Opinion: Daily Journal

Flashback: Explaining Economic Growth

Back tomorrow with a fresh DJ. This column originally ran in 2007.

RALEIGH – What makes some countries rich and others poor?

It’s a question policymakers and economists have debated for centuries, probably for millennia. Adam Smith wrote about the subject more than 200 years ago. Plato, Aristotle, and the post-Confucian philosophers of China weighed in on the subject hundreds of years before the birth of Christ. In today’s political debate, you hear all sorts of theories: climate, nature’s bounty in flora and fauna, the presence of valuable natural resources, education level, infrastructure, exploitation, sheer luck.

The question is relevant to North Carolina political debate, too, in that variations in economic performance among the states, while not nearly as wide as among countries, are significant enough to draw research attention about what factors are most associated with economic growth, and to what extent these factors are amenable to influence by government policy.

Many popular notions about rich and poor economies are surprisingly lacking in empirical support. Within the U.S., it is simply not true that states with more generous incentive policies or higher-education subsidies grow faster than states without them. Internationally, many of the most successful economies in the world are in places such as Japan, Singapore, and Hong Kong that are relatively poor in natural resources, including arable land.

Economist Kirk Hamilton and his colleagues at the World Bank have been pursuing some pathbreaking new research into the question of what makes national economies succeed. Their key insight is that the vast majority of the capital stock in the world economy is held neither in commodities, manufacturers, or financial assets. The most valuable capital is intangible, made up of personal knowledge, skills, social cohesion, and a body of clear and fair rules of conduct and exchange. Hamilton’s team estimates that for the world as whole, natural resources account for just 5 percent of total wealth, with another 18 percent made up of machinery and other human-produced tools and physical assets. The remaining capital stock, 77 percent of the total, is intangible. Its constituent elements are brainpower, habits, and trust.

Moreover, to the extent that countries differ in these relative proportions, the ones with a higher share of total wealth in intangible capital are the wealthiest. For example, Switzerland ranks 1st in wealth at about $650,000 per person. Natural resources make up only 1 percent of Switzerland’s wealth, while intangible capital makes up 84 percent. On the other hand, the poorest country is Ethiopia, with only $2,000 in wealth per capita, 41 percent of it in natural resources and 50 percent in intangible capital.

The two most important determinants of a country’s intangible capital are education and government corruption. This will sound plausible to many North Carolina policymakers, but I’ll bet they couldn’t guess the proper proportions. Hamilton says that a “rule of law index” measuring corruption, the security of property rights, and other legal matters explains 57 percent of variances in intangible capital. Education explains 36 percent.

To put this in practical terms: assuming that what is true at the level of national economies is also significant at the state level, North Carolina policymakers should be paying at least as much attention to rule-of-law issues – raising ethics and lobbying standards, policing government scandals, reforming confusing and counterproductive regulations, strengthening property-rights protections, and providing adequate funding for the state judiciary – as policymakers currently pay to education policy.

The quality of education is, indeed, a critical issue for North Carolina’s economy. But strengthening the rule of law is even more critical.

Hood is president of the John Locke Foundation.