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Saturday, 18 July 2009

Mercantilism Reconsidered

A new piece by Rodrik makes a case for more government direction of markets :

A businessman walks into a government minister's office and says he needs help. What should the minister do? Invite him in for a cup of coffee and ask how the government can be of help? Or throw him out, on the principle that government should not be handing out favors to business?

This question constitutes a Rorschach test for policymakers and economists. On one side are free-market enthusiasts and neo-classical economists, who believe in a stark separation between state and business. In their view, the government's role is to establish clear rules and regulations and then let businesses sink or swim on their own.

Public officials should hold private interests at arm's length and never cozy up to them. It is consumers, not producers, who are king.

This view reflects a venerable tradition that goes back to Adam Smith and continues a proud existence in today's economics textbooks. It is also the dominant perspective of governance in the United States, Britain, and other societies organized along Anglo-American lines - even though actual practice often deviates from idealized principles.

On the other side are what we may call corporatists or neo-mercantilists, who view an alliance between government and business as critical to good economic performance and social harmony. In this model, the economy needs a state that eagerly lends an ear to business, and, when necessary, greases the wheels of commerce by providing incentives, subsidies, and other discretionary benefits. Because investment and job creation ensure economic prosperity, the objective of government policy should be to make producers happy. Rigid rules and distant policymakers merely suffocate the animal spirits of the business class.

This view reflects an even older tradition that goes back to the mercantilist practices of the seventeenth century. Mercantilists believed in an active economic role for the state - to promote exports, discourage finished imports, and establish trade monopolies that would enrich business and the crown alike. This idea survives today in the practices of Asian export superpowers (most notably China).

Adam Smith and his followers decisively won the intellectual battle between these two models of capitalism. But the facts on the ground tell a more ambiguous story.

The growth champions of the past few decades - Japan in the 1950's and 1960's, South Korea from the 1960's to the 1980's, and China since the early 1980's - have all had activist governments collaborating closely with large business. All aggressively promoted investment and exports while discouraging (or remaining agnostic about) imports. China's pursuit of a high-saving, large-trade-surplus economy in recent years embodies mercantilist teachings.

Early mercantilism deserves a rethink too. It is doubtful that the great expansion of intercontinental trade in the sixteenth and seventeenth centuries would have been possible without the incentives that states provided, such as monopoly charters. As many economic historians argue, the trade networks and profits that mercantilism provided for Britain may have been critical in launching the country's industrial revolution around the middle of the eighteenth century.

None of this is to idealize mercantilist practices, whose harmful effects are easy to see. Governments can too easily end up in the pockets of business, resulting in cronyism and rent-seeking instead of economic growth.

Even when initially successful, government intervention in favor of business can outlive its usefulness and become ossified. The pursuit of trade surpluses inevitably triggers conflicts with trade partners, and the effectiveness of mercantilist policies depends in part on the absence of similar policies elsewhere.

Moreover, unilateral mercantilism is no guarantee of success. The Chinese-US trade relationship may have seemed like a marriage made in heaven - between practitioners of the mercantilist and liberal models, respectively - but in hindsight it is clear that it merely led to a blowup. As a result, China will have to make important changes to its economic strategy, a necessity for which it has yet to prepare itself.

Nonetheless, the mercantilist mindset provides policymakers with some important advantages: better feedback about the constraints and opportunities that private economic activity faces, and the ability to create a sense of national purpose around economic goals. There is much that liberals can learn from it.

Indeed, the inability to see the advantages of close state-business relations is the blind spot of modern economic liberalism. Just look at how the search for the causes of the financial crisis has played out in the US. Current conventional wisdom places the blame squarely on the close ties that developed between policymakers and the financial industry in recent decades. For textbook liberals, the state should have kept its distance, acting purely as Platonic guardians of consumer sovereignty.

But the problem is not that government listened too much to Wall Street; rather, the problem is that it didn't listen enough to Main Street, where the real producers and innovators were. That is how untested economic theories about efficient markets and self-regulation could substitute for common sense, enabling financial interests to gain hegemony, while leaving everyone else, including governments, to pick up the pieces.


  1. Now they tell us.

    Look, let's use some common sense. How about import substitution for everything Zambian comsumers consume - food, energy, housing must be produced locally by Zambian producers (not FDI).

    Then, start developing the infrastructure - dams, ditches, ponds, etc. for rainwater harvesting, agriculture, etc.

    Turn Zambia's copper into finished products for exports. Generate energy domestically.

  2. Cho is to be congratulated for raising the issue of mercantilism versus liberalism. Personally I am a liberal. Freedom requires some regulation certainly – especially where banks are concerned. But regulation in the interest of popularity – whether from producers or consumers – is always dangerous.

    Adam Smith was rightly distrustful of business people and of politicians, as they both tend to promote their own minority interests. And even well meaning people who try to promote what they see as the interests of the majority are often mistaken, with regard to both means and ends. The interests of the majority are most likely to be met through self-serving competition.

    Cho says government in America listened too much to Wall Street (finance) rather than to Main Street (industry). But we should be careful about crediting the latter, as he does, with innovation. Economics is about incentives, and innovation comes in reaction to incentives. As Hayek saw, the great discovery process is competition.

    So we need to beware of mercantilism, and in general of economic control by governments. As we learn from Hong Kong, and from countless other examples, it is the economies with the fewest regulations and the greatest openness to competition – foreign as well as domestic – that develop fastest.

  3. Murray,

    it's Rodrik at Harvard not me!

  4. Thanks, Cho. I should have realised that. I still have a contrary view!

  5. Murray,

    I think the issue of liberalism versus mercantilism debate probably for me misses the point.

    The debate really should be about which sectors is government control necessary, for what purpose and to what degree?

    I think for a nation like Zambia its not good enough to simply say markets or governments will do it..we have to be able to explain SECTOR by SECTOR why certain solutions are more adequate than the other..

    So I think I would say, I have no ideology really...All I have is a tripod...

    Better society are founded on :
    1. Democracy
    2. Strong markets
    3. Religious/ Cultural Institutions

    As I say in my review of Chang's book (would be good to hear your views on his book or the review -
    I make the point that :

    "Where I find Chang particularly enlightening is in the concept of how we ensure strong markets emerge in developing countries that form the basis of durable societies. To Chang strong markets are not found in neo-liberal free trade but in a pragmatic long view of what delivers development. Sometimes domestic markets have to be protected, as one would a young child, until they grow and are able to compete and stand strong. The mistake of the neo-liberal ideology is to make strong markets synonymous with unregulated markets. Chang is clear that the goal is not state or free markets, but finding the right balance that delivered strong and durable markets that underpin long term productivity."

  6. On reviewing 'free trade', pleaes check out:

    The Myth of Free Trade: The Pooring of America
    by prof. Ravi Batra (Southern Methodist University)


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