Economic progress is a modern phenomenon. For most of human history, growth was stagnant or low, calculated on a per-person basis. Mass poverty was the norm. According to the World Bank, in 1820, about 75% of the world’s population lived on the equivalent of $1 a day or less. Today, that figure is about 15% according to the bank and even less according to leading independent economists. The modern era of economic growth that began in Western Europe in the mid-18th century and that has since spread unevenly around the world has produced a diverse record of economic development. Western Europe, its offshoots, and Japan have experienced sustained increases in wealth; poorer countries have gone through erratic growth cycles; some have seen declines in income or have merely stagnated; and at least one country—Argentina—went from developed country status in the early 20th century to developing country status. In recent decades, a minority of poor countries have enjoyed economic success by achieving and sustaining high growth.
The varying growth paths, including the West’s initial escape from poverty, have prompted a diversity of explanations about what causes prosperity. As far back as 1755, Adam Smith cited the importance of policies and institutions as key determinants of economic progress, factors he would highlight later in his monumental work, An Inquiry into the Nature and Causes of the Wealth of Nations. “Little else,” he wrote, “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.”
Smith focused mainly on Europe and the Western world, as did other classical economists. It was not until the closing years of World War II and the postwar era that a strong interest arose among economists and policymakers in the development of what came to be known as the Third World. It was during this period that the field of development economics, a subfield of economics, was born. The promotion of economic development as a policy objective of rich countries became institutionalized through various foreign aid programs.
The early development economists were influenced by the experience of the Great Depression, which they interpreted as a failure of the free market, and by Keynesian economics, which emphasized macroeconomic stimulation of national demand to reduce unemployment and spur growth. The apparent success of the Soviet Union at industrialization also influenced policy prescriptions for rapid growth. From the beginning, the orthodoxy in this field viewed industrialization and capital accumulation—characteristics associated with advanced economies—as policy goals. The lack of capital was seen as a major cause of poverty. Paul Rosentstein-Rodan and Hans Singer wrote about the “vicious circle” of poverty, in which the lack of savings and investment perpetuated underdevelopment as small markets and limited resources made it unlikely that private investment would rise to a level sufficient to raise growth. Theorists assumed a direct relationship between investment levels and growth rates, and growth models calculated the “financing gap” said to exist in poor countries. Foreign aid was used to fill that gap.
Trade pessimism also dominated the thinking of development economists and Third World governments. Ragnar Nurkse believed that the conditions that helped developed countries increase exports in the 19th century no longer held and that trade would stimulate unnecessary consumption and reduce savings rates in poor countries. Raul Prebisch argued that developing countries faced deteriorating terms of trade—the price of their exports, mainly primary products, fell in relation to the price of their imports, mainly industrial goods from rich countries. Thus, free trade favored rich countries and condemned poor nations to poverty.
The policy response to these analyses was protectionism and development planning. Poor nations erected trade barriers to encourage the growth of domestic industry. The contribution of agriculture to development was considered to be limited, and the rural poor were thought to be unresponsive to price signals in a market economy. Because private capital was seen as unable or unwilling to invest in poor countries, government planning became widespread. Policies included reliance on price and wage controls, state-owned enterprises, agricultural marketing boards, government-directed credit, capital controls, and extensive regulation of the private sector. Gunnar Myrdal recommended “central planning as a first condition of progress.” Countries such as India and Pakistan adopted Soviet-style 5-year plans.
Such planning was supported and encouraged by the World Bank and other aid agencies, which were thought to provide a “big push” to poor nations and, in the view of Walt Rostow, lead to an economic takeoff. The idea that modernity had to be forced on backward societies pervaded the development orthodoxy. Myrdal wrote approvingly about compulsion to make planning succeed.
Dissent against the development consensus arose, but was limited to a few voices in the wilderness. Peter Bauer, the most articulate of the dissenters, criticized the disregard of individual choice, reliance on extensive state interventionism, and the obsession with capital accumulation. Bauer explained, “To have money is the result of economic achievement, not its precondition.” Thus, he noted that the notions of a vicious circle of poverty and of foreign aid as essential to development were absurd as is evidenced by rich countries that were once poor but developed without outside aid. In Bauer’s view, decentralized decision making in the market led to the best use of resources and limited an increase in “man’s power over man.” Economic progress depended on the complex interaction of policies, institutions, and values, not all of which were easily susceptible to measurement or manipulation.
It would take decades of development experience, however, before some of those views became more widely shared. By the 1960s, inward-looking development strategies were already failing. Protection of domestic industries increased production costs on agriculture and prices on consumer goods, but failed to produce quality products. Agricultural goods also often faced export taxes. The bias against agriculture depressed that sector, perpetuating poverty in rural areas, and reduced its export earnings. Imports of capital goods and even food increased, exchange rates became overvalued, and countries began having balance of payment problems.
Highly protected industrialization turned out to discourage exports and lead to macroeconomic distortions. But not all developing countries followed that model. In the 1960s, South Korea and Taiwan began turning away from import substitution industrialization and toward the open trade policies that characterized Singapore and Hong Kong. In 1979, Ian Little documented the four nations’ reliance on comparative advantage:
The major lesson is that labor-intensive export-oriented policies, which amounted to almost free-trade conditions for exporters, were the prime cause of an extremely rapid and labor-intensive industrialization, which revolutionized in a decade the lives of more than 50 million people, including the poorest among them.
As the four tigers advanced economically, wages rose, poverty fell, and their economies became modern, more service-oriented, and dependent on higher skills and higher technology. Japan’s postwar rise from devastation to First World country within a matter of decades also set an example. Labor-intensive production then shifted to other countries in Asia as, among others, Thailand, Malaysia, Indonesia, and China began opening their economies.
The development orthodoxy, meanwhile, went through various fads and adjustments, emphasizing, for example, government support for agriculture and redistribution to the poor. However, it was not until the outbreak of the Third World debt crisis in the early 1980s and the subsequent collapse of central planning that the failure of state-led development became widely acknowledged.
The debt crisis revealed that a lack of capital was not a problem for the Third World. Rather, economic mismanagement and the domestic policy environment were at fault. Highly indebted South Korea did not experience economic crisis as did highly indebted Latin American countries. Thus, by the early 1980s, Deepak Lal was moved to declare “the poverty of development economics.” A worldwide move to the market slowly began and by the early 1990s accelerated in pace and scope, including most of the formerly socialist countries.
The early liberalizers set a pattern of development that other countries have emulated with varying degrees of success. From 1960 to 2000, the four Asian tigers maintained average annual per-person growth rates of more than 5%, increasing their income by at least seven times, with Hong Kong and Singapore surpassing the United Kingdom. Likewise, reform pioneers Chile and China began liberalizing their economies in the 1970s with notable results. Chile’s per capita income is now more than 3 times greater than in 1975, whereas China’s income is nearly 10 times higher than when reforms began.
The era of globalization has produced other reform successes in countries as diverse as Vietnam, El Salvador, Ireland, and Estonia. Central European nations have succeeded in introducing policies of political and economic liberalization, putting them on a convergence path with Western Europe. Yet other countries—in Latin America and in the former Soviet Union, for example—have had a more difficult time implementing coherent reforms and sustaining high growth. Most of sub-Saharan Africa and much of the Middle East have yet to see significant economic reform. Mainly because of their economic policies, Africans are poorer today than they were 30 years ago.
The era of globalization has also renewed an interest in domestic institutions, such as the rule of law, and other factors that could explain widely different reform experiences. The International Monetary Fund estimated, for example, that if institutions in Africa were brought up to the level in emerging Asia, African long-term per capita income would nearly double. The Fraser Institute’s annual Economic Freedom of the World report—the most systematic long-term study measuring policies and institutions consistent with personal choice, voluntary exchange, protection of private property, and freedom to compete—finds a strong empirical relationship between economic freedom and prosperity. Countries that are more economically free tend to be wealthier and grow faster. That relationship remains even after taking into account other factors such as education or demographic indicators.
Poor countries that move in the direction of economic freedom in a significant way, as China and India have done, tend to enjoy fast growth and are thus catching up to rich countries. Annual per capita growth rates of more than 8% since the early 1980s and about 5% since the early 1990s in China and India, respectively, have pulled hundreds of millions of people from poverty and reversed the centuries-long growth of world income inequality.
Greater economic freedom also is strongly related to improvements in the range of human development indicators—longevity, access to safe drinking water, infant mortality rates, environmental quality, and so on. During the past several decades, the gap in human well-being between poor and rich countries has been closing dramatically and at a faster pace than the gap in incomes. The advantage of underdevelopment today is that poor countries can grow at much faster rates than was the case for rich countries when they were at similar stages of development. Moreover, for a given income level, countries enjoy notably higher standards of living than was the case even 30 years ago. More economic freedom in the world appears to be benefiting even those countries that have done little to reform.
The development consensus now generally favors market-oriented policies and institutions that constrain political power and support market exchange. Although we know that institutions matter, there is no consensus on how to promote the right institutional or policy environment. The difficulty that countries as different as Russia, Argentina, and Malawi have had in successfully introducing reforms has generated an awareness of institutional inertia and the role of institutions in shaping political behavior and seemingly enduring power structures.
Development appears to be more a political than an economic challenge. The recognition that institutional change is more complex and occurs at a slower pace than policy change has led to pessimism among some observers about the prospects of development in many parts of the world. Yet precisely because institutional change takes time, such conclusions may be premature. It took about eight centuries for the institutions supportive of market exchange and the rule of law to develop in the West. By contrast, the current era of liberal reforms is still only a few decades old and may already be leading to incipient institutional and cultural change in countries that have recently begun opening their economies. The 21st century will tell whether the case for optimism is stronger than the case for pessimism.
The thinking regarding economic development has matured and has involved a rediscovery of classical liberal insights into the causes of prosperity. Experts have a greater appreciation of the limits of development economics and its ability to forcibly promote growth; of the relevance of the development path of advanced economies to developing countries; of the role of local knowledge and of incentives on individual and entrepreneurial behavior; and of the complex influence that institutions, culture, geography, history, political regimes, and other factors exert on each other and on growth. As such, the study of development has become qualitative and multidisciplinary, drawing on work from economic historians, legal scholars, anthropologists, and political scientists.
Despite those advances, a political push led by international organizations such as the United Nations and the World Bank and a minority of economists continue to call for massive increases in aid for the poorest countries, especially in sub-Saharan Africa. Old and bankrupt ideas from the 1950s and 1960s have been revived, including the notion of poverty traps, the need for planning, and an aid-financed “big push” that would lead to economic takeoff. Unlike the early postwar period, however, skepticism of such grandiose plans is widespread among academics and development practitioners.
In practice, the rise of aid is likely to continue, but so is globalization and its modernizing effects. In most of the world, where the latter is more predominant than the former, we can expect to see more enduring progress even if it occurs in fits and starts. Liberal advocates of economic progress would do well to promote the ideas of human freedom and keep a modest view of their own influence. The complex process of economic development will continue to be unpredictable and influenced by unique factors, including, as Peter Bauer and Milton Friedman used to remind us, chance events.
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Originally published .