How politics influences economics in nations | Interview with Dr. Ha-Joon Chang

We met with University of Cambridge’s Dr. Ha-Hoon Chang to discuss economic struggles in South America, schools of economic thought, politics, and much more. Enjoy!

How politics influences economics in nations | Interview with Dr. Ha-Joon Chang
"There's no economic theory that says that you shouldn't have a market in firearms. There is a market in firearms in the US. In other countries, there isn't."” – Dr. Ha-Joon Chang

Noted economist Dr. Ha-Joon Chang shares insights into his work in empirical economics, analyzing schools of economic thought for their strengths and weaknesses. He examines the economic struggles of nations and governments, especially in South America, and how politics can drive economic success or failure in institutions, concluding with thoughts on making economic theory match reality. Reader in the political economy of development, faculty of economics, University of Cambridge, Dr. Chang talks with Dr. Jed Macosko, academic director of AcademicInfluence.com and professor of physics at Wake Forest University.

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Interview Transcript

(Editor’s Note: The following transcript has been lightly edited to improve clarity.)

00:16Being an empirical economist

Jed: Hi, I’m Dr. Jed Macosko at academicinfluence.com and Wake Forest University. And we today have Professor Ha-Joon Chang coming to us from University of Cambridge, and he’s an economist. So we’re excited to hear some of the things he has to say. In particular, Professor Chang, I was wondering if you could explain to us how you have synthesized the work of very different kinds of economists into your own theory of economics that you have given to the world.

So what would somebody 50 years from now look back on what you have given to the intellectual community?

Ha-Joon Chang: Yes, I think, first of all, I, in terms of using different schools of economics, two things. One is to use the existing theories to analyze problems that I think are the best analyzed with this or that particular theory. So when you are trying to understand why, for example, financial crisis happens, I think the Keynesian school is the best, so that when I analyze that particular problem, I would mainly draw on the Keynesian school. If you want to understand technological progress and innovation and so on, the Schumpeterian school is the best, so I would use mainly their theories.

So that’s one level, but another level, yes, I try to synthesize some of the things that these different schools have said. And indeed, my motto has been not just let 100 flowers bloom, but also let them cross-fertilize. And yeah, I have tried some of those, I have drawn some insights from the Marxist school and the American institutionalist school of Thorstein Veblen and tried to combine it with insights from Herbert Simon’s behavioralist school to develop new theories of how institutions emerge and evolve. I’m not saying that I’ve done a lot of work in that avenue because I’m mainly an empirical economist, but insofar as I have developed theories, I have tried to do that.

Jed: For people who don’t understand, what is an empirical economist versus a theoretical economist?

Ha-Joon: Oh, yeah. No, no, I basically try to understand real-world economies. So probably 80% of what I write is analyzing why, for example, that Latin American countries have experienced declining manufacturing sector, how a particular poor developing country can develop its economy by drawing lessons from, say, the so-called East Asian miracle economies, including my native South Korea.

So I mainly work with international organizations, policymakers, trying to give practical advice on how to develop this industry or that, how to restructure your economic system and so on. But sometimes I go to the more abstract level and try to discuss how institutions emerge and evolve and how the individual level things that get through the social interaction that elevate it to collective action and that kind of...

Yeah, so even those theoretical work, of course, is based on some understanding of reality, some assumptions about the real world, but it’s not necessarily talking about a particular type of economy, particular country, particular industry. So in that sense, that’s more theoretical.

So yes, in between the application of existing theories from different schools to understand different problems, and this attempt to theoretically synthesize different schools of economics, I think I’ve done some things that other economists normally don’t do.

05:13South American nations

Jed: It does sound really cool. I mean, to put it another way, 50 years from now, what people may remember you best is to teach the rest of the economic world how to use the right school of thought for the right problem, and you might be known for that. But I think that a lot of people will want to pick up on the two things you mentioned, wanna know a little bit more about them.

Number one, how do institutions evolve economically? And number two, what practical advice could you give a nation in South America to be more like the miracle economies of East Asia? So those are the two things. You can take either one of those. Which one do you wanna take?

Ha-Joon: Yeah. Sorry, one of those?

Jed: Yeah, just for a start. Start with one of those, and we can ask...

Ha-Joon: Yeah, yeah, okay. Yeah. Well, yeah, let’s begin with the more concrete problem, the South American nations. Until the 1970s or even into the ’80s, most of South America was way ahead of East Asian countries.

For example, back in the early ’60s when I was born in South Korea, and the per capita income there was about $90 per day. Yeah, that was essentially same as that of India, Kenya. And yeah, I think only Haiti at the time, in the whole of Central and South America had lower income than South Korea. At the time, Argentina had per capita of nearly $400.

Jed: And when you say pocket bank, what does that mean for us if you don’t...

Ha-Joon: Sorry?

Jed: $400, did you say pocket bank? Sorry, $400...

Ha-Joon: Oh, sorry. Yeah, per capita.

Jed: Per capita.

Ha-Joon: Per capita income, sorry. Yeah, I was speaking too fast.

Jed: Oh, no, no. Thanks for clearing that...

Ha-Joon: Yeah, so in early ’60s, South Korea had per capita income of $90, Argentina had something like $380, nearly four times. Yeah, so the South American nations were way, way ahead. But what eventually made a difference was that... And at the time, the policies they used were apparently rather similar. They tried to protect their domestic industries against foreign competition and tried to develop the Western market. But in the end, there was a big divergence because basically the East Asian countries wanted to one day become competitive with the best of the world, whereas Latin American economies were more or less satisfied with having second grade European standard of living.

So there was a difference in ambition. But more importantly, the East Asian countries basically invested hugely in raising their abilities to produce more sophisticated things. So huge investment in education, huge investment in the worker training, huge investment in modern technology both in terms of buying better machines from the more advanced nations and also investing in their own research and development, and over time this really created a huge gap between the two parts of the world.

Today, South Korea’s per capita income is over $30,000. Mexico’s is at barely $10,000. Chile, which is the richest in the continent is only half that. Despite the fact that the Latin American countries have much better natural resource endowments, so they start from a higher base. So yeah, I would... I’ve been to many South American countries, and basically, whenever I go there I try to tell them, "Look, it’s not enough to protect your producers from American, European, and Japanese competition. You really need to invest in developing your ability to do more productive things." Just one very shocking contrast is South Korea spends something like 4.5% of GDP on research and development, Mexico and Chile spend something like 0.3%-0.4%. Okay, South Korea is more advanced, so it’s natural that they spend more on research and development, but not 10 times, not 15 times.

So this a huge problem with South American countries not doing enough to move into high productivity industries. And now, why is that? How do you change that? It’s a very complicated story, this issue, about the balance of power between the different elements in societies.

So in South America, the financial sector and the natural resource-based sector are much stronger than in East Asia, which means that they favor policies that promote finance or agriculture or mining rather than manufacturing, which is where most of our modern R&D and innovation are.

So at some level, you could say that, well, unless you have some kind of political revolution you cannot change this, but there are also a lot of practical things that you can do to at least simulate some of the things that are being done in East Asia. So for example, the governments, when they give protection to the enterprises in what it regards as a strategic industry, it could, the South American governments, they can insist that these recipients of protection need to deliver results within a certain period of time, which is what the East Asian governments did.

"It's like, I don't know, spoiling a child; you give protection but without demanding that it grows up and becomes more independent and eventually become the fully responsible adult."” – Dr. Ha-Joon Chang

Unfortunately South America, once protection is given, there was no quid pro quo. So you get protected. It’s like, I don’t know, spoiling a child; you give protection but without demanding that it grows up and becomes more independent and eventually become the fully responsible adult. This was not always done in East Asia, but this was frequently done, whereas it was rarely done in South America. There are some practical things that you can do to change this, but obviously it’s a very complex story that involves historical research, political economy, and more technical economic analysis.

So yeah, by mobilizing different schools, different theories, you can do this complicated job much better because if you follow just one perspective they might over-emphasize the constraints that politics puts on the economic policy making or they might completely ignore that and give very technocratic advice that, yeah, looks good on paper but that cannot be implemented given the political condition.

Jed: So probably your ability to think about different schools of thought has helped you when you’ve been advising governments and countries in South America, in Central America, because you realize that it can’t just be one story. It can’t be the technocrat story, it can’t be the government policy perspective. It has to be the right perspective in the right area of each of the problems, and there are many problems, that a government faces.

Ha-Joon: Yeah. Definitely. And also that knowing economic history of today’s rich countries is very helpful because that gives you some idea of how you can rebuild the political coalition, how you can start doing things differently even though your historical legacy might push you in a certain direction.

So one good example of this is Sweden which is kind of model social democratic country today. It used to be a very conservative country. In the late 19th century it had one of the smallest governments in Europe. At the time the French government spent about 15% of national output, the British government about 10%, Sweden’s was only 6%. You might have thought that the Swedes invented the progressive income tax, but the country didn’t even have income tax until 1932 when even the US had permanent income tax by 1913 and Britain had one already back in 1842.

So it was a very anti-tax, anti-labor country, but somehow in the 1930s with the rise of trade union movement and the rise of the Social Democratic Party, they managed to forge this compromise with the capitalist class in which the workers under the control of this highly centralized union would refrain from the strike activities in return for the capitalists promising to make the investment in productive capacities and also pay higher taxes to finance a welfare state.

So if you looked at Sweden in 1920 you would have thought this is a hopeless, right-wing, conservative country. Thirty years later it became the pioneer of the welfare state model. Looking at those examples, you then begin to think okay if you want to do things differently in Ecuador or Guatemala or whatever, we can start to think, okay, maybe you can build this kind of new political coalition. Maybe you can do this, not necessarily by the outright political conversation, but by changing the structure of the economy which will give more power to this group or that group of, I don’t know, capitalist workers, whoever. And that way you can come up with a much more politically viable policy advice because unfortunately most economists just go and tell them, "Look, this is what the theoretical textbook says." Or, at best, "This is what the Koreans did. You do it." It doesn’t work like that.

18:32Theoretical work

Jed: Yeah. Well, it’s good you have a better perspective, that you’re always challenging the standard way of thinking about things, thinking more skeptically.

Now how did it bring about your more theoretical work of understanding how different institutions evolve? Was it because you were looking at these specific cases in South America, Central America, you started thinking theoretically, or... How did that happen?

Ha-Joon: Oh, I think it has always been an interactive process because you always get to learn some theory first and then you try to use it to understand the world, and sometimes it works and sometimes it doesn’t. And then you begin to ask why is this the case? And then you then realize that in this case it might be because of the particular form of politics that dominates this country or in this other case, it might be a particular policy, and then yeah, you begin to think, okay then if these things can make a difference, shouldn’t we reframe the theory or bring in some elements from different schools so that we can kind of modify this theory? Or should we just not use this particular theory to understand this kind of problem? And then, that brings you to another level of understanding of how theories should be formulated.

And then you go back to reality and then it still doesn’t work in some cases, and then you have to go back to the drawing board again. So yeah, I don’t think that we’ll ever achieve one theory that rules all. And it’s a constant struggle and, yeah, with different results for people who are interested in different things. I’m mainly interested in economic development, but if you are more interested in, I don’t know, management of the pension system or the financial regulation or something, they may have to go through very different routes to achieve some kind of... Sorry, some kind of a better synthesis between the different theoretical elements.

Jed: Yeah. And what does cause these institutions to evolve? Is there something simple that a non-economist like one of us can understand?

Ha-Joon: Ah. Yeah, well, this is a very complicated theoretical issue. Once again, I’m synthesizing this... Sorry, synthesizing different schools of economics here, but there are some people, like Hayek who believe that there are certain institutions that have evolved, but through a long evolutionary process. And, yeah, basically we have to accept them, because otherwise we just are not smart enough to understand this very complex and uncertain world. So it’s like, he once famously said that between instinct and reason are customs and tradition. So he believed that rational behavior is only possible exactly because we do not try to behave rationally in certain areas, accepting historically evolved institutions.

That kind of institutions are very important, but also we design institutions. Hayek had the fundamental insight there, but I think he went too far in one direction and didn’t quite realize that a huge range of very complicated institutions have come into being largely, although not entirely, through design.

Jed: Yeah, like Sweden, like you mentioned with the social structure [inaudible] institute.

Ha-Joon: Exactly, yeah. And there are many different institutional arrangements that work, so it shows that while Hayek is right in saying that you cannot just dismiss the history and pretend that we know everything, he was also wrong in saying that therefore you cannot design new things. So that then you look at all this more recent literature on institutional design in which, into which the works of Herbert Simon comes in very, very useful, because he really built a whole theory of institutional evolution based on his understanding of the human cognition and psychology. He studied artificial intelligence, he was a professor of psychology, as well as economics.

So you then begin to see that, yes, there are some historically evolved aspects to our institutions, but we can also design them. But then reading people like Hayek, you become more humble. Let’s not think that we know everything and we can design everything, and then, in order to... Sorry, in order not to make mistake in over-trusting your rationality, you will draw on people like Simon to better understand what are the limits of human cognition and rationality, what are the in-built psychological and cognitive biases and how this can be overcome by building individual habits, organizational structures and social institutions.

Jed: So you would say that your theory of how institutions can evolve into being is kind of a synthesis of what Friedrich Hayek said on one hand and what Herbert Simon said on the other hand, sort of putting them together and using Simon to show you, "Well, when could something like Sweden come about?" because Sweden came about through design, through human design, but it was in line with human psychology that Simon talks about.

And so your theory, have you published these more theoretical aspects of your work?

Ha-Joon: Yeah, I have a few articles of developing these theories.

Jed: And is that a good way to summarize it, that it’s kind of the synthesis of those two?

Ha-Joon: Yeah, I call my approach the institutionalist political economy, and I take the role of the institutions very seriously, but I think what is somewhat lacking in Hayek and Simon is the understanding of politics surrounding institution-building and institution evolution.

Jed: So you add into your own concept of politics how politics is also a necessary facet of when some institution can be human-designed like in Sweden. Is that your contribution?

Ha-Joon: Yeah. No, no, I go as far as... In my book, 23 Things They Don’t Tell You About Capitalism, I titled the first chapter "There is no such thing as a free market." To cut a long story short, my argument there was that even the freest looking markets are based on some regulations on what can be traded, how they can be traded, what are the responsibilities of the trading parties, what you do when there’s some disruption in the process of trade and so on.

And all these institutions that regulate the market process, in the end are politically determined. There’s no economic theory that says that you shouldn’t have a market in firearms. There is a market in firearms in the US. In other countries, there isn’t. It’s not an economic theory that decided that it will be there in one country and... Yeah.

Jed: Yeah, it’s politics. So you could be known as the economist who put politics back into economics.

"…what makes me a bit different from other people is that I say that even the market is a political construct."” – Dr. Ha-Joon Chang

Ha-Joon: Oh no, I’m not the only one doing that, but yeah, no, no, I’m... But what makes me a bit different from other people is that I say that even the market is a political construct. Because many economists who try to incorporate politics into economics, they assume that there’s this kind of a natural domain of the market and there’s politics, and these two interact.

But what I’m saying is that actually the market itself is a political construct. So without understanding power relationships, without understanding how different groups interact politically, without understanding how all these institutions that regulate the market process themselves are politically determined, we cannot really even understand the market.

28:55Sign-off

Jed: Yeah. Well thank you so much for enlightening me and the people who watch this video into some of the intricacies of finding out why countries do well, why others do not as well, and how countries can change radically. And we really appreciate getting your insights. So thank you so much, Professor Chang, for taking some time with us today.

Ha-Joon: Pleasure. Thank you for inviting me.