TCS Daily

Hong Kong on the Steppe

By Jan Arlid Snoen - July 8, 2004 12:00 AM

OSLO -- The liberal Mongolian Motherland Democratic Coalition seems to have defeated the ex-communist government in the 27 June parliamentary elections. This reversed the Communist landslide in 2000, which was seen by some western leftist as a repudiation of the mostly liberal economic policies pursued by the MDC from 1996-2000. Although Mongolian politics is not easily translated into familiar western terms, Mongolian governments before and after 1996-2000 have mostly been marked-oriented. The MDC defeat in 2000 was largely due to internal feuding, corruption and an economic slowdown caused by unusual bad weather.

Why should we be concerned about the arguably marginal subject of Mongolian politics? Perhaps because Mongolia is one of the latest examples that free trade works, even when unilaterally pursued by a tiny, poor and landlocked country. This repudiates the litany of the anti-globalizers, which reads something like this: Developing countries should be allowed to shield their industry behind tariff walls until the economy is mature enough to withstand competition from richer and more efficient countries. After all, that is the way rich countries have done it.

Let me first note that when the "Washington consensus" institutions (World Bank, IMF and WTO) and western governments are calling on poorer countries to open up their economies, they have a gradual opening in mind. Contrary to popular perceptions, often found even among free-traders, the barriers to trade are much higher in developing countries than in the rich part of the world, average tariffs being 12 and 3 percent respectively. Thus, there is ample room for liberalizations without moving immediately to totally free trade.

Secondly, there is much academic debate on the alleged success of protection of infant industries. In the last decades, many countries in East Asia have seen impressive growth while protecting certain industries against foreign competition. Even so, causality has not been established. There are many reasons countries like Japan, South Korea and Taiwan achieved growth, but the claim that protectionism played a significant role was largely dismissed in the major World Bank study The East Asia Miracle in 1993. Marcus Noland and Howard Pack of the Institute for International Economics last year published an extensive study on the impact of industrial policy, including trade protection, in East Asia. They concluded that instead of enhancing growth, such policies reduced it.

This also seems to have been the case in the U.S. after the Civil War, another celebrate example of successful protectionism. J. Bradford Delong concludes that high tariffs reduced the annual growth by some 0.3 percent, chiefly by restricting import of capital goods and machinery, and thereby retarded capital deepening and delayed the development of capital-intensive infrastructure and industry.

There are a number of recent studies that show quite conclusively that after World War II there is a strong connection between free trade and higher economic growth. Among the most important are the classic 1995 study by Jeffrey Sachs and Andrew Warner, and a more recent one by the World Bank's David Dollar and Aart Kraay. Late last year two researchers at Stanford University, Romain Wacziarg and Karen Horn Welch presented a study on the effects of trade liberalization (NBER Working Paper no. 10152). They compared growth rates in 133 countries before and after implementation of liberalization programmes, and found that the liberalizers increased their annual growth rate by an average of 1.5 percent. Perhaps the most compelling study is the one by economic historians Peter Lindert and Jeffrey G. Williamson that could not identify a single country that had a less open economy in the 1990's than in the 1960's and at the same time had improved on their economic ranking.

However, to muddy the waters somewhat, the same Jeffrey Williamson, in a paper co-written with Michael A. Clemens, have found that protectionism seems to have worked quite well for the "industrialized core" countries before the first World War (NBER Working Paper 8459). Contrasting this to more recent experience, the authors identify this finding as the "tariff-growth paradox." It is not clear why protectionism worked better in the past, if indeed this was the case. Clemens and Williamson categorically dismiss the argument that protectionism works better in an early industrializing phase than in leading industrial countries. Their evidence from the 1875-1908 period points in the opposite direction, as the poorer countries in the European periphery were harmed by their own high tariffs.

The case for unilateral free trade, although theoretically compelling, is empirically harder to prove, for the simple reason that very few countries have tried it. In that respect, it is true that most countries have kept trade barriers but still been able to achieve growth. It is however unwarranted to conclude that the trade barriers caused growth. By the same logic, undemocratic countries should give men the vote first, and wait a couple of generations before letting women into this dangerous game. After all, this has been the historical development route of democracy. If we want to examine the results of unilateral free trade, it surely is better to study the few countries that actually have implemented this policy than to study those that have not?

I know of three and a half examples of "cold turkey" trade liberalizations. The first is the well-known radical free trade policy pursued by Great Britain after the abolishment of the Corn Laws in 1846. There is little disagreement that this policy was good for Britain, but the sceptics are not that easily persuaded. They point out that Britain liberalized from a position of strength. It was already a dominant trader and industrial power with a growing empire, which accounted for much of the trade. It is therefore difficult to draw any broad conclusions from this example. The success of Hong Kong after World War II is undeniable, but again the colony is said to be atypical -- a small city state with a history as a trading port, and access to the potentially huge mainland China market. I find this objection less compelling. However, let's move on to the much more recent experiences of Estonia and Mongolia.

Immediately after independence in 1991, Estonia started to cut tariffs and this process was completed in 1994. By then all other forms of non-tariff trade impediments, such as quotas and import monopolies had been abolished. This radical free trade policy has been upheld by all Estonian governments, but sadly had to be reversed as Estonia joined the EU on May 1, and by implication had to implement the common EU trade policy. Although is it difficult to isolate the effect of free trade from the other free market policies pursued by Estonia, the results are undeniable impressive. Economic growth in Estonia after 1994 has been the highest of all the former Soviet possessions in Eastern Europe, rivalled only by Poland. The last four years GDP has grown by some 6 percent annually. Estonian trade has been completely transformed. Upon independence the West only accounted for 5 percent of total trade, but now the EU alone covers some two thirds. Exports and imports have grown simultaneously since independence, with annual growth rates averaging some 10 percent. The recent current account deficits average some 5 percent, but such deficits are quite normal for a high growth country were foreign capital pours in.

After breaking free from the Soviet empire in 1990, Mongolia has "taken the capitalist road" and reformed the economy more or less according to the advice of the World Bank and IMF.

Under MDC rule and after becoming member of GATT in 1997, Mongolia greatly reduced tariffs and most other trade restrictions. Tariffs are now 5 percent on most goods, thus earning my halfway free trader designation. Even so, tariffs are much lower than demanded by GATT/WTO, far lower than in most developing countries, and Mongolia receives the highest possible score for trade openness in IMF comparisons. Indeed Mongolia is often pointed out by anti-globalizers as an example of radical (but in their view misguided) market reforms.

Just as all other members of the Soviet empire, the Mongolian economy suffered output losses at the outset of its transition, but it has subsequently benefited from efficiency gains following its market reforms and achieved decent growth rates in recent years, averaging more than 3% annually after 1994. Maybe not that impressive, but extreme weather harmed the economy in 1999-2002, and especially in 2000/01. What the Mongolians call the dzud, extreme drought followed by unusually harsh winters, together with an outbreak of foot-and-mouth disease, took a heavy toll on the herd stock and depressed GDP growth. But of course, bad weather conceivably might be the fault of the Vast Right Wing Conspiracy.

Given this strike of bad luck, I find it quite impressive that an economy so dependent on agriculture grew at all. The negative effects must also be compared to the havoc environmental catastrophes of this kind usually wreck in poor countries. The IMF concluded in 2003 that "empirical evidence suggests that if there were no dzud effects, economic growth would have reached about 8 percent per annum in recent years." Growth has picked up to 4 and 5 percent respectively in 2002 and 2003.

So it is fair to say that almost all empirical evidence, both studies involving a large number of countries and the experiences of the most ardent free trading nations, show that freer trade does indeed seem to be a necessary, although not sufficient condition for economic growth. Although to introduce totally free trade overnight is seldom politically possible, and even could create short-term shocks better to be avoided, it is no doubt which way rich and poor countries alike should follow.


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