How Rich Countries Got Rich...and Why Poor Countries Stay Poor [Englisch] [Taschenbuch]

Erik Reinert masterfully uses experienced-based economics to demonstrate how rich countries got rich. Economic growth and welfare in rich countries originated not in unrestrained international free trade, but in conscious and deliberate industrialization policy that progressively shaped a particular form of economic structure (pp. xx, xxiv, 9-10, 47-48, 65, 79-83, 88, 98-100, 115-20, 177, 198, 246-49, 288-89).

Reinert's greatest merit is to clearly show how economic development really works (pp. 39, 52, 305-08):

1) A country first industrializes behind a wall of tariffs, direct subsidies, and/or patents and is then slowly and systematically integrated economically with nations at the same level of development (pp. 17, 22-24, 56, 84, 88, 134, 171, 210, 235, 268-69, 273). The United States followed the example of England to industrialize behind a protectionist wall for about 150 years based on Adam Smith's Wealth of Nations (pp. 23-25, 31, 58, 212). The Marshall Plan to reindustrialize Europe after WWII was built on the same logic (pp. 63, 89-90, 179-81, 241, 265-66).

Countries already wealthy need very different economic policies from those of countries still poor (p. 81). An aspiring poor country needs to tax "bad" trade, i.e., exports of raw materials (read agricultural or mining products) and imports of industrial products (pp. 17, 21, 62, 78). Perfect or commodity competition is for the poor, resulting in price-driven diminishing returns, no industrialization, and immigration to the rich world (pp. 8, 18, 62, 71, 133, 149-201, 245, 280-81). Unlike development economics, palliative economics do not radically change the productive structures of poor countries but instead focus on easing the pains of economic misery (pp. 63, 179, 211, 239-70, 282, 296-97).

Paradoxically, being poor in natural resources is one of the keys to becoming rich (pp. 7, 77). A poor country has to encourage "good" trade, i.e., imports of raw products and exports of industrial products. The existence of an (inefficient) manufacturing sector establishes a national wage level which prevents countries from moving too far into diminishing returns (pp. 109, 124, 183, 251, 265, 295). Reinert observes that "good" trade also results from the export of industrial goods in exchange for other industrial goods (p. 89).

That initial protection is essential to achieve increasing returns and to access new technologies (p. 67). Once these goals are achieved, further protectionism is counterproductive. Reinert contrasts the "good" protectionism of East Asia with the "bad" protectionism of Latin America (pp. 224, 285, 311-12). Solidly industrialized countries require bigger and more international markets to further develop and prosper (p. 81).

The timing of the opening up of an economy to international competition is therefore critical. Opening up too late undermines growth (p. 205). In contrast, opening up prematurely will result in deindustrialization, falling wages, and increasing social problems (p. 252). Mongolia and Peru are two examples that come to mind (pp. 110, 164, 173-79, 251-52). That insight about the timing of free trade is absent in the Washington Consensus as applied to most of the developing world (pp. 19, 55, 68-69, 81, 84, 107, 204, 216-37, 244, 278, 295).

2) The preconditions for wealth, democracy, and political freedom are diversified manufacturing and knowledge-intensive services subject to increasing returns (pp. 268-69). In some economic activities (read manufacturing and advanced services), costs fall as the volume of production increases (pp. 36, 38, 108-09).

David Ricardo's theory of comparative advantage in international trade relies on a number of simplistic, abstract assumptions that too often lock poor countries into specializing in being poor (pp. 15, 23, 42, 59, 75, 106, 277, 301-04, 309-10). One of the key assumptions is that there are no qualitative differences between economic activities. If left alone, the market will even out the differences between say, Microsoft in the U.S. and goat-herders in Mongolia (p. 177). Ricardo's theory is also built on the rigid assumption that there can be no change in specialization, which unsurprisingly results in factor-price polarization (pp. 19, 117, 213-14).

3) Economic wealth results from synergies, i.e., people of many different trades and professions sharing a community (pp. 73, 93-95, 102, 136, 268-69, 275). The diversity of economic activities based on the extent of division of labor makes it possible for new knowledge to be transferred from one sector to the other (pp. 94-95, 256-63, 276). Ricardo's theory completely ignores synergies (p. 214).

Reinert clearly explains to his audience that this path for a country to join the club of rich countries is much more difficult today than in the past for the following reasons (pp. 290, 292-93):

1) Information Technology: Unlike process innovations, product innovation tends to create imperfect competition and higher wages. For example, at Google, search technology as a product innovation results in high wages and high profits. When the same technology is employed in say, the hotel and airline industries, the results are falling margins for the travel industry and lower wages for many persons employed in that sector of activity (pp. 188, 229).

2) Intellectual Property: The increasing percentage of copyrighted, trademarked, and patented products widens the gap between rich and poor countries (pp. 111-14). For example, the pharmaceutical industry based in rich countries works hard to legally protect the output of its substantial investment in research and development.

3) Workers Distribution: There is a transition from single-plant economies of scale towards multi-location economies of scope. For example, the integrated American automakers are evolving toward modular architectures for their mainstream models to compete on speed and flexibility.

4) Workforce Mix: Manufacturing increasingly gets automated while services occupy an increasing percentage of the total workforce.

5) Workers Substitution: Service workers are often more easily substituted than specialized industrial workers, resulting in diminished workers' bargaining power.

6) Employers Fragmentation: Decentralized franchising instead of centralized ownership also reduces workers' power at the negotiation table.

To summarize, Reinert recommends that poor countries study the policies of those who created American and European prosperity, and ignore the advice of their forgetful successors (pp. xxix, 13). "Do not do as the Americans tell you to do, do as the Americans did," concludes Reinert (pp. 23, 168).

Erik Reinert, Professor of Technology, Governance and Development Strategies at Tallinn University of Technology in Estonia, has written a most remarkable book. He has shown that the free trade creed - the free movement of capital, deregulation and privatisation - doesn't work. As Keynes wrote, "the worse the situation, the less laissez-faire works."

The American economist Paul Samuelson won a Nobel Prize for `proving' that under free trade prices paid to capital and labour tend to be the same across the world. But in the real world, free trade has led, not to the levelling up of world wages and the end of poverty, but to growing inequality and poverty. Half the world lives on less than $2 a day. In many countries, real wages peaked 30 years ago.

Reinert proves that the mode of production determines social forms, and that the technology and mass production of industry are the key to economic growth, not capital, property rights and the rule of law. Industry also has good economic, social and political effects. As he writes, "Creating and protecting industry is creating and protecting democracy."

But how can countries build industry? They need to protect their infant industries and to subsidise their industries.

Countries need to have an industrial policy that provides work for their educated people. Otherwise Western countries, outsourcing their education costs, will take them away - education for migration.

For example, 82% of Jamaica's doctors practise abroad and 70% of university-educated Guyanans work abroad. Their remittances fund consumption and dependence, not investment and industry.

It is better to have an inefficient industry than no industry at all. Reinert points out that the Soviet countries were better off before the 1990s counter-revolutions which deindustrialised and then depopulated them. In 1991-95 Mongolia pastoralised, cutting 90% of its production; wages fell, but the finance, insurance and real estate sector grew.

The old empires all banned manufacturing industry in their colonies. Now the World Bank and the IMF ban industrial policy. They lie to third world countries -open up to imports of goods and capital, be competitive, make your labour markets flexible and you'll grow. The European Central Bank tells EU members the same story.

Welfare colonialism, with $2.3 trillions in aid since 1950, has failed. The Millennium Development Goals will fail too. Aid is a means of control, not of growth, keeping the third world dependent. Palliative economics, which is supposed to ease poverty's symptoms while ignoring its causes, does neither.

Of course, the true market faithful believe that the economics are right, but then the question arises, why are the poor still poor? If the theory is right, there must be something wrong with the people. So some say that it must be race - Keynes was, shamefully, a vice-president of the English Eugenics Society.

Reinert writes, "a major financial crisis is increasingly likely." But the true market faithful are still in power and are making the workers of the world pay for their failed system. How much longer will we allow this?

Erik Reinert's "How Rich Countries Got Rich ... and Why Poor Countries Stay Poor" is in many ways similar to Ha-Joon Chang's "Bad Samaritans". It argues that rich countries acquired their wealth by protecting their manufacturing industries in their infancy and allowing them to mature. Poor countries are thus poor because they are not allowed to industrialize using infant industry protection and industrial policy. However, Reinert goes about his argument in a very different way than Chang. While Chang mostly his book into neat chapters dealing with pieces of conventional (neoliberal) wisdom (development comes through free trade, some countries are not developed because their culture is unfit, privatization is good in itself, etc.), Reinert structures everything around the dualism of economics: the "Standard Canon" that currently dominates and the "Other Canon" which is what Reinert advocates.

According to Reinart, the "Standard Canon" ("Ricardian" economics named after David Ricardo) has completely lost touch with reality. On one occasion he quotes Milton Friedman according to whom the more important a theory, the more unrealistic its assumptions will be. The inadequacy of assumptions leads to an inadequate understanding of how capitalism works and subsequently - to bad policy. Above all, Reinert dislikes the "equality" assumption that means that all economic activities are qualitatively the same, e.g. it makes no difference whether to specialize in manufacturing or agriculture.

The "Other Canon" draws ideas from the German Historical School, the old Institutionalists, Schumpeter, Keynes, a host of long dead and forgotten Italian and German economists and others. It focuses on production rather than exchange. Logically, then, its main insight is also about production: different economic activities are qualitatively different. Manufacturing has the potential for what Schumpeter called "historical increasing returns" (technological innovation plus increasing returns to scale) and imperfect competition that allow for higher wages, higher profits and a broader tax base. Agriculture (as well as some manufacturing products in the end of their product cycle), on the other hand, provides little or no room for innovation and results in diminishing returns to scale, perfect competition, low wages and low profits. Countries that engage in these activities stand no chance to develop. Another point that Reinert makes again and again is about synergy between different sectors of the economy: agriculture will be more productive when a manufacturing is present, etc.

Reinert makes many other points besides qualitative differences of economic activities and synergies between different sectors of the economy. This includes many interesting shots at standard economics: Washington institutions assume full employment in their models when in many cases that is just ridiculous (e.g. in countries like Haiti less than half of the population has a normal job); in the world of Ricardo's comparative advantage there is no capital while labor hours are devoid of any skills or other characteristics; Schumpeter, usually thought of as a classical liberal, in fact sarcastically called Ricardo's trade theory "excellent" and said it lacked "nothing but sense". Sometimes these small pieces seem to fit into a larger picture, sometimes they seem all over the place and hard to absorb, or make sense of. That is the main problem of this book: after reading it, it would be hard to summarize it outside of the most basic insights. "Increasing returns" and "synergies" are repeated endlessly, whereas some other ideas are not so well established. It is often said that Schumpeter's classic "Capitalism, Socialism and Democracy" suffers from poor editing. Reinert seems to have inherited that same problem from one of his main intellectual influences.

That is not to say that this book is stylistically unappealing. Reinert's digressions to a more personal narrative are fairly effective: they include the story of Mongolia's deindustrialization (including the idiotic prattle of Jeffrey Sachs about how Mongolia should specialize in computer software) which he witnessed first hand, his experience with Irish and Finnish industrial policy, manufacturing industry, and academia.

Moreover, he does not hesitate to attack beliefs coming from anywhere within the political spectrum: besides attacking conservatives like Friedman, he attacks Paul Krugman (cherished by many American liberals) for his "Krugmanian vice": developing a more realistic trade theory that incorporates diminishing and increasing returns (New Trade Theory) and then ignoring it altogether for policy purposes. State-planning and market fundamentalism were both born from Ricardian economics, Reinert argues. The preoccupation with redistribution rather than wealth creation is also criticized. In terms of personal influences he draws from a broad range as well: Polanyi (a social democrat) and Schumpeter (a conservative) both inform the author's arguments.

This book is provoking, interesting, somewhat messy and hard to summarize. If you are interested in economic development as well as heterodox perspectives, check it out.