Hey Reader! I can’t be more happy to see you :)
So first of all I welcome you all and I hope that you like my first article on Why Some Nations are Rich & Some are Poor?
Introduction
Pursuing Masters in Economics and being a capitalist, I have always wondered on a micro level that why Mr. Gates is richer than X?
This question may have quite a wide variety of answers including but not limited to the ‘value’ he created, the luck factor involved, the country where he was born in, personal background and what not.
This may sound intimidating and confusing. Why the heck should we compare Bill Gates to any common person. Right?
I totally understand your point. But this may hold a relevance when we talk about differences in countries.
Let’s think about the most capitalist oriented country, USA and a socialist regime like North Korea. Oops sorry, not socialist but a communist state!
Have you guys thought about this, why North Korea is much poorer than USA?
Why so many technological developments happened in USA and not North Korea?
How come 70% of American teenagers own a pair of Airpods?
Why, if one observes, there is such a difference between an American’s standard of living vis-à-vis a Chinese standard of living?
First of all before delving into these questions let me touch on some of the important definitions of what constitutes rich?
Economic Lingo
When we talk about rich from a country perspective, we are not looking at GDP itself. But a more comprehensive concept called Economic Growth. We are also signalling to make everyone’s life easier, a more nuanced concept of GDP per capita.
Okay, so GDP per capita is GDP i.e. value of goods and services produced in the country divided by the population during a time period. This is done to remove the effect of population difference and make the comparison more apples to apples.
If one wants to take a broader view of the economy, one should focus on economic growth. This concept talks about ‘sustained’ growth in production of goods and services in a country over time. If one thinks deeply, how do you sustain growth?
Your inputs should be the focus. - It is as simple as that
Until and unless, the inputs which are factors of production here like land, labor, capital & entrepreneurship are not rising, a country will not be on a path to ‘enlightenment’!
Don’t take the above in literal sense, for eg.
‘land’ is the natural resource which can either be discovered, improved or ‘imported’ in some cases.
Entrepreneurship is more people starting-up.
Capital is the amount of capital which is getting invested in the real economy- like infrastructure, businesses, factories etc.
Labour is the number of people working i.e. labour force
If a country can increase its raw materials sustainably over a long term, it can drive on the road to economic growth.
So, you got the answer, right? No, continue reading.
You haven’t got the complete answer
The important question to ask now is, why will it increase or what will make these raw materials rise over time?
On Point
Why do you go to work every day to an office- job or business? Because you have an incentive to work- money, respect, love for the work and retirement (apart from other reasons).
The above-mentioned land, labor, capital or entrepreneurship will only rise over time if we have proper incentives for them. What will be these incentives? Or the broad question~ what will make an economy rich over time?
The economic environment in terms of institutions will make a country progress/rich/grow over time.
Institutions are basically rules of the game.
Both political and economic institutions.
Political institutions include whether the government is a democracy, how stable the government is, taxation policy, property rights etc.
Economic institutions are how independent businesses, central bank is from the government, sustained value of the currency, export-import policy, free trade, market system- capitalist or socialist?
These are the two factors which determine whether a country will be rich over time or not.
Adam Smith- What do you say Sir?
Adam Smith in one of his texts talks about the problem of mis-allocation of resources (capital allocation).
He effectively remarked the economies don’t become rich like England due to not proper allocation of scarce resources (capital, natural resources etc) to areas which has the potential for high growth.
However, he took the stable political (democratic setup) and economic landscape existing in England in 18th century as given!
Smith talked about invisible hand as well~ the market system of demand and supply. But the problem comes when the market find it difficult to play its game properly.
Like in case of scarcity (vaccines availability) or public goods (parks), the capitalist system just won’t work and the invisible hand will fall short.
Hence, the theory propounded by Smith doesn’t tell us much about wealth distribution and income inequality between countries.
Cases
England had the Glorious Revolution in 1688, which basically helped it transform from an absolute monarchy to a peripheral version of democracy.
All males owning property were allowed to vote in a parliament. The elected representatives in the Parliament were composed of a broad spectrum of people present in the society.
Of course, the Tudors tried to take the power back as no absolutist will cede control but there was a fight back from the broad section of society! People realised the importance of voting their representatives themselves and having a control over the political system of the country (even though degree of control was less)
Post the revolution, there was economic growth visibility with a stable political and economic climate ‘incentivising’ the growth!
The supreme reason why industrial revolution happened in UK.
The Soviet Union in the 1980s were growing at such a high growth rate that it was thought that it will undertake US’s GDP in a 5-year time frame.
How the country under a monarch was growing at such an aggressive rate?
This is perceived as ‘forced growth’ due to the force used by the SINGLE person to allocate resources where he can extract the most out of in the form of taxes.
An important point here to be stated, that the union couldn’t sustain its growth over a sustainable time frame due to the missing element of ‘creative destruction’ (not my term) or in other words innovation!
Innovation is the key that will support the institutions and help the country growth and lead over time. The reason why Silicon Valley came in USA and not Russia!
China- A ‘weird’ country
China had started its sustained growth under Deng’s leadership.
He didn’t let go of the policies of Communist Party but simultaneously, he sort of gave the free hand to businesses to grow. He followed industrialisation to the letter and focused on removing Chinese dependence. I will not be bogging down in the history of the country, but it is really surprising what they have done in the past 25 years.
This refutes the theory that I mentioned as it breaks the basic tenet of democracy, ‘intrusive’ political and economic institutions!
So what is making China different? According to my view and I can be wrong here, China will continue to grow for some time period simply because of its manufacturing prowess.
Where it will lack and fall short will be- the intellectual property! It currently imports technology from USA and other countries like Taiwan or South Korea. A case in point- semi-conductor industry.
Although, China also made some great strides in technology- if you look at their number of patents from Peking University- it is still has some hinderances and bottlenecks to go through like buearucracy
The above conjecture can go awry, if China turns it’s a market-dynamic economy with embracing of democracy and intrusive institutions.
The recent fiasco with Alibaba makes China go in the opposite direction which according to me, was the worst move.
Incidentally, the government’s capital allocation had been relevant but this might be impacted due to the rapidly changing world and dynamism.
Differences Observed
If there are books written about it and a novice ‘economist’ like me can figure out these policies, then what is stopping other countries implementing them?
First reason, as already stated somewhere above, that monarchs or absolute governments, will not give up control.
A more specific reason, we cannot just incorporate a system which worked somewhere else into a different country!
Latin American countries gained their independence from Spanish Empire in the 19th century. They looked around and figured out that their northern neighbour has done well. Most of these countries adopted the US constitution. It didn’t work well. Why?
Because the element of informal institutions. Basically, the inherent historical experiences, feelings, nature, personality, beliefs etc of people.
How they can be changed? Time is the key here along with some nudges in form of strict enforcement without harming people’s liberty.
The above statement holds lot of relevance. It can be easily written and pontificated by politicians, policy makers, bureaucrats etc but very difficult to implement.
Conclusion
If you observe around us, we, Indians followed socialism post-Independence. We have a history of such policies. We have a history of traders stealing from our economy like East India Company. So, just telling people, that embrace businesses or startups is easy but understanding why people shirk from owning shares or having a business is the key. People are not dumb. But, people are thinking quite logically from their own set of beliefs and experiences included in their genes, ingrained in their minds by their parents and reading/studying historical books.
How to tame this problem? Read my newsletter first (just kidding)
On a serious note, focus on your institutions. Embrace technology and give time and better experiences (better and encouraging policy) to citizens. This will strengthen the foundation and make us rich and grow sustainably well over time.
Thank you so much for reading and I hope I could add something to your knowledge.
I learnt new things from this newsletter. It was absolutely amazing. Waiting for the next !!!