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Tuesday, January 17, 2006

Vested Interests and Economic Development

Martin Wolf summarizes The Power of Productivity: Wealth, Poverty and the Threat to Global Stability by William Lewis. He makes a good point about developing economies. For capitalism to live up to its promises, the assumptions behind those promises must be satisfied.  If competition is suppressed by special interests, then development will be thwarted:

Overthrowing the tyranny of vested interests, by Martin Wolf, Commentary, Financial Times:  Why are some countries rich and many others so poor? Why has it proved so difficult for those mired in poverty to catch up with the prosperous? These are the most important questions in economics. Adam Smith addressed them. Many have followed in his footsteps. Few, however, have recently done so with more insight than William Lewis, founding director of the McKinsey Global Institute. His answer would have pleased the author of The Wealth of Nations: remorseless, pervasive, fair and open competition. ...

Investors are ... desperately seeking opportunities for profitable investment across the globe. Yet they cannot find them in many countries where existing producers are grotesquely inefficient. How can this be? The answer is that the people with power – incumbent businesses, corrupt bureaucrats and politicians, possessors of sinecures, protected workers in formal employment and beneficiaries of government subsidies – combine to oppose the competition that would force uncomfortable economic changes. Anti-market intellectuals also laud this recalcitrance. The result is a pervasive bias against competition.

Mr Lewis and his colleagues were able to demonstrate the significance of competition ... by ... linking microeconomics to the overall macroeconomic outcomes ... So, what are the chief conclusions? First, ... the development effort of the last half-century has largely failed. Second, two and only two successful routes to development have been discovered: the high productivity, low input-intensity path of the US and the low productivity, high input-intensity path of Japan and South Korea (see chart)...

Third, huge numbers of workers produce services or work in construction, even in developing countries. Thus, the productivity of these industries plays a big part in determining overall output per person. ... Fourth, neither education or lack of capital is a binding constraint on productivity. Illiterate Mexican workers reach world-class productivity levels in building houses in Houston. Similarly, Toyota has succeeded in raising productivity to close to Japanese levels in its plants around the world. ... Finally, undistorted competition in product markets is the most important long-run determinant of productivity and so prosperity. Competition is how the more productive companies win out. ...

It is in developing countries ... that competition is most systematically thwarted. Just read the chapters on Brazil, Russia and India and weep. In many developing countries ... legitimate companies compete with businesses that pay no taxes, ignore regulations and steal intellectual property. ... Big government, which is also almost always interfering and corrupt in poor countries, is a curse.

What is to be done? ... Policymakers need to understand that the aim of policy must not be to nurture specific producers, but to promote the interests of consumers and, so, competition. Openness to the world economy matters most for this reason. International competition explains, for example, why the export sectors of Japan and South Korea are so productive, while the rest of their economies are not.

Unfortunately, what is required is also a revolt against the conspiracy of predatory vested interests. Almost everybody would be better off, and quite quickly, if these interests could be disarmed simultaneously. But this is always hard to achieve. In a democracy with well-entrenched interest-group politics, it is almost impossible. ...

Free and fair competition sounds simple to achieve. Nothing is further from the truth: competition upsets intellectuals who glory in the notion of state benevolence, bureaucrats who administer government programmes, businesses that receive state favours and, in short, all those who gain, directly or indirectly, from distortions. Competition benefits often-despised outsiders against those who are well-connected and entrenched. It also requires the courts and government to work honestly. The surprise may rather be that some countries became rich than that so many are poor. ...

There is a debate about market-based versus directed paths to development that can wait for another day. With the focus on distribution lately in the U.S. and questions about why worker income has stalled in this recovery, this quote caught my eye: "distorting competition ... is a damaging route to cherished distributional goals." The article is intended as a guide for developing countries, but it applies to developed economies too. It is not just any market, it is competitive markets that produce the desired gains and reward factors of production according to their productivity. Those who promote markets above all else sometimes forget that not all markets have this feature.

With globalization, has there been a net shift in market power away from workers and towards owners of capital that might explain some of the shift in the income distribution in recent years? Is the shift in power reflected in tax and other recent legislation? I'm not sure how much of the change in income distribution shifts in market power can explain, but it's something to think about.

    Posted by on Tuesday, January 17, 2006 at 06:33 PM in Economics, Market Failure | Permalink  TrackBack (0)  Comments (6)

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