The G-8/G-20 summits came and went, the communiqués have been issued and the idea of unfettered free trade was lauded as if there were no rival ideas and no other options to consider. Also, before going to the summits Mr. Geithner who is the US Secretary of the Treasury and Mr. Summers who is the Director of the National Economic Council seemed to support the idea of limitless free trade in an article they published jointly under the title: “Our Agenda for the G-20” in the Wall Street Journal on June 23, 2010 without expressing a hint of critique for it. Well, free trade is a good thing to have but in the same way that too much of a good thing can be a bad thing if allowed to run amok and if we fail to curtail its excesses, so can unfettered free trade. Maybe this says the time has come to consider holding back, if only a little, the horses of export. I elaborate on this point in this article and I offer alternative ideas in the next article.
Mathematical formulas, otherwise known as equations, are a wonderful tool in the hands of those who engage in science and engineering because, no matter which field you dabble in, they express the exactness for which Newtonian physics is renowned if you are allowed to ignore the relativistic variances that intrude under some conditions. Equations can also be a wonderful tool in the hands of those who engage in the humanities where mathematics can play a role such as the pseudo-science of economics as it is sometimes called. The problem with the humanities, however, is that human beings are complex creatures and this makes them unpredictable. When you inject their behavior into a formula you automatically make assumptions that can vary in exactness from being totally correct to being completely false. In effect then, implicit in the equations that deal with the humanities is the reality that an element of probability exists in them even if no term to express it is inserted in the equation. As a result, the final answer may be absolutely exact or totally erroneous or something in-between which means that, in many instances, the answer will be of no use to anyone although no one will know it at the time.
Take for example the formula for the Gross Domestic Product of nations. It says that GDP is equal to Consumption plus Investment plus Government Expenditure plus Export minus Import. It is written in mathematical form as follows:
GDP = C + I + G + X - M
If you try to use this equation to make a prediction or an economic decision for a country, you need to be honest with yourself and keep in mind at all time that you will fall on the spectrum between being totally wrong and absolutely correct. In fact, being wrong is what happened to many poor countries when, in response to an apparent success by a few of them, the remainder rushed to try and duplicate the success. What gave impetus to the rush was the fact that there seemed to be a surefire mathematical indicator to guide the few that succeeded; the indicator being none other than the famous GDP equation. It all started when the economic Tigers of Asia in the decades of the Nineteen Seventies and Nineteen Eighties triggered a rush among the poor nations many of which rushed without giving the matter much thought. Some of these nations decided to do so on their own and some did it because they were encouraged by the World Bank, the IMF and the private lenders who came from the rich countries to lend money to the poor countries or to start a business in them. The tragedy was that in the end, the result proved to be disastrous in many of the cases. Indeed, we had since then the Latin American crisis, the Asian crisis, the Eastern European crisis and the Euro-Peripheral crisis.
What actually happened was that many poor countries were deceived by the success they saw in Taiwan, Hong Kong, South Korea and a couple of other places where the nations became industrialized and wealthy, and did so at the proverbial speed of light. That is, the GDP of those countries grew at an astonishing rate while the explanation bandied about was to the effect that export was fueling the growth. In fact, there seemed to be a competition among the writers of books and articles as to who will extol the virtues of export more than the other. It was dizzying trying to keep up with all these authors. The poorer countries heard the talk, they red the books and the articles, they looked at the formula for GDP and they saw that yes, the formula says GDP grows in relation to the growth in export. And they all went banana about the need to export. They set out to export their commodities which ranged from bananas to copper to all sorts of natural resources, and they began to manufacture the kind of goods that can be exported. By coincidence, these were the goods which were made inside the factories that the foreign investors brought to the country for the specific purpose of exporting their goods. And all these activities meant that the poor countries needed to borrow from abroad so as to upgrade their manufacturing facilities and shipping networks. And borrow they did like there was no tomorrow.
At first, it looked like the poor countries were getting rich the way that Taiwan, Hong Kong and South Korea did. But then several crises hit in sequence whereupon it became clear that the apparent growth in the poor countries was a phony one and that it did not resemble the growth enjoyed by the Asian Tigers. How did this happen? Well, two things happened. First, while the GDP equation is correct in the sense that you can use it at the end of the year to tell what has transpired throughout the year, it is incomplete therefore useless when it comes to making predictions because (a) it does not contain a term for the random effect caused by the human element and (b) it is not a one size fits all proposition. Second, the belief that export was a major factor in fueling the growth of the Tiger economies turned out to be a fallacy.
Let us look at the equation again:
GDP = C + I + G + X - M
As can be seen, there exist at the beginning of the equation the terms C and I (consumption and investment) that compete for the same pool of money which is the wealth created in a country during the year. How to apportion this money? Well, if the country is extremely poor to begin with and the people live at near starvation levels, they will at the start of their industrialization favor consumption over investment until such time they feel they are doing well enough to set aside some of their income for investment. But if the country is already advanced to some degree and getting wealthier, the likelihood is that the people will increase their investment at the same time as they increase their consumption. And because all of this will vary from culture to culture, no term can be added to the GDP equation to which a value can be assigned that will work for every country at every moment of its development and determine how the money will be apportioned. Still, predictions will be made by economists who will rely on their gut feeling to say that on the one hand this thing may or may not happen; on the other hand that thing may or may not happen. And they will more or less be correct some of the time but not all of the time. See how exact and how helpful this is!
Next, you have in the equation the term G which stands for government expenditure; the government being that massive institution which competes with the private sector for funds. In fact, the government takes in a share of the money that could be fueling consumption and investment. Depending on the political orientation of the government and what the public is clamoring for at any given time, the G may be large or it may be small, and this will dictate how much borrowing the government will do on the local market and abroad. But like everyone else, when the government borrows, it is obliged to pay back the principal and the interest. In the case of money borrowed on foreign markets, paying it back is considered an outflow of money having the same effect as the negative term (-M) in the equation which is the opposite of export. And this will add to the randomness of the equation's result. Moreover, the changing ratio between the inflow and the outflow of money will affect the exchange rate of the local currency thus render the result even more random. By now you will need an economist with four hands to explain it all to you.
Finally, if the aim is to increase export (the X in the equation) you may have to import raw materials, machinery and the services of experts from abroad to produce goods with a high enough quality that you can export them. This will increase the size of the negative (-M) in the equation and offset the value of the exports. Depending on how much you need to import, the danger will be that you could overwhelm the exports and thus frustrate your vision of growing the GDP by increasing the exports. And running out of foreign reserves due to an imbalance between the imports and the exports is one of the troubles that have plagued the countries of Latin America and Asia when they rushed to industrialize without doing enough planning. In short, to rely on export alone and treat it as a one size fits all method for success will not do the trick.
So then, how did Taiwan, Hong Kong and South Korea do it? The short answer is that politics did it for them. This is how the drama unfolded: The Cold War was raging between the Capitalists and the Communists in the decades before the fall of Communism, and by the luck of the draw the three Asian countries became the beneficiaries of that war. America poured its heart and soul into South Korea and Taiwan to show North Korea and Mainland China it had a better system than the Soviet Union. And Britain participated in the effort by doing the same thing in Hong Kong. To this end, America and Britain did more than encourage their business people to invest in the three would-be Tigers; they instructed them to invest without exploiting the locals there by too much. The two Western governments explained to their people that the aim was to prop up the Asian countries so as to make showcases of them, showcases that will look so attractive, they will help win the public relation campaign and defeat the communists by winning the hearts and minds of their people. And the incentive that the governments gave to their businesses was to explain to them that the plan will result in the opening of China, North Korea and the entire communist empire to Capitalism and to Western business people – the people who were listening to the talk.
The two governments themselves transferred large sums of money to the Asian countries under the guise of procuring military and civilian goods and services. They also had bases in those countries for which they paid rent; and they had troops stationed in them that transacted in hard currencies. In addition, the US and Britain played a role in the construction of the infrastructure upon which rose the magnificent skylines of the cities that were meant to impress the communist visitors and did so brilliantly. And there were government-to-government programs by which the Western institutions of higher learning educated and trained the Asian students both in their home countries and in the West.
It was this earnest effort to improve the lot of those countries and not the export activities per se that did it for them. It can be said that the Asian Tigers were treated as offshore provinces of the capitalist countries not economic colonies waiting to be exploited for their resources and their cheap labor. The building of the hard infrastructure in terms of physical plants, the building of the soft infrastructure in terms of the transfer of knowledge and the restructuring of the institutions were the moves that made the advancement of the Asian tigers an authentic one therefore a durable one. And thanks to these moves, even the exports were made to serve a useful purpose in that they contributed to the progress of the Tiger economies by bringing in the hard currencies. It happened because the benefits that normally accrue from export were made to flow to all of society and not allowed to be pocketed by the foreign investors or the few locals who were in charge. The end result was that without suffering a crisis that was serious enough to hold them back or disintegrate them, the Tigers were able to increase their GDP and become so wealthy as to catch up with the advanced nations and move alongside them at the leading edge of progress where they still shine.
And the question now is how to translate these ideas into a program that will help the current crop of developing nations follow in the footsteps of the Asian Tigers. This will be discussed in the upcoming article.