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What explains the rise of populism?

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Donald Trump

Consider the following thought experiment: Sibusiso and Thulani each own a firm that competes with the other. In each of the following scenarios, Sibusiso’s firm outcompetes Thulani’s. Which of the four do you consider unfair competition?

  • Sibusiso works hard, saves and invests his profits, and invents new techniques and products, while Thulani’s products change little and he loses market share.
  • Sibusiso finds a higher quality input supplier in the US, which makes his products better and he therefore takes market share from Thulani.
  • Sibusiso outsources some of his services to Bangladesh, where workers work 12-hour shifts under hazardous conditions, earning very low wages.
  • Sibusiso brings Bangladeshi workers into South Africa under temporary contracts, and puts them to work at lower than minimum wages.

From an economic perspective, each of these scenarios have a similar result: there are winners as well as losers as they expand the economy. But people generally react very differently to them. Most people are happy with scenario 1 and 2: even if someone loses (Thulani and his employees), this comes through what is perceived as fair competition from Sibusiso. It is scenario 3 and 4 that creates problems: when Sibusiso ‘breaks’ local laws (even though it may be perfectly legal in the foreign country), his competitive advantage, and by implication international trade, is viewed as unfair.

In a provocative new NBER Working Paper, Harvard University economist Dani Rodrik use this example to argue that too-rapid globalisation – the increasing use of scenarios 3 and 4, of outsourcing production to the developing world or of employing immigrants – is the underlying cause for the rise of populism across the developed world. The ‘losers’ from globalisation feel that foreigners – abroad or as immigrants in their own countries – have taken unfair advantage of then, stealing their jobs. They have chosen the politics of populism as a way to ‘punish’ this rapidly globalising world.

Economists know that free trade creates both winners and losers, and that the winners almost always gain more than what the losers lose. If the winners could perfectly compensate the losers, everyone would be better off from a free-trading world.

But Rodrik argues that such compensation is not always easy, and rarely happens. Aside from Europe, where an extensive social safety net was institutionalized to support ‘losers’, most countries failed to find a way to sufficiently compensate those that suffered the consequences of open borders. Make no mistake: open borders resulted in massive global gains, notably for the poor of China and India. But in each country, as trade theory predicts, there were losers. In Rodrik’s words: “People thought they were losing ground not because they had taken an unkind draw from the lottery of market competition, but because the rules were unfair and others – financiers, large corporations, foreigners – were taking advantage of a rigged playing field.”

There are many new studies to back up this claim. In a 2016 paper, David Autor and his co-authors show, for example, that the trade shock of China joining the World Trade Organisation aggravated political polarisation in the United States: districts affected by the shock moved further to the right or left politically, depending which way they were leaning in the first place. Analysing the Brexit vote, Italo Colantone and Piero Stanig show that regions with larger import penetration from China had a higher Leave vote share. They repeat the study for fifteen European countries, showing that China’s entry into the WTO had similar political consequences across Europe. In a 2017 working paper, Luigi Guiso and his co-authors use European survey data to draw even more precise conclusions: the more individuals are exposed to competition from imports and immigrants (the higher their economic insecurity), the more they vote for populist parties.

To summarise: because there were uncompensated losers from global free trade, argues Rodrik, there were political consequences. Rodrik then constructs a model to explain this populist rise on both the left and the right. According to the model, there are three different groups in society: the elite, the majority, and the minority. Says Rodrik: “The elite are separated from the rest of society by their wealth. The minority is separated by particular identity markers (ethnicity, religion, immigrant status). Hence there are two cleavages: an ethno-national/cultural cleavage and an income/social class cleavage. An important implication of this reasoning is that even when the underlying shock is fundamentally economic the political manifestations can be cultural and nativist. What may look like a racist or xenophobic backlash may have its roots in economic anxieties and dislocations.”

Populists who emphasize the identity cleavage target foreigners or minorities, and this produces right-wing populism. Those who emphasize the income cleavage target the wealthy and large corporations, producing left-wing populism. The large numbers of immigrants into Western Europe has resulted in the rise of right-wing populists, for example, while Latin America, because of large disparities between rich and poor, has seen more left-wing populism. The United States, argues Rodrik, falls somewhere in the middle – with Donald Trump on the right and Bernie Sanders on the left.

These findings have important implications for South Africa too. South Africa joined the WTO in 1995 and liberalised our complicated tariff schedule, opening our borders to foreign competition. There were many winners from cheaper imports, notably consumers, but some firms and industries struggled, leading to job losses, often concentrated in certain regions. And although South Africa rolled out an impressively comprehensive social safety net for a middle-income country, they could not compensate all the losers, especially as the global financial crisis hit in 2007 and unemployment began to worsen. It is not entirely coincidental that the first large-scale xenophobic attacks on foreigners happened in 2008 (what Rodrik would call right-wing populism) and that the ANC shifted left with the election of Jacob Zuma as South African president in 2009.

Even if globalisation creates more winners than losers, the losers, like Thulani and his employees, may feel that the system is rigged, and retaliate by voting for more populist parties. As South Africa stumbles into another recession, this may have profound consequences for the ANC’s December elective conference – and the national election in 2019.

*An edited version of this first appeared in Finweek magazine of 10 August 2017.

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Written by Johan Fourie

August 14, 2017 at 16:47

High-skilled migrants matter – and we’re not winning

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elon-musk-is-making-history

One of the baffling things in explaining the Industrial Revolution is that education, that pillar most economists believe to be critical for economic growth, seems to have played a relatively minor role. Universal public education was a consequence rather than a cause of the Industrial Revolution. Eighteenth-century England did not first have a skilled population before they had an economic transformation; the uncomfortable truth is that it was the other way round.

This uncomfortable truth does not suggest that formal education was completely unimportant. It suggests, instead, that much of what caused the Industrial Revolution was the scientific knowledge obtained by an elite group of highly skilled artisans, inventors and entrepreneurs. It was not the average level of education of every Brit that mattered. Most of the breakthrough technologies of the era – the Spinning Jenny, the steam engine – came instead from upper-tail tinkerers who had hoped to make a profit from their innovations.

A wonderful new research paper by economists Mara Squicciarini and Nico Voigtländer in the Quarterly Journal of Economics confirm this. They use the subscriber list to the mid-eighteenth century French magazine Encyclopédie to show that knowledge elites mattered in explaining the first Industrial Revolution: in those French towns and cities where subscriber density to the magazine was high, cities grew much faster in the following century, even when controlling for a variety of other things, like wealth and general levels of literacy. Their explanation? Knowledge elites (engineers, scientists, inventors) raise the productivity at the local level through their piecemeal innovations, with large positive spill-overs for everyone around them.

Fast-forward to the twenty-first century. High-skilled workers are the stars of today’s knowledge economy. Their innovations and scientific discoveries spur productivity gains and economic growth. Think, for example, of the immense contributions of Sergey Brin’s Google, or Elon Musk’s Tesla, or even Jan Koum’s WhatsApp. It is for this reason that the mobility of such highly talented individuals has become such an important topic – consider that all three individuals mentioned above are immigrants to the United States. There is little doubt that the most prosperous economies of the future will be the ones to attract the most skilled talent.

Which is why understanding the push-and-pull factors of current global talent flows are so important, and the subject of an important new article in the Journal of Economic Perspectives. The four authors begin with the facts.  High-skilled elites are more mobile: between 1990 and 2010, the number of migrants with a tertiary degree increased by 130%; those with only primary education increased by only 40%. More of these high-skilled migrants depart from a broader range of countries and head to a narrower range. While OECD countries constitute less than a fifth of the world’s population, they host two-thirds of high-skilled migrants. 70% of these are located in only four countries: the United States, the United Kingdom, Canada and Australia.

The United States, unsurprisingly, dominates all rankings. Since the 1980s, of all the Nobel Prizes awarded for Physics, Chemistry, Medicine and Economics, academics associated with American institutions have won over 65%, yet only 46% of this group was born in the United States.

emigration-rate

One fascinating and underappreciated fact of global migrant flows is the role of highly educated women. Between 1990 and 2010, high-skilled women immigrants to OECD countries increased from 5.7 to 14.4 million; in fact, by 2010, the stock of highly skilled women migrants exceeded male migrants! As the authors note, ‘Africa and Asia experienced the largest growth of high-skilled female emigration, indicating the potential role of gender inequalities and labour market challenges in origin countries as push factors.’

And what about South Africa? The authors calculate the emigration rates of high-skilled individuals by country for 2010, and plot these on a graph. South Africa is a clear outlier: emigration of high-skilled individuals is the sixth highest of the countries included, and by far the highest for countries with more than 10 million people. This is worrisome. True, some of this emigration is made up by high-skilled immigrants from our African neighbours, like Zambia and Zimbabwe, who also have high emigration rates. But the fact remains: our economic outlook will remain precarious if we continue to shed high-skilled individuals at these exorbitant rates.

Is there something to do? The authors mention various push and pull factors that affect the decision to migrate, from gatekeepers that pull the best talent by giving citizenship based on a points system to repressive political systems that suppress freedom of speech and scientific discovery and push the best and brightest to emigrate. If South Africa is to prosper, high-skilled individuals should be recruited and retained – not pushed to find opportunities elsewhere. Protests at universities do not help; providing residency to graduates, as the South African government has proposed, will.

In the knowledge economy, knowledge elites are the bedrock of success. If we are to learn from history, cultivating them should be our number one priority.

*An edited version of this first appeared in Finweek magazine of 3 November.

Africa’s $500 billion-a-year treasure fleet

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zambezi

I usually tell my students that understanding the world is much like understanding the flow of a river. We busy our lives floating on its surface, unaware of the tremendous forces below. Those forces, or currents, have various layers. Just below the surface are the forces still visible to us, the things we might still want to influence. Media, popular culture, sport. Below that is the more established institutions – political, judicial. And below that, I would argue, are the economic forces, pushing us down the river without us ever knowing the true source of the current.

But I often neglect a perhaps even deeper current, a current so slow-moving that in the business of our day-to-day operations, we fail to see its significance. Demographic change.

The world has witnessed massive demographic change over the last two centuries. In the eighteenth century, Reverend Thomas Malthus predicted that because humans increase at a geometric rate but food production only grow at an arithmetic rate, humans will continue to live just above subsistence. What he did not consider was human ingenuity. Since his famed prediction, not only has global population numbers increased by a factor of 7, our average level of prosperity has increased by at least a factor of 8 (and in many countries much more).

But demographic change is more than just an increase in numbers. As medical knowledge and modern medicine expanded, mortality rates, especially those of young children, have fallen to historically low rates. As families recognised that many of their children now survive into adulthood, they have begun to reduce the number of children they have. (When Adam Smith wrote about Scottish Highlands mothers in 1776, he noted that of the 20 children they might bear, only two would survive into adulthood. In 2014, the average Scottish women had 1.56 children.)

The difference between the decline in mortality and the decline in fertility is known as the demographic dividend. A demographic dividend essentially means that there are many more people of working age than there are dependents (very old and very young people); thus, there are more paying taxes than those needing the tax money. Most developed countries experienced their demographic dividend somewhere during the nineteenth or early twentieth century. Most Asian countries experienced theirs during the latter half of the twentieth century; even in Bangladesh, one of the most densely populated countries on earth, the fertility rate is now 2.21, just above replacement level.

Africa has not seen fertility rates fall to the same extent. A new NBER Working Paper by David Bloom, Michael Kuhn and Klaus Prettner argues that this is likely to happen in the next few decades, which means ‘Africa has considerable potential to enjoy a demographic dividend’. This will be a boon to Africa’s economic prospects, but, as the authors argue, only if countries implement good policies.

One place to start is to give women the freedom to choose the number of children that they have. Access to contraceptives and family planning services are among the reasons for the decline in fertility rates elsewhere, and too many women in African countries still lack access to such services. Policies focusing on female education will boost female labour force participation, which not only reduce fertility rates, but also increase investment in their children; more educated, working mothers tend to have fewer, more educated children. The main challenge, as the authors acknowledge, is the capacity of many of the weakest governments to coordinate such policies effectively.

Once fertility rates in African countries start falling – as they already have, down from a high 6 in the 1960s to a still relatively high 4.7 in 2015 (South Africa is an outlier, with a fertility rate of only 2.4) – and the demographic dividend begins to boost government coffers as the number of child dependents fall relative to the working age population, governments will have to make clever, forward-looking decisions about what it is they want to invest in. Education, particularly tertiary education, is an obvious candidate.

Barriers that might prevent African countries from realising these gains include climate change (which affects migration decisions) and, more alarmingly, the wastefulness of government expenditure (corruption, state capture). The authors calculate that a demographic dividend could ‘yield’ as much as $500 billion per year in additional expenditure possibilities. It is easy to see how such a boon could lead to political opportunism in the worst degree.

Because a demographic dividend ‘only’ lasts a couple of decades, after which the working age population grows old and become dependents again, governments must ensure that they invest wisely during the good years. Many developed countries, from Italy to Japan, are today struggling with aging populations, and the fiscal demands of promised pensions.

That is why long-term fiscal planning is essential. In those African countries where fertility rates have already fallen significantly, notably in South Africa, these issues are much more prescient than in others where the demographic dividend is still to be realised. What is clear, though, is that we should be more cognizant of the deep underlying currents that determine the flow of the river, and the direction our boat is likely to go.

*An edited version of this first appeared in Finweek magazine of 22 September.

Written by Johan Fourie

October 27, 2016 at 06:33

South Africa’s long walk to economic freedom after apartheid

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Towering above  his successor: How long before Nelson Mandela's long walk to economic freedom will end?

Towering above his successor: How long before Nelson Mandela’s long walk to economic freedom will end?

South Africa’s economy is in trouble. In June, StatsSA announced that the South Africa’s gross domestic product had fallen 1.2% in the first quarter of 2016. We are on the verge of a recession, hanging on by our fingernails. Weak and weakening capacity within national government to enact the necessary economic reforms stipulated in its own policy programme (the excellent National Development Plan) is largely to blame. And it is becoming increasingly apparent that the weakening capacity is the result of appointments based more on political affiliation than competency.

Global events have contributed to the malaise. The self-inflicted Brexit wound will hurt for a long time, and may even leave a permanent scar. Austerity measures implemented in the post-Great Recession era may have reduced government debt somewhat but had the political consequences of the rise of nationalists and fascists. As an older generation of political economists would have known but many modern-day macroeconomists may have ignored in their models, economics doesn’t happen in a political vacuum. England may have been first, but right-wing groups across Europe will only be encouraged by the UK’s ‘independence’. It wasn’t only austerity, though. Demographics played its part. Again, much was said about the economics of an ageing population, but few predicted that it would have political consequences too. Old people voted for Brexit; young people, who will suffer its consequences for longer, wanted to Remain.

It is in this context that I recently wrote a short paper on the economic history of South Africa since apartheid, and the road ahead. The paper is now available as a working paper. I divide the post-apartheid in two: the first 14 years of Nelson Mandela and Thabo Mbeki, and the next eight following the Great Recession and Jacob Zuma. While there is much to commend about the first period when the country reached GDP growth rates above 5%, the sad reality is that the last 8 have been dismal. A bloating state salary burden, ideological conflict within the ANC, and state capture have pulled the South African economy – and the poor’s prospects to enjoy social mobility – down.

I then outline a tentative plan for what to do next. The utopian dreams of the NDP are now worth little more than the paper they are written on. What is needed is a list of priorities of ‘low-hanging fruit’, policies that are affordable, politically acceptable and would support those most in need. I outline five such policies, beginning with family planning, early childhood development, education (schools and universities), and affordable and widespread broadband. Much more is needed, of course, to take us back to the optimism of the mid-2000s. But even with just a start in the right direction, I argue, we can benefit from the opportunities that a rising Africa and technological innovation have to offer.

Shock and surprise as Britain leaves European Union

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Brexit

Britain has decided to leave Europe. It is an utterly foolish thing to do, but that is the consequence of a referendum by people who have suffered from the austerity measures they voted in and now wants to blame Europe (and immigrants) for their malaise. Few can, unfortunately, distinguish cause and effect, and it doesn’t help when those few are distrusted.

The consequences of the UK leaving the EU is hard to determine because it depends on so many things. But one thing is for sure: the world economy is in for an even more bumpy ride. The pound has already taken a beating (see image below), and the effects will become more apparent when global markets open. But be wary of overreaction too. Until the details of the new arrangement are made clear, it’s best to take it slow. Keep calm and carry on.

The irony, of course, is that it is entirely self-inflicted, and could easily have been avoided. But those discussions are for another day. Instead of speculating what the consequences might be, let me leave you with a few brilliant early-morning (late-night) tweets to sum up the sentiment:

And my favourite:

Written by Johan Fourie

June 24, 2016 at 06:13

Walking with my father

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Camino-28

For most of May, I walked in the footsteps of my father. Literally. Starting on the 6th of May, we hiked the Camino Primitivo, an ancient route from Oviedo in the north of Spain to Santiago de Compostela on the west coast. 343 kilometres in 11 days. It was tough but beautiful. I’ll let the pictures do the talking.

My father had turned sixty the previous year, and I decided to let him choose his birthday gift. (My gold standard for him is chocolate and I was unable to conjure up something more creative.) Sensing an opportunity, he mentioned that he has a short ‘bucket list’, and that hiking the Camino is at the top. Not knowing much about the Camino, I happily agreed. I would be in Europe in 2016 in any case, and we tentatively decided that May would be a good month to go to Spain.

His preparation started almost immediately after this conversation. He would put on his backpack and, almost daily, hike the 24km mountain route from our home in Paarl, South Africa. He would send me tonnes of emails of people who had done ‘the Camino’. Deciding to do some research of my own, I soon realised that there were many decisions to make long before arrival. What route? How many days? How to get there and back? Where and how to get a ‘Camino passport’? What shoes to wear? What to pack?

Camino-29We decided on the Camino Primitivo for mostly three reasons. The first was that it is a manageable length given our available time. The Primitivo is also, according to legend, the most ancient route. Fearing the Moors to the south, two bishops from Oviedo hiked the Primitivo around 800 CE to visit St James’ tomb. And, according to the few sites I could find, it was also a physical challenge. That sounded like something we would enjoy.

Our journey started on the morning of the 6th. We met in Bilbao the day before, and took an ALSA bus that arrived at 22h30 in Oviedo. We had brought no map of the city, and had to ask a few people before we managed to find our hotel. That is also when we realised the language barrier may be bigger than expected. The next morning we were up early, ready for our first day. We found the cathedral where we would start from, but were slightly disappointed that there were no signs pointing the way. We still had no map, and we thus walked, a bit less confidently, in a generally western direction. And then, after maybe half-an-hour and an increasing unease, a random woman stopped us and pointed to the street where we would see our first arrow – we had found the route to Santiago de Compostela!

It was a beautiful hike through the farms and small villages that dotted the hilly landscape. Our first night we spent in Grada in an overpriced, dodgy hotel because we could not find the albergue, the hostel for pilgrims. The second day we stayed with Micheal in his private albergue in Salas, although, looking back, we could probably have hiked a bit further. We paid for it on the third day, when we hiked a total of 40km to Campiello. The day was memorable for another reason too. Walking down a hill, my father in front, I slowed down a bit to enjoy the view. Thinking my father was still in front of me, I continued downhill only to realise, at the bottom, that he was not in front of me anymore. I could see the shells (pointing to Santiago), so I knew I was on the ‘right’ route, but what had happened to my father? I asked a farmer who was working in a neighbouring field whether he had seen anyone, but his English was as bad as my Spanish. He did point me to the actual correct route whence my father should come, and so I decided to run (with my 8kg backpack) back on this route. Needless to say, after about 1km of running (having already hiked about 25km), I was dead tired. I also realised I wasn’t on the actual correct route anymore: there weren’t any shells. So I turned around and ran the 1km back again, deciding that I would probably just walk on and hope to either catch up with him or wait at the next town. But fortunately, just before the ‘correct’ route intersects with my ‘wrong’ route, I could see him coming down a hill towards me. We had a few laughs afterwards, but it wasn’t so funny at the time. That evening, another 15km after my run, we found a wonderful albergue, Herminia’s in Campiello. That was also the first evening we would meet people that we would see throughout our journey, and ultimately in the cathedral in Santiago de Compostela.

Camino-32The next day the path split in two, and we decided to choose Hospitales. Here is the recommendation in a booklet we (unfortunately) only purchased after our trip: ‘The Hospitales option leads into the mountains and away from civilisation for most of the day. While this is one of the most demanding walks on any Camino, made more so by the lack of resources, it is strikingly beautiful with expansive mountain vistas unfolding in all directions.’ That is spot on. The views are just incredible, and we were fortunate that we had clear skies for most of it. (It can be misty, but the route is very well marked, in contrast to what we were told beforehand.)

That night we also had our first experience of one of the hallmarks of any Camino: snoring. We ended up in a room with 12 people. One of them, a Spanish guy, which we would unfortunately meet later on the journey again, had a remarkable snore which no earplug in the world could keep out. I’m not sensitive to sound; you can’t be if you’ve spent four years in a university dormitory. But I think I didn’t sleep more than two hours that night, and judging by the other people’s faces the next morning, neither did they. That is what makes the Camino a physical challenge: hiking 30kms and then not sleeping, and not eating very well, and hiking another 30kms, and not sleeping. We did this for another five nights until we reached Lugo, a city with an incredible Roman wall, where we decided to stay in a hotel. By that stage we were tired and dirty, but in good spirits. Our feet miraculously had no blisters (in contrast to some of our companions on the journey), and the next morning, after circling the Roman wall, we decided that we could push through to Santiago de Compostela in three days. That, in hindsight, was maybe the wrong call.

Our first night of the last stretch we stayed in a very nice albergue. Some fantastic paella was served, and the Spanish snorer had decided to go to a different spot so we could at least enjoy a good night’s rest. The route from Lugo to Santiago is less hilly. You walk along tarred roads most of the time. My expectation was that this would be easier, but it turned out that the hard surface was tougher on our feet and knees. By the second evening, after a 38km walk, I had cramps in my right leg, and my feet were beginning to show signs of wear and tear. The next day would be our final stretch to Santiago and I hoped the legs would last for just one more day.

Camino-22They didn’t. With about 10km to go, my right leg could barely bend. Those last kilometres, when you could see Santiago in the distance but it would not get closer, was gruelling. The road into Santiago (the French route, which we joined two days earlier) descends steeply, and I had to shuffle sideways for most of it, keeping my leg straight. There were hundreds of other hikers on this stretch. Some had been on the road for weeks, even months. You could see it in their faces and the only thing you could do is to applaud their achievement. There were unfortunately also those, in larger numbers, that had just signed up for three days or even just one day of hiking, and were now crowding the route. That did make it feel a bit touristy.

After we entered the town, there were another three kilometres to endure before we finally reached, through the archway, the Cathedral square. It is difficult to describe the emotions at the ‘finish’. Elation, yes, but you’re mostly just dead tired. (Our last day was another 38km.) We took a few photos and then went to get our compostela (certificate), and then to find our hotel. The rest of the week we relaxed in Santiago and Finisterre, a small village on the western coast of Spain where the Camino reaches the ‘end of the world’.

Many have asked me since we’ve returned whether the Camino is what I expected. I envisaged a lot of time philosophising, thinking about life, liberty and the pursuit of happiness. That did not really happen, because, and this is perhaps due to nature of the Camino Primitivo, most of your time is spent deciding where to step so that you don’t fall. It is a technical walk, especially because it is almost constantly wet and muddy underfoot (both of us fell twice, luckily without serious injury). Yes, there were times when you could let your thoughts wander, but often those thoughts just wondered about where the next shell indicating the route might be.

I did not come to any major new insights. And, actually, I am perfectly fine with that. I did something with my father which we both enjoyed. It was challenging – I lost 4kgs in 11 days – and that ‘intellectual break’ was perhaps exactly what I needed after an eight-month sabbatical. We did meet some fascinating people along the way, many with their own compelling (and sometimes heartbreaking) stories. But I also think the pilgrims that choose the Primitivo are slightly different than the rest: they are there because they want the physical challenge. And they are okay with walking for an entire day without seeing anyone else.

Will I do it again? Maybe, but there is no urge to return immediately. And yet, there are times that I miss the simplicity of it all. Only two sets of clothing. Only two choices of bocadillo (ham or cheese), only two types of coffee (with or without milk). Just me and my dad on a mountain path in a country where no-one speaks your language. And where it is sometimes good to get lost, so that you realise what it is you value most.

The Primitivo route I’d suggest (if you want to do it in 11 days):

Oviedo -> San Juan de Villapanada -> Bodenaya -> Campiello -> (via Hospitales) Berducedo -> Castro (bookings required) -> Padron -> Castroverde -> Lugo -> Ferreira -> Arzua -> Santiago

Written by Johan Fourie

June 18, 2016 at 16:30

Open or closed borders, that is the question

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Trade bottleneck: The border between Zambia and Zimbabwe in 2008 (Photo: Johan Fourie)

Trade bottleneck: The border between Zambia and Zimbabwe in 2008 (Photo: Johan Fourie)

Most professional economists would agree that open world trade increases economic growth and raises living standards. Trade barriers such as tariffs and non-tariff barriers – which include rules-of-origin clauses or sanitary and phytosanitary conditions – reduce countries’ ability to specialise in those goods and services which they are good at, and force them to produce things that they are not good at.

But despite this important insight that dates back to Adam Smith and David Ricardo, economists also know that free trade is not always good for everyone. Industries that are uncompetitive but employ many thousands of people can suffer when trade barriers protecting those industries fall. Many countries protect certain key industries, arguing that they are industries of national security. The classic examples here are military spending or food security. (This can have ridiculous consequences: Gilette argued that its razors deserve tariff protection during the Second World War, ostensibly because soldiers could not go unshaven.) Other industries are protected because they are young and, it is argued, will become more efficient once they obtain certain economies of scale. This is known as infant industry protection. The problem is: many infants never grow up. The South African clothing and textile industry has received government support since the 1930s, and we still pay exorbitant import tariffs on clothes.

But sometimes it does work. As Concrete Economics, a new book by Stephen Cohen and Brad de Long, explains, the United States became the manufacturing hub of the late nineteenth and early twentieth centuries because it was protecting its local industries from cheap British imports. In Economics jargon, their comparative advantage (the thing they were relatively better at making) switched from agricultural goods to manufacturing goods. And with manufacturing came higher paying jobs and more dynamic technological innovation.

It is this same model that the East Asian Tigers followed, copying the basic and later advanced technological products of the West, building a domestic industry behind high tariffs, and once they’ve built up the necessary technological know-how, exported their way to prosperity. Now they are at the technological frontier designing and building new phones (Samsung, Korean) and computers (Lenovo, Chinese) and robots (Honda, Sony, Fujitsu, Hitachi and Toyota, all Japanese firms, have built human robots).

But this strategy did not work everywhere. The evidence for Latin America is mixed: attempts at import-substitute industrialising failed to propel Argentina, Brazil and many other smaller South American countries to prosperity in the same way it did East Asian countries. And in postcolonial Africa it only managed to impose a heavy burden on poor consumers without stimulating any large-scale industrial activity. Many African countries remain incredibly protected – just ask any importer to Nigeria, for example – and this has contributed little to the rise of African industry.

So are open borders good or bad? A new paper by Pable Fajgelbaum and Amit Khandelwal in the Quarterly Journal of Economics gives the standard economist response: it depends. Some consumers buy more tradable goods and are therefore more affected by relative price changes caused by international trade. They find, using a novel methodology, that those consumers who gain most are often the poor, who buy more tradable goods and services. Open borders, they claim, is a very good thing if you are a poor person.

So policy makers are stuck between a rock and a hard place: close borders in the hope that some industries grow beyond infants, at the cost of cheaper goods and services for poor people. Or open the borders and allow the poorest access to cheap goods and services, but with the caveat that some uncompetitive industries suffer injury.

Take South Africa’s dispute over chicken imports. Chicken is the largest protein for poor South Africans. By denying them access to cheap food we not only hurt them but also their children’s ability to consume nutritious protein so critical for early childhood development. We thus perpetuate the cycle of poverty. And by protecting chicken imports, do we really stimulate local economic development in dynamic industries with agglomeration and spill-over externalities? Probably not.

In contrast, we protect the local automotive industry because it not only creates direct jobs but because vehicles support an entire value-chain, from raw material to assembly. Unlike chicken producers, building a car requires vast numbers of engineers and other skilled artisans that may have large (and unexpected and unplanned) spill-overs in related industries.

What made Japan, the first Asian Tiger, so successful was a capable bureaucratic administration that could, with little political influence, judge which industries required support and which did not. Some that received support failed to deliver, and support was quickly removed. We only recognise the successful ones: Panasonic, Kawasaki, Canon.

Wherever protection has failed, it has done so because supported firms gain political influence to protect their support. Bureaucrats are people too – often poorly paid – and find it difficult to challenge entrenched interests of the firms they initially supported. The government bureaucrats that steered Japan’s miracle were not only well remunerated (making them less corruptible) but were also the top graduates from Japan’s best universities. They had the foresight to invest in industries of the future.

In general, then, open borders are likely to be more beneficial than closed ones, especially to those people who are worst off in society. But this is not to say that there is no role for industrial policy. If political influence can be thwarted – and that’s a big ‘if’, especially given the recent revelations of state capture in South Africa – support for strategic industries that have large spill-overs can play an important role in building a thriving economy. The hard questions remain, though: Who picks the winners? And what happens when they fail?

*An edited version of this first appeared in Finweek magazine of 21 April.