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Wednesday, April 19, 2017

This is the Formula for Prosperity (and the Lousy Excuses Not to Use It)

For starters, they think power leads to plenty.

The formula for an economy to get rich nowadays is as easy as H2O.

It is: Follow China and India. Containing four out of every ten humans, the two gradually gave up on central planning, China after 1978, India after 1991. They gave up the socialism imposed by Nehru and Mao, imitated later by Castro and Chavez, first imposed by Lenin and Stalin, first imagined in the nineteenth century by Saint-Simon and Marx and Luxemburg.

For decades after World War II the economies of China and India had been run so badly that as late as the 1970s they looked hopeless. Not anymore.

The Rule of 72

At rates of 7 to 12 percent, in a couple of generations, the Chinese and the Indians will have an American standard of living.

Before their takeoff years they were growing miserably, in inflation-corrected terms at 1 percent per year per capita, 2 in a good year. After the partial freeing of markets, they started growing at 7 to 12 percent.

In 1981, Shanghai had only two tall buildings, two western hotels. Now it has two thousand. It’s a matter of arithmetic: If real income grows at the miserable 1 percent of the Great Leap Forward or of the License Raj, it will double, if it does not meet any intervening obstacles, in a painfully slow 72 years. (Proof: calculate it.) At that rate Shanghai would now have three tall buildings. If real income is growing at 7.2 percent, though, it will double in 10 years. If 12 percent, in 6 years. The arithmetical truth that years-to-double is 72 divided by the growth rate is called The Rule of 72.

At rates of 7 to 12 percent, in a couple of generations, the Chinese and the Indians will have an American standard of living. If that doesn’t impress you, you are hard to impress.

Maybe the slower but pioneering history of northwestern Europe will do. First in Holland in the seventeenth century and then in England and Scotland and the new United States by 1800, and then in Belgium and Northern France and the Rhineland, the H2O formula was, in a word, liberalism — just what it has been recently in China and India. The government might competently provide roads and canals and railways (though in Britain these were private) but it mainly provided the rule of law and then left people alone.

When in 1681 Jean-Baptiste Colbert asked the bourgeois of France what the government should do for them, they replied laissez-nous faire, “let us do it.” Such liberalism was what Adam Smith called a century later “the liberal plan of equality [of social standing], liberty [to open a grocery store when you want], and justice [before the law and the state].”

It made ordinary people bold. Masses of people came to believe for the first time that they actually could, as the British say, “have a go.” And they did. Sweden liberalized in the middle of the nineteenth century and grew in seventy years from being the second poorest country in Europe to the second richest. Japan, admittedly with a more intrusive government than liberal Sweden, grew at a similarly startling rate.

Formula for Prosperity

Loony tyranny, it turns out, is not good for ordinary people.

So what is the H2O formula to get continental Europe and the anglosphere, with Japan, out of their current funk? It’s the same: liberalize. Let people have a go, laissez-nous faire, and accept the Bourgeois Deal: “Let me, a bourgeoise, make a pile with betterment in the first act, and by the end of the third act, after those pesky imitators have entered in the second, I’ll make you-all rich.”

The economist William Nordhaus reckons that entrepreneurs and inventors retain only 2 percent of the social value of what they create. Two percent of the improvement over other retailers by WalMart is a lot of money. But it leaves the 98 percent to us.

Why, then, doesn’t it happen everywhere? Why has the demonstration effect of the Asian and Celtic and other Tigers, such as Botswana, and the longer history of successful liberalism in Europe and its offshoots, not been decisive?

There are obvious answers available for places such as North Korea or Zimbabwe. Loony tyranny, it turns out, is not good for ordinary people. Non-loony tyranny, such as in Singapore, is occasionally alright. But the betting has to be that absolute power corrupts absolutely.

Let us not, however, conclude that nothing can really be done for them, or for us; let us not go all the way with the most cynical side of the theory of public choice espoused by the late James Buchanan and Gordon Tullock of Virginia.

Policy Mistakes

Even if the government is not malicious, it does make mistakes.

Let us indulge instead the Massachusetts theory of public finance originating from Richard Musgrave and Paul Samuelson, on display in newspaper columns by the fierce Paul Krugman and the amiable Joe Stiglitz and the genial Robert Reich. The theory is that governments and their supporters really do want to help the poor to help themselves. So let’s stipulate honesty and see where it leads.

But let’s amend it slightly towards realism by noting that even if the government is not malicious, it does, alas, make some mistakes. Joe and Paul and Bob on their good scientific days would admit as much. The history of economic policy offers a rich array of more or less innocent but anti-liberal mistakes leading directly to impoverishment of all or big parts of a society.

Protectionism, for example, recently popular, relies on an error in accounting. Yes, workers making tires in Ohio are made better off by protection. But Americans buying tires are made worse off, regularly by a large multiple of the annual income of the saved job. The erroneous social accounting does not acknowledge the whole country. Trump voters in Iowa, for instance, soon realized that protection is not good for soybean sales.

Or the War on Drugs. It has made gangs profitable in Humboldt Park and West Englewood here in Chicago, and in many other places around the country and the world. The honestly misled makers of policy apparently thought, “Well, the war on alcohol in the 1920s was a disaster, encouraging gang warfare and police corruption. So let’s do it again, with a war on drugs.”

Or plain old war, with empire, the activity that some people such as the classicist Ian Morris or the economists Ronald Findlay and Kevin O’Rourke insist are good for you. They think power leads to plenty. Thus Mussolini’s imperial adventures from 1935 to 1945, impoverishing Italy. War is a perpetual temptation, even among the honest.

Because Chaos

I want to note especially here, though, the excuses that the good-hearted and peace-loving folk we all know and love will articulate for not adopting laissez-nous faire, even though the evidence is that when countries adopt an approximation of it they prosper mightily.

An economy of 324 million people, the lawyers claim, will require masses of regulation.

Why for example doesn’t my beloved South Africa, where I have lived and taught, adopt the Indian example of economic policy, and get 7% per year per capita real growth every year instead of 2% in a good year? Why don’t French people on the left realize that attempts to extract higher real wages and better working conditions by piling constraints on the wage bargain don’t work? Why doesn’t the American left realize that safety regulation and occupational licensure lead to unemployment?

One answer you hear from good but frightened people of the left is “Chaos.” You hear it from the good people of the right, too, because it is a lawyer’s theory of the economy, and lawyers come in all flavors. An economy of 324 million people, the lawyers claim, will require masses of regulation. The claim is mistaken, of course, since regulatory interference in the trillions of decisions made in such a country will have unintended, unlegislated, and often disastrous consequences.

Such interference regularly kills trade-tested betterment. The young CEO at the retailing app company Infor, Corey Tollefson, points out that in his space the regulators have not caught up. When he imagines a betterment, he can just do it. Not so in electricity generation or auto manufacturing.

Another frightened worry is “the Race to the bottom.” Robert Reich is eloquent in the claim that if we do not have strong unions and high minimum wages the bosses will drive wages down to $1.00 an hour. It is a bargaining theory of wages, and economists have understood clearly since the 1930s that it is scientifically mistaken. Wages are determined mainly by supply and demand, not mainly by bargaining. If a worker doesn’t like what she is paid, she can (with some difficulty) take the job and shove it. So too on the side of the boss. No race happens.

The arguments deny the splendid logic of economics after the 1870s.

These two are negative, pessimistic excuses for not adopting laissez faire. They are misunderstandings of how a market economy operates, even by some economists.

The arguments deny the splendid logic of economics after the 1870s. (Das Kapital, in 1867, was not the first text of a new order, but last of an old.) Indeed, some of the pessimists, even if they are economists, do not exhibit a bare understanding of the logic of economics, or the facts of economic history. I refer you to the foot of page 6 of the English translation of Thomas Piketty’s Capital in the Twenty-First Century (2014) or the later, policy chapters of Robert Gordon’s The Rise and Fall of American Growth(2016).

Positive Excuses

But then there are the positive, generous excuses, earnestly proffered by the good people of left, right, and center. These excuses, while agreeable in themselves, still keep countries poor and illiberal.

One of them is “Education first.” The cry for more education is regularly an excuse for not liberalizing the economy directly and quickly. I have seen it in South Africa. Blacks there do poorly, expressed recently in violence against immigrants, because they are excluded from employment by the labor laws installed in 1994, amounting to a progressive version of apartheid. The South African elite calls not for relaxation of the labor laws, but for more education, to make the poor worth hiring at the high minimum wage. The policy is back to front.

If people had jobs they would see to the education of their children. Meanwhile they would sell food on the street or get basic consumption with a job in a factory opening in the township. They did so in Singapore and Botswana and South Korea. They could in South Africa, too, if the elite of the African National Congress or the Congress of South African Trade Unions would relent. They show no signs of doing so.

Beyond the establishment of peace, easy taxes, and a tolerable administration of justice, we do not need masses of police and civil servants guarding us.

Another is “Institutions first.” The excuse is: first get good courts and good administration and good enforcement of laws, and then you will get economic growth, after a while. Meanwhile, don’t liberalize.

Yet such neo-institutionalism, the orthodoxy nowadays at the World Bank, fails as badly as did the Bank’s earlier orthodoxy, which William Easterly calls “capital fundamentalism.” The formula of “add new legal institutions and stir” works no better than did the old “add new dams and roads and stir.”

True, growth can’t get going in the middle of a civil war. And liberty and new ideas do indeed make profitable new institutions and new capital. But beyond the establishment of peace, easy taxes, and a tolerable administration of justice, as Smith said in 1755, we do not need masses of police and civil servants guarding us, even if they have university degrees.

Yet another is “Eliminate corruption first.” One hears this excuse often from the citizens of poor countries, who are angry at or envious of the extractions by the Communist Party or the African National Congress. True, honesty is a fine thing. But it is normally the result, not the cause, of growth.

Governmental attempts to stop corruption, short of Georgia’s program of firing every policeman in the country, are in most cases failures, in the 97 percent of countries lacking a Scandinavian standard of righteousness in governing. And growth need not be stopped by corruption. Chicago in 1880 had wretched enforcement of laws and a stunning level of corruption. Every law could be bought for cash, along with every judge and every policeman and every politician. (Supposing they would stay bought.) Yet Chicago was the fastest growing city in the world, like Shanghai nowadays.

Imperfection and Liberty Aren’t Mutually Exclusive

We do not need at the outset a perfect government. Perfect government is unattainable, and anyway unnecessary for a free economy. We do not need more laws, more education, or more guardians. What we need, comprehensively, is liberty.

The one theory that worked, allowed every man to pursue his own interest in his own way.

Consider the fruit vendor Mohamed Bouazizi of Tunisia who set himself on fire in despair because of extortion by the government’s custodians. Consider the law in Tennessee that new moving companies need the permission of the old ones to open. Consider the ordinances in Chicago that prevent food trucks from operating with liberty.

In the nineteenth century the clerisy formulated the new theories of nationalism and socialism, imperial theory and eugenic theory. But the one theory that worked was the H2O one, devised in the eighteenth century, allowing every man to pursue his own interest in his own way.

As the democratic poet put it, “Nature without check with original energy… I am large, I contain multitudes.” And he, and we, did.

Republished from the Cato Institute.

  • Deirdre Nansen McCloskey taught at the University of Illinois at Chicago from 2000 to 2015 in economics, history, English, and communication. A well-known economist and historian and rhetorician, she has written 17 books and around 400 scholarly pieces on topics ranging from technical economics and statistical theory to transgender advocacy and the ethics of the bourgeois virtues. Her latest book, out in January 2016 from the University of Chicago Press—Bourgeois Equality: How Ideas, Not Capital or Institutions, Enriched the World—argues for an “ideational” explanation for the Great Enrichment 1800 to the present.