Trade and the state
By Shahid Javed Burki
Tuesday, 11 Aug, 2009
IN the article today I will discuss the role of the state in economic management and how this relates to the making of trade policy. It is important to develop this understanding in order to fully comprehend what the government is attempting to accomplish in the important area of international trade.
Economists since the days of Adam Smith and David Ricardo, the pioneers of the discipline, have believed in the rationality of the individual. They argued that each person behaves in a way that is in his or her own best interest. They also thought, naively it would now seem, that when these individual actions came together the larger interest of the community and society would be well served.
Some called it the social utility of greed. However, it took a while before economists journeyed from the micro to the macro, from the behaviour of individuals and firms to that of the entire economy. The term ‘macroeconomics’ first appeared in 1945. It was coined by Jacob Marschak to explain how national economies worked. Much of his work was based on that of John Maynard Keynes who, a decade earlier, had questioned the rationality assumption as applied to both individuals and markets.
But some of the work done by Keynes and his followers was forgotten once mathematics invaded the domain of economics. Rationality was easy to model mathematically; irrationality less so. This line of thinking and this way of doing economic work eventually led to the development of the ‘efficient markets hypothesis’ or the EMH in the jargon of economists. In 1978, Michael Jerden, the American economist boldly declared that “there is no other proposition in economics which has more solid empirical evidence supporting it than the EMH”.
An important byproduct of this way of theorising was the reduction of the role of the state in the making of economic policy. A belief developed that individuals, firms and markets should be left to their own devices, allowed to do what was best for them. What will result from this will be good not only for components of the economy but also for the economy as a whole. This was an attractive way of thinking and also elegant since it could be embedded in sophisticated economic models.
Such an approach was attractive for what I would call lazy governments — governments that did not have the intellectual equipment or political pressure to use public policy to guide the workings of firms and markets or the behaviour of individuals.
There were many areas of economic activity where the governments could and should have intervened but chose not to do so since economic theories supported a stand-off approach. Trade was one such area. Activist governments in East Asia took a deep interest in trade, in particular international trade, but lazy governments largely stayed away from this area. Some of these were in South Asia. Pakistan was one such country where the governments chose to do little to influence the content of exports and the direction in which they were sent.
But economies are like complicated living organisms. What happens in one part of the body can have a deep impact on other parts. Even weak and lazy governments make fiscal policy and what they do with the structure of taxes deeply affects the pattern of trade. Export promotion may not become an important objective of government policy but whether a country creates an important space for itself depends to some extent on fiscal policy. In East Asia, for instance, by combining tax policy with some direct interventions, the state was able to create an impressive amount of space in the global markets for domestic producers.
Some other areas of public policymaking also influenced the pattern of trade and its importance for the economy at large. Industrial policy was one such government endeavour that had important consequences for what a country did in international trade. Lazy governments produce lazy economic actors. It is easier to continue to support the established order through tax and industrial policies. Doing anything different meant exposing economic actors and governments to risk. Innovation can produce attractive returns for those who succeed and for the economy as a whole but the road to success is often paved with failures. This is one reason why lazy governments prefer the status quo.
If the state is to get actively involved in promoting trade what is it that should be done? A good trade policy has at least four components. It must be based on a good understanding of the international marketplace. There are profound changes occurring in the way countries trade, the products they produce and the relationships they develop with other nations. Understanding all this requires careful analysis and production of current data and information on many aspects of international trade.
Second, the state must be aware of what the economy is capable of producing. If there are opportunities available in the international marketplace, can they be successfully exploited by firms engaged in production and marketing? If there are major gaps between opportunities and capabilities what kind of tax and industrial and other policies could be adopted to bridge them?
Third, to be effective, the making of public policy must not be jerky. This means that the various actors in the economy must familiarise themselves with the public policy milieu in which they are operating. Once a broad framework has been established, changes in public policy must be at the margin.
Fourth, there should be broad public support for the approach being adopted. Economic policies work well when citizens have some say in their formulation, when they are understood by the citizenry and when citizens have the means to watch over their implementation.
The new trade policy has met some but not all of these objectives. I will return to this subject in a later article.