What’s in a policy? The efficacy of Friedman’s logic and whether it really matters.

Cody ValdesIntro to Comparative Politics

Professor David Art

November 24, 2009

Synopsis

In Part I, I question the efficacy of Export-oriented industrialization (EOI) as it

has been implemented in throughout the world during the latter half of the twentieth

century. EOI and the Washington Consensus are essentially interchangeable derivations

of Milton Friedman’s liberal ideal of limited government protection of markets, low

tariffs, free trade, and the creation of a favorable environment for growth and investment

in businesses. It is on the latter condition that I will contend EOI has failed in developing

countries, especially in post-colonial societies. In Part II, I question the debate between

Export-Oriented Industrialization and Import-Substitution Industrialization, asking

whether either of these distinct models of economic structuring can explain the disparate

pace of growth in East Asian countries in the wake of cataclysmic events. I conclude that

the state’s democratic potential and ability to manage conflict are far more important than

EOI/ISI as determinants of economic growth in the long term.

PART I – The Failure of EOI as Implemented in Developing Countries

According to Dani Rodrik of Harvard University, a mixture of the basic ideas of

the liberal and statist schools of thought constitutes the “most valuable heritage that the

twentieth century bequeaths to the twenty-first in the realm of economic policy.” (Rodrik,

2000) If the nineteenth century pioneered capitalism, the twentieth “learned how to tame

it and render it more productive by supplying the institutional ingredients of a self-

sustaining market economy: central banking, stabilizing fiscal policy, antitrust and

regulation, social insurance, political democracy.” The tenants of the Washington

Consensus – deregulation, privatization, and free trade – were conceptually sound, for

they arose from a country whose market economy was sufficiently regulated to prevent

Valdes 1

the robber barons of the late nineteenth century from ever emerging again. When free

markets were transposed onto developing world economies, however, the merging of

theory and implementation produced a series of cataclysmic outcomes that would grip

certain countries in a dire cycle of inequality, conflict, and poverty. A strong regulatory

framework was conspicuously absent, while a disparity between the speed of

deregulation and privatization – “creative destruction” – on the one hand, and the erection

of regulatory institutions, on the other, created a window of opportunity for self-

interested elites to plunder the state resources and emerge as the twentieth-century

oligarchs.

Friedman and EOI

Friedman’s position on the role of government in market economies naturally

precedes the idea of free trade and EOI as embraced by the Washington Consensus.

Friedman places his argument for “politically unfettered market coordination,” as James

C. Scott succinctly describes it, in the context of his benevolent critique of

authoritarianism and all forms of freedom-repressing polities whose desired ends fail to

justify their undesirable means. If societies of competing and disparate actors cannot

reach a productive level of conformity without having to suppress or omit the voices of

the few, his argument goes, then no form of political control is as acceptable as the

ultimate vehicle of proportional representation: the free market. In a free market, one’s

capital (i.e.: money, land, skills and knowledge, networks, motivation, etc.), as opposed

to one’s voice in an inherently flawed political system that imposes misrepresentative

restrictions on individual aspirations, becomes the ultimate determinant of one’s power in

society. The Rousseauian threat of a corrupt, nepotistic, and exclusionary polity is

Valdes 2

eschewed, a meritocracy is produced, and individual liberties are guaranteed. A state

apparatus is surely necessary for debating “indivisible matters” such as the “protection of

the individual and the nation from coercion,” matters that cannot, because of the

collective action problem of self-interested rational actors, be adequately addressed

through reliance on a free market. But for all other matters where “men feel deeply yet

differently,” and where explicit agreement from all sides is impossible, adhering to the

zero-sum outcomes of the “ballot box” excludes the voices of the losing minority and

threatens the stability of fragile societies.

For Friedman, moreover, the Hobbesian view that men are naturally barbaric and

need the advanced apparatus of government to temper the ills of an anarchic society has

merit as well. Because “absolute freedom is impossible… in a world of imperfect men,”

the state assumes the role of an “umpire” that can “enforce compliance with the rules on

the part of those few who would otherwise not play the game.” Echoing the opinion of

John Locke with remarkable conformity, he grants two scenarios in which free market

exchanges under an umpire state are incapable of providing or regulating certain goods,

namely imperfect markets that require technical monopolies (i.e.: capital intensive

industries) and the regulation of “neighborhood effects” (i.e.: pollution costs borne by

individuals other than the producer). In these second-best situations, he prescribes private

monopolies where possible and government intervention as last resort. In all other

situations, however, he concludes that “tariffs on imports or restrictions on exports” and

“detailed regulation of industries… [and] banking,” among other state policies, are

detrimental to growth.

Valdes 3

Friedman’s argument is conceptually sound, but for the astute observer of global

political economies it is conspicuously lacking in prescriptive richness. This is surprising

given that he was writing at a time when many of the world’s states were achieving

independence from colonial rulers. The importance of the colonial legacy in many

developing countries in the 1950s and 60s as a variable of Friedman’s free market

argument cannot be overstated, for these legacies brought feudalistic societies into the

lucrative global economy without any redistribution of land and political power. In most

situations, a small family of elites, formerly the puppet of the colonial master, assumed

greater control over the domestic political economy and transposed feudal systems of

patronage onto the macro-level of the state, thereby forbidding a true meritocracy from

emerging. By the time EOI and free markets were simultaneously imposed by western

technocrats and embraced by these elites, privatization and the sale of public industries

offered even more opportunity for private enrichment and consolidation of private

monopolies (notably, as Friedman would agree, in markets where monopolies are most

unwanted). Post-Soviet Russia provides the most drastic and obvious case of rapid

privatization and subsequent state plunder, but other countries saw the same process take

root over time as well, only more discreetly. As the ‘race to the bottom’ gathered speed,

the peasantry, which had been economically disenfranchised under feudalism, became

even further marginalized under the new social, political, and economic order. What is

important to recognize here is that polyarchies, not liberal democracies, became the

norm; as is often the case, what Friedman might have dismissed as the exception became

the rule.

Valdes 4

With the concomitant increase in inequality and the bifurcated stratification of

society between elite and peasantry, an unsustainable social contract emerged where the

only recourse was one of Barrington Moore’s two solutions: a popular uprising by the

peasantry ending in a communist takeover, or a consolidation of force by the elite and the

erection of a fascist state; the absence of a strong bourgeoisie in light of such inequality

precluded any hopes for his third, the emergence of a true democracy/meritocracy. In

many modern countries, both the peasantry and the elite have drifted towards their

respective means for achieving power (communism and fascism) simultaneously,

evincing conflicts over resource distributions that verge on civil war. In India or Pakistan,

for example, state-sponsored ‘death squads’ and traditional armies are pitted against

pockets of popular uprisings – in the North East regions of India where the Maoist

insurgency continues, and in Balochistan, FATA, and the NWFP of Pakistan where

Balochi and Pashtun insurgents demand equitable distribution of state resources – with

dire consequences for regional development. Most notably, conflict creates a poor

investment climate, and the pillar of EOI economies – foreign direct investment – is thus

dismantled. With the exception of brave Chinese corporations extracting minerals south

of Kabul in Afghanistan, foreign capital holders have little motivation to engage with

countries where insecurity, let alone the corruption and nepotism that gave birth to the

inequality that produced the insecurity, is rife. Consequently, the cycle of poverty begins

anew, and the free market prescription for unfettered growth loses its currency.

There has been experimentation in one conflict-ridden country, Guatemala, to

provide a channel for FDI that bypasses the corrupt elites perched upon the national

economy by engaging directly with organizations of individual localities known as

Valdes 5

Municipal Commonwealths. Unified in their frustration with the national elite, the

collection of municipalities can promise a safe investment climate for foreign capital,

thus reducing the risk of doing business in their regions and attracting greater

development. Here we see liberal economics working the way it should, but only after

decades of attempting and failing to fix the legacy of liberalization-without-regulation at

the national level. What Friedman proposed was a vision for a truly liberal society where

rational economics was politics. He did not, however, provide a suitable roadmap for

post-colonial and post-feudal countries to arrive at this destination. Ironically, for the

future policy makers in the ranks of the Bretton Woods organizations, the ends of

liberalism became the means, and the ends were never truly achieved.

PART II – EOI vs. ISI: Does it Really Matter?

Speaking of the nature of industrial society, Ernest Gellner said that “its favored

mode of social control is … buying off social aggression with material enhancement; its

greatest weakness is its inability to survive any temporary reduction of the social bribery

fund, and to weather the loss of legitimacy which befalls it if the cornucopia becomes

temporarily jammed and the flow falters.” In a global economy of boom and bust, an

environment in which natural disasters descend upon countries unannounced, and a world

where interstate wars can erupt at any time, a country’s ability to withstand economic

cataclysm is arguably more important than the fiscal and trade policies it adopts in the

times in between.

While great shocks to the world economy are intermittent and would conceivably

have a minimal effect on the long-term growth of a country, they catalyze policy changes

that often have deep distributional consequences for the various classes of a population.

Valdes 6

When overlaid on a society with preexisting cleavages and weak democratic potential,

this redistribution can reinvigorate conflict and political instability for years to come, an

obvious consequence of which is more stagnation and poverty.

If we take the case of the oil shock of 1973 and the Asian Economic Crisis of

1997, we see that neoclassical arguments of what causes growth (and, as a corollary,

what perpetuates poverty), which at the time were embodied in the Washington

Consensus of western international government organizations and in the ideas of free-

trade economists such as Friedman, failed to account for more powerful country-specific

realities that allowed Japan, Thailand, and South Korea to succeed while countries like

Indonesia lagged behind. The ongoing debate over EOI vs. ISI, both of which have had

strong showings in various contexts after WWII, largely misses the point, for it distracts

us from the bigger question of whether the state was prepared to mitigate the

destabilizing effects of cataclysmic events.

The Asian Financial Crisis of 1997 demonstrated the importance of institutions of

conflict management in tempering domestic unrest resulting from external shocks. Prior

to the crisis, Indonesia was ruled by an autocratic regime under President Suharto.

Ethnically divided and exhibiting weak democratic potential in government, Indonesia

eventually “descended into chaos” as the fallout of the capital exodus rattled East Asian

countries across the board. According to Takashi Shiraishi and Hal Hill (Asian Economic

Policy Review, 2007):

Indonesia was deeply affected by the 1997-1998 crisis, more so than its East Asian neighbors. Its economic contraction was deeper and more prolonged. It was the only one to experience a (temporary) loss of macroeconomic control. It also suffered 'twin crises', in the sense that its serious economic and financial problems were accompanied by regime collapse. Consequently, recovery was a slow and complex process, as new institutions had to be created, and old ones reformed under successive short-lived administrations.

Valdes 7

For Thailand and Korea, however, relatively new democratic institutions enabled

the transfer of power from discredited politicians to newly elected leaders,

obviating the need for the kinds of “riots, protests, and other kinds of disruptive

actions by affected groups” that had afflicted Indonesia’s citizenry. With new

mechanisms for “participation, consultation, and bargaining,” policy makers were

able to “fashion the consensus needed to undertake the necessary policy

adjustments decisively.” (Rodrik, 2000) The strength of Thailand and Korea’s

economies since the crisis is a testament to strength of their democratic institutions

of consensus building when the crisis struck.

Japan provides the best example of a country where the question of EOI or ISI has

been secondary to its institutions of conflict management in the wake of global

cataclysm. In Japan, the structural, cultural, and institutional variables were perfectly

aligned to withstand the oil shock of 1973. Structurally, Japan has long been comprised

of a homogeneous society built on high levels of trust and a fairly ubiquitous devotion to

the nation. This has enabled firm consensus building and relative stability in the political

process, as evidenced by the decades-long rule of the Liberal Democratic Party since

1955 (which only ended in 2009). Institutionally, Japan’s polity was firmly committed to

democracy – even the Japanese Communist Party now espouses democracy under a

capitalist framework – and economic decisions were further safeguarded from political

pressure and unrest by the power invested in the bureaucracy, most notably the Ministry

of International Trade and Industry. Finally, the culture of the Japanese people lends

itself to unity, sacrifice, and productivity, all traits that enable an effective collective

response to the external threat.

Valdes 8

These factors allowed Japan to succeed in the aftermath of the 1970s oil shocks

under contextually appropriate growth policies and industry regulations, not under a

distinct policy of either EOI or ISI. Tellingly, the economists have struggled to explain

the “Japanese Miracle” of the mid twentieth century, with some attributing it to the

“efforts of private individuals and enterprises… in quite free markets”, while others note

that state control over industry was significant and state-owned industry accounted for up

to 40 percent of its growth in the post-war period. (Johnson) Japan bucked the economic

crisis of 1973 by shifting away from oil-intensive industries and into the production of

energy-efficient vehicles and electronics. This transformation was state guided and thus

only possible with the broad consensus (or abiding faith) of the people and the state,

which in turn was achievable because of the appropriate cultural, institutional, and

structural conditions that prevented mass conflict and a subsequent growth of poverty.

While Japan’s commitment to free-market capitalism remained ambiguous, its capacity to

prevent conflict, like in Thailand and South Korea two decades later, was the deciding

factor that enabled it to weather external crises and continue its pursuit of economic

growth.

Of all the factors that account for economic growth in the developing world, the

question that is most often asked – to protect or not to protect? – is a moot point if the

structural conditions that produce conflict are ignored. Conflict will trump

industrialization policy as a deterrent to growth if it is not directly managed by the state,

especially in the wake of cataclysmic events. Friedman’s argument for liberal markets,

while sound in theory, has been perverted by the staunchest advocates of EOI with direct

consequences for inequality in the developing world. As inequality breeds class conflict

Valdes 9

and regional instability, foreign direct investment plummets and the moorings of EOI

crumble, creating a self-fulfilling cycle of wide-scale poverty.

External References:

Hill, Hal and Takashi Shiraishi, “Indonesia After the Asian Crisis,” Asian Economic Policy Review. Vol.2, No. 1, pp. 123-141, June 2007.

Rodrik, Dani. “Development Strategies for the Next Century.” Presented at the conference on “Developing Economies in the 21st Century: The Challenges to Globalization,” organized by the Institute of Developing Economies, JETRO, in Chiba, Japan, January 26-7, 2000.

Valdes 10