Laissiz Faire as a Development Policy; J. Semmens

In contrast, it is argued, a planned economy can aim at specific objectives of development. Target industries can be developed and nur tured. Educated and trained experts can guide the economy onto planned paths that might, or might not, have been taken by an uncon trolled economy. The experts, informed by exMr. Semmens is an economist for the Arizona Department of Transportation. The views expressed here are those of the author and do not necessarily reflect Departmental policy. perience and observation of what has worked elsewhere should be able to avoid many of the costs of an unguided, trial-and-error, profit and-loss market system. Thus, the planners conclude, economic growth should be forced into a higher pace. While planned development may sound good in theory, the reality is quite a bit different. The government experts in control of Third WorId nations' economic policies are neither willing nor able to chart a better course than the un planned market. Government attempts to direct economic development are little more than plausible sounding theory. An especially pessi mistic view of the role of government interven tion in economic development was expressed by Mancur Olson in The Rise and Decline of Nations. On the one hand, he perceived that it would require ". . . an enormous amount of stupid policies ... to prevent economic devel opment . . ." On the other hand, he observed that " ... growth-retarding regimes, policies, and institutions are the rule rather than the ex ception ... "

The problem with government control of the economy is one of devotion to socialist dogma. The key elements of this dogma include (1) suppressing or supplanting the market with government price and allocation schemes, (2) a reliance on government manipulation of the economy that routinely ignores individual in centives, (3) interference with free commerce via tariffs, quotas, or subsidies, and (4) an em phasis on redistribution of income. Many de veloping countries were formerly subjected to colonial status by various European nations.

The socialist regimes that have arisen in the wake of decolonization are often reflective of government controls employed by colonial powers. That less developed countries have not thrown off the yoke of interventionist policies is probably due to a combination of the tradi tional tribal tendency to authoritarian political structure and the advice of development econo mists who believe that the laws of economics don't apply in the Third World. The contrast between approaches to eco nomic development could not be more stark. The advocates of a strong government role in directing economic development frequently write and speak as if there is no alternative to government intervention. It seems to be as sumed that the market hasn't worked or cannot work or that the mere demonstration of imper fection in the market is sufficient to justify in tervention by government. Little consideration seems to be given to the prospect that govern ment imperfections may be worse than those of the market.

The First Development Economist It is interesting that in all of the many articles on development economics listed in the Journal of Economic Literature only one in the last de cade explicitly mentions Adam Smith. Even at that, the article questions the relevance of Smith's work to development economics. Granted, the analogy between a developing Western world of the eighteenth century and the less developed countries of today is not a perfect match. However, Adam Smith was concerned precisely with the fundamental issue facing less developed countries: how to achieve prosperity. After all, Smith's main treatise was An Inquiry into the Nature and Causes of the Wealth of Nations. Smith's objective was to elaborate on how wealth could be obtained. How a nation is to obtain wealth is the cru cial issue in development economics . Wealth must be produced by the efforts and invest ments of human action. However, not all effort and investment are guaranteed to produce wealth. The waste of time and money is a pos sible outcome of any effort or investment.

Some undertakings yield losses. These di183 minish the wealth of the nation. Undertakings that yield profits increase the wealth of the na tion. Reducing the occasions of loss and multi plying the occasions of profit are the essence of development economics. The prevailing economic policy in the eigh teenth century was mercantilism. This policy was oriented toward promoting national wealth by extensive government intervention. There were regulations, exclusive monopoly fran chises, trade barriers and manipulations of all sorts designed to guide commerce and industry into paths deemed favorable by the govern ment. The government controls may have re sulted in high profits for favored firms, but did they really increase the wealth of the nation? Like the socialistic development economists of today, mercantilists perceived that the nation could be guided to superior economic perfor mance via the wisdom and expertise of knowl edgeable experts and statesmen. Smith, in con trast, perceived that the statesman was also a politician subject to influence by special in terests to the detriment of the economy as a whole. As Smith saw it, establishing barriers to free human action enabled the few to profit at the expense of the many. This could not be the true path to a wealthier nation. Prosperity could not be built upon the deprivation and exploita tion of the many, no matter how much gold was earned by state franchised monopolies.

Ironically, many who today profess an abiding concern for the well-being of the masses end up asking that the government use its powers of coercion for the benefit of the powerless masses. The improbability of this outcome should be readily apparent. The pow erful are apt to control or influence the govern ment already. Granting the government more power in the economic sphere and urging that this power be used to control the economy is unlikely to dismantle the privileges of existing elite~ or their political successors. Adam Smith was acutely aware of this difficulty. His solu tion, unlike the misguided notions of modem radicals, was not to merely transfer coercive governmental power to a new "right-thinking" elite, but to urge the diminution of government economic intervention. This would allow indi viduals the freedom to pursue their own wel fare. Freedom would allow the economy to as184 THE FREEMAN. MAY 1987 sume its natural course-which is to grow and prosper.

The Key to the Wealth of Nations Economic growth was the key to the wealth of nations and the prosperity of the masses of people. Individuals didn't need to struggle over the distribution of a fixed amount of wealth. More could be created. Rather than the des perate squabbling over redistribution that breeds envy and expropriation, the human con dition can be one of cooperation for mutual benefit. If government can be restrained, the market can channel the human proclivity for acquisitiveness into a process of serving the needs of others. In the market economy, free of government interference,' the only path to indi vidual riches. is through service to consumers. Thus, individual greed is made to fulfill human need by the "invisible hand." So, Adam Smith did provide a model for promoting economic growth and development. The role of the government was to be confined to that of protecting the individual's right to freely pursue his own interest. Pursuit of this self-interest would lead the individual to specialize and cooperate with other economic actors. This specialization and cooperation would permit greater productivity. The greater productivity would broaden markets and lead to even more specialization and cooperation. The result would be an ever-expanding wealth for the nation.

Smith's laissez-faire model for economic de velopment provided an effective rationale for the liberal political economies of the nineteenth century. This model appears to have been a better predictor and explainer of economic growth in the ensuing period than the theories of some of Smith's famous successors (i.e.: Malthus, Ricardo, and Marx). However, is Smith's model still relevant for less developed countries today? Even if we question the fit of Smith's model to contemporary development problems, the issue is whether the ideas ad vanced by the first development economist, imperfect though they may be, are better than alternative approaches. There is much to sug gest that Smith's ideas are better. Government vs. Market: The Evidence Adam Smith's model for economic growth was a key guiding influence for nineteenth-cen tury economic policy. Policy in Britain upheld the security of property rights over class privi lege. This meant that contract rather than status determined an individual's position and fate in the economy. This is the crucial distinction be tween a liberal capitalist society and a more traditional social structure. Inevitably, the re placement of status by contract "disrupts" the static equilibrium of the society. Unconstrained individuals desert their traditionally assigned roles and create new places for themselves. In the process, old ways of doing things may be made infeasible, even for those who would wish to maintain them.

It wasn't so much that the 1776 publication of The Wealth of Nations immediately let loose a flood of reform legislation. Undoing some of the regulatory restrictions left over from the mercantilist period took decades. However, a key feature of the capitalist economy is its dy namic nature. Without being prevented from doing so, individuals will tend to adopt easier ways of accomplishing objectives. This leads to increasing efficiency, productivity, and wealth creation. As long as the political regime does not raise new barriers in anticipation of new in dustries and new methods, the dynamism of the market will surge past obsolete government regulations by innovating around them. This is precisely what transpired in the industrial revo lution of the nineteenth century. New industries and methods fell outside the scope of many ex isting regulatory constraints. The political support of capitalism in the in dustrial revolution was basically passive in na ture. This is not to say that there were no public works programs or no assistance through sub sidies or tariffs. These types of government ac tion were relatively insignificant, as well as contrary to the guiding principles of laissez faire capitalism. Low taxes and the shrinking relevance of obsolete trade barriers and regula tions were government's major contributions to economic growth.

Comprehensive government planning, direc tion, or control did not playa major role in the LAISSEZ FAIRE AS A DEVELOPMENT POLICY 185 development of any of today's most highly ad vanced Western nations. In fact, the more closely a nation's policies approximated the laissez-faire model promulgated by Smith, the more rapidly its economy grew. The overall success of the market approach to economic de velopment has been overwhelming. No other approaches have even come close to matching, much less exceeding, the results. (See Rosen berg and Birdzell: How the West Grew Rich.) Today, less developed countries have not only Smith's basic model, but the demonstration of specific examples of economic development experienced in the West. Consequently, some of the false starts and unsuccessful investments undertaken in the past can be avoided by na tions just beginning to industrialize today. So, entering the development process later should be a significant advantage.

Unfortunately, only a few developing na tions have made the most of this late-start ad vantage. For the most part, the economic poli cies adopted by the majority of less developed countries can be characterized as disastrous. Rather than benefiting from the demonstrated utility of Smith's laissez-faire model, all too many less developed countries insist on im posing mercantile-like heavy government inter vention on the economy. Seeing that modern economies are industrialized, developing nation leaders pursue ritualistic imitation. A prime victim of the attempt to modernize via ritual istic imitation is the agricultural sector. In spired perhaps by Marx's denigration of "rural idiocy, " many less developed countries sup press farm prices in order to provide cheap food for urban workers. The idea is that low food prices will permit lower wages and make indus trialization more financially feasible. The pre dictable result, of course, is the simultaneous suppression of agricultural output. In terms of resource availability, it has been estimated that the world's farmers could feed 40 billion people. (See Rydenfelt: A Pattern For Failure: Socialist Economies in Crisis.) That millions starve is a reflection of bad economic policies, not inadequate means.

A favorite, and sad to say frequently recom mended, policy of less developed countries is the establishment of inefficient, capital-inten sive, highly subsidized, and protected industries. Like the mercantilists of the eighteenth century, many modern development econo mists seem to imagine that sheltered monopoly franchises will make nations develop an indus trial base. This approach is just as senseless today as it was in Smith's time. Establishing protected industries causes the nation to consume capital rather than build an industrial base. By producing a resource that it could have bought more cheaply, a firm or na tion diverts scarce capital from more productive uses. Of course, many endorse protective poli cies as a temporary expedient, a sort of invest ment in the future. In the market, businesses have been known to sustain short-term losses on investments intended to produce long-term gains. The fact that private firms decline to es tablish the types of firms that require protec tion, unless protection is assured, is convincing evidence that the supposed long-term gains are sufficiently remote or uncertain to discourage these uses of resources. It should not be sur prising, then, to discover that "temporary"

protection becomes permanent, and that few "infant" industries ever grow to self-sup porting maturity. The long-term effect of government inter vention on the fortunes of less developed coun tries is clearly negative. There is no sound theoretical support for government enhancing growth through planning, directing, and control ling the economy. Statistics also bear out the theoretical case against government control. Unprotected economies consistently perform better than protected ones. Government inter vention consistently and significantly reduces a country's rate of economic growth. The price distortions caused by heavy government inter vention can more than halve the potential growth rate of a developing nation. A study for the World Bank in 1983 found that countries with heavy governmental controls grew at an annual rate of about 3 per cent (on average). This is less than half the annual 7 per cent average growth rate for economies with a low incidence of government interference in the market.

As Adam Smith predicted, market-oriented economies grow faster. The so-called "gang of four" (Singapore, Hong Kong, Taiwan, and South Korea) have engineered what many label 186 THE FREEMAN. MAY 1987 High-tech industrial development in Taiwan. Taiwan, Singapore, Hong Kong, and South Korea have all experienced significant economic growth rates since 1960. Rapid growth in Taiwan and South Korea appeared only after U.S. aid declined. ,'economic miracles" in spurring their nations into high growth paths. The performances of these economies are not due to any miraculous event, unless, of course, one views sensible re frain from interference on the part of their gov ernments as miraculous. The 1960 to 1980 annual combined growth rates for these countries exceeded 7 per cent. This compares favorably with the low income country average of 2.9 per cent, the middle in come country average of 3.7 per cent and the oil-producing country average of 6.2 per cent.

In terms of current levels of well-being we find that Taiwan with a per capita Gross Domestic Product of $2160 is substantially better off than the People's Republic of China with a GDP of $300/capita (figures are for 1981). South Korea with a GDP/capita of $1700 is more well off than the Democratic People's Republic of Korea with a GDP/capita of $1000. While these data do not conclusively prove that a freer market is the cause of improved economic results, they lend important support to the premise that a freer market can make a substantial difference. Critics of the market approach to economic development cite U.S. for eign aid to Taiwan and South Korea as a pos sible alternative explanation for the growth in these countries. However, rapid growth in these countries appeared only after U.S. aid de clined. (See Melvyn Krauss: Development Without Aid.) Why the Market Works Better Supplied with both the theory and the prac tical demonstration of the superiority of a laissez-faire model for economic development, the tragedy is that the adoption of market ap proaches has not been more widespread. The seductive allure of using government power to force a faster pace of growth now dominates most economic development policies. Waiting for the market to produce growth seems so pas sive. However, the attempt to jolt an economy into more rapid growth by government inter vention has more often electrocuted than elec trified less developed countries.

It is not the announced intentions of develop ment policies that are defective, but the instituLAISSEZ FAIRE AS A DEVELOPMENT POLICY 187 tion through which they are to be implemented. Government is an institution designed to apply force. This makes it suited to performing func tions like national defense and law enforce ment. Government is not well suited to the task of making a profit. Yet, making a profit-gen erating a surplus of value over cost-is essen tial if real economic growth is to occur. Adam Smith recognized this truth and advised against an active governmental role in the economy. The key problem with looking to an active government to promote development is that it serves to politicize economic decision-making. The same force that can be used to deter ag gressors or punish criminals can also be used to seize and redistribute resources. Profit-maxi mizing actors in the society may perceive that it is harder to produce resources than to use the government to seize them. Considerable effort and investment will be diverted toward in fluencing government to grant monopoly fran chises, provide subsidies, outlaw competitors, and so on. So, not only do we observe the dis torting inefficiencies of the interventions, but the additional diversion of resources toward po litical lobbying. This attempt to obtain re sources through government coercion and its policy outputs act as a drag on the productive capacity of the economy. The result is retarded development.

Rather than promoting an active government and the struggle over who will seize whose wealth, development policy could achieve better results by seeking governmental pas sivity in order to permit an active private economy to create wealth. After all, wealth creation is a subjective, individualized process. The goal is to maximize value. However, value is a subjective concept. Only individuals are in position to know what is valuable to them. Left free to pursue value, people are more likely to achieve it than if they are channeled toward Francis E. Mahaffy what some government expert believes will benefit the society. Smith recognized this in urging that individuals be left to make their own economic decisions. People will tend to be more energetic and more enthusiastic when carrying out plans of their own choosing than when responding to the plans others seek to impose upon them. A laissez-faire development policy will allow a maximum of individual plans and actions. This market-based approach can unleash what may be the most scarce resource of all: entrepre neurship. Developing an economy entails risk.

Not all plans can succeed. Government plan ners can afford to devote huge sums of a na tion's scarce resources to moneylosing ven tures. Private entrepreneurs cannot. Bad deci sion-makers in the pr~Nate sector will lose their capital. Bad decision-makers in government lose someone else's capital. A policy frame work that allows private sector entrepreneurs to experience the rewards and penalties of their decision-making will generate a better set of decisions than a policy framework that sup presses or supplants this market process. The market economy involves a dispersion of power that facilitates optimal growth. When political power plays an excessively large role in the economy, entrenched elites and vested interests will be positioned to oppose the trans formation of society that will inevitably occur with economic growth. Whether the entrenched position is one favoring traditional culture, well-connected elites, or an ideology, the victims are still the masses of people denied the opportunity to better themselves. Constructing a laissez-faire model for political economy that would grant the masses of people the opportu nity to better their economic condition was Adam Smith's ingenious contribution to world economic development. 0 IDEAS ON LIBERTY O nly when the state is restricted to the administration of justice, and economic creativity thus freed from arbitrary restraints, will con ditions exist for making possible a lasting improvement in the welfare of the more miserable peoples of the world.