Greece, growth and hysteresis

Can countries get rich by free market reforms alone? One effect of the Greek crisis is that we might find out. The Eurogroup seems to think they can. It called (pdf) this week on Greece to implement a “bold structural reform agenda, in both the labour market and product and service markets, in order to promote competitiveness, employment and sustainable growth.”

This, though, runs into Ha-Joon Chang’s objection:

Free-trade, free-market policies are policies that have rarely, if ever, worked. Most of the rich countries did not use such policies themselves, whilst these policies have slowed down growth and increased inequality in the developing countries. (23 Things They Don‘t Tell You About Capitalism, p73)

He cites the fact that the US in the 19th century had massive trade barriers. We can add to this that two of the great growth success stories of recent years - South Korea and China - were built upon massive state intervention. And post-1945 growth in Japan and Germany was aided by hand-outs (pdf) from the US and prolonged by under-valued exchange rates - two advantages Greece lacks.

You might object to this that Britain had free market policies in the 19th century. True enough. But it did not grow quickly then. Between 1846 (the repeal of the corm laws) and 1914, real per capita GDP grew just 1.1% a year. Britain is rich because we grew slowly for a long time, not because we got rich quick.

There’s one other factor here that I’d mention which is under-appreciated - path dependency. Barring very radical change, relatively poor areas tend to stay relatively poor. My chart shows the point. It plots US states GDP per capita, as a percentage of the US total, for 1880 (p100 of this pdf) and 2010. The key thing here are the points in the lower part of the chart - which represent states which were relatively poor in 1880. You can see that, generally speaking, states that were relatively poor in 1880 - generally southern ones - were still relatively poor 130 years later. Of the 17 states with GDP per capita of 80% or less of the US average in 1880, only three had above-average GDP in 2010. And this, remember, is true for a much more effective fiscal union that the euro area has.

In other words, history matters. The habits and institutions that cause a region to be poor can cause it to stay poor, and the things that cause it to be rich keep it rich. One reason why Germany prospered after 1945 was that it had a great industrial tradition which it only had to rediscover. And Malcolm Gladwell would add that Japan and South Korea's history of rice cultivation inculcated habits of diligence that facilitated economic growth.

And herein lies the question. Mightn’t Greece today might be more like West Virginia in 1880 than Germany in 1945 in that it lacks the  culture, institutions or human capital which facilitate relative growth? If so, aren’t managerialist top-down efforts to implant such features likely to fail?

Hysteresis, remember, is a Greek word.

Comments

[Luis Enrique]

not sure Greece is such a great test of free market reforms, being stuck in the Euro and all.

if you believe this "Free-trade, free-market policies are policies that have rarely, if ever, worked." then you believe that those countries that currently come closes to these things (OECD) would be better off with not-free trade and not-free markets. Do you believe that? Also, it kind of ignores countries that have gotten rich by moving from not-free in the free-market direction.

[Greg]

Erik Reinert ("How Rich Countries Got Rich ... and Why Poor Countries Stay Poor") is also worth reading on this topic. Countries get the free trade religion only after they have developed a strong manufacturing base, because free trade benefits countries with market power. Then they start proclaiming their racial and cultural superiority - Weber's "The Protestant Ethic and the Spirit of Capitalism", and all that. We deserve to be rich because we are (a) better people.

Britain got rich by forcing its colonies - mainly India - to take its textiles, and discouraging them from developing their own manufacturing sectors or selling their produce on the open market. Germany developed its manufacturing prowess through sustained industrial policy following Jena - it wanted to avoid having free trade imposed on it by France, and used the English example. And so on.

Yes, Greece has a cultural problem with corruption. And this matters. But Greeks work many more hours per year than Germans, so "diligence" can hardly be a factor.

Greece's problem is that it specializes in low productivity growth industries: tourism, shipping, agriculture, and personal services. Could this be the product of cultural factors and history? Perhaps they helped. But the more important factors are likely to be geographical and population quirks. Either way, top-down efforts to impose 'competitiveness' are unlikely to succeed.

[Luke]

I remember once reading (can't remember the source) that much of a country's growth rate can be explained by how far behind the US it was in (I think) 1900. The idea was that catch up was more important than system of government. That sounds plausible, but is at least partly contradicted by the evidence you cite.

Is there some distinction between regions/smaller countries (such as states within the US or Greece within the EC) and larger countries? I.e is a poor part of England more trapped than, say, Korea? Or is it relative ie a poor part of Korea will tend to remain poor compared to the rest of Korea, even if Korea catches up with US?

PS thanks for posting on this topic - like many non-economists, I am puzzled by what governments can do to boost sustainable growth.

[Account Deleted]

The key to Greece has always been geography. It is at the intersection of a number of natural trade and communication routes, while its fragmented nature (mountain valleys and islands, with few big plains) has militated against monocultures in agriculture or large industrial concentrations. It's disproportionate success in shipping has been a feature for four millenia.

Today, it remains a key route into the Balkans and Black Sea, while its proximity to the Eastern Mediterranean makes it potentially attractive to outside investors who want access to both Europe and the Near East and a (up till recently) stable operating environment.

What it does suffer from is a long history of clientelism (not unlike its neighbours in Southern Italy), which was entrenched in C20 by the antagonisms of the civil war and the consequent "division of spoils" after the colonels.

Its biggest immediate challenge will be the flight of human capital (not unlike Ireland and, to a degree, Italy), due to a long history of temporary emigration and established communities across Europe, North America and Australia.

Greece's best hopes for growth remain tourism, shipping and other services. Foxconn aren't going to move there. An interesting question is whether this would be better served as part of the Eurozone or through a devalued "nea" Drachma.

What is certain is that it needs to fix the perceptions about corruption if it is to thrive as a service centre, in competition with Turkey and Israel. Ironically, the "Troika occupation" may provide the best opportunity to visibly clean the Augean stables.

[UnlearningEcon]

@Luis Enrique

'then you believe that those countries that currently come closes to these things (OECD) would be better off with not-free trade and not-free markets. Do you believe that?'

You seem to regard believing that as self evidently wrong, but I think it's clear Chris is leaning towards that view from his post.

'Also, it kind of ignores countries that have gotten rich by moving from not-free in the free-market direction.'

Let's ignore your silly 'unleashing the free market' framing, which is nonsensical. Which countries are these (HK is a city state linked to statist China and the government owns most of the land, whilst Singapore has actually had a reasonable amount of industrial policy, so these two don't qualify).

[Ralph Musgrave]

The economies of China and India have gone from strength to strength since abandonning the worst exceses of state central planning.

As to why Britain’s economy grew relatively slowly in the 19th century, reason was that it was a pioneer: doing something (industrialising) for the first time. That is a hundred times more difficult than just copying, which is all that those genius “central planner” have ever done.

[TimJ]

"He cites the fact that the US in the 19th century had massive trade barriers."

Isn't the standard response to this that the US in the 19th Century was essentially a socking great internal free market?

[Luis Enrique]

instead of unlearning economics why don't you try learning about the history of economic reform in China. Then explain to me why it's still to describe the reforms that sparked growth in the rural economy as moving in the not-free towards the free direction.

try

The China Miracle: Development Strategy and Economic Reform

Capitalism with Chinese Characteristics: Entrepreneurship and the State

and whilst it's possible that in a alternative universe the OECD countries would be better off if they had not-free markets and not-free trade, I would be rather more worried about the absence of examples of better-off-than-OECD countries with not-free markets and not-free trade than you appear to be.

[Luis Enrique]

explain to me why it's silly, I meant

[Account Deleted]

Ralph,

China and India haven't abandoned central planning (I'm not sure about the "worst excesses"). The Chinese still have 5-year plans (renamed guidelines for PR) and Indian Railways remains nationalised.

Their growth has come through globalisation (sub-contracted manufacturing and call centres for Western business) as much as internal liberalisation. In other words, in addition to rather than instead of. They have shown that globalisation and central planning can co-exist.

I don't think the UK suffered a "first mover disadvantage" in C19. Markets were undeveloped generally. The annualised per capita GDP growth for the UK and US between 1846 and 1939 was 1.03% and 1.48% respectively (measuringworth.com). Momentum increased after WW2 when rates averaged 2%.

Re "copying", I recall this was what we accused Japan and Korea of in the latter half of C20. In both cases there were strong elements of central planning, but these were domonstrably capitalist economies.

[Colin Flavin]

the love of free trade and free markets from OECD countries is primarily rhetorical, the practices they pursue are much more revealing

massive state subsidies of argriculture in addition to heavy tarrifs on products from the developing world in the US and the EU just one example of our non-commitment to free trade

free trade and free markets is what we impose on them; protectionism is a more accurate description of OECD trade policy particulary with regard to imports: as it should be for growth and economic development of the domestic sector as history has repeated shown.

[Keith]

I think it is important to be careful about throwing around meaningless phrases about "free market reforms". This wording covers a huge range of different policies. Not allowing any price mechanism is clearly inefficient as other allocation methods are usually less conducive to economic growth. As is a Stalinist or Fascist dictatorship or constant chaos in the form of a "cultural revolution". These are however, rare examples of extreme social and political dysfunction.

In the "west" free market reforms usually mean the idea that cutting taxes for the rich and big business and allowing unlimited growth in inequality will increase GDP growth and the living standards of the average person. There is no evidence for that idea. The more "free market" reform you impose the less the economy grows and the less of the growth is received by average people. So free market really should be called "pro plutocrat" policy. As the owner of A4e could say, nice slave labour if you can get it, or get Mr. Cameron to give it to you.

[UnlearningEcon]

I'll ignore your snark, luis.

There is no such thing as a free market. It's a catch all term, and its proponents simply see a free market where they want to. Keith's comment has it.

I'm no China expert, but I know enough to know that, unlike the former USSR, they integrated private production with preexisting centralised structures to smooth the transition.

In the USSR they simply implemented capitalist reforms with no consideration for the starting point. It did not work:

http://i.imgur.com/gifFT.gif

http://i.imgur.com/XqbsB.png

'and whilst it's possible that in a alternative universe the OECD countries would be better off if they had not-free markets and not-free trade, I would be rather more worried about the absence of examples of better-off-than-OECD countries with not-free markets and not-free trade than you appear to be.'

What? There you go using the term as a catch all. Developed economies are characterised by heavy planning - large corporations, central banks, infrastructure/zoning, progressive taxation and welfare states, and regulations. Furthermore, the social democratic states of Scandinavia do better than anglo american 'neoliberal' ones, which are supposedly more 'free market'. And no, they aren't regulated less:

http://flipchartfairytales.wordpress.com/2011/06/07/is-red-tape-holding-britain-back/

[Luis Enrique]

Oh heck. When discussing actually existing economies, rather than use the term free market to refer to a non existent abstraction, it is more helpful to use it to distinguish between those actually existing economies that are relatively free market from those that are less so. So mindful of the fact that OECD economies feature a good deal of regulation and state intervention, these are the economies that largely allow private actors to choose what to produce at what price, and are those referred to as free market economies.

"there is no such thing as a free market" is one of the most overused and pointless observations out there.

And don't complain about snark after you've called somebody else's comments silly and nonsensical, you twat

[Luis Enrique]

" they integrated private production with preexisting centralised structures to smooth the transition."

Which sounds rather like moving from not- free market towards a free market direction, doesn't it?

[UnlearningEcon]

'"there is no such thing as a free market" is one of the most overused and pointless observations out there.'

Nope, it's completely true and encompasses everything wrong with the way the right view economies. Why use the term if it doesn't exist?

'it is more helpful to use it to distinguish between those actually existing economies that are relatively free market from those that are less so.'

No it's not helpful because the free market doesn't mean anything, something you seem to have admitted.

The problem is that you can refer to OECD countries as 'free market' when it suits you, but when they encounter problems you can simply say that they 'aren't free market enough'. It's a catch-all, as I said and as you seem to be proving repeatedly with your comments.

'Which sounds rather like moving from not- free market towards a free market direction, doesn't it?'

You obviously didn't read my comment properly. In your skewed vision of the economy as a battle between governments and markets, both the former USSR and China could be said to be moving 'towards a free market'. The difference is that one is doing it gradually and taking preexisting institutions into account, whilst the other didn't. You can't capture the difference with silly terms like 'free market'.

Your comments are silly and nonsensical, but there's a difference between me calling you out on that and straight up insults.