Economic Growth

“The means are, first, a better government: more complete security of property; moderate taxes, and freedom from arbitrary exaction under the name of taxes…”

– J. S. Mill (1848, Principles of Political Economy)

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“Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things.”

- Adam Smith (1755, Lectures on Jurisprudence)

Measuring Economic Growth

“Once you start thinking about economic growth, it’s hard to think about anything else.”

– Nobel laureate Robert Lucas

Why Does Economic Growth and Measurement Matter for a Business Student?

• Understanding global business conditions is vital for businesspeople making international investments or who rely on international customers or suppliers.
• Understanding what factors drive or inhibit economic growth is necessary for doing responsible market research.
• Understanding how economic growth is calculated, and the strengths and weaknesses of how it is measured, is necessary for market forecasting.

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Y=F(A,K,L)

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Y= GDP

A= Technology

K= Capital

L = Labor

Peter J. Boettke, Peter T. Leeson, and Daniel J. Smith (2008). “The Evolution of Economics: Where We Are and How We Got Here,” Long Term View Journal 7(1).

“Institutions that eliminate piracy, improved enforcement of contracts and property rights, reduced risk and provided credit, insurance, information, and the reasonable assurance that trading partners would meet their commitments were a major factor in Smithian growth. As a consequence, in the centurires before the Industrial Revolution, markets got better at the allocation of resources. Economics teaches that if labor or capital is reallocated from low- to high-productivity uses, overall output rises.”

- Joel Mokyr (The Enlightened Economy)

How Is Economic Growth Measured?

Gross Domestic Product

• The market value of all final goods and services produced within a country in a year
• GDP per Capita divides GDP by the number of people in the country.

Gross National Product

• Includes economic output or income from abroad made by nationals.

Components of GDP

“We must however not count the same thing twice. If we have counted a carpet at its full value, we have already counted the values of the yarn and the labour that were used in making it; and these must not be counted again.”

– Alfred Marshall (1890, Principles of Economics)

What fraction of antebellum US national product did the enslaved produce?�Paul W. Rhode �Explorations in Economic History

• “This article evaluates the high-profile claim that enslaved African-Americans produced over 50 percent of US national product in the pre-Civil War period. The accounting exercise shows the fraction was closer to (and indeed likely slightly below) the share of the population, that is, about 12.6 percent in 1860.”
• “We do not need to include items such as the value of feed production, for work stock as an example, if we attribute 100 percent of the value of enslaved-based commodity production to the enslaved. The value of these inputs is already included in the value of the commodities produced; that is, they do not have to be netted out. Including them separately would involve double-counting.”

“The rise in material affluence in the United States in this century has been so great that citizens whom the government labels “officially poor” currently have incomes surpassing those of average middle-class Americans in 1950 and higher than all but the richest Americans (top 5 percent) in 1900.”

- Gary M. Walton and Hugh Rockoff (2002). History of the American Economy.

$50K Invested for 50 Years

$131,941

$2,171,371

“Remember that money is of a prolific generating nature. Money can beget money, and its offspring can beget more, and so on.”

-Benjamin Franklin (1748)

“‘A matter of degree,’ some might say, but degree is everything in economic history and the acceleration in the rate of economic change is the central event that needs to be explained.”

-Joel Mokyr (The Enlightened Economy)

Calculating GDP Growth Rates

((Current GDP – Historic GDP)/Historic GDP)*100

Calculating GDP Growth Rates

• GDP 2005: 12,455
• GDP 2004: 11,712

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What is the growth rate?

• New-Old/Old * 100
• (12,455-11,712)/11,712 * 100 = 6.34%

Real vs. Nominal GDP

Nominal GDP

• Calculated using prices at the time of sale (not adjusted for inflation)

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Real GDP

• Have been adjusted for changes in inflation

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National Spending Approach to Calculating GDP

Y = (C + I + G –M) + X

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Y = Nominal GDP

C = Consumption (private spending on goods & services)

I = Investment (private spending on tools, plant, and equipment)

G = Government purchases (except transfer payments)

M = Imports

X = Exports

Y = (C + I + G – Imports)+ Exports

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C, I , & G

• We want Y to only include those goods produced domestically, whether for domestic or foreign consumption.
• That is why we add in exports
• A reduction in exports hurts GDP
• We need a further adjustment, however, because Consumption, Investment, and Government purchases contain both goods produced domestically, and goods produced abroad.
• That is why we subtract imports
• Decreasing imports does not boost GDP, as it also decreases consumption.

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Problems with National Spending Approach to Calculating GDP: Y = C + I + G + NX

GDP as a Measure of Economic Growth

Excludes:

• Leisure
• Underground markets
• Home production
• Environmental costs
• Distribution of income
• Privatization
• Consumer surplus
• Variety (multiple restaurants vs. one)
• Happiness not included
• Non-measurable improvements

GDP as a Measure of Economic Growth

• Includes:
• Government spending
• At cost, not at value
• Post Office – saving 50% of 40 million budget would decrease GDP 20 million
• Militarization & war expenditures
• Debris removal and rebuilding after disasters
• Litigation costs
• Skews data for developing nations
• Moral Issues
• Philosophical (What is growth? What should be included?)

Leisure and GDP

“Wages hath proved an inducement to Idleness; for many are being Idle the oftner, because they can get much in little time … Excessive Wages is a load upon a Nation.”

- Mercantilist Sir Henry Pollexfen (1967)

WHY DO AMERICANS WORK SO MUCH MORE THAN EUROPEANS?�Edward C. Prescott �FRB Minneapolis – Quarterly Review (2004)

Americans now work 50 percent more than do the Germans, French, and Italians. This was not the case in the early 1970s when the Western Europeans worked more than Americans. In this paper, I examine the role of taxes in accounting for the differences in labor supply across time and across countries, in particular, the effect of the marginal tax rate on labor income. The population of countries considered is that of the G-7 countries, which are the major advanced industrial countries. The surprising finding is that this marginal tax rate accounts for the predominance of the differences at points in time and the large change in relative labor supply over time with the exception of the Italian labor supply in the early 1970s. This finding has important implications for policy, in particular for making social security programs solvent.

The Shadow Market and GDP

Leandro Medina and Friedrich Schneider IMF WP/18/17

Home Production

“The person who buys instruction, buys an amount of wealth, which it must be presumed is equal in value to what he has paid for it, while the self-taught person, who is in possession of much superior knowledge, has acquired no wealth.” �- Thomas Malthus (Principles of Political Economy)

How Did COVID-19 Affect GDP?

Pinker, Steven (2018). Enlightenment Now: The Case for Reason, Science, Humanism, and Progress. Penguin Random House Publishers.

“Luxuries that had once been reserved to the very rich and powerful (or had been unknown altogether) were becoming routine consumption for ever-larger segments of the British population.”

– Joel Mokyr (The Enlighted Economy)

Environmental Costs

“…recent evidence has fostered an optimistic view by suggesting that the curve is actually flattening and shifting to the left. The driving forces appear to be economic liberalization, clean technology diffusion, and new approaches to pollution regulation in developing countries.”

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-Dasgupta, Susmita, Benoit Laplante, Hua Wang, and David Wheeler (2002). “Confronting the Environmental Kuznets Curve,” Journal of Economic Perspectives 16(1): 147-168.

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• Carbon emissions per capita are actually down
• Deforestation peaked back in the 1980s
• The air we breathe now is vastly improved from centuries ago
• And more people died from natural disasters a hundred years ago

Everything on this page that is now in the iPhone cost $3,054.82 in 1991, or $5,993 in 2023.

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-Based on Steve Cichon (2014). “Everything From This 1991 Radio Shack Ad You Can Now Do With Your Phone”, Huffington Post. January 16^th.

GDP & Distribution of Income

“Of 402 articles [peer-reviewed] citing the EFW [Economic Freedom of the World] index, 198 used the index as an independent variable in an empirical study. Over two-thirds of these studies found economic freedom to correspond to a “good” outcome such as faster growth, better living standards, more happiness, etc. Less than 4% of the sample found economic freedom to be associated with a “bad” outcome such as increased income inequality.”

-Joshua Hall and Robert Lawson (2014). “Economic Freedom of the World: An Accounting of the Literature,” Contemporary Economic Policy 32(1): 1-19.

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Privatization

The government doesn’t sell its final product on the market. We must calculate its value by price (of wages and inputs), which involves the assumption that the government is perfectly efficient.

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Consumer Surplus

Broadband-generated consumer surplus is estimated to be $8.7 Billion

• Wikipedia alone is estimated to create $43.5 Million in consumer surplus
• Online bookstores provide an estimated $731 Million to $1.03 Billion in consumer surplus

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“Considering only memory, processing, and broadband communications power, duplicating the iPhone back in 1991 would have (very roughly) cost: $1.44 million + $620,000 + $1.5 million = $3.56 million.”

–Bret Swanson (2014)

Variety

• Sporting Events
• Restaurants
• Cars
• Clothing
• Careers
• Cereal

“The growth in choice and variety were as much an improvement in economic welfare as falling prices and growing consumption.”

– Joel Mokyr (The Enlightened Economy)

Happiness

• Difficulties with measuring happiness overtime and across countries.
• GDP is unlimited while happiness is limited. Even during a small recession, happiness falls drastically.
• Philosophical Concerns:
• If happiness becomes the goal of governments then, according to surveys, churchgoing and marriage should be top priorities.

Stevenson, Betsy and Justin Wolfers (2008). “Economic Growth and Subjective Well-Being: Reassessing the Easterlin Paradox,” Brookings Papers on Economic Activity. Spring.

Non-Measurable Improvements

Non-Measure Improvements: Innovation

“If everything is so good, why is everything so bad? Why the gloominess of so many of my colleagues? Part of the story is that economists are trained to look at aggregate statistics like GDP per capita and measure for things like "factor productivity." These measures were designed for a steel-and-wheat economy, not one in which information and data are the most dynamic sectors. They mismeasure the contributions of innovation to the economy.

Many new goods and services are expensive to design, but once they work, they can be copied at very low or zero cost. That means they tend to contribute little to measured output even if their impact on consumer welfare is very large. Economic assessment based on aggregates such as gross domestic product will become increasingly misleading, as innovation accelerates. Dealing with altogether new goods and services was not what these numbers were designed for, despite heroic efforts by Bureau of Labor Statistics statisticians.”

- Joel Mokyr (2014, The Wall Street Journal)

The Progress We Have Made

“…the poverty of the sixteenth-century peasants must have been inexpressibly distressful. How keenly the cold pierced the dark huts of the poorest, is hard for us to imagine. The winter diet of salt meat, the lack of vegetables, the chronic filth and squalor, and the sorry ignorance of all laws of health opened the way to disease and contagion. And if the crops failed, famine was added to plague.” – Carlton Hayes (A Political and Social History of Modern Europe)

Jahn Ekenæs (1847–1920), Women Doing Laundry Through a Hole in the Ice (1891)

Betsey Stevenson and Justin Wolfers (2008). “Economic Growth and Subjective Well-Being: Reassessing the Easterlin Paradox,” Brookings Papers on Economics Activity 39(1): 1-102.

What Causes Economic Growth?

“nations…are so miserably poor, that, form mere want, they are frequently reduced, or, at least, think themselves reduced, to the necessity sometimes of directly destroying, and sometimes of abandoning their infants, their old people, and those afflicted with lingering diseases, to perish with hunger, or to be devoured by wild beasts.”

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“Among civilized and thriving nations, on the contrary, the produce of the whole labour of the society is so great, that all are often abundantly supplied, and a workman, even of the lowest and poorest order, if he is frugal and industrious, mayy enjoy a greater share of necessaries and conveniences of life than it is possible for any savage to acquire.”

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-Adam Smith (Wealth of Nations)

What Causes the Difference in the Wealth of Nations?

• Geography or natural resources?
• Slavery?
• Work ethic, genetics, or culture?
• Population growth?
• Education?
• Technology or capital and financial investment?
• Vicious circle of poverty?
• The absence of violence or fractionalization?

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Alfred Marshall decided to study economics after he “visited the poorest quarters of several cities and walked through one street after another, looking at the faces of the poorest people.”

The Case for Geographic Determinism

• Natural resources
• Climate or proximity to equator
• Rainfall
• Vertical or horizontal countries
• Soil quality
• Access to navigable waterways or transport infrastructure
• Traversable (non-rugged) terrain
• Disease environment

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Natural Resources

Have Abundant Resources

China

Africa

India

Soviet Union / Russia

Congo

Bolivia

Have Limited Resources

Hong Kong

Japan

Singapore

Venice

West Germany

Switzerland

Taiwan

“Modern economic growth has made the ‘resources’ that everyone except economist thinks of as especially scarce – oil, fresh water, chromium – into an unimportant share of national income.”

– Deidre McCloskey (Bourgeois Virtues)

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“Whatever the precise counterfactual chosen, the interference “no coal, no Industrial Revolution” seems untenable.”

- Joel Mokyr (The Enlightened Economy)

The Curse of Natural Resources �Jeffery D. Sachs and Andrew M. Warner�European Economic Review

“Almost without exception, the resource-abundant countries have stagnated in economic growth since the early 1970s, inspiring the term, `curse of natural resources. Empirical studies have shown that this curse is a reasonably solid fact. It is not easily explained by other variables, or by alternative ways to measure resource abundance.”

Reversal of Fortune�Daron Acemoglu, Simon Johnson, and James A. Robinson �The Quarterly Journal of Economics

“Among countries colonized by European powers during the past 500 years, those that were relatively rich in 1500 are now relatively poor. We document this reversal using data on urbanization patterns and population density, which, we argue, proxy for economic prosperity. This reversal weighs against a view that links economic development to geographic factors.”

In the mid-1960s, Ghana and South Korea had very similar levels of per capita GDP. Ghana, however, had the benefit of rich natural resources including oil and precious metals, which South Korea lacked.

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“The responsibility of economic historians is to remind the world what things were like before 1800. Growth was imperceptibly slow, and the vast bulk of the population was so poor that a harvest failure would kill millions. Almost half the babies born died before reaching age 5, and those who made it to adulthood were often stunted, ill and illiterate.”�

- Joel Mokyr (The Wall Street Journal)

“Many of the conveniences now enjoyed in an English cottage, would have been thought luxuries at an earlier period of our history.”

– David Ricardo (1817, On the Principles of Political Economy and Taxation)

“In two centuries daily life changed more than it had in the 7,000 years before.” – Joel Mokyr (The Levers of Riches)

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“This paper explores the effect of market orientation on (known or available) natural resource wealth using a novel dataset of world-wide major hydrocarbon and mineral discoveries. Our empirical estimates based on a large panel of countries show that increased market orientation causes a significant increase in discoveries of natural resources. In a thought experiment where economies in Latin America and sub-Saharan Africa remain closed, they would have only achieved one quarter of the actual increase in discoveries they have experienced since the early 1990s. Our results call into question the commonly held view that known or available natural resource endowments are exogenous.”

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The Shifting Natural Wealth of Nations: The Role of Market Orientation

-Arezki, Rabah, Frederick van der Ploeg, and Frederik Toscani (Journal of Development Economics)

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Noack, Frederik and Christopher Costello (2024). “Credit Markets, Property Rights, and the Commons,” Journal of Political Economy 132(7).

Credit markets and property rights are fundamental for modern economies, but their implications for the commons are unknown. Using a dynamic model of competitive resource extraction, we show that improving property right security unambiguously increases conservation incentives, but the effect of credit markets on resource extraction effort hinges on the security of property rights. We test these predictions using data on global fisheries, credit markets, and the largest ever marine property rights assignment. We find that property right security reduces resource extraction and that credit market development increases resource extraction under insecure property rights but reduces resource extraction under secure property rights.

“America—a large, high-tech country that accounts for about 25% of the global economy—is now generally using less of most resources year after year, even as its economy and population continue to grow. What’s more, the US is polluting the air and water less, emitting fewer greenhouse gases, and replenishing endangered animal populations. And, as McAfee shows, America is not alone. Other countries are also transforming themselves in fundamental ways.��What has made this turnabout possible? One thing, primarily: the collaboration between technology and capitalism, although good governance and public awareness have also been critical.”

“we…analyzed prices of hundreds of food items, metals, minerals, finished goods, and fuels going back to 1850. We found that, contrary to expectations, resources became more abundant, not scarcer. On average, every one percent increase in population corresponded to a one percent price decline relative to wages. That means that every one percent increase in population also corresponded to a five percent increase in personal resource abundance and a 16 percent increase in global resource abundance.”

The Case for Slavery’s Impact on Economic Growth

• Edward Baptist estimates that nearly 50% of the antebellum U.S. economy was attributable to slavery.

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• Sven Beckert argues that slavery made capitalism possible.

Examining the Impact of Slavery of Growth

• Slavery ended in 1865 in the U.S., yet our growth has increased drastically since then (you would have expected a dip in GDP at this time)
• Cotton was the biggest exported good in the U.S., but it was less than 5 percent of GDP (Baptist’s estimates contain naïve double and even triple counting).
• The South, despite its larger slave population, was economically stagnant compared to the North.
• Spain had a larger slave population than the U.S. and an earlier foothold in the Americas, yet the Industrial Revolution occurred in the U.S.
• Brazil had more slaves than America and their slavery lasted until 1888, but Brazilians have always been, and continue to remain, poorer than Americans.
• Canada, Australia, and New Zealand industrialized without slavery.
• Slavery was present throughout many human societies around the globe long before countries started growing economically (e.g., the Roman Empire)

Consensus of the Economics Profession on the Growth Effects of Slavery

• Slavery was profitable to slaveowners, but it was not a particularly efficient form of production.
• In the Quarterly Journal of Economics, Nathan Nunn finds “that not only was the use of slaves detrimental for a society, but the production of slaves, which occurred through domestic warfare, raiding, and kidnapping, also had negative impacts on subsequent development.”
• And, in a chapter published in Institutions and Economic Performance, Nathan Nunn finds that the historical existence of slavery in a country has a robust, negative impact on its income today.
• In the Journal of Economic Perspectives, Gabin Wright concludes, “The essay considers the claim that slavery played a leading role in the acceleration of US economic growth in the nineteenth century. Although popular among pro-slavery apologists, the proposition fails under rigorous historical scrutiny.”

One Giant Leap-Emancipation and Aggregate Economic Gains�Richard Hornbeck and Trevon Logan��NBER Working Paper 31758

“We re-characterize American slavery as inefficient, whereby emancipation generated substantial aggregate economic gains. Coercive labor markets were severely distorted, with the social marginal cost of labor substantially above its marginal benefit. Production during enslavement came at immense costs imposed upon enslaved people that reduced aggregate economic surplus, or the total value of output minus total costs incurred. The costs of enslavement are inherently difficult to quantify, which leads to a wide range of quantitative estimates, but we calculate that emancipation generated aggregate economic gains worth the equivalent of a 4% to 35% increase in US aggregate productivity (7 to 60 years of technological innovation). Emancipation decreased output but sparked dramatic aggregate economic gains by decreasing costs substantially more, illustrating the substantial potential for aggregate economic gains in the presence of severe misallocation.”

The Economic Effects of American Slavery: Tests at the Border�Hoyt Bleakley and Paul Rhode �NBER Working Paper 32640

To engage with the large literature on the economic effects of slavery, we use antebellum census data to test for statistical differences at the 1860 free-slave border. We find evidence of lower population density, less intensive land use, and lower farm values on the slave side. Half of the border region was half underutilized. This does not support the view that abolition was a costly constraint for landowners. Indeed, the lower demand for similar, yet cheaper, land presents a different puzzle: why wouldn't the yeomen farmers cross the border to fill up empty land in slave states, as was happening in the free states of the Old Northwest? On this point, we find evidence of higher wages on the slave side, indicating an aversion of free labor to working in a slave society. This evidence of systemically lower economic performance in slavery-legal areas suggests that the earlier literature on the profitability of plantations was misplaced, or at least incomplete.

Work Ethic, Genetics, or Culture?

Work Ethic, Genetics, or Culture?

• Wide variation in economic growth between nations with same work ethic, genetics, and culture
• West/East Germany
• North/South Korea
• Botswana and neighboring countries
• Hong Kong and China
• Immigrant Studies
• Immigrants increase their productivity immensely in moving from a poor to a rich country
• Moving from Haiti to the U.S. increases output by a factor of 20.
• Immigrants from different countries (West Germany and Haiti) do not retain their economic differences after immigration to the U.S.
• There are also drastic changes in economic growth among people with the same work ethic, genetics, and culture over time.
• “Reversal of Fortune”

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Overpopulation as a Detriment to Economic Growth

Examining Overpopulation as a Detriment to Economic Growth

Malthus assumes homogenous population, using the same tools, same trade (agriculture), and the same opportunities. Thus, every new homogenous worker will lead to a reduction in marginal productivity

• Labor is diversified and specialized
• Labor may yield increasing, not decreasing returns
• More population means a higher return for innovation and more people to engage in innovating.

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“Technological change and the creation of new information are processes that do not obey the laws of arithmetic.”

– Joel Mokyr (The Lever of Riches)

“the dire predictions of the political economists influenced by Malthus were not realized…the explosion of knowledge in the later nineteenth century eventually led to the reverse problem…overproduction.” Joel Mokyr (The Enlightened Economy)

Population Growth and Technological Change�Michael Kremer�The American Review of Economics

“For much of recorded history, the arch-enemy of economic growth was not population pressure so much as predators, pirates, and parasites, often known euphemistically by economists as rent-seekers, who found it easier to pillage and plunder the work of others than to engage in economically productive activities themselves.”

-Joel Mokyr (The Enlightened Economy)

Population Per Square Mile and GDP Per Capita (2020 data)

• Singapore (20,212 / $94k), Hong Kong (17,521 / $61.7k), Germany (603 / $52.5k), San Marino (1,471 / $63.5k), and Switzerland (539 / $66k) are some of the countries with the highest population density but also among the countries with the highest GDP per capita.
• New York City (27,000 / $73.5k)
• San Francisco (18,440 / $89.9k)
• Chad (31 / $1.5k) , Mali (39 / $2.2k), Papua New Guinea (47 / $4.2k), Niger (47 / $1k), and Sudan (57 / $4.9k) are some of the countries with the lowest population density but also among the countries with the lowest GDP per capita.

Population Without the Advantages of Population

• There are countries that do have large populations and abysmal economic conditions
• These tend to be countries where the advantages of population, innovation, and trading partners are undercut by government policies that limit the reward for ingenuity and inhibit the opportunities for trade.
• When the advantages of population are eliminated, only the disadvantages remain.
• There is a also an empirically observed tragedy of the commons when there is lack of private property rights
• People tend to have more kids because then you have more hands to grab the limited resources

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“the evil [from overpopulation] proceeds from bad governments, from the insecurity of property, and from a want of education in all ranks of the people.” ��– David Ricardo (1817, On the Principles of Political Economy and Taxation)

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Education?

“The education system which emerged after the establishment of the Soviet Union in 1922 became internationally renowned for its successes in eradicating illiteracy and cultivating a highly educated population.”

-Wikipedia (Education in the Soviet Union)

Education and the Industrial Revolution

“…formal education for the masses was unimportant for per capita GDP growth during the Industrial Revolution.”

-Alexandra M. de Pleijt (2016). “Human Capital Formation in the Long-Run: Evidence from Average years of School in England, 1300-1900,” Cliometrica: 1-28

“If England led the rest of the world in the Industrial Revolution, it was despite, not because of her formal education system.”

– Joel Mokyr (The Lever of Riches)

Das Human-Kapital: A Theory of the Demise of the Class Structure�Oded Galor and Omer Moav, Review of Economic Studies

This paper suggests that the demise of the capitalists-workers class structure was a socio-economic transformation orchestrated by the capitalists in reaction to the increasing importance of human capital in sustaining their profit rates. Physical capital accumulation in the process of industrialization enhanced the importance of human capital in production and generated incentives for capitalists to support the provision of public education for the masses, triggering the demise of the existing class structure. The implications of the theory are consistent with the voting patterns on England's education reform of 1902.

Does Schooling Cause Growth?

“…the impact of schooling on growth explains less than one-third of the empirical cross-country relationship [in economic growth].”

-Mark Bils and Peter J. Klenow (2000). Does Schooling Cause Growth? American Economic Review 90(5): 1160-1183.

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“Education is a weapon, whose effect depends on who holds it in his hands and whom it is aimed.”

– Joseph Stalin

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“The whole end of education…is found in burning into the heart and brain of the youth entrusted to it an instinctive and comprehended sense of race.” – Hitler (Mein Kampf)

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“In China…knowledge accumulation and education were largely controlled by the state administration… Hence, its content was entirely determined by the state, and mandarins and other government officials largely controlled the market of ideas and the course of intellectual innovation. Moreover, the Chinese bureaucracy increasingly privileged the study of traditional Confucian doctrine, bent primarily on social peace and preserving regime stability, over subjects more relevant to the natural sciences.”

– Grief, Mokyr, and Tabellini (Two Paths to Prosperity)

Das Human-Kapital: �A Theory of the Demise of the Class Structure�Oded Galor and Omer Moav (2006). The Review of Economic Studies 37(1): 85-117.

“Physical capital accumulation in the process of industrialization enhanced the importance of human capital in production and generated incentives for capitalists to support the provision of public education for the masses, triggering the demise of the existing class structure.”

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Private Incentives for Education

• Greater openness to trade and property rights will induce school enrollment because it provides people with the incentive to acquire skills that will increase their future income.
• An institutional environment that encourages entrepreneurship attracts the development of human capital.
• People who did get educated in nations where there isn’t free trade and property rights, tend to flee their native countries precisely so they can utilize those skills.

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Technology and the Availability of Financing?

• Technology and financing are an output of development, not an input
• The “recipes” for technology exist and investment is constantly moving to areas where there is a high rate of return to finance its adoption (especially in developing economies with high rates of return).
• Weak property rights, political instability, inflation, lack of the rule of law discourage investment.
• This is necessary to move from relational finance to bank finance to stock finance (Cooter and Schafer’s Solomon's Knot).

“As a general rule, it seems likely that in

the past 150 years the majority of important inventions…have been used long before people understood why they worked…”

-Joel Mokyr (Lever of Riches)

“Credit is a consequence, not a cause … it is produced and grows insensibly from fair and upright dealing, punctual compliance … the Off-spring of universal probity.”

-Daniel Defoe (1710)

Vicious Circle of Poverty?

“The claim that “well-governed poor nations” are caught in poverty traps is rejected by simple regressions that control for both initial income and quality of government.”

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-Easterly, William (2006). “Reliving the 1950s: The Big Push, Poverty Traps, and Takeoffs in Economic Development.,” Journal of Economic Growth 11: 289-318.

Vicious Circle of Poverty?

• high infant mortality rates
• drastic inequality
• lack of basic infrastructure
• slow communication
• conflicts between warring native tribes
• growing religious dissension
• lack of money for investment
• lack of domestic financial institutions
• growing debt to foreigners

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United States, 1700s

Raghuram G. Rajan & Arvind Subramanian (2008). “Aid and Growth: What Does the Cross-Country Evidence Really Show?,” The Review of Economics and Statistics, 90(4): 643-665

Easterly (2003) “Can Foreign Aid Buy Growth?” Journal of Economic Perspectives 17(3): 23-48.

Violence and Fractionalized Agents

• Average annual war deaths as proportion of population, 1965–2005 in Africa:
• 0.0001
• Proportion of male children ages 10–17 who were child soldiers in 1999 in Africa:
• 0.0019
• Proportion of population who are refugees or internally displaced persons in 2005 in Africa:
• 0.0053

Easterly, William (2009). “Can the West Save Africa?” Journal of Economic Literature 47(2): 373-447.

Easterly (2001). “Can Institutions Resolve Ethnic Conflict?,” Economic Development and Cultural Change 49(4): 687-706.

Institutions as the Primary Cause of Economic Growth

“The belief that Britain had a more favorable supply of entrepreneurs does not imply that Britons were in some sense superior…or that their economy inherently stronger, but only that its institutions made it attractive for the most talented and those with a taste for risk to devote themselves to business rather than to military or bureaucratic careers, or a livelihood based on the redistribution of rents rather than their creation.”

- Joel Mokyr (The Enlightened Economy)

Economic Freedom of the World: An Accounting of the Literature�Joshua Hall and Robert Lawson�Contemporary Economic Policy�

In a meta-study of 402 separate studies conducted over the last 15 years on the connection between capitalist-inclined policy and human welfare conclude that: “The balance of the evidence is overwhelming that economic freedom corresponds with a wide variety of positive outcomes with almost no negative tradeoffs.”

“The literature connecting economic freedom indexes to income levels and growth generally points in the direction of a positive association. In this paper, we argue that this finding is a highly conservative as the data is heavily biased against finding any effects. The bias emerges as a result of the tendency of dictatorial regimes to overstate their GDP level. Dictatorships also tend to have lower scores of economic freedom. This downwardly biases any estimations of the relation between income and economic freedom. In this paper, we use recent corrections to GDP numbers – based on nighttime light intensity – to estimate the bias. We find that the true effects of economic freedom at its component on income levels are between 1.1 and 1.33 times greater than commonly estimated.”

-Sean P. Alvarez, Vincent Geloso, and Macy Scheck (2023). “Economic Freedom Matters a Lot More for Economic Development Than You Think!” Working Paper.

PHOTOGRAPH BY EARTH SCIENCE & REMOTE SENSING UNITY, NASA JOHNSON SPACE CENTER

“Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.”

-Adam Smith

3 p’s generate the 3 i’s

Property, Prices, & Profit and Loss

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Information, Incentives, and Information

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Party, Power, and Popularity

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Inefficiency, Intimidation, and Indoctrination.

“the general prevalence of law and order, and the prospect of the continuance of peace and tranquility, have considerable influence. The more perfect the security, the greater will be the effective strength of the desire of accumulation. Where property is less safe…fewer persons will save at all…”�- John Stuart Mill (1848, Principles of Political Economy)

The Incentive Problems in Collective Ownership

Collective Equality

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Workers: 10

Production: 100 bu.

Consumption: 10 bu.

Reward for Shirking

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1 worker shirks

(-50% effort)

Production: 95 bu.

Consumption: 9.5 bu.

Consumption ↓ by 5%

Reward for Extra Effort

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1 worker works more

(+20% effort)

Production: 102 bu.

Consumption: 10.2 bu.

Consumption ↑ by 2%

Example Source: History of the American Economy by Walton and Rockoff

World Bank study looked at data from 137 countries to determine what policies helped the poor and which ones hurt the poor. They concluded that: "private property rights, fiscal discipline, macro stability, and openness to trade increases the income of the poor to the same extent that it increase the income of other households in society" not in a "trickle-down process but contemporaneously." These capitalist institutions helped the poor more than "governmental social spending, formal democratic institutions, primary school enrollment rates, and agricultural productivity.” Additionally, overall centralized government spending negatively and disproportionately affected the poor.

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Dollar and Kraay (2002) 

Structuring of Incentives

• Profits
• Risk-taking
• Innovation
• Entrepreneurial Alertness
• Losses
• Prudence
• Stewardship
• Reallocation of misused resources
• Consensual pooling of risk
• Risk-mitigation

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“A democratic society can’t use firing squads [like the Soviet Union used to motivate]. It must therefore use profits. Firing squads could never give us real business efficiency anyway, no matter how much terror they inspired. Fear can make a man run fast or fight hard in physical combat. […] It paralyzes the higher mental and moral qualifies. […] Hope of reward is in the long run the only efficient motive fore for civilized life.”

– Orval Watts (Why Are We So Prosporous?�

Insurance and the Price System

Bankruptcy

Information – Tin Mine Example

The Washington Consensus Works: Causal Effects of Reform, 1970-2015�Kevin and Robin Grier�Journal of Comparative Economics�

• Sustained economic reform significantly raises real GDP per capita over a 5- to 10-year horizon.

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• Despite the unpopularity of the Washington Consensus, its policies reliably raise average incomes.

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• Countries that had sustained reform were 16% richer 10 years later.

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How Does Expropriation Risk Affect Innovation?�Jose-Miguel Benavente, Claudio Bravo-Ortega, Pablo Egaña-delSol & Bronwyn H. Hall �NBER Working Paper 32288

We analyze how expropriation risk reduces incentives for innovation and reallocates resources from the innovative sector, building on Romer’s(1990) model. Our framework predicts the R&D expenditure, the share of human capital in R&D, the number of patents, technical progress, and economic growth are all lower due to lower expected profits and patent devaluation in the presence of expropriation risks. Empirical analyses, based on a LASSO Instrumental Variable approach and a novel comprehensive dataset spanning nearly two decades, confirm our theoretical predictions. We find robust evidence that expropriation risk, such as corruption, negatively impacts innovation by reducing R&D expenditure, human capital in R&D, number of patents, scientific publications, and the Economic Complexity Index, which is our proxy for technical progress. These findings highlight the detrimental effects of expropriation risk on innovation and economic development at the country level.

Economic Freedom of the World:

2022 Annual Report (Fraser Institute)

“Industry and frugality cannot exist, where there is not a preponderant probability that those who labor and spare will be permitted to enjoy.” – J. S. Mill (1848)

The Components of Economic Freedom

• Size of government
• Legal system and property rights
• Sound money
• Freedom to trade internationally
• Regulation

“Political conditions generate insecurity of property and a consequent high rate of interest, lack of initiative in the adoption of improvements and general lethargy.” – Charles S. Griffin (1902). “The Sugar Industry and Legislation in Europe,” Quarterly Journal of Economics 17(1): 1-43.

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Per Capita Income and Economic Freedom Quartile

Source: Mark Skousen’s The Making of Modern Economics

“Society can subject the distribution of wealth to whatever rules it thinks best: but what practical results will flow from the operation of those rules, must be discovered…by observation and reasoning.”

-J. S. Mill (1848, Principles of Political Economy)

“Taking it for granted that a more equal distribution of wealth is to be desired, how far would this justify changes in the institutions of property, or limitations of free enterprise even when they would be likely to diminish the aggregate of wealth?.”

-Alfred Marshall (1890, Principles of Economics)

“…the facts are inescapable. It is the increase in output in recent years, not the redistribution of income, which has brought the greatest material increase, the well-being of the average man. And, however suspiciously, the liberal has come to accept the fact.”

-John Kenneth Galbraith

“It may at first appear strange, but I believe it is true, that I cannot by means of money raise a poor man and enable him to live much better than he did before, without proportionably depressing others in the same class. […] But if I only give him money, supposing the produce of the country to remain the same, I give him a title to a larger share of that produce than formerly, which share he cannot receive without diminishing the shares of others.”

-Thomas Malthus (Principles of Political Economy)

“As a matter of arithmetic, expropriating the rich to give to the poor does not uplift the poor very much. […] And redistribution only works once. You can’t expect the expropriated rich to show up for a second cutting.” ��“one-time redistributions are two orders of magnitude smaller in helping the poor than the 2,900 percent Enrichment from greater productivity since 1800.”�-Deirdre McCloskey

Andrew T. Young and Robert A. Lawson (2014). Capitalism and Labor Shares: A Cross-Country Panel Study,” European Journal of Political Economy 33: 20-36.

“the cost of production of a workman is restricted, almost entirely, to the means of subsistence that he requires for maintenance, and for the propagation of his race.”

-Friedrich Engels and Karl Marx (1848, Communist Manifesto)

Two Cheers for Capitalism?

Peter T. Leeson

Society

Two Cheers for Capitalism?

Peter T. Leeson

Society

A Rising Tide That Lifts All Boats: An Analysis of Economic Freedom and Inequality Using Matching Methods �Justin T. Callais and Andrew T. Young�Journal of Comparative Economics 1(3): 744-777.

The cross-country relationship between economic freedom and inequality is explored using matching methods. This approach addresses selection bias and endogeneity generally better than extant studies. Meaningful increases in the Fraser Institute's Economic Freedom of the World (EFW) index are related to changes in (i) decile income shares, (ii) decile income levels, and (iii) Gini coefficients. Increased economic freedom is associated with significant gains across the income distribution. It is also associated with modest increases in inequality – associated particularly with gains in the top income decile.

Does Economic Freedom Boost Growth for Everyone? �Andreas Bergh and Christian Bjørnskov�Kyklos 74(2) 2021: 170-186.

While the association between economic freedom and long-term economic growth has been well documented, the parallel research literature on the distributional consequences of economic freedom is full of conflicting findings. In this paper, we take a step toward reconciling these two bodies of literature by exploring the within-quintile growth consequences of changes in three separate elements of economic freedom: the size of government, institutional quality and and policy quality. Although the distributional consequences of increases in economic freedom are theoretically ambiguous, we find evidence that economic freedom affects all parts of the income distribution equally, in addition to indications that the growth effects are largest for the poorest and richest quintiles.

You Have Nothing to Lose but Your Chains? Re-examining the Hayek-Friedman Hypothesis and the Relationship Between Capitalism and Political Freedom�-Nicholas Reinarts, Gabriel Benzecry, and Daniel J. Smith�Public Choice

“Even the greatest enemies of trade and manufactures…must allow that when they were introduced into England, liberty came in their train.”

-Thomas Malthus (An Essay on the Principle of Population)