Changing paradigm on economic policy

Fashions change in economics. From the 1950s to the 70s, inward orientation of economic development and trade was in vogue, associated with concepts of ‘industrial policy’ and ‘protectionism’. From the 1980s, outward orientation became the fashion in economics and in governments’ policies. With the Washington Consensus, industrial policy and protectionism became bad words. Barriers to flows of trade and finance across national boundaries had to be reduced. The ‘invisible hand’ of the market, not government policies, would produce welfare. However now Government leaders, even in US and Britain who were cheer-leaders of the Washington Consensus, are being pressed to answer to citizens who feel they have been left behind.  

Thomas Kuhn explained, in The Structures of Scientific Revolutions, how ‘paradigms’ of thought form in scientific communities. Once established, a paradigm is difficult to change. Its high priests are placed on pedestals in society. They resist the emergence of a new paradigm because they will lose respect and power. When new data emerges, they interpret it to support their paradigm, or they suppress it. For example, evidence that the earth goes around the sun, rather than the sun around the earth, was suppressed by religious leaders, and by the scientists close to them, who were champions of the old theory. 

Dani Rodrik analyses the waves in economics in Diagnostics Before Prescription (Journal of Economics, Vol. 24, No. 3, Summer 2010). He points out that economists often interpret data to fit their ideologies. For example, Taiwan, a very successful early industrialiser after World War II, is held up as an archetypical outward-oriented country, contrasted with Mexico as a leading case of import substitution policies gone wrong. Looking at the evidence more closely, Rodrik shows that effective rates of protection in manufacturing were higher in Taiwan than in Mexico. Moreover, there was also greater variation in effective rates of protection across activities in Taiwan. Thus, Taiwan was more protectionist than Mexico!

If ideas in vogue are hard to change in physics, where objectivity is easier, they are much harder to change in economics where ideas spill into politics, even causing political revolutions, as Marx’s ideas did. In economics, ideas are unlikely to be changed merely by quantitative proofs. Political forces have propelled changes in trade and economic theories in the last century. Ideas of a ‘social state’ responsible for the welfare of all citizens grew after the Second War, to rebuild many economies ravaged by war, and also as political protection against the rise of communism. With the decline of the Soviet Union in the 1980s, the US dominated international politics. The free-market, pro-business, and anti-government ideologies of the Chicago school of economics, combined with the increasing power of corporate lobbies, and suppression of labour unions by Thatcher and Reagan, created the Washington Consensus--a powerful coalition of ideas with strong political power. In trade, GATT, which had a global welfare orientation, and which gave space to countries to shape their domestic policies, morphed into the WTO, with its focus on increasing global economic growth by imposing uniform trade rules and giving more freedom to the private sector too.  

Rodrik points to the significant role played by US-trained economists in Latin American countries in shaping the Washington Consensus. They moved back and forth with changing domestic political tides, between roles in their governments and positions in the World Bank, IMF, and US universities. They gave substantial ‘soft’ power to promote the Washington Consensus ideologies within their countries. In India too, Mitu Sengupta explains, in From ‘Hard Sell’ to ‘Soft Sell’: the IMF, World Bank and Indian Liberalization (World Affairs, Vol. 14 No.1, Spring 2010), a similar process of revolving doors, since the 1980s, between the Indian government and international financial institutions in the US, built a caucus of economists in India aligned with the Washington Consensus. The influence of these economists caused India to concede domestic policy space to support WTO more than was necessary, which crimped the growth of Indian manufacturing compared with China, which did not bend its domestic policies, and which nurtured its manufacturing industries. 

Trade is an instrument. The over-arching goal of a society should determine how trade must be regulated. If the over-arching goal of humanity is to increase the size of the global economic pie, all barriers to trade must be removed. Each country should produce only what it can produce most competitively and buy from others what it cannot. Thus, on a global basis, economic resources will be most productively used, and the global pie will be larger. This suits those who can benefit from growth wherever it takes place: that is those with financial resources they can move around. However, if the goal is to improve global welfare, then governments must have freedom to make policies that improve their citizens’ welfare. Citizens who have no capital and only their labour as a resource cannot migrate easily to wherever growth is happening. Therefore, governments have to promote domestic livelihoods even if this is not most efficient from a global growth perspective. 

The welfare argument is not an anti-trade argument. More trade can benefit all countries. However, it must, most of all, benefit those who need a lift the most, i.e. those deprived of opportunities so far. The economic paradigm of providing incentives to the rich to grow richer (and thus to grow the global pie), and then hoping that trickle down will happen equally fast, has not worked. Therefore, a change in the economic paradigm is in the air along with political changes in many countries. Free trade dogmatists who have been on policy pedestals must give way to other economists who give primacy to social welfare and environmental sustainability. 

(The writer is a former member of the Planning Commission and author of the recently released book “Listening For Well-Being: Conversations with People Not Like Us”)