We now know it is possible to move from the third-world to the developed world in a generation: Hong Kong, Singapore, Taiwan, South Korea have done it. We also know that it is possible to move from the developed world to the third-world in the same time frame -- Argentina has done it. In 1950, its GDP per head was equal to 90 per cent of the developed world average, and was, as it had been in 1900, comparable to that of France. By 1992, its GDP per head was, at 45 per cent of the developed world average, well below that of any developed country.
Thanks to the work of a range of scholars such as Eric Jones, Jack Powellson, the late Mancur Olson, Lord Bauer and Peruvian thinker Hernando de Soto and his international band of researchers, there is no great mystery to all of this either.
Mancur Olson -- author of The Logic of Collective Action and The Rise and Decline of Nations -- posed a revealing question. Why does the income of illiterate Mexican peasants go up, and go up substantially, when they cross the Rio Grande from Mexico to the US? (Which is why, of course, they continually seek to so cross). Their skills do not improve: in fact, they move from a Spanish-speaking country to an English-speaking one. The answer is: American institutions work much better than Mexican ones.
P.J. O'Rourke expressed it in a joke.
American: "why do you hate us?"
Mexican: "because you stole half our country and, what's more, you stole the half with all the paved roads".
In a sense, the answer is obvious. Mexico was settled by Europeans a century before North America: most of the great Latin American cities are a century or more older as European settlements than the great North American ones. If North America is so much more prosperous than Latin America -- and Hispanic immigrants to the US achieve American average incomes within a generation -- then the answer has to lie in institutional differences.
Hernando de Soto got some researchers to conduct a famous experiment: to attempt to get all the legal approvals needed to set up a small textile concern in Lima, Peru. It took 289 days of dealing with the bureaucracy, just to get the legal approvals. The same exercise in Miami, Florida (also a largely Hispanic city nowadays) took less than a day. It is perfectly obvious where there will be more economic activity, and where people will be more prosperous.
De Soto's teams of researchers conducted similar examinations elsewhere and got similar results. In Haiti, for example, one can expect the process of acquiring legal title to land to take 19 years -- and even then, retaining title is not certain. How does economic activity take place in such circumstances? The answer is, extra-legally. People trade, but, apart from small items, they only trade within small networks who can enforce good behaviour on each other. This allows people to survive, but is crippling as far as aspiring to a wider prosperity is concerned.
Just think how limited your economic existence would be if you could only engage in major purchases with people known to you, or immediate friends and family, personally. And if you had no legal title to anything, so could not use the processes of formal credit: no bank loans, no mortgages, no credit cards. If everything you had was fundamentally insecure, at the mercy of any corrupt official who came along.
That is what it means to live in the third world.
It is not that the poor lack assets. De Soto estimates that, if the United States raised its foreign aid budget to 0.7 per cent of national income, it would take it 150 years to transfer to the poor of the world income equal to the value of assets they already hold.
What the poor lack, de Soto points out, is capital; specifically the institutions which give them the ability to turn assets into capital. In his new book The Mystery of Capital, de Soto identifies six principles a well-ordered system of property law possesses: it fixes the economic potential of assets, integrates dispersed information, makes people accountable, makes assets fungible, networks people; and protects transactions. By defining and protecting property rights under a clear and open system, the institutions of developed countries allow people completely unknown to each other to trade securely. It creates huge interlocking networks which raise the wealth and income of everyone in them.
And the Mexican peasant swimming across the Rio Grande is trying to plug into those networks.
All this is particularly interesting to Australians and New Zealanders. Why? Looking at long-run economic growth since 1870, New Zealand is the developed country most likely to drop out of the ranks of developed countries and we are not far behind. From 1870 to 1997, New Zealand's economic growth rate per head was a mere 39 per cent of the developed world average. Australia's was the next lowest at 45 per cent, followed by the UK at 50 per cent. Then there is a jump to Belgium and the Netherlands at 71 per cent and then the US at 88 per cent. (All those immigrating peasants don't do great things for American averages, for lots of indicators).
This is very much a twentieth century phenomena. Australia had above average economic growth per head in the nineteenth century. We achieved the highest average income in the world. Australia and New Zealand took a major wrong policy turn around the beginning of the twentieth century.
Mancur Olson advanced the theory that the accumulation of interest groups could retard economic efficiency and that this could get worse over time. One way to look at this is that all social systems produce barnacles: interest groups which take in more resources than they produce and which actively retard the operation of the society. The question is: how well does a polity's institutional structure frustrate the creation of such barnacles or eliminate them if they do begin to grow?
Market economies with well-ordered property laws have barnacle elimination mechanisms: they are called profit, loss and free contracts. The state can provide protection from such mechanisms, allowing the barnacles to thrive. In the extreme case -- socialism -- the society entirely lacks barnacle-removal mechanisms; so barnacles pile up until the polity sinks. In third-world countries, barnacles are the rulers, not the exception.
It is not hard to see why Britian's long-run growth record has been so mediocre. The UK paid for two World Wars (the losers welshed on their debts), had the interlocking network of social cartels -- including its union structure -- we call "the class system" (again, the losers had their interest groups broken up), had become highly protectionist prior to entry into the EU and had the complacency that came from its remarkable success over the nineteenth century.
All very well, but why did we and New Zealand do even worse? Did Australia and New Zealand inflict barnacle-generation and protection systems on themselves? Yes they did: they are called trade protection and wage arbitration. Being small economies, Australia and New Zealand suffered particularly badly from trade protection restricting our ability to access economies of scale and scope in world markets and which made us more vulnerable to exploitative cartels and monopolies: a process that wage arbitration actively encourages. Wage arbitration represents arbitrary interference by unaccountable officials in private contracts. It violates all of de Soto's principles. Attacking the value of the most common asset (people's labour) by restricting its use is a great way to retard economic growth. (If Australia had maintained equivalent American standards of living -- and we were wealthier throughout the nineteenth century -- the average Australian family would now be about $40,000 a year richer).
Further support for the barnacle thesis can be garnered from looking at the improved growth performers since 1980. The Celtic Tiger is the star improver: from 1870 to 1980, Ireland's per head economic growth was 62 per cent of the developed world average, since 1980 it has been 328 per cent. Next best is the UK (from 48 per cent to 114 per cent), followed by Australia (from 46 to 97) and then New Zealand (from 44 to 61). Thatcherism shook up the UK class system, while all four countries have moved to free trade and liberalised their internal markets. (Ireland also massively cut company tax rates and government's share of GDP)! Labour market reform occurred earlier in the UK and went much further than in the antipodes (given that New Zealand has recently re-regulated its labour market).
Australia has managed to catch up to average developed world growth rates (even be a star performer in the 1990s), but New Zealand has merely achieved falling behind more slowly. Showing we have learnt nothing from a century of mediocrity, Australia is now in the process of re-regulating its labour market State by State to protect the interests of a union officialdom whose own members are deserting in droves (union membership has dropped 29 per cent since 1990) in ways which greatly extend arbitrary intervention by officials in private contracts. New Zealand has banned forestry in Department of Conservation land (30 per cent of the country), the push is on to ban mining also. It, a country dependant on biological production, may ban the use of bio-technology, crucial for increased productivity. The same technology is under threat here. We have placed 15 per cent of our land area under "indigenous title" -- a form of title which violates most of de Soto's principles -- and made property rights insecure across another 65 per cent.
Most of this nonsense is done on the basis of posturing by status-seeking elites -- also a very third-world phenomena -- supporting policies very poorly designed to achieve their alleged intentions. If we keep this up, New Zealand really will become the only third-world country where you can drink the water, and we will not be far behind.
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