What Makes a Nation Rich?

Say you’re a world leader and you want your country’s economy to prosper. According to this Clark Medal winner from MIT, there’s a simple solution: start with free elections.

CLICK HERE FOR A MAP OF HOW GOVERNMENTS AFFECT THE WEALTH OF NATIONS >>

That is a bad headline I think – free elections may not work unless the institutions are right — especially the rule of law and private property rights. Here’s MIT economist Daron Acemoglu:

(…) The question social scientists have unsuccessfully wrestled with for centuries is, Why? But the question they should have been asking is, How? Because inequality is not predetermined. Nations are not like children — they are not born rich or poor. Their governments make them that way.

(…) yet while Sachs and Diamond offer good insight into certain aspects of poverty, they share something in common with Montesquieu and others who followed: They ignore incentives. People need incentives to invest and prosper; they need to know that if they work hard, they can make money and actually keep that money. And the key to ensuring those incentives is sound institutions — the rule of law and security and a governing system that offers opportunities to achieve and innovate. That’s what determines the haves from the have-nots — not geography or weather or technology or disease or ethnicity.

Put simply: Fix incentives and you will fix poverty. And if you wish to fix institutions, you have to fix governments.

How do we know that institutions are so central to the wealth and poverty of nations? Start in Nogales, a city cut in half by the Mexican-American border fence. There is no difference in geography between the two halves of Nogales. The weather is the same. The winds are the same, as are the soils. The types of diseases prevalent in the area given its geography and climate are the same, as is the ethnic, cultural, and linguistic background of the residents. By logic, both sides of the city should be identical economically.

And yet they are far from the same.

On one side of the border fence, in Santa Cruz County, Arizona, the median household income is $30,000. A few feet away, it’s $10,000. On one side, most of the teenagers are in public high school, and the majority of the adults are high school graduates. On the other side, few of the residents have gone to high school, let alone college. Those in Arizona enjoy relatively good health and Medicare for those over sixty-five, not to mention an efficient road network, electricity, telephone service, and a dependable sewage and public-health system. None of those things are a given across the border. There, the roads are bad, the infant-mortality rate high, electricity and phone service expensive and spotty.

The key difference is that those on the north side of the border enjoy law and order and dependable government services — they can go about their daily activities and jobs without fear for their life or safety or property rights. On the other side, the inhabitants have institutions that perpetuate crime, graft, and insecurity.

Nogales may be the most obvious example, but it’s far from the only one. Take Singapore, a once-impoverished tropical island that became the richest nation in Asia after British colonialists enshrined property rights and encouraged trade. Or China, where decades of stagnation and famine were reversed only after Deng Xiaoping began introducing private-property rights in agriculture, and later in industry. Or Botswana, whose economy has flourished over the past forty years while the rest of Africa has withered, thanks to strong tribal institutions and farsighted nation building by its early elected leaders.

Now look at the economic and political failures. You can begin in Sierra Leone, where a lack of functioning institutions and an overabundance of diamonds have fueled decades of civil war and strife and corruption that continue unchecked today. Or take communist North Korea, a geographical, ethnic, and cultural mirror of its capitalist neighbor to the south, yet ten times poorer. Or Egypt, cradle of one of the world’s great civilizations yet stagnant economically ever since its colonization by the Ottomans and then the Europeans, only made worse by its post-independence governments, which have restricted all economic activities and markets. In fact, the theory can be used to shed light on the patterns of inequality for much of the world.

If we know why nations are poor, the resulting question is what can we do to help them. Our ability to impose institutions from the outside is limited, as the recent U. S. experiences in Afghanistan and Iraq demonstrate. But we are not helpless, and in many instances, there is a lot to be done. Even the most repressed citizens of the world will stand up to tyrants when given the opportunity. We saw this recently in Iran and a few years ago in Ukraine during the Orange Revolution.

Please continue reading…

When Sarkozy Spoke Truth to Obama

Claudia Rosett, as usual, did a great job contrasting Obama’s rhetoric with Sarkozy’s call for action:

The setting was the special, summit-level Security Council meeting Thursday morning, chaired by Obama, in which the official topics were nuclear nonproliferation and disarmament for the entire world — but with no focus on any specific country. The meeting was advertised by the White House as “historic,” if for no other reason than that no U.S. President has ever before stooped to chair the often feckless and at times just plain sleazy UN Security Council — where the 15 members currently include Vietnam and Libya. For this particular occasion, Libya’s foreign minister attended (thus sparing the Council the risk of a replay of Qaddadi’s 96 minute performance the previous day on the General Assembly stage). The rest of the table was filled with presidents and prime ministers.

They began with Obama’s pre-packaged deal of unanimously adopting a “historic” resolution, which Obama said “enshrines our shared commitment to the goal of a world without nuclear weapons,” etc, etc. etc (All very nice, but what does this have to do with the real world?). Secretary-General Ban Ki-Moon kicked off the ensuing round of official self-congratulatory huffing and puffing (”…a historic moment…a fresh start towards a new future”). The canned diplo-speak continued, as each member spoke in turn – Costa Rica, Croatia, Russia, Spain, Austria, Vietnam, Uganda, China … and then it was the turn of the French president, Nicolas Sarkozy. Here’s his wakeup call, in the UN’s translation from the French (boldface mine):

“We are here to guarantee peace. We are right to talk about the future. But the present comes before the future, and the present includes two major nuclear crises. The peoples of the entire world are listening to what we are saying, including our promises, commitments and speeches. But we live in the real world, not in a virtual one.

We say that we must reduce. President Obama himself has said that he dreams of a world without nuclear weapons. Before our very eyes, two countries are doing exactly the opposite at this very moment. Since 2005, Iran has violated five Security Council Resolutions. [Ed note: Sarkozy then listed international proposals for dialogue with Iran attempted in 2005, 2006, 2007, 2008, 2009.] I support America’s extended hand. But what have these proposals for dialogue produced for the international community? Nothing but more enriched uranium and more centrifuges. And last but not least, it has resulted in a statement by Iranian leaders calling for wiping off the map a Member of the United Nations. What are we to do? What conclusion are we to draw? At a certain moment hard facts will force us to take decisions.

… Secondly, there is North Korea — and there it is even more striking. It has violated every Security Council decision since 1993. It pays absolutely no attention to what the international community says. Even more, it continues ballistic missile testing. How can we accept that? What conclusions should we draw? …”

You can read President Sarkozy’s entire statement here (in all its Defcon 1 relevance to the disclosures Friday of another Iranian uranium enrichment plant hidden on a military base near Qom) – click on this link to Security Council meetings for 2009, then click on the link for “Meeting Record” of Sept 24th and scroll to page 12.

UPDATE: the full text English translation is here. The closing paragraph:

….So, ladies and gentlemen, my dear colleagues, this is what I believe, in full support of what was decided in the resolution and in full support of President Obama’s initiative. What I believe is that by having the courage to strengthen sanctions, together, against countries that violate Security Council resolutions, we will give credibility to our commitment to a world whose future holds fewer nuclear weapons and perhaps, one day, no nuclear weapons./.

Obama worries China

David Goldman, aka “Spengler” on Obama’s foreign policy

From conversations with friends and acquaintances in Hong Kong, the damage the Obama administration has done to American interests in the Far East may be far worse than meets the eye. The Bush administration, whatever its other failings, achieved something that no previous US administration had done, namely to reassure China that the United States was committed to preserving its territorial integrity, among other things by defusing the Taiwan issue.

<snip>

Relations with Islam occupy the top spot on Obama’s international agenda, and Obama announced this policy in Turkey, the supposed showcase for moderate Islam– except that this “moderate Islam” wants to destabilize China, which is not a smart thing to do. The Chinese are trying to understand why America is going out of its way to placate a bunch of losers and sacrificing key relationships in order to do so.

Add to this the very well publicized lack of confidence in an economic policy which keep shoving American debt down the throat of the world market, and I would say China is very worried indeed.

[From Obama worries China]

And in his recent post on Gold and American Power

But the Obama administration is so destructive of American influence that the world has to own gold as a hedge against the collapse of America’s international position. I own a bit myself, not as an investment but as an insurance policy.

Everyone Should Be Responsible…(except the aid agencies)

This is a big deal: Bill Easterly has a new blog on foreign aid. Here is his first post:

Today, I foist a new blog called Aid Watch on the blogosphere. The objective is to be brutally honest when aid is not helping the poor, but also praising it when it is.

Alas, there is far to go. Take World Bank President Robert Zoellick’s oped (A Stimulus Package for the World) in last Friday’s New York Times and another one in today’s Financial Times (It is Time to Herald the Age of Responsibility).

The more you promise, the more you are telling us you don’t expect to be accountable for promises

In the NYT, President Zoellick requests an additional $6 billion from the US in foreign aid, which will “speed up global recovery, help the world’s poor and bolster [America’s] foreign policy influence…facilitate fast and flexible aid delivery…create jobs while building a foundation for productivity and growth…increase demand for American-made equipment…[and] limit the depth and length of the international downturn, prevent the contagion of social unrest and help save a generation from a new poverty trap.”

The more actions you list, the less you are serious about each action

Right after saying “priorities” for actions in poor countries (NYT), President Zoellick manages to touch on agriculture, health, education, nutrition, infrastructure, banking systems, small-and-medium-enterprise development, microcredit, global warming, and private sector development. Mr. Zoellick (FT) also wishes for international action on the Millennium Development Goals, the Doha trade round, the Copenhagen climate change agreement, humanitarian food supplies, energy conservation, and more G20 meetings to agree on fiscal expansion and reopening credit market agreements.

It’s not about aid money to reach objectives, aid money IS the objective

NYT: “The United States could begin by pledging some $6 billion…0.7 percent of its stimulus package.” FT: “How we respond to the crisis…will set the course.” The “first step” is to give more aid.

President Zoellick does mention briefly the critical issue in both the NYT and FT: some “safeguards to ensure that the money is well spent,” which don’t currently exist. In the FT, he makes the inspirational call for an “Age of Responsibility,” but the Responsibility seems to apply only to rich donors, there is nothing about holding the World Bank responsible.

If you are not accountable for promises, if you try to do everything and focus on nothing, and if you obsess about aid money raised rather than results achieved, haven’t you already told us that the money will not be “well spent”?

Why Bill Gates Hates My Book

NYU economist William Easterly is one of the true experts on the history of foreign aid [see my earlier posts on Easterly’s research, such as “Foreign aid vs. growth: Robert Lucas and William Easterly

This newspaper reported recently that Bill Gates hates my ideas. I have no hurt feelings, at least nothing that months of intensive psychotherapy can’t cure. Mr. Gates, after all, has allied himself with the foreign aid establishment. This establishment is notoriously sensitive to criticism from people like me, who find no evidence that the aid industry’s grand schemes are actually lifting anyone out of poverty.

Mr. Gates has now put forward his own scheme — “creative capitalism” — in a speech at the recent World Economic Forum in Davos. He argues that today’s capitalism does not benefit the poor. For Mr. Gates, regular capitalism works “only on behalf of those who can pay.” While entrepreneurs fall all over themselves trying to meet the needs of the rich, “the financial incentive to serve [the poor is] zero.” As a result, basic needs such as food and medicine go unmet.

Mr. Gates seems to believe that the solution is to persuade for-profit companies to meet the poor’s needs by boosting the “recognition” of corporate philanthropy. But the dossier of historical evidence to suggest this would work is as thin as Kate Moss on a diet. First of all, the recognition motive has proven to be awfully weak compared to the profit motive. Otherwise we would have had a lot more than the $5.1 billion of annual American corporate philanthropy to the Third World (as of 2005, which has the most recent reliable figures). That was four one-hundredths of 1% of the $12.4 trillion of U.S. production for the free market. Is it really the poor’s only hope that the Gap will donate a few pennies per sexy T-shirt for AIDS treatment in Africa?

Profit-motivated capitalism, on the other hand, has done wonders for poor workers. Self-interested capitalist factory owners buy machines that increase production, and thus profits. Capitalists search for technological breakthroughs that make it possible to get more output for the same amount of input. Working with more machinery and better technology, workers produce more output per hour. In a competitive labor market, the demand for these more productive workers increases, driving up their wages. The steady increase in wages for unskilled labor lifts the workers out of poverty.

The number of poor people who can’t afford food for their children is a lot smaller than it used to be — thanks to capitalism. Capitalism didn’t create malnutrition, it reduced it. The globalization of capitalism from 1950 to the present has increased annual average income in the world to $7,000 from $2,000. Contrary to popular legend, poor countries grew at about the same rate as the rich ones. This growth gave us the greatest mass exit from poverty in world history.

The parts of the world that are still poor are suffering from too little capitalism. Foreign direct investment in Africa today, although rising, amounts to only 1% of global flows. That’s because the environment for private business in Africa is still hostile. There are some industry and country success stories in Africa, but not enough.

Mr. Gates also announced his foundation is starting “a partnership that gives African farmers access to the premium coffee market, with the goal of doubling their income from their coffee crops.” This is fine as a modest endeavor to help a few Rwandan and Kenyan coffee farmers, but it’s hardly going to remake capitalism. The main obstacles to exports in poor countries are domestic ones like corruption and political strife, not lack of interest from rich-country buyers for premium coffee.

Moreover, how do philanthropists choose just which product is going to be the growth engine of a country? Much research suggests that “picking winners” through government industrial policy hasn’t worked. Winners are too unpredictable to be discovered by government bureaucrats, much less by outside philanthropists. Why did Egypt capture 94% of Italy’s import market for bathroom ceramics? Why did India, an economy with scarce skilled labor, become a giant in skill-intensive IT and outsourcing? Why did Kenya capture 39% of the European market in cut flowers? Why did tiny Lesotho become a major textile exporter to the U.S.? Why did the Philippines take over 72% of the world market in electronic integrated circuits? Because for-profit capitalists embarked on a decentralized search for success.

Sure, let those who have become rich under capitalism try to do good things for those who are still poor, as Mr. Gates has admirably chosen to do. But a New-Age blend of market incentives and feel-good recognition will not end poverty. History has shown that profit-motivated capitalism is still the best hope for the poor.

Mr. Easterly, professor of economics at New York University and visiting fellow at Brookings, is the author of “The White Man’s Burden: Why the West’s Efforts to Aid the Rest Have Done So Much Ill and So Little Good” (Penguin, 2006).

Australia: Howard loses to Rudd – 2

Australia’s new prime minister, Kevin Rudd, outlined his vision for his country in an article he wrote last year for a local political magazine, the Monthly. Riffing off Dietrich Bonhoeffer, a 20th century German pastor and theologian, the bookish former bureaucrat decried what he called “rampant individualism.” John Howard’s conservative government, Mr. Rudd argued, had gone too far by liberalizing labor markets and sacrificing “family time” at “the altar of market utility.” Australia needs a new kind of socialism, he said, one that keeps the economy running but simultaneously emphasizes “equity, community and sustainability” and gives “power to the powerless.”

Mr. Rudd’s pitch came at just the right time. Mr. Howard was entering his 11th year as prime minister. The economy was humming along like it hadn’t in a generation, boasting full employment, manageable inflation and 16 years of economic expansion. Why not try something new, Mr. Rudd’s “Kevin ’07″ campaign asked. “It’s time for a change,” the slogan went.

On Saturday, voters agreed. Mr. Rudd and his Labor Party surged to victory in one of the largest swings against an incumbent government since World War II, winning at least 83 seats in the 150-seat lower house of Parliament. Now the big question is what Mr. Rudd will do with his mandate. The answer lies, in large part, with how much power the prime minister can wield within his own party.

Mr. Rudd is a relative political lightweight compared to his deputy, Julia Gillard, who earned her stripes in the rough and tumble trade union movement. Mr. Rudd, who is 50, is not a career politician. He was elected to Parliament in 1998, joined the front bench in 2001 and was named party leader last November. The Labor Party is underpinned by trade union money and influence, and Mr. Rudd’s brand of socialism is too far right for many. It’s a risky balancing act. If Ms. Gillard’s hard-line socialism prevails, Australia could see trade unions gain power as the global economy is slowing — in other words, just as Australia, the world’s 15th-largest economy, should be liberalizing, not restricting, its domestic markets.



Fortunately, Mr. Rudd is also hemmed in by his campaign promises, particularly on economic policy. In a bid to “reclaim the middle ground” and make Labor electable, Mr. Rudd effectively copied the Howard government’s program of fiscal responsibility, lower taxes and support for free trade. When Mr. Howard announced a 34 billion Australian dollars (US $30 billion) tax-cut plan, Mr. Rudd rolled out a strikingly similar A$31 billion program. Dubbing himself an “economic conservative,” he persuaded voters he’d be a safe pair of hands. If he strays too far toward redistributionist policies, he risks losing public support rapidly.

If trade unions do take control of Australian policy I don’t think a Labor government will last long. <more>

Time for the ADB to go away

an iron law of aid: Aid agencies need bad news to justify their existence… Indeed, the ADB is currently following and will surely continue to follow another iron law of aid: Not only do old aid agencies never die, neither does any single old department of an old aid agency.

I’ve written several times on the research of economist William Easterly on the damage done for “foreign aid”. E.g., see Africa’s Poverty Trap and Foreign aid vs. growth: Robert Lucas and William Easterly which begins:

That didn’t work, so let’s try it again

Which of the following policies have helped developing countries reduce poverty?

1. investment in physical capital

2. investment in education

3. controlling population growth

4. loans to countries in financial crisis

5. forgiving foreign debts

Today Easterly examines another of these aid institutions, the Asian Development Bank, that is determined to keep its 2000 employees and $6 billion of annual lending.

Pity the Asian Development Bank. It is trying to come up with a reason to exist for an Asian continent that already is achieving development and doesn’t need a Development Bank. Given all the economic success stories in today’s Asia, you’d think the ADB could pat itself on the back for a job well done and then pack up and go home.