Global Inequality, Free Trade, and Development Economics

Introduction: Technology Versus Property Rights

To understand the nature of inequality between the global north and south, one must understand the role of technology in the international system. A common assumption holds that the amount of technology available to a nation determines its prosperity — but this view overlooks the more important question of how technology is used. In the wealthiest western nations, the application of technology has been actively directed by well-regulated capital lending mechanisms. These financial instruments allow inventors, laborers, and merchants to borrow money at interest, which can later be repaid within a legal environment that protects property and contracts.

According to Weatherby, the tragedy of the third world has four culprits: dependence on the west, delayed modernization, increasing population, and the unequal distribution of wealth. He argues that even if all third world countries do not possess all four of these characteristics, each possesses at least two or three. If the lack of modernization is taken as an example, these problems can be seen as symptomatic of third world poverty rather than as root causes of it. People in developing countries are dependent on the west, yet most never see the foreign aid dollars sent to their governments — that money is spent instead on wasteful economic schemes or by ruling elites. Those governments would not exist without such transfers. It is also well established that higher standards of living encourage lower population growth rates. The question of modernization, then, requires closer examination.

In the 18th century, one of the most popular playthings of continental European royalty was the automaton. These ingenious devices were essentially wind-up toys that used clockwork to mimic natural phenomena — a butterfly, or a man playing chess. Such devices had existed in Europe since before the fall of Constantinople in 1453, when the Byzantine emperor's court featured an automatic tree populated by hydraulic-powered singing birds. Despite such remarkable examples of human ingenuity, the predominant portion of European society lived as it had for centuries: illiterate and impoverished. It was not until entrepreneurs were able to borrow money at interest to develop these technologies into mills and steam engines that their existence fomented the Industrial Revolution.

In much the same way, the developing world today exists alongside vast technological improvements — nuclear reactors in China, the Aswan Dam in Egypt — yet remains poor. According to noted economic theorist Hernando De Soto, "when you step out the door of the Nile Hilton, what you are leaving behind is not the high-technology world of fax machines and ice makers, television and antibiotics. The people of Cairo have access to all those things. What you are really leaving behind is the world of legally enforceable transactions on property rights." These property rights, De Soto argues, do not stem from a democratically elected regime or even from the privatization of large government-run industries, but from the ability of farmers and merchants to borrow against what they already own.

Dead Capital and the Property Rights Problem

In the United States and other western countries, the greatest asset owned by most people is their home. An American homeowner holds a deed to his or her property and can borrow against it to start a small business. In developing countries, crippling bureaucracies and the absence of an infrastructure to support the establishment of contracts makes this impossible. In addition, creating a legal business requires private citizens to navigate innumerable bureaucratic hurdles.

De Soto compares the experience of third world countries to the early history of the United States, where a plot of land might be simultaneously claimed by someone who bought it from the local Native tribe and by another to whom it was granted by the king as part of a sea-to-sea land grant — neither of whom may ever have set foot in America. When the situation was resolved, the land was held by the federal government, which became the first entity to allow settlers to own land legally. De Soto notes that the establishment of a system of recognized and transferable ownership was developed in order to protect that ownership — which is why it is difficult for many to grasp its significance in the world economy: it enables ordinary men and women to borrow money against collateral.

De Soto's research foundation conducted studies of several large developing nations, including Peru, the Philippines, Haiti, and Egypt. In Peru, they found that 53% of city-dwellers lived in illegal dwellings, and 81% of people in the countryside lived and farmed as squatters. If capitalized, this property would be worth $74 billion — five times the value of the Lima Stock Exchange before its 1998 crash, eleven times the value of government industries that could be privatized, and fourteen times the value of all Foreign Direct Investment ever spent on Peru in its entire history. In the Philippines, where 57% of urban dwellers and 67% of rural dwellers occupy extralegal property, this asset would be worth $133 billion — four times the value of the Philippine Stock Exchange, or fourteen times the total amount of Foreign Direct Investment ever spent there.

The total estimated value of all such extralegal property worldwide is approximately $9.3 trillion — equal to twice the total money supply of the United States, or the combined market capitalization of the twenty largest stock exchanges in the world. This enormous reservoir of "dead capital" sits locked outside the formal economy, unable to generate the loans, investments, or growth that recognized property rights would make possible.

In Matthew Maly's Understanding Russians, the laws of post-communist Russia are described as characteristic of undeveloped, non-contrarian nations. Such laws tend to be: (1) all-encompassing, to regulate everything so that a bureaucrat can extract a bribe from every legal transaction; (2) vague, so that everything depends on the interpretation and goodwill of the bureaucrat; (3) unpublished, so that one needs a bureaucrat merely to discover what is permissible; and (4) very severe, so as to frighten citizens into compliance — yet not enforced, so that people can continue to function at all.

Foreign Aid, Development Loans, and Their Failures

According to Maly, Russian law reflects the Russian view of property: it is "suspended in air" by the conflicting claims that beset it on all sides. Only one with the power to repel all other claimants may retain real property for the purpose of generating revenue from it. In Russia, this role is played by the country's oligarchs, whom many argue were created with western encouragement so that American businesses would have a finite and easily identifiable number of counterparts to deal with. This explains the vast gap between wealthy and poor that is as apparent on Tverskaya Street in Moscow as it is in Mexico City.

Instead of encouraging the development of a lending infrastructure to support the lower class, the west has responded to these problems by issuing development loans and foreign direct investment. According to the late Lord Peter Bauer, issuing development loans is worse than doing nothing because it enables governments to engage in costly social programs that accomplish little. In Africa, for instance, price controls were introduced to make food affordable to consumers in large cities. Farmers responded by growing roses, which commanded premium prices in western flower markets thanks to the advent of air shipping. As a result, the massive over-production of export flowers contributed to food shortages and even starvation conditions in many countries. Rather than being lent to or given to poor people who had a genuine need for it, this money was squandered by political leaders. Lord Bauer documented the mismanagement of western loans to developing nations time and again — whether spent on villas in Spain by formerly communist Russian political cronies, or on an international airport in the tiny home village of Zimbabwe's late President Mobutu.

In many African countries, trade is confined to the sale of commodities, and profit from that trade flows only to the owners of those commodities, who frequently act in collusion with local governments to maintain the stability of their operations. Two notorious examples are South African mining concerns: De Beers and Anglo American Platinum, both of which actively supported the Apartheid regime. Fortunately, public pressure has led Anglo American, a platinum mining company, to reconsider its policies. According to the Sunday Times of November 10, 2002, "Angloplat runs its own education and healthcare programmes for communities in the Limpopo and North West. It also supports the development of small and medium black enterprises through its procurement policy, while a comprehensive HIV/AIDS programme is in place at all its operations and in the surrounding communities."

In other countries — Saudi Arabia, Egypt, Cuba, and Jamaica among them — the entrenched reluctance of western resource extractors has led to nationalization. Russia is proving to be the new face of this form of dependence, where formerly state-owned enterprises have fallen into the hands of their former directors, who own them exclusively and are known as "magnati," or oligarchs. A notorious example is Vladimir Potanin, who was able to purchase Norilsk Nickel — one of the world's largest nickel producers — for a fraction of its value using western loans.

Examples of autocratic leaders controlling the natural resources of developing countries abound, from the Saudi royal family to the military dictatorship that controls Nigeria. Many of these regimes were actively promoted by the west to ensure that politically empowered raw materials importers had a single point of contact overseas and that these resources would not fall under communist control. Perhaps even more troublingly, there is evidence that this dynamic continued with the failed coup attempt against Venezuela's president, who had sought to keep oil prices high in order to fund social services.

Free Trade Theory and Comparative Advantage

Free trade provides a comparative advantage to different economies because it encourages goods to be produced where they can be made most efficiently. The absence of free trade intensifies the negative effects of raw-material shortages, particularly in agriculture. A bad harvest in a country that actively trades results in little more than mortgage difficulties for indebted farmers and windfalls for commodities brokers; in a country hampered by trade restrictions, the same shortfall can produce famine. Conversely, poor countries stand to lose from trade when international organizations arbitrating trade disputes enforce strict intellectual property rights — especially regarding the unlicensed reproduction of medicines for life-threatening diseases.

To understand free trade fully, it helps to examine its origins. David Ricardo, a member of Parliament and close friend of John Stuart Mill, developed the theory of comparative advantage in the early 19th century. Using the example of two nations (Portugal and England) and two commodities (wine and cloth), Ricardo mathematically demonstrated how trade would benefit both nations even if Portugal held an absolute cost advantage in producing both goods — that is, England would still gain from trade even if Portugal could produce both wine and cloth more cheaply. Ricardo argued that both countries benefit if each specializes in the good it is comparatively better at producing and then trades with the other. He also argued that consumers would enjoy greater purchasing power because they could buy foreign goods at lower cost. Ricardo's philosophy became the foundation of the "classical school" of economics; development economists who favor trade are generally referred to as "neo-classical economists."

This argument remains current. Proponents contend that if third world countries produce goods in which they hold comparative proficiencies, these countries will benefit enormously from their lower costs of production. This dynamic has already transformed the economies of Southeast Asia. According to the Economist, "In 1950, the typical East Asian woman had six children. Today she has two. As a result, between 1965 and 1990, the working-age group rose from around 57% to over 65% of the total population, increasing four times faster than the number of dependants." As East Asian workers voluntarily move from subsistence farming to factory work in the textile industry, they are able not only to afford their own consumer goods but also to send remittances back to their villages. East Asia has also benefited from increased western tourism — another channel through which western spending creates new goods and services locally.

In The Race to the Top, Thomas Larsson offers the example of Thai workers in western-style resort towns such as Pattaya, where they are able to earn living wages rather than suffering under conditions of near-serfdom in traditional establishments. According to Larsson, "Foreign exploitation of Thai resources assumes perhaps its most brutal manifestation in the sex industry. But to [Thai workers] — just as for the child workers of the small workshops — school and ordinary employment are not genuine options. They make their way to the Trat Inn, Pattaya, and illegal factories for lack of better alternatives. They do not end up there solely because of the demand for commercial sex and the labor of deft little fingers."

Richard Cobden, a Whig member of Parliament in the 1830s and 1840s, was the first to address trade in the context of development economics in his role as co-founder of the Anti-Corn Law League in Manchester. At the time, England refused to allow imported grain, which would have allowed English workers to eat more affordably — much to the displeasure of Britain's protectionist grain producers, mostly landed aristocratic members of the conservative Tory party. It was believed that normalized trade would lead to world peace, and the League adopted the slogan "Free Trade, Peace and Good-Will Among Nations." Cobden's group was also the first to recognize and condemn the Irish Potato Famine of the 1840s, which most historians argue could have been mitigated had tariffs not existed.