The long lasting effects of trade

In The Long Process of Development: Building Markets and States in Pre-industrial England, Spain and their Colonies, my co-author and I show that smugglers in New Spain (current Mexico plus much more) conducted virtually all trade with Europe in the 1600s, including much of the exportation of silver.  In fact, it is estimated that in some decades over 50% of the silver sent to Europe was shipped illegally from Mexico.  Because this trade was illegal, it didn’t bring about a growing system of laws, rules, & regulations enforceable in a judicial system.

As Douglass North wrote, it is important to have property rights that are internalized in people’s consciousness and unconsciousness, embodied in multi-volume codes of laws and regulations, and enforced by impartial courts and professional bureaucracies. That Mexico did not have because of its smugglers ’ economy.

In principle, the de facto legalization of trade between Mexican ports and the United States during the war with France should have been highly beneficial to the development of a commercial culture in Mexico. It was, in fact, advantageous, but the benefits were limited by the fact that Mexico had few ships on the East coast to use in trade with either the US or anyone else.

An excellent new working paper shows that perhaps illegal trading wasn’t so bad after all, even if it didn’t give rise to good institutions.  Daphne Alvarez Villa and Jenny Guarded, in “The Long-Run Influence of Institutions Governing Trade: The Case of Colonial and Pirates’ Ports in Mexico,” show that:

“The presence of trade, either in its legal or illegal form, leads to significantly better development outcomes compared to neighboring areas where such activities were absent.”

They note that conventional wisdom would assume that “smuggling may be detrimental for long-run economic growth and development for numerous reasons: first, by fostering a culture of informality and illegality in detriment of revenue collection; second, the weaker presence of the state may make it difficult to enforce contracts and protect property rights thus depressing economic activity; and finally, colonial smuggling was at times accompanied by piracy and these ports were often subject to armed attacks and pillage, particularly during the 16th and 17th century.”

However, “smuggling during colonial times may have created the necessary conditions to benefit from trade liberalization in the late 18th century (comercio libre) and after independence (1821). For instance, merchants with the “know-how” and experience of clandestine networks had an advantage in the business once trade restrictions were lifted. Such an early start in commercial activities (either legal or illegal) may have compensated for the damaging effects of a weak state presence and supports an emphasis on increasing returns to scale mechanisms.”

The paper is quite good and well worth reading in full.

 

Thinking harder about globalization

I’ve been thinking recently of how little credibility economists have with working class Americans (or so it seems to me).  In some sense, I’m not surprised.  Economists did a terrible job of predicting the Great Recession and didn’t have much new to offer when it came to fixing the mess.  I could hardly blame anyone for questioning how much faith to put in economic theories.

The Harvard Business Review has a great article this week by Joan Williams called “What So Many People Don’t Get About the U.S. Working Class” and she gives a lot of other reasons that white, middle class voters may distrust economists.  She writes “One key message is that trade deals are far more expensive than we’ve treated them, because sustained job development and training programs need to be counted as part of their costs.” 

I think that she is absolutely correct and that perhaps we have focused too much on the long run benefits of trade (wouldn’t be the first time) to the detriment of the short term costs on American workers.  I had a student once who argued that we should just elect economists as presidents and they can then enact the best policies.  Beside the fact that economists don’t come close to agreeing what the “best policies” are, there is also the issue that we live in a democracy and any policy (good or bad) needs popular support behind it.  I stress all the time to my students that they need to understand the economics and the politics in whatever country they are studying.  It is not enough to just know the economics.  You can recommend awesome, growth-producing policies, but if you can’t convince anyone that you are right, then you have nothing.

Somehow this is harder for me to do when it comes to thinking of US policy.  One of the best, and most honest, exchanges I’ve read about the effect of trade policy on the US middle class came in an interview with Angus Deaton.  The interviewer asks Deaton for his thoughts about globalization and the increasing mortality rate, a provocative finding described in The Atlantic in January 2016:

“Between 1998 and 2013, Case and Deaton argue, white Americans across multiple age groups experienced large spikes in suicide and fatalities related to alcohol and drug abuse—spikes that were so large that, for whites aged 45 to 54, they overwhelmed the dependable modern trend of steadily improving life expectancy. ”  

And this is Deaton’s response to the interviewer:

“But you asked me why this [the mortality rate]—what has this got to do with globalization, and I’m like, you know. And I’ve always taken the position which is—you know, I’ve done a lot of work over the years for the World Bank, and I think this is a pretty accepted, in those organizations, cosmopolitan position—globalization has dragged or pulled or liberated hundreds of millions of people from poverty, in India and China in particular. And those people were really poor to start with. So this is just like an incredibly major achievement in the world.

So when you think the world is going to hell in a handbasket, which it sort of is right now, you have to look back on those amazing achievements. And a lot of those have come from opening up markets, you know, from greater international trade, from all the things we know about. And the sort of cosmopolitan position is, OK, maybe some people in the U.S. and Western Europe were hurt by this process, but you know, they’re really well-off compared with the people in China and India who are being helped. So if you take this sort of positon, that we prefer to help people who are poorer than people who are richer, then this seemed like a pretty good thing.

And so, however, when you see these middle-aged people—and these are the people in the U.S. who are bearing the brunt of this—these are the people who used to have good factor jobs with on-the-job training. These are the people who could build good lives for themselves and for their kids. And all of that has gone away. The factory’s in Cambodia, the factory’s in Vietnam, the factory’s in China, wherever. And, you know, there’s been a lot of dispute between the right and left as to how badly off them are. You know, are the price indices correct, are median wages really falling, and so on. But when you actually see them killing themselves, you know, and the mortality rates are going up, then you think something really, really seriously has gone wrong. One of my colleagues—an anthropologist, Carolyn Rouse—has used the term these people have lost the narrative of their lives.

Now, Pamela asked me the question, you know, why? We don’t know why is the answer. And, of course, everybody has their theory, and that’s where—but, I mean, it’s hard to believe it’s not connected up with those 20 or 30 years of declining economic prospects for people with only a high school education in the United States. And, you know, somehow we’ve got to find a way—I’m not against globalization. I’m certainly not going to go for protectionist solutions or something. But we’ve got to find a way of sharing the benefits with those people, too—and if not with them, at least with their kids.”

Perhaps economists shouldn’t have been so surprised about working class support for Donald Trump.

*Note: The blog title derives from a good quote by Deaton on globalization and its short to medium term effects, saying “We’ve really got to think harder about this than we have.”  

 

 

 

Historical Political Economy

I find that some of the most interesting development papers are ones that have a historical perspective.  These two papers look really interesting and are heading to the top of the stack.

1. “The transatlantic slave trade and the evolution of political authority in West Africa” by Warren C. Whatley

I trace the impact of the trans-Atlantic slave trade on the evolution of political authority in West Africa. I present econometric evidence showing that the trans-Atlantic slave trade increased absolutism in pre-colonial West Africa by approximately 17% to 35%, while reducing democracy and liberalism. I argue that this slavery-induced absolutism also influenced the structure of African political institutions in the colonial era and beyond. I present aggregate evidence showing that British colonies that exported more slaves in the era of the slave trade were ruled more-indirectly by colonial administrations. I argue that indirect colonial rule relied on sub-national absolutisms to control populations and extract surplus, and in the process transformed absolutist political customs into rule of law. The post-colonial federal authority, like the colonial authority before it, lacked the administrative apparatus and political clout to integrate these local authorities, even when they wanted to. From this perspective, state-failure in West Africa may be rooted in a political and economic history that is unique to Africa in many respects, a history that dates at least as far back as the era of the transatlantic slave trade.

 

2. “Bounded Leviathan: or why North and Weingast are only right on the right half” by Maria Alejandra Irigoin and Regina Grafe

The great merit of North’s and Weingast’s insight into the importance of a ruler’s credible commitment to protecting property rights is that it is both parsimonious and it lends itself beautifully to generalizations. It has e.g. inspired the economic literature on the importance of legal origins” (LaPorta et al., 1998, 2008), which seemed to vindicate the notion that post-Glorious Revolution English institutions were particularly conducive to economic growth. More recently economists have acknowledged that growth in fact depends on state capacity. This encompasses not only investor protection (legal capacity) but also the ability of the state to finance itself, fiscal capacity. (Besley and Persson, 2009, 2010) show that the protection of private property rights and that of public property rights to taxation are linked and most likely co-evolutionary. However, the precise relation between the two is anything but clear. This paper argues that North’s and Weingast’s models one-sided focus on state coercion that threatened subject’ property rights has obscured the relation between coercion used in revenue collection and total revenue role of fiscal capacity. We suggest a very simple model to show that this relationship between state fiscal capacity and legal capacity is not linear, especially in the phase of nation state building. Before 1800 states faced one of two very different central challenges. 1) States that already exhibited high levels of coercion had to try to keep in check the ruler’s potential for predation as North and Weingast argued. 2) States that used very low levels of coercion faced a coordination problem instead of a predation issue. The case of Spain provides empirical evidence for the existence of states where an increase in coercion would have improved fiscal capacity, but high levels of legal capacity paradoxically prevented the ruler from adopting this path. Finally, we use financial market developments to show the serious welfare implications that resulted from such a lack of coordination and integration.