Counting the Costs of Trade
Trade economist Meredith Startz and I talked about her research on the information costs of trade. We discussed the strategies that traders use to lower costs associated with search (ensuring they get their goods to the market on time) and moral hazard costs (ensuring they get what exactly was ordered from their suppliers). We talked about how big businesses use fixed cost strategies to lower costs, the benefits of higher revenue for firms, and how innovative business models can improve contracting in long-distance trade. Meredith is doing important work, and I think her research deserves a lot more attention. Bonus point; she also did field research surveying traders in Lagos.
TL: Welcome to Ideas Untrapped and my guest today is Meredith Startz. Meredith is a trade economist at Dartmouth College. You're welcome, Meredith.
MS: Thank you so much for having me.
TL: I love your work so much, I have to say. 'Cause, um...
MS: Thank you.
TL: Usually, when we talk about trade, at least from my familiarity with the literature and matters of policy, we usually focus on tariffs and like you mentioned in some of your papers, transportation costs. I kind of see your work as getting into the microeconomics of trade a bit, and I found it really, really fascinating. So briefly, if you can just introduce us to the concept of information costs in your work with you called search and moral hazard problems.
MS: Sure. So let me back up just one step to sort of talk about the context in which I'm often thinking about trade costs, including information costs. So I spend a lot of time talking to and interviewing wholesale and retail traders often in Lagos, in Nigeria. And as you sort of said, while the policy world and often the academic world focus on kind of the macro side of trade and trade costs and things like tariffs and sometimes transportation costs. You know, if you talk to any business actually engaged in trade, there's a whole lot more to it than that. There are things we kind of often lump under trade logistics that really make up a big part of the business, and so if you talk to people in Lagos who are importing clothing, or electronics, or something like that, you realise they're facing all kinds of challenges that they deal with in their business every day that you can't really summarize through these kinds of standard trade policy, tariffs discussions.
And so one of them that I ran across very early is that these traders are often travelling to the countries that they're sourcing from in-person to make purchases. So they'll get on the plane and go to China to buy things. And of course, they know that they don't have to do that. They could pick up the phone or get online to buy their products. And so you talk to them about why they're doing that and two things came up really frequently and this is where we're going to get to what I mean by information costs. So one is that they have to actually figure out what kind of products are available for sale, where in the world, who's selling it, what are the characteristics of those products, what's their quality? And when Economists hear that, it makes us think of what we call search - which is sort of a weird way of saying that the world doesn't conform to this very oversimplified assumption that Economists sometimes make use of that we call perfect information. Which is the sort of silly idea that everybody knows everything about the whole world that's relevant to the decisions they're making.
Obviously, that's not true in reality. And in the case of traders, one of the ways it's not true is that they have to figure out what products out there are actually available, at what prices, from what sellers? So that's the search problem that I'm talking about in my work. The other problem that these traders talk about all the time that they sometimes solve by going to make a purchase in person is the fact that you can't just send money off to the other side of the world and assume that you will necessarily get back exactly what you were expecting when you were expecting it. And so when I talk about a moral hazard problem, I kind of mean the trust or contract enforcement problem related to that. You send off money, you don't know what you're going to get back. It could be the wrong product or a lower quality version than you expected. Or somebody could even just keep your money and send you nothing. So that's the second kind of information cost that I talk about in my work.
TL: Yeah, that's fascinating. And I mean we buy these products every day, we interact with the retailers every day, and you're sort of getting into a lot of the things that go on through the backchannel. What are the strategies you observe? At least, from your study and what your model predicts, how do traders try to work around these costs? What are the strategies you observed?
MS: Yeah, there are a lot of strategies, the one that I focused on a lot is the one I just mentioned which is travelling to do business in person. And the way I kind of think about formalizing that is that when you're standing face to face with someone in a market or with your supplier, you can almost literally exchange money for goods at the same time. Right? You can be standing there in the warehouse, you see the shoes that you want to buy, you've looked at them, you've checked them out, you know that they're correct. You hand over your cash or you sign off on that wire transfer and you pick up the box of shoes and you leave with it. And at that point, you know exactly what you're getting and you know that you've gotten what you paid for. And so this is kind of a very formal way of thinking about something that I think is just a really practical, obvious solution for people in the trading business, right?
But if you think about flying to China, you kind of reduced your very remote problem back down to that face to face problem that you would have if you were right there in person with your supplier. And so that's kind of a way of avoiding all of these search problems and contract enforcement problems (one) that you face when you're far apart by just literally turning it back into a face to face transaction.
TL: One thing I thought about though, I mean, hearing you speak and reading through your work is that individual traders bear this cost. And from your observation, are there high trust clusters among traders and firms, where, for example, they can pull their resources and have a representative go to China or Dubai, or some of these entry ports in order to reduce the individual cost of travel and search?
MS: That's a great point and I had exactly that question when I started working on this. So I think the idea that you're getting at, is if some of these strategies you have for solving your problems like travelling abroad, carry these big fixed costs and you're a relatively small business, then you think it would be smart to get together and share that big fixed cost and only pay it once. To be totally honest with you, when I started asking traders about this, they kind of looked at me like I was a crazy person. Like, who are you asking me if I get together with my competitors and share all my information about the products I want to buy and let them go buy for me with my money? And of course, that's not always the case, we do see some people who collaborate with other traders.
But broadly, I think what's going on here is, you know, if you put yourself in the shoes of these small businesses, the people that it would be the easiest for them to network with or, you know, the most sensible in some ways are exactly the people who work near them and deal in similar goods. Those are the people it's easy to talk to, the people who might want to buy the same kind of things, to see you at the same time. And those are exactly the people who you're in competition with, who you don't want to give your private information to, who you don't want to give a leg up against you. You know, you want to have newer, more interesting things that customers will like more at lower prices than those people. And so I think what we see is that it's actually really hard for these businesses to cooperate in that way precisely because it would involve sharing information or cooperating with their competitors.
TL: So, how do big firms, I mean, these are small traders, right, and...how sensitive are these patterns to farm size? I think that's what I want us to start with, basically.
MS: Yeah, I mean so if I'm understanding you right, just as it would make sense for a couple of small firms to get together and try to share this fixed cost, the larger your company is the more it makes sense to you from a profit perspective to use this kind of high-cost strategies that then let you get goods at lower prices or get better goods, for instance. And so we should see larger firms doing more of this. And you know, within the data that I've collected, which still focuses on fairly small trading firms, that is true. Larger firms are more likely to take this kind of strategies like travelling to go buy in person. I think there is sort of a broader question which is, as the structure of the economy changes and the nature of firms engaged in the retail sector or in trading changes, do you see kind of a shift in ways of doing business? And my suspicion is that that is true, right? That larger firms do engage in things like setting up supply chains and distribution networks that sort of have higher setup costs, but then let them (to) continue to do things at lower prices.
And so in some countries, where you've seen a transition in the way retailing works, so for instance, in a lot of Latin America or in Mexico as you've seen this kind of big box store multinationals move in, you do see them lowering prices and changing the way supply networks work. And I think not much of that has happened in West Africa yet and why not is sort of an interesting question about how Nigeria's economy might change in the future.
TL: I will understand if you want to pass on this question, but does that strengthen or weaken the case for big businesses generally from, say, a policy incentive perspective?
MS: Yeah. That's a really tough question and this is sort of related to some work I'm doing now, so I may have a better answer for you in a couple of years. So let me lay out one thing that I think is a trade-off you might want to think about there.
MS: So, I think the kind of intuitively appealing aspect of increasing firm size is sort of what we were just talking about, right? That they have an advantage at paying these costs to set up really efficient distribution networks or supply chains. Right? The tradeoff going in the other direction is when you have large firms, they may have a lot of market power, either in the sense of their ability to raise prices for consumers or in the sense of their ability to sort of capture local regulation and lobby for policy or political decisions that are favourable to them, in a way that small firms have to be very competitive with each other and may not individually have the ability to influence those kinds of decisions. And I think it's not obvious, kind of, in theory, which of those is going to weigh out, right? That's an empirical question. And I think one thing that's interesting is to make a very broad generalization. I think you've seen this kind of big-box chains struggling both in West Africa and to a lesser extent in East Africa in recent decades, right? So you have the example of ShopRite which made a big initial expansion in Nigeria and is now pulling out.
And I don't know exactly what all went into that, how much of that was about bottom line, business tradeoffs not making sense versus other things. But the fact that Nigerian retailing is still so dominated by these small scale enterprises suggests that there may be some kind of countervailing costs or challenges that large firms face in scaling up, which might even directly outweigh the advantages you expect them to have in setting up sourcing or distribution networks. Right, and so I think there's both a question kind of right now, are they actually more cost-efficient, and if not, what are those other countervailing features? And then there's a second question down the road which is, suppose they can actually do things at a lower cost, does that result in lower prices for consumers or they're kind of able to capture markets in a way that makes things not actually better for consumers in the end?
TL: Talking about the struggles of large larger retail chains in West Africa and the case of ShopRite as an example, one thing I also found very interested in your results and your paper is the role of higher-income generally in the population and an increased consumer spending. And you pointed out that in that kind of environment or economy, it's not really about firm size, it's about the revenue of individual firms. Can you just outline how that works briefly?
MS: Sure, I mean that I think relates a lot to what we were just talking about, right? The really simple insight there is that suppose you have these strategies for overcoming, for instance, search or contracting problems like travelling or like investing in a distribution network, they carry some fixed cost. When a firm has higher revenue and they expect to be able to sell more to more people, they're going to be more able from a profit perspective to carry those big fixed costs. And to the extent that those strategies actually reduce marginal costs, they are then able to supply goods at lower prices. That abstracts from what we were just talking about, which is these sort of other issues about market power or regulatory capture.
TL: Does your model indicate any comparative result between an overall reduction in information costs generally, and how some of these multinational retail firms with established supply chains like you mentioned and some market power (which I would interpret as fixed cost strategies used in reducing this information cost)....which of these channels and I know this may be asking too much of you Meredith... which of these channels would you say improves welfare faster in terms of prices and, just generally, economically?
MS: Yeah, that is a really hard question. Let me say this...
MS: You know, if you ask most economists, I think their instinct will be - solve the underlying challenges, and then let the market tell you what the best strategies are or what the right firm size is. That's a big oversimplification, but I guess what I mean by that is I'm not sure there is necessarily a conflict between trying to reduce information costs for everybody and allow these sort of larger multinational firms to kind of bring in some of their cost advantages, right? Trying to reduce this other kind of frictions or challenges related to trade which might be about the difficulties of travel, it might be about financial regulations, it might be about, you know, access to Internet or infrastructure. Those are likely to help with everybody, right? And if you solve those problems then you can see, well, is what happens that these small firms are able to compete so much better that actually they survive or is what happens that kind of enables the ShopRites to come in and do an even better job. And so I would say rather than kind of trying to answer that question ahead of time and plan for it, you just solve the underlying problems and then you learn a lot about who's able to operate best in that environment.
TL: I understand your answer, but why I find that question relevant is the way that...and this is a bit political, the way that policy is actually done here, at least in my experience in Nigeria, where local firms are prioritised and even in some cases there are very serious barriers in terms of policy in the way of large multinational firms. You know, there's a bias towards local firms and policymakers kind of treat it as a tradeoff. Because in some countries, again Nigeria as an example, there are no really big local retailers with experience in supply chain management and all these advantages that multinationals may possess.
So I feel like if there is a better answer or a more informative answer about the implication of what you are making a tradeoff as a policymaker, it might not be economically speaking. Like you said you, you may just have to improve the overall business environment and let the market dictate. But as a policymaker, if I know that letting multinational firms operate alongside local firms and not erect all these barriers and make it an unnecessary tradeoff, I'm actually improving the overall welfare of the people and it might improve how we discuss trade and the overall attitude of policymakers. That’s why I find that question very relevant because trade can be a very sensitive issue in terms of policy here.
MS: Yeah, I completely hear you. And I think it's worth distinguishing two things in what we're talking about, right? One is about, kind of, the firm size and the business model and the other is about multinationals versus local firms. And I hear what you're saying that in Nigeria we may not be able to separate those things in practice if there aren't, kind of, local champions that are able to expand that larger-scale retailing model.
MS: The evidence that we have from other countries right now, right? Which you always have to be a little careful when you extrapolate from one context to a very different context. But the evidence that we do have seems to suggest that those kinds of big multinational retailing firms do help consumers when they enter the market. There's a very nice paper from the expansion of Walmart in Mexico by 3 economists who, sort of, studied related issue that says that that definitely lower prices for consumers and it actually did it in two ways. One was that the Walmart subsidiary itself offered lower prices, but the other was that it provided more competition for local firms who then also lowered their prices.
So you know, I think, my inclination is to say that I have a little trouble seeing, especially if you don't have local champions who can step up and try that business model that it's a little harder for me to see why you'd want to block firms from other countries that are able to do that. But as you say things are complicated and there's sort of a lot about how politics in any particular place works that makes it harder to implement that in practice.
TL: Interesting. One other thing I also like about your work is that there's a lot of room for improving the status quo without really spending so much money in regards to developing countries - without committing too much resources to interventions, there are some frictions that you can just get rid of and would generate some positive results. So I want to talk about contracting frictions a bit. You talked about third parties using financial services to deal with some of these frictions but, again, there's a situation where they bear excessive liabilities and they don't have the incentive to invest in providing those services. Are there government interventions or regulations that you think can create a market for reducing contracting frictions?
MS: So my hunch is that a lot of what is needed here is not only a conducive policy environment, but also innovation to make these type of financial and legal services more useful and accessible to small firms. So for instance, things like letters of credit or international arbitration services are perfectly well-established tools that large firms all over the world used to deal with this same kind of contract enforcement problems that they face when engaging in international trade. And I think, you know, the reason those are not very accessible to, say, smaller wholesalers or importers in Nigeria in their current form is not necessarily any specific regulatory barrier. But because for a bank to be willing to offer something like a letter of credit, they have to charge a cost that would be prohibitive for a small firm, for a bank to be willing to take on that liability and process the service.
And so I think probably a lot of what we need is innovation in how this kind of e-commerce platforms or financial services work to be able to provide that same function at a lower cost, right? 'Cause I think what we see, certainly in the data that I work with, is that if the cost of a letter of credit isn't lower than the cost of a one week trip to China? Importers are still going to solve their problem by just going to China.
MS: I'm not an expert on financial regulation in Nigeria, but I think that maybe the best thing you can do is try to set things up in a way that actually encourage innovation in these services, right? Not just encourage the entry of kind of established players providing established products, but innovation that lets people figure out how to adapt these products in a way that works better for the local economy.
TL: How do traders respond to huge exogenous shocks like the global pandemic that the whole world is dealing with? How does it affect their strategies in terms of cost and every other thing they do to adapt?
MS: Yeah, as I'm sure you can imagine, it's been a really tough six months for these traders that I work with. So we've been doing some high-frequency phone surveys, just calling them to see how they're doing and how they're coping with things. And you know one thing that I think is interesting is they were actually feeling the crunch from the pandemic well before, I think, most people were because they started to see problems with their supply chains in China back in January. Right, which makes sense when you think about where they're getting their goods, and where was experiencing problems that early. So they've actually been suffering through this even before the local lockdowns and before, kind of, the general public started having issues. So I think overall, what we're seeing is that so far these kind of businesses are mostly surviving. They made it through the lockdown. They, kind of, totally shut down for a month or so and they're now back up and selling.
And they're kind of facing problems from two sides as you might expect, right? So the demand side is maybe not surprising right. Customers can't come around as much, customers are worried about their own income and their own livelihoods, and so they're buying less. And of course, the restrictions on interstate travel in Nigeria also cause problems. The kind of importers that I work with are selling not only in Lagos, but throughout the country. And so when half of their customers couldn't show up from other states where they had to kind of incur all these extra costs to get goods to them, that was really causing problems for them as well. On the supply side, they are still seeing problems, so when we were interviewing these traders as of early July, a lot of them still had not restocked this year. And they had about a month's worth of goods in stock, and so they were facing the challenge of how to deal with that. We're going to go back and talk to them again soon, so we'll find out what they're doing. But I would say, overall, the attitude seemed to be one of a holding pattern, just kind of wait and see what happens. And so we saw people starting to think about things like well, can I buy and sell more online or can I find different ways to deliver products to my customers? But in terms of their basic business model, it was really a see if we can wait it out kind of attitude the last time that we talked to them.
TL: It's been terrible. I can imagine.
MS: It's really tough, yeah.
TL: Yeah. I know I've been pushing you into policy talk quite often, so are there things you think traders - and of course, we can't really ignore policymakers in the whole picture - can do to better mitigate the effects of future shocks? I know we can really predict what's going to happen next, no one saw this coming, I don't know if anyone could have. But as a sort of general heuristic, what can better be done to mitigate the effects of future shocks?
MS: Yeah, that's I think the question on pretty much the mind of everybody in the world right now. You know, I think one thing that seems to have been quite hard, especially in Nigeria, that I think some countries or some regions in some countries have dealt with better than others is, there's sort of no planning for this kind of shock, right? I mean, kind of by definition, this is sort of such a large catastrophic problem that it would be hard to set up your business in a way that was completely immune to or insured against this kind of challenge. And part of what's particularly difficult about this kind of catastrophe is, in a way, we don't want people to go back to business as usual. From a public health perspective, the question isn't how can we get customers out there buying more things? It's how can we tide people over until we deal with the health problems so that then we can go back to business as usual. And so I think one thing that some countries have done better than others is basically finding ways to help people just tide things over until we solve the public health problem.
And my sense is that in Nigeria, not just from a business perspective, but even from a private citizen's perspective, there is a feeling that palliatives have not been very forthcoming or emergency loans have not been very forthcoming, and if you sort of talked to people about what have they actually been able to access to try to tide their business over or get a little bit of working capital so that they can get going again after the lockdown, they have struggled to access those kinds of things. And so, I think looking toward the future this is kind of what we have governments for, right? It's this kind of huge public collective problems that it's really hard for individuals or businesses to self insure against, and so being more prepared to give that kind of emergency insurance and emergency support that just gets people through to the other side, I think, is probably what we can focus on.
TL: Hope we all pull through together.
TL: Yeah, so we're going to get into some speculative grounds here, so please just indulge me.
TL: So as a general question I want to ask you this. Why is straight policy so controversial? I mean, either throughout history or now in Africa, at some point in Latin America. Importing versus exporting. Local firms versus foreign firms. What are the surrounding issues of trade that makes the economics, which to me seems pretty clear, so difficult to accept either by elites or policymakers, generally?
MS: Yeah, so here you're getting, sort of, my personal opinion as somebody who kind of wonder sometimes why trade economists aren't more effective at communicating what we know about the world to policymakers or to the general public. My sense is that there are two things going on, right? Or it's kind of the intersection of these two issues. So, one is that people throughout history in all circumstances are very susceptible to us versus them narratives. And so when you start talking about international trade or foreign investment or multinational activity in your country, it very naturally lends itself to that kind of us versus them political narrative, right? If you need somebody to blame for economic problems, it's very easy to say 'well, we don't want these foreigners being the ones who are profiting in this circumstance, we want it to be us.'
One of [the] deep insight of economists about trade is about the gains from exchange due to comparative advantage, which is the idea that if you have sort of different endowments or different skills in different places, right? So one place has a lot of capital, one place has a lot of skilled labour, or one place has a lot of unskilled labour. The kind of deep insight about trade is that if those places interact with each other economically, actually the kind of total surplus that everybody has access to is going to increase. And if we divide that up the right way, everybody can be better off. And economists really like this idea, and we think it's probably true. The thing that we haven't done so well about communicating about is that we've also known for a long time that that doesn't mean that everybody does end up better off in practice, right? There can be allocative or distributional consequences right where even if the total pie has gotten bigger, we fail to divide it up in a way such that everybody is actually better off in the end. And trade economists know that. And we've known it for a long time and I think to maybe unfairly malign my profession, we've kind of thought that that second part of the problem, which is how to divide up the pie so that everybody is better off, is kind of a problem for somebody else.
That's for the politicians or the political economists. Or the labour economists, I don't know who. And so we've really kind of pushed this narrative of trade is good, trade is good without then addressing the second part of that, which is trade is good, how do we make it good for everybody? And I think that's really fed into this kind of natural us versus them story, which is that it's easy to blame the foreigners for your economic problems. I wish I had a better package to offer you here, but I think that's really on me and my profession to come up with better ways of communicating about how you bring both parts of that puzzle together. Right? Trade can be good, and then how do we make it good for everybody?
TL: Okay, 2-part question in reacting to that. One is that, I mean, some economists might try to dance around that fact but the economics is also a normative science, right? And I see economics as utilitarian in a way. So if protectionism benefits a few people but you have a more open trade regime and you liberalize and it benefits a lot of people, even though, like you said, some people are going to lose out. Is there something fundamentally wrong with that vision of the world?
MS: I think, no. If I'm understanding you correctly, you're saying 'does everybody have to win to make it a good idea, or can we just have more people winning?'
TL: Yeah, yeah exactly.
MS: Yeah no, I don't think economics has anything to say about that, sort of, context free, right? I guess what I was sort of trying to emphasize before is you can say trade is good without even having to argue that it's better to make more people better off at the expense of a few. Now, you may also be right that we can go a step beyond that and say 'look, even if we can't redistribute perfectly so that literally everyone is better off, we're still in favour of this because we can make a lot of people better off and we're willing to accept the cost of a set of people who lose.' Personally, I am in total agreement with you about that. I would say that I think there's a bit of a cautionary tale in that strategy, in the backlash against trade that I think you're seeing in a lot of countries in the world right now, including my country, including in the United States. Where, increasingly, there's a negative reaction to free trade and pro-trade policies of all sorts, and I think a lot of people think that this may be because, you know, we… where, by “we” I mean, sort of, politicians and policymakers and economists and the general public kind of ignored the set of people who were losing from trade for too long.
And, it doesn't necessarily have to be the majority, it just has to be a group of people who are really hurting to then kind of change the whole narrative and to change the public view of trade. And so I think you do still want to be a little careful about saying, ‘well, the majority gain, and so we're willing to accept some losses’ [be]cause that could backfire on you in terms of the public perception of trade later on.
TL: The second part question is, would you think we'll be better off if there are more economists running policy? Maybe not every policy, but at least trade policy and we don't get into all the political complications or all the other things. Because...I'm not an economist, obviously, but economic findings can be counterintuitive. A couple of days ago I was still listening to somebody at the Central Bank talking about the recent ban on importation of maize that 'it's pretty stupid to have someone else produce what you eat.' But we know that is not true, right? So I'm just wondering would the world or us in Nigeria or anywhere else where some of these things can be a problem be better off if economists just run things, you know, and then we won't have to have endless tribal debates about some of these things?
MS: You're asking an economist, 'should you just hand us the reigns to let us take over?'
MS: You know, my personal preference... I am really speaking for myself here, I would be wary of just letting economists run things, or at least let me put it this way - letting academic economists run things. You know, we're very motivated by a desire to understand how the world works and the skills that make you good at that are not always the skills that make you good at, you know, thinking about or empathizing with everybody's circumstances, or communicating about that, or coming up with creative, practical solutions. Right, and so I think actually, in my ideal world, you have policymakers who are good at those things who are really, really listening to their advisors who are a bit more technocratic, who include economists and even academic economists.
And I think I would actually prefer that to letting economists run things, because I think economists can sometimes do stupid things like discount the set of people who are really, really hurting because they've been on the losing side of trade for the last 30 years. That's kind of not our skillset to know how to deal with those things. And so I think you want policymakers who are a bit more well rounded, but who take really seriously the technical advice that they are getting from economists.
TL: That's a very important nuance. So how do pro-trade institutions then evolve? That is, how do you have this sort of equilibrium that you're describing where the people running things may not necessarily be academic experts or economists, but they take the advice of experts seriously. They look critically at the evidence and things like that. How does a country evolve such institutions, generally? I know I am asking you hugely speculative questions.
MS: This is hardball here. If I knew the answers to this, you could just give me the Nobel Prize right now.
TL: So I'm just interested in your opinion and your speculations, so...
TL: Just feel free.
MS: Yeah, Okay, so let me try to say something about two different sides of that. So thinking about institutions more broadly. I sometimes wonder if, especially when it comes to trade or industrial policy, we get a little bit too fancy. That, you know, as far as anybody knows, there are some sort of fundamentals that seem to be associated with countries getting richer and people's standard of living improving and those are things like good infrastructure investments, and increasing human capital through health and education and international connections and communication. And having sort of sensible domestic policy even in just a very limited sense of not unnecessarily getting in the way of businesses doing what they need to do. (Kind of ease of doing business-type thing is what I'm thinking here.) And far be it for me to say those are easy things to accomplish, those are incredibly difficult things to accomplish, but you know some of it is not that complicated, right? Some of it is kind of stop getting in your own way.
And, I sometimes wonder if we spend a lot of time thinking about, you know, should we ban imports of this product or that product or try to have this kind of industrial policy and it's not that those couldn't have important effects on development but I sometimes wonder if we're spending a lot of time thinking about that rather than thinking about how to just improve the fundamentals. A kind of different way to think about your question, which is less about who is setting policy and more about kind of how do maybe nongovernmental institutions arise that are helpful to trade? I think is a super fascinating question that, to be totally honest with you, I don't think academics know a ton about. But let me give you an example, which is that credit bureaus, which are basically organizations that just report on the creditworthiness or the past history of individuals or firms, didn't start as a policy intervention, right?
If you look at their origins in a place like the US, that was actually a private business that started offering credit reports on individuals and then selling a service to businesses which was just their reports on all these people so that they could make a better decision about whether to lend them money or whether to go into business with them. So some of those kind of things I'm not sure we have to look to government for, it's more about thinking about what are private businesses or sort of mutual aid associations or business associations trying to accomplish and are there things that we're kind of putting in their way that make it more difficult for those sort of institutions to arise? I know that's a very abstract answer to a very tough question. So maybe a better of putting it is, I think that's a really important area for further study.
We know for instance, in the areas that I work in that market associations do a lot of work in Lagos. A lot of things like providing local order and dispute resolution and facilitating security or utilities or cleanups. Those are actually things that are at least in part being provided by these private market associations. So then you start asking yourself, 'okay, why are they not doing other things?' Why are they not providing kind of a credit bureau type service? And I wish I knew the answer to that question. I don't. But I think that, you know, that's sort of very fruitful both in terms of trying to learn about how the world works, but also thinking about kind of where some of these protrade institutions could come from in the future.
TL: How much do some underlying societal factors or initial conditions affect the evolution of pro-trade institution? What I have in mind here is culture, right? How much influence would you say that has on how institutions and, specifically, protrade institutions like we are discussing, how much influence do you think they have in the evolution of such institutions? I mean, one example I got from, I think [Avner] Greiff was, the Maghrebi Trader (Jewish traders) in Italy and the Genovese traders and how the former relied on ethnic networks and the latter kind of developed this statewide rule of law contracting regime. What determines such divergences? I mean, speculatively?
MS: Yeah. I think it's pretty clear that there are...this is going to now sound so abstract as to be a bit meaningless, but you know, obviously there are multiple ways of getting the same thing done. And just clearly you look around the world, there are different ways of doing business, and that those ways of doing business are kind of sticky overtime right? Certain places kind of have certain traditions and ways of doing things and they keep doing them. I think the place you want to be careful, though, is how much those kind of ways of thinking about business or those attitudes are a cause versus a symptom. So some of them are clearly a cause, but let me give you an example. You know, in the kind of work I do, people talk about trust a lot. And they try to come up with ways of measuring trust right? And we go around the world and we ask people questions about, you know, 'in general, how much do you trust people and would you trust your neighbour to do this? Would you trust a stranger to do this?' And then we try to think about, you know, is that a cause of growth or of a successful economy.
I'm very wary of that kind of thinking, that trust is a cause as opposed to a symptom, right? It's certainly meaningful. It's certainly correlated with all sorts of things like how you structure firms in your country. Like, there's some evidence that higher trust places even within countries are more likely to have larger decentralized firms for instance. But if you think about it, like, where do[es] trust come from? A lot of it is a response to the conditions that you experience in your daily life, right? And if you're in a place where your experience is that you can't assume that your local government or your police or whoever it is will follow through on what they say they'll do. Or will follow the rules or will make other people follow the rules, right? Or that somebody will be brought to justice if they do something to wrong you, then, of course, you say you don't trust people. And if you live in a place where if somebody steals something from you, they get caught and have to pay you back, then you might say that you have higher general trust because you correctly believe that other people will not end up doing bad things to you.
And that doesn't necessarily mean that the people are fundamentally different, right? People would be inclined to steal things all over the world. It's more a reflection of the environment you live in and how that constrains the way people behave. So, sorry you got me on my high horse about this particular issue, but I guess I'm really cautious about essentialist thinking about things like culture or trust kind of determining our outcomes, as opposed to reflecting the circumstances we are in, and maybe kind of nudging us along one path about how we tried to accomplish the same thing.
TL: That's abstract like you said, but I see your point.
MS: You got us into philosophy here, right?
TL: Yeah, one thing that has always got me thinking too is that, earlier you talked about industrial policy, right, and how we can overthink some of these things. In terms of development and how it relates to trade, the "East Asian Tigers" have sort of become the standard for other low to middle-income countries. How much weight would you ascribe [to] export as a strategy in how those countries develop?
TL: Again, that's a bit speculative, but let's go with it.
MS: So let me separate kind of two things. One is, how much you need a strong manufacturing sector? And the other is maybe something about trade balance, right? How much you need to have net exporting to promote growth. And I think the latter, right, this kind of intense focus on exporting has led to some policy choices that there's not great evidence for. So there's this now sort of old-fashioned idea about import substitution that you want to, sort of, restrict imports in part to kind of give your domestic industries a chance to grow strong and then start exporting and that's what you really need for growth. And I will say that there is I think very limited evidence that that actually works. The fact that some East Asian countries did that does not seem to extrapolate to... you know, we can't say that that generally has a causal effect on growth, and I think some countries are sort of nonetheless hanging on to that old idea in a way that is kind of dangerous.
The more general question about manufacturing is a really tough one right? Like there are a lot of countries out there that are trying to emulate the East Asian growth miracles, and I think there is a tendency to say, 'Well, okay, they followed this pattern, how can we follow that pattern too?' Dani Rodrik, who I think is probably one of the world's foremost experts on growth and structural transformation, has sort of for a long time, I think, be more of a proponent of the 'you need a strong manufacturing base approach.' Recently, he's been writing a lot about how growth patterns in the last couple of decades haven't necessarily involved that same pattern of industrialization and promotion of manufacturing, and that there's been some sort of skipping more directly to a more service-based economy in a lot of countries that have been growing quickly. And I think it's a little too early to know whether that pattern is equally successful. But I will say that I don't think we have a ton of evidence that just because some countries happen to follow this pattern, that there's anything that says you have to go through that exact same set of steps in order to grow.
I'm gonna be on the same hobby horse again just bringing it back to the case of Nigeria. You know, I do think that there's a tendency to set up a bit of a false dichotomy, right? You sort of talked about it [that] often, for sort of political reasons, it's popular to feel like it's a good idea to ban imports of something or to discourage foreign investment. And this is kind of set up as a like us or them situation. I think there's not much evidence that that's the case, right, that if you kind of work on fundamentals like infrastructure, human capital, good domestic policy, that's going to help your domestic firms. And if you don't do those things, keeping everybody else out doesn't necessarily do you any good.
TL: Interesting. How much do free trade agreements... I'm sure you're aware of the African Continental Free Trade Agreement that even Nigeria has been very slow to ratify and it's even keeping its borders closed to trade and making negotiations and things a bit difficult. But how much does do those agreements between blocs of countries, how much impact do they have on the overall pattern of trade generally?
MS: Yeah, this is well outside my area of expertise. My understanding is that regional trade agreements actually can have quite a bit of influence on trade patterns. What I will say is that I think there can be a big distinction between what's on paper at a high level in these agreements, and both the nitty-gritty of the regulations and what's actually happening on the ground, right? So I think what you've seen in some of including, like, African regional trade agreements in the past is, you call something some sort of trade agreement or free trade zone, but when you look at all of the accompanying regulations like phytosanitary regulations or border control approaches or harmonization of, you know, product regulations, those aren't in place. And so you get rid of the tariffs, but you don't still have anything that really looks like free trade if the goods are being held up at the border and hit with all sorts of fees for inspections or rejected for phytosanitary reasons supposedly or something like that, right? And so I think there is a lot of legwork to turn this kind of high-level intentions about regional agreements into something that actually encourages higher trade flows on the ground. You know, especially when it comes to smaller traders, if you think about small agricultural traders engaged in cross border trade. They are the ones who often either aren't really complying with what's on paper or are getting kind of held up by all of these little fees and inspections and regulations that they have to deal with.
TL: That's interesting. Tell me a bit more about what you're working on currently.
MS: Sure, so one thing that I've been thinking about recently actually, kind of, brings us back to the beginning of our conversation when we were talking about larger firms that might have kind of more formal supply chains or distribution networks. And so I've been thinking about, you know, in a place where you don't see a ton of those kinds of firms, how do goods actually get all the way out to consumers? And not just in a place like Lagos, but you know, maybe think about somewhere a little bit more remote, a smaller town, or even somewhere rural.
And what's interesting is that instead of kind of having one integrated supply chain where one firm owns the goods and imports them, and employs lorries and distributors and takes them out to its own stores, what you see instead is kind of a chain of actors who are all involved in getting those goods out. Right, and so you might see something like a cell phone or shoes or food products or whatever it is passing through the hands of you know 4, 5, 6 even more different firms or people on its way out to consumers. You have lots of intermediaries for buying and selling along the way, and so my recent work has been trying to think about why does that happen and when do we see goods passing through the hands of more intermediaries? And how does that affect consumers? And I think that kind of instinct for both a lot of economists and a lot of policymakers is that middlemen are bad, right? Middlemen are people who don't add value and maybe they increase prices and that must be bad for consumers. And So what I've been trying to think about both, kind of, empirically and in theory is: Is that true, and if so, when is that true? And one of the conclusions that I'm starting to get to is that in a situation where you have kind of a remote consumer, going through that long chain can actually be good because it's pro-competitive right? That if you had to have one big firm serving that little market, they would be a monopolist and they could charge really high prices. And if instead, you have this chain of smaller actors and goods pass through lots of hands, you might actually have more competition in that local market and that might be good for consumers in the form of lower prices.
TL: I really can't wait to read it. That sounds super cool.
TL: One final question before I let you go - you've spent a lot of time with me, thank you very much - is what's the one idea you really like to see spread? It may be about trade or economics or your personal philosophy, anything generally. So what's that one idea you really think deserves a lot more attention in society or the world, generally?
MS: That's a great question. I think, you know, you may have gotten this idea from our conversation so far, but an idea that's important to me is that people are really infinitely creative and energetic in solving the problems that they face. And that if policymakers and academics follow their lead a bit more, you might find some unconventional approaches to solving the kind of economic challenges or promoting growth in the ways that we're after. So in my first project that we were talking about, right? The example of this is that people have these search and contract enforcement problems and they just get on a plane and go there in person to solve it. And I don't think I would have thought of that, I don't think most policymakers would necessarily have thought of that as a trade promotion tool, right? But if you look at what people actually do in reality to solve the problems they're faced with, you get those kinds of ideas. And so in the kind of research I do, for instance, when you talk about contract enforcement problems, people often take a very literal approach to thinking about policy solutions, right?
Like, okay, contract enforcement, you start thinking about improving the court system or increasing the rule of law right? And those are very good things. If you can get them right, that's a great idea. But, you know, even in countries with very strong rule of law, a lot of business and trade-related issues are resolved without the involvement of those formal institutions. They've involved things like personal relationships and travel and financial services and arbitration and credit bureaus and so on, continue to be important no matter how rich your country is. And so I think looking to those kinds of solutions that people actually use in practice gives you a lot of ideas about how you might be able to sort of smooth the path to these underlying goals without something like improve the court system, which is a really tall order, whereas maybe change your air services agreement, or, you know, let firms experiment with new trade credit services might be a slightly easier ask that could help us accomplish the same goals.
TL: I love that idea so much and we do our best to help you spread it.
MS: Thank you.
TL: Yeah, thank you very much. I've been speaking to Meredith Startz who is the assistant professor of economics at Dartmouth College. It's been fun talking to you, Meredith. Thank you very much.
MS: It's been a pleasure. Thank you so much for having me.