Throughout this section of the course, we’ve been trying to solve a complicated economic puzzle—why are some countries rich and others poor? There are various
Throughout this section of the course, we’ve been trying to solve a complicated economic puzzle—why are some countries rich and others poor?
There are various factors at play, interacting in a dynamic, and changing environment. And the final answer to the puzzle differs depending on the perspective you're looking from. In this video, you'll examine different pieces of the wealth puzzle, and learn about how they fit.
The first piece of the puzzle, is about productivity.
You'll learn how physical capital, human capital, technological knowledge, and entrepreneurs all fit together to spur higher productivity in a population. From this perspective, you'll see economic growth as a function of a country's factors of production. You’ll also learn what investments can be made to improve and increase these production factors.
Still, even that is too simplistic to explain everything.
So we'll also introduce you to another piece of the puzzle: incentives.
In previous videos, you learned about the incentives presented by different economic, cultural, and political models. In this video, we'll stay on that track, showing how different incentives produce different results.
As an example, you'll learn why something as simple as agriculture isn't nearly so simple at all. We'll put you in the shoes of a hypothetical farmer, for a bit. In those shoes, you'll see how incentives can mean the difference between getting to keep a whole bag of potatoes from your farm, or just a hundredth of a bag from a collective farm.
(Trust us, the potatoes explain a lot.)
Potatoes aside, you're also going to see how different incentives shaped China's economic landscape during the “Great Leap Forward” of the 1950s and 60s. With incentives as a lens, you'll see why China's supposed leap forward ended in starvation for tens of millions.
Hold on—incentives still aren’t the end of it. After all, incentives have to come from somewhere.
That “somewhere” is institutions.
As we showed you before, institutions dictate incentives. Things like property rights, cultural norms, honest governments, dependable laws, and political stability, all create incentives of different kinds. Remember our hypothetical farmer? Through that farmer, you'll learn how different institutions affect all of us. You'll see how institutions help dictate how hard a person works, and how likely he or she is to invest in the economy, beyond that work.
Then, once you understand the full effect of institutions, you'll go beyond that, to the final piece of the wealth puzzle. And it's the most mysterious piece, too.
Because the final piece of the puzzle is the amorphous combination of a country’s history, ideas, culture, geography, and even a little luck. These things aren't as direct as the previous pieces, but they matter all the same.
You'll see why the US constitution is the way it is, and you'll learn about people like Adam Smith and John Locke, whose ideas helped inform it.
And if all this talk of pieces makes you think that the wealth puzzle is a complex one, you’d be right.
Because the truth is, the question of “what creates wealth?” really is complex. Even the puzzle pieces you'll learn about don't constitute every variable at play. And as we mentioned earlier, not only are the factors complex, but they're also constantly changing as they bump against each other.
Luckily, while the quest to finish the wealth puzzle isn’t over, at least we have some of the pieces in hand.
So take the time to dive in and listen to this video and let us know if you have questions along the way. After that, we'll soon head into a new section of the course: we’ll tackle the factors of production so we can further explore what leads to economic growth.
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Farmers in Kenya and Vietnam are much more productive per acre than in the US or Europe. Something seems not right to me with the factors of production formulation: subsidized agriculture is a major element of rich country production: should this be part of the explanation? Or is it that rich countries can also be more wasteful with resources (against conventional economic theory as I understand it?) Being rich enables you to dispense with narrow 'economic' thinking and concentrate on other returns? i.e. dominating the market (Google, Microsoft, Ueber), locking out competitors, manipulating the system (General Electric, Trump Enterprises, grain merchants), controlling investment flows (big banks). Do we have a scientific (as distinct from Marxist) account of how this whole system operates?
Kenya is probably not the best example of agricultural productivity because half of its farming is mere subsistence farming (the product is just enough to feed the farmer's family).
In the US, output per working hour has grown 12 times from 1950 to 2000. Corn productivity for example is 153 bushels of corn per acre every year. At a price of 3.40 dollars per bushel, that gives 520 dollars productivity per acre. It's pretty good. Have subsidies produced this change? It cannot be subsidies that made this happen because the government has been constantly (not increasingly) subsidizing farming. Labor has remained the same, or to be precise, it has decreased by 2 percent. So what explains the growth in productivity? To answer this question growth theory speaks in terms of (a) factors of production or inputs such as pieces of capital and pieces of labor; (b) the knowledge to combine the inputs in such a way that the value of output is greater than the sum of inputs' values; and in terms of (c) the incentives that people face to combine them in that way.
One key to understanding how the whole system works, is to recognize that the economically relevant knowledge to combine inputs only exists in dispersed, local and tacit form in many people's minds. F.A. Hayek's Use of Knowledge in Society explains this in more detail. The article is available on econlib.org. The other key is to recognize that the institutions which provide those people with the right incentives are those which support economic competition. These institutions are free exchange and free enterprise, and private property (which means that those entrepreneurs who combine inputs profitably keep the profit, and those who combine them badly suffer the losses).
You are right that the US is also wasting money. In fact, the level of subsidies is 20 dollars per acre, and this is a lot of waste. This is not just a waste at the economy level. It might even retard agricultural productivity rather than explain its productivity, since subsidies protect existing farmers from competition, the institution which fosters innovation in combining inputs. But the U.S. can afford some waste because it is also getting rich. And the U.S. becomes rich when people play upon rules which encourage entrepreneurs to use their knowledge and combine inputs in the least wasteful ways.
Do entrepreneurs really bring ideas and capital together on their own? Most innovative research these days comes from the universities. So i think this caveat has to be included. Is Bill Gates really responsible for the spread of computing into modern society and what ideas has he brought (as distinct from prevented)? Most of Microsoft's products have better alternatives (offering more manageable, 'efficient' answers to challenges and needs). This is not to decry his achievements. It just seems the simplified theory discussed here seems hardly to match the facts: Microsoft or Apple can be considered entrepreneurial but Gates or Jobs? Wozniacki most fits your description of human capital, or the creators of Visicalc. It seems that 'entrepreneurial' skills (if that is what they are) have to mesh with something else: do you have any recommendations for exploring this aspect?
I totally agree. Entrepreneurial skills have to be combined with something else to produce value. For an economist, the value of an entrepreneurial idea simply means how much people are willing to pay for it. This means that the generation of value entails a whole system or network, in which the entrepreneur is just one node. Value requires a market, so people can bid for acquiring an idea; that those people have enough assets to buy it; have enough knowledge to understand it; expect they will enjoy the security to use it without fear of confiscation, accusation etc; that they will have the expectation that once they acquire it they will be able to make and keep their profit, if any. Moreover (just like you suggest when you mention a university system) an entrepreneurial skill, like the skill needed to create Visicalc is itself generated within a special kind of network which rewards, step by step a certain kind of intellectual progress. It is too complex to simply pop up in someone's mind out of nothing. These two observations lead us to conclude that if you extract one node -- say, Wozniacki -- and transport it in another network, not only might he die anonymous, but would never come up with that idea. (All this in no way suggest that entrepreneurs should share their profits with the so called "community" in the form of taxes to the government. The larger network is already enriched by innovators' ideas.) But perhaps we talk too much about the heroic innovators. Hayek (the author I mentioned in my earlier comment) talks about the small entrepreneur, the shipper who earns his living from using otherwise half-filled journeys, or the small arbitrageur who speculates local differences in prices. These business ideas qualify as "new" ideas, since no one had them before. They too are innovations, literally, they are new ways of combining concrete inputs. Growth is produced by a large number of small innovations like these. These people who provide small services, who only has ideas of circumstantial and transitory value, who combine unique concrete pieces of capital, don;t have any general or theoretical ideas. This view of the entrepreneur belongs to Ludwig von Mises, and is developed by Israel Kirzner.
Does your incentives discussion suggest that the 'care' industries and 'caring' activities in economies free-ride because the returns lack incentives? Or is this the reason economists exclude caring and reproduction from their calculations? Or do they?