Expert: Free trade a myth

Costa Rican economic policymakers probably haven’t read Ha-Joon Chang’s best-selling book “Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism.” It paints a picture far different than Costa Rica’s economic path.

Chang, a world-renowned economist and professor of economics at the University of Cambridge in the United Kingdom, is one of the leading voices against the theory that international free-trade pacts lead to economic development, particularly for developing countries like Costa Rica.

“The book is an attempt to destroy this myth that there is only one path to economic development through free-trade and free-market,” Chang told The Tico Times in a recent interview. “I tried to encourage developing country economic policymakers to think about alternative ways to develop their economies.”

Chang’s ideas on free-trade policies starkly contrast with Costa Rica’s current economic strategy. Should the pending Costa Rican free-trade agreement with China be passed (it’s currently under debate in the Legislative Assembly), it would be Costa Rica’s eighth free-trade agreement. Costa Rica and the European Union have reached another free trade deal, and talks with Peru are moving along at a fast pace.

“All the rich countries have gotten rich through the use of protectionism, government subsidies and regulation of foreign investment,” Chang said. “Basically everything that developing countries have been advised not to do is the way rich countries developed in the first place.”

In her speech after being elected in February 2010, President Laura Chinchilla said her administration would “make Costa Rica the first developed country in Latin America.” To accomplish that goal, Chinchilla’s plan has been to continue exporting national goods and attracting foreign investment. Despite increased export revenue, imports are on the rise at a faster pace. The Costa Rican trade deficit in 2010 was about $4.2 billion, which is about 8 percent of national GDP.

Chang said a figure like that is indication of an economy’s “structural weakness” and should be cause for concern.

This week Chang talked to The Tico Times about his best-selling 2007 book, as well as economic theory, the recent change in Latin America’s approach to free trade and the historical route nations took to reach developed status.

Excerpts follow:

TT: For readers not familiar with your work, what is the premise of the “Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism?”

 HJC: Basically the book tries to expose what I call the secret history of capitalism, which is an attempt to correct the pervasive myth, both between the supporters of free-market and critics of free-market, that just about all the rich countries have become rich through free-trade and free-market policy.

 Developing countries that adopted these policies in the 1950s, 60s, and 70s now are trying to make sure that smaller nations participate. The world’s powerful countries have set up the World Trade Organization and are pushing countries into bilateral and free-trade agreements, like the ones that Costa Rica has been signing in recent years.

 This pervasive myth that all the developed countries have become rich through free-market and free-trade policies has spread, and other countries feel that that is what they have to develop as well. This is especially true in Latin America.

 In the book I actually reveal that, except for one or two places, such as the Netherlands and Hong Kong, all rich countries have gotten rich through the use of protectionism, government subsidies and regulation of foreign investment. Basically everything that developing countries have been advised not to do is the way rich countries developed in the first place.

 Without an initial period of protection and nurturing, young industries in developing countries cannot develop…

 Another common misperception is that the policies of opening up markets and market liberalization have improved economic performance. It is actually reversed. In the 60s and 70s, during the era of import substitution and industrialization policies, per capita income in Latin America grew about 3.1 percent per year. Since 1980, after three decades of liberalization and opening up markets, per capita income growth rate in Latin America has been barely 1 percent.

 Some critics of free-market policy agree that liberalization policies accelerate growth, but it makes income distribution much worse…    

What are some of the negative results that some these Latin American countries have seen in response to opening their markets during the last 30-40 years?

 A lot of Latin American countries are turning away from the neoliberal policies of the 80s, 90s and first half of 2000s. Rafael Correa, president of Ecuador, has expressed this, as well as countries such as Uruguay, where policies have been significantly modified, as well as Argentina since their days of financial crisis.

It seems that countries have finally come to the recognition that neoliberal policies have failed to deliver what they promised.

President Laura Chinchilla has said that she hoped Costa Rica would become the first developed country in Latin America.

 Well, you have to set your goals high.

In your work, what have you found to be the root of development for countries to attain “developed” status?

 Essentially you have to develop your own capabilities to innovate and create products and production technologies. Some interesting statistics I have found in relation to Costa Rica is from the World Bank. They publish data about what proportion of countries total exports are made up of high-tech products, such as electronic devices. Costa Rica is right at the top of the league in the world, around 45 percent. In contrast, South Korea’s is only 33 percent, Finland 21 percent, Japan 19 percent. Some people might think, wow, Costa Rica is great, they are one of the most high-tech countries in the world, but why does it have only around $6,000 per capita income when Finland, Japan, and South Korea all have significantly larger per capita incomes?

 The reason is that Costa Rica does it with other people’s technologies.

 Another example is the Philippines, whose high-tech exports are higher than Costa Rica. It is the highest in the world at 54 percent. But the Philippines only has a $2,000 per-capita income because all they do is assemble the products and add very little value to them. All the technologies such as the key parts, the design, the organization of production and marketing all come from somewhere else.

 Unless you develop those capabilities to do them yourself, you are not going to become a developed country in the true sense. If Intel were to pull out of Costa Rica, for example, I don’t want to imagine what would happen to the country…

 Costa Rica has presented itself as a very attractive site for foreign investment for companies such as Intel and other companies to set up there, but what happens when these companies decide to relocate to Vietnam?

 A similar thing already happened to Mexico. After Mexico signed the North American Free-Trade Agreement (NAFTA) people thought they had secured a bright future. Initially there was a lot of optimism because a lot of Japanese, Korean and European companies entered to assemble things like automobile and electronics aimed at the U.S. market, but since that initial wave of optimism passed, Mexico has actually been losing huge amounts of production and jobs to countries like China. As a result, in the last decade, Mexico’s economic growth rate has been basically zero.

 Relying on other people to come in and do things for you is a strategy that will work for a while, but once you hit a certain level, for example a $10,000 per capita income like in Mexico, people will start saying “this country is becoming too expensive” and go somewhere else…

Last year President Chinchilla visited Wall Street and encouraged foreign investors to continue looking at Costa Rica. Rarely is it talked about that this could be a dangerous strategy should these companies one day leave Costa Rica. What are the dangers in bolstering your economy with extensive foreign investment, which was about 5 percent of the Costa Rican GDP last year?

 Unless you really offer exceptional quality of labor force and infrastructure and location that, for example, Singapore does, it will be very difficult to become a truly developed nation on the basis of having foreign companies operating inside your border.

 Singapore has a lot of its own companies, many are state-owned, that support the country’s economy. It is not top-heavy with foreign companies. There is a big foreign presence, but how many companies can replicate their model? Maybe Costa Rica can. If Costa Rica wants that, it really needs to develop a strategy to do so. Singapore didn’t attract a lot of high quality foreign investment simply because it exploited its workers. It invested massively in education, housing, infrastructure, port developments and more. Is Costa Rica doing that?

There is a lot of investment in education and a nationwide push for learning English. Recently, a large port development has begun on the Caribbean but transportation remains a thorn in the nation’s side.

I agree that Costa Rica is probably small enough to support a Singapore-type strategy, but if you want to do it you have to really study what they did. Don’t think that Singapore is just some free-market paradise. It does have free-trade policies and does welcome foreign investors, but all the land is owned by the government, 85 percent of housing is supplied by a subsidized rate by the government housing organization and state-owned companies produce more than 20 percent of national output. It is not what many people think it is.

 Costa Rica does have some very apparent similarities as far as population size and is considered in a good location, but, if you want to follow that model, study it carefully.

You mentioned the income disparity that free-trade agreements can create. What have you seen as a result of some of the countries that have adopted free-market and neoliberal strategies?

 Income distribution is not solely affected by policies such as trade and foreign investment, but basically most countries that have adopted neoliberal policies in the last two to three decades have seen an increase in income inequality. That is what you would expect if you let market forces act freely, it will create more inequality…

You’ve written a lot about import duties that developed countries implemented as they were developing. What were the import duty safeguards that they established?

 Basically all countries when they were developing set up trade barriers against imports from more advanced countries so that national producers would have space to grow and develop. When Britain was inferior compared to Dutch and Belgian producers in the 1800s and early 1900s, it had some of the highest industrial tariffs in the world. The U.S. invented the theory to justify these practices in the early 1800s, when U.S. Treasury Secretary Alexander Hamilton set up what is known as the “infant industry protection”. The U.S. developed the theory and from the period of the 1830s to the Second World War, the U.S. had the highest industrial tariff rate in the world…

Costa Rica continues to have a large trade deficit that has grown significantly in the last decade. How common is that among nations of the world, and what are some of the dangers of having such a high trade deficit?

 I was actually quite shocked to see the trade deficit figures. Costa Rica’s national income is about $35 billion and the trade deficit is around $4.2 billion, which is equal to 12 percent of national income. That is really high by international standards. There are not many countries that have such a high trade deficit.

 I looked more into Costa Rica’s accounts deficit and saw that remittances and investment abroad reduce the overall deficit, but it remains very high in comparison to other nations of the world. According to the World Bank, the Costa Rican account deficit was $1.6 billion, which is about 6 percent of GDP. That is still very high. Countries can have a financial crisis with figures like that. Countries like Thailand and Indonesia that had financial crises in 1997 had account deficits right around the same amount.

 This appears to be quite worrying, particularly if you have such a high trade deficit. It means that you are importing more and more and can’t keep up on exports. It is really indicative of the structural weakness of the economy. It basically means that you export quite a lot but you import most of the parts and are adding little value. It is very indicative of the country’s structural weaknesses.

Just looking at account deficit versus trade deficit, it is quite high. If you are running account deficits, you owe money to the rest of the world, and suddenly the rest of the world can demand that you pay the debt and you can wind up in huge trouble. It can leave a permanent scar on your economy.