Do free trade, open market, and globalization really benefit a country and bring it economic growth?

This was the assignment I did in my first semester in year 2. Actually now I find some disagreement with this paper. I will write my current thoughts later. But sometimes looking backwards can help you look further in the future since it can remind you where the journey begins. Without distorting the original article, I modify some paragraphs to make it more fluent.

The end of Cold War brought the widespread tale of victorious self-regulating market as well as the era of second globalization. With advocacy of international organizations and ambition to engineer prosperity, many post-soviet and third world countries attempted to transfer the formal Western institutions to their own and implemented drastic economic policies, like large-scale market liberalization and reducing trade barriers. However, the expectation of prosperity was substituted by ensuing chaos of reform and still-persistent poverty (Acemoglu & Robinson, 2012). Reversely, China achieved substantial economic growth and simultaneously reduced poverty at a large level (Xu, 2011). The essay will first delve into the history of the rise of Western world, and then analyze the failure of pre-socialist and developing economies, post-soviet and sub-Saharan countries for example, and then the success of transition in China. By these case studies, the essay try to show that the success of capturing benefits from globalization depends on clear delineation and enforcement of property rights. It will also discuss the cost of opening market and integrating into global economy.

Beginning in Britain around eighteenth and nineteenth century, the Enlightenment with Industrial Revolution and the advance of science initiated the economic progress in the western world and brought the “Great Divergence” between western and the rest of world (Deaton, 2013). Released from the medieval rigid customs and without deliberate design, the unchaining freedom and uncontrolled efforts of individuals enabled science innovation, establishment and enlargement of market and price system, which made possible the complex economic activities, such as division of labor and knowledge or coordinated utilization of resources (Hayek, 1944 & 1945). The principle of “laissez-faire” and “spontaneous order” provided the foundation for the “Hundred Year’s Peace” and the first era of globalization (Polanyi, 1957). The globalization nowadays is not only a revival of the past but just with more rapid flow of commodities, services, and information and larger scale of market and specialization (Bhagwati, 2004).

However, the seemed spontaneous order concealed the cost of establishing a free market and the role of government in economic life. Before the Great Divergence, the market was not autonomous but embedded in social relations. In order to create a self-regulating market, natural environment and human beings had to be turned into the commodities in form of land and human capital, which made social fabrics face severe disruptions and go through long-time adaption. The international trade of wool and cottage resulted in enclosures and conversion of the farmland into sheep runs. The destruction of the habitation and labor dislocation from the countryside ensued. The Industrial Revolution strengthened the impact and made urbanization irreversible, forcing the rural proletariat into urban industrial workers (Polanyi, 1957). The problem of poverty thus gained public awareness (Ravallion, 2011). At the expense of social dislocation, the rearrangement and creation of property rights, stimulated by deliberate state action to capture the gains from specialization, brought the realization of modern economic growth (Polanyi, 1957; North & Thomas, 1973). It was also government enforcement and delineation of property rights that brought incentives for individuals to undertake socially beneficial activities and encouraged innovation, advance of technology, and investment in human capital (North, 1990; Schultz, 1993). “Laissez-faire was planned; planning was not.” (Polanyi, 1957, p.141)

The rearrangement and delineation of property rights not only involved government enforcement itself because “they are always embedded in the institutional structure of a society” (North & Thomas, 1973, p.5) According to North (1990) and Xu (2011), an institution refers to the humanly devised rules or mechanisms in the society that coordinate human activities and structure incentives, “including formal constraints (e.g., laws, constitutions), informal constraints (e.g., norms of behavior, conventions and social fabrics) and their enforcement characteristics” (North, 1994). Moreover, formal rules can change overnight, while informal norms have surprising continuity and slow evolution with experiences inherited from past generations or culture. The characteristics of path dependence embedded in informal norms influence formal rules and enforcement, leading to different results when the formal rules in one country are transplanted to another (North, 1990 & 1994). Also, because informal norms require long-time adaption and usually lag behind economic movement, government needs to take cautious measures to mitigate downside effects in gradual transition to market economy, meanwhile capturing potential benefits from globalization (North, 1990; Schultz, 1993; Bhagwati, 2005).

According to Sachs (2006), Chang (2008), and Deaton (2015), the overlook of institutions in different countries and illusion of likening economic development to a purely technical and engineering problem made international organizations propose a one-size-fits-all suggestions, abandoning developing countries’ own and imitating the rich countries’ formal institutions with maximum speed of transition, rather than careful design for each developing and post-soviet countries specifically. It caused turmoil opposite from the expectation of rich countries just because of distinct informal constraints and enforcement characteristics (Chang, 2008; Acemoglu & Robinson, 2012). With the demise of communism, the Eastern Europe countries implemented drastic measures of liberalization and privatization, expecting spontaneous emergence of private sector itself. However, without state intervention to delineate and enforce property rights clearly, the collapse of old system had been followed only by socially adverse actions like asset-stripping by self-dealing managers, rent-seeking, and collusion between oligarchs and government officials (Sachs, 1992). The legacy of communist ideology and norms left the huge and inefficient bureaucracy and excessive administrative interventions (Kornai, 1990). Also, without cautious adjustment, the maximum speed of transition made the unemployment and inflation rate surge to a spectacular level and the whole society fall into the severe disorder. Underlying the turmoil was the contradiction with formal rules and informal norms. Different from past experience of a socialist economy, people have no knowledge of market mechanism and need time to adapt (Kornai, 2006). In the façade of privatization, the abrupt adoption of the market and the absence of government in important aspects, ranging from protection of private property to enforcement of private contracts, caused national assets being stripped to oligarchs, further translating into the huge contraction of economy and social discontent (Kornai, 1990).

As in sub-Saharan region, the situation was similar to or even more severe to Eastern Europe. However, the lack of appropriate governance was not only a result of illusion seeing economics as a technical problem, but also because of political instability there. The stable polity is the precondition of creating and enforcing efficient property rights (North, 1994). With divide and rule in colonial period, after independence and decolonization, the colonial history left grievance and conflicts between different ethnic groups within the country, undermining the legitimacy and stability of political institutions. To stabilize the political power, the government chose to extract resources and confiscate citizens’ property for immediate fiscal needs to suppress the opposition, and just created a vicious cycle between weak and extractive institution. Moreover, the desire to obtain the extractive institution and the consequential suppression intensified the conflicts and even invoked civil wars, again intensifying the vicious cycle (Collier, 2008; Acemoglu & Robinson, 2012).

Conversely, with gradual reform and successful rearrangement and delineation of property rights, China achieved substantial economic growth and integrated into the global economy smoothly. The evolutionary way of creating formal market-supporting rules and transforming informal norms avoided possible chaos during transition. The introduction of household responsibility system, for instance, was a revival of long tradition of private farming in China, and regional decentralization of authoritarian regime combined with tournament-like competition came from the long governance experience during imperial China period and policy of local autarky left by Mao (Coase & Wang, 2012). The successful transformation of institutions solved incentive problems, and make not only farmers but also the officials and managers of state enterprises devote themselves into socially productive action (Xu, 2011). Also, with dual-track price system and the Special Economic Zones, the whole society have had enough time to adapt to the fluctuation of price and meanwhile could avoid the possible failure of the experiment spreading countrywide.

In conclusion, clear delineation and enforcement of property rights are crucial to capturing the benefits of globalization, namely the enlargement of market and specialization, for they provide individuals incentives to undertake socially beneficial activities, like market competition, innovation, and capital accumulation. However, the whole rearrangement of property rights involves the adjustment of formal rules as well as informal norms, which have a characteristic of slow adaption. Without thorough understandings of preexisting institutions, especially implicit informal norms, the drastic measures of privatization and open market would only disturb the incentives embedded in the original institutions and hence put the whole society into chaos.

References:

  • Acemoglu, D., & Robinson, J. A. (2012). Why nations fail: the origins of power, prosperity and poverty (Vol. 4). New York: Crown Business.
  • Bhagwati, J. N. (2004). In defense of globalization. Oxford University Press.
  • Bhagwati, J. N. (2005). In defense of globalization: It has a human face. The 2005 Angelo Costa Lecture, Rome, Italy.
  • Chang, H. J. (2008). Bad Samaritans: The guilty secrets of rich nations and the threat to global prosperity. Random House.
  • Coase, R., & Wang, N. (2012). How China became capitalist. Palgrave Macmillan.
  • Collier, P. (2008). The bottom billion: Why the poorest countries are failing and what can be done about it. Oxford University Press.
  • Deaton, A. (2013). The great escape. Health, wealth and the origins of inequality. Princeton University Press, Princeton.
  • Deaton, A. (2015). On tyrannical experts and expert tyrants. The Review of Austrian Economics, 28(4), 407-412.
  • Hayek, F. A. (1994). The Road to Serfdom. George Routledge & Son, Ltd.
  • Hayek, F. A. (1945). The Use of Knowledge in Society. American Economic Review, 35(4), 519-530.
  • Kornai, J. (1990). The affinity between ownership forms and coordination mechanisms: The common experience of reform in socialist countries. The Journal of Economic Perspectives, 131-147.
  • Kornai, J. (2006). The great transformation of central Eastern Europe. Economics of transition, 14(2), 207-244.
  • North, D. C., & Thomas, R. P. (1973). The rise of the western world: A new economic history. Cambridge University Press.
  • North, D. C. (1990). Institutions, institutional change and economic performance. Cambridge university press.
  • North, D. C. (1994). Economic performance through time. The American economic review, 359-368.
  • Polanyi, K. (1957). The great transformation: The political and economic origins of our time. Beacon Press.
  • Ravallion, M. (2011). Awareness of poverty over three centuries. Voxeu.org. Retrieved from http://www.voxeu.org/article/poverty-enlightenment-awareness-poverty-over-three-centuries
  • Sachs, J. D. (1992). Privatization in Russia: some lessons from Eastern Europe. The American Economic Review, 43-48.
  • Sachs, J. (2006). The end of poverty: economic possibilities for our time. Penguin.
  • Schultz, T. W. (1993). The economics of being poor. Oxford: Blackwell.
  • Xu, C. (2011). The fundamental institutions of China’s reforms and development. Journal of Economic Literature, 1076-1151.
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