Getting Serious About Teaching Economics to Boost Developing Countries, Not Just the Big Guys

Calls for a new university economics curriculum in the wake of the financial crisis have been on the rise, increasingly making the case for an economics that is broader and more encompassing than the narrow free-market orthodoxy that pervades the discipline today in most university economics departments. There are calls for a more interdisciplinary approach that addresses real world economies, to factor in environmental aspects, to focus on how to lessen inequality and to prevent the financial system from creating instability. But any overhaul of the curriculum must also include the area of development economics.

Over the last few decades, the free-market orthodoxy in economics has distorted the field of economic development and foreign aid. The idea of developing a discrete national economic development strategy was abandoned in favor of the idea of globalization, in which developing countries are expected to just “integrate” into the global economy through trade, finance and investment liberalization, regardless of the level of national economic development they have yet achieved.

The “Win-Win Scenario”

In these decades, foreign aid policies became indistinguishable from short-term commercial policies of trade ministries, and a pernicious happy mythology began to pervade official development discourse. According to the myth, there is an amazing coincidence that suggests the policies that best promote the short-term commercial interests of industries in advanced economies just so happen to also be the same policies to best promote long-term economic development in poor countries. It is often referred to as a “win-win scenario.” While there are specific circumstances in which trade deals with, and foreign direct investment (FDI) from, rich countries can truly support the long-term development goals of developing countries, in fact there are also other circumstances in which the short-term commercial imperatives of advanced economies are directly at odds with the long-term developmental needs of developing countries. Today’s university curriculum only teaches about the former and not the latter. But a better appreciation of development economics would enable students to tell the difference between these two situations.

Under the reigning free-market policy approach, if all countries need to do is liberalize and privatize and integrate into the global economy, then the foreign aid and development industry can limit itself to ameliorating human suffering with projects such as the UN Millennium Development Goals (MDGs). But fundamental development issues like manufacturing and industrialization – and the macroeconomic and industrial policies that countries will need to achieve them – are off the table.

Yet there are some basic economic indicators that can tell us how well countries are really developing or not: not just overall GDP or exports, but the precise composition of that GDP and those exports – and their sophistication level – over time. For hundreds of years before the 1980s free markets craze, it had long been understood that the main way to reduce poverty was to diversify the economy from dependency on primary agriculture and extractive industries toward manufacturing and services industries over time. Most rich countries figured out that primary agriculture and extractives tended to suffer from diminishing returns over time, and manufacturing and certain services tended to provide increasing returns – a basic fact that has been all but stripped from the curriculum.

With the higher wages and skills in manufacturing and services, countries built up bigger domestic tax bases more capable of adequately increasing public investment in health, education, social protection and transportation infrastructure over time (the same things for which the aid industry clamors for more external aid). The four basic indicators of real development to watch were long considered to be manufacturing as a percent of GDP; manufacturing value-added (MVA) as a percent of GDP; MVA in exports; and wages as a percent of GDP – if these were not going up over time, then a country was not developing. But under free-market globalization, that’s all gone now, and primary agricultural commodity exporters like Malawi are expected to just integrate into the global economy as they are, without having first diversified or developed, virtually guaranteeing they will stay locked in plantation mode.

Why Africa is Not “Rising”

Despite all the recent hoopla about “Africa rising” narratives (high GDP growth rates, increased mobile phones usage, more billionaires than ever before, etc.), if one looks at how well Africa has been doing on the four basic real development indicators over the last 20 years, the data shows that Africa has not been industrializing and that, except for a few outliers, these indicators have either been stagnating or regressing among most African countries. This should be a red flag, signaling serious problems with the dominant development model. But it isn’t, and doesn’t because hardly anyone pays attention to such indicators under the reigning globalization thesis, where national economic development as a discrete project is off the agenda.

Promoting “free trade” and the “win-win scenario” in the economics curriculum may well serve the commercial interests of foreign investors from more advanced economies who wish to enter developing country markets, out-compete domestic firms and expand their market share, but this often has little to do with helping developing countries build up their domestically-owned firms. Similarly, teaching that liberalization of FDI is always good may make it easier for foreign firms from advanced economies to keep their technology for themselves and use cheaper imported inputs, but this has little to do with providing technology-transfer or useful forward and backward linkages to benefit local firms in the host country.

A curriculum that claims that financial liberalization is always good may make it easier for international banks to compel local firms in developing countries to have to buy their short-term, high-interest commercial loans, but this does little to enable developing countries to offer more affordable, subsidized, long-term, low-interest commercial credit for their domestic firms. And the notion of “comparative advantage” dangerously suggests to countries like Malawi that it’s a good idea to just stick with tea and tobacco exports rather than to diversify into manufacturing.

Under the free-market curriculum, mostly students do not learn the history of what the rich countries actually did when they were industrializing, and how they all used trade protection, subsidized credit for their companies, public technology, research and development (R&D) support, tax incentives and a host of other policies to successfully build up their industries over decades and centuries – all in direct contravention of free-market principles. They are not taught that rich countries only liberalized their trade once their domestic firms had become competitive in international markets – not before. But rather, today’s students of economics are taught that states should not use trade protection or give any further industrial policy support to their current (or future) industries because such state intervention in the economy is always inefficient, bad and wrong. They are taught that the steep deregulatory and liberalizing features of World Trade Organization (WTO) membership requirements and the conditions of joining free trade agreements (FTAs) and signing bilateral investment treaties (BITs) are just fine, so there is nothing to worry about because of the win-win scenario.

In fact, the WTO, and most FTAs and BITs go far beyond trade and investment issues and seek deep domestic deregulatory reforms, including “standstills,” which would prohibit future regulations and require that developing countries give up the right to use various industrial policies in the future in the name of creating a “level playing field” and “national treatment” for foreign investors.

Meanwhile, countries like Malawi stay as commodity plantations – incapable of building up their manufacturing sectors – and with low wages incapable of building a tax base that can finance their own health and education. This then compels the aid industry to launch campaigns for ever more external assistance.

The Continuing Need for Industrial Policy

People often respond to arguments in favor of industrial policy by saying that the world has moved on and that we are in a global economy now, so the old rules no longer hold sway. Yet, we are in fact still very much in an international economy based in nation-states with albeit increasingly globalized features, but not a global economy. And therefore long-term national economic development strategies still do matter. If this were not the case, it is doubtful that industry associations in the advanced economies would still be spending millions of dollars per year on legions of lobbyists to seek various forms of industrial policy support from their own nation-states (despite the free markets orthodoxy being taught in their universities, at the same time).

Yes, the world may have changed, but some things remain as true as ever. For example, here are a few timeless lessons that all the rich countries learned the hard way in the course of their own industrialization trajectories and which are still true for developing countries today:

• If you only stick with primary agriculture and extractives industries, your wages will always stay low, and your domestic tax base will never be able to adequately finance health, education, transport or social protection for real development (why they diversified into manufacturing and services);

• If you liberalize your trade prematurely before your domestic firms are yet competitive in international markets, they will get wiped out; thus while some degree of trade liberalization may be good, too much can easily wipe them out (why they used trade protection);

• If your firms are not yet competitive in international markets, the thing to do is to make them more competitive, not wipe them out with premature trade liberalization (why they used extensive technology policy for R&D for innovation, emulation and upgrading);

• If you liberalize your finance, your domestic firms will not be able to afford the short-term, high-interest borrowing terms offered by private banks (why they used public development banks);

• If you wait for only private entrepreneurs to start new industries that are vital for long-term industrialization strategies, you will wait forever (why they used state-owned enterprises who served as ‘entrepreneurs of last resort’);

• If you wait for individual private companies to finance all of their own R&D, you will not get very many innovations (why they used extensive public support for R&D for their firms);

• If you abide by intellectual property rules and tough enforcement of such, your firms won’t be able to as easily use reverse engineering and emulation to build up the manufacturing sector over time (why they ripped off technologies from one another);

• If you liberalize your FDI rules, foreign investors will not transfer technology or provide useful forward and backward linkages to help build up your domestic companies, but they will take their profits earned out of your economy (why they used entry and performance requirements and domestic content rules).

But if students of economics don’t learn these tried and true fundamentals of development economics, they will be confounded and at a loss to explain why Malawi is still basically a tea and tobacco plantation (if they even ask).

Development Policy has Nothing to do With “Fairness”

The university curriculum promotes the same sense of entitlement about “fairness” and a “level playing field” as do the rich-country trade negotiators, as though everybody ought to agree with this. And yet fairness has no basis at all in the history of how rich countries industrialized, and as a concept, never guided their trade and FDI policies. In the abstract, it may seem imminently fair that both rich and poor countries alike lower their quotas and tariffs at the border in any agreement. Yet we don’t let grown men play football against an opposing team comprised of toddlers for a very basic reason – the playing field may be “level,” yet it is still clear which side is going to get wiped out. For precisely this reason, the advanced industrialized countries used trade protection when building up their industries.

The global trade talks at the WTO have ground to a halt over the years because the biggest developing countries understand the game is rigged and stacked against them: While all countries agree to lower formal tariffs and quotas at the border, the rich countries then use a host of other expensive and sophisticated “behind-the-border” tricks called non-tariff barriers (product quality controls, sanitary and phytosanitary requirements, rules of origin, etc.) to, in effect, still block imports from developing countries. Few developing countries have the capacity to do the same to imports from rich countries, so in practice, only one side actually liberalizes.

In response to the WTO breakdown, lobbyists for the advanced industries in the rich countries have taken their liberalization agenda into a virtual alphabet soup of smaller regional and bilateral FTAs and BITs. Examples include the European Union’s Economic Partnership Agreements (EPAs), the US-proposed Trans-Pacific Partnership Agreement (TPPA), the 50-country Trade in Services Agreement (TISA) and BITs like the US-India Bilateral Investment Treaty.

With these they are hoping that developing countries such as Bangladesh, Vietnam and Uganda, etc., will foolishly give up their future right to use of industrial policies on the false hope of getting more of their plantation commodities into advanced country markets in the short term. Indeed, when developing countries are presented with offers to sign onto an FTA or BIT, there is often a domestic political fight between those sectors of the economy that wish to increase exports in the short term and others wishing to have further industrial policy support in the future. Yet, this fundamental political fight is completely missed by students of economics, who are unhelpfully taught that there is no need for industrial policies, that the “win-win scenario” always prevails in trade and FDI, and that developing countries never have to do anything when it does not.

Africa Takes Bold Steps Away from Free-Trade Model

So while rich country university economics departments and official trade negotiators continue to insist on the virtues of free trade, there are interesting grumblings being heard on the ground in places like Abuja, Pretoria and Kampala, which are increasingly at odds with the orthodoxy. In the last year, Nigeria adopted a new industrial policy and turned down a free trade deal with the EU because it would undermine its future use of industrial policies and ability to develop manufacturing; South Africa finished a 3-year review of BITs to conclude that it would not sign any more until they were redesigned by a domestic law that would ensure the treaties are in the country’s interest and would not take disputes with foreign investors out of domestic courts and into arbitrary international tribunals; and Uganda announced it would no longer sign on to any more double-taxation avoidance agreements (DTAAs) until a new guiding framework policy can be drafted by the government to ensure such agreements support the country’s interests, and will not be abused by third parties for purposes of capital flight or tax evasion.

In fact, in a dramatic and relatively under-reported about-face on three decades of free market orthodoxy, the last two annual summits of African finance and development ministers focused exclusively on the need to industrialize and reconsider using industrial policies. Many of the new proposals are in stark contrast to the prevailing orthodoxy: trade protection, subsidized credit, capital controls, and alternative fiscal and monetary policies that typically would outrage the IMF. And yet today’s students of economics are wholly unprepared to help these countries.

To better make sense of these real world developments, the overhaul of the university economics curriculum must include bringing back the fundamentals of development economics, including the importance of industrial policies. The short-term commercial policies of rich countries are not always the same thing as long-term development strategies for developing countries, and students of economics should be taught how to tell the difference.