All Commentary
Tuesday, May 18, 2010

Fair Trade for All: How Trade Can Promote Development

Stiglitz Suffers from Imperfect Knowledge

Joseph Stiglitz is a professor of economics at Columbia University. He served as a member and then chairman of President Bill Clinton’s Council of Economic Advisers from 1993 to 1997, and then was the chief economist and senior vice president at the World Bank from 1997 to 2000. In 2001 Stiglitz was awarded the Nobel Prize in economics for his work on imperfect and asymmetric information in markets.

His new book,  Fair Trade for All, is coauthored with Andrew Charlton, a researcher at the London School of Economics. Their central thesis is that if poor countries are to develop and prosper, the developed world must not merely acquiesce in their interventionist and protectionist policies, they must assist them. You see, free markets, according to Stiglitz and Charlton, just don’t work.

They start with the standard economics-textbook model of a perfectly competitive market, where the institutions through which the participants interact assure a full and efficient use of all relevant knowledge. Looking around the “real world,” and especially in poor and less-developed countries, they observe that financial and other markets fall far short of this stylized textbook conception. These poor countries, therefore, suffer from severe “market failure,” which only wisely directed government intervention and regulation can cure.

Stiglitz and Charlton drag out of the grab bag of policy proposals many of the oldest and most frequently refuted ideas. A leading one, on the basis of which they defend protectionist tariffs, is the “infant industry” argument. The premise is that a new industry will only be able to grow in a less-developed country if it is protected from more cost-efficient foreign competitors who otherwise would dominate the market. Later, once the infant has “grown,” it will no longer need that temporary trade protection.

The infant-industry argument, however, is merely one example for the authors, who believe that it is quite legitimate and useful for governments to undertake various “industrial policies” in which they pick potential “winners” for subsidies and regulatory benefits so that an underdeveloped country eventually can become a major player in the arena of global trade.

They also advocate controls on capital and investment flows in and out of less-developed nations. Governments in these countries will determine what foreign investment will be permitted and also restrict the ability of foreign investors to withdraw their funds if they become concerned about the policies being followed in the host country.

At the same time, they call for the developed countries to remove all their trade barriers to the exports of these less-developed nations, while providing them low-interest loans, foreign aid, and other subsidies in order to fully afford all those interventionist and welfare-state projects behind their high tariff walls. Furthermore, Stiglitz and Charlton insist that it would be a misuse of American or European “power” to impose any significant guidelines or restrictions on those countries’ interventionist and protectionist policies. Those governments should have a relatively free hand to use the money from Western taxpayers in any way they want. To impose rules or guidelines would be “elitist” and undemocratic!

Other than in an occasional passing comment, the authors give no weight to the idea that financial and other markets fail to function more efficiently in less-developed countries because property rights are not legally recognized and enforced. Stiglitz and Charlton seem oblivious to the important work that has been done by people like Hernando de Soto, who, in The Mystery of Capital (2000), demonstrated that throughout what used to be called “the third world” governments have either prevented or made extremely difficult the legalization of property titles, without which access to both domestic and international financial markets for economic growth is virtually impossible.

Also, their textbook conception of “perfect” financial markets totally ignores how local markets develop to fit and serve the economic capabilities of participants. The authors seem to be equally unaware of the work done by the late Peter Bauer on this very theme. In his last book, From Subsistence to Exchange (2000), Bauer explained in great detail the process by which subsistence and low-income farmers and producers are spontaneously integrated into the wider national and international market through the evolution of networks of local traders and merchants who also provide credit.

Such networks need neither government support nor subsidy. Local merchants and budding entrepreneurs know the local conditions and opportunities that enable the trading connections to best fit the situation in each part of the poorer country.

The alleged nonexistent or “imperfect” product or financial markets in these countries only seem so when looked at through the analytical “glasses” of textbook perfect competition. When looked at through the eyes of the participants, the markets in fact may be functioning just as efficiently as the transactors require. Market institutions naturally evolve at that pace and in those forms that match the expanding potentials and opportunities of producers, merchants, and traders.

As Bauer and others have emphasized, what is needed from government is security from private and political plunder through the guarding of property rights, contract law, and equal treatment under the judicial system. In addition, low taxes, limited government expenditures, and a noninflationary monetary system are all that government can contribute to helping the development process.

Stiglitz seems also not to have read the writings of his fellow Nobel laureate James Buchanan. Otherwise, he would have learned from Public Choice theory that the interventionists into whose hands he wishes to leave the fate of the poor around the world are most likely to use their political power to serve themselves and various special interests with whom they are aligned, and not to improve the circumstances of the vast majority over whom they rule.

Joseph Stiglitz apparently suffers from a lot of imperfect knowledge in the field of economics, in spite of his confidence in knowing how to plan and regulate other people’s lives.