The Pin Factory Blog

The ninth thing we're told is that even though manufacturing is becoming a smaller part of our economy, of all economies, it's still very important oh yes indeed it is! There's a certain sadness in watching the argument develop in this chapter in fact.

Chang is quite right on his facts: it isn't that manufacturing output has shrunk at all. In the UK that was rising until 2007 (and we don't know how much of the subsequent fall is recession related or structural) and it's still rising in the US. It's just been rising less than the growth of the rest of the economy: thus falling as a proportion but not absolutely. Manufacturing employment has been falling substantially: a small part of this is simple reclassifcation. The graphic designers who used to work at the factory were counted as manufacturing workers: now they take their cocaine in Soho lofts they're service workers. The majority of that workforce fall is because of rising productivity: we simply need fewer people to make ever more stuff as we become more efficient at using labour to make things.

Chang gets all of this right: then he makes something of an intellectual leap and it's sad to see the tumble into the chasm of illogicality.

Given all of the above he says that manufacturing is still important and we should work to increase the portion of the economy that is such. The argument being that as productivity is easier to increase in manufacturing than it is in services, as manufacturing becomes an ever smaller part of the economy then total productivity growth will fall. Well, yes, it will, undoubtedly (and there's rather a clue as to why productivity growth has been falling in rich societies in recent decades: because that manufacturing where productivity growth is faster has been becoming an ever smaller part of the economy).

But to then insist that we must have more manufacturing in order to improve productivity growth is most odd. For we don't desire productivity growth per se. It's nice to have, for sure, it means we can make more stuff with fewer inputs. But even with that we only actually want to make more stuff, become more efficient at making stuff, that we actually want. There's no point in becoming more efficient at making Simon Cowell for example, as we've all got a surfeit already. And so it is with things that are manufactured. We don't want to simply become more productive: we want to have more of the things that we want with the resources we've got available, not more things that are manufactured just because it improves average productivity.

It's also true that manufacturing (yes, output is rising, but as a portion) of the global economy is falling. So the advice that every country whould focus more on manufacturing is ridiculous. Manufacturing what for whom? If manufacturing is carriages and services are cars (bear with me) Chang's insistence here is like saying we should all be making more buggy whips. Sure, no one particularly wants them but we're getting ever so much better at making them that average productivity would rise as a result of doing so.

The point here being that "productivity" isn't some thing that we should reify. It is indeed the secret to rising living standards: as Paul Krugman has said productivity isn't everything but in the long run it's almost everything. What Chang's missed though is that the output is measured at market prices: if we overproduce manufactures simply because this will raise the productivity number then their market price will fall: and productivity won't in fact increase at that point, will it?

So even though his basic facts are right here his prescription still fails. For while we would like rising productivity and it's easier to raise productivity in manufacturing than servicves this does not then mean that we want to throw resources at manufacturing.

Another way of clarifying this point is that, as we said yesterday, the purpose of all production is consumption. Sure, it would be nice to be more efficient at production: but only of things that people want to consume. And as it happens, it appears that further units of services produce greater consumer surplus than further units of manufactures.

Chang also goes on to point out that developing countries must concentrate on manufactures as this is the only way to raise their general productivity, that productivity increase that by definition leads to becoming a developed country. And I'd agree that it's highly likely that the developing countries will go through their own industrial revolutions. But not for this particular reason:

"If you base your development largely upon services from early on, your long term productivity rate is going to be much slower than when you base it on manufacturing."

The confusion here is that yes, when you're at the technological frontier then improving manufacturing productivity is easier than service productivity. For when you're at that frontier there's an awful lot of head scratching and pondering about what to do next. When you're well behind that frontier then there's no particular reason to think that this is so: indeed, we might think that services are easier. Take, just as an example, retailing in India and the computer hardware industry in India. In which do we think it would be easier to improve productivity?

I'd argue in retailing, the service, rather than computing, the manufacture. To improve the productivity of retailing all we've got to allow (or, err, the Government of India has to allow) is WalMart and Tesco in to start building the standard retailing logistics chain. That's going to be far easier (and cheaper!) than trying to build silicon fab plants (and all the rest) in a country without reliable electricity supplies. Or we might argue that we could improve the various state bureaucracies by computerising them away from the current quill pen and parchment systems.

That it is more difficult for us rich world people to improve services productivity than manufacturing such is entirely true. That the same is true of those places mired in seventeenth century services productivity is not. And what's really interesting about this argument is that if services are 70% of the economy (as they are, UK and US alike) and current poor world services became as productive and efficient as ours, then we'd see those poor countries become vastly richer whatever they do about their manufacturing. Simply because they'll be getting more services for the same as the current input: that's what increasing productivity means you see?

Our fifth thing is this insistence that free market economists claim that everyone is greedy, therefore untrustworthy. But a market economy wouldn't actually work if this were true. Chang then goes on to point out that there are many more motivations to human action than simple greed: in which statement he is obviously correct. Risking your life to save that of a stranger is clearly not motivated by economic greed.

However, he's rather misrepresenting that free marketeer's insistence upon greed being a motivating force. We do indeed insist that most people are greedy and most people are also lazy. They'd like to have as much as they can (or wish) of whatever it is with the least effort required in getting it. This does not rule out there being other motivating forces of course. But more than that, we're insisting that it is "enlightened self interest". That is, looking at rather more than the immediate future, thinking about reputation in general and so on. All of which is pretty much the standard argument. We'd also try to limit pure self interest to being an economic motivation, perhaps not a general one for the entirety of life.

However, there's something that Chang has entirely missed here and that's the implications of the ultimatum game.

Going back to our examples above, if you, as a taxi driver, want to chase and beat up a runaway customer, you may have to risk getting fined for illegal parking or even having your taxi broken into. But what is the chance of you benefiting from an improved standard of behaviour by that passenger, who you may not meet ever again? It would cost you time and energy to spread the good word about that Turkish garage, but why would you do that if you will probably never visit that part of the world again? So, as a self-seeking individual, you wait for someone foolish enough to spend his time and energy in adminstering private justice to wayward taxi-passengers or honest out-of-the-way garages, rather than paying the costs yourself. However, if everyone were a self-interested individual like you, everyone would do as you do. As a result, no one would reward and punish others for their good and bad behaviour. In other words, those invisible reward/sanction mechanisms that free-market economists say create the optical illusion of morality can exist only because we are not the selfish, amoral agents that these economists say we are.

Which brings us to the ultimatum game. In this, player one is given $100. Told to split it between herself and player two, she can choose any split she likes. $99 for her, $1 for the poor second. Or $50/$50, whatever. Player two gets to decide whether the split stands. If it does then the money is divided as was decided upon by player one. If the second player rejects the split then the money is confiscated and no one gets anything.

The results of this rather astonished the people who first performed it. Once the split starts to look "unfair" (roughly, when it passes through $60/$40 or so) then player two starts to reject it more often. Being entirely rational one should accept any split at all: better to have $1 from an unfair split than no dollars from confiscated money. But that's just not what people do. People will harm their own immediate economic interests in order to punish those they see as acting unfairly.

And it is this very ultimatum game that gives us the answer to whether we're all greedy or not. The answer being, yes, we are: for almost no one at all ever offers a $40/$60 split or better than that. The player one offers always start at 50/50 and get worse. That is, we're greedy in our own motivations and actions if we can get away with it. However, in observing (or having influence over) the actions of others we seem to turn on that fairness switch.

That is, human interaction seems to have within it, as the very basis of how we interact, a mechanism to curb and revise the inherent greediness of others. That willingness to punish our own economic interest to punish those we think are taking a liberty. Now why would have such a mechanism have arisen if it were not true that people are indeed greedy in their own actions? We don't protect the virginity of our daughters because we think it's unnecessary to do so: we protect the virginity of our daughters precisely because we know there's great interest in relieving them of it. The existence of a powerful social force to punish greed insists that greed is prevalent.

You could indeed say that player two's reaction is altruism. But even if you do want to say that it's still altruism from the second actor, not the first. The reaction clearly exists in the first place in order to curb that greed we all expect from player one,. And that's what brings us back to enlightened self interest. Such social interactions are not one time games. Indeed, the way to play the closely related prisoners' dilemma game is tit for tat. That is, if the game is to be played through many iterations. As most social life actually is. We have in our most basic reactions something that curbs that innate greed. Which is a pretty good indication that that greed really does exist in the first place.

An interesting little aside. The ultimatum game has really only been played with rich world students. There are those who wonder (and I'm one of them) whether the results would be the same in every society. I'm willing to agree with Chang that an entirely selfish society would not work well as a market economy. He is saying that because market economies do work therefore we cannot all be selfish. I'm claiming that we know that there's a very powerful force that curbs that selfishness. But the results of the ultimatum game from other societies would be incredibly interesting.

For there's the possibility that in societies that are not functional market ones then that willingness to punish, at one's own economic cost, might not be there. Which would, of course, be further proof that my contention is correct. It isn't that we're not all greedy: it's that in some societies there is a countervailing force. A countervailing force that must be there for markets to work. Or at least, one that we consistently find is not there where markets do not work very well at present.

The bottom line is that we cannot go around claiming that humans aren't, in their own motivations and actions, inherently greedy when we can observe such a powerful social force to curb the greed in the motivations and actions of others. The results of the ultimatum game prove that force exists: therefore people must be inherently greedy.

The sixth thing about capitalism we're told is that inflation just isn't so bad. Further, that the attempts to reduce inflation have led to greater economic instability elsewhere. We should thus chillax about inflation and concentrate on other things.

Chang is indeed correct about low rates of inflation. The 1-3% sort of levels that central banks currently aim for aren't so bad: indeed they often aid other changes in the economy. Take, for example, Keynes' point about the rigidity of nominal wages. If inflation is 3% and wage rises 1% then real wages will be falling (as, sadly, they sometimes need to do, see Germany early this century) and this will cause a great deal less fuss and social unrest than if inflation is zero and nominal wages fall 2%.

It's also true that the aim is for low inflation because, in a debt financed society, we really don't want to get into a deflationary period. If nominal incomes and production values fall while nominal debt levels stay static it's entirely possible to enter a sort of death spiral. So erring on the side of caution, a couple of percent, is sensible enough.

Chang goes on to make the leap to the idea that moderate (which, apparently, means 20-40% a year) is also not so bad. He agress that hyperinflation is bad for:

" Hyperinflation undermines the very basis of capitalism, by turning market prices into meaningless noise".

This is an example of how Chang continually conflates capitalism and markets. They're really just not the same thing. They might work well together but capitalism is a description of who gets to own the productive asserts: the capitalists. Markets describe a method of exchange. These simply are not the same thing at all. Indeed, we can have capitalism without markets (the Soviet system was state captialism without markets) and we can have various forms of socialism with markets (Tito's Yugoslavia was an attempt at this and we can certainly have socialist entities within markets: Mondragon, the Co Op and John Lewis come to mind), but it is vital to keep in mind that the two are descriptions of different things, not just interchangeable names for the same socio-economic system.

But Chang's real complaint isn't about inflation: it's about the economic instability of the other parts of the "neoliberal" package. By concentrating on killing inflation we've raised such things as job instability and other forms of non-price instability. Chang thinks this is a bad idea: I think it's entirely excellent. No, not because I'm a rabid neoliberal (although I am) nor because I want to grind the faces of the workers into the dust as they cower in fear of losing their jobs.

No, the entire point and aim of this game of an economic system is that we want to move productive assets from lower value uses to higher value ones. That's what we're trying to do for this movement is the very definition of wealth creation. And, given that we've still got near a billion people living on $1 a day and the like, more wealth creation is still an urgent task.

If we have this need to be continually moving productive assets to higher valued uses then yes, labour will be more insecure in its current employment. As will capital and land of course: and most especally so will human capital. Very few indeed expect to leave university these days and not have to learn new skills by the time they retire. Price insecurity, that inflation, does aid us in these reallocations: but not once we've got past that 1-3% level. Byt the time we get to 20% and up, the price insecurity is raising that signal to noise ratio in that information that prices are giving us. Thus we find that the allocations of assets that we're making is becoming less efficient as a result of the rise in that noise.

Even what Chang calls "moderate" inflation will, in an economy anywhere near the technological boundary, lead to us simply not having accurate enough information to know what we should be doing next: and that hampers wealth creation. It's worth noting that the economies he uses to show that inflation isn't so bad are those which were, at the time, decidedly not at that technological boundary.

As an analogy let us compare inflation to oil or grease. Chang and I are agreeing that drowning in a vat of hyperinflation is a bad idea, most unpleasant. We're also both agreeing that a little bit of oil greases the operation of the economy. The difference is that he sees the lake of oil on a skidpan as being an exciting experience, one that doesn't limit our speed, I as one where the feedback from the system leaves us all entirely out of control and with no idea where we're going or how to change where we are.

As to increasing economic instability in this neoliberal age: yes, quite. We've got the instability we need and require: the flexibility to deploy productive assets from lower to higher value uses. You know, to aid in making the poor rich.

What Chang wants us to understand is that because we used to have protectionism and we still had economic growth and development then therefore we should have protectionism in those places where we want to have economic growth. In other words the poor countries should throw up trade barriers so that all the rich world megacorps cannot supply the people of those countries. Thus will industry develop and in the long term, wealth will be created.

There are a few problems with this argument. One of the most glaring is that he takes historical levels of tariffs as evidence of levels of historical protectionism. Which is an absurdity: until well into the 20th century transport costs were more important than whatever tariff levels were as a barrier to trade. Just as an example, it is true that US tariffs near doubled post Civil War. But actual trade barriers fell as transport prices (essentially, the ocean going steam ship) fell by more than that doubling of the tariffs. His historical evidence of tariff barriers is thus highly suspect. The reason that most countries developed their own industries is precisely because non tariff barriers, those high transport costs, were more important.

Another problem is that, as he actually points out but doesn't make the connection with, all of his examples who developed behind such tariff barriers and with infant industry protection etc simply were not democracies in any modern sense. Even the countries that developed behind them in the 20th century like Taiwan (or his native Korea) were not. Semi-fascist military dictatorships would be a more useful description of the political systems actually. And don't forget what the sort of planning that he's advocating means: not just that government should encourage certain industries but also that local people must be actively prevented from wasting their energies in things which are not part of the plan. It's extraordinarily difficult to think of a way in which a free and liberal democracy could do such things. Force some companies to enter ship building, yes, perhaps that could be done with carrots and not with sticks, but how would one, in any semblance of a liberal society, prevent someone from setting up to build ships if that's how they desired to waste their money? This is the sort of thing that did actually happen in those planned economies too.

Even if we grant him his thesis, that such planned and directed industry, protected by trade barriers, did lead to industrial development, I can't actually see how anything like it could be done in anything close to a free society. Indeed, I'd even be willing to consider the idea that the reason this "worked" in certain societies (like parts of East Asia) and did not work at all in others (parts of Latin American and Africa) was precisely that those two latter sets of societies were not authoritarian enough to allow it to work. People had enough freedom to be able to ignore the plan.

One further very important point from Chang's own argument. He does insist that only those countries that have got to the technological leading edge benefit from free trade. His argument is absolutely not that the rich countries of today, those on that leading edge, would benefit from restrictions on trade: quite the contrary. His argument, such as it is, applies only to developing, not developed, nations. So don't allow anyone to start using his arguments, faulty even as they are, to propose that the UK or the US, EU, should retreat behind tariff barriers. That's not what even he is saying.

We might also mention that historical evidence of restricted trade areas is interesting in an historical sense: but it's not really of any relevance today. This is becasue of the sheer scale of modern industry. Perhaps, maybe, it made sense for the US to build a steel industry behind barriers. There were a number of companies in it and between them they created a market, however protected it was. These days, even the EU isn't a large enough market, all 500 million of us, to produce, say, a viable computer industry. The idea that Tanzania (just as an example)  should have tariff barriers in order to encourage an indigenous computer industry is therefore ridiculous. Or a car industry: it costs $1 billion just to plan out a major new car platform these days, let alone tool up to manufacture it.

The scale of modern industry is simply such that anyone trying to recreate any substantial part of it behind tariff barriers is just going to be making shoddy goods, very expensively, for no very good reason. You might, just about, get away with a little bit of restriction with the billion and more in China and or India. But the idea that Somalia will, with the appropriate planning and protection, ever have a viable steel, car, chemicals or comuter industry is simply nonsense. It might well end up producing firms in an interesting niche or other: but the creation of an entire industry for such a small number of people just isn't ever going to happen.

And there's one final overarching reason why this autarkic route to development is undesirable: it's immoral. Building up infant industries behind tariff barriers is very much a case of jam tomorrow, not jam today. The idea is to deliberately remove from the inhabitants of the country concerned the ability to consume the delights of the current world. So as to enrich those who own the industry within those tariff barriers. That populace is subjected to decades of worse consumption goods than they could have had. Even if this does, in the end, lead to development we've still impoverished the people in favour of the capitalists of that society. Not that I think it does lead to such development: but even if it did that's what is being urged.

Which rather brings us back to why I don't think this will work in a democracy, or in anything even vaguely approaching a free and liberal society. Yes, sure, economic growth is important but not at the cost of deliberately impoverishing this generation. And that's what infant industry protection does and not only do the voters appear not to be willing to sit still for that (and thus it only, if at all, succeeding under authoritarian regimes) I very seriously doubt that it's moral for us to go around insisting that they should.

In our eighth chapter Chang tells us that as capital is, despite Marxist insistences, national in some manner therefore we should be nationalist about capital. Whether or not we allow Johnny Foreigner to come and invest in our pristine and national economy thus become a political question: the politicians should stroke their beards and ponder upon whether this specific capital is going to do the right thing in our specific economy.

One major problem with this is that, unlike Chang, we do not think that politicians, however long and grey their beards, have the ability to note whether a particular investment is good for the economy or not. The average political researcher turned Cabinet Minister could not invest their way out of a wet paper bag. But let's not talk about British politics specifically.

In one part of his analysis Chang is obviously and clearly correct: that captial and companies do still have a national character however multi- or trans-national they may seem. This is not, of course, a new idea:

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

Yes indeed, that's Adam Smith. Wealth of Nations Book IV Chapter 2 para 9. And it's also the only mention of "invisible hand" in the entire tome. No, invisible hand is not a shorthand for the market and all its wondrousness: it's a comment upon the way in which even if capital were entirely free, foreign profits were higher than domestic, there's still something about security and familiarity that leads to capital being invested in that domestic trade. Very much the same reasons Chang gives for why corporates do indeed still have something of a home nation bias.

So Chang's right here but only because he's not original. And it's really most odd to insist that no one tells us this about capitalism when the very point is made in the Ur-foundation document of capitalist economics.

However, there's a very large mistake that is being made in the rest of the argumentation here. In short, it's in this sentence:

"This means that the home country appropriates the bulk of the benefits from a transnational corporation."

If the high end R&D is done at home, if the profits flow home, then the home country gets the major gains because these are the major benefits of a transnational corporation. Which is absurd poppycock. It's an entirely ludicrous thing for an economist to try and claim.

The major benefit of any productive organisation is what is produced: the benefit that people get from what the company (or co-op or individual) pumps out. This is known as the consumer surplus and this really ought to be known even at Cambridge. The benefit of Google is not cushy jobs for engineers, nor the lack of tax revenue in the UK, the benefit of Google's existence is that we all get to use Google. Whether VW's R&D is in Wolfsburg or not matters very much less than that we all have the chance to drive VWs.

Indeed, we can make an attempt at showing how vast is the difference between these two concepts of the value that a corporation provides. It's not quite exact, because this paper talks about Schumpeterian profits (ie, what the entrepreneurs get, not finance capital) but the stunning fact is that the entrepreneurs only get 3% of the value created.

The present study examines the importance of Schumpeterian profits in the United States economy. Schumpeterian profits are defined as those profits that arise when firms are able to appropriate the returns from innovative activity. We first show the underlying equations for Schumpeterian profits. We then estimate the value of these profits for the non-farm business economy. We conclude that only a minuscule fraction of the social returns from technological advances over the 1948-2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.

As I say, it's not quite exactly the same but it is indeed indicative. The vast majority of the value that is created by any productive enterprise is not in who gets the jobs nor the profits nor the tax from that enterprise. It flows to the consumers who get to use the produce of that enterprise.

That is, after all, why the consumers buy it: they value it at more than it costs them to purchase it.

At heart this chapter shows one of Chang's basic problems. He views the economy as being about the benefits to producers and the benefits of production. He's entirely lost sight of the fact that the whole game, the economy and economics as well, is about consumption and opportunities for consumption. Whether or not foreign owners of companies do their R&D locally, pay their taxes or employ locals in the higher echelons of management is such a tiny part of the whole that it's an irrelevance. That foreign capital is still pumping out things that the local gets to use and that's where all the value is, in that consumer surplus.

After all, Smith did also say:

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self-evident that it would be absurd to attempt to prove it. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.

That was back in 1776: isn't it about time that it sunk in?

The tenth thing we have to understand is that actually Americans aren't as rich as all that. This is very important because if that sort of free market capitalist society did lead to the richest society on Earth then of course all the other strictures about how awful free market capitalism is would be rather wasted. We'd start to believe our own lyin' eyes rather than the Reader in Economics at Camdridge and that would just never do.

The rest of the chapter is just hemming and hawing about how we should change the figures to show that actually Americans are not the richest society on the planet. Well, OK, even I'm not going to claim that there aren't certain microstates that beat the US: Luxembourg for example. But comparing a few hundred thousand people to 300 million seems rather like cheating. It would be like comparing Manhattan to Texas for example, just not quite fair. Or, again about the same distortion of scale, comparing the residents of Eaton Square to the entirety of Luxembourg.

Chang has two basic methods in use here to show that the American Dream is just that, a wraith. After we go through all the various ways that we can measure income he agrees that Purchasing Power Parity is the right one. Which is good, for it is. We don't measure just incomes, but incomes as compared to prices in the places the people are living. This gives us a much better idea of living standards. And by PPP measurements, absent those microstates, the US is indeed the winner. To which Chang says but hang about a bit.

Firstly, we know that the US is a more unequal society than many others. Thus the average doesn't give us a true view of how people really live. In an unequal society there will be more people below that (mean) average and thus the real average (ie median) living standard is lower than in a more equal society. Which could even be true but it's not all that large an influence. After we account for all of the taxes and benefits then everyone from Sweden to the US is in a gini (the way we measure inequalty) range of 0.25 to 0.38 or so. And the scale does run from 0.01 to 1.00.

More importantly perhaps we do have some evidence of what actual living standards are at the bottom of the pile in a number of different societies. This chart:

These are the incomes at PPP (so adjusting for price differences) after taxes and benefits. And the comparison is to US median income: so, the bottom 10% in Sweden get 38% of US median income. The bottom 10% in Finland get 38% of US median income. And the bottom 10% in the US get 39% of median income.

Hmm, I think our contention that the US higher average income isn't really valid because the poor get less than the average....thus the greater inequality means that the lives of the poor in the US are worse off than the poor in other countries....doesn't really stand, does it?

The US is definitely a more unequal country. But the poor seem to be about as well (or badly) off as the poor elsewhere.

The other trump that Chang plays is to point out that Americans have longer working hours than people in most other countries. Given that slaving away over a hot desk isn't what life is all about then perhaps we shouldn't all attempt to emulate this US lifestyle then? And while it's true that money isn't everything and that very few of us go into that long dark night bemoaning the paucity of hours we spent working for The Man, Chang has committed a terrible error here. He has assumed that the only form of work we do is paid working hours.

The actual division made is between personal time (we cannot get someone else to sleep for us, take our shower for us), paid working time, household production time and the balance left over is leisure time. The important point to note here is that there is that unpaid working time: that time spent in household production. We might think of digging the allotment to feed the family, childcare time, cooking time, washing and cleaning, repairing the car. It is this time plus paid working time for The Man which produces total working time. And when we look at this total working hours it isn't obviously true that Americans do work more hours than, say, Europeans. It is also possible to substitute household production for paid working time and vice versa. Once can slave over the hot desk to buy a takeaway, or slave over a hot stove to make up for the lack of income from the time not spent at the desk.

In fact, when people actually study exaclty this question (ie, here) they find that the opposite is true, Americans don't work longer hours. For example, the average German woman is working an hour and a half a week more than her US equivalent. And for the men the working hours are almost exactly the same. The German woman might be making sauerkraut at home (I know, terribly culturalist of me) while her American sister goes out to work, earns the money and they buys it: in the process the American sister gaining more leisure time than the German.

It is indeed true, as Chang states, that Americans do more paid working hours per year than Europeans. It is also true that the US is a more unequal society than most of Europe (Italy is actually more so than the US). However, the American poor have incomes around and about the same as the European poor. Americans work fewer unpaid, household production, hours leading to equal or greater leisure time. And as Chang has already admitted, the Americans do indeed, on average have both higher incomes and greater command over consumption opportunities as a result of those higher incomes.

The poor get about the same: the regular guy is both richer and has equal or greater leisure time? Perhaps there is something to say for this free market capitalism stuff they have in the US then?

Footnote. For those who think we shouldn't be talking about household production, please read the Stiglitz Report. The entire issue is well explained there.

The eleventh thing we've not been told about capitalism is so bizarre as to make me wonder whether Chang was proofread before publication. The layout of the free market position is that Africa is irredeemably doomed to low or no economic growth because of structural factors: ethnic diversity, disease, geography and so on. And the reason that we free marketeers say this is because we're embarrassed about the fact that Africa instituted free market reforms in the 80s and hasn't grown since then. Thus we've invented reasons as to why it hasn't rather than rethinking our committment to free market development.

Chang also tells us that post colonial Africa grew rather well (hmm, well, even he admits not well but better than nothing) in the 60s and 70s. So therefore we free marketeers are doubly wrong. We not only killed off what was working we also prescribed what does not and are now lying about it.

There is one teeny little problem with this. Chang has shifted his decades a bit. There was indeed a change in the 80s but this wasn't the widespread adoption of free market policies. That was the debt fuelled autarkic development that was abandoned. Actual free market policies didn't take root until the 1990s in sub-Saharan Africa (the place Chang and we are talking about) and since the mid-1990s there has indeed been a take off in growth in those countries.

In fact, if we look at the work of people like Xavier Sala-i-Martin (do look him up, his web page is a hoot but he's also one of the most cited economists around) we find that Africa is growing so well that they've actually got rising Sen Welfare. That is, not only are incomes going up but inequality is falling at the same time.

What drove the much slower growth of the 60s and 70s was exactly the set of policies that Chang usually proposes. Infant industry protection, government direction of the economy, planning. And most crucially, borrowing to fund that economic development. And, as is usually the problem when people play socialism at some point you run out of other peoples' money. The actual investments that were made (just about every country decided they needed an integrated steel mill for example. Almost none of which ever worked at anything like capacity as the continent could really support perhaps two, not the dozens planned) simply never did pay back the borrowings made to construct them. So the policy of state directed development not only didn't work it came crashing down in a ghastly and impoverishing heap.

What happened to African development is an argument against Chang's policies, not one in favour of them. And I've already mentioned that I'm not sure that you can do Chang's form of directed development in a democracy. Even if (which I'll not admit anyway, but just for the sake of argument) you can do it in an authoritarian or repressive society, the political dynamic is such that you can't wher the people get to vote.

Take, as an example, Ghana. Nkrumah very definitely believed in the socialist and state directed development model. Vast sums were borrowed in order to construct the industry it was thought the place needed (and there were many a western socialist writing these plans in Accra at the time). But while Nkrumah did become increasingly repressive himself he did still face democratic pressures. So the economic policies favoured the urban population, those who tended to vote (or even riot where they could be seen) rather than the larger rural one. The exchange rate was fixed high for example: to the great detriment of the cocoa farmers trying to export, to the great benefit of the urbanites who wished to import goods. There was indeed an attempt to have that planned economy, to build and protect those infant industries. It's just that they were all bad plans: and as I say, I'm convinced that at least part of the reason the bad ones were followed was precisely because it was a democracy.

No, this does not mean that I think that we should have authoritarian government in order to attain economic development through planning. Quite the opposite: that given that we've got democracy we cannot have that planning because the democratic pressures will lead to bad planning.

So, Ghana, and everyone else who tried to follow the same development path (pretty much everyone) ended up going bust. Which is what gives us the slump of the 80s. Finally the recommendations of the Washington Consensus manage to trickle through the intellectual barriers (and let us recall that the Consensus is really just a list of stupid thing you shouldn't do) and to be applied in the 90s. Since then we've had good and decent growth in sub-Saharan Africa. Hurrah etc: but that is a very different story indeed than the one Chang is telling. Which is what rather makes me wonder whether the book was proofed before publication.

There is one little aside as well. Chang does correctly point out that many to most African countries have bad external transport links. For reasons both historic and geographic. What puzzles me is this. Given that Chang says that a country should not leap into the global marketplace, but should develop at least to begin with behind its own borders, well, given that Africa's had no choice in this, why isn't it developed? If few imports lead to economic development as this encourages domestic production then why haven't African countries developed as they've had few imports?

That is just an aside though. The real problem with our eleventh thing is that Chang just isn't describing things as they really did happen. Sub-Saharan Africa did do the planned and tariff bound infant industry protection thing in the 60s and 70s. And growth was there but feeble: and then the entire system went bust. Once the mess was cleared up and free market policies adopted in the 90s we've seen good and decent growth across the region. And no, it's not the free marketeers who have been ascribing Africa's problems to anything other than economic policy. Quite the contrary: we've been using the benighted continent as absolute proof of our contentions. Managed development was tried and failed: free market development is working.

Our twelfth thing about capitalism that we're not told is a masterpiece of straw manning. We're told that the free marketeers insist that government can never pick winners and are then presented with a couple of examples of supposed winners that have been picked by government. QED, the free marketeers are wrong.

But that isn't actually our argument: we don't insist that government, or planning, can never produce a winner. Only that it's less likely to do so than a free market approach to such decisions. At which point the proof falls apart.

Chang does tell us of the foolishness that accompanied the 60s and 70s approach to the planning of economies. The famous line from Eugene Black, the World Bank President, that developing countries were fixated on the three totems - the highway, the integrated steel mill and the monument to the head of state. The monuments got overturned along with the head of state, the roads were unused and the steel mills, as I've already mentioned, were built with gay abandon and then left to rot.

Chang's response to this is that South Korea managed it though! POSCO was set up as a state planned and run, financed, company and it has ended up as a thriving steel company. Even though S. Korea didn't have either the iron ore or the coking coal that would normally be domestically produced to feed such a series of plants. Thus planning can indeed work.

To which there are three responses: the first being that an example of not-A is not a refutation of generally-A. For example, we cannot refute the statement that ugly blokes generally don't end up with good looking women by observing the beauty of Simon Cowell's latest squeeze. We could refute ugly men never by such an observation, but not generally. So it is with our observation that governments are generally bad at picking winners, generally make bad investment decisions, is not refuted by the observation that one government, once, managed to invest in a decent enough steel company.

Which is where Chang's straw man argument comes in: he has claimed that the free market argument is that governments can never, while the actual argument is simply less often than alternative methods.

The second is that the power to direct the economy as S. Korea did in the time Chang is talking about isn't something that's available in a free society. You'll note that I've mentioned this before but it's worth using some of the examples that Chang himself gives us:

“However, even when all those carrots were not enough to convince the businessmen concerned, sticks – big sticks – were pulled out, such as threats to cut off loans from the then wholly state – owned banks or even a “quiet chat” with the secret police......(...)....In the 1960s, the LG Group, the electronics giant, was banned by the government from entering its desired textile industry and was forced to enter the electric cable industry.....(...)...In the 1970s, the Korean government put enormous pressure on Mr. Chung Ju-Yung, the legendary founder of the Hyundai Group, famous for his risk appetite, to start a shipbuilding company. Even Chung is said to have initially baulked at the idea but relented when General Park Chung-Hee, the country's then dictator and the architect of Korea's economic miracle, personally threatened the business group with bankruptcy.”

One can hear, all the way from Cambridge, the lascivious licking of the lips at this display of firm authoritarian government in true Confucian style. But I do rather think we'd all agree, being the good little liberals that we are, that whatever the economic results of such plans we'd rather not have a General as dictator with the power to insist upon such things. As indeed we don't and as I've been pointing out, as a result we would get planning driven by democratic concerns, something very different.

The third argument is that Chang is entirely ignoring opportunity costs here. Which is astounding in self-professed economist. For opportunity cost is the first and most important thing that one has to grasp about the subject (the only other is that there's no free lunch). The actual argument is not whether government can decree that a steel mill, or a shipyard, gets built. Nor even whether such projects will make a return on their investment, survive into the future. It is rather whether that money and investment would have produced better returns if employed in another manner? What could S. Korea have built instead of a steel mill or shipyard? Perhaps the profits would have been larger in building a world beating textiles industry?

By resolutely ignoring this point Chang is here showing that whatever it is that he's talking about it's not really economics. For as I say, opportunity cost is the heart of the subject.

The final argument against government picking investments is best described as momentum. The most important part of an economic system is not actually the decision about what to do. It's about what to stop doing. More specifically, how do we decide that a project, an investment idea, as gone wrong and needs to be killed off? It is in this that governments are appallingly bad, horribly, hugely, worse than the private or free market sector.

To take once recent example: the London Olympics. Before the selection of which city would hold it we were told that it would cost some £2.5 billion or so to stage. Once the decision had been made the budget started to balloon. One of the things that drove it through the £10 billion barrier was the realisation that the government plans hadn't included the VAT that the government would be charging itself. A reasonable estimate of the final cost is £20 billion and change. A private sector adventure that was going ten times over budget would have led to a phone call to Paris asking if, despite having lost the selection competition, they'd still like to have the Games. Or even to stick them in Athens, which already had all the stadia from a previous one.

The impetus in politics, the incentive, is never to admit to having made a mistake. Thus government designed projects, even if they turn out to be disasters, tend not to get cancelled. Doubling down, good money after bad, this is how it works. Whereas the free market sector does indeed look at error, agree that it's an error, and closes it down.

Which is as I say the clinching argument against that state planning of investment and industry. It's not that governments can never pick a winner: even the blind monkey finds a banana occasionally. It's not just that governments are less likely to pick a winner either. Nor that private industry hasn't decided upon some stinkers along the way. Even if government and the market were equally capable of picking winners, government's a lot worse at closing down, bankrupting, the losers. And so are resources wasted by government in a manner that the private sector does not.

Thing 13 is simply that trickle down economics doesn't work. Making the rich richer doesn't make everyone richer therefore we shouldn't be planning to make the rich richer. The whole thing is based upon the marginal propensity to invest: investment is good for the future of the economy, the rich invest more of their incomes than the poor do thus if the rich get more of the money then there will be more investment and that's good for the future. Chang insists that this idea is wrong, based as it is upon the classical economists. The rich don't necessarily invest more therefore allowing them to have more of the pie won't increase investment and so no glorious future.

There's a very serious problem with this argument of Chang's. For the flip side of this marginal propensity to invest is the marginal propensity to consume. And it's an absolutely standard part of Keynesian economics (most definitely not classical economics then!) that the poor have a greater marginal propensity to consume than the rich do. Indeed, we do get people telling us that in economic hard times we should be taking money of the rich to give to the poor. Precisely because the rich will just save and invest it while the poor will spend it thus boosting aggregate demand.

Here is such an argument in fact:

“For example, in an economic downturn like today's, the best way to boost the economy is to redistribute wealth downward, as poorer people tend to spend a higher proportion of their incomes.”

The greater marginal propensity to consume is exactly the same thing as the lower marginal propensity to save and invest: if the poor are more likely to spend then this is the same statement as the rich are more likely to save. The really unfortunate thing for Chang's rejection of the idea that the rich invest more is that this sentence comes from Chang. In this very same chapter where he urges us a to reject the greater marginal propensity to invest of the rich. Oh dear, eh?

It's also probably true that Chang should be deprived of his economists' secret decoder ring or confusing wealth and income as he does in that sentence. Wealth is a stock, income a flow, and never should the two be confused.

There's a common rhetorical flourish throughout the chapter that should have been avoided as well. He veers between talking about a redistribution of income upwards in recent decades and the way in which the growth in incomes has gone disproportionately to the already rich. The two are very much not the same statement: the first is that extant incomes have been snatched, like a humble crust from a Dickensian waif's lips, to be awarded to the rich. The second is that of the new incomes that are being created the upper part of the income distribution is getting most of that new income: the crusts are still safe in the waif's hands. The truth is that there has not been a redistribution of incomes upwards: the last few decades have seen average (both mean and median) incomes rise therefore nothing has been taken away from anyone. It is true that a large portion of the new income created has gone preferentially to those already gaining high incomes.

You may be happy about that or not but that is what has been happening, not the first but the second.

And now we should look at the proof that Chang uses to show that allowing the rich those higher incomes doesn't improve the growth of the economy. It is, fairly simply, that in more equal times like the 50s and 60s then economic growth was higher than it has been since the 80s, when inequality started to rise. What more proof could we require that the rich getting more of the pie doesn't grow said pie?

At which point we'd probably recommend that Chang read his own chapter 9. In which he tells us, entirely correctly, that as economies mature growth will become more difficult and thus, presumably, slower. Chang's (and, interestingly, the correct, which is an amusing coincidence) argument is that in the long term economic growth comes from improvements in total factor productivity (tfp). This tfp is easier to increase in manufacturing than it is in services. Chang uses this to argue that therefore economies should have lots of manufacturing so that tfp can be improved: an argument we rejected as there's only so much manufacturing that we actually want.

But look at what that does to Chang's subsequent argument about economic growth. We know very well that manufacturing has fallen as a portion of western world economies in recent decades. Indeed Chang tells us that manufacturing as a percentage of total production fell, in Britain, from 37% in 1950 to 13% today. That's the manufacturing where tfp growth is easier than in the services which have grown faster (for yes, manufacturing output has still grown, just not as fast as services) which has shrunk as a portion of the economy. And it's Chang himself who tells us that this makes future economic growth more difficult as a result of that difficulty in increasing tfp in services.

Yet when it comes to comparing growth rates in manufacturing heavy and services heavy economies the lack of growth is all about how the rich have all the money. Go figure. Consistency isn't just the hobgoblin of little minds you know.

One final point about why we don't want to be taxing those high incomes too much. It isn't, as Chang purports, because only the rich can make everyone else rich by investing. Rather, it's because the process of people getting rich is what makes us all richer. Assuming no rent seeking (which we free marketeers do indeed abhor) and the lucky sperm club then the only way you can get rich, become rich, is by satisfying the desires of others. You need to be producing something that others are willing to purchase. That they are willing to purchase it shows that they value it more than it costs them: by definition this makes them richer. As the influx of cash makes you richer.

It's not the static state of being rich that makes everyone better off: it's the activity of producing what others value that makes both the producer and consumer richer. And that's why we don't want to take huge bites out of the incomes of people who are doing this: because we'd like them to be seen to be well rewarded so that others are willing to take the risks of similarly producing value that all can enjoy. After all, we know that taxing something produces less of it: thus taxing the creation of wealth will produce less wealth.

Our fourteenth thing is simply that American executives get paid far too much money and that this is wrong. In itself this is proof that a market manner of doing things is ineffective: just the simple fact that the average US CEO gets 300 times the wage of one of his workers proves this.

And we should admit that Chang has some useful points to make here. It's entirely possible that there is rent seeking in the way that CEO pay is determined. Interlocking boards, where you scratch my back with a pay rise and I'll approve your's next month could be partly to blame. The agent/principal problem may well be in play as well. While the shareholders are the legal owners of the company we can all find examples of organisations being run for the benefit of the managers, not the owners. So there is some truth to the processes which Chang points to as raising US CEO incomes.

However, not enough truth for his contention that these pay rates are in some manner wrong or unjustified.

For example, the comparison between the 30 or 40 times average wages that CEOs used to be paid and the 300 they are now. Back when the average US CEO was running a US domestic market company. This simply isn't the case now: the large corporations there (as with the large corporations everywhere in fact) are now global companies. They're massively larger than they used to be so it's not entirely surprising that pay for those running them has gone up.

The two major mistakes made though are not quite so simple.

The first is that Chang wants to claim that people are paid according to their marginal productivity: only if a CEO is worth 300 times the average worker should he be paid that. But that's really not quite how labour markets work. Yes, average wages in a country are going to be determined by average productivity, this is true. But the wages of individuals are going to be determined by supply and demand of those particular skills. Given the mess certain CEOs make of running large corporations we can also see that the supply of the necessary skills is fairly small. We'd thus expect a high price to be paid for them.

But even this is still understating the point. The job of a CEO is not just to make profits for the shareholders: it's to avoid making losses for them. The value therefore of a CEO is not just the profit booked at the end of the year: it's the losses avoided. And those losses can, of course, amount to the entire value of the firm itself as Chrysler and GM shareholders found out.

The second is that Chang hasn't recognised that CEO compensation is like that of traders or footballers. We're in a tournament here. There's no static benchmark by which we measure the performance: that performance is only ever relative to everybody else in the same field. You can be a very fine footballer indeed and never make it to the Premiership simply because there are a couple of huindred players who are better than you are. You could make a perfectly adequate CEO: but you'll not get there if there's a few hundred to a few thousand who are better at it than you are. So CEO pay isn't being based upon some critical appraisal of some abstract standard: it's all about whether you're actually better than the other candidates or not.

And we do very much know one thing about what happens to pay in such tournament markets. It soars: because being 5% better than the other guy means that the employer wants to have you, not the other guy.

And that's really what is behind high executive pay. Yes, there's undoubtedly rent seeking, there's certainly some aspect of larger companies paying larger amounts and so on. But the real point is that it is indeed a tournament and as I say, the one thing we know very well about tournament markets is that they pay massively to those who win the tournaments.