Economics

Highlights

• Education and health go by the name human capital. A literature pioneered by the economists Theodore Schultz and Gary Becker reveals that the accumulation of human capital has been a significant factor behind the high standard of living people in Becky’s world enjoy today.

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• No economist has ever claimed that there is a single driving force behind economic growth. All would appear to agree that the accumulation of manufactured capital, human capital, and the production, diffusion, and use of new scientific and technological ideas go together, each contributing positively to the contributions of the others. In the contemporary world, an accumulation of, say, manufactured capital goods raises real GDP, other things being equal. This enables societies to set aside more of their incomes for education and health, triggering a reduction in both fertility and child mortality. Education increases GDP further, other things being equal, while reduced fertility and child mortality typically lower population growth; which, taken together, enable societies to set aside more of their incomes for the production of new ideas. This raises the productivity of manufactured capital; which in turn brings forth further accumulation of manufactured capital; and so on, in a virtuous cycle of prosperity.

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• Economists use the terms virtuous and vicious cycles to characterize polarization (a few of us refer to vicious cycles as poverty traps); mathematicians say instead that the poor and rich worlds are in two different basins of attraction.

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• Economic historians such as Robert Fogel, David Landes, and Douglass North have argued that the rich world is rich today because, over the centuries, it has devised institutions that have enabled people to improve their material conditions of life. This is a deeper explanation. It says that people in rich countries work with superior technologies, are healthier, live longer, are better educated, and produce many more productive ideas, because they have been able to get on with their lives in societies whose institutions permit – even encourage – the economy-wide accumulation of such factors of production as machines, transport facilities, health, skills, ideas, and the fruits of those ideas. The accumulation of productive capital assets is only a proximate cause of prosperity, the real cause is progressive institutions.

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• It used to be argued that bribery of public officials helps to raise national income because it lubricates economic transactions. It does so in a corrupt world: if you don’t pay up, you don’t get to do business. But corruption isn’t an inevitable evil. There are several poor countries where corruption is low. Having to pay bribes raises production costs; so less is produced. Citizens suffer, because the price they have to pay for products is that much higher.

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• Economists have speculated that government corruption is related to the delays people face in having the rule of law enforced. The thought is that delays are a way of eliciting bribes to hasten legal processes. To enforce a contract takes 415 days in the poor world, as against 280 days in the rich world. It may be that corruption is also related to government ineffectiveness. To register a business takes 66 days in the poor world, 27 days in the rich world. In poor countries, registering property takes 100 days on average, while in rich countries the figure is 50 days. Some economists have suggested that government officials in poor countries create lengthy queues (that’s government ineffectiveness) so as to elicit bribes from applicants if they want to jump those queues (that’s corruption).

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• Given that enforcing contracts involves resources, what is the basis of that confidence? After all, the contemporary world has shown that there are states and there are states. One answer – in a functioning democracy – is that the government worries about its reputation. A free and inquisitive press helps to sober the government into believing that incompetence or corruption would mean an end to its rule, come the next election. Notice how this involves a system of interlocking beliefs about one another’s abilities and intentions. The millions of households in Becky’s country trust their government (more or less!) to enforce contracts, because they know that government leaders know that not to enforce contracts efficiently would mean being thrown out of office. In their turn, each side of a contract trusts the other not to renege (again, more or less!), because each knows that the other knows that the government can be trusted to enforce contracts. And so on.

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• The two rules embody a common idea: begin by cooperating and continue to cooperate so long as neither party has broken their word, but withdraw cooperation permanently following the first defection from the agreement by either party. Withdrawal of cooperation is the sanction. Game theorists have christened this most unforgiving of rules the ‘grim strategy’, or simply grim. We show next that grim is capable of supporting the long-term relationship if r is not too large.

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• In short, even when appropriate institutions are in place to enable people to cooperate, they may not do so. Whether they cooperate depends on mutual beliefs, nothing more.

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• How does an increase or decrease in cooperation translate into macroeconomic statistics? Our numerical example captured a salient point, that an increase in cooperation raises incomes by permitting a more efficient allocation of resources: A’s working capital was put to better use under cooperation, as was B’s labour. Consider now two communities that are identical in all respects, excepting that in one people have coordinated at an equilibrium where they trust one another, while people in the other have coordinated at an equilibrium where they don’t trust one another. The difference between the two economies would be reflected in their total factor productivity, which would be higher in the community where people trust one another than in the one where they don’t. Enjoying greater income, individuals in the former economy are able to put aside more of their income to accumulate capital assets, other things being equal. So GDP growth there is higher. Mutual trust would be interpreted from the statistics as a driver of economic growth.

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• We could conclude from the World Values Survey that trust is good for economic growth and several other good things besides. But the survey didn’t identify the reasons why the degree of trust in each of the countries sampled was what it was. Nor could it identify the reasons. This poses a problem. As trust doesn’t get created in a vacuum, its presence cries out for explanation. Which means that the presence of trust shouldn’t be used to explain the presence of something else. What the statistical findings tell us is that such emergent features of an economy as the degree of trust people have in one another go hand in hand with economic progress, they tell us nothing more. Statisticians remind the rest of us repeatedly that correlation isn’t the same as causation. It is an instruction social commentators have all too often ignored.

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• A possibly even stronger pathway is the influence newspapers, radio, television, and the internet exert by transmitting information about lifestyles elsewhere. In other words, the media can be a vehicle by which conformism increasingly becomes based on the behaviour of a wider population than the local community: the reference group widens. Increased conformity with the behaviour of people in distant lands can even be mistaken for growth in individualism.

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