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Collapsing the Tent on the Mercantilist Revival

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Harvard professor Dani Rodrik’s recent mercantilist apology attempts to illustrate the unappreciated benefits of a much-maligned political-economic system: mercantilism. “Today, mercantilism is typically dismissed as an archaic and blatantly erroneous set of ideas about economic policy,” Rodrik acknowledges. Thus his essay provides a defense of this system, which he believes has much to offer over the alternative and (according to Rodrik) in-vogue market liberalism.  The best feature of his essay is its level-headedness. Arguments regarding the form that society’s political-economic institutions ought to take are often fraught with ideological snarling and gnashing of teeth rather than reasoned analysis. Rodrik’s essay is free of such invective and he paints a charitable picture of the opposition. Despite that, however, his arguments fall short of the mark. The benefits of his particular brand of mercantilism are either overstated or mistakenly given credit for market liberalization, and he fails to categorize correctly an important evaluative foundation of liberalism.

Before considering Rodrik’s arguments, it is important to pin down the essential features of market liberalism and mercantilism.  According to Rodrik, “The liberal model views the state as necessarily predatory and the private sector as inherently rent-seeking. So it advocates a strict separation between the state and private business. Mercantilism, by contrast, offers a corporatist vision in which the state and private business are allies and cooperate in pursuit of common objectives, such as domestic economic growth or national power.” The essence of the distinction between the two paradigms lies in the relationship between government and civil society. Should government be strictly limited in its powers and capabilities, so as not to encroach on the wealth-creating potential of voluntary market arrangements? Or should government be an ally and active cooperator with market actors in their quest to create and secure material values? In other words, should we rely on the invisible hand or should we prefer the vigorous support of the helping hand?

Cronyism

To Rodrik’s credit, he immediately recognizes a problem inherent in a close relationship between government and market (corporate) actors: “The mercantilist model can be derided as state capitalism or cronyism.” The ability of corporate actors to capture the coercive power of government to transfer to itself desirable goods, such as monopoly privileges or direct subsidies — a phenomenon known as rent-seeking — is indeed a feature of any system that so closely links the boardroom and the capitol building. But in the very next sentence Rodrik downplays such concerns by pointing to the success some Asian countries, most notably China, have had with such a system. That is surely a case of mistaken attribution. Before 1970 China was extremely poor and, on the basis of trend-growth rates, it did not look as if that would change.  As everyone today knows, it did change: China began retreating from some of its command-and-control policies and embraced limited market liberalizations at the margin. Today the political-economic structure of China does indeed feature large businesses and government that act in collaboration, but that is because of the limited extent of liberalization.  In attributing China’s success in recent years to a government-corporate partnership, Rodrik is implicitly asserting that the result brought about by marginal market liberalizations is itself the cause of increasing prosperity.

Next, Rodrik points out the differing importance market liberalism and mercantilism place on the interests of consumers and producers: “For liberals, consumers are king. The ultimate objective of economic policy is to increase households’ consumption potential, which requires giving them unhindered access to the cheapest-possible goods and services…. Mercantilists, by contrast, emphasize the productive side of the economy. For them, a sound economy requires a sound production structure. And consumption needs to be underpinned by high employment at adequate wages.”

Much here needs to be untangled. First, liberals have good reason to analyze the impact of economic policy, and the effects of the political-economic system more generally, on the welfare of the consumer: For any given good or service, potential consumers outnumber potential producers. More fundamentally, people do not produce goods and services as ends in themselves; they produce to increase their well-being. Thus to focus on producers’ privilege over consumers in economic analysis is to misunderstand the point of production in the first place.

The second point is closely related to the first.  Any privilege that producers enjoy as a result of government largess must be paid for by somebody; usually that somebody is the consumer. Producers benefit by enjoying a favorable legal environment and financial support, while consumers get saddled with the bill.  Rodrik explicitly recognizes this point and even cites a study suggesting this might be a losing proposition. But he then dismisses the argument, asserting, “These are simply the costs of building a modern economy and setting the stage for long-term prosperity.”  It is impossible to falsify such a vague statement, and to assume mercantilism can in fact “set the stage for long-term prosperity” in a way impossible (or prohibitively costly) for market liberalism is question-begging.  Since Rodrik admits that his views are far outside the mainstream, it seems appropriate for him to bear the burden of proof.  But the only support offered in justification for the above is more praise for the economic performance of South Korea, Taiwan, and, especially, China, as if that were sufficient to demonstrate the superiority of Rodrik’s model.  Tricky though it may be to analyze counterfactuals, there are good theoretical reasons for believing that further liberalization would have served those countries better — such as the perverse incentives for cronyism mentioned above and the knowledge-generating and -disseminating capabilities of the decentralized market process.

Production, specific and general

What of Rodrik’s implicit claim that mercantilist policies would do a better job securing “high employment at adequate wages”? From the points above we can see that claim does not follow.  Since production is the source of, and reason for, consumption, an environment conducive to production — respect for property rights and the rule of law, which are foundational to market liberalism, come to mind — will result in ample consumptive opportunities for the populace. Wages in turn will reflect the value that workers add to the production process.  Ultimately there is no getting around the need for a political-economic framework that is conducive not to specific acts of production, but to production in general.  There is no magic formula policymakers can use to avoid the constraint that “the division of labor is limited by the extent of the market,” as the founding father of modern economics, Adam Smith, pointed out centuries ago.  All mercantilist policies can do is benefit specific lines of production at the expense of others. What the mercantilist state giveth, it first taketh away.

Rodrik ends his essay with a casual indictment of liberalism on other margins, attributing to it “the rise in inequality and the plight of the middle class in the West, together with the financial crisis that deregulation spawned,” along with continuing economic malaise in America and Europe. Each of these concerns merits a separate essay.  For now, it should be pointed out that attributing to market liberalism rising inequality and the financial crisis, while perhaps accepted by a majority of “men in the street,” is hardly the consensus among economists. Changing demographics and perverse incentives stemming from the political sector are the chief opposing explanations for distributional and macroeconomic conditions, respectively.

Again, Rodrik’s essay is commendable as a dispassionate and reasoned argument for an out-of-favor set of social arrangements.  However, by assumption he attributes many of the observed facts to the success of mercantilism, and he does not identify correctly the motivating factors underlying market liberalism. We should demand much more in the way of convincing argument before we seriously consider reverting to a political-economic system that, historically, was based on a number of highly suspect beliefs regarding how economies function.

This article was originally published in the June 2013 edition of Future of Freedom.

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    Alexander William Salter is a Ph.D. student in economics at George Mason University.