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By Philippe Legrain 5 COMMENTS

In a thoughtful comment on my recent Doha post, Matthew argues that

It is simply not the case that the enormous growth of the Asia tigers
is evidence of the efficacy of free trade because most of those
economies were protected behind trade barriers and currency controls
for most of their development and still are.

I started replying in a comment, but then I thought the subject was so important that I would start a new post about it instead.

I think that China and India are very powerful examples of the benefits of liberalisation: before they started their reforms, growth was slow, but as they have opened up their economies, growth has accelerated. Just because they still have some tariffs in no way implies that their faster growth stems from this residual protection: if it did, the increase in growth would surely have preceded liberalisation, which it did not. Critics claim that if developing countries lower their tariffs they will be giving up their chances of development – yet China’s markets are already far more open than those of most developing countries and it is thriving. I think China’s decision to join the WTO was a powerful signal that its leaders believed that to sustain economic growth, the country needed to liberalise further, as indeed it has done.

But what about South Korea? Undeniably, it has protected some of its export
industries. Undeniably too, it has grown in leaps and bounds. The
question is: did the trade protection cause the growth?

Not necessarily. South Korea might
have succeeded despite the trade protection, or the trade protection might
have had little effect at all. Observing that tariff protection
preceded development does not in any way demonstrate a causal link. Saudi
Arabia has grown rich while protecting its industry behind tariff walls,
yet the source of its prosperity is soaring oil prices, not
infant-industry protection.

In an exhaustive study of South Korea’s experience for the Institute for International Economics, Marcus Noland and Howard Pack find that

the weight of the evidence derived from both econometric
and input-output studies… indicates that industrial policy made a minor
contribution to growth in Asia… Countries with less dedicated and
less competent bureaucracies and policymaking apparatuses that are more
amenable to lobbying pressures could expect even smaller net benefits.

They conclude that governments would do better to focus on measures
other than selective industry protection to foster development. Along
with sound macroeconomic policies,

Growth-enhancing measures in the Asian countries, which did
not differentiate among sectors, included large expenditures on primary
and secondary education, the building of large and efficient social
infrastructure, a favourable attitude towards technology transfer,
including both technology licensing and direct foreign investment, and
a substantial investment in public technology institutions.

The bottom line is that South Korea’s success does not support the
critics’ faith in state-led development through infant-industry
protection – and developing countries should not mistakenly try to
follow that path today.

Indeed, if a government protects the domestic market, by definition a local
company can sell at a higher price in that market that it can abroad.
Selling at home becomes much more profitable than selling abroad. So import
protection creates a strong incentive to focus on the domestic market
instead of exporting on the world market.  Other things equal, then,
protecting an industry is unlikely to turn it into a world-beating
exporter. South Korea got round this by providing cheap loans and other benefits to
exporters – giving companies an offsetting incentive to sell abroad –
and by cutting off those loans if the companies were not successful on
the world market – thus allowing the market, not the government, to pick
winners. In crucial aspects, then, the South Korean system mimicked many of the advantages of a free-trade environment.

Posted 05 Jun 2006 in Blog, Globalisation, Trade
  1. Peter says:

    Having worked in South Korea, I find it very hard to believe the report on the econometric and input-output evidence you quote. Government intervention was (and is) immense — even, until recently, to the point of banning Japanese pop music (on the grounds that music from the former colonial power would inhibit Korean musicians).
    Among other projects there, I worked on a bid for the second mobile telecom licence in 1992. Under strong pressure from the Bush 41 administration, the Government of Korea reluctantly allowed bidders to have up to 30% of equity owned by foreign firms. When foreign or local firms met with Korean officials in charge of the bids, however, we were told very emphatically that the Korean Government bid evaluators would only tolerate a much lower percentage. Wanting to win, bidders of course capped the foreign equity at much lower levels, mostly under 15%. Even liberal trade laws may be implemented in a way which is very illiberal.

  2. Philippe Legrain says:

    Thanks for your comment, Peter. You are right that until the 1997 crisis, South Korea did its best to keep out foreign investment. You are also right that the Korean government was, and in many respects still is, interventionist. The issue is whether these interventions boosted growth, had little impact, reduced growth, or had unintended consequences. The study found that while government policies in broad areas like education did help, its attempts to pick winners did not have much impact. And I added that where Korea has succeeded, the winners have often indirectly been selected by the market. Do you disagree?

  3. Peter says:

    Philippe — You could well be right that Korean governments have been unsuccessful in picking winners. (Similarly, MITI in Japan has tried for 30 years to push Japan’s entry into the global large-craft avionics – electronics used in aircraft – market and failed, despite Japan’s other strengths in electronics.)
    However, what about Posco, the world’s largest ship-builder? As far as I can tell, South Korea’s only competitive advantages in ship-building was its access to the sea and cheap labour. It is not strong in the necessary raw materials, nor was it geographically close to the main western buyers of large merchant ships. Nor did it have other market connections to these buyers. Yet, with strong Government direction and financial support, a commanding global presence in large ship building was created over the last 5 decades. I would say that ship-building provides a compelling counter-example to claims that government intervention has failed in South Korea.

  4. Philippe Legrain says:

    Well, I am no expert on Posco, so I can’t answer you with certainty. But I do know that most of the Korean government’s heavy and chemical industries drive was extremely wasteful. Infant industry protection is extremely costly: ordinary Koreans have borne the burden of sheltering and subsidising government-favoured industries in higher prices and taxes. Such protection is only a good investment if the social returns from it exceeds the costs. “A commanding global presence in large ship building” is certainly an achievement, but it is not clear that Koreans have got back more from the ship industry than the vast sums their government spent on it to get it afloat.

  5. Jim says:

    Good to see you blogging, Philippe – I’m afraid my first comment is a negative one:
    “before they started their reforms, growth was slow,”
    No it wasn’t, at least not if you’re talking about trade liberalisation. Both India and China grew strongly through the 1980s, well before any significant trade liberalisation. And while they did eventually liberalise significantly and kept growing, the evidence that the trade opening caused the growth is pretty thin. For example, Martin Ravallion and Shaohua Chen (1) looked at the causes of China’s poverty reduction in the 80s and 90s and concluded:
    “The view that greater trade openness brings rapid gains to the poor is not borne out by our data. China’s periods of more rapid expansion in external trade were not associated with more rapid poverty reduction. Nor do we find evidence that the tariff reductions implemented since the mid-1990s (in the lead-up to China’s accession to the World Trade Organization) have had anything but a rather minor impact on poverty and inequality.”
    Also, Dani Rodrik and Arvind Subramanian (2) found that “Trade liberalization … did not play a role” in India’s productivity surge around 1980.
    “China’s markets are already far more open than those of most developing countries and it is thriving.”
    Again, I have to disagree. According to a recent IMF paper (3), China is at best middling in terms of trade openness in comparison to other developing countries, while India and Vietnam (another extremely high-growth country) are both still highly protectionist.
    Also, I would note that there is evidence that tariffs are more beneficial the poorer a country is (4).
    As for South Korea, I’d agree that trade policy can’t explain all its success, and would suggest as other contributing factors its very equal land distribution, its highly favourable geography and the mountains of aid it received through the 1950s and 1960s.
    (1) http://www.imf.org/external/pubs/ft/fandd/2004/12/pdf/ravallio.pdf
    (2) http://www.imf.org/external/pubs/ft/wp/2004/wp0477.pdf
    (3) Table 4 here: http://www.imf.org/external/np/pp/eng/2005/021405r.pdf
    (4) http://www.wif.ethz.ch/resec/teaching/seminar_aussenwirtschaft_wt_04_05/yanikkaya_JDE.pdf and
    http://www.pitt.edu/~ripoll/files/rstat-round3.pdf

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