Urban Bias & the US trade deficit in fruits and vegetables

Beginning in the 1970's, and accelerating in the 1980's, the sub-field of development economics in Anglophone universities was taken over by neo-classical economists. One major element in the neo-classical economists' critique of the earlier perspective, which emphasized industrialization and society-wide dynamic structural change, focused on the purportedly anti-agrarian policies, or "urban bias" that resulted from industrial policies. This attack lent the neo-classical critique a populist flavor and positioned them as sympathizers of downtrodden peasants in Africa and Latin America.

Prominent contributions in this literature included work by economist Michael Lipton and Harvard University political science professor Robert Bates. Urban bias was a common element in a number of studies produced by the World Bank after Ann Krueger took over and expelled developmentalists and those supportive of industrial policy (including a former professor of mine, Swarthmore's Larry Westphal, a Korea expert).

The basic argument of the urban-bias literature was that developing world governments had erred in following policies that reportedly reduced the incentive to invest in commercial agriculture. Farmers were taxed heavily so as to provide capital for urban industrialization, and governments intervened to lower the prices of food products to satisfy urban consumers. Having supposedly demonstrated the urban bias of Third World governments, scholars such as Robert Bates then developed a conceptually subtle argument rooted in the political incentives faced by these governments. Bates argued these governments favored urban areas because they were more vulnerable to threats from politically mobilized urbanites (particularly in capital cities) than they were from politically demobilized rural areas.

A number of scholars have challenged this analysis. T.J. Byres offered an early critique in the 1970's, challenging the empirical claim that third world governments discriminated against commercial agriculture. Byres argued that the urban bias thesis was rooted in a fundamentally flawed understanding of the nature of development. The urban bias critique is based on general equilibrium models of the economy, and emphasizes static allocative efficiencies. In contrast, development economics historically was rooted in earlier models that emphasize structural change and the shifting of surplus labor (ie the unemployed) from rural areas into higher productivity activities, largely in manufacturing. Industrial and manufacturing sectors tend to be more dynamic over time and are the engine of economy-wide technological progress. More recent empirical work by Dani Rodrik suggests that this earlier understanding is in fact correct. Rodrik has found that high growth economies in East Asia, and a few standout economies of Latin America (Brazil, Argentina, Mexico), have benefited from a shift of labor from low productivity agricultural and informal activities into the dynamic and fast growing industrial sector.

Massoud Karshenas has added to Byres earlier critique by noting that in much of the empirical literature on urban bias, the degree of urban bias was heavily influenced by the degree of currency overvaluation. In a detailed examination of a World Bank study on South Korea, Karshenas found that the degree of currency overvaluation closely follows World Bank economists' estimation of urban bias, which in Korea's case was high in the early and mid-1960's and then fell off dramatically. Currency overvaluation is an extremely poor and misleading proxy for urban bias, because maintaining an overvalued currency simultaneously harms all tradable goods sectors, including manufacturing in addition to agriculture.

This, strangely enough, leads us back to the old bugbear of neoclassical economics: mercantilism. Dani Rodrik, an economist based at Harvard University, has suggested that one of the fastest ways for poor countries to become wealthier is to foster economy-wide structural change. As a practical matter, the easiest way to do this is to maintain a dramatically undervalued currency for several decades, as the successful industrializers in East Asia have done. An extraordinarily undervalued currency makes all tradable good -- both agricultural and industrial -- hyper competitive in international markets. It functions according to mercantilist precepts as a tax on imported products and a subsidy to exports simultaneously.  This helps to explain anamolies such as why the US runs a trade deficit in fruits and vegetables with China, a country with very little water, and very little arable land that is also located four to seven thousand miles away from most US consumers. The undervalued Chinese currency equally subsidizes manufactured goods such as computers, clothing and furniture exported to the US as well as apples, tomatoes and fruit juice. Thus, a water and land rich economy, the United States, has a large trade deficit in fruits and vegetables with a country that has very little water and very little arable land.

Sources:

T. J. Byres. 1979. "Of Neo-Populist Pipe-Dreams: Daedalus in the Third World and the Myth of Urban Bias." The Journal of Peasant Studies. 6(2): 210-244.

Massoud Karshenas. 1996. "Dynamic economies and the critique of urban bias." The Journal of Peasant Studies. 24(1-2): 60-102.

America's informal economy rising

One of the features of many third world economies is that a large percentage of the labor force is involved in what economists call the "informal" sector. These are individuals, frequently migrants to urban areas, that do not have formal jobs, but instead work on the streets carrying out various menial tasks, such as cleaning car windows, selling cigarettes or candy, or hawking newspapers. In countries without a welfare system and with tiny industrial sectors, these individuals survive - precariously - by juggling a variety of menial jobs or becoming involved in criminal activities.

Unfortunately, as the US has deindustrialized and formal sector employment has shrunk as a percentage of the total labor force (there are fewer jobs in the US in 2012 than twelve years ago) many people are turning to the informal sector. A writer with Businessweek recently wrote up his experience working in the informal sector in San Francisco, where online sites such as Taskrabbit helped him locate a variety of extremely low paid short term jobs.

Unless the US reindustrializes, tragically, this is the future that awaits many millions of formerly middle class Americans.

Meanwhile on the Pampas....

Argentina is booming! The laggard of the Western Hemisphere has now become one of the world's high growth milagros! According to the World Bank, in 2011, Argentina's economy expanded by 8.9% --- in 2010 Argentina grew by 9.2%. Since 2003 average growth rates have ranged between 6.8 to 9.2% year after year. The global financial crisis did cause growth to dip to 0.9% in the annus horribulus of 2009, but for almost a decade Argentine growth rates have rivaled those of China and India.

Argentina's growth has been led by manufacturing, and Argentina is the most industrialized nation in the Western Hemisphere in terms of the share of manufacturing in the total size of the economy. As the chart below shows, after the dramatic economic crisis of 2001-2002, manufacturing rebounded sharply. Average annual growth in manufacturing value added since 2002 has been extremely robust. Of course, this begs the question: why has manufacturing in Argentina grown so fast?

A lot of credit is due old-fashioned mercantilism. As today's WTO complaint by the US makes clear, Buenos Aires has been bringing extraordinary pressure on foreign companies who sell to Argentina to also expand industrial production within the country. In addition, Argentina's currency has become much more competitive over the last decade. In the 1990's Argentina dollarized its economy, and committed itself to an exceedingly overvalued peso-dollar exchange rate of 1:1. Since this policy was abandoned in 2002, Argentina's currency has lost 75% of its value against the dollar. In 2011, one dollar bought roughly 4 pesos, compared to just 1 peso in 2001. To get a sense for the magnitude of this change, this is the equivalent of shifting from the current US dollar to Chinese yuan exchange rate of roughly $1 = 6.5 yuan to an exchange rate of $1 = 1.6 yuan. In the US case, were the US dollar to lose 75% of its value against the yuan, the price of Chinese imports to the US would quadruple overnight and the US would instantaneously become a much, much more competitive location for manufacturing.

Postindustrial America: Cleveland, Ohio

Postindustrial America: Baltimore, Maryland

Postindustrial America: Camden, New Jersey

Dean Baker takes on the Washington Post

Dean Baker, an economist trained at the University of Michigan, and co-founder of the Center for Economic Policy and Research (a D.C. based think tank) is a frequent critique of bad economics reporting that one commonly finds in  the so-called mainstream media.

Today Baker has a take down of an overly rosy Washington Post article on the rise of Mexico's middle class. Mexico's middle class is expanding largely thanks to steady (re)industrialization (the Mexican peso has been held at an artificially low level the last decade) but it is a relative laggard in Latin America. An extremely heterodox Argentina has been growing much more rapidly. Today Argentines are roughly 25% richer than Mexicans, while twenty years ago Mexico had the higher per capita income.

David Landes on The Wealth & Poverty of Nations

David Landes' six hundred-fifty page tome, The Wealth and Poverty of Nations: Why some are so rich and some are so poor (W.W. Norton 1998) provides rich insight into the causes of economic growth and decline, although he is careful not to emphasize the mercantilist implications of his writing. Landes is keenly aware that the countries of East Asia do not, and will not, practice free trade, preferring to build up their industrial strength by seizing foreign markets.

Landes' discussion of Spanish decline resonates with my own interpretation of the sources of later Dutch, British and American decline. Landes picks up an argument made by the 20th century American economic historian Earl Hamilton (one that is applied to many natural resource exporters today in the form of Dutch Disease arguments). As Landes observes, Spanish industry withered as a consequence of gold and silver inflows from the New World. Importantly, Landes draws out the comparison between the attitudes of Spanish Nobility and the views of contemporary American elites:

"In 1545, Spanish manufacturers had a six-year backlog of orders from the New World. At that time, in principle, the overseas empire was required to buy from Spanish producers only. But customers and profits were waiting, and Spanish merchants turned to foreign suppliers while using their own names to cover the transactions...Nor did the American treasure go to Spanish agriculture; Spain could buy food. As one happy Spaniard put it in 1675, the whole world is working for us:

"Let London manufacture those fabrics of hers to her heart's content; Holland her chambrays, Florence her cloth.....so long as our capital can enjoy them. The only thing it proves is that all the nations train journeyman for Madrid, and that Madrid is the queen of Parliaments, for all the world serves her and she serves nobody." [Alfonso Nunez de Castro] (p. 172)

"Such foolishness is still heard today, in the guise of comparative advantage and neoclassical trade theory. I have heard serious scholars say that the United States need not worry about its huge trade deficit with Japan. After all, the Japanese are giving us useful things in exchange for paper printed with the portrait of George Washington. That sounds good, but it's bad. Wealth is not so good as work, nor riches so good as earnings. A Morroccan ambassador to Madrid in 1690-91 saw the problem clearly:

"....the Spanish nation today possesses the greatest wealth and the largest income of all the Christians. But the love of luxury and the comforts of civilization have overcome them, and you will rarely find one of this nation who engages in trade or travels abroad for commerce as do the other Christian nations such as the Dutch, the English, the French, the Genoese and their like. Similarly, the handicrafts practiced by their lower classes and common people are despised by this nation, which regards itself as superior to the other Christian nations...." (p. 172)

Landes concludes: "Reading this story one might draw a moral: Easy money is bad for you. It represents short-run gain that will be paid for in immediate distortions and later regrets." (p. 173)

Unfortunately, in spite of this keen awareness, Landes does not point to the obvious policy implication, namely that the US and other declining societies should adopt the same mercantilist policy tools deployed with such fantastic success across East Asia. Landes writes:

"Withal, I do not want to advocate any particular national policy, the less so as activist intervention can as easily make things worse as better. Each case must be judged on the merits, and governments are capable of as many mistakes, and bigger, than the businessmen who try to shape and play the market" (p. 523). Landes then offers a strong dose of weak tea for wealthy countries with eviscerated industrial sectors:

"To be sure, the rich, industrial countries can defend themselves (ease but not eliminate the pain) by remaining on the cutting edge of research, by moving into new and growing branches (creating new jobs), by learning from others, by finding the right niches, by cultivating and using ability and knowledge. They can go a long was on cruise control and safety nets, helping the losers to learn new skills, get new jobs, or just retire." (p. 523)

These are certainly nice sentiments, and it's hard to argue that people in the developed world shouldn't "cultivate and use ability and knowledge." But does anyone believe that will prevent the entire US from sinking down to the level of slums like Flint or Camden? Is it really the case that individual-level population features (lack of creativity, sloth) is what pushed industry out of towns and cities across America?

[Landes is an emeritus professor of economics at Harvard.]

Postindustrial America: Youngstown, Ohio

Postindustrial America: Gary, Indiana

Postindustrial America: East St. Louis, Illinois

Acemoglu & Robinson on Why Nations Fail

Daron Acemoglu and James Robinson are an economist and political scientist based respectively at MIT and Harvard, who have co-authored numerous articles and books over the last few decades. Their oeuvre represents an articulate distillation of some of the principles guiding mainstream economic thinking in the Anglo-American world. Acemoglu and Robinson's most recent book, Why Nations Fail (Crown Business, 2012) is an ambitious application of their theories across a large number of historical and contemporary cases.

Acemoglu & Robinson's basic argument is that political openness leads to the adoption of superior economic institutions, which they label "inclusive economic institutions." As Acemoglu & Robinson explain, "Secure property rights, the law, public services, and the freedom to contract and exchange all rely on the state, the institution with the coercive capacity to impose order, prevent theft and fraud, and enforce contracts between private parties." They also consider a few other things important: "To function well, society also needs other public services: roads and a transport network so that goods can be transported; a public infrastructure so that economic activity can flourish; and some type of basic regulation to prevent fraud and malfeasance." (p. 75-76).

Importantly, Acemoglu and Robinson view technological development as an ancillary process that flows naturally from the establishment of good institutions. The subsidiary role of technology in their thinking is clear when they write: "Inclusive economic institutions also pave the way for two other engines of prosperity: technology and education. Sustained economic growth is almost always accompanied by technological improvements that enable people (labor), land and existing capital (buildings, existing machines and so on) to become more productive."

Acemoglu and Robinson's account of economic growth suggests that with the right institutions an isolated 10th century community of Alaskan Inuits could become fantastically wealthy. This seems unlikely -- but why? Where did Acemoglu & Robinson go wrong?

Acemoglu & Robinson's emphasis is characteristic of Anglo-American thinking more generally, which emphasizes the role of transactions and the market place in the economy and economic growth. This is a tendency that can be traced back to Adam Smith. There is an alternative tradition that instead emphasizes the role of production and technology. In this alternative tradition, articulated historically by Alexander Hamilton and the American economist Henry Carey, exchange and consumption can only occur provided that something is produced. The quality and price of these products are in turn powerfully determined by the level of technology. What makes a country poor is not the inability of its inhabitants to freely trade the objects that they produce, but rather their inability to produce a wide range of objects as well as the relative inefficiency with which they produce these goods. The key obstacle to development is thus technology and the inability of individuals to access the most up to date production technologies, which are almost always tacit, and require individual learning-by-doing as well as the presence of "teaching" by more skilled producers.

To pick up one of Acemoglu and Robinson's favorite examples, South Korea is rich while North Korea is poor, not because the former is a democracy and the latter a dictatorship, but because South Koreans have acquired the technology to produce a fantastic range of manufactured goods, everything from ships and cars to computers and flat screen televisions.

To Acemoglu & Robinson's credit, they correctly draw out the implications of their theory and apply it to the People's Republic of China, which they believe is likely to experience a dramatic economic reversal akin to the fall of the Soviet Union. They write: "China is unlikely to generate sustained growth unless it undergoes a fundamental political transformation toward inclusive political institutions" (p. 151). One suspects that neither Acemoglu nor Robinson has ever been to China, otherwise they would be unlikely to make such an assertion. China has already built close to 10,000 kilometers of high speed rail, while the US has a single, relatively slow high speed train line that is only 300 kilometers long (Acela). China has a manned space program, while the US has mothballed its program, and instead relies on the Russians. Unfortunately for Acemoglu and Robinson, their assertion has already been disproven. Per capita income appears higher in the US than in China only because the US dollar is overvalued by 500 to 600%. As China continues to crush the United States, will they be willing to rethink their approach?