“I have worked with immigrants who came to the US and people who live in their own countries and work for me remotely. They are much more hardworking and skilled (even in technical areas) than my American colleagues. Foreigners work hard, are grateful for their work and use any opportunity to advance. For all their skill and ambition, it seems like their home countries should be vastly richer than US cities, but they aren’t. What is the cause of poverty in these countries?”

This was a question posed by a reader of the Foundation for Economic Education and answered by economist Peter Jacobsen.

A long history of answers

In 1776, the Scottish philosopher Adam Smith published perhaps the most influential work in the history of political economy: “An Inquiry into the Nature and Causes of the Wealth of Nations.”

This book, known as The Wealth of Nations, attempts to answer the question the reader asks. Since then, rich countries have become much richer, some poor countries have become richer, but there are a large number of countries that are lagging far behind.

Economist Bill Easterly provided some answers in his book The Elusive Search for Growth

Easterly’s idea is simple. Throughout the 20th century and into the 21st century, the United States and other countries tried to stimulate economic growth in countries that were considered poor. These attempts failed.

Easterly discusses three possible solutions that experts believe will promote development: investment, population control, and education. The idea was that developed countries tend to have higher levels of investment, lower birth rates and better educated people. From this, experts concluded that if these conditions are reproduced in poorer countries, they will develop.

But this strategy failed. It turns out that these factors are more a consequence of economic growth than a cause of it.

1. Investments

In the 1950s, experts believed that a healthy financial market could make countries richer. This belief, ironically, was based on the (false) success of the Soviet Union. The volume of Soviet production was much higher than that of the United States, and for decades economists believed that the USSR would overtake the United States. Why

The Soviet Union industrialized by force. Thanks to the reallocation of private resources to giant industrial investments, the economy grew faster than in other countries and then collapsed.

This approach was not confirmed – the investments made in poor countries did not help them. And the reason for the failure is the same that Rothbard noted in his analysis of the economy of the USSR. Production is a means of achieving population consumption goals. Production planners tried to create production for the sake of production, resulting in a misallocation of capital and resources. Just investing is not enough – you need to make the right investments.

2. Education

Education was another topic of development experts. If increasing production at the expense of physical capital was not enough, perhaps a more educated human factor would ensure economic growth.

But the results did not confirm this. Quite the opposite: studies show that because of the education boom in poor countries, the rate of income growth in those countries has fallen, which is exactly the opposite of expectations.

Another study found that for countries growing 1% faster than the average, education could explain only 0.06% of this growth in human capital.

3. Demographic policy

Perhaps the worst theory to test in the developing world was the neo-Malthusian idea that large population causes poverty. .

Despite the opinion of some thinkers, people are not just consumers. Humans are also producers. People are not an obstacle to economic development, but even one of the causes of growth, as the late economist Julian Simon argued.

The low birth rate in rich countries does not mean that this is the secret of their economic development.

4. Other answer options

There are other answers that economists address indirectly. One of them will be geography. Of course, a country’s resources, climate and characteristics have some influence on a country’s economic future, but there are many examples that make me doubt that it can be the main driver of growth

For example, the United States is rich in natural resources and its citizens are rich. On the other hand, Hong Kong has very few advantages in terms of natural resources, but it also has a high level of wealth. On the other hand, there are poor countries with a lot of natural resources, and there are poor countries with very few natural resources.

So it seems that geography is not a plausible explanation when it comes to a country’s wealth.

The best answer

So, if all of these answers are wrong, which answer is correct? Let’s go back to Adam Smith: Why do countries get rich?

“In order for the state to achieve the highest degree of economic progress and prosperity, something else is necessary: ​​low taxation and correct justice; everything else comes from the natural course of things.”

Smith claims that the main reason for a country’s economic growth is its institutions. In other words, the rules governing economic activity are the basis of economic growth.