Thoughts on the Source of International Economic Advantage

What are the possible sources of America’s international economic advantages and success at creating a superior standard of living for its people?  Each fundamental factor of production gives rise to a potential competitive advantage.  According to the classic list of Adam Smith, these factors are Land, Labor and Capital.  A more compete list would contain five fundamental factors:

1.       Natural Resources

2.       Labor

3.       Capital

4.       Knowledge

5.       Social Infrastructure.

In the revised list, Natural Resources is a more general version of Land.  Labor must be understood to include the essential element of education, as well as a crucial kind of labor: that of the entrepreneur.  Capital is what allows risks to be taken and economic growth to accumulate.  Knowledge most importantly means science and its offspring, technology of all kinds.  Knowledge also includes knowing how to manage large, complex organizations.  Social Infrastructure means the laws, property rights, financial practices, enforcement of contracts, culture friendly to enterprise, the lack of stifling or corrupt bureaucracy, and the essential political stability that together allow markets, including financial markets, to function well.

Historically, America had important advantages in all five fundamental factors, leading to its establishment by 1920, a hundred years ago, as the dominant economy in the world.  But global development, a very good thing for mankind in general, makes it harder to maintain America’s former advantages.  This suggests the U.S. political economy will be continuingly challenged at how to provide higher pay than elsewhere in the world—otherwise known as a higher standard of living.  It means we have less room than before for subsidizing political drag.

In the global competition of the ongoing 21st century, America no longer has as great an advantage as it previously did in the first four factors, but a continuing and central advantage in the fifth.  This advantage, however, can be weakened by unwise politics and bureaucracy.

Let us consider each of the factors in turn in a globalized world.

1. Natural Resources.  Commodities trade actively in world markets, move among countries with very low transportation costs, historically speaking, and are available almost everywhere.  Being a natural resources-rich country, as the U.S. is, matters less than before.  For example, making Land more productive by the scientific agriculture of the 19th century, as symbolized by the institution of land grant colleges, and by the continuing advances in agricultural science since then, is available everywhere in the world.

2. Labor.  The great historical revolution of public education has spread around the world, while the struggles of large parts of U.S. public education are well known.  The ability to organize and manage large, capital-intensive enterprises to make labor productive has also spread around the world.  Large pools of educated, technically proficient labor are increasingly available, notably in China and India.  Napoleon thought China a sleeping giant and recommended not waking it up.  Now we have two giants awake, as well as other countries, with increasingly educated labor.  If America wants to provide higher pay than they do for work with the same level of education, this must be based on a different fundamental advantage.

3. Capital.  Capital is essential to all risk-bearing, economic growth and productivity.  Savings available for investment as capital now flow quickly around the world, seeking and finding the best opportunities wherever they may be.  While capital is raised and employed in huge amounts in the U.S., we are not the leaders in savings.

4. Knowledge.  The incredible economic revolution of the last 250 years, or modernization, which empowered first Britain, then Western Europe and America with vast leadership advantages, has as its most fundamental source science based on mathematics.  Scientific Knowledge, turned to technology and harnessed to production by entrepreneurial energy, then matched with learning how to manage large organizations, created the modern world.  Mathematical science began as a monopoly of Europe and America, but is now the most cosmopolitan of human achievements.  America has world-leading research capabilities, including top research universities, but Knowledge is now available everywhere and incorporated into international scientific endeavor.

5. Social Infrastructure.  The political stability, clear property rights and safety of America have long served to attract investment as a safe haven and supported the role of the U.S. dollar as the dominant reserve currency.  By designing a stable political order which continued to work for an extremely large republic, the American Founding Fathers also created a powerful economic competitive advantage.  This advantage was augmented when Europe destroyed itself in the First World War, and New York replaced London as the center of world capital markets, and when Europe again destroyed itself in the Second World War.  This key advantage continues and helps explain how the U.S. can finance its continuous trade and budget deficits.  It may be an “exorbitant privilege” as viewed from France, but it is one earned by superior Social Infrastructure.

As John Makin instructively wrote a decade ago, “The fact that global savers accommodate U.S. consumers…is simply a manifestation of America’s competitive advantage at supplying wealth management services.”

This advantage in wealth storage, reflecting an advantage of Social Infrastructure, yields not only economic, but also large political and military benefits.  But no competitive strength is incapable of being lost over time, as former world economic leader Britain found out.  The strongest advantages can be weakened by political, bureaucratic, legal and regulatory drag.  The constant effort to maintain these advantages also maintains the ability to pay more for work than other countries do.