economics

july'08

Economics is the study of managing the resources of a people and government encompassing the laws of *production and distribution of wealth according to Adam Smith, 18th century Scottish economist and philosopher who penned the 'Wealth of Nations', the first masterpiece in economic freedom.

(*Factors of production include labour, land, capital and enterprise.)

Economics is a dynamic subject which studies changes in an economy and which itself changes as new and old ideas battle for influence. And it is the economy which is held by many politicians to hold the key to a government's re-election prospects as former US president Bill Clinton knew all too well when asked about the chances of securing a second term in 1996 - its the economy, stupid!

It is not intended here to visit all the complexities of economics but instead lay out what are considered successful measures in laying the foundations for strong economic development which is necessary for winning the war on poverty.

But, first let us look at the world economy.

In 2006, the total value of the world Gross National Income (GNI) - basically the value of goods and services produced - was $47,700,000,000,000 or simply $47.7 trillion (£23.8 trillion) up from $31.3 trillion (£15.7 trillion) in 2000. With an estimated world population of 6.5bn people GNI per capita works out at $7,450 compared to $5,220 in 2000. The composition of world GNI is made up as follows - services 68%, industry 28% and agriculture 4% whilst the world labour force is occupied - 41% in agriculture, 38% in services and 21% in industry.(In rich countries only 2-4% of the labour force work in agriculture)

World GNI, however, is severely distorted. The 31 advanced nations (sometimes called the North) - US, 15 Euro Zone members, Japan, UK, Australia, Canada, New Zealand, Switzerland, Sweden, Denmark, Norway, Iceland, Israel, South Korea, Singapore, Taiwan and Hong Kong - have 15.3% of the world's population but 56.4% of global GNI. This leaves the mainly developing world (the South) of 161 countries with 84.7% of the world's population with just 43.6% of world GNI. (In the developing world China now accounts for 10.8% of world GNI, India 4.6%, Russia 3.2% and Brazil 2.8%)

At the turn of the millennium world economic growth slowed after the frenetic technology boom of the late 1990's and the attack on the USA on 9/11 (2001) leading to large declines in most world stock markets. However, thanks to a combination of low inflation and easy credit, economic activity soon picked up again in the North. At the same time in the South, led by China and India, developing economies were starting to grow rapidly sparking a huge demand for raw materials and commodities. As a result the world economy has probably never seen such balanced growth as it did in the years 2003-7. This universal fast-track growth began to show worrying signs, however, towards the end of 2007 with easy-lending provoking a sub-prime mortgage crisis in the US leading to a credit crunch in the North. Meanwhile heavy world-wide demand for oil and other commodities was boosting prices substantially leading to rising inflation pressures. With credit now tight, falling house values and prices rising fast the scene is set for a major slowdown in economic activity in the North but the developing world led by China and India could continue to forge ahead.

(China has now seen almost 25 years of robust growth of around 10% pa with India averaging 6% during that period. These 2 countries together which are responsible for 38% of the people on Earth are moving forward rapidly lifting millions of people out of poverty every year.)

The best way to promote economic growth is considered by most economists to be in the form of a mixed market economy where government provides the essential services like health, education and infrastructure and private enterprise is encouraged to set up businesses. And in order for private enterprise to flourish it is now considered that the capitalist system based on private ownership of property, business and industry directed towards making the greatest possible profits will create the largest number of jobs and provide the tax revenues needed by governments to invest in social services. And in this way it is left to individuals and companies to decide what to produce, how to produce it and for whom. And the best way to get good support from any employees will come from workers who are paid a fair wage and enjoy reasonable working conditions.

As well as providing essential services governments also have the duty to regulate both the private and public sectors ensuring that the rule of law is always adhered to and that monopolies are not created where lack of competition means that consumers pay exorbitant prices. Governments should also seek to help enterprise to flourish by keeping taxes low and fair and balancing budgets over the economic cycle. But the hand of government should be as light as possible for the freer the economy, the higher the growth and the richer the people. And monetary policy which incorporates adjustments in money supply, controlling inflation and setting interest rates levels is best left to an independent central bank so that politics do not get in the way when, for example, a presidential or general election approaches.

The Index of Economic Freedom set up by the Heritage Foundation in Washington calculates economic freedom amongst the countries of the world based on trade policy, government intervention, wages and prices, regulation, fiscal burden, monetary policy, banking, property rights and black market activity. And the following countries are considered to have the firm but lightest of touches in facilitating and regulating economic activity:- Hong Kong, Singapore, Australia, US, New Zealand, UK, Ireland, Luxembourg, Switzerland, Canada

The Heritage Foundation scores Hong Kong at No 1 for the following reasons - Income tax and corporate tax rates are extremely low, business regulation is simple, and the labour market is highly flexible. Inflation is low and investment in Hong Kong is wide open, with virtually no restrictions on foreign capital. The judiciary, independent of politics and virtually free of corruption, has an exemplary ability to protect property rights. (Hong Kong is part of China but it retains a separate economic system)

At the other end of the Index of Economic Freedom stands those countries where Communism or state control raises a heavy hand over most aspects of economic activity:- North Korea, Cuba, Libya, Zimbabwe, Burma, Turkmenistan, Congo Republic, Iran, Angola and Guinea-Bissau. In these nations the state controls most of the wealth and productivity of the nation which tends to limit ideas and enthusiasm for work as pay is generally equal and innovation goes unrewarded.

A further comparison can be made here if we look at West and East Germany in 1989 after 40 years of separation under 2 different systems from the end of World War II. The capitalist W. Germany was a modern dynamic country whereas E. Germany through state direction produced second-rate goods for markets which no longer existed. Further comparisons can be made between South and North Korea which have been separate countries for 50 years. GNI per head in free S. Korea is $16,410 whereas in totalitarian N. Korea where many people go hungry GNI per head is just $800.

Capitalism then as an economic system has much to recommend it but there does seem to be a problem - capitalism doesn't seem to export successfully to poor countries. Numerous attempts have been made but most have ended with failure. So what can the problem be?

In his book ‘The Mystery of Capital’ Hernando de Soto suggests that the main problem for the developing world in trying to establish capitalism is the actual raising of capital itself. And yet he goes on to say that the poorest people in the developing world are sitting on phenomenal amounts of savings. However, they are generally held in imperfect forms in the shape of homes built on pieces of land which are not recorded, crops growing in fields with no title deeds and businesses set-up outside the law.

He compares this situation to life in rich countries where every house, business and piece of land is registered and therefore recognised under the law. As a result loans and mortgages can be raised against them thus enabling owners to inject life into their fixed assets.

Countless millions of people in the developing world live in makeshift homes in great urban slums on government owned land. Most of these homes are probably unregistered and even if anyone wanted to come within the law, it could take years to cut through all the red tape and probably cost too much. So these people perch perilously side-by-side on the wrong side of the law, destined to remain in poverty. Even in many villages, home-owners cannot get title to their house as the land is only lent to them by the chief for, as all land is owned by the tribe, the chief has no authority to dispose of it.

A permanent recognised address is important for other reasons too. It gives access to credit, insurance and utility services. It also acts as an indicator to the authorities about where there is a need for schools and medical centres.

In conclusion, de Soto estimates that as many as 80% of the people in developing countries may hold assets that are unregistered by the authorities. Keeping this potential capital locked-up out of the system is an huge drag on improving living standards throughout these countries. Poor countries should work to free up the system, recognise these unofficial homes and bring order and potential benefits out of chaos and decrepitude.

There also needs to be land redistribution in many countries - it cannot be right for 50% of the people to own 1% of the land and 1% of the people to own 50% of the land. Many of these large estates include land that is perfectly able to be farmed but is left barren. This should be purchased by the state for a nominal price and divided up amongst interested families. Encouraging people back into villages with the promise of a plot of land will help ease urban squalor whilst at the same time increasing the supply of food and giving the promise of a better quality of life to those willing to move.

Carrying through these reforms then should help desperately poor countries lay the basis that will enable them to develop mixed market economies. However, it will not be easy and success will require strong leadership by government ministers and civil servants. But the rewards are huge and there is no greater success story of a mixed market economy starting to work well than the recent success story of China.

In the twenty-five years since it opened up, the Chinese economy has grown nearly 8 fold, incomes have quadrupled and over 370m Chinese have been lifted out of absolute poverty. When the agricultural communes were disbanded, the Chinese government started to separate business from government and encouraged the setting up of small companies. The economy flourished with economic growth for the period from 1980 to 2007 averaging over 10%. China has also achieved huge current account surpluses with low inflation. With its extraordinary pool of labour and educated graduates and a social welfare programme to help those thrown out of work, this momentum behind the Chinese economy has now made it the second largest in the world.

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