Leveling Up: Making the Transition from Poor Country to Rich Country

A Home in Jakarta, Indonesia (at the intermediate levels of development)

Deirdre McCloskey posted her wonderful essay “Factual Free-Market Fairness” on bleedingheartlibertarians.com a few days ago.  In it, she focuses on the follies of government.  Her essay has generated a huge debate: 193 comments so far.  These are central issues being debated. For example,  here are Noah Smith’s comments.  Noah points out that governments have also done good things and that some of the most successful economies in the world have high tax rates and high levels of government spending. 

I have several reactions (which I will put here rather than in Deirdre’s comment thread where you would have trouble finding them in the thick forest of surrounding comments). First, regulation is much like distortionary taxation in its costs, only worse.  In particular, by mandating a particular way of doing things, regulation often tends to stifle innovation in a way that distortionary taxation doesn’t.  But regulation, like distortionary taxation, typically has benefits as well as (often fearsome) costs.  One of Deirdre’s key points is that the costs can often outweigh the benefits even for the intended beneficiaries of a regulation.

One of the biggest questions in all of the social sciences is why some countries are rich and some countries are poor, with per capita incomes differing by more than a 100 times from poorest to richest.  (The richest countries have per capita incomes above $40,000 per year; the poorest countries have per capita incomes below $400 per year.)  Let me give you my view on that question in a nutshell. 

The entry levels in the quest to become a rich country are the hardest.  The basic problem is that any government strong enough to stop people from stealing from each other, deceiving each other, and threatening each other with violence, is itself strong enough to steal, deceive, and threaten with violence.  Designing strong but limited government that will prevent theft, deceipt, and threats of violence, without perpetrating theft, deceipt, and threats of violence at a horrific level is quite a difficult trick that most countries throughout history have not managed to perform.  To see how difficult this is, think of how strong a temptation it is for a sovereign to simply take someone’s accumulated wealth. As long as the rulers of a country regularly succumb to this temptation, no one in that country will work very hard to accumulate wealth unless he or she has some form of special protection from such takings.  Also think of how difficult it is to have a strong enough military to avoid falling prey to the next country over, without having the military take over and run one’s country for its own benefit.

The intermediate levels in the quest to become a rich country are somewhat easier: establishing the rule of law and stamping out corruption.  If unchecked, corruption and the arbitrary decisions that are the antithesis of the rule of law act like huge tax distortions that discourage commerce and industry. 

In comparison to the earlier levels, the advanced levels in the quest to become a rich country are a piece of cake: keeping tax rates reasonable while providing key public goods such as roads and other public works, getting monetary policy right, encouraging education and science, and fostering the environmental amenities that are part of what should be counted as “being rich” even though environmental amenities don’t happen to be counted in GDP.  Most of the economic policy issues I am addressing on this blog are at this advanced level.  Even governments of countries at these advanced levels that get the balance of taxing and spending wrong are still doing very well by having in place the basics of preventingtheft, deception and threats of violence; perpetrating only a little theft, deception and threats of violence (except perhaps internationally); maintaining the rule of law and keeping down corruption.  When looking at an advanced country that has very high tax rates, the right question is not “Is it still rich even with high tax rates?” but “Would it be even richer if it had lower marginal tax rates and less regulation?"  There are some European countries that might have what it takes to be much richer countries than the United States if only they liberalized their economies by cutting marginal tax rates and loosened regulations that make it hard for new firms to get started. 

Note: Much of what I am saying here comes from my reading of my favorite economics textbook: David Weil’s book Economic Growth.  Any reader of this blog would learn a lot by sitting down to read this book.