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How Rich Countries Got Rich . . . and Why Poor Countries Stay Poor

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How Rich Countries Got Rich … and Why Poor Countries Stay Poor

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How Rich Countries Got Rich… argues that important economic lessons can be learned from setting the historical record straight. Reinert suggests that the history of the United States has the greatest economic relevance to today’s poor countries. Seventeen seventy-six was not only the year of the first publication of Adam Smith’s Wealth of Nations, but also saw the beginning of the first modern war of national liberation against British imperialism. The Boston Tea Party was after all a mercantilist action. The economic theorist of the American Revolution was none other than its first Secretary of the Treasury, Alexander Hamilton - now recognized as the pioneer of what is often termed `industrial policy’.

The alternative theory that some of us are trying to revive is built up from below, based on observations of a reality that very often does not favour economic development. Rather than seeking to `remove the obstacles’ to prosperity, development must be seen for what it has always been: the outcome of conscious and deliberate policy.

Today’s mainstream economics proudly traces its ancestry back to the Physiocrats, who believed that the wealth of nations was to be derived solely from agriculture. Historically, however, the Physiocrats did not dominate economic policy for long, and where they did - as in France - their policies created scarcity of food and poverty. Virtually all important European intellectuals of the day, from the Frenchmen Voltaire and Diderot to the Italian Abbe Galiani and Scotsman David Hume, were fierce anti-Physiocrats.

Just as we do not create more food in the Third World by eating less ourselves - at the moment famines are essentially caused by a lack of purchasing power rather than a lack of world supply - we do not create development in the Third World by closing down First World agriculture. This book argues that a deal should be struck by which the First World is allowed to protect its own agriculture (but prevented from dumping its surpluses on the world markets) while the Third World is allowed to protect its manufacturing and advanced service sectors. This is the only policy that can be consistent with successful development policy over the last 500 years.

Rather than creating democracy and development, this approach - regardless of the nobility of the intentions - will produce a crippling welfare colonialism in which rich countries maintain their political power over poor countries. This is not to say we should not do what we can to relieve suffering through aid, but we must also take on the more important task of understanding how poor countries can become richer by themselves. Advocates of free trade often use similar rhetoric for their policies, but there is a crucial difference: while I argue for development over assistance as the priority for the world’s poor, I want to advocate development that serves the world’s poor, not passive transfers that in the end take the form of covert colonialism.

rich countries got rich because for decades, often centuries, their states and ruling elites set up, subsidized and protected…

Poor countries specialize in activities that have one or more of the following three characteristics: (a) they are subject to diminishing rather than increasing returns, (b) they are either devoid of learning potential; and/or (c) the fruits of learning - rather than producing local wealth - are passed on to their customers in the rich countries in the form of lower prices. From this perspective, what we call `development’ is essentially a knowledge- and technology-based rent that often is reinforced, rather than reduced, by free trade between nations at very different levels of…

Both these audiences must appreciate that the main difference between rich and poor countries is that rich countries have all moved through a stage without free trade, which - when successful - subsequently made free trade desirable. This mandatory passage point in the history of all presently developed countries - allowing poor…

If you take anything from this book, let it be this: if you want to understand the causes of American and European prosperity, study the policies of those who created it,…

A paradigm can, for that matter, even insulate the community from those socially important problems that are not reducible to the puzzle form, because they cannot be stated in terms of the conceptual and instrumental tools the paradigm…

At this point it is necessary to introduce and explain two sets of key terms that describe the differences between the economic activities that typically dominate the poor countries and those that dominate the rich countries: perfect' and imperfect’ competition and increasing' and diminishing’ returns.

When production is expanded in manufacturing industry, cost developments go in the opposite direction - down rather than up. Once mechanized production has been set up, the larger the volume of output, the lower the cost per unit produced. The first copy of a software product costs a lot to produce, but subsequent copies have a very low cost. Manufacturing and service industries have no immediate inputs provided by nature, no fields, mines or fishing grounds that are limited in quantity or quality. They experience falling costs - or increasing returns to scale - as volumes of production increase. It is very important for industrial companies and advanced service providers to have a large share of the market, because this larger volume also gives them lower production costs (due to the increasing returns). The increasing returns produce market power: to a large extent they are able to influence the price of what they sell. This is termed `imperfect competition’.

Rich countries display generalized imperfect competition, activities subject to increasing returns, and, as I gradually began to understand, all have become rich in exactly the same way, through policies steering them away from raw materials and diminishing returns activities into manufacturing, where the opposite laws tend to operate.

In Serra’s view the key to economic development was to have a large number of different economic activities, all subject to the falling costs of increasing returns. Paradoxically, being poor in natural resources could be a key to becoming wealthy.

Perfectly consistent with this, Karl Marx contributed a regular weekly column to the New York Daily Tribune, the organ of Lincoln’s Republican Party, from 1851 to 1862. This is, of course, not to say that Marx and Lincoln agreed on everything - but they agreed that what creates wealthy nations are industrialization and technological change.

What made Europe so strong subsequently? And - looking at the present huge gaps in world income - how and why was development in Europe so evenly distributed by the 1700s, from northern Sweden to the Mediterranean? Why is it seemingly impossible to repeat the same experience in Africa? Many factors clearly contributed to Europe’s forging ahead: the geographic position of its sources of energy (coal); later the availability of food, wood and markets from the colonies; but also its brutality, religious zeal, organizational ability, institutional creativity (e.g. double-entry book-keeping) and intellectual curiosity.

Once it had been observed that throwing resources at problems during wartime produced inventions and innovations, this mechanism could be replicated in times of peace.

The spread of wealth in Europe, and later in the other developed parts of the world, was a result of conscious policies of emulation: the market was a force tamed, like the wind, for the purpose of reaching a defined goal or destination. You may not necessarily be going in the direction that the wind, or the market, happens to be blowing.

There is an important pattern here: since its founding fathers, the United States has always been torn between two traditions, the activist policies of Alexander Hamilton (1755-1804) and Thomas Jefferson’s (1743-1826) maxim that `the government that governs least, governs best’. Alexander Hamilton was a key figure behind the establishment of the first central bank of the United States in 1791, while Thomas Jefferson fought it and contributed to its closing down in 1811. With time and usual American pragmatism, this rivalry has been resolved by putting the Jeffersonians in charge of the rhetoric and the Hamiltonians in charge of policy. Today’s economic theorists have an important mission in producing Jeffersonian/Ricardian rhetoric, which, as Paul Krugman points out above, is not very influential on the domestic market.

Also, historically, global free trade has been a chimera, and those who adhered to it least during the crucial moments of their development have become the world’s most successful economies. The standard argument these days is to show that wealth is strongly correlated with the openness' of economies. This is akin to measuring the income of people still attending university with those who have graduated and are already on the labour market, and later concluding that education does not pay because university students have lower incomes. In the past, a period of protecting a manufacturing sector has been mandatory for all presently rich nations. The educational function of this period is emphasized by the term educational tariffs’ (Erziehungszoll, opp fostringstoll) used in Germanic languages. The English term used to be `infant industry protection’, which was something virtually everyone understood was necessary. Comparing countries that have been through this stage with countries that have not is simply not meaningful.

That a nation specializes according to its `comparative advantage’ means that it specializes where it is relatively most…

In very broad terms, one can distinguish between two main types of economic theory. One is based on metaphors from nature, generally from physics. Examples of these metaphors are the invisible hand' that keeps the earth in orbit around the sun (late 1700s) or the equilibrium metaphor, based on the science of physics as it stood in the 1880s. What this book refers to as standard textbook’ is based on the equilibrium metaphor, which physicists themselves abandoned in the 1930s. This theory is built from the abstract metaphor downwards, and `being an economist’ essentially means someone analysing the world through the glasses and tools provided by the metaphor. This is the theory the profession uses on Africa’s children. The other type of economic theory is based on experience, built from the ground upwards, and often appears as practical policies before being distilled into theory. The city-state of Venice practised a certain kind of economic policy for centuries, long before economist Antonio Serra codified this practice into a theory and explained why it worked. Much in the same way Stone Age tribes chewed on willow bark in order to cure headaches thousands of years before Bayer codified the active substance as salicylic acid (salix = willow) and produced…

The problem is that the physics-based models that have virtually monopolized the discourse tend to exclude precisely those factors that create wealth, factors that are present in wealthy countries but not in poor ones: imperfect competition, innovations, synergies between economic sectors, economies of scale and scope and the presence of economic activities which make these factors possible.

The Other Canon tradition has been the one determining economic policy in all nations which have taken the path from being poor to being wealthy. England started down this path in 1485 and continued for centuries and continental Europe rapidly followed suit. The Scandinavian countries - today so dependent on free trade due to their small home markets - followed the same policy for centuries, until (at different points in time) they were ready to compete globally. The United States did the same thing, starting just after independence in 1776, and then in the 1820s in a most aggressive way.

Standard textbook economics is created as an abstraction from an economic scenario in the same way that the game of chess is created as an abstraction of a war scenario. But just as the war in Iraq is not solved by referring to the rules of chess, the problems of world poverty are not solved by referring to an economic theory that does not contain key variables from factual knowledge.”

One result of the twentieth-century development of economics is the loss of two important dimensions: time (history) and space (geography). The world of economics became a fairy-tale world, lacking time, space and friction, a world of automatic and timeless harmony, where an oak grows to enormous proportions in the same time that is taken to cut it down (i.e. zero time). One result of this high level of abstraction is that things repeatedly happen that are not supposed to happen. One example of this is the Asian financial crisis; another is that some nations become poorer under globalization.

Today’s standard economics - as applied to poor countries - fails to recognize the importance of increasing returns (the fact that in some economic activities costs fall as the volume of production increases), technological change - the possibility of which varies widely between economic activities - and synergies, factors that acting together produce the cumulative causations or reactions that create the structural change we call economic development.

Charles Babbage (1791-1871), otherwise known for his contributions to the basic design of computers, actually went into an English pin factory with a Baconian mind and provides us with wage data.24 The person tinning (whitening) the pin earned 6 shillings a day, while the people straightening the wire only had a wage of 1 shilling per day. Increasing returns and specialization here begin to reveal why economic growth is so uneven. The risk with globalization is that the value chains of production are broken up in such a way that the rich countries take all the high-skill jobs, in this case tinning the pin, while activities similar to the straightening of the wire are farmed out to poor countries. Poor countries tend to specialize in the economic activities which rich countries can no longer mechanize or innovate further, and are then typically criticized for not innovating enough.

A nation exporting goods where there is rapid technological progress, large increasing returns and important national synergies suffers little from these factors not being part of ruling economic theory: they have them in reality. Poor countries which often export articles where the same crucial elements are absent - no technical change, no increasing returns and no synergies - are the ones bearing the damage. Furthermore, a task requiring much physical strength will not hurt someone who possesses this strength, only those who don’t.

Together with the rhetoric-reality gap, economic assumption-juggling is an important tool in the power game that keeps poor nations poor: economics, power and ideology intertwine.

Technology and increasing returns, which are the main sources of economic power, create economic barriers to entry. By keeping technology and the increasing/diminishing returns dichotomy out of international trade theory, economists become useful fools/tools for the vested interests of the nations that are in power. Once this dichotomy is included, some countries will grow richer and others poorer under globalization (see Appendix III). In this real world, rich countries, specializing in the right economic activities, will develop economies of scale in the use of force'25 and a capacity for coercion’.26

Again, as in the 1840s, the market was seen as a producer of automatic harmony and the revolutions that brewed in the 1840s were as a result of social inequities within nation-states. However, similar social problems have appeared today, this time arising more between nations than within nations.

The way economics was `mathematized’ reinforced the weaknesses already inherent in the Ricardian system - its inability to include facets of reality that are important determinants for wealth and poverty.

Modern economics is `sick’. Economics has increasingly become an intellectual game played for its own sake and not for its practical consequences. Economists have gradually converted the subject into a sort of social mathematics in which analytical rigor as understood in math departments is everything and empirical relevance (as understood in physics departments) is nothing. If a…

Quantitative and qualitative understandings of the world are complementary. The problem is that most factors creating a world polarized in wealth and poverty are of a nature…

The two broad types of theory discussed here produce different views of globalization. In fact two Nobel Laureates in economics have provided two largely conflicting theories of what will happen to world income under globalization. In the first type of theory, based on the standard assumptions of neo-classical economic theory, Paul Samuelson proved' mathematically that unhindered international trade will produce factor-price equalization’, which in essence means that the prices paid to the factors of production - capital and labour - will tend to be the same all over the world.36 In the second type of theory, based on the alternative tradition we have broadly labelled the `…

The economic policies of the Washington Consensus - the basis for the economic policies imposed by the World Bank and the International Monetary Fund - are exclusively built on the type of theory which is represented by Paul Samuelson. The developments of the 1990s are in sharp conflict with Samuelson’s ideas, but confirm Myrdal’s assertion: rich nations as a group seem to converge into a cluster of…

It is precisely because the abovementioned factors are ignored that standard theory arrives at the conclusion that globalization will benefit everybody equally, even if a country is still in the Stone Age knowledge-wise. Development, then, tends to be seen as…

The two types of theory set out two very different origins for humankind: either, for the Lincoln type, `in the beginning there were social relations’ or, for…

In the English tradition, Type A, a human brain is a passive tabula rasa inhabiting a pleasure-calculating machine, avoiding pain and maximizing pleasure. This view leads to a hedonistic and barter-based economics with a corresponding value system and incentive system. Economic growth tends to be seen as a mechanical addition of capital to labour. In the continental tradition, Type B, the essence of a human is a potentially noble spirit with an active brain, constantly registering and classifying the world around him according to set schemata. Economics then becomes centred on production rather than barter, and on the production, assimilation and diffusion of knowledge and innovations. The driving force of the continental type of economics is not capital per se, but Nietzsche’s Geist- and Willens-Kapital, the human spirit and will. If one believes in Type A, then Type B becomes irrelevant, and vice versa. The first view of humankind makes…

Smith uses the invisible hand to produce a truly Panglossian vision of society, an attitude that carries over in today’s standard economics. With the invisible hand, in unison with the four previous economic insights his system abandoned, Adam Smith created the foundations of an ideology that considers the economy a Harmonielehre (theory of harmony) where the market is assumed to bring automatic harmony and equalize welfare. Needless to say, the consequences of this for modern economic policy are staggering.

It is useful to think of the economy as being made up of two different spheres (see figure 4). On the one hand one has the complex, heterogeneous and chaotic world of the real economy, encompassing the production of numerous goods and services, from shoelaces to hotels and barbers. On the other hand there exists a far more homogeneous financial side, where we find all the activities of the real economy translated into dollars and cents. Today’s theory of globalization tends to assume that all the different economic activities embraced by the real economy are qualitatively equal as bearers of economic development, and therefore that globalization and free trade will automatically result in economic harmony. In real life, economic inequality results from the diversity and the complexities inside the `black box’ of the real economy.

Today the World Bank tends to turn this insight on its head, and wants to explain that poverty arises in countries as a result of the institutions they lack, disregarding the important connections…

No historical period resembles the 1990s as much as the 1840s in terms of economic policy. Both periods were characterized by irrational, infinite optimism based on a technological revolution. Stephenson tested the first steam locomotive, The Rocket, in 1829, and by 1840 the age of steam was in full bloom. In 1971, Intel developed its first microprocessor, and in the 1990s a new techno-economic paradigm was again unfolding. Such paradigms, based on explosions in the productivity of specific sectors, carry with them possible quantum leaps of development. But they also bring with them speculative frenzies and numerous projects and practices which try to make normal industries perform like the core industries of the paradigm.41 The dubious accounting practices of Enron were virtually the same as those Thorstein Veblen had heavily criticized a hundred years earlier. In the late nineteenth century, the US Leather Corporation sought to build up its stock value in the same way as the US Steel Corporation, the Microsoft of its day. At the end of the twentieth century, many companies sought to gain a similar stock value to Microsoft, but failed. In both historical periods, they were helped by a…

Even now, politicians the world over seem convinced that it has been the openness of the economy and its free trade, rather than its technological breakthroughs, that have made Silicon Valley wealthy. This illusion was catastrophic for the small investors who had put their life savings into projects that turned out to be bubbles. The parallel illusion of `free trade’ is equally damaging for the…

The historical paradox here is that it is specifically during the periods when new technologies are fundamentally changing the economy and society - as with steam in the 1840s and information technology in the 1990s - that economists turn to trade- and barter-based theories in which technology and new knowledge have no place. One can say, in the spirit of Friedrich List, that they confuse the carrier of progress, trade, with its cause, technology. The same, ironically, can be said of Adam Smith’s theory…

During the first period of globalization - from the 1840s to the outbreak of the First World War - the rich countries became ever more industrialized, while the Third World remained technologically underdeveloped. It was this first wave of globalization that seriously dug the ditch dividing rich and poor countries in a process in which the colonies, as the practice had been for centuries, were not allowed to industrialize. As long as the latest wave of globalization builds on the same principles as the first - in other words, as long as poor countries continue to specialize in the production of raw materials - it cannot achieve more than the first one did: an increase in the difference between rich and poor, even though some new countries may join the rich.

The thought process corresponded to the normal industrial protectionism of the times, as with Friedrich List,' says John Sanness. New industries needed tariff protection, but the tariffs should gradually become superfluous.’ This is the dynamic that we have forgotten today.

Since 1990 the World Trade Organization trade negotiations with the Third World have once again brought back the days of unfair treaties'. Empire is again not such a bad word, and the first-hand reports I receive from African delegates on the way the green room’ negotiations take place certainly brings back visions of Chief Lobengula and his fate.

The outcome is that the African countries are being prevented from practising the kind of trade they really need: trade among themselves that later grows towards global free trade in the Listian manner. The EU works hard to make Egypt buy strongly subsidized EU apples, thereby ousting the apple producers of Lebanon, who have traditionally delivered their produce to Egypt.

Small African industrial markets are not integrated into a larger market that might have industrialized Africa. Instead, industrial Africa is increasingly fragmented, and while some countries are better off than others, each market is relatively open to the killing competition from the North. To believe that these conditions can be improved by letting poor countries export their agricultural products to the industrialized countries is an illusion. No country without an industrial sector (today we have to change the term to a combined industry-and-service sector) has ever managed to raise the wage level of its farmers.

Just as cancer patients are given palliative treatment - treatment that relieves the pain without attempting to cure the disease - we are witnessing an increasing focus on palliative economics as a substitute for development economics.

It is interesting that even a country like Norway, so long a kind of colony itself and with several current initiatives aimed at making the world a better place, has `forgotten’ the strategy we fought for: to obtain industry and economic growth. We have forgotten that central to our own nation-building there was an industrial policy which was the opposite of the principles we today force on the Third World. After the Second World War the Labour government, aided by the Marshall Plan, reindustrialized Norway extremely successfully. Today’s government, led by the same Labour party, makes a point of prohibiting the same policies for others that made us rich. Yet we have ambitions to be champions in palliative economics, in relieving the symptoms of poverty.

In every inquiry concerning the operations of men when united together in society, the first object of attention should be their mode of subsistence. Accordingly as that varies, their laws and policies must be different.' Human institutions were determined by their mode of production rather than the other way around. Today's new institutional economics’, based on standard textbook economics, tends to reverse the arrows of causality, blaming poverty on the lack of institutions rather than on a backward mode of production.

This is the key point where today’s standard textbook economics, the descendant of Adam Smith’s `Age of Commerce’, deviates from the production-based economics I refer to as the Other Canon, a descendant of continental European (particularly German) and American economics. Having ignored the importance of technology and production, as was stated previously, modern international trade theory insists that free trade between a Neolithic tribe and Silicon Valley will tend to make both trading partners equally rich. Other Canon trade theory, on the other hand, insists that free trade is beneficial to both parties only when they have both reached the same stage of development.

The pre-Columbian population of North America, consisting essentially of hunters and gatherers, has been estimated as low as 2-3 million people, whereas the pre-Columbian population of the Andes, having reached the agricultural stage, has been calculated at 12 million. This gives a population density thirty to fifty times higher in the apparently inhospitable Andes than on the fertile prairies. Thus the concept of…

Because the focus of analysis was to be trade and commerce, and not production, English and, later, neo-classical economic theory slowly came to see all economic activities as being qualitatively alike. Theories of production which were later added to this Anglo-Saxon tradition of economics - today’s standard theory - essentially came to regard production as a process of adding capital to labour in a rather mechanical way, similar to that of adding water to genetically identical plants growing under identical conditions. Economics developed, to use Schumpeter’s phrase, `the pedestrian view that it is capital per se that propels the capitalist engine’. Because we…

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