The myth of liberalization

[Neo]

January 15, 2007 Monday Zilhaj 24, 1427

The myth of liberalization

By Yousuf Nazar

Pakistan’s trade deficit hit an all time record of $6.5 billion for the six months ended December 2006 as exports growth continued to stagnate while imports rose to new record. The trade policy whose stated objective has been to facilitate exports-led growth does not seem to be working. Pakistan’s trade liberalisation policy, pursued since the early 1980s, has not delivered the exports-led growth experienced in the East Asian economies for more than two decades.

Pakistan’s GDP growth while impressive during the past four years has been led by consumption and an exports-led growth seems like a distant dream. The government’s top economic managers continue to espouse the benefits of trade liberalisation and maintain that in an age of globalisation, this is the only way forward. Free trade agreements abound and Pakistan’s markets have never been so open. The proponents of ‘free trade’ appear to give the impression that it is the widely accepted way forward to development. Is it?

Even renowned western economists like Joseph Stiglitz, former chief economist of the World Bank and a Nobel laureate, have rejected the notion of free trade as a panacea for development and the so-called Washington Consensus as a means to lift the developing countries out of poverty. In the context of the ‘free market’ policies being pursued by the current government (over which even the main opposition parties do not seem to have any substantial difference of opinion), it is instructive to go back to the early 1990s. Trade and capital market liberalisation were two key components of a broader policy framework, known as the Washington Consensus – a consensus forged between the IMF (located on 19th Street in Washington D.C.), the World Bank (on the 18th Street), and the U.S. Treasury (on the 15th Street) on what constituted the set of policies that would best promote development.

It emphasized downscaling of government, deregulation, and rapid liberalisation and privatisation. Many Latin American and East European countries took it as a gospel and religiously followed its prescriptions. Almost two decades later, the two countries that have grown the fastest, that is China and India, are the ones that did not follow these policies. Our political leadership, be it in the government or in the mainstream opposition parties like the PPP or the PML (N), seems to believe that once the economy is liberalised and privatised, sustained economic development will follow and benefits will trickle down to the poor. Is it that simple? Not just that, this notion is out-dated and has been rejected by some of the World’s leading development economists as well as by the World Bank itself.

Latin American and East European countries that followed the policy framework laid down by the Washington Consensus have had mixed success with their share of disasters but it is those Asian countries who devised their policies in accordance with their own individual circumstances and environments have been the most successful. These Asian countries believed in the importance of markets, but they realised that market had to be created and governed, and that sometimes private sector might not do what needs to be done. While China and Korea were slow to privatise, they focused on exports-led growth, especially in the early days of development, and limited imports that would undermine local manufacturing and agriculture.

Asia tigers followed a course markedly different from the Washington Consensus, with a role for government far larger than the minimalist role that is being currently articulated in Islamabad. Both China and India did not rush to privatise large-scale manufacturing, banks, or the oil and gas industry nor did they allow unrestricted short-term capital flows. While they opened up their markets for long-term investors, they made sure that the foreign investors transferred technology and trained local workers, so that they contributed to the nation’s development.

While it is true that China and India are very competitive in terms of labour productivity, they did not gain this competitive advantage through any ‘market’ reforms. For example, since 1978, China has been the world’s most successful economy, growing at an average per capita rate of eight per cent per year. At that rate, its per capita income has doubled every nine years, (our planners should note this simple mathematical rule that it takes an average of eight per cent growth to double an income level in nine years. How we have been able to achieve almost doubling of our per capita income in less than nine years when our average growth rate has been less than eight per cent is something of a statistical miracle) and thus had increased more than eight-fold by 2005.

China did not start privatising until only a few years ago. Paradoxically, the foundations of China and India’s historic successes were laid down during the much castigated ‘socialist’ period. Both invested heavily in education, particularly science and technology education, as well in heavy engineering and other capital-intensive industries. In China, the liberalisation started from the agriculture sector in the early 1980s as it was ready for the markets after the Green Revolution of the 1970s, which promoted the use of better farming techniques and new seeds and increased crop yields many time over.

The next steps of China’s reforms, in the early 1980s and early 1990s, involved liberalisation of international trade and investment, but initially only in specially designated free-trade zones, known as special economic zones (SEZs). Foreign investors looking for trained and low-cost workers found no shortage of human talent as the ‘communist’ China had invested heavily in basic education and these SEZs jump started the labour-intensive exports-led industrial revolution that has transformed China and indeed the global economy.

The government took an active and leading role in planning and building these SEZs as the trained human resources were already available. Both China and India continue to follow five-year official planning cycle with clearly defined goals and policies. We also did that but the critical difference is that our policies provided just protection and subsidies to a selected few while China and India made large investments in basic education and heavy industries.

In contrast, Mexico, which signed the North American Free Trade Agreement (NAFTA) with the United States and Canada in 1994, has not seen the benefits the free trade advocates thought it would bring to Mexico. NAFTA did not result in rapid growth during the first decade following the signing of NAFTA (per capita income grew by only 1.8 per cent) and its economy grew more dependent on the United States. Mexico followed the Washington Consensus and rapidly privatised and liberalised its economy while not investing enough in infrastructure and human development.

Today, Mexico’s exports are having a tough time competing with China’s goods despite the existence of a ‘free trade’ agreement with the United States. It is just not tariffs or subsidies that make goods cheaper or competitive. Labour productivity in China (as well as in Korea, India or Taiwan) is higher simply because of decades of investment in education and training. Tariffs played a limited role in China’s success.

Now more importantly, and our policy makers should make a careful note of this, the Washington Consensus is no longer the accepted conventional wisdom it once was. Following the success of Asian economies and disappointing results of following its straight jacket policies in Latin America and Eastern Europe, even some of the World Bank’s top officials, like its former President Jim Wolfensohn and the Chief Economist Joseph Stiglitz, began to accept that that the strategy of just getting government out of the way of the private sector and markets had failed. By the late 1990s, following the collapse of the Russian economy in August 1998, the policy of just privatising and liberalising had been abandoned even by the World Bank which came up with what was called the comprehensive approach to development – with emphasis differing from country to country and from time to time.

According to Mr. Stiglitz’ own admission, the comprehensive approach to development did not contain anything really new: “they were variants of the strategies that had worked so well and for so long in East Asia but had been ignored” by the believers of what he called market fundamentalism.

We would be better off if we can come up with our development strategy, learn from the successes of China and other Asian countries and stop following the now discredited and out-dated strategies advocated by the market fundamentalists and believers of rapid liberalisation and privatisation as a panacea for development.

The writer is a former head of Emerging Markets Equity Investments, Citigroup.

http://www.dawn.com/2007/01/15/ebr17.htm