Up From Poverty

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For most of recorded history, economic growth was static. For centuries, the global economy grew, according to our best estimates, less than half a percentage point annually. Famous displays of wealth, such as the extravagances of the French Court, reflected the concentrating of wealth by duress within a stagnant economic system—not evidence of an economic system that knew how to make new wealth. By 1820, the industrial revolution was starting to change this dismal pattern. At that time, the United States would have been seen as a bad bet to participate in the world’s first real economic expansion. Its enormous wealth in natural resources, locked away in remote forests and prairies, was not fully appreciated. Compared to England and the continental powers—with sophisticated cities, well-established banking cultures, great universities, and phalanxes of proto-scientists and successful merchants—the U.S. was an underdeveloped country. In 1820 China was among the world’s most productive nations, accounting for one-third of gross world product. The United States produced only 2%. Just over a century later, the U.S. had eclipsed all nations, accounting for over a quarter of global product. China, meanwhile, had fallen to less than 5%.

It is tempting to think, in light of this history, that America was somehow destined to become the world’s wealthiest country. Yet if the outcome were obvious and inevitable, we ought to have a clear grasp of how it happened. But we don’t. Harvard economist Elhanan Helpman published an entire book exploring the “mystery” of economic growth only a few years ago, and even Robert Solow, who won the Nobel Prize for his pioneering growth theory, today says there are more questions than answers as to the causes of growth. This failure to understand the sources of America’s own economic performance, let alone the world’s, will be a serious handicap as we try to figure out how to renew prosperity in the face of a dramatic global slowdown. Economists, who continue to feud over what really ended the Great Depression, must help society better understand the modern forces of growth.

A Theoretician’s Paradise

Traditional explanations of America’s success—our exceptional national character rooted in the Mayflower Compact, our heritage of liberty and equality stemming from the Declaration of Independence, the unique presence of our frontier, our unparalleled capacity to innovate—have been, if not exactly refuted, at least written out of “enlightened” discourse by revisionist social, political, and historical scholarship. Retreating to economics provides no certain perspective: the discipline has produced a wonderland of competing theories. Some attribute America’s growth to free trade; others retort that the U.S. was protectionist during its years of growth. The role of institutions is highlighted by some, while others reply that the U.S. succeeded in spite of a poor institutional structure. Despite the fact that we don’t really know what caused the acceleration of our own growth, the literature on economic development operates from the premise that not only do we know, we know how to engineer the growth of other countries as well.

Only within the past 20 years has development economics produced comparative data on the behavior of various national economies. Lacking data, the discipline had in the previous three decades become a theoretician’s paradise. Every theory was as good as another—none could be proved or disproved. This empirical dearth can be ascribed, at least partly, to context: it was during the Cold War that international development emerged as a popular intellectual pursuit. We needed a strategy right away to ensure that fledgling democracies were able to outgrow Communist regimes notorious for their false promises of economic competence. State-funded aid, official gifts, and even bribes to foreign governments were intended to shore up sometimes democratic and sometimes capitalist allies that might otherwise by force, temptation, or inertia find themselves drifting into the Soviet orbit.

As an early part of this Cold War strategy, the Marshall Plan, in addition to its undisputed success in rebuilding war-shattered economies and helping to keep the western half of Europe free, produced one major unintended consequence. Experts with necessarily limited perspectives stretched the Marshall Plan approach to non-European nations, many of which had been desperately poor throughout their histories. The U.S. thus provided aid even where there were no economies to restore. At first, we simply determined to go through the motions (and garner the supposed goodwill that results from public acts of generosity), even though we didn’t honestly believe modern economies could emerge in, say, Africa.

In time a consensus theory did emerge, one that all but ruled out the possibility of the emergence of modern economies anywhere they didn’t already exist. Formal development theory can be said to have rested on three assertions—all of which should have discredited it. One was that ethno-cultural characteristics limited the likely spread of modern capitalism. The leading books of the time clearly show that the academic establishment was certain that (say) Hinduism and Confucianism operated as impenetrable bars to economic growth. At best, India and China (if even mentioned!) could hope for subsistence futures, though social disintegration was held to be more likely. The second was an unswerving focus on natural resources as the key to growth. This unreconstructed colonialist worldview—extract what you can and send it home, or at least abroad—drove the construction of massive public infrastructure (in large part to move material to port), littering poor countries with projects that to this day look like incongruent artifacts of western economies that never emerged. Finally, and most tellingly, development theory aggressively argued that economic growth was possible only in the absence of population growth; raising indigenous agricultural production to levels high enough to sustain high birth rates was assumed to be impossible. This tenet above all should have been suspect even at the time. It was already well known that, between 1820 and 1920, the population of Europe increased at an unprecedented rate—while Europe enjoyed rapid economic expansion. Yet the former was explained away as a result of the latter when in fact it was one of the causes. (Similarly, today’s anti-growth literature ignores the trend, which emerged in the second half of the last century, that as populations become richer their birth rates decline.)

Later, however, this endemic pessimism gave way to some cautious optimism. Economist Walt Rostow argued in the 1960s that sufficient capital had to be present in an economy for it to reach the point of “take off.” Poor countries’ development was held back by a lack of capital: expanding populations consumed resources too fast for capital to accumulate. The answer, therefore, was to provide generous infusions of foreign capital.

But any hope of establishing self-sustaining economies was doomed by the method of intervention. A lesson of America’s record of growth—that development is often, despite government involvement, messy and unpredictable—was shelved. Aid administrators preferred instead formula-based, orderly, central planning. Much of the mental framework for our own overseas economy-building efforts was borrowed from Soviet theory and practice. The foreign policy community held a tight grip on the process, and insisted that only schooled experts could deploy development grants and organize internal resources to achieve “self-sufficiency.” America’s success was not a model to be emulated or a goal to be sought. Other countries would have to learn to do with less—even after factoring in all that American, and later developed-country, largesse. Indeed, first generation thinking on economic development took for granted that the populations to be assisted were intrinsically incapable, or perhaps unworthy, of building and sustaining a modern economy. Much of early (and, sadly, contemporary) development policy is tinged with a kind of paternalism that implicitly despairs of other races ever managing their own growth.

Eradicating Poverty

After capitalism’s victory in the Cold War, interest in development waned. Lately, however, economic development has returned to fashion, mostly because the “take off” that Rostow theorized is occurring all over the world. In the touchstone year of 1820, 84% of the world’s population lived in what would today be judged “extreme poverty.” Today, only 16% do. That is such an astounding achievement that it is difficult even to comprehend. According to the World Bank, in the last 30 years alone—a time of rapid globalization—the number of people living in extreme poverty fell by 25%, or 500 million people. The outbreak of entrepreneurial capitalism within the Communist political system of the People’s Republic of China accounts for most of this achievement, but almost every region of the world has seen a decline in the share of its population living in extreme poverty. Bright spots such as Israel and Mauritius, moreover, have proven that growth can occur in regions previously thought allergic to it.

All this appears to have happened in the absence of, or even in spite of, those infusions of foreign aid once presumed to have been poor countries’ only hope. In fact, the one factor we can say with certainty is a force behind global growth is capitalism—a reality stubbornly resisted by those who seem blinded either by the now fashionable resistance to growth, often dressed as anti-globalism, or by their unbreakable embrace of planning as the predicate for economic success, or both. But beyond that connection, which not even capitalism’s most fervent supporters would say explains everything, lies continued uncertainty. We still don’t know why this economic development happened, or how it ever happens. Brilliant economists have developed elegant models to explain the “why” of growth after the fact. Theories, however, are supposed to be predictive. No honest economist would argue that such models could help a country lay out a practical strategy for making growth certain, or even more likely.

Appreciating this reality helps us weigh several recent contributions to the development literature. In his recent book, One Economics, Many Recipes (2007), Harvard professor of international political economy Dani Rodrik wisely reminds us that there exists no general theory of growth, though he offers pragmatic suggestions in individual cases. In many ways this is an anti-planning book but it is unlikely to be read as such. Many will inevitably see his advice as merely a different way for outsiders to impose answers that necessarily involve more capital investment from the West. Those readers—looking for justifications to continue Western aid programs—are likely to overlook Rodrik’s careful elucidation of how the eradication of poverty is the natural result not of foreign aid but of the emergence of free market economies.

In this regard, One Economics, Many Recipes echoes a sound and sober work of some years back by Deepak Lal, The Poverty of “Development Economics" (1989). Lal, a professor of international development studies at UCLA, characterized the debate among development experts as polarized between state-guided capitalism, a descendant of Keynesian thought, and classical laissez-faire liberal economics. He called the former “dirigiste dogma” and declared that it rejected much of what modern, empirical economics has to teach. In later editions of his book, he contended that the restoration of confidence in markets in the 1980s, more or less formulated in what came to be known as the Washington consensus, had two unintended consequences. First, it provoked a backlash in many developing countries and among many Western observers. And second, it became conflated, unfortunately, with the view that the welfare state, too, had to be exported to poor countries.

Planning Utopia

The title of Jeffrey Sachs’s new book, Common Wealth: Economics for a Crowded Planet (2008), suggests its argument: because the developed world is not generous enough with its wealth, some of it must be seized to prevent the rest of the world’s further impoverishment. For Sachs, a Columbia University professor, advisor to the secretary general of the United Nations, and author of the credible earlier work, The End of Poverty (2005; a book strangely out-of-step with his recent work), the very presence of poverty in the world demonstrates the failure of international economics. There are too many people, too little water, not enough of the right kinds of foods, too much carbon emission, and too unquestioned a reliance on the nation-state’s right to operate without regard to global welfare. The only reason poor people still suffer on our rich planet is because markets have failed them. Sound familiar? The vicious-cycle thesis of the last century reemerges as the “poverty trap” of the new. The only acceptable, moral choice is for rich nations to send money. Common Wealth is, by any account, a political book—one that aspires to recruit and satisfy an audience that wants complex public policy to be as accessible as an issue of Vanity Fair.

This prescriptive approach is entirely consistent with Sachs’s broader solution: tax the incomes of rich countries, i.e., extend redistributionist policy beyond the boundaries of the nation-state. Because the nation-state is part of the problem, deploying the accumulated wealth of the world should fall to more informed and neutral non-governmental organizations. (NGOs are the deus ex machina in market-skeptical literature these days.) The long-awaited world free of poverty, deprived of the ultimate cause of war, is within our grasp and Sachs provides the prescription. Surely, a Nobel Prize awaits this kind of contribution.

This book would run the risk of becoming a contemporary gazetteer of utopian thought but for two disabilities: it is much too ambitious and it is poorly written. Embracing “millennium goals” set by the U.N. and invoking a transnational income redistribution might stir applause at undergraduate convocations but the “real world” won’t be moved. Looking to the U.N. for a solution falls outside the constraints of reality.

Economists are reflexively nervous with utopian solutions, especially when these involve enlightened cooperation among the governments of the world which will allegedly cede authority to yet wiser NGOs, entities supposedly above the malignancies of political (and democratic) institutions. Nothing in economists’ understanding of reality suggests that such thinking can lead to anything that will improve human welfare. To the contrary, excursions down these paths have mostly brought genocide, corruption, police states, and the erosion of individual freedom and creativity.

Muhammad Yunus, a Ph.D. in economics who won the Nobel Peace Prize, disregards all such evidence in Creating A World Without Poverty (2008). Having created Grameen Bank, an institution that increased remarkably the welfare of millions of the world’s poorest in Bangladesh through the innovation of micro-credit, he appeals for a new world economic order that does not contemplate growth. “The bigger the world economy, the bigger the threat to planet Earth.” For global welfare to increase, he argues, capitalism will have to be reformed through “social businesses”—entities that put people above profits.

The book is all nostrums and set-piece stories. The reader is left without a clue as to how this new capitalism might be formed or, more importantly, how it might improve human welfare. Yunus might have expounded the lessons of Grameen Bank so that others might expand on his success. He might have described, perhaps, a transitory state of capitalism, in which an innovation in the non-profit sector could be marshaled to help a poor nation reach the point of “take off” into a modern economy. But to understand that, we must turn elsewhere.

Realism and Foreign Aid

William Easterly’s masterly assessment of foreign aid, The White Man’s Burden: Why the West’s Efforts to Aid the Rest Have Done So Much Ill and So Little Good (2006), is a sober reflection on what really has—and hasn’t—worked. The author, a professor of economics at New York University, concludes that growth is fundamentally driven by local factors that are difficult for outsiders to notice, much less understand. In short, there is no template. In this regard, he anticipates Rodrik’s insight that for outside intervention to have a positive effect, it must be carefully tailored to local circumstances. Development is the product of “searchers”—entrepreneurs, accountable politicians, and the rare aid workers—who take measured risks hoping for large payoffs. Easterly argues that development interventions most often fail because professional aid culture insists on planning within a static framework that seldom engages the target population and never allows for feedback.

A realist of the first stripe, he sees aid as more likely to create worse misery, largely because it does not accept that recipient countries can ever become competent capitalist economies. Implicit in his analysis is that planners—most often careerists who rejected making their way in the private sector—are opposed or at least indifferent to private market solutions. Such assumptions infuse the process of aid with a desperation that may explain why so much corruption is tacitly underwritten and tolerated.

Oxford economics professor Paul Collier helps us understand this trap. In his book The Bottom Billion: Why The Poorest Countries Are Failing And What Can Be Done About It (2007), Collier sees aid as having readjusted its aspirations. In many countries, aid has morphed into a confused anti-growth strategy of “sustainable, pro-poor growth.” He describes an ideological aversion to growth that has created a “deformation” in strategy, whereby growth is embraced and avoided at the same time. So, in pursuit of what central planners believe is the acceptable or right kind of growth, actual growth is sacrificed for fear of making the world worse off. Seeing the destructiveness wrought by prior aid, and unable to think of any other solution, Western officials effectively have given up on these countries. The result is that the poorest one-sixth of the world’s population missed out on the enormous global boom of the past 20 years. In a well-crafted book overflowing with insight there is this further blessing: phrases that capture the essence of important points. The best: “Growth is not a cure-all, but the lack of growth is a kill-all.”

Collier observes that the world’s poorest live in conditions little different from what prevailed in the 14th century. Although it does not contain a panacea for growth, the best of the new development literature presumes that growth is good and should be the shared experience of all. Sachs, to his credit, helped establish this consensus. Yet most of this literature is silent on the most fundamental point: how we in the privileged West were able to grow so rich so fast that we can take our own wealth almost for granted, and worry about producing growth for the world’s poor.

The Secret to Growth

Economists can’t explain growth in part because growth transcends economics. Economic development is intimately tied to the larger historical drama of progress within entire societies and cultures. Growth cannot be divorced from the political environment and its treatment of human creativity. Throughout the development literature, one finds a highly technical debate about which of three ingredients has proven most important to past, and future, development: resources and the capital to exploit them—more infrastructure aid is key; human capital—and therefore more education; and more recently, technology—flood developing countries with laptops and the rest will take care of itself. A credible case can be made for the importance of all three, but their adherents tend to slip into overzealous “magic bullet” rhetoric. The truth is, to a large extent, these solutions are popular because they are so understandable. More capital, more schools, more laptops are manageable concepts to planners. Just paint by numbers.

The debate seems to miss a new ingredient, obscured perhaps by its very ubiquity. Social networks exist and thrive on a scale and to an extent unimaginable even 25 years ago. The cell phone and the internet help well-trained and well-educated individuals multiply exponentially the return on investments in schooling and acquired skills. And the entire world benefits, too. Frictionless information markets, made possible by the world’s nearly spontaneous adoption of English as the language of business, makes the phenomenon of social networking perhaps the single most important factor in economic development.

In the end, however, the economic future of all countries hangs on decidedly hard-to-measure political and cultural conditions in which these factors operate. Economic expansion in the United States, now nearly continuous for 200 years, has no deeper cause than the creative freedom individuals enjoy and the absence of limits on their aspirations. Indeed, individual freedom is the ultimate source of America’s investable wealth (including the largesse that is shared with the world in the form of aid), its demand for schooling (higher education in particular), and the science that leads to the technology that sustains a virtuous cycle of economic expansion. The readiness of individuals to take risks, the predicate of all economic growth, is intimately tied to their ability to envision making the future different, better, and richer for themselves.

The principles of liberal democracy have made sustainable economic development a possibility for the whole world going forward. The application of creative talent by the individual in the context of commerce—once found only in liberal democracies—is now seen as necessary even inside socialist regimes. The rediscovered insight that entrepreneurs bring forth expanding welfare for all is so powerful that growth has regained its rightful place as a legitimate goal of economic theory. Tragically, books such as Common Wealth—its thesis endorsed by many of the world’s most highly regarded intellectuals and celebrities—seek to resist the reality that market-based growth is the only real way to eradicate poverty.

No one should pretend that the state is absent in the process of economic growth—in 1817, after all, work began on the Erie Canal, a government project. Throughout the 19th century, the state and federal governments helped facilitate growth through investments in infrastructure and protection of property rights. The United States raced ahead of Europe in patents, for example, because of the way government institutions treated their filing and enforcement.

This, however, highlights an enduring truth often forgotten (or ignored) by proponents of state-led development: economic growth owes more to the forbearance of the state than to its intervention. Governments do not, indeed cannot, make wealth—only their citizens can. And when government protects their freedom, the world’s growing population of entrepreneurs, in the bargain, expands human dignity and establishes the foundation of ongoing growth on which civil society ultimately depends.

Carl J. Schramm is president of the Ewing Marion Kauffman Foundation and author of The Entrepreneurial Imperative: How America’s Economic Miracle Will Reshape the World (Collins) and co-author with William Baumol and Robert E. Litan of Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity (Yale University Press).
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