economics

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 'it's 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.

However, first let us look at make up of the world economy.

In 2009, the total value of the world Gross National Income (GNI) - basically the value of all goods and services produced - was $70,000,000,000,000 or simply $70 trillion (£45.7 trillion) up from $31.3 trillion (£20.5 trillion) in 2000. With an estimated world population of 6.7bn people GNI per capita works out at $10,450 compared to $5,220 in 2000. 2009 was the first year in the post World War II era that global output declined falling by 1% compared to average increases of 3%+ since 1946. The composition of world GNI is made up as follows - services 63%, industry 31% and agriculture 6% whilst the world labour force is occupied - 38% in agriculture, 40% in services and 22% in industry.(In rich countries only 2-4% of the labour force work in agriculture)

World GNI, however, is severely distorted. The 32 advanced nations (sometimes called the North) - US, 16 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 52.6% of global GNI, with the US making up 20.2% of global GNI alone. This leaves the mainly developing world (the South) of 160 countries with 84.7% of the world's population with just 47.4% of world GNI. (In the developing world China now accounts for 12.5% of global GNI (second only to the US), India 5.1%, Russia 3.0% and Brazil 2.9%)

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 of coming apart towards the end of 2007 with easy-lending, particularly in the US, provoking a sub-prime mortgage crisis. Banks there, and in the UK, had literally thrown lending criteria out of the window as they fell over each other to lend money to people who would not normally qualify for a mortgage purely because they believed house prices would go on rising for ever. Not only that but the resulting mortgages were re-packaged and sold on to other willing participants keen for a slice of the action. Literally this was pass the parcel big time and when the music stopped some of the most respected banks in the world had been found to have taken their shareholders to the cleaners. Some like Lehman Brothers in the US were allowed to go under; others like the Royal Bank of Scotland, which had been a bastion of conservative banking run from Edinburgh since 1727, suffered the humiliation of being 84% nationalised.

The resulting credit crunch affected most rich countries and led to dramatic cuts in interest rates in OECD countries along with huge government support for the ailing banking sector. Meanwhile commodity prices which had risen to record levels started to fall back rapidly from the third quarter of 2008 leading to a huge fall in inflation throughout the world. With low interest rates in place coupled with benign inflation, and with China and India still expanding rapidly, OECD countries slowly started to pull out of recession in the 4th quarter of 2009. But the jury must still remain out as to whether this progress can be sustained with so much debt, both household and national, still outstanding.

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 forge strong working relationships in companies is to pay workers a fair wage, provide reasonable working conditions and engage with them constantly.

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 does not get in the way when, for example, a presidential or general election approaches.

The World Bank produces annually a set of world governance indicators including one which assesses the ability of individual governments to formulate and implement sound policies and regulations that permit and promote private sector development. And the following countries are considered to have the firm but lightest of touches in facilitating and regulating economic activity:- Denmark, Luxembourg, Hong Kong, Singapore, UK, Ireland, New Zealand, Netherlands.

At the other end of the scale stand those countries where Communism or state control raises a heavy hand over most aspects of economic activity:- North Korea, Zimbabwe, Burma, Turkmenistan, Eritrea, Cuba, Afghanistan, Timor-Leste, Iran, Belarus, Venezuela. 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, he 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-eight years since it opened up, the Chinese economy has grown 8 fold, incomes have quadrupled and over 400m 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 2009 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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