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Horses for courses

June 14, 2012

I have long thought that the smallperipheralised economies in which I do most of my work require a specific approach, one that isn’t provided by conventional economics. The economic world is so varied that it is difficult to analyse almost anything from a pre-defined blueprint. First principles are of course possible, but they shouldn’t involve a methodology so specific as to be only capable of producing a narrow range of results. This is what happened under the Washington Consensus. The man who coined the phrase, John Williamson, in 1989 drew up a list of 10 policies which he thought that most countries should follow: cutting budget deficits and lowering public expenditure; lowering taxes; liberalising financial markets and the exchange rate; reducing import tariffs; abolishing barriers to foreign direct investment; privatisation; and fostering competition. In  most places it didn’t work.

This may not just be a matter of whether you are Keynesian or neoclassical. It just might not be possible, for example, to model Brazilian and Tuvaluan trade in remotely the same way. The sort of economics required to study the US stock market is far removed from the kind needed for looking at the communal, subsistence societies of many poor, rural communities in the developing world. One is individuated, atomised and behaves according to certain well-analysed patterns of behaviour which can be readily mathematised (although in light of recent events many rightly question the success of financial economics), the other is communal, possibly less predictable and less quantifiable, and the goals are altogether different. It’s not good enough just to use different models and techniques (which happens already). I wonder whether economics should come up with entirely  separate modes of analysis for a range of different country categories, modifying these categories based on evidence and results. My external PhD examiner Geoff Harcourt, for example, a prominent post-Keynesian, advocated something like this, terming his methodological approach ‘horses for courses’.

Economics in small island developing states

The following example, from small island developing states (SIDS), is based on a paper i’ve worked on with Dan Hetherington. The unique character of SIDS poses challenges to standard economic theory, and the failure of policy initiatives that have failed to take this into account is a common feature of SIDS’ experience. Contrary to the assumptions of traditional economic models SIDS never experience perfect competition or even a close approximation of it; they face severe uncertainty; and in several SIDS, particularly in the more community-orientated cultures of the less-developed SIDS, individualistic utility maximisation is an inappropriate framework within which to conceptualise economic activity.

In trade, one of the most promising avenues of development for SIDS, a conventional neoclassical economic approach is often applied irrespective of the size, fragmentation, distance and vulnerabilities of SIDS. Standard economic theory predicts that a country will tend to specialise in its comparative advantage, and that opening up by liberalising barriers to trade will help generate a more efficient productive structure, with a country exporting products and services at which it is more suited to producing and importing goods and services at which trading partners are better at producing. Countries are supposed to specialise in the products for which the relevant factor – labour or capital – is relatively abundant. It tends to be assumed that the supply response is automatic. The standard neoclassical method has promoted a tendency to focus on the demand-side rather than the supply-side, and to reducing trade barriers through trade agreements and domestic liberalisation rather than to building productive capacity through state or donor intervention.

As an approach to development this theory is not particularly helpful in many SIDS. (Some question whether the approach is relevant anywhere, including Keen (2011), Rodrik (2008), Stiglitz and Charlton (2004, 2005), and Chang (2007)). Many SIDS are so small and undeveloped that the range of options for production is limited and competition is highly imperfect. In several of the 65 inhabited islands in the Vanuatu archipelago, for instance, there is limited infrastructure, including no asphalt roads, no wharves, limited electricity and highly infrequent inter-island transport. Participation in the cash economy for some islands, often with a only a few hundred inhabitants, is limited to cutting copra and selling it on the beach when a ship happens to visit. It is unrealistic to expect new infrastructure and in turn economic activities to emerge soon without significant external intervention. Long-term specialisation in copra production, one of the lowest-valued international commodities, is not conducive to development. Moreover the production base is so small that the development of goods exports is curtailed and the majority of consumer goods must be imported. Most Pacific island states have run persistent goods trade deficits since independence. World Bank data shows that goods trade weighted by GDP is 60% of total trade for SIDS, compared with 80% for low income countries.

The relative abundance of labour or capital becomes something of a secondary question owing to factor immobility and a lack of technology, skills or training. Again, in Vanuatu, which attracts considerable foreign capital as a tax haven and which for an officially least developed country has a relatively high GDP per capita of $3,042, the vast majority of economic activity and investment is concentrated in the main island, Efate, an outcome which is concomitant with the extreme inequality between the main towns and elsewhere. Capital does not move easily to different geographical locations. Cultural and linguistic barriers present a surprising barrier to labour mobility between and among the outer islands, and educational attainment must improve further before a rapid move is made into value-adding activities.

Winters and Martins (2004) confirm this generally critical view of conventional theory by quantitatively examining the higher costs faced by SIDS, which leads them to argue that the combination of transaction costs and scale diseconomies alone may prevent SIDS from participating in the world economy without preferences, concluding that “free trade could mean no trade for these economies.”

This is not to suggest that the development of trade is not possible but that the standard approach to trade is misplaced and that a greater role for external intervention is both necessary and inevitable. Markets are frequently highly undeveloped or non-existent, and either they must be actively stimulated by some kind of external agency or some economic activities must be conducted by the state. Moreover governments and development partners have focused unduly until now on goods rather than services trade.

Government in SIDS

One specific economic challenge facing SIDS is a unique role for government owing to the significance of natural monopolies. In some cases even  corner shops can form a natural monopoly on a sparsely populated outer island. Kiribati, Tuvalu, the Solomon Islands and several other SIDS have distant islands with only a few hundred inhabitants, restricting competition and the functioning of markets. Government must play a ‘backstopping’ role, making its size and remit larger. In many cases more consideration needs to be given to the role of the state as a complementary or supportive player in the development process.

Some government functions are indivisible, and these constraints can be inevitable and permanent. For instance several countries do not have the resources to devote sufficient time and attention to trade negotiations. Outsourcing certain government roles has been considered.

An further important reason why the state plays a particular role and why SIDS deserve special attention is that they are more vulnerable than other developing countries. UNCTAD research finds that they are a third more vulnerable to external shocks with economic consequences than other developing countries. SIDS are 12 times more exposed to oil price-related shocks than non-SIDS and structurally at least 8% more vulnerable to climate change effects than developing nations in general.

Again, all these specificities are more than just deviations from a methodology which remains basically right in most respects. They are fundamental departures from the mainstream of economics, and require a fresh approach to thinking about economics in this context. I’ve always thought that the  defence of unrealistic modelling by people like Paul Krugman was faintly ridiculous: we use unrealistic assumptions like rationality and perfect foresight so as to be able to do modelling, and later relax those assumptions during the application of models. But if you’re journeying to London, why start from Inverness when you can start from Oxford?

 

References

Chang, H-J. 2007, Bad Samaritans, London: Random House

Keen, S. (2011) Debunking Economics, London: Zed Books

Rodrik, Dani, 2008 One Economics, Many Recipes, Princeton University Press

Stiglitz, Joseph and Andrew Charlton, 2004, “A Development Round of Trade Negotiations?”, paper presented to Annual World Bank Conference on Development Economics: Europe, Brussels, 11th May 2004

Stiglitz, Joseph and Andrew Charlton, 2005, “Fair Trade for All: How Trade Can Promote Development”, Oxford: Oxford University Press, ISBN 978-0-19-921998-8

Winters, Alan and Pedro Martins, 2004, “When Comparative Advantage Is Not Enough: Business Costs in Small Remote Economies”, World Trade Review, 3:3, pp347–383

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