What are the underlying drivers of economic development?
I’ve previously mentioned that freer countries are richer countries. See
- Economic development makes every country healthier and richer
- “If you care about improving peoples lives, then you really care about economic freedom”
What does freedom have to do with countries getting richer?
Russell Roberts offers a partial explanation in his book The Price of Everything – A Parable of Possibility and Prosperity
The main character in the book makes a lot of great points in a monologue discussing why rich countries are rich. A few of the comments and my thoughts:
…The wealthy nations have more capital. More physical capital, machines and factories and computers. The people in those wealthy countries have more human capital, more knowledge and skills to work with the physical capital. The wealthy countries have policies that encourage risk-taking and the accumulation of both kinds of capital.
When you have that kind of capital you are more productivity. Everyone in the country is more productive. It takes time and effort to build up that capital, whether knowledge, machines, tools, or companies that can produce stuff. If you can’t build it up, or you risk having everything ripped off on a moment’s notice, or the regulatory structure makes it extremely difficult to accumulate the capital, then there would be less of it. If you have less capital, the entire country will be less productive and every person living there will be less wealthy.
Economic and political power are disbursed in the wealthy countries. The poor countries are more likely to be run by thugs who take what they can. Think Cuba or Syria. That discourages the accumulation of physical or human capital. That discourages foreign investment that might make workers more productive. The presence of thugs discourages risk-taking.
Just how much money are you willing to invest in a country that might steal it from you at any moment? Not much.
A long time ago I traveled in some countries that had severe currency restrictions. It was quite enlightening. You could bring money into the country but it was extremely difficult to take money out. Feel free to bring money in to make an investment, but you can’t take your money out. Why would anyone be so foolish as to invest in such a country when they could not do anything with the profits or the proceeds from selling the investment when they were ready to move on?
The rich countries have the rule of law, so a person can buy something or enter a deal and know that the fruits of the deal won’t be arbitrarily stripped away. And on top of all that, the rich countries have a culture of trust so that everything doesn’t have to be put into a contract.
Here’s a formula for failure – try building a plant or developing a distribution system in a setting where the rules only have meaning based on what the powerful or connected want them to be at the moment. Oh, and those rules are subject to change on a whim. Why would you build up something complex or difficult if someone who has better connections than you could take it away or change the rules at any time?
But if I have to sum it up in a single thought, the rich countries have more freedom. Freedom to innovate, freedom to compete, freedom to take risks, freedom to fail.
Freedom is the underlying driver for economic growth. That is the message you see in the posts I linked above. Professor Roberts’ characters explain the concept well.
By the way, go get the book. You will get a fun read and be enlightened at the same time.