A middle way around the economic errors of the past

'Masterpiece' by former World Bank economist Justin Lin charts a practical path out of poverty

PUBLISHED : Monday, 24 December, 2012, 12:00am
UPDATED : Monday, 24 December, 2012, 4:27am

The most valuable new book I've read this year is Justin Lin Yifu's The Quest for Prosperity.

George Akerlof, a Nobel laureate in economics and a man not given to reckless overstatement, calls it "a masterpiece". I'd say that's right.

Lin is an interesting man. In 1979, as an officer in Taiwan's army on the fast track to the elite, he defected to the People's Republic of China by swimming the channel between a Taiwanese island and Xiamen on the mainland.

He continued his studies in economics, became a leading scholar, and was an observer and participant in China's economic miracle. From 2008 until earlier this year, he was the World Bank's chief economist. Today he's back in China, at Peking University.

Lin's book is intellectually ambitious. He sets out to survey the modern history of economic development and distil a practical formula for growing out of poverty. It's a serious undertaking: Lin isn't trying to be another pop economics sensation.

But The Quest for Prosperity is lightly written and accessible. It weaves in pertinent stories and observations, drawing especially from his travels with the World Bank. He leavens the economics skilfully.

Essentially, he proposes a middle way between two contending schools: structuralism, which emphasises barriers to development that need government intervention to overcome, and the neoclassical approach, which stresses market forces and frowns on industrial planning. He calls his hybrid "new structuralism", suggesting a closer affinity with the first.

Under the banner of the old structuralism, governments in developing countries made huge mistakes in the 1960s and 1970s. The prevailing approach was import-substitution: develop capital-intensive industries behind tariff barriers to supply domestic consumers. It worked in the sense that many places industrialised quickly, sometimes on a massive scale.

For decades the Soviet Union was perceived both as a great success and as a development model. In India, Africa and Latin America, economic planning led the way.

In every case, this approach ran into the ground. One problem was technological backwardness. Isolation from global markets slowed the accumulation of industrial knowledge, so growth in productivity stalled. Another was fiscal stress. Supporting industrial champions required enormous subsidies, and governments lacked the revenue.

Import-substitution came to be seen as a stunning failure. Especially after the Latin American debt crisis of the early 1980s, the neoclassical consensus and its "structural adjustment" formula took over. Keep government intervention to a minimum, squeeze public spending, free the exchange rate, liberalise finance and foreign trade, and give market forces full rein.

This didn't work either - at least, not as well as its most enthusiastic advocates had predicted. Growth in many countries stayed slow. Financial crises kept happening.

Structural transformation, of course, is exactly what China has achieved. Elsewhere Lin has acknowledged that China needs further policy reforms and that all is not well.

Yet the country's success of the past several decades is indisputable - and this is no Soviet-style industrialisation mirage. Russian factories sold their output to captive markets. Nobody with a choice ever bought a Soviet-made car or television.

China's outward-looking producers are world-class. I'm typing this on a best-of-breed Apple laptop, manufactured in China.

China is a capitalist country. But how did it get that way? Lin's answer draws on both development paradigms. He sees a vital role for government in overcoming barriers to development.

But interventions, he argues, must respect compelling market realities. Of these, the most important is international comparative advantage. Poor countries have lots of cheap labour. For them, capital-intensive heavy industry isn't the way to go.

For today's developing countries, Lin says, the global economy is the indispensable setting, and looking outward is the sine qua non of rapid development. On this view, "export pessimism", the idea that poor countries couldn't prosper through international trade, was one of the biggest mistakes of the import-substitution school. Globalisation is the poor's best friend.


Tom Holland is on holiday