The Anarchy of Success

In the latest issue of the New York Review of Books I have a review (ungated here) of: Leonard Mlodinow, The Drunkard's Walk: How Randomness Rules Our Lives

Ha-Joon Chang, Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism.

The success of the East Asian Gang of Four—and now China—has exerted an irresistible lure to researchers of growth. Academic economists who were used to studying whether a politically difficult tax reform might make Americans better off by an amount equivalent to 0.1 percent of US GDP rushed into a field of inquiry that promises to explain how to increase your income seventeen times over. Theoretical breakthroughs in the late 1980s by Paul Romer (now at Stanford) and by Nobel laureate Robert Lucas helped inspire a remarkable effort by economists to find in the empirical data which factors reliably lead to growth. Yet hundreds of research articles later, we wound up at a surprising end point: we don't know.

In 2007, the dean of growth research, Nobel laureate Robert Solow, said: "In real life it is very hard to move the permanent growth rate; and when it happens...the source can be a bit mysterious even after the fact."

In view of this acknowledged ignorance, how can there still be so many writers who claim to know how to promote growth? The Drunkard's Walk by Leonard Mlodinow offers a crucial insight. Humans are suckers for finding patterns where none really exist, like seeing the shapes of lions and giraffes in the clouds. It wasn't that economists had no explanations of what causes growth. On the contrary, we had too many. One survey of the field counted no fewer than 145 separate factors that had been found to be associated with growth. But most of these patterns were spurious, because they failed to hold up when other researchers tried to replicate them. Economists can say something useful about economic success, but we have to clear away a lot of false overconfidence before we get to that point.

In Bad Samaritans, Ha-Joon Chang is both a critic and a purveyor of such overconfidence. He rightly criticizes those who have made overly strong growth rate effects for free trade and orthodox capitalism, but then he turns around and makes equally strong claims for protectionism and what he calls "heterodox" capitalism, which includes such features as government promotion of favored industries, state-owned enterprises, and heavy regulation of foreign direct investment.

Chang and almost everyone else, have also been suffering from a fallacy, what Mlodinow (following Nobel laureate Daniel Kahneman) calls the Law of Small Numbers. This is a sarcastic reference to the Law of Large Numbers, in which you can have a high degree of confidence in the average value of a sample if the sample includes a very large number of observations. The Law of Small Numbers is when you stop short of having "enough" observations and show high confidence anyway. The Law of Small Numbers is our tendency to judge performance by too small a slice of experience.

Chang at one point suggests as evidence that free trade isn't working the fact that Mexico had only 1.8 percent per capita growth from 1994 to 2002—the period following the enactment of the North American Free Trade Agreement. Chang also picks and chooses episodes in which it appeared heterodox policies were doing well. But economic growth is so volatile across and within countries that it takes a very long time to decide what policies are having a positive effect on growth, which lies behind the failure of both systematic growth evidence and anecdotal evidence a la Chang.

One way to escape from the Law of Small Numbers is to seek to explain levels of per capita income already attained today rather than rates of growth. The level of income you have reached today frees you from small numbers because it reflects the outcome of your entire previous growth experience. So let's ask, who are the richest and the poorest countries now, and what is the difference between them?

The now-rich countries leaped ahead during a long period in which they were more free-trade and free-market (although Chang is correct they were far from perfectly laissez-faire) than the rest of the world. More important than the policies that Chang emphasizes, the now-rich countries had far better institutions and transport infrastructure that made free trade and free markets possible; the now poor countries historically always had a lot of “protection” through high transport costs and lousy infrastructure.

This big stylized fact just confirms the Western consensus around the basic concept of a state shaped by representative democracy, safeguarding individual rights and supplying crucial infrastructure such as transport, while rewarding entrepreneurship and technological creativity. Such common-sense ideas have stood the test of time over the very long run, both in their acceptance by the population in most economically successful societies (compared to their absence and rejection in unsuccessful economies) and in their pragmatic consequences for prosperity (as showed by the comparison to the poverty of states that lack most of the above conditions).

Despite Chang's air of desperation about the experts getting it right (something shared by some of Chang's free-market opponents), in the end, third-world growth seems to have been fairly expert-proof. Perhaps prosperity is not after all designed from above; perhaps it emerges from below, from the independent actions of many individuals who figure out their own paths.