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The world is not a zero-sum game, but it matters if you think it is

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Question: A farmer in your neighbourhood has had an exceptionally productive 2016. He has managed to double wheat output, and his favourite cow – Daisy – was awarded first prize in the national competition. What is the reason for the farmer’s success? Is it: a) He has worked very hard, b) He was lucky, or c) he put a spell on the rest of the farmers in his village?

This is an example of the type of survey questions a team of Harvard economists have been asking to subsistence farmers in the Democratic Republic of the Congo on several visits over the last few years. In contrast to what one might think, the answer to this question is almost always the same: C. Witchcraft and supernatural beliefs are widespread in Africa and throughout the developing world. One aim of the research group is to identify how these cultural traits affect economic decision-making. Clearly, if my answer to this question was that the farmer’s success was due to hard work, I would conclude that the way to excel is to work harder. But if my understanding is that this farmer somehow cheated – that his success was due to a spell he put on the rest of the community, and that his gain was our loss – then my takeaway is that I need to spend more of my surplus not on investing in my farm, but on bribing the local spiritual leader for favours.

The belief that the world is a zero-sum game is widespread. Like these Congolese farmers, many of us believe that the success of one member of our communities must be to the detriment of others. In some cases, this is, of course, true: when one bowler takes 7 wickets in an innings, it leaves only 3 scalps between the remaining bowlers. But, generally, the world is not zero-sum. China’s success is not a consequence of America’s decline, despite what the Trump propaganda machine says. Trade, as economists have known since David Ricardo, can be mutually beneficial, even if it means that the benefits and costs of growth are not shared by everyone equally. My neighbour’s financial success after she designed and marketed a new app is not the result of her ‘stealing’ my success.

But beliefs of a zero-sum world are widespread, and results in what has become known as the Tall Poppy Syndrome. I’ve seen this in action: students that excel sometimes draw the envy of their poorer-performing peers. And it has consequences: the envious ones believe that the good student must have achieved the high marks because of external factors, such as being the teachers’ favourite. They avoid taking responsibility for their own mediocre efforts. The star student, depending on the sanction of the envious ones, also reacts, either by withdrawing from social interaction or, worse, by putting in less effort in the next test to avoid standing out.

The Tall Poppy Syndrome is prevalent in all societies, but its density and effects are likely to vary. If TPS is more concentrated in poorer communities, for example, it will hamper social mobility, reinforcing both the poverty and the cultural beliefs itself. Development economists are therefore hoping to not only identify the causes of these beliefs but also how to change them.

This will not be easy: beliefs are difficult to measure accurately, and their origins may be deep in history. Nathan Nunn and Leonard Wantchekon’s work several years ago showed how the Atlantic slave trade still affects trust in African societies: people that today live in areas where most slaves were captured are more likely to distrust their neighbours and the government. In a new paper, Oded Galor and Ömer Özak show that people’s belief about time preference – whether you have a long-term horizon or not – were affected by what type of crops their ancestors grew. Both trust and time preferences are necessary ingredients for development. As Adam Smith already pointed out in the eighteenth century, trust is necessary for specialisation and exchange. A long-term horizon allows one to forego future income, invest in the present and earn the higher future returns. It affects our propensity to save, to adopt new technologies, and, as Galor and Özak show, even our likelihood to smoke.

If these cultural beliefs are so deeply rooted and have such a pervasive influence over our behaviour, what can be done to change them? This is difficult to answer and requires the interdisciplinary efforts of psychologists, economists, anthropologists and neuroscientists. The answers they provide may not only contribute to sustainable development and social mobility, but may have applications elsewhere. Marketers may have to design products that appeal to those with a zero-sum worldview, or managers may have to lead teams of people where some ascribe to this view. The incentives that motivate people who have Tall Poppy Syndrome, for example, are likely to be different to those who are less envious of their successful colleagues.

Our beliefs about the world shape our economic decision-making. We are only now beginning to understand how it does, and what to do to change it.

*An edited version of this first appeared in Finweek magazine of 1 December.

Written by Johan Fourie

January 16, 2017 at 08:16

The invisible barriers of international trade

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One of the biggest barriers to deeper economic integration in Africa is the excessive trade costs that prevent regional trade. Import tariffs have traditionally been an important source of revenue for poorer countries, and it has taken several spaghetti-like agreements to reduce these. Although an agreement has been signed to create a Free Trade Area from the Cape to Cairo, none of the 26 countries have ratified it. Import duties remain between most African countries.

But tariffs are only of the costs of trade. It takes time to move a container from Johannesburg to Kinshasa, and the journey by land is often filled with tales of unscheduled delays and red tape. I remember traveling through the Victoria Falls border post between Zimbabwe and Zambia a few years ago and asking the truck drivers how long they had to wait to cross into Zambia. Their response: ‘A couple of days, if we are lucky’. This is no way to encourage regional trade.

Poor infrastructure is another significant barrier. The massive distances between major economic centres means that the unit cost of transport is high. A new paper in the Review of Economic Studies by Tufts University economist Adam Storeygard confirms this. Storeygard measures the impact of the oil price increases between 2002 and 2008 on the incomes of African cities. He compares two types of cities: those with a port on the coastline, and those of similar type but 500 kilometers inland. Using satellite imagery over the period, he finds that the oil price shocks increased the size of port cities by 7% more than in cities in the hinterland. The take-away: high transport costs retard growth. And because many African cities are located far from the coast, the high transport costs of poor transport infrastructure explains why African manufacturers find it difficult to compete with manufacturers in Asia and Europe. Just think of the difficulty manufacturers in landlocked countries like Malawi or Zambia face.

But even where better physical infrastructure reduces transport costs, other, ‘softer’ trade barriers often remain. Corruption, for example. Traveling into Malawi on my trip of a few years ago, we were pulled off the road a few kilometres after the border post by an armed man, and then required to return to the border post because we needed ‘additional insurance’. That was a $50 payment that went straight into the friend of the armed man’s pocket.

The effects of these ‘invisible’ trade barriers on trade and consequently economic performance have been hard to quantify, though, until now. In a new American Economic Review paper – ‘Corruption, Trade Costs, and Gains from Tariff Liberalization: Evidence from Southern Africa’ – Sandra Sequeira of the London School of Economics and Political Science finds that a reduction in tariffs between South Africa and Mozambique in 2006 had a very limited effect on trade. This is surprising: one would expect that lower tariffs would lead to higher levels of trade. And yet, the sharp decrease in tariffs had basically no effect (in technical terms, the elasticity of imports to tariff changes was very low).

mozambique-and-malawi-border-postWhat explains this surprising result? Sequeira uses a novel dataset of exporters’ bribe payments between South Africa and Mozambique to show that the decline in tariff rates at the border resulted in a 30% decline in the probability of bribe payments and a 20% decline in the average bribe amount paid. In other words, the lower tariffs did not actually reduce firms’ trade costs, it just shifted paying corrupt border officials to actually paying the tariffs as required by law, boosting government revenue. That is also why the elasticity of imports was so low: because costs did not fall in practice, there was no concomitant increase in trade.

Sequeira’s innovative study shows that high tariffs explain why corruption thrives. Remove the tariffs and the ability to solicit bribes vanishes. But don’t think that trade will suddenly blossom. Bribes keep trade costs lower than what they would be if tariffs were fully paid; lowering tariffs only lower the amount corrupt officials receive.

This has important implications for policy-makers: first, lower tariffs may actually result in an increase in tariff revenue as traders switch from paying bribes to paying the now more reasonable official tariffs. Free trade agreements  (with zero tariffs) may not result in a significant fall in revenue either, because much of the revenue goes into the pockets of corrupt officials in any case, and will likely lead to greater transparency; Sequeira finds, for example, that trade statistics also improve when corruption practices decline.

But don’t expect free trade agreements like the one being discussed at the moment to result in a large increase in regional trade. As long as other barriers, like delays, severe red tape and poor infrastructure, remain, regional trade in Africa is likely to remain too weak to foster the economic development it promises to deliver.

*An edited version of this first appeared in Finweek magazine of 17 November.

Written by Johan Fourie

December 8, 2016 at 21:17

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

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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.


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 should invest in itself

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Imagine you receive the news tomorrow that an unknown, distant family member has passed on and left you a bequest of a million dollars. What to do? Spend it immediately on luxury consumption – a round-the-world trip, perhaps – or invest it offshore and live off the returns, thereby smoothing your consumption and protecting the wealth for your own and your children’s futures? There is another option, though: immediate investment in yourself, say by enrolling at Harvard for an MBA. This way you not only boost your personal future income, but more educated parents tend to have more educated (and healthier and connected) children, thus boosting the prospects of future generations.

This third option, in a nutshell, is what three new papers in the Journal of African Economies suggest for developing countries that have jumped on the Sovereign Wealth Fund-bandwagon. Sovereign wealth funds (or SWFs) are state-owned investment funds designed to preserve the high returns from non-renewable resources, like oil, for future generations. A quarter of the world’s economies still depend on non-renewable resources, and more than half of them now have some type of SWF, including many recently established funds in Africa: consider, for example, Ghana (2011), Angola (2012), Nigeria (2012) and Senegal (2012). Others, like Kenya, Tanzania and Mozambique, are finalising SWF policies. And these funds matter: Sovereign Wealth Funds are a quarter of Algeria’s GDP, 40% of Botswana’s GDP and over 100% of Libya’s GDP.

There is good reason for the turn to this type of investment fund. SWF have many good properties, as the experience of Norway since 1990 have shown. It converts temporary resource revenue into a permanent investment income. Best to keep it offshore, too, so as to avoid domestic inflation, real exchange rate appreciation and the contraction of other traded sectors (also known as Dutch disease). And why invest locally when all profitable investment opportunities would presumably have been financed already at the world interest rate if the capital account is open? For these theoretical reasons, and because of the practical successes of SWF across the world – Norway, Chile, Saudi Arabia – many African countries followed suit.

But the authors of the three Journal of African Economies papers question this logic. They argue that many African countries do not have open capital accounts, meaning that there are still many profitable opportunities to invest within Africa. Why then send precious investment funds abroad when the highest returns can be reaped locally? To return to our earlier metaphor, why invest your long-lost family member’s bequest in stocks on the JSE, when you don’t even have a high school education yet. Invest in yourself first!

In Africa, the focus should be on infrastructure. One set of authors, Rabah Arezki and Amadou Sy, argue for three stages of financing infrastructure with the help of SWFs: First, involve development banks, who are often more informed about viable investment projects, in the first phase of large projects that are often the riskiest. Second, offload more mature projects to arms-length institutional investors like SWFs. Third, develop an African bond market to facilitate this offloading.

The maintenance of infrastructure in Africa is of particular concern, and SWFs can play a role here. Arezki and Sy calculate that at least one-third of Africa’s investment needs are in maintenance, and suggest bundling construction and maintenance services in private-public partnerships as one way to overcome this (by making sure builders have an incentive to minimise maintenance costs).

South Africa does not have a SWF, although the idea of a supertax on mining profits has been mooted before. If we did decide to go this route, as many of our neighbours seem to do, the question becomes: who gets to choose how the funds are spent? Anthony Venables and Samuel Wills, another set of authors, argue that it should be done through the usual budgetary process; in South Africa’s case, that will be through Treasury. Another author, Joe Amoako-Tuffour, argues instead for a more independent SWF that take direct positions in investments. Whatever strategy is followed, it is important to remember an additional reason for Sovereign Wealth Funds: to minimise the misuse of resource rents by politicians.

There is no better example of this than the second smallest nation in the world: the Pacific island of Nauru with a population of 10000. In their paper, Samuel Wills, Lemma Senbet and Witness Simbanegavi note how the island, made almost entirely of phosphate, was the richest country in the world in the 1960s. Two-thirds of the phosphate revenues were invested in a Trust, which peaked at $100 000 per person. In 2004, after some questionable investment decisions that included a cruise ship that never left port and a Lamborghini for the police chief (to drive on an island of 21km2), the fund had only $3000 per person left.

The lesson is that we do not live in a world of benevolent dictators. Politicians make bad decisions often, and state-owned investment fund should be structured to avoid their misuse. But going to the extreme and parking all resource returns offshore is also not the answer for many African countries. Investing in local infrastructure and its maintenance may provide far higher returns for future generations – if the possibility of misuse can be curtailed.

*An edited version of this first appeared in Finweek magazine of 8 September.

Written by Johan Fourie

October 4, 2016 at 10:20

What you need to know about South African exporters

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One of the most profound (and often most difficult to teach) insights in economics is the idea that trade is not a zero-sum game. Just as my salary allow me to purchase all the things I cannot (or don’t want to) produce on my own, so do our exports (of the things we are good at) allow us to buy imports (of the things we are not good at). We do not work simply to accumulate a salary; we work because it allows us to buy nice things.

In other words, we are not mercantilists. A mercantilist hopes to export as much as possible and restrict imports. A large, positive trade balance, they believe, will ‘make a nation rich’. Not so. Mercantilism is not why England experienced an Industrial Revolution, and it is not why Africa will grow rich. Having more exports than imports over the long-run simply means that a country’s citizens are not reaping the fruits of their labour. To return to the earlier metaphor: it’s like earning a salary but not being allowed to purchase anything with it.

It’s easy to sell mercantilist ideas, though. Here is Mr Wilmot in the Legislative Council of the Cape Colony in August 1891: ‘Let us be wise in time, and really patriotic, grow our food, encourage our own industries…’. Or Mr Merriman in the same debate: ‘The best form of Protection was for everybody to set to and buy as much as they could in the Colony. (Hear, hear.)’ Or Mr Van den Heever: ‘The question was to keep, through fostering Colonial industries, the money in the Colony’.

You don’t need to go too far to find similar sentiments in contemporary debates. The clothing and textile industry recently held an Imbizo to discuss ways to grow the industry. Some of the comments on news websites reporting this story summarise the sentiment I often find in my classes too: ‘Chinese imports killed the textile industry in South Africa’, ‘You forget the greedy retailers preferring the cheapest suppliers’, ‘All we need is a 90% buy local campaign’, ‘With a bit of good will and assistance in the form of import restrictions we would all benefit. Jobs, better quality and some pride in the achievement would do all of us some good!’.

Again, not true. Aside from the small detail that the industry has received support since the 1930s, long before China was a competitive force, we should rather export what we are good at, and import the cheap goods which we aren’t relatively good at. (Also, Chinese clothes are becoming increasingly expensive as Chinese wages increase. We are increasingly importing clothes from other parts of Asia, and Africa.)

But how do we do this? Two recent UNU-Wider working papers by South Africa’s foremost trade economists help to answer exactly this question. The first, by a team of economists from North-West University and Stellenbosch University, use a new firm-level dataset of South African manufacturers to understand exporting firms better. They report five key findings: 1) Export participation is rare – only 19% of South African firms export. 2) Exporters are systematically different to non-exporting firms – they are larger, more labour productive, pay higher wages, and are more capital and intermediate-input intensive than non-exports. I will lump all these things together and just say they are ‘better’. 3) Firms that export to multiple destinations and across multiple product lines are ‘better’ across all the dimensions listed above. 4) Exporters to countries outside Africa are ‘better’ across the same dimensions than exporters to countries within Africa. 5) Firms that already export are most likely to grow the total value of exports than new entrants.

The second paper, by researchers at the University of Cape Town and the University of Bari in Italy, use similar data to show that the most productive South African firms are the ones that both import and export. Importing from advanced economies especially makes local firms more productive, and more likely to export at greater scale, scope and value. The authors argue that access for domestic firms to a variety of intermediate inputs from abroad can be crucial to raising local employment and gaining access to new technologies.

The takeaway: South Africa’s exporters need imports to be competitive. We can only grow our local exporting firms by giving them access to the cheapest inputs and the best technologies, and these are often found outside South Africa. Much like our 19th-century ancestors, our zest to expand exports will only inflict harm if we adhere to the mercantilist sentiment by restricting imports.

*An edited version of this first appeared in Finweek magazine of 14 July.

Written by Johan Fourie

August 11, 2016 at 09:13

How technology will shape Africa’s future

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Much has been said about the economic future of sub-Saharan Africa. One camp is largely optimistic, claiming that the relatively high economic growth rates of the last decade (even during and after a global financial crisis) is evidence of ‘Africa rising’, a continent slowly emerging from three decades of slumber. Another camp is less optimistic, claiming that this growth was limited to natural resource industries benefiting from rapid Chinese growth. (To put Chinese growth in perspective: even though China grew at ‘only’ 6.9% in 2015, it added $714 billion to its GDP. In contrast, South Africa’s GDP in 2014 was $350 billion. In other words, China added more than two South Africas to the global economy in 2015 alone.)

Both camps, of course, have elements of the truth. Many African countries, some of them very poor, have seen high economic growth rates over the past few years, growth that was and remain essential in lifting many thousands of people out of poverty. But it is also true that much of this growth has been limited to resource sectors that do not have the same spill-overs into other parts of the economy that manufacturing, for example, has. This raises doubts about its sustainability.

In April, the United Nations Economic Commission for Africa published a new report that clearly sides with the more cautious view. African countries are stuck in low-productivity, primary sector exports; the fall in the price of commodities, like oil in the past 18 months, has swelled budget deficits in places like Sudan, Nigeria and Angola. It is likely to have political consequences too.

To combat such vulnerability, the authors advocate ‘smart’ industrial policies to ‘upgrade’ the commodity sectors and promote the ‘development of higher-productivity sectors, especially manufacturing but also some high-end services’. They acknowledge that there are two trends working against such industrial policy action. First, a shrinkage of the ‘policy space’ due to the establishment of the WTO and the proliferation of bilateral and regional trade agreements. Simply put, countries have less scope for raising tariffs or other creative industrial measures than before. Second, the strengthening of global value chains makes ‘nationalistic’ industrial policy less effective. But this does not deter them: ‘There are still many industrial policy measures that can be used. Moreover, if anything, these changes have made it even more necessary for developing country industrial policy-makers to be ‘smart’ about devising development strategy and designing industrial policy measures.’

So what are these so-called ‘smart’ industrial policies? Unfortunately, after spending 156 pages explaining the need for ‘smart’ policies, the authors give us only one page of very vague principles: policy-makers ‘need to identify the ‘right’ policies’; policy-makers ‘need to induce foreign firms to create linkages with the domestic economy’; and policy-makers ‘should pay attention to the possibility of upgrading not just through the development of capabilities to physically produce goods but also through the development of producer services, such as design, marketing, and branding’. So much for practical guidelines!

The authors have missed a golden opportunity to actually think more creatively about Africa’s economic future. Technology is changing Africa’s comparative advantage. Global manufacturing will become increasingly capital intensive as robotics and technologies like 3D-printing (not mentioned once in the report) advance. What we consider low-skilled labour-intensive manufacturing (shoe-making, for example) may, overnight, become high-skilled, capital-intensive (once shoes can be printed), with production switching from countries like Vietnam and Bangladesh back to the developed world. Cheap labour will become less of an advantage as robotics becomes more affordable.

An additional factor that makes manufacturing in Africa so expensive is trade costs. We have few large cities on the coasts with easily accessible port facilities. How can landlocked Zambia compete with similar-sized Cambodia? Zambia has a railroad that goes through two other countries before it reaches the eastern coast of Africa; Cambodia’s capital has a river port that can receive 8000-ton ships. And statistics confirm this: the World Bank calculates that the cost to import a 20-foot container to Cambodia is $930. It is $7060 in Zambia. It is difficult to see how any ‘smart’ industrial policy can mitigate these massive cost differences.

Does this mean Africa is doomed to remain a primary good exporter? Not necessarily. Mobile technology is revolutionising the way Africans do business. It is a technology that negates Africa’s rugged terrain, leapfrogging the need for expensive fixed-line infrastructure. If it can receive the necessary investment, broadband and wireless technologies will do the same. This will allow Africans to provide services to a world that would have been impossible to reach only a decade earlier.

Can services alone propel Africa into the industrialised world? Apart from a few small economies – Singapore and Luxembourg – there is little past evidence that it can. A pessimist may thus proclaim little hope for the continent; an optimist may instead remember that technological innovation has a way to revolutionise existing industries. It is already happening: consider the much higher returns of Ugandan farmers after mobile technology allowed them access to real-time market prices for their goods. Or how Airbnb has empowered middle-income South Africans with a spare room to benefit from the country’s thriving tourism industry. Or how renewable technologies – also completely neglected in the UN report – will affect African countries’ power generation and distribution capabilities, supplanting the need for coal and other minerals.

What is clear is that the image of factories with thousands of low-skilled labourers working 8 to 5 jobs belongs to a previous century. To imagine that industrial policy can somehow transplant that image to Africa in the twenty-first century is fictional. The smartest industrial policy we can hope for is instead a belief that Africans have the agency to shape their own destiny, as long as they have access to the hard (fast and affordable internet and reliable electricity) and soft (IT colleges and programming degrees) infrastructure that will allow them to benefit from the technologies of the future.

*An edited version of this first appeared in Finweek magazine of 2 June.

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.