human consciousness and creativity, human love and human soul, the great works in which all these things are displayed. Add also to this list repositories of scientific knowledge and knowhow, seed reserves, and certain materials necessary to re-start the manufacturing of fundamental technologies. Spreading these goods to a few additional locations within the solar system would be a major species-and-civilization-level accomplishment that all living at the time could feel satisfied by, and even take some pride in. And this is something that we seem to be just on the cusp of being able to do, given our recent and rapid technological advances in rocketry, computers, and materials science and engineering, among other important fields for space exploration and settlement. Quickly the uniplanetary human situation is becoming, if it is not already, one of pure choice.

Who, then, will take us beyond the “exclusively-Earth-based” stage of our civilization? Many will have a role to play, as space is not just for nerds. Humanists and economists (two audiences with whom this site is popular) should want humans to greatly improve their spaceflight and off-world-dwelling capabilities, too—not just technophiles and STEM types. There need not be a clash of visions between cyber-futurists who would bring self-sustaining cities to Mars and classicists who would rather see us die out on Earth than submit to a posthuman, dystopic future among the stars. Alignment of visions is key. Humanistic input early in the development of space settlement plans would allow for the design of better, more user-oriented (in the richest sense of the phrase) systems and processes for settling space colonies. The kind of space future humans have—and I am relatively confident we will have a robust one, someday—depends in part on the kinds of choices we make today about the plans for and structure of our involvements on other worlds. All sorts of experts, artists, and practitioners—from physicists to economists to poets—should have a say in these decisions.

Certainly humanists and economists could exert a positive influence on our space future by leaning into, instead of opposing, human space exploration, and by taking a constructive-critical interest in the plans and ideas of those who are already making progress toward space exploration today. Rather than cede the field completely to those who will build the rockets and raise the off-world settlements, social science and humanities advocates should get invested in the various problems space exploration will pose and that their disciplinary perspectives can help resolve. For instance, one space challenge for humanists and economists to consider is what kind of cultural practices and social institutions will be necessary to enable small, fledgling space colonies to grow and to thrive with a minimum of conflict, all while poised precariously somewhere out there on the barren edge of a brutally indifferent cosmos.

There are other questions as well: How well will markets function—and what kinds of markets will function—in remote areas among small groups of space settlers? Are there minimum population density requirements for an adequate off world division of labor, considering not just baseline productive necessities but also humankind’s need to consume and participate in leisure-based culture? As these complex, interdisciplinary queries suggest, successful space exploration and off-world settlement will entail much more than a string of engineering advances. Humanists, economists, historians, and indeed all students of human culture will continue to have their place in the economy of things, even when that economy is dispersed amongst the stars.

Analogies to our space present spring to mind from other ages of human adventure, exploration, and discovery. Certain critics of space exploration are wont to point out the rapacity that has often attended early human colonial efforts, like those of European powers in the “New World”-era Americas. I point out in reply, however, that such comparisons are hardly appropriate when discussing the settlement of barren planets wholly void of (sentient) life. At a minimum, concerns about the exploitation of other worlds would require there to be exploitable agents on those worlds in order to be justified. In reality, we have little reason to believe that there will be much to find on our first stops beyond Earth besides (potentially very valuable) minerals, rocks, dust, and ice. Discovering liquid water, or microscopic life, or even hints of extinct former life, would be like finding El Dorado. But unlike the conquistadores, we have good evidence-based reasons to believe in the existence of what we are looking for, and we can all but guarantee that no blood will be shed in the process of our looking for it.

(I’d be more worried about the potential for competition among fellow human space settlers or prospectors to occasionally turn violent in the absence of a meaningful law enforcement presence somewhere on the space frontier, than the possibility that we might discover, and then tyrannically dominate, ET’s home planet. And in the latter case, we have no reason whatsoever to believe that we would automatically be the ones doing the dominating.)

Space is vast, and the idea of humans exploring it is epic. But we will not realize that epic vision if the main legacy of those living today ends up being digital participation in dysfunctional politics, a declining emphasis on education, innovation, and productivity, and the willful sacrifice of culture to “culture wars.” Continuing down this path for decades would spell death to the optimistic interstellar imagination. If we choose to remain caught up with fighting amongst ourselves, we will just be “waiting around” in precisely the sense that Musk says, and we’ll be dumbing ourselves down as we do so. But if we choose instead—in budgetary and investment decisions and with our words and arguments about the relative importance of human space exploration in a world of scarce resources—to collaborate around a more hopeful, humane blueprint for the future continuity of our species, a much better world, a world of worlds, becomes possible for our descendants. In this world, the human future is significantly more secure than it is now, and the conditions for those who will inhabit it are far better. Isn’t this a world we would all prefer to be working toward?

 


Shanon FitzGerald is Assistant Websites Editor at Liberty Fund. He can be found on Twitter @shanonspeaks.

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The two China policies

The Economist has an article showing a dramatic difference in economic growth between northern and southern China:

There has been some migration to southern China, but nowhere near enough to fully explain this divergence.  The southern provinces really have done better, even in per capita terms.

The Economist provides a number of explanations for this gap, but barely even alludes to the most important; southern China is considerably more capitalist than northern China.  That oversight would not have occurred in the Economist I read when I was young.  Someone should revive the Far Eastern Economic Review.

PS.  Of course there are more than two Chinas.  Taiwan is even more capitalist than the southern mainland, and is even richer.  Hong Kong is even more capitalist than Taiwan, and is even richer.  Funny how that works.

PPS.  I said, “barely even alludes to” as this is the only reference to free market policies in the article:

In 2013, the peak of China’s building frenzy, investment in assets such as roads and factories reached an eye-watering 66% of gdp in the north versus 51% in the south. Southern officials have been more hands-off.

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Stakeholder Capitalism and the “Great Reset”

A couple of weeks ago I published an article in the Neue Zürcher Zeitung, in which I have defended stakeholder value capitalism vis à vis the “great reset” envisioned by the World Economic Forum’s Klaus Schwab. The title of the piece is: “A better capitalism is a worse capitalism”.

My main point is that the many narratives used to refashion capitalism according to some criteria of alleged “sustainability” are actually going in the direction of making businesses less accountable. My article is now available in English too thanks to the Austrian Institute, a remarkable think tank led by Martin Rhonheimer. A Professor of Ethics and Political Philosophy at the Pontifical University of the Holy Cross, Rome, Fr. Martin is a true scholar and a committed champion of economic freedom as a necessary component of human liberty and I am very glad he wanted to translate my piece and put it on the Austrian Institute’s website.

In the piece, I was specifically referring to a Time magazine article by Schwab (I’ve linked it in the post) where he claimed that for “the past 30 to 50 years”—and it would be interesting to know whether it is actually thirty or fifty years—“the neoliberal ideology has increasingly prevailed in large parts of the world.”

Klaus Schwab responded immediately with a counter-piece, which the NZZ published on line here. The title says that “CSR is in the best interest of businesses”. I was impressed that Schwab claims he battled for thirty years with Milton Friedman on corporate social responsibility, but acknowledges that Friedman won the debate. That is, in a sense, true: the jargon of CSR is all over the corporate world. But typically advocates of CSR and shareholder capitalism present it as a ought and not an is, a vision for the future. Schwab considers it pretty much a thing of the present. I consider this an admission potentially conducive to a healthier debate. In the real world of 2020, it is libertarians à la Friedman, who want a pristine separation between business and politics, that are in fact insisting on how the capitalist system *should* be and should fashion themselves as proponents of radical reform, not the other way around.

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It’s Not Just Christmas Today, but EVERYDAY!

Christmas is not only a time for rejoicing and celebration, but also a time of gratitude for what we have. In times such as these, in which all of us have been affected by the circumstances related to COVID-19, this is all the more important. It’s for this reason I would like to point out that it’s not only Christmas today, but every day. What do I mean by this? To answer this question, I’ll provide a lesson from my mother.

My mother was born in a town called Carini, in the Province of Palermo, Sicily. She was born and grew up in a home with no car, no television, and no air conditioning. After she migrated to the United States in 1971, see never thought of returning to her hometown, and always reminded us how wonderful life in America is.

It was 30 years today that she imparted on me a lesson, one that I will never forget and that I only fully appreciate now. It was an important lesson of economic development and the blessings of a free society that she taught me, even though my mom never made it to high school. She would reflect on her own childhood, telling us that the smell of oranges would remind her of Christmas.

What’s baffling about this story is that, even before my mom was born and to the present day, Sicily remains the largest producer of oranges in Italy, and a major producer of oranges and other citrus fruits worldwide. You’d think, in spite of the poverty within which she was raised, she would enjoy oranges on a more regular basis. Yet, today, most us enjoy (or can enjoy at little cost) and take for granted what had been a luxury that was consumed during Christmas, even amongst those residing in a part of the world where they were grown in relative abundance.

My intention here is neither to secularize nor undermine how special and joyous the Christmas season is. Rather, it is to express gratitude and place in perspective what the beneficial consequences of economic development are, and not to take for granted how new in the history of humankind our way of life is, even during times as hard as this. The point here is that one of the fruits of economic development, and the institutional preconditions that facilitate it, namely private property and freedom of contract under the rule of law, not only provide the framework to practice religious freedom, but also allows the masses of the population to get just not a smell, but a taste of Christmas every day.

 


Rosolino Candela is a Senior Fellow in the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics, and Associate Director of Academic and Student Programs at the Mercatus Center at George Mason University

 

 

 

 

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Jean-Baptiste Say on the Millionaire Next Door

A man is not rich because he pays largely; but he is able to pay largely because he is rich. It would not be a little ridiculous, if a man should think to enrich himself by spending largely, because he sees a rich neighbor doing so. It must be clear, that the rich man spends, because he is rich; but never can enrich himself by the act of spending.”

This is from Jean-Baptiste Say, A Treatise on Political Economy, translated from the 4th edition, Book III, Chapter VIII.

In the above quote, Say is pointing out the absurdity of the claim that Great Britain is rich because its taxes are high. (Britain’s taxes were high at the time to pay for the war against Napoleon.)

So while Say is simply making an analogy between the rich country and the rich man, I found myself, while reading this passage, thinking of a really good book by Thomas J. Stanley and William D. Danko titled The Millionaire Next Door: The Surprising Secrets of America’s Wealthy. In it, they show, with ample data, something that is obvious as soon as you think about it: most millionaires got that way, not by spending, but by saving, almost never being extravagant.

 

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The COVID/Lockdown Recession Is Over

And the recovery is well under way.

Real gross domestic product (GDP) increased at an annual rate of 33.1 percent in the third quarter of 2020 (table 1), according to the “advance” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP decreased 31.4 percent.

This is from a news release from the U.S. Department of Commerce’s Bureau of Economic Analysis, October 29, 2020.

A 33.1 percent annual rate of increase means that that would be the rate if the rate of increase of the summer quarter continued for 3 more quarters. Of course, that won’t happen. To put it in perspective, a 33.1 percent annual increase implies that real GDP in the summer quarter increased by 7.4 percent. That’s a record increase for a quarter.

Of course it comes after the huge decline of 31.4 percent (annual) in the spring quarter, which happened due to Covid-19 and the lockdowns.

That doesn’t make it even. If a number falls by 31.4 percent, then to get back to where we where, we need an increase of 45.8 percent.

To help with the math on the second point a little, here’s how I put it after a tutorial during which I watched myself on video in prepping for my first distance-learning class way back in 2002: “The camera loses 1/4 of my energy; therefore I need to increase my energy by 1/3.”

 

Here’s the math on both if you’re interested and, for that matter, even if you aren’t interested.

Let x be the quarterly rate of growth.

Then (1+x)^4 = 1.331.

4 ln(1+x) = ln(1.331) = 0.2859

ln(1+x) – 0.2859/4 = 0.07148

1+x = e(0.07148) = 1.074

Therefore x = 0.074. Growth rate = 7.4 percent.

 

On the second one.

If a number falls by 31.4 percent, it falls to 68.6 percent of what it was.

To get from 68.6 percent to 100 percent, it must rise by 1/0.686 = 45.8 percent.

 

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Iskander’s Challenge: What Took Hong Kong So Long?

Iskander, a devoted EconLog reader, sent me a fascinating question.  With his permission, I reprint his original email and a followup.


Original Email

Dear Professor Caplan,

I was reading through some old Econlog posts, and I saw one about Hong Kong (“Statist at Heart”) where you attribute rapid post war growth to the free market policies of the British. I tend to agree with this, however I do wonder about why growth was only rapid after 1950. There was next to no institutional/political change as far as I know, yet per capita output growth was not that large in the century beforehand. I can see why wages might be held down by elastic labour supply from mainland China, but not output per capita.

In many ways the British Empire acted as if it was ruled by a cabal of free market economists. It should have led to rapid global convergence as modern technology and goods were free to flow from Europe to the rest of the world and it made sure property rights were protected. Not only European property rights, as there were a large number of Indian, Chinese, Jewish and Parsi merchants and businessmen who flourished. If a Indian merchant wanted to set up a modern factory there were very few impediments from the government, which has not been the case post 1947.

In addition, taxation was low (India’s tax to GDP ratio was around 5% in the 1920s) and it usually came in forms with low deadweight loss (lump sum land taxes, excise taxes on goods with inelastic demand).

The exceptions to this were the settler colonies which were the most badly behaved (especially in South Africa) in terms of economic freedom.

Why do you think all this led to very little growth pre-1950, if these policies made Hong Kong rich post-1950?


Followup

Dear Professor Caplan,

I’m not able to find a totally convincing answer to the question myself. That said I can imagine that economic freedom has benefits even if it doesn’t lead to rapid growth.

I think that the area of China near Hong Kong was spared from most of the fighting until the 1940s (It was the base of the Kuomintang), even then Hong Kong could have produced goods for more stable South East/ South Asia (or Europe/America given the low level of wages).

At least in India, the British only moved away from free trade after WW1. A rearguard action by pro-free trade civil servants meant that tariffs were originally given only if an Industry made the case that it would raise productivity and eventually be weaned off protection, called “discriminating protection”. Under this scheme, perhaps the only successful case of Indian “infant Industry” actually growing up came about, Tata Steel. By the 1930s the rise of nationalism and fiscal pressures (The government was on the edge of bankruptcy) led to the decline of the discriminating part of protection.

The Bombay cotton textile industry was being beaten in its home market by Japanese textiles despite cotton being shipped from India to Japan, processed there and shipped back even with 50% tariffs. An interesting thing is that both industries were using the same machines but the Japanese firms had managed to raise productivity thrice as fast as the Indian firms (as far as I can remember, this is from the work of Gregory Clark and Susan Wolcott). This was a inglorious end for the first modern textile Industry in Asia (The imperial connection and an open economy meant that India’s first modern factory came thirty years before Japan’s).

Perhaps good economic policies can only go so far without widespread change in attitudes and aspirations.


Personally, I’m tempted to blame the chaos in China from the overthrow of the Manchus until the Korean War, but I’m not married to that story.  Iskander’s knowledge of colonial economic policy seems better than mine, but if I were researching this in earnest I would start by nailing down the facts.

In any case, what’s the best response to Iskander’s challenge?

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More Capital Per Worker Makes Workers More Productive

 

In a recent blog post, I wrote:

Aside for non-economists: Why would reductions in income tax rates on corporations and on high-income individuals even be expected, at a theoretical level, to increase real wages? By increasing the incentive to invest in capital. The greater the capital to labor ratio, the higher are real wages.

Commenter Robert asked:

Could someone expand on this a bit for me? Does investing in capital, mean investing in capital goods (i.e., land, machinery, tools, etc)? I don’t understand why that would necessarily lead to higher real wages.

Commenter Laron gave a nice succinct answer:

The capital goods like machinery increase labor’s productivity, which increases wages. Others can chime in with more detail or to correct me tho.

Here’s what the article on “Capital Gains Taxes” in The Concise Encyclopedia of Economics says about the issue:

Between 1900 and 2000, real wages in the United States quintupled from around fifteen cents an hour (worth three dollars in 2000 dollars) to more than fifteen dollars an hour. In other words, a worker in 2000 earned as much, adjusted for inflation, in twelve minutes as a worker in 1900 earned in an hour. That surge in the living standard of the American worker is explained, in part, by the increase in capital over that period. The main reason U.S. farmers and manufacturing workers are more productive, and their real wages higher, than those of most other industrial nations is that America has one of the highest ratios of capital to worker in the world. Even Americans working in the service sector are highly paid relative to workers in other nations as a result of the capital they work with. In their textbook, Nobel laureate Paul Samuelson and William D. Nordhaus noted: “Because each worker has more capital to work with, his or her marginal product rises. Therefore, the competitive real wage rises as workers become worth more to capitalists and meet with spirited bidding up of their market wage rates.” The capital-to-labor ratio explains roughly 95 percent of the fluctuation in wages over the past forty years. When the ratio rises, wages rise; when the ratio stays constant, wages stagnate.

The quintupling in the above is certainly an underestimate because the Consumer Price Index, used to adjust for inflation, overstates inflation.

A way to think about it is with a person on a desert island catching fish. If he does it with his bare hands, he can catch, say 2 fish a day, enough to keep from starving. But if he fashions a stick that can spear the fish, he can catch, say 4 fish a day. So that one piece of capital, the spear, has doubled his productivity. His real wage has doubled.

Then Robert followed up:

Thanks Laron. That was kind of what I was assuming was meant in the quote. I don’t know if I fully trust a business to return higher productivity back to workers in the form of higher salaries, but I can see how and why that could happen.

Here’s why it would happen. A worker becomes more productive, not just with his current employer but also with other potential employers. So if an employer does not pay the employee an increased wage for increased productivity, another employer will offer more than the current employer. That will happen until the marginal revenue product (the marginal revenue produced by the employee’s marginal product) equals the wage.

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