Congratulations Dani Rodrik – winner of the Albert O. Hirschman Prize

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Any hint that virtue is it’s own reward offers its own reassurance – bracing though it may be. I fancy that the look on this face is the contentment of genuine achivement.

Yes folks you heard about it first on Troppo. A while back I came across a terrific article by Dani Rodrick – “Goodbye Washington Consensus, Hello Washington Confusion? A Review of the World Bankâs Economic Growth in the 1990s: Learning from a Decade of Reform“. Before I’d had time to read it I sent it to James Farrell who I know is interested in this kind of stuff and he duly posted on it here.

Now we have two further pieces of excitement. Rodrik has started a blog – which is shaping up very well. Often bloggers, like newspaper columnists are at their best when they start – with a fresh take on things they’ve been thinking about for a long time.

And he has just won the Albert O. Hirschman Prize. Hirshman was one of the great economists of the decades from the 1960s to the 80s or so. He was unusually ecclectic and commonsensical in his methods as is Rodrik. As Rodrik puts it rather cutely on his blog announcing that the winner of the prize has been announced. “I won’t tell you who the recipient is, except to say that I do not agree with everythng he has written.”

One of the things I’m enjoying is his category of ‘economics bloopers’ on his blog – where (so far) he engages in very Krugmaneque catching of economic pundits in various inadvertent lapses into what I call pre-Ricardian thinking.

I’ve always worried about claims that tariff cuts lower prices in the host economy. The claim always seemed to me to partake of the ‘pre-ricardian fallacy’, but I never tried to nail down why. Now Rodrik does so kicking off a bit of a storm on his blog.

Advocates of globalization love to argue that free trade lowers prices, and the argument seems sensible enough. Think of all the cheap goods from China that we can buy at Wal-Mart. But anyone who understands comparative advantage knows that free trade affects relative prices, not the price level (the latter being the province of macro and monetary factors). When a country opens up to trade (or liberalizes its trade), it is the relative price of imports that comes down; by necessity, the relative prices of its exports must go up! Consumers are better off to the extent that their consumption basket is weighted towards importables, but we cannot always rely on this to be the case.

But ultimately this is a bit of smartarsery – or at least one-upmanship albeit in my opinion righteous and worthwhile one-upmanship.

First a caveat – then all the things I like about his brand of economics. I get the impression that Rodrik is more comfortable with intervening in trade than I am. He tends to overdo cautions to free trade â for instance saying that scale economies weaken the case. They donât â they complicate it, including by making it possible that a country will lose from free trade, but itâs hard to think that thatâs very likely â and with more gains to trade free trade becomes more (generally much more) not less important. Though he warns that industrial policy a can become an illegitimate excuse for not facing up to the pressures of structural adjustment, I think he somewhat overrates the benefits of industry policy â though I think heâs right that they offer reasonable potential benefits as shown by the experiences in Asia and elsewhere.

What I like about him is – as I intimated above – his commonsensical ecclecticism and his accompanying open mindedness and pluralism. The guardians of economic orthodoxy have an unfortunate habit of being too rigid and unimaginative in the way they apply their formulas for success. Thus by the early 1990s everyone was sure that liberalisation was the key – liberalisation of anything as fast as possible. In the wake of the disasters of Russian and South American liberalisation and the problems which capital liberalisation produced in Asia the focus turned to the quality of ‘institutions’. This was a Good Idea – as Rodrik says. But how does one apply the insight?

As he comments in the article previously cited on the Washington consensus:

Telling poor countries in Africa or Latin America that they have to set their sights on the best-practice institutions of the United States or Sweden is like telling them that the only way to develop is to become developed- hardly useful policy advice!

While Rodrik does not demur from the broad policy objectives of economic development – the desirability of freer markets and freer trade, he believes that the main agencies like the IMF and World Bank have been insufficiently imaginative in understanding the second best choices that countries inevitably make in their development journeys.

In another great article (pdf) published in 1999 “Institutions for high-quality growth: what they are and how to acquire them” he offers some arguments in this vein that are very much to my taste.

[D]esirable institutional arrangements vary, and that they vary not only across countries but also within countries over time.

It is a common journalistic error to suppose that one set of institutional arrangements must dominate the others in terms of overall performance. Hence the fads of the decade: with its low unemployment, high growth, and thriving culture, Europe was the continent to emulate throughout much of the 1970s; during the trade-conscious 1980s, Japan became the exemplar of choice; and the 1990s have been the decade of U.S.-style freewheeling capitalism. It is anybody’s guess which set of countries will capture the imagination if and when a substantial correction hits the U.S. stock market.

The point about institutional diversity has in fact a more fundamental implication. The institutional arrangements that we observe in operation today, varied as they are, themselves constitute a subset of the full range of potential institutional possibilities. This is a point that has been forcefully and usefully argued by Roberto Unger (1998). There is no reason to suppose that modern societies have already managed to exhaust all the useful institutional variations that could underpin healthy and vibrant economies. Even if we accept that market-based economies require certain types of institutions, as listed in the previous section, such imperatives do not select from a closed list of institutional possibilities. The possibilities do not come in the form of indivisible systems, standing or falling together. There are always alternative sets of arrangements capable of meeting the same practical tests. (Unger, 1998, 24-25)

We need to maintain a healthy skepticism towards the idea that a specific type of institution – a particular mode of corporate governance, social security system, or labor market legislation, for example – is the only type that is compatible with a well-functioning market economy.

By way of illustration, in his article on the Washington consensus quoted above (See also his article “Economic Development as Self-Discovery” – pdf) he gives the example of the way in which the Chinese managed to secure greater certainty for investors with local communal stakeholding than the Russians were able to deliver with (notionally) private property.

We know that growth happens when investors feel secure, but we have no idea what specific institutional blueprints will make them feel more secure in a given context. The literature gives us no hint as to what the right levers are. Institutional function does not uniquely determine institutional form. If you think this is splitting hairs, just compare the experience of Russia and China in the mid- 1990s. China was able to elicit inordinate amounts of private investment under a system of public ownership (township and village enterprises), something that Russia failed to do under Western-style private ownership. Presumably this was because investors felt more secure when they were allied with local governments with residual claims on the stream of profits than when they had to entrust their assets to private contracts that would have to be enforced by incompetent and corrupt courts. Whatever the underlying reason, Chinaâs experience demonstrates how common goals (protection of property rights) can sometimes be achieved under divergent rules. This is a theme that Learning from Reform loudly trumpets. . .

Simple as it may be, this first-best logic often does not work, and indeed can be even counterproductive. The reason is that we are necessarily operating in a second best environment, due to other distortions or administrative and political constraints. In designing policy, we have to be on the lookout for unforeseen complications and unexpected consequences. Let me return to an example from China. Formal ownership rights in Chinaâs township and village enterprises (TVEs) were vested not in private hands or in the central government, but in local governments (townships or villages). From the lens of first-best reform, these enterprises are problematic since, if our objective is to spur private investment and entrepreneurship, it would have been far preferable to institute private property rights (as Russia and other East European transition economies did). But the first-best logic is not helpful here because a private property system relies on an effective judiciary for the enforcement of property rights and contracts. In the absence of such a legal system, formal property rights are not worth much, as minority shareholders in Russia soon discovered to their chagrin. Until an effective judiciary is created, it may make more sense to make virtue out of necessity and force entrepreneurs into partnership with their most likely expropriators, the local state authorities. That is exactly what the TVEs did. Local governments were keen to ensure the prosperity of these enterprises as their equity stake generated revenues directly for them. In the environment characteristic of China, property rights were effectively more secure under direct local government ownership than they would likely have been under a private property-rights legal regime.

Such examples can be easily multiplied (Rodrik 2005a). As an additional illustration, consider the case of achieving integration with the world economy. Policymakers in countries such as South Korea and Taiwan in the early 1960s and China in the late 1970s had decided that enhancing their countriesâ participation in world markets was a key objective. For a western economist, the most direct route would have been to reduce or eliminate barriers to imports and foreign investment. Instead, these countries achieved the same ends (i.e., reduce the antitrade bias of their economic policies) through unconventional means. South Korea and Taiwan employed export targets and export subsidies for their firms. China carved out special economic zones where foreign investors had access to a free-trade regime. Policymakers chose these unconventional solutions presumably because they created fewer adjustment costs and put less stress on established social bargains.

The latter example is particularly close to my heart as my own analysis of the needs of the Australian automotive industry led me to question the existing orthodoxy that we should adopt tariff only protection for the industry rather than assistance which did not discriminate against exports to allow our industry to search for viable export niches while we gradually wound down its protection. That led me to a very general defence of heterodox methods of trade liberalisation (pdf) published in the Economic Record.

Of course as Rodrik points out, there’s nothing good about heterodox arrangements for their own sake. He’s not arguing that everyone’s development has to be unique in every particular or that they can’t borrow many things – perhaps most things – from others or learn the lessons available from others’ experience. And he fully acknowledges that the arguments he’s putting, can offer plausible debating points for vested interests seeking simply to obstruct development.

Like I said – he’s ecclectic, pluralistic and commonsensical.

Postscript: others feel the same way.

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[…] of my posts on Troppo will have noticed my own enthusiasm for Dani Rodrik’s style of economics and my view that ‘post-Fordist’ production systems like the Toyota ‘just in […]