Economic Growth | How & How NOT to Do Economics with Robert Skidelsky

– This is a course of lectures and discussions on economics. Here I take up the second view
of what economics is about, not about the logic of choice
as we discussed last time but about wealth. And I quote Adam Smith
here in his famous book, “An Inquiry Into the Nature and Causes “of the Wealth of Nations, 1776.” I apply this to three
stories of development, the neoclassical story, told
by the heirs of Adam Smith, the structuralist story
and the Marxist story. And what these three stories illustrate is the diversity of views
about economic growth. After all, that’s the central
narrative of economic history and it’s seen from very
different points of view. What these narratives try to explain is both why some countries have grown and others remain poor? One’s got to remember also something else, that for most of human history, there was no sustained growth of wealth, countries remained more
or less at the same level. We need to understand what happened in the 17th, 18th centuries when wealth did start to take off. What changes had caused that to happen? There’s one other point I
think one should remember in Adam Smith’s definition and that is he says, “The nature
and causes of wealth.” Using the word nature, and
that does raise the question what is wealth? The questions are going to run through the whole of these sessions because we’re always being told that we must increase the rate of growth and increase the growth of GDP but what is wealth? Which is the object of the whole exercise. (upbeat music) One way out of a Malthusian trap was obviously to increase
the production of wealth so that it could match and even overtake the growth of population. So, you know, the trick was to reverse the Malthusian ratios, essentially. Let’s get back to what the
18th century economists thought they were after. They correctly surmised
that economic growth depends on the widening of the market and the accumulation of stock. In other words, trade and investment. And these were profound insights on which economics still largely lives. First, economists understood
that with a growing population, people needed to aside part of
what they currently produced to invest in future production. Walt Rostow would later claim
from historical evidence that, societies need to save at
least 10% of their income to take off into “Self-sustaining growth.” If they were too poor to
save so much themselves, then they should get the money, savings they needed from richer countries. The classical economists
also believed that the economic stagnation
of pre-modern times was due to the fact that all
income surplus to basic needs had been squandered by
rulers and landlords. Instead of investing in
productive facilities, pre-modern rulers had invested in God, going back to the ancient
pyramids and then the cathedrals, they’d invested in God and once God was no
longer considered to be the object of economic activity,
once you were no longer preparing yourself for the afterlife, then you started thinking
about investing in this life. And so, the surplus, which
there always was a surplus of wealth over basic requirements because that surplus
supported governments, it supported building programs, it supported a lot of consumption,
extravagant consumption, once you moved into a different frame of thinking about these things, then the question was how can you use that surplus productively in order to increase
the wealth in this life? And so you’ve got
economics starting to think in modern terms of accumulation. So profits in the classical system were the source of accumulation. The rate of economic
growth thus depended on how much of the surplus from production accrued to the business class? Specifically, economic growth depended on depriving landlords of their rents by instituting free trade in food, and it depended on keeping
wages at subsistence. Since the state wasn’t productive
but was simply wasteful, its claim on resources should be reduced to the minimum compatible with defense and maintaining law and order. The merchants were the frugal people, postponing present satisfaction
for future benefits. As late economics would term
it, their time preferences were much better suited to economic growth than the time preferences
of monarchs or landlords. So that was the classical position. Now the neoclassical,
when they came to consider the problems, same set of problems a hundred years after Adam Smith, they left out the story of these classes and class differences in
contribution to economic growth and this was because their
classical predecessors had won the class war intellectually and in practical terms, by
limiting the income of the state, the rents of the landlords
and the wages of the workers. So the neoclassicals
never stopped to consider how fragile this situation was. The triumph of market-based
analysis left power invisible, that is, and in particular, the power that was left invisible was the power of the business class and that, of course, was the
entry of Karl Marx’s analysis of the classical economic system, but we’ll come to that later on. A very important omission from both the classical and
neoclassical story of growth is the role of the state
in economic development. Now, I’ve suggested why this should be so. Adam Smith writes, for example, “Little is requisite to carry a state “to the highest degree of opulence “from the lowest barbarism, but peace, “easy taxes and a tolerable
administration of justice. “All the rest being brought about “by the natural order of things.” By the natural order, of course, Smith meant the market system because he thought markets
were natural to people, humans had a natural propensity to track, barter and exchange. So it was all from nature
that these benefits flowed and governments really interfered with this flow of benefits. And one of the very
interesting consequences of this way of thinking,
it’s a powerful insight, is that trade provided an
alternative principle of order, it was alternative to war and so that the market
system was self-regulating in the sense that it removed the main reasons for going to war because trade was mutually beneficial. That was the classical growth story, you know, the state wasn’t there, it was a priori almost. But, as a matter of historical fact, most economic growth has
been state-led not market-led in the sense that a great
deal of capital accumulation was done by the state itself or depended on state subsidy or direction or depended on frameworks
which the state had created, including class frameworks
which it sustained. And this was true of industrialization in Japan in the 19th century and has been true of
industrialization in the 20th century, particularly modern
industrialization of Japan and economic growth of
Japan and China today. The state has taxed the
profits of the private owners to create its own investment
and welfare funds. Trade too was an
instrument of state policy, it didn’t follow the precepts
of the classical economists and, as many historians have pointed out, most countries industrialized
under tariff protection or other kinds of protection,
not under free trade. I think you can understand
the low standing of the state in the eyes of the classical economist from its previous performance and the fact that it was very corrupt. Even when governments did
start accumulating capital for economic purposes, economist theorists
were quick to argue that public investment was
bound to be less efficient than private investment. And this was because the
state couldn’t direct capital in line with any consumer
other than itself, so it was bound to be less efficient, even when it did sort of
undertake these things. And today, neoclassical economists, and I’m talking really about
neoclassical economists here, love to tell stories of how governments invariably pick losers. And so whenever, you know, anyone suggests bringing something into public ownership for the first time or renationalizing it, people will always say, well
the state is bound to lose out, you know, be less efficient
at running these things than a private enterprise. They ignore the fact that governments have often picked winners. Consider Toyota, the Japanese
automobile manufacturer. Starting as a tiny textile manufacturer, it was propelled into world rank by acts of government tariffs, exclusion of competitors and subsidies. And I quote Ha-Joon Chang here, “Had the Japanese government “followed the free trade economists “back in the early 1960s, “there would have been no Lexus. “Toyota today would, at
best, be a junior partner “to some western car manufacturer, “or worse, have been wiped out. “The same would have been true of “the entire Japanese economy.” You know, you can tell the
same story about Silicon Valley and other dynamic centers of innovation. These are not explained by the
state getting out of the way but actually subsidizing and taking risks that your private venture
capitalists wouldn’t have taken. From the internet to nanotechnology, most of the fundamental
technological advances of the past half century were
funded by government agencies. That’s true in the United States. I mean, what’s so extraordinary
in the United States is the rhetoric is totally
against government interference and yet, a great deal
of the American economy depends on government subsidy, government procurement policies. There’s some cognitive
dissonance going on, isn’t there? The profound disparagement about the role of the state
in economic development has run through mainstream
economics from the start. In every park, you find
a debate between those, the majority of economists who believe laissez-faire desirable with, I quote, John Stuart Mill, “Every departure from it,
unless required by a great good, “a certain evil.” And those who believe that
markets need to be embedded in social, moral, legal
institutional structures to keep them free enough to grow wealth but limit their power. These historical
disagreements are reflected in the disagreements by economists today about why some countries grow rich and other countries stay poor. And there’s a free trade story about this which is the main one, there’s a structural story,
that’s a heterodox story, and, of course, there’s
an exploitation story. You know, the structural
and exploitation stories are quite similar to each other. If you look at the
arguments for globalization, now, they are free trade
arguments, essentially. And at the heart of them lies Ricardo’s theory of comparative advantage. “However rich one country is, “and however poor another is, “there is always a trade which “will make both of them better off.” And his theory has turned even the most hard-nosed of
economists dewy eyed. Paul Samuelson calls it, “Beautiful.” And says that, “In any beauty
competition in economics, “Ricardo’s theory of comparative advantage “would take the prize.” Now, it is a very interesting theory. I mean, the fact is that
no one’s ever followed it. You know, that doesn’t diminish
its aesthetic properties. And it’s counterintuitive, which also adds to its attraction to people
who want to show that their thinking is more sophisticated than that of common sense. Adam Smith had recognized that trade arises from natural advantage, and you do see this in all
these historical trade patterns. I mean, I’ve been in Egypt,
they’ve got lapis lazuli in ancient Egypt from Afghanistan, they gave, you know, papyrus and things that couldn’t
be made there in exchange. And that’s trade in natural advantages. Inland regions trade with coastal regions. But Ricardo explains that trade is not confined to natural advantage. Rational agents understand that
their gains will be greatest if they specialize in those activities in which their advantage is greatest. That seems sensible
from one point of view, a professor who can both think and type better than anyone else in the town but who can think better
than he or she can type will hire a secretary to do the typing, leaving himself more time for thinking. I mean, that seems to follow, division of labor does seem in some way correspond to this kind of idea. And then you simply apply it to countries and you say, you know, Portugal should concentrate
on producing wine, leaving cloth production to the English even though Portugal can
produce wine and cloth at a lower cost than England can. So you get this sort of extrapolation from what is an observation, you know, quite local and makes
a lot of sense locally to the whole world. And then you ask, has comparative
advantage been the basis of international trade
as a matter of fact? And the answer is it hasn’t. The free trade theory has, of course, been successively refined
from where Ricardo left it to bring it closer to reality, but it still ends up prescribing how trade should be conducted rather than explaining how it is and that is a continuous
confusion in economic theory between the normative and positive. Because economic economists
have proved arithmetically that free trade makes
both partners better off, they expect countries to do
this, to trade in this way and if for some reason they don’t, they must be induced or forced
to change their bad habits. What seems to be scientifically objective turns out to be very dependent on the facts of power, actually, your ability to make
countries trade in the way you think they should
for their own benefit. In the 1990s, the growth agenda was taken over by the
so-called Washington Consensus. Economists of the IMF and the World Bank induced countries to liberalize
their financial markets, reduce trade barriers,
privatize public enterprises, cut down on state spending
and allow production decision to be taken in the global marketplace in return for loans. They were made the condition of loans and, of course, that
was a powerful leverage. And the Washington Consensus was the intellectual
engine of globalization. Globalization would enable poor countries to exploit their comparative advantage in cheap and abundant labor. If you look at it from the
free trade story perspective, development and underdevelopment are successive points on the same road, the road to riches. Some cars overtake others, some break down but all ultimately are
headed in the same direction and towards the same destination. Now, you turn to another story which is one of the heterodox
stories, structuralism. They say this picture’s
profoundly misleading, capitalism is a world system and free trade locks
rich and poor countries into their preexisting positions. In other words, it is a static, it is a static theory. And the Argentinian
economist Raul Prebisch argued in the 1950s and 1960s that the gains from trade are
systematically biased against poor countries. The bias operates through
something he called “Declining terms of trade.” The tendency for the terms of trade of primary goods producers
to decline against those of the producers
of manufactured goods. Such a decline is equivalent to long term transfers of income from poor to rich countries. Prebisch claimed that
manufacturing countries have a permanent cost advantage because technical change benefits them more than primary producers. So his, that argument,
the Prebisch argument really comes out in 19th
century nationalist economics, Alexander Hamilton, Friedrich List. In other words, they emphasize that comparative advantage is, a la Ricardo, is a static theory and what you should do is to try and shape your
comparative advantages by deliberate state policy and, particularly, encouragement of what are called infant industries. And so, Prebisch and his
followers in the 1950s and 60s demanded all kinds of state
intervention in markets to improve developing
countries’ terms of trade. You know, import
substitution was the policy for which they were mainly known. This would free developing countries from dependence on imported
manufactured goods. So that’s the structuralist account and then you have the exploitation theory, which is an extreme version
of the structural argument. Unequal exchange, the
exploitation theorists would go and these are Marxists, sometimes called the
dependencia theorists. They argue that unequal exchange isn’t something contingent
that can be remedied by changes of policy within
the world capitalist system because is a necessary condition of capitalist survival that this
structure should continue. And therefore, if you really want to free countries from unequal exchange, you’ve got to have a revolution, you’ve got to withdraw them
in some way from the system. At a time when theories
had a lot of traction, the socialist world was a counterpoint was, you know, offered
an alternative model. It’s all based on
declining rate of profit. As the rate of profit falls
in the developed countries, exploitation has to be transferred
abroad and intensified. And then, more than echoes here of Mao Tsetung’s redefinition
of the revolutionary struggle in terms of the countryside
versus the towns. And a crucial point made by
the dependencia theorists, and I think there’s a lot that’s wrong with their
argument, by the way, I’m just telling it, I’m just saying this is a story and we have to then decide which of this stories we
find more plausible for explanatory purposes as well
as for prescriptive purposes. I think one point they do make is that capitalism at the center developed on the basis of the home market whereas capitalism on the periphery was really imported from outside. Thus, the capitalist
economies on the periphery lack any internal capitalist
dynamic of their own and capitalism in such conditions leads to an enclave economy which has no or very few
beneficial spillover effects but kills off the remaining economy by diverting resources to
artificial export activities, shrinking the tertiary sectors
of traditional economies and encouraging wasteful
modern production techniques when they’re really inappropriate. And theories of this kind still
have considerable purchase in Latin America in particular. What makes them theoretically dissident in terms of mainstream economics is their reliance on a modeling of the world economy as a binary system borrowing from Marxian class analysis and replacing capitalists and labor with scent and periphery. That’s why development economics has never been recognized
by the mainstream as a legitimate branch of economics until it was assimilated
to the mainstream. And so I think development economics was always regarded as rather inferior, it introduced a lot of
extraneous considerations, no tight modeling, lots
of politics, sociology and other sort of
extraneous elements added and they didn’t really feel satisfied with the state of development economics until they’d managed to reunify economics as a single set of theorems which applied everywhere, to rich and poor countries, into division into binary, no binary divisions of any kind. And that was the basis of
the Washington Consensus. What was good for the rich was equally good for the poor and they should all accept that. So we have these three
stories of development. The free trade theory shows us different cars on the same road with some ahead, others
behind and others starting but assures us that those
in the rear will catch up by following the recipes of
Adam Smith and his followers. Structuralist theory allows some cars to be stuck in the slow lane but argues that they can
move over to the fast lane by following import substitution policies. The exploitation theory argues that capitalism has consigned
most peripheral countries permanently to the slow lane from which they can only escape by revolution against their exploiters. That’s the way economics
has set out this problem, that is set out its
inquiry into the causes of the growth and retardation of wealth. And I think I’ve covered the ground very, very broadly, very, very simply but I would emphasize
that mainstream economics only accepts the first story, the others are properly called heterodox which doesn’t mean they’re wrong, but it just means that you don’t find them either in the textbooks or given any, or the basis of the theory
that the textbooks deploy. So is there a good point now to have a discussion on this? And I mean, you know, obvious
questions that occur to me and maybe occur to you is what do we think of the three
diagnoses and prescriptions? What does the evidence show? Has liberalization a
la Washington Consensus been good or bad for the
countries adopting it? In other words, what has been
the effects of liberalization on poverty rates in poor countries? Has liberalization actually
done the job it claims to do, which is lift poor
countries out of poverty? What’s it done to equality? Again, a missing subject in
the mainstream is equality, is distribution, because it’s
not interesting, distribution. What do we think about protection
and import substitution? Are they always right? Are there valid arguments for protection? Is it always just a second best?

2 thoughts on “Economic Growth | How & How NOT to Do Economics with Robert Skidelsky

Leave a Reply

Your email address will not be published. Required fields are marked *