By Francis Lee who looks at the politics of development and under-development for the Saker Blog.

I think it was Sir Ian Gilmour (now deceased) who, as one time member of Mrs Thatcher’s first Cabinet in 1979, referred to her economic policy as ‘Clause 4 dogmatism in reverse.’ (1) This was an apt description from a thinking Tory. The notion that there existed a magic panacea which would banish all the problems associated with Britain’s (and the world’s) economic ills, formed the basis of Thatcherism, Reaganism, and the Third-wayism of Clinton and Blair. The so-called ‘supply-side’ revolution consisted of removing all the controls from capitalism which had been painstakingly put in place over the centuries, and simply letting the system rip – and rip it did. The 1970s was the beginning of the interregnum to the new order of the 1980s and beyond, which had ushered in policies of privatisation, deregulation, liberalisation which were the key components of this policy paradigm.

In international terms free-trade and free-markets were of course at the heart of the system – a system which was to become known as ‘globalization’ and/or neoliberalism packaged and sold as an irresistible force of nature. It was considered, by all the people that mattered, that free-trade was always and everywhere the best policy. This view was codified in what was to become known as the ‘Washington Consensus.’ The new conventional wisdom was conceived of and given a legitimating cachet by political, business, MSM and academic elites around the world.

However, many of the elements – if not all – of the Washington Consensus were hardly new, and indeed many date back to the 18th and 19th centuries and perhaps beyond. It could be said that the newly emergent mainstream orthodoxy represented a caricature of an outdated and somewhat dubious political economy.

The theory that free trade between nations would maximise output and welfare was first mooted by Adam Smith, but its final elaboration was conducted by David Ricardo in his famous work The Principles of Political Economy and Taxation first published in 1817. Briefly, he argued that nations should specialise in what they do best and in that way world output would be maximised. This policy was called ‘comparative advantage’. The hypothetical example he used was England and Portugal and the production of wine and cloth, where he calculated that England should produce cloth and Portugal should produce wine. It was asserted, though no evidence was ever presented, that all would gain from this international division of labour. The theory is in fact full of unsubstantiated and seductive notions, but its practical application is limited. Because it is based upon so many rigid and static assumptions, it is especially appealing to those of a status quo disposition, including most present- day globalist thinkers.

However, even a cursory glance at economic history, and particularly the transition from agrarian to industrial societies, demonstrates the weaknesses, and indeed, serves to falsify the whole Ricardian trade paradigm. The brute historical fact is that every nation which has successfully embarked on this transition – including the UK – has done so adopting policies which were the exact opposite of those advocated by the free-trade school. In the world of actually existing capitalism, free-trade is the exception rather than the rule. Contemporary world trade is mainly a matter of intra-firm trading, that is, global companies trading with their own affiliates and subsidiaries in different countries, mainly for tax avoidance purposes (see below). Next there are regional trading blocs like the EU or US which erect tariff barriers to non-members. Thirdly there is barter trade where goods and services are exchanged for other goods and services rather than money. Finally, only about 20% at most, can be considered to be free trade, and even here there are exceptions involving bilateral specifications and agreements.

Modernisation and industrialisation, wherever it took place, involved tariffs, infant industry protection, export subsidies, import quotas, grants for R&D, patents, currency manipulation, mass education and so forth … a smorgasboard of interventionist policies whereby the economy was directed from above by the state. For example during its period of industrialisation the United States erected tariff walls to keep out foreign (mainly British) goods with the intention of nurturing nascent US industries. US tariffs (in percentages of value) ranged from 35 to almost 50% during the period 1820-1931, and the US itself only became in any sense a free-trading nation after World War II, that is once its financial and industrial hegemony had been established. In Europe laissez-faire was also eschewed. In Germany in particular tariffs were lower in the US, but the involvement of the German state in the development of the economy was decidedly hands-on. Again there was the by now standard policy of infant industry protection, and this was supplemented by an array of grants from the central government including scholarships to promising innovators, subsidies to competent entrepreneurs, and the organisation of exhibitions of new machinery and industrial processes. In addition, ‘’during this period Germany pioneered modern social policy, which was important in maintaining social peace – and thus promoting investment – in a newly unified country … ‘’(2)

It has been the same everywhere, yet the Ricardian legacy still prevails. But this legacy takes on the form of a free-floating ideology with little connexion to either practical policy prescriptions or the real world. It has been said in this respect that ‘’ … practical results have little to do with the persuasiveness of ideology.’’(3) This much is true, but it rather misses the point: the function of ideology is not to supply answers to problems in the real world, but simply to give a Panglossian justification to the prevalent order of things.

Turning to the real world it will be seen that ‘’ … history shows that symmetric free-trade, between nations of approximately the same level of development, benefits both parties.’’ However, ‘’asymmetric trade will lead to the poor nation specialising in being poor, while the rich nation will specialise in being rich. To benefit from free trade, the poor nation must rid itself of its international specialisation of being poor. For 500 years this has not happened anywhere without any market intervention.’’ (4)

This asymmetry in the global system is both cause and consequence of globalization. It should be borne in mind that the Least Developed Countries (LDCs) are suppliers of cheap raw material inputs to the industrialised countries of North America, Western Europe, and East Asia. In technological terms the LDCs find themselves locked into low value-added, low-productivity, low-research intensive dead-end production, where no discernible development or technology transfer takes place. Thus under-development is a structural characteristic of globalization, not some unfortunate accident. Put another way:

‘’ … if rich nations (the North) as the result of historical forces, are relatively well endowed with the vital resources of capital, entrepreneurial ability, and skilled labour, their continued specialisation in products and processes that use the resources intensively can create the necessary conditions for their further growth. By contrast LDCs (the global-South) endowed with abundant supplies of cheap, unskilled labour, by intentionally specialising in products that use cheap, unskilled labour … will often find themselves locked into a stagnant situation that perpetuates their comparative advantage in unskilled, unproductive activities. This in turn inhibits the domestic growth of needed capital, entrepreneurship, and technical skills. Static efficiency becomes dynamic inefficiency, and a cumulative process is set in motion in which trade exacerbates already unequal trading relationships, distributes benefits largely to the people who are already well-off, and perpetuates the physical and human resource under-development that characterises most poor nations.’’ (5)

The cocoa-chocolate industry (hereafter CCI) of the West African nations, Cameroon, Ghana, Ivory Coast and Nigeria are a case in point. These countries produce the majority of the world’s raw cocoa beans. But of course the industry as a whole is controlled by western multinationals such as Hershey, Nestlé and Cadbury-Schweppes (now Kraft). The structure of this industry – vertically integrated – is very typical of the relationship between the LDCs and the developed world. The low value-added part of the industry – growing and harvesting the beans – is left to individual farmers in West Africa. Buying agencies, either very close to, or in fact subsidiaries of multinational companies (MNCs), then buy the raw material at prices usually dictated by the MNCs. This asymmetrical relationship between supplier and sole buyers (the African farmers) is termed ‘monopsony’ in the economics jargon. It should be understood that large companies not only over-price their products to the final consumer, but also under-price their purchases from their captive suppliers. From then on, the various stages of the processing supply chain are in the hands of the parent company. From raw beans, to roasting, milling, refining, manufacturing of chocolate or cocoa, shipping, and packaging, branding and advertising – all of these stages add value to the product, value which is garnered by the MNC. The exporting African nations are left with the low or no value-added end of the operation, a technological cul-de-sac.

Nor does it end there. MNCs can avoid much local taxation by shifting profits to subsidiaries in low-tax venues by artificially inflating the price which it pays for intermediate products purchased from these same subsidiaries so as to lower its stated profits. This phenomenon is known as transfer pricing and is a common practice of MNCs – one over which host governments can exert little control as long as corporate tax rates differ from one country to the next. Hypothetically it works as follows:

Take a company called World Inc. which produces a type of food in Africa; it then processes it and sells the finished product in the United States. World Inc. does this via three subsidiaries: Africa Inc. (in Africa Malawi ), Haven Inc. (in a tax haven, British Virgin Islands with zero taxes) and America Inc. (in the United States).

1. Now Africa Inc. sells the produce to Haven Inc. at an artificially low price, resulting in Africa Inc. having artificially low profits – and consequently an artificially low tax bill in Africa. 2. Then Haven Inc. sells the product to America Inc. at a very high price – almost as high as the final retail price at which 3. America Inc. sells the processed product. As a result, America Inc. also has artificially low profitability, and an artificially low tax bill in America. By contrast, however, Haven Inc. has bought at a very low price, and sold at a very high price, artificially creating very high profits. However, Haven Inc is located in a tax haven – so it pays no taxes on those profits. Easy Peasy, no?

Bear in mind also that although the IMF and World Bank enjoin LDCs to adopt market liberalisation policies, they apparently see – or conveniently ignore – the past and current mercantilist practices of developed nations. Agriculture for example is massively subsidised in both the US and the EU. But it really is a question of don’t do what I do – do as I say. This hypocrisy at the heart of the problem represents the elephant in the room. We know that countries which attempt to open their markets when they are not ready to do so usually pay a heavy price (in the 1990s with Russia and the free-market shock-therapy for example). The countries which protect their growing industries until they are ready to trade on world markets have been the successes – even in capitalist terms. The wave of development in the 19th century and the development of East Asian economies during the 20th century bears witness to this.

But the object of the free-trade rhetoric and finger wagging posture of the developed world is precisely to maintain the status quo. We should be aware that: ‘’… multinational corporations are not in the development business; their objective is to maximise their return on capital. MNCs seek out the best profit opportunities and are largely unconcerned with issues such as poverty, inequality, employment conditions, and environmental problems.’’ (6)

Given the regulatory capture of the political structures in the developed world by powerful business interests, it seems that this situation is likely to endure for the foreseeable future. Development will only come about when the LDCs take their fate into their own hands and emulate the nation-building strategies of East Asia and in the 19th century by Germany and the United States. These leaders and leading nations were not to sit back and let the British rule the roost. They acted and they overcame.

Germany: Georg Friedrich List (1789-1846).  He was a forefather of the German historical school of economics and ‘National System of Political Economy’. He argued for the German Customs Union from a Nationalist standpoint. He advocated imposing tariffs on imported goods while supporting free trade of domestic goods and stated the cost of a tariff should be seen as an investment in a nation’s future productivity.

The USA – Alexander Hamilton In the aftermath of ratification, Hamilton continued to expand on his interpretations of the Constitution to defend his proposed economic policies as Secretary of the Treasury. Credited today with creating the foundation for the U.S. financial system, Hamilton wrote three reports addressing public credit, banking, and raising revenue. In addition to the National Bank, Alexander Hamilton founded the U.S. Mint, created a system to levy taxes on luxury products (such as whiskey), and outlined an aggressive plan for the development of internal manufacturing.

The USA – President – Ulysses S Grant

“For centuries England has relied on protection, has carried it to extremes and has obtained satisfactory results from it. There is no doubt that it is to this system that it owes its present strength. After two centuries, England has found it convenient to adopt free trade because it thinks that protection can no longer offer it anything. Very well then, gentlemen, my knowledge of our country leads me to believe that within 200 years, when America has gotten out of protection all that it can offer, it too will adopt free trade.” (7)

Markets have a strong tendency to reinforce the status quo. The free market dictates that countries stick to what they are good at. Stated bluntly, this means that poor countries are supposed to continue with their current engagement in low productivity activities. But engagement in those activities is exactly what makes them poor. If they want to leave poverty behind, they have to defy the market and do the more difficult things that bring them higher incomes – it is as simple as that, and there are no two ways about it.

NOTES

(1) Clause 4 was part of the British Labour Party’s early Constitution. But is no longer in any real sense part of the constitution of the contemporary UK Labour Party, setting out the aims and values of the party (New Labour) as it is now called. The original clause, adopted in 1918, called for common ownership of heavy industry, and proved controversial in later years; the then leader, Hugh Gaitskell, attempted to remove the clause after Labour’s loss in the 1959 general election.

In 1995, under the leadership of Tony Blair, a new (revisionist) Clause IV was adopted. This was seen as a significant moment in Blair’s redefinition of the party as New Labour, but has survived and become a centrist party along with sister parties in Europe and the Democratic party in the US beyond the New Labour branding.

(2) Kicking Away the Ladder – Ha-Joon Chang

(3) The Trillion Dollar Meltdown – Charles Morris

(4) How Rich Countries Got Rich and Why Poor Countries Stay Poor – Erik Reinert.

(5) Development Economics – Todaro and Smith

(6) Ibid – Todaro and Smith

(7) Collected Works