Adam Smith Institute

It is not often that I agree with our incumbent Prime Minister, but on the rare occasion it happens, it is certainly worth mentioning. On Wednesday, Gordon Brown called for the UK’s G8 partners to find a way to break down trade barriers and implement a world trade deal.

Speaking in the House of Commons, Brown stated:

I'll be working very hard with our G8 (Group of Eight) partners and others in the hope that in this 11th hour, where we need a trade deal now or it will be delayed for a great deal of time, we can make urgent progress in the next few days.

Earlier this week at the Google Zeitgeist Conference he spoke along the similar lines. Coming down strongly against protectionism he argued once more for free trade:

The two great protected industries of the moment are the two industries that are causing us the greatest problems today: the oil industry, with a cartel run by Opec; and the food industry, with high levels of subsidy.

It is well known that one of Brown’s personal concerns is poverty. He is absolutely correct in highlighting the iniquity of protectionism, and that it is holding back the economic development of the world.

Brown’s concern is timely. Following President Bush’s departure there is a strong risk that a protectionist Democrat will take the White House. With his growing unpopularity Brown may also be out of office before too long, but if he is capable of leading the world towards a free trade deal, he will leave office having done at something to be proud of.

It is of course foolhardiness to the point of madness to criticise the developmental views of an economist who has been awarded the Nobel Peace Prize but despite my reputation as a level and clear headed sorta guy I'm afraid that it has to be done with the recently announced ideas of Muhammd Yunus.

Yes, indeed, food prices have risen and yes indeed, there are things we can do about this. But the specific suggestions seem, well, odd would be a polite way of putting it.

Of the six points, getting the money together for any necessary emergency food aid is uncontroversial, aid for seed and fertiliser also seems sensible.

Crop subsidies and export controls in many important countries are distorting markets and raising prices; they should be eliminated. In particular, subsidies for ethanol that made sense when oil cost $20 a barrel cannot be justified at $120 a barrel - nor can subsidies for oil.

Indeed, quite so. Fourthly, of course we shouldn't stop the long-term search for solutions to poverty and matters environmental and fifthly, of course we want to continue and extend the green revolution: most especially to the standard crops of Africa. The sixth sounds good but of course has no chance whatsoever of becoming reality:

Sixth, to help fund these important initiatives, I propose that each oil-exporting country create a "poverty and agriculture fund", contributing a fixed amount - perhaps 10% - of the price of every barrel of oil exported. This would be a small fraction of the windfall they have been gaining from higher prices. The funds would be managed by the founding nations and devoted to overcoming poverty, improving agricultural yields, supporting research for new technology, and creating social businesses to help solve the problems of the poor, such as health care, education and women's empowerment.

A ratio of five decent if uncontroversial ideas to one that's very odd indeed is a clear (if not unprecedented actually) advance on most political interventions, so why am I saying that they're odd? Because of this part: 

UN Secretary-General Ban Ki-Moon deserves credit for convening the leaders of 27 UN agencies and programs to organize a coordinated response. They have agreed to establish a high-level task force under Ban's leadership, with sound immediate objectives. A comprehensive global plan should include the following six elements.

Yes, it's that global comprehensive plan part (leave aside the giggle induced by asking the UN General Assembly to solve problems). Yunus received his Nobel for both noting and then proving that top down development doesn't work: that bottom up development does. He started Grameen Bank, by far the most successful of the micro-lending institutions. Lending out $30 here and $100 there to people who wish to improve their own lives works: that's why he's lauded, for he proved this.

The oddity is that someone who has spent decades proving this to be true now turns around and says that the solution to such problems is in fact a top down one, detailed planning from the centre. As I say, most odd.

A leader in last week's Economist summed up the case against farm subsidies perfectly. It started by noting the absurdity of farmers using world foot shortages – and consequent high prices – as an excuse.

For years the farm lobby have justified their subsidies on the grounds that low food prices meant farmers couldn't make a living and that the countryside would be left to ruin without government money (ignoring that fact that their "subsidized overproduction" was partly responsible for low prices).

But now prices are high, the same farm lobbies say they need subsidies to ensure 'food security'. Which is nonsense. The point of rising prices is to encourage higher production, so that supply catches up with demand. Indeed, as The Economist notes, high food prices present a perfect opportunity for subsidies to be removed – any hardship for rich-world farmers will be far less keenly felt. But it's not going to happen. Franco-German pressure means the EU's common agricultural policy (CAP) is here to stay:

This is bad news for European consumers and taxpayers, who were promised a proper debate on CAP reform later this year. They will have to continue paying (€55 billion last year) for this wasteful and wicked system. It is terrible for poor-country farmers, who have long suffered from being shut out of rich-world markets, and having rich-world products dumped on them. Now they can hear the gates of fortress Europe clanging shut just when world prices should be triggering an export boom. And it is dreadful news for the hungry poor, because restricting trade in food exacerbates shortages.

Frankly, I don't see any real chance of reforming the CAP – EU politics is too dominated by special interests for that. This doesn’t mean we should stop trying, but the UK needs to be ready to take matters into its own hands. If we have to, we should unilaterally abolish agricultural subsidies and tariffs, and withhold part of our EU budget contribution – encouraging other trade-friendly countries to do the same.

Certainly, Old Europe would make a fuss, but what's the worst that could happen?

Progressives all over the West – and most fiercely the two Democratic presidential candidates – tend to blame globalization for everything because it's an easy escape from political accountability. Protectionist posturing and scrapping free trade agreements is suddenly all the rage. But research shows it’s not primarily globalization but the worldwide skills revolution that is driving change in the world's most important economies.

• Capital is crossing borders worldwide but 90 percent of fixed investment worldwide is domestic and is always attracted by local markets.
• It's wrong to blame globalisation for the decline in manufacturing jobs in developed countries, since the global US share of manufacturing output has indeed slightly increased since 1980, because productivity doubled.
• Developing countries experience the same change. China lost 25 million manufacturing jobs between 1994 and 2004, which is ten times the US loss.
• Information is travelling 15,000 miles in a moment, but what is decisive is whether the person on the receiving end has the capacity to understand it.
• Human capital has become the main source of wealth creation, as addressed in our 2003 report The People Economy.

As David Brooks wrote in The New York Times:

The central process driving this is not globalisation. It's the skills revolution. We’re moving into a more demanding cognitive age. In order to thrive, people are compelled to become better at absorbing, processing and combining information. This is happening in localized and globalised sectors, and it would be happening even if you tore up every free trade deal ever inked.
 

101. "We should help third world producers by buying Fair Trade goods."

Actually, we should help third world producers by buying more of everything they produce. 'Fair Trade' aims to give higher prices to approved producers in the developing world, inevitably at the expense of others. It tries to manage trade, setting the price it thinks more appropriate than the market price, and giving some of the extra money paid to producers who have signed up to its organization.

But only a small proportion of the price differential finds its way back to people in poorer countries. The movement is big on heart-warming individual anecdotes, but scores low on the overall statistics. Only a tiny proportion of goods are designated as 'fair trade,' and most of the higher prices paid are swallowed up before they reach the original third world producer.

It might make a few people feel good, but it is not going to be a significant factor in the drive of poor countries to become richer. They do that by selling goods that the world wants. Often this starts with primary products, but real development can come when they gradually add value to their products by such things as refining and marketing, and take more of the value back to their own country.

Countries do not stay poor because we all pay too little for our coffee. Coffee responds to market forces, and some of these countries over-expanded production, with an increased supply that caused a price fall. Some have sensibly moved into added value, doing the processing, packaging and branding themselves for greater returns. If 'fair trade' keeps more basic coffee-growers in business, it contributes to that over-supply and depressed price.

We could help poor countries most not by trying to manage a small part of the market at inflated prices, but by removing our tariffs and subsidies, and buying as many of their goods as we can.
 

97. "We must increase the foreign aid we give if less developed countries are to escape from poverty."

Foreign aid does not lift countries out of poverty; trade does. No poor country has ever become rich from foreign aid, and no poor country which has become rich achieved it without trade. The notion that poor countries will become richer by a more equal sharing of the world's wealth is wrong; they will become richer by creating additional wealth for themselves, just as the rich ones did.

It's all very well for people in rich countries to feel good by increasing foreign aid perhaps from 1 percent to 2 percent, but it will make negligible difference. If they at the same time ban the import of goods from poorer countries or impose punitive tariffs on them, they are preventing people in those countries from pursuing the surest path out of poverty.

The EU waxes pious about the few crumbs of foreign aid it hands out, and then sets tariffs against the goods the poorer countries produce in order to protect its own producers. Its Common Agricultural Policy is little short of criminal, subsidizing its domestic agriculture so foreigners can't compete, them dumping surplus goods onto world markets so they can't sell there either.

Humanitarian aid to combat disease and starvation and to bring relief after natural disasters is a good thing which we perhaps could and should do more of. But development aid is not. Instead we should open our markets to their produce and buy as much as we can. With the money that trade brings they will be able to invest more in developing and upgrading their industries.

Many once poor nations are now set on the upward path that trade makes possible. On our part we can buy their stuff and switch our own economies to produce different things. This, not aid, will help them out of poverty.
 

Unless you realize how wealth is created, you’ll fret about how to distribute it more equally, thinking the only way the poor can become richer is by receiving some of the wealth the rich have. Wealth is not created by industrialization, though it can be helped by this. It is created by specialization and trade. At the GI blog Tim Worstall draws attention to the wealthy trading towns of the Roman period. He cites the discussion on Marginal Revolution about the drop in living standards between Roman times and the 18th Century. The reason is the cutback over the intervening years in specialization and trade. It’s a timely reminder that while the application of potent energy sources to mass production assists this process, wealth was being created in the ancient world long before water and steam mills proliferated. It reinforces our determination to increase the wealth of poorer peoples by making it easier for them to specialize and to trade.

This doesn't bode well for the collective intelligence of our rulers:

Governments are racing to strike secretive barter and bilateral agreements with food-exporting countries to secure scarce supplies as the price of agricultural commodities jump to record highs, diplomats and cereal traders say.

How marvellously insensible, replacing the information flow of market pricing with the bounded knowledge of the bureaucrat making plans.

How is that bureacrat going to estimate the demand for wheat, say, or bread, or flour, as tastes, technologies and prices change? He can't, of course, it is simply impossible, as Hayek pointed out (and no, "socialist calculation" doesn't work either). If, however, in the face of changing prices, the assumption is simply that what will be demanded next year is the same amount as was demanded this, then the vital information those rising prices contain will simply be being ignored. For example, that it's about time to look for a substitute or two.

Now if countries really were worried about basic food supplies, about the ability of the population to ingest the necessary daily calories, there is in fact a much easier solution for them. Simply buy futures on the commodity markets and hold them until maturity and ask for delivery in kind. That's actually what they are there for, after all.

The added bonus here is that politics doesn't come into it. Instead of Syria and Egypt (an actual example) needing to be politicaly friendly in order to sign a deal, they can both deal with the entirely amoral market. Further, in such a barter deal, (again, from the real example) the import of rice from Cairo to Damascus is dependent upon the export of wheat from Damascus to Cairo. And what if the wheat crop in Syria fails? Does that also mean no rice in the country as well?

No, far better that the products themselves are exchanged for money and then the money used to purchase from anyone with the requisite goods. That is why we invented money, after all, to free us from the tyranny of having to barter for everything.

90. "The results of globalization and free markets can be seen in the shanty towns of third world countries."

There's an important sense in which this is true. Were it not for the economy of the modern world, the people in the shanty towns would not exist at all. In primitive economies large families are the norm because the children contribute to the family's earning power, and support the parents when they are too old to care for themselves. People live on subsistence farms, suffering malnutrition and even starvation when harvests fail or floods destroy crops.

When their country begins economic growth and trade, jobs become available in towns and cities, and people are attracted there by better wages and living standards. Often they send money home. Many live in slum shanty towns while they advance themselves. Conditions are indeed poor, but afford many a chance to survive whereas they faced death in the countryside. So the population increases as they gain access to the rudiments of modern medicine and to a better and more secure diet than they had before.

Population expansion does settle down as the economy advances; the shanty town dwellers are the intermediate stage on the way up. In previous ages they would have died in childbirth, or of disease or malnutrition. Now, poor though they are, their country's economic advances have made it possible to keep them alive. Their equivalent was roughly the slum tenement housing that characterized many of the cities of England's early industrialization. Conditions improved as society prospered.

As society becomes more wealthy, large families become less necessary because children are no longer an economic necessity. Some campaigners suppose that societies must limit their population in order to become wealthy, but it is the other way round: wealthy societies limit their populations. These changes break with subsistence poverty and bring opportunities to climb with their expanding economy into a better life.

88. "The gap between rich and poor countries is growing larger, meaning that global poverty is growing worse."

This is usually recited parrot-fashion as a mantra: "The rich are getting richer, the poor are getting poorer, and the gap is widening." In fact the rich are indeed growing richer, and in most places outside Africa, the poor are growing richer too. Historically the gap has never been narrower, though civil wars have held back progress in Africa.

Prof Paul Ormerod has measured the Gini coefficients which reveal income disparities, and shown that since World War II the world has become more equal, not less. Common observation shows the same. After the Second World War there was a handful of rich countries, mainly in Europe, the US, and the former dominions. The rest of the world was dirt poor, with most of their populations struggling to survive on subsistence farming.

Since then Japan joined the rich club, followed by the Asian quartet of South Korea, Singapore, Taiwan and Hong Kong. Then came the little tigers, including countries such as Thailand and Malaysia. Then economic growth came to some of the countries of South and Central America. Most recently and most spectacularly, China and India have surged ahead.

Last year saw more people lifted out of poverty than in any previous year in human history. Fundamentally we now know how to do it, by enterprise and trade. Instead of trying to implement socialist-style 5-year plans, with governments directing aid-assisted industrial growth, most countries now try to get the conditions right for their businesses to get ahead on their own.

Poor countries can turn their low wages to economic advantage by producing lower cost goods to sell to the rest of the world. The money thus gained can be re-invested in expansion and development, and the wages gradually rise. This roughly mirrors the way in which the rich countries did it.

It can be quite depressing trying to convince paid-up members of the Aid Brigade that people will climb out of poverty by selling things, and not by being given money taken from richer people. For that matter soup kitchens are no real substitute for people selling things and being able to afford to eat properly. Tim Worstall takes a look at it over at the Globalisation Institiute, remarking on the objection by so many NGO people to trade agreements.

Their objection seems to be that buying things made by poor people is to exploit them: and that insisting that their government allow them to purchase things made by rich people is similarly exploiting them.

Globalization isn't new, points out Tim Worstall at the Globalisation Institute.  He's had a preview of an upcoming paper by Prof Leslie Hannah which shows that "Most of Europe's (and Britain's) problems of restricted twentieth-century growth derive from the tariff escalations, wars, dictatorships, expropriations, partitions, nationalism and related problems of 1914-1945."  Before the First World War we were quite happily interconnected with the world and enjoying the benefits.

Germany was dominant in the older industries such as coal and steel, while the UK was forging ahead in things like banking and finance.  These are echoes of the present day, with Germany more dependent than we would like to be on the white goods now so capably produced out East, while we lead in financial services.

Then, as now, the gains are to be made in specialization and trade, not in cowering behind protective tariffs, and certainly not in having government decide which areas the country should concentrate on. In the words of HRH Prince Charles, "People do that."

69. "Britain's wealth came from exploiting its colonies, and should be repaid to some degree."

The source of this error is interesting. When the British economy neither collapsed  nor produced greater poverty as Marx had predicted, communist theorists invented the imperial excuse. The British had postponed the evil day by exploiting their empire as a source of cheap raw materials, and as a captive market for their finished goods.

The theory ignores the facts. During most of that imperial period the rates of return on capital were higher in advanced countries such as the United States or Germany, or in undeveloped areas outside the empire, such as Argentina. When the British did invest in the empire, in many cases it was against their economic interest. In other words, they invested in the empire because they believed in it, not because it was where the greatest return was to be made. Indeed, in opportunity terms, this is equivalent to the empire costing Britain money.

The empire also cost money to administer, to police, and to develop with roads, railways, bridges and harbours. In many cases these were done for military and political purposes which owed more to Britain's self-perception as a world power than to any economic gain. Furthermore, much of the wealth that did accrue from Britain's colonies was not wealth until the processes and products were developed which needed it. The rubber trees in Malaysia had negligible value to the native inhabitants. Only an industry which used rubber turned them into wealth. The ore deposits in central Africa had far less value to the indigent population who walked and hunted over them than they did to the British, who were developing industries to use them.

The world did not have a fixed supply of wealth, and Britain's was not 'taken' from other countries. It was created by trade and manufacture, for which Britain should not be apologetic but proud.

65. "Drug patents should be scrapped so third world countries can access them."

Scrapping drug patents would be a sure-fire way of reducing the number of therapeutic drugs being developed and marketed. Pharmaceutical firms research new ones to bring future profit streams for their company. The scientists might work from commitment or for peer group respect, but company money provides the research facilities, the equipment, the grants and the salaries.

There is a compromise between allowing the drug companies to recoup their costs and show a return, and allowing them to exploit monopoly prices. At present they are allowed 20 years of patent protection before other companies can copy their work and produce generic equivalents. The research company has to recoup its investment within that time before it faces competition from low cost variants of it drug.

In practice their 'protected' time is shorter. The process of testing and trials, of attempting to establish product efficacy and safety, and the process of securing regulatory approval takes an estimated 12 years from when the patent is registered. That leaves 8 years of unique market exploitation, and it is why some drugs cost so much.

Poorer countries cannot afford these prices, and there are calls for them to be allowed generic copies. If this happens, the cheaper versions will rapidly leak into rich country markets, undermining the drug's and the manufacturer's profitability and their ability to continue to develop new drugs. Some drug companies have, however, reached voluntary agreements with poor countries, allowing controlled generic production for poorer patients.

The present compromise broadly works, and means that rich country patients pay high prices for drugs so that in a few years poor country patients will have access to them at lower prices. It means rich people have the first access to new drugs, as they do to everything, but it also means that poorer people can benefit from them later on.