It’s politics, stupid!

Economic versus political logic. In search of Plato’s philosopher king. 

Politics gone badly wrong
Consider the following examples of how politics is often in the way (in most cases this is a tremendous understatement) of economic development.

Alan Garcia in his first term in office in Peru almost singlehandedly wrecked the country in the spell of just a couple of years in the 1980s. (Unbelievably, he got a second chance, and seems to have learned from his mistakes, Peru is doing much, much better).

Many countries in the world that are now screaming about high food prices have neglected their agricultural sectors, often in a terrible manner, pandering to the urban middle class and totally neglecting the country side, depriving it of resources or just regarding it as a source of funds.

Many countries in the world where the state apparatus is seen as a means to appropriate as many resources as possible to further the interest of the clan/group/family. There are quite a few countries in which the ruling elite has enriched itself while the country was terribly managed (Mobutu’s Zaire, Mugabe’s Zimbabwe).

It doesn’t always have to be such a zero sum game as present day Zimbabwe though as there are even countries where economic development has proceeded pretty ok but which nevertheless suffered from an appropriating elite (Suharto’s Indonesia comes to mind).

Many developed countries in which special interest play a disproportionate role. We have record energy and food prices, yet in the US, fossil energy and agriculture are the two most subsidized sectors.

We know basically what works to get economies going, roughly the following conditions are crucial elements of economic development, things like:

  • stable macroeconomic environment providing a predictable business climate
  • competitive markets, which includes competition from abroad
  • independent rule of law
  • working infrastructure
  • good education and land distribution

This is not rocket science. If these conditions are set, the incentives and institutions are in place for people to embark on economic activity to further their own interest, and, in the famous analogy from Adam Smith, the common good will also be taken care off in most cases (and were it is not, there is often a reason for smart state intervention)

There are also examples (far fewer), where politics jolted the economy back to life, and even fewer where governments have, even against current trends

Good examples

It might surprise you (especially in these cynical times), but sometimes politics does get it right. One of the most spectacular policy changes for the better, and a showcase for what can be achieved is the policy change in the early 1980s under Deng in China. The first step was perhaps the most significant.

He allowed private tilting of the land and disbanded collective farming. An eminently sensible measure, when you consider that it was known from the Soviet Union that the little plots of land farmers were allowed to keep amounted to only a couple of percentages of land holdings, but produced something like 20% of agricultural output.

Collective farm, unless you have a strong sense of duty or ideology, run into what economist call a collective action problem. Incentives are not aligned as individual effort does not correspond to individual gain. The gains have to be shared, so hard work is not rewarded.

Those simple changes in agricultural policies had a dramatic effect. China, which had been a country where poverty was rife and hunger occasionally wrecked havoc for most of the century saw its agricultural output treble in a couple of years.

Without this simple policy change, industrialization would hardly have been possible. Of course, industrialization was started far away from the smokestack state-owned factories in greenfield free trade zone’s, where foreign technology and companies were allowed, another Deng innovation.

Two simple policy changes, but their dramatic effect is to lift more than a billion people out of poverty and propell a dirt poor nation into emergent superpower status. Can it be more dramatic than that?

Of course, there was enormous room for improvement in China and its numbers were always on its side once they were enlisted with proper incentives to bring China greatness, but there are smaller countries that have done well with smart policy.

South Korea is perhaps another spectacular example. In the early 1950s, ravished by war with 2 million people dead, having no resources to speak off, and being poorer than most African countries, it embarked on a series of sensible managed capitalist policies that made clever use of the only resource it had; people.

Now, half a century later, South Korea is rich, has high-tech companies that are world beaters, is one of the most advanced in terms of broadband, and the contrast with it’s Northern half couldn’t be greater. The different fates of the two Korea’s is perhaps the most dramatic tribute to the difference policy can make.

But even on a smaller scale, subtle policy changes can change the fate of whole nations. At various stages in their existence, the economies of Ireland, Finland, and the Netherlands were all in deep problems.

Martti Ahtisaari premier of Finland in the early 1990s, didn’t look at polls, just realized his country would not survive on a few basic industries (such as pulp and wood) alone, especially with the collapsing economies of the former socialist countries with which it happened to trade a lot. He had a vision and implemented this, Finland, which experienced an almost 1930s stile recession in the early 1990s, with unemployment above 20%, became a widely admired high-tech hub in a decade or so.

Ireland is a similar story, only until recently it was a basket case in Europe, with it’s youth emigrating, stagnant salaries, labour strife, poverty. At the end of the 1980s, social partners and politics recognized things could not go on like this, a social pact was formed and a consensus emerged on embarking on a more business friendly coarse, relying mostly on good education and low taxes to attract foreign technology companies.

Those policies really changed the country around, and from being one of the most poor in the European Union, it has become one of the richest. Emigration has turned around to immigration, and Ireland has even be compared to the Asian tiger economies for it’s high growth rates.

In the Netherlands, the early 1980s was not a happy time, the country was experiencing severe economic problems, but social partners came together and concluded the ‘pact of Wassenaar’ in which unions traded wage moderation for shorter working hours.

Respective coalition governments of center right and center left embarked on policies of moderate reform, never resorting to the spectacular, never really radical in it’s approach, just a series of small steps often the result of compromise, but the cumulative effect has been to right a number of structural wrongs in the economy which has propelled it from a European underarchiever to one of it’s admired economies, with a GDP per person in the top three.

So, politics can make a dramatic difference to the fate of a country, it has the capacity to jolt a country out of poverty, but also the opposite capacity, to dramatically reduce it’s economic prospects. The next question is, can we say something about under which circumstances politics is likely to to one or the other? This will have to wait until a next time.