How rich countries got rich, and why poor countries stay poor

Book review: ‘How rich countries got rich, and why poor countries stay poor‘, by Erik Reinert.

There are two main schools of economic thought, capitalism and marxism, and we all know which one dominates the world today. What is less known is the divisions within capitalism, that there are two main ‘canons’ of literature. Neo-liberal economics prevail, are taught in business schools and applied by the Washington institutions of the IMF and the World Bank, but there is a whole ‘other canon‘ of forgotten or conveniently ignored literature that needs to be taken into account. Reinert is a leading scholar of this alternative philosophy, and it is in this canon that he believes we’ll find the answers to the question of the title.

Countries get rich, says today’s orthodoxy, by finding a niche where they have a comparative advantage, specialising, and then producing whatever that speciality is for the world market. In return, by opening their own markets to import, the best of the world will come to them, and everybody wins. This is all very well in theory, but it isn’t how the already rich countries of the West made their money. They became rich by diversifying trades within the cities, which creates synergies. The governments then supported growing businesses with monopoly rights, and tariffs to prevent cheaper imports from sinking the market. Out of these hot-spots of business activity come innovations, and then manufacturing, and exports. No country has ever developed without a manufacturing industry.*

The first rich countries, Holland, England, and Italy, developed through these rounds of diversification, and industrialisation protected by government intervention. Holland followed the process through ship-building. England started with wool, and later cotton, coming to dominate the European markets for cloth. Each realised that selling finished products was more worthwhile than selling raw materials, and used tariffs and sanctioned monopolies to protect their early industries. It was England’s planned shift from selling raw wool to selling finished cloth that set it on the road to development.

Philipp Von Hornigk, writing in Prussia in 1684, observed how these countries had become rich, and counselled his own nation accordingly: “all commodities found in a country, which cannot be used in their natural state, should be worked up within the country; since the payment for manufacturing generally exceeds the value of raw material by two, three, ten, twenty, and even a hundred-fold, and the neglect of this is an abomination to prudent managers.”

Consider then, that this abomination is exactly what the IMF impose on developing countries today, who are encouraged to gear their whole economies towards raw materials. They are encouraged to focus on one tradeable commodity, like coffee, rather than diversify. They are forbidden to use tariffs, subsidies, or other forms of market protection to develop any kind of manufacturing industry.

The United States is the leading champion of this false route to economic progress, even though they themselves used the route described above, of developing a manufacturing industry and protecting themselves from European imports: “It is particularly interesting to note,” says Reinert, “that the United States fought long and hard against the economic theories that today they vehemently support.”

Consider too that in 1744, Matthew Decker advised colonists that colonies should not be allowed to develop manufacturing industries, as the only thing where “our interest can clash with theirs.” Instead, they should be persuaded to grow raw materials and tempted with promises of free trade: “because people in the plantations, being tempted with a free market for their growths all over Europe, will all betake themseves to raise them to answer the prodigious demand of that Free Trade, and their heads be quite taken off from manufactures.” In other words, the IMF preaches the exact doctrine that the old colonists preached to make sure that the colonies never developed.

Reinert delivers page after page of evidence of how the orthodox economic policies of the Washington Institutions have ignored history, and therefore don’t understand how countries develop. He shows how “real wages in Peru peaked when the country did everything ‘wrong’ according to the Washington Institutions, how NAFTA destroyed Mexico’s manufacturing, how China and India are developing by completely ignoring IMF policy.

In fact, says Reinert, the rich countries have systematically outlawed all the methods they used to get rich themselves. “To receive support from the rich countries, poor countries had to refrain from using the policies the rich countries had used and often still use. These are the ‘conditionalities’ of the Washington Institutions.”

‘How rich countries got rich, and why poor countries stay poor’ is not an easy book. I actually bought it last autumn, and didn’t know enough economics to understand it at the time. It’s a long book too, and I’ve been working through it for weeks. I’m glad I came back to it though. It is full of good historical analysis, and pulls no punches. Reinert is not afraid to stir up controversy, dismissing the Millenium Promises for example. Like Naomi Klein, he has no time for Jeffrey Sachs, comparing him indirectly to both Attila the Hun, and elsewhere Marie Antoinette. (for suggesting in an Economist article that Mongolia specialise in software development, in a country where only 4% of people outside the capital have electricity – a comment with echoes of Antoinette’s ‘let them eat cake’.) Despite his rhetoric, he appears to be right. Joseph Stiglitz, former director of the World Bank, would agree with much of the critique here. It is a critique from within capitalism, from the other canon, rather than from the left. As such, it is far more applicable than many alternative theories.

I will leave you to explore more of the Other Canon yourselves, but Reinert’s book is best summarised in the line “today’s best advice to Third World countries is ‘Don’t do as the Americans tell you to do, do as the Americans did.

*To understand this, imagine five villages in a forest – one has a woodcutter, another a blacksmith, one a sawmill, the next a carpenter, and the last has a trader with a river barge. Now imagine you put all those together on one street in a city, where each can buy each other’s good and services, where the blacksmith and the carpenter can cut a deal for cheap nails, where customers can find everything they need in one place and easily ship it downriver. That’s a synergy. Each of those little businesses will do better than they would do out on their own in a village. (But that’s banned by the IMF or poor countries won’t get debt forgiveness or loans for investment – countries should focus on just one exportable commodity.)

Let’s say a wood market develops on this street. Traders start coming from other parts of the country to buy good wood, the king wants building materials for his summer house from there. The city becomes the cut wood capital of the region. But, as the market develops, traders from the hill tribes start bringing pine logs to the market and selling them cheap, undercutting the local businessmen. To prevent this, the mayor of the city puts a tax on any wood brought into the city that was cut outside the region, giving local traders a definite advantage. (That’s intervention, or protectionism – strictly banned under WTO rules, unless you’re the US or the EU. The recent round of WTO trade talks collapsed because India and China insist on their right to protect their industries, and the US and EU insist they mustn’t, even though they spend billions a year in subsidies to protect theirs)

A few years later, a joiner and a wheel-maker have set up in the street. They start making furniture, and carts. These make a bigger profit than wood or planks because of the value added through manufacturing, so the market gradually shifts. The mayor relaxes the tariffs on imported wood, and soon the city is more famous for its furniture. (That’s manufacturing, adding value to raw materials. Under IMF guidelines, developing countries are to focus on the materials, and let the rich countries process them and sell them back.)

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