Thursday, August 24, 2006

No Quick Fix from Partially Free Markets

If you want markets to work ,you have to clear away obstructions to them working freely. This has costs, some unpaletable politically. If you cannot meet those costs (and few countries have been prepared to do so) then it takes longer to achieve the gains from marketing working freely. That is the road almost all countries have taken. Smith noted that if perfect liberty was a precondition for progress towards opulence, no countries would ever have progressed at all (he was never a fanatic).

It follows that if you choose, as most do, not to interfere with obstacles to free markets, for whatever reasons you do so (and in many cases you have no choice but to leave the obstacles operating), you cannot expect speedy results over a generation, and certainly not within the life of a government, including totalitarian self-appointed for life governments of the kind presently occupying seats at the United Nations.

If you expect speedy results from partially free markets, you will be disappointed. This does not justify blaming markets for not working when you prefer not to let them work.

Sumati Mehta, writing in the Financial Express, Bombay, in an article entitled “Reorienting India’s Development Strategy” observes the following:

Prior to 1980, India’s development strategy was characterised by a heavy emphasis on the public sector, investment and import licensing and significant protection for labour. However, from the early 1980s, there were pro-business reforms which accelerated in the early 1990s. These included, inter alia, the abolition of industrial licensing, narrowing the scope of public sector monopolies, sweeping trade liberalisation and reduction of non-tariff trade barriers. The present decade has seen a continuation of the same strategy, based on the belief that the free market approach would enable Adam Smith’s invisible hand to operate and the benefits of higher growth to automatically trickle down. This has not happened to the extent expected. How should the strategy, therefore, be modified?”

Her first part on events post-1980 (thirty years after political Independence; which left an as yet unresolved legacy of national animosity towards and from Pakistan), with its fairly timid reforms in the industrial business sector, later speeded up after 1990, has not yet gone far enough. The danger is that India changes tack again and fails to complete the market conditions it has been trying to repair since its quasi-Soviet style socialism proved incapable of achieving its goals.

This is suggested in her semi-mocking reference to the failure to ‘enable Adam Smith’s invisible hand’ to operate. Not surprising that such a notion failed: there never was any invisible hand to operate. The myth that there was an invisible hand has become the prime alibi for failing to tackle the conditions that are the real obstacles to economic progress in countries like India and elsewhere. Sumati Mehta does not mention them, and I presume few others do in India.

I have mentioned the national animosity between India and Pakistan, to which we could add the growing sense of commercial rivalry between India and China, which could tip over into national animosity and jealousy too, both of which are conditions inhibiting markets from working. She does mention India’s ‘labour laws need reform because inflexibility in labour markets has led to use of capital-intensive methods’ (the latter a permanent possibility where other countries demonstrate the superiority of capital-intensive goods – no, do not prohibit their import into India!). But labour reforms are definitely needed, as are reforms away from interference in markets for political, religious, and superstitious reasons.

As bad, she seems to place a great reliance on ‘strategies’ being introduced. No wonder she is disappointed with those they have tried already. She writes:

The shift has taken place directly away from agriculture, and in favour of services, without the intermediate transition to the industrial sector. This fact, would not in itself be a cause for concern if high growth rates had also been accompanied by adequate employment generation. Since this did not happen, there is reason to believe that by-passing growth in the industrial sector may not be the best option.”

This is a familiar concern to students of Wealth of Nations, in which Smith noted the failure of the reviving commerce in 16th to 18th century Europe (following its thousand-year interregnum after the Fall of Rome in 476) to follow the ‘natural’ progression from agriculture. Instead, manufacturing followed the ‘unnatural’ path of leaping over an incomplete improvement that should have thoroughly developed agriculture, much of it still barely emerged from a Feudal land structure, to the rapid development of manufacturing, allied to technology. In the 19th century this process led to industrialisation.

India, according to Sumati Mehta is doing something similar by leaping over manufacturing to services. She hints, menacingly, of a strategy (read legislation and compulsion) to prevent or reverse this process. Britain had a period of economic lunacy along the same lines leading to Labour’s ‘Selective Employment Tax’ in the 1960s, aimed at discouraging services in favour of manufacturing. It failed, spectacularly. Should India adopt a similar strategy (the London School of Economics has a lot to answer for!) it too will fail, at great expense for no gain.
If you want employment gains, encourage by not interfering in, markets. They work without mystical invisible hands. Smith explained why. It’s only the epigones who misread, or didn’t read’, his books who get this wrong.


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