Sitting in the Cafe Paris in Prague checking email, I receive a challenge from an old friend. He sends me John Cassidy's "Enter the Dragon: Why "State Capitalism" is China's Biggest Knockoff," New Yorker (December 13, 2010). The abstract is here, to access the full article you need a subscription or you could have a friend send you a scanned copy of the pdf as I did. The challenge put to me is, do you have an answer to Cassidy's claim that it is "state capitalism" and not free trade that led to the wealth of nations in the West (e.g., UK and USA). I don't know if a blog post is the best place to respond, but I wanted to put up some links and arguments that I think have already provided a response.
First, let me say that I probably read John Cassidy more than any other economic journalist at the moment. This is true for two reasons: (1) I find his writing style and his ambitions to be admirable, and (2) I disagree with almost everything he argues. This article is no different. In the course of a book review essay, he covers basically 300 years of history and attempts to draw policy implications for our contemporary world. So I actually appreciate my friend sending me the article in full.
Second, the argument that Cassidy tries to marshall is certainly not new to him. Great Britain was protectionist and the US was protectionist during their time of growth. So, therefore, protectionism is the key to growth, the argument goes. This is a classic example, I would argue, of the fallacy of "after this, therefore because of this" in economic analysis. Yes, Great Britain was protectionist, but as Barry Weingast often argued in the discussions surrounding John Nye's wonderful War, Wine and Taxes, which also includes an argument about the myth of free trade Britain, the critical issue is domestic economic freedom. It turns out that Britain was an extremely free domestic economy at the time that we are discussing. Cassidy could have cited John's work as well, but he would have missed the critical issues in Nye's brilliant work --- namely the political economy of fiscal institutions as a function of fiscal technology.
The argument that Cassidy gives is also basically found in Liah Greenfeld's The Spirit of Capitalism. Though Greenfeld doesn't talk about Great Britain but the USA,and her argument is basically that while the USA used Jeffersonian rhetoric they followed Hamiltonian policies. Policies of protectionism and which developed a strong national identify, etc. If we didn't temper our Jeffersonian rhetoric with Hamiltonian action, the US never would have developed into a capitalist juggernaut. At a conference on Deirdre McCloskey's next volume, Bourgeois Recalculation (though don't forget her current volume, Bourgeois Dignity and see this interview by William Easterly), I actually argued that Greenfeld's book is my least favorite book of the past decade because of this argument and the problem once again of "after this, therefore because of this" type argument in a book supposedly addressing economics. Though the reality is that Greenfeld is one of the great spokesperson for the anti-economists economic analysis in the guise of historical sociology. Where are the mechanisms in her "theory"? Observation is not analysis, it requires analysis. And the tools of analysis are provided by economics. And just like Weingast's comment about the domestic economy in Britain, you would have to ask about the extent of domestic freedom as well as the magnitude of "state capitalism" in 19th century USA.
Let me be clear about why I keep repeating this "after this, therefore because of this" line. The problem is, as Adam Smith pointed out long ago, that the market economy is so powerful and resilient that it can overcome hundreds of impertinent regulations that human folly has thrust upon it. The market cannot side-step impertinent regulations forever, there is some tipping point. But the fact that it can side-step and meet head-on so many and still produce wealth creates a problem I have discussed before. Regulations and other "bad" economic policies are passed, but the market nevertheless muddles through and we are still better off tomorrow than we are today, and thus the advocate of regulation points to the fact that regulations were passed yet growth continued and says "see these policies are not counter-productive as you market fundamentalist would have us believe." But this perspective, fails to consider the "unseen", the true cost of the policies that are captured in a counter-factual. What economic growth would have been had no impertinent regulations and restrictions been passed at all.
Did the USA pursue Hamiltonian mercantilist policies that were at odds with the Jeffersonian rhetoric? Of course. But we also did a lot of things that were consistent with Jeffersonianism and the involvement of the government in the economy was minimal by any reasonable measure. So not only do works such as Greenfeld, which Cassidy does not discuss, as well as the works Cassidy does discussion miss the point about "what is seen and what is unseen", they are confused on the magnitude of what they see! We have to do the detailed historical work to counter this new myth making a state capitalist Britain and state capitalist USA during their industrial development phase, but there is an extensive literature that already counters much of what is being argued.
Before I go there, let me in the interest of full disclosure point out that Alex Fink and I recently participated in a symposium in the Journal of Institutional Economics motivated by a paper from one of the authors Cassidy does rely on -- Ha Joon Chang of Cambridge University. Our contribution is entitled "Institutions First", and we focus our critique mainly on Chang's confusion of institutions with policy, but we could have ventured into even more areas of misdirection. In reading Chang's paper and the book Cassidy relies on, I was reminded of a story Murray Rothbard once told me. He was at a conference and a speaker presented a paper critical of Rothbard's work and said, "I feel bad criticizing a man who wrote a thousand page book but only made 10 errors." When Rothbard got up to reply, he told us with his characteristic cackle that he responded. "You feel bad, I have to comment on a 10 page paper that has 1000 errors in it." There are many errors of fact and judgment in Chang's book and in the article about development, that the conversation is hard to get started. So you have to focus.
The Cassidy article has the same problem for the economist. So lets focus on this claim that "state capitalism" is the cause of the wealth of nations, and to look at the evidence on the Asian Tigers which supposedly provides the most recent evidence in favor of this hypothesis. David Henderson years ago challenged the Myth of MITI, and my former doctoral student Ben Powell actually wrote his thesis on the issue of state-led industrialization versus real economic development. And I think the most comprehensive book of a theoretical nature on the subject is Don Lavoie's National Economic Planning: What is Left? And inside of my edited collection, The Collapse of Development Planning, you can find several essays which challenge the mythology that state-led development was the cause of the Asian economic growth.
"State Capitalism" is not the source of economic growth and development. There is no doubt that mercantilist processes are in operation in China, just as there was mercantilist policies followed in the US from Hamilton to today. The question is always whether they dominate the economic scene or are merely one of the hundreds of impertinent restrictions that human folly has thrust upon the market economy. Rather than cause of growth these restrictions are impediments to real growth and development, and to the realization of generalized prosperity for a nation and its people. The Dragon would be better served by following the spirit of enterprise rather than the spirit of capitalism, if by capitalism we mean the myriad of special interest legislation that passes as industrial policy.