The Dragon in the Room

I just finished reading The Dragon in the Room: China and the Future of Latin American Industrialization by Kevin Gallagher and Roberto Porzecanski, both of whom are at the excellent Tufts Global Development and Environment Institute. Boiled down, this is a concise and powerful argument for an active government role in Latin American development.

The economic rise of China, the authors argue, has meant two separate things for Latin American economies. First, China has been importing increasing amounts of primary products to feed its industrial development, and the conventional wisdom that Latin America has gained from supplying those products is true – but only to a limited extent. Gains from this kind of trade have been limited to a few sectors in a few countries, and can hardly be said to be improving the economies of most Latin American countries. Furthermore, the growth has been confined to commodity sectors, which are subject to price volatility and historically downward-trending terms of trade. So the “China to the rescue” thesis (i.e. other developing countries riding China’s coattails, as it were, on the path to prosperity) is unlikely work for most Latin American nations.

Second, China is positioned to out-compete Latin American countries in virtually all manufacturing sectors, especially high-tech sectors. The authors find that 94% of Latin American exports in the manufacturing sector are threatened by Chinese competition; the figure is 40% for all Latin American exports overall. (See the methodological note at the end of the post for a few clarifications.) When the data are disaggregated by Latin American country, virtually all countries have high levels of exports threatened, but Mexico is the most vulnerable.

This analysis takes up two-thirds of the book. The first 100 pages are pure empirical economics: in these chapters, the authors basically just walk through their findings in a long series of numbers and graphs and explain what they mean. The conclusion from all these numbers is that there is a danger that China’s rise to global competitiveness could lead to de-industrialization in Latin America, and a return to economies based largely on volatile (and – this is left mostly unsaid – potentially environmentally unsustainable) primary product exports.

With this as background, chapter 6 is where the real meat is: the policy implications of all this. Latin America can avoid this fate, the authors say, but only if they step in and begin managing their economies. To support this conclusion, Gallagher and Porzecanski compare and contrast the policies that Mexico and China have taken with regards to development in the postwar era. Most of us have heard this before: Mexico’s turn to unfettered free markets resulted in foreign direct investment replacing domestic capacity instead of supplementing and nurturing it. By contrast, China’s much more cautious liberalization allowed the country to ensure that foreign investments created important linkages in the domestic economy, spurring growth in domestic manufacturing sectors. China also implemented policies to ensure that technology transfer took place, while Mexico assumed that such transfers would take place automatically in the free market – which it clearly has not. While Mexico is involved in medium- and high-tech manufacturing, it is largely just assembling and re-exporting products, while China is engaged in much more of the value-added production chain.

I found one framing device used in this book particularly helpful. The authors repeatedly refer to China’s developmentalist efforts as “gradual” and “experimental.” That is, rather than assuming that free markets would automatically bring economic growth, China carefully managed which sectors would be exposed to global forces and in what ways, all with an ultimate goal of national growth in mind. The implication is that Latin American countries, by contrast, engaged in “ideological” (not the authors’ word) development, trusting blindly that free-market neoliberalism would give the results they sought, and failing to make adjustments as it became more and more clear that those results were not forthcoming.

This is all very High Development Theory, with the extensive invocation of Hirschmanian “linkages” and all. But the authors are careful to say that they are not implying that a return to the pre-1980s Latin American import-substitution industrialization policies is the answer. While they certainly make an argument for active industrial policy, they indicate that such policy should be oriented towards export markets rather than domestic markets (potentially implying that infant industries should be exposed to world competition relatively early, but not immediately). What is less convincing is their response to the frequent criticism that many governments are unlikely to be competent enough to manage their economic development as well as China has. “A high degree of government leadership and accountability” is necessary, they say, but make no indication of how this might be guaranteed.

Also left mostly unexamined is the fact that Chinese development has been incredibly uneven, and that China’s well-managed national economy has not translated into concrete gains for many Chinese citizens or improvements in civil and human rights. This is surely an intentional omission to make the book more concise and readable, since GDAE researchers are always aware of the human and environmental aspects of development – but it’s still an important missing piece.

All told, though, The Dragon in the Room is an excellent example of how to take empirical economic data and translate it into a cogent and highly relevant series of policy recommendations. Certainly, more arguments for industrial policy – and the space to be able to implement industrial policy in the context of the WTO and bilateral and regional trade agreements – are welcome in this day and age.

(Methodological note: The authors use a simple but pretty reasonable methodology to categorize Latin American export sectors as under “direct threat” or “indirect threat” from Chinese competition: if China has a rising market share in a given sector and Latin America [disaggregated by country] has a falling market share in the same sector, that’s a “direct threat.” If both China and Latin America have rising world market shares, but China’s market share is rising faster, that’s an “indirect threat.” One could quibble with the names, but those seem like pretty useful categories to me.)

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  • […] makes it clear that NAFTA did not exactly translate into rosy outcomes for Mexican workers, either. The Dragon in the Room, about which I wrote earlier, also goes into some detail about how NAFTA was a flawed strategy for […]

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