Third world economic development is often portrayed as if the task is hopeless. No one knows how to do it. This ignores countries such as South Korea that have succeeded and countries like China that are succeeding. Everyone knows precisely what must be done economically. The mechanics of development are straightforward. The problem is execution. Execution requires social organization, and that is precisely what most third world countries lack.
Execution begins with an important mental mind-set. Economic development requires the mentality of a marathon runner and not that of a sprinter. The catching-up process is long. No one does it quickly. It took the United States a hundred years to catch up with the per capita income of Great Britain. Japan has been chasing the United States for more than a hundred years and still hasn’t caught up on purchasing power parity measures of per capita GDP. Taiwan has had half a century of 7 to 8 percent growth rates, yet its per capita GDP is still less than two-thirds that of the United States.1
It takes a long time to catch up because the world’s economic leader is not standing still. Almost by definition, the world’s most successful country is rapidly moving forward. Leaders can easily be moving forward faster than those attempting to catch up. This happened in the 1990s when America was sprinting ahead and widened its lead over almost everyone.
Education is another reason why the catch-up process is slow. Countries cannot quickly move from illiterate workforces to well-educated workforces. Brazil will proudly tell you that 90 percent of its children are now in school, but the average level of education in the Brazilian workforce is 4.5 years and only slowly rising. Unless something dramatic is done about adult education, illiterate workers stay in the economy for forty to fifty years.
Many nations are looking for the quick fix. They want a twenty year, or at a most thirty year, catch-up plan. There are none. Brazil is a good example. Frustrated that they haven’t caught up after less than a decade of moving toward freer markets with less government intervention, the Brazilians elected a new president in 2002 who promised a different, faster, as yet unspecified model of economic development that will involve more active government participation and less hardship. Brazil shifts so fast from strategy to strategy that nothing has time to work—and then its people wonder why the country is falling behind.
Among the economic leaders in the developed world, per capita incomes are rising at about 2 percent per year. A country with a 4 percent growth rate and a 1 percent rate of population growth has a 3 percent annual rise in per capita income and is only slowly catching up with the industrial world at the rate of 1 percent per year. The same country with a 3 percent rate of population growth is falling behind at the rate of 1 percent per year. To catch up, low rates of population growth are essential. It is simply impossible to catch up with high population growth rates.
If one looks at wealthy countries, one sees they have all had a century or more where population growth rates did not average much more than 1 percent per year. The reasons are simple. Before per capita incomes can go up, the new individuals added to any society have to be provided with those items necessary to generate the society’s already existing per capita GDP. Newborn citizens must be fed, housed, and given medical attention until they enter the labor market and can support themselves. Entering the labor force on average at age 20, they need $8,000 per year in living expenses for twenty years if they are to have the average American childhood. To get an average job they must be given the average amount of education. American elementary and secondary education costs $7,200 per year, and higher education $14,700 per year. A little multiplication will tell you what must be invested in education if everyone is to have twelve years of education and 34 percent of the population is to have some college education. To create an American average job requires $122,700 in capital equipment. About two-thirds of the adult population works. Social infrastructure, such as roads and airports, requires another $21,000 per person. Adding it all up, total investments of a little less than $400,000 per person are needed to make each new American into an average adult American.2
Human populations can at their maximum grow at about 4 percent per year. No country has ever had a 4 percent population growth but some, like Mexico, have come close for a while. Suppose America’s population were growing at 4 percent per year. This would mean 11.3 million new Americans every year and a required investment of $4.4 trillion per year. But the American GDP is only $11 trillion. Forty percent of the American GDP would have to be devoted to making these new Americans into average Americans. This would require a big reduction in the standards of living of existing Americans. They simply would not accept it. The necessary investments would not be made, and the average per capita American GDP would start to fall.
In poor countries the investment numbers in each category are different, but when one divides by the local GDP the percentages come out about the same—somewhere near 40 percent. As a result, with population growth rates much above 1 percent it is essentially impossible to catch up. This is one of the main reasons to be optimistic about China’s economic prospects and pessimistic about India’s economic prospects. One country has its population under control and the other does not.
Countries need both social capital and social capabilities to engage in economic development.
Working together, individuals have higher productivity than when they work alone. Social capital refers to the social networks individuals join to raise their standard of living. It is estimated, for example, that bilateral trade between ethnic Chinese countries is nearly 60 percent larger than it would be if both sides were not ethnic Chinese.3 Trust, culture, social solidarity and language make a difference. At a more local level, rural irrigation systems raise output, but they require farmers willing to work together to build and maintain the irrigation canals and to share the available water supplies.
Social capabilities refer to the ability to get organized—to set up village schools, to separate drinking water from sewage water, to take preventive actions to stop AIDS from spreading, to establish the institutional frameworks (political, social, and legal ground rules) necessary for economic development.4 This cannot be done by outsiders, no matter how well intentioned. No country can organize a school system for another country. This is a task each country must do for itself. Some countries are much better than others when it comes to this task. Egypt and Ecuador have the same per capita income, yet illiteracy is only 9 percent in Ecuador and 40 percent in Egypt.5
If the third world can organize its schools, the first world can help pay for those schools. Without the third world’s internal ability to organize, however, first world money simply ends up in corrupt hands and Swiss bank accounts. First world outsiders can help with financial resources, but third world insiders have to do the hard lifting—the basic organizational work.
Not long ago my wife and I visited a number of Mung villages along the Mekong River with a local agricultural economist as a guide. All of the villages had about the same amount and quality of land to use in their coffee farming. The density of TV antennas seemed similar. But it is only a slight exaggeration to say that some villages looked like little Switzerlands, with drinking water and sewage separated, children cared for, and houses neat and tidy, whereas others were chaotic, with drinking water and sewage mixed, children uncared for, and houses a mess. The difference was local leadership and the villagers’ willingness to work together. Some villages had social capital and social capabilities, whereas others did not.
Local countries have to provide for personal safety and be able to control crime. Capitalists engaged in the business of creating wealth need protection from criminals. If the protection is not there, capitalists won’t be there. Crime destroys capitalism essentially by being an unpredictable erratic tax on economic success. Studies indicate that the effects of corruption are similar to tariffs, with a 10 percent increase in corruption leading to a 5 percent reduction in output.6
But the story is complex. Capitalism seems to tolerate some kinds of corruption easily yet be completely intolerant of other kinds of corruption. In a recent ranking of corruption China, currently the most successful country in the developing world, ranked fifty-ninth out of 102 countries. Above China with less corruption were many economic failures: Belarus at 36, Jordan at 41, Ghana at 50. The most honest poor country is Botswana, in the twenty-fourth position. In terms of honesty it is rated ahead of the far wealthier France or Italy.7 Greece at number 44 ranks as the most corrupt among relatively wealthy countries. All of the least corrupt and most honest countries at the top of the list are wealthy, but what is the direction of causation? Does honesty cause wealth to grow, or can the wealthy simply afford to be honest?
Issues of personal safety, such as the kidnapping or murder of foreign executives, are even bigger deterrents to economic activity than are bribes. Both threaten lives and take a lot of executive time. Not too long ago, I ran into a Japanese friend who manages a large auto parts manufacturing firm’s activities in North and South America. He told me that he had just spent the previous two months, the worst two months of his life, negotiating with Columbian kidnappers who held two of his executives. What do you think my Japanese friend is going to do when he gets his executives back? The answer is simple: pull out of Columbia. Business people have better things to do with their lives and their time.
All of the indicators of personal safety show big differences among Africa, Latin America, and Asia, with Asia being much safer than the other two. Assaults and robberies are five times as likely in Sub-Saharan Africa as in Asia. In Latin America most kidnapping involves citizens, but in Africa the majority of those kidnapped are foreigners (80 percent in Nigeria).8
Corruption is something outsiders find much harder to deal with than do locals. Corrupt systems are by definition not transparent. No one publishes the rules. Locals know the local rules of corruption (whom to bribe, how much to pay, when to say no, who can really deliver what they promise), outsiders do not. When periodic political crackdowns on corruption do occur, it is also true that outsiders are much more apt to be arrested than insiders.
If one looks at countries with a lot of corruption, government officials, including the police, are usually paid very low wages by the standards of their own countries. Being paid very low wages, they have to find ways to supplement their family incomes. Demanding bribes is the easiest way to get more income; being paid very little, they have little to lose if caught and fired. The Cambodian police officer takes you to the temple you want to see, though it is not open to the public, if he gets the right sum for “protection.” If government officials are paid high wages, as they are in Singapore, they have much to lose and don’t need bribes to feed their families.
But it is also true that corruption is an area where history plays a big role. Once endemic, corruption is very hard to stamp out. Few throw their trash on the streets when the streets are clean, whereas almost everyone will throw their trash on the streets that are already dirty. So too with corruption. Few want to be the first to test whether the system will tolerate corruption, but many are willing to participate in corruption when it is clear that the system is corrupt.
Some global industries have learned to live with murder and terror. The oil industry operated right through the Nigerian civil war. Today it operates in the chaos of central Asia. Other extractive industries are operating and investing in the midst of Africa’s current civil wars and chaos. If the investors in extractive industries don’t get the official protection they need, they know how to hire private armies. They are tough enough to kill a few people to prove they should be left alone.
Normally these arrangements are kept very quiet but occasionally they pop into public view. According to a recent press report a very profitable mining company supplemented the salaries paid to the regular army in its neighborhood in Indonesia to get protection. Soldiers were said to have high expectations when assigned to the mining company’s area and to have been very disappointed when the mining company reduced their pay and perks.9 In retaliation for this reduction in pay, two American schoolteachers were killed and eight wounded in army attacks designed to convince the company to restore their previous pay scales. But most global investors have neither the profits nor the stomach to take on such activities.
All of these factors are magnified in the case of systematic terrorism. Investors are going to avoid or withdraw from places where their employees feel physically threatened. Murdered missionaries in Yemen mean that no global firm is going to invest in Yemen. A disco blown up in Bali means that no global firm other than those involved in natural resource extraction is going to invest in Indonesia. Killing a journalist and blowing up Christian churches in Pakistan forecloses investment in Pakistan. If the Muslim world is seen as dangerous, all of the Muslim world, except that part that produces oil, will be left out of globalization. There are a lot of other places to go where terrorism does not exist.
There is a clear economic bottom line on corruption and personal safety even if the exact location of that line is murky. Beyond some point corruption and issues of physical safety become so large that capitalism cannot and will not tolerate them. Capitalism needs governments to stamp out corruption. Firms cannot do it by themselves since their incentives lie on the side of paying bribes. In the short run paying bribes is less costly and less time consuming than banding together to force governments to stamp out corruption. But most firms also cannot live with corruption. As a result, their only option is to move to other, less corrupt locations. And that is exactly what they do—leaving corrupt countries outside of the global economy.
Corruption has to be controlled locally. First world laws prohibiting first world companies from paying bribes or ransom in the third world don’t work. Those laws cannot be enforced, and where there is an effort to enforce them, firms simply decide that avoiding or leaving corrupt countries is easier than reforming corrupt countries. Business firms are not in the business of making countries honest. It is expensive and time consuming.
Social capital and social organization are not synonyms for great political leaders. America is the best example. Most Americans can remember none of the names of the presidents from Lincoln to Theodore Roosevelt in the second half of the 19th century. The presidents cannot be remembered because they did not do anything worth remembering. Yet the United States caught up with Great Britain economically during this period. The names that Americans do remember from the late 19th century are those of the great industrialists—Edison, Rockefeller, Eastman, Carnegie, Vanderbilt, and Morgan—who actually led the American economic advance. They were more important than the presidents—not just for their successful businesses but for their pioneering activities when it came to using their fortunes after they had made them. The idea of charitable foundations came from these men. Carnegie put libraries in every town. Rockefeller and Eastman built universities. They were leaders both when it came to making money and when it came to giving it away and making their societies better places in which to live and work.
Presidents Truman and Roosevelt will be remembered in the history books for their activities in the Great Depression and World War II, but a hundred years from now the 20th century is apt to be like the 19th century. Few presidents will be remembered. The names that will dot the history books about the 20th century will be those of Ford, Sloan (GM), Watson (IBM), Hewlett and Packard, and Bill Gates, and not the presidents. Leaders are essential, but it is not necessary that they be political leaders.
Once the social foundations are in place, all economic growth depends upon improvements in technology. Successful countries go through three stages in acquiring technology. In stage 1 they mobilize human and capital resources to fully exploit existing technologies. In stage 2 they copy existing technologies from more advanced countries to catch up. And in stage 3 they build new industries based upon the advances in knowledge that flow from their own research and development.
Since Japan is the only non-oil country that has gone from poor to rich in the last century, it is worth examining its economic development.10 After the Meiji restoration, Japan began by mobilizing its capital resources to produce a high savings society. It was fortunate to start its economic development with a population as well educated as that of the world’s economic leader, Great Britain. It did not need to build a school system.11 It had one. Its population growth rate was low.
All of the successful economies of East Asia in the last half century have followed the Japanese pattern. Starting with large labor forces, they organized themselves to produce very high savings rates so they could afford massive investments in new capital equipment. China, with its internal savings rate of 30 percent, is only the most recent example of a country on this path.12
With a reverse twist, the same pattern is visible if one goes back to the United States in the last half of the 19th century. Having a shortage of labor, America mobilized labor rather than capital. Foreign workers were actively recruited as immigrants from Europe and China. Millions of farmers moved from farms where they worked relatively few hours per year to factories where they were working almost 3,000 hours per year.13
Education is the second part of resource mobilization. Those who study how the United States caught up with Great Britain’s per capita GDP in the early 20th century trace much of the catch-up to a better-educated workforce.14 People talk about a digital divide between rich and poor, but the real divide is an educational divide. Any country that can afford an army, and all do, can afford to provide the hardware part of the digital divide. It is just a matter of priorities. The educational divide is more serious. Technology cannot be absorbed without an educated workforce and, as a result, all societies that wish to develop must organize to educate their labor forces.
For a country to really upgrade educational skills, women must be educated and their talents fully utilized. Americans would not have an American standard of living if only men worked outside of the home. But it is skills and not numbers that are important. Americans would not have an American standard of living if its women weren’t educated.
A branch of the Muslim religion in northern Pakistan, the Aswali Muslims, associated with the Aga Khan, believes in educating girls. They place a simple slogan on many of their schools: “Educate a man, educate a man; educate a woman, educate a family.” Men with illiterate mothers are not going to be well-educated men. The same can be said for fully using the talents of minorities. India’s caste system retards development. The issue is not theoretically legal rights but actual practices. Whatever its laws, as long as India has its caste system (and one in six Indians are in practice treated as untouchables), India will not be rich.
The third part of resource mobilization is building the infrastructure that lets a country’s existing productive resources more fruitfully interact with each other. America’s investments in transcontinental railroads were central in creating the American economy in the 19th century. Electrification played a big role in the early part of the 20th century. Interstate highways and airports were important in the second half of the 20th century. Communication systems in the 21st century are what the railroads were in the 19th century. Labor, capital, and natural resources were made more productive by tying them together more efficiently.
After mobilization the next step is motivation. Communist countries were good at mobilizing large numbers of workers (by law all women worked in the USSR, and those of us old enough can still remember picture of millions of Chinese being mobilized to build dams, one handful of dirt at a time), but not much was produced because the individuals saw no payoff for themselves in working hard. That is why the USSR imploded and Communist China decided to move toward free markets. Countries have to build individual incentive systems that work.
It is at this point that capitalism becomes a necessity. Socialism simply does not provide the necessary structure of individual incentives. One has only to look at Israeli kibbutzim: they have capital, skills, and infrastructure in abundance, but they cannot maintain motivation from one generation to the next. As a result, they have failed economically and are gradually fading out of the Israeli economy. In the short run, individuals will sacrifice their own self-interests to help their neighbors, but no one has been able to organize a society where individuals will do so in the long run. In the long run, humans work, invest, and sacrifice to help themselves.
After mobilizing capital, educating the workforce and tying it together with the necessary infrastructure in a system with strong individual incentives, countries can move on to stage 2, where they start to acquire new technologies. Everyone begins by copying technologies from those who already have them. Great Britain, as the initial industrial leader, is the only exception. Americans were famous for being copiers in the 19th century, just as the Japanese were famous for being copiers both before and after World War II.
Whom one copies depends upon your model of technological development. Until the Japanese provided an alternative model, what was called the “product cycle” was seen as the standard way technology moved around the world.15 Over time high-tech industries become low-tech industries as any particular technology slowly moved from the most-advanced countries to the least-advanced countries.
Textiles were the prototypical example. Starting as a high-tech industry in Great Britain in the early 19th century, they moved on to become the economic starting point for Britain’s closest followers, Germany and the United States, later in the century. Eventually, almost two centuries later, textiles have become the place where every poor country starts its industrial and technological development.
In the product cycle model of economic development, countries copy the countries immediately ahead of them—one stage farther along in their economic development. The newly acquired technologies are then used in an import substitution model of economic development. Products previously imported because they required technologies a country did not have are replaced with products produced locally.
The Japanese demonstrated that it was possible to develop a leapfrogging model. Instead of following historical patterns and looking at the countries just slightly wealthier than they were, the Japanese looked at where the economic leaders were and where these leaders were going. Japan then charted a technology path for intersecting with the leader’s technological path without following it. In this model economic followers quickly become technological competitors with the economic leaders.16
To succeed in this strategy, countries need technological policies to speed up the copying process. In the 19th century, official Japanese delegations were sent around the world to study what were believed to be the leading models of social organization and technological development. These models were then brought back to Japan to be adopted and then adapted to Japanese conditions.17
After World War II a wide variety of specific policies were put in place to accelerate the copying process.18 A productivity center was established in Washington to translate scientific and engineering articles into Japanese and to send them to the Japanese companies that might benefit from their content. Students already working for private companies were sent to leading American universities to master American technologies that were relevant to their employers. In the aftermath of a 1957 antitrust decree that ordered the Bell Labs of AT&T to freely share their technologies, a Japanese office was set up in New Jersey to monitor and transfer the Bell Labs technologies back to Japan. Camera-equipped Japanese on factory tours of American plants were so common that they became a subject for jokes by late-night TV comedians. When technologies had to be purchased, the Japanese government acted as a monopsonistic buyer using its bargaining power to buy cheaply and then broadly share the purchased technologies across the entire Japanese economy.
Japan understood that historically there is no tight connection between scientific leadership and economic leadership. The per capita GDP of the United States exceeded that of Germany in the first half of the 20th century, although Germany was the scientific leader of the time. The technological gap between Germany and the United States wasn’t small. It was huge. At the last global physics conference held before World War II (the Solvay conference in 1936), only one individual from America was invited.19 Scientifically, America was far behind. If one looks at Europe today, the rank order of spending for research and development is not closely correlated with the rank order of per capita incomes.20 In purchasing power parity terms, Luxembourg has Europe’s highest per capita GDP but is in no sense a scientific leader.
The central issue is acquiring engineering knowledge. Basic science can be learned from textbooks. Engineering knowledge is difficult to acquire because much of it is acquired from informal on-the-job experience rather than from what one formally learns in a school of engineering. One cannot competitively design and manufacture semiconductor chips based upon what one learns with a degree in electrical engineering.
Japan’s development strategy did not stop with just copying engineering know-how. It invested heavily in improving engineering knowledge. It spent about the same fraction of its GDP on research and development as did the United States, even though it was much poorer. But the spending patterns were very different. Two-thirds of Japan’s R&D money was spent on improving products and processes, whereas the United States spent two-thirds of its money on developing new products. The Japanese strategy was to copy a technology from the rest of the world, learn to make those copied technologies work 10 percent better or 10 percent cheaper, and then use that margin of superiority to outcompete those who had first developed the technologies. Robots and copiers are good examples. The Japanese invented neither, but in just a few years they had become leaders in both.21
The recently acquired and improved technologies were then used to support an export-led model of economic development. Japanese companies that successfully exported products made with their new technologies were rewarded with protected local markets where high profits could be made to offset the losses necessary to penetrate foreign markets.
Because of the economic reversals of World War II, Japan’s per capita income had fallen to less than 10 percent of that of the United States in 1950. By 1989 Japan had a per capita income above that of the United States in currency terms ($36,966 versus $25,980) and below that of the United States in purchasing power parity terms ($18,880 versus $23,223).22 Inside and outside of Japan, the Japanese were widely seen as a technological equal to the United States at the beginning of the 1990s.
South Korea is the best example of a developing country that has explicitly followed the Japanese model to catch up. The model requires a high degree of social organization if it is to be successfully implemented. An educated workforce and high levels of spending on process technologies are both necessities if copied products are to be successfully exported. The products being copied have to be more cheaply made or have better performance characteristics than the originals. Not surprisingly, South Korea is the only country in the developing world whose R&D spending equals that of the world’s biggest spenders as a fraction of GDP and exceeds that of many of the much richer industrial countries.23 Global brand names have to be established. Establishing brand names is both difficult and expensive. South Korea makes the necessary investments.
Japan was lucky in that for a few decades after World War II copying was particularly easy. The U.S. government actively encouraged copying to create prosperous Cold War military allies. America even helped pay for foreign students to study at its leading technological universities. From the U.S. Cold War perspective, Japan needed American help so it could be a prosperous unsinkable aircraft carrier off the east coast of the Soviet Union. In the aftermath of the Korean War, South Korea was similarly seen as a country to be helped.
American business firms did not closely guard technology, since technology was not seen as central to economic success. Economic success flowed from the control of natural resources or from economies of scale. Those with well-situated iron and coal deposits dominated steel production. Those with economies of scale dominated auto production. Controlling the dissemination of technology was not central to maintaining a country’s or a company’s competitive advantage.
American arrogance also contributed to the ease of copying. America’s technological lead after World War II was so big that American companies saw themselves moving on to the next generation of technologies before those in the rest of the world had mastered America’s last generation of technologies. As a result, they did not worry about those who were trying to copy their current technologies.
Perhaps it is an exaggeration to say that the Japanese route of direct copying-to-catch-up is no longer open, but it is certainly a much harder route to follow than it used to be. Japanese and European success in the 1970s and 1980s erased American arrogance. Technology is much more guarded, since controlling the dissemination of technology is now seen as central to future success.
If one looks at more recent economic success stories—Singapore, Taiwan, Ireland, Malaysia, China, and Thailand—the copying-to-catch-up comes via a very different indirect route. Countries seek to attract global companies wishing to establish foreign production facilities to reduce their costs. In these offshore production facilities, global companies will employ their latest, or close to their latest, technologies. Local workers are taught the necessary production skills and, over slightly longer periods of time, local managers are trained to replace expatriate managers. Copying is the end result, but one is “taught” the latest technologies more than one “copies” the latest technologies.
Realistically, economic development today depends upon a country’s ability to attract foreign direct investment (FDI). Such investment is not important because it brings money. Any country can easily borrow money. Global companies possess markets, technology, and scarce management or engineering skills that developing countries must have if they are to participate in the global economy. Without FDI, markets are difficult to penetrate, new technologies are hard to acquire, and missing engineering or management skills are impossible to find. By themselves, developing countries cannot produce at the quality levels demanded in high value-added industries and cannot market what they produce even in low value-added industries such as textiles or shoes.
There is a close link between being able to attract FDI and being economically successful.24 It is no accident that China is the world’s largest recipient of FDI in the third world and the world’s most successful developing economy. It is likewise no accident that the United States is by far the largest recipient of FDI and the world’s most successful developed country. Without FDI the United States would have been a lot less successful than it is. In the twelve years from 1990 to 2002, the United States received $1.27 trillion in direct foreign investment—more than Japan, Germany, France, and the United Kingdom combined.25 German and Japanese auto plants have been central in maintaining the U.S. position in the auto industry. Some auto makers, like Honda, have almost become American companies. At every level of economic development there are new things to be learned, and the easiest way to learn them is to have an experienced teacher.
If one looks at FDI as a fraction of the country’s gross capital formation, the importance of FDI is clearly visible. In Ireland, the most successful country in Europe in the 1990s, FDI accounted for 88 percent of capital formation. Despite its huge size, FDI contributed 11 percent of total investment in China—as it does in Mexico. In contrast, FDI accounts for only 2 percent of gross capital formation in India.26 Very little of the world’s foreign direct investment goes to the world’s poorest countries because they do not have the characteristics business firms need.27 Africa gets almost none. When the required characteristics vanish, as they did in Indonesia, global corporations quickly move on to better locations. In Indonesia an inflow of more than $2 billion per year in foreign direct investment in the first half of the 1990s had become an outflow of almost $4 billion per year in 2000 and 2001.28
Attracting foreign direct investment has the advantage that it requires much less social organization than the direct copying approach. Local companies do not have to start by gaining the ability to compete against the world’s top producers. Countries do not have to find ways to acquire technologies from foreign owners who do not want to share those technologies. Instead, countries have to set out to make themselves into what the world’s global corporations see as desirable production bases.
When making their investment decisions, global corporations are looking for low cost production bases, but “low cost” is not a synonym for the world’s lowest wages. They want relatively low-waged but well-educated workers, engineers, and managers. Singapore spends more than anyone else in the world on education. Ireland offers a good education system and a plentiful supply of relatively cheap engineers. Taxes and market access play a role. Ireland offers a very low corporate tax rate and access to the European common market. Mexico offers access to the U.S. market. Companies considering investments want infrastructure, such as dependable electrical power and reliable transportation. Singapore claims to have the world’s best infrastructure. They want social order, including safety from criminal behavior and the control of corruption. Taiwan gives it to them.
It takes time and money to set up a subsidiary in a new country. Among developing countries, there typically is a 20 to 1 difference between the countries that take the most time and the least time for basic activities such as land acquisition and other entry requirements.29 Time is money. Monetary costs rise and production opportunities are lost if it takes a long time to get organized in a new country.30 How easily outsiders can deal with local bureaucracies explains many of the differences in foreign direct investment.
If the right conditions are in place, global corporations will transfer the specific production technologies and market linkages necessary to participate in the global economy to their local subsidiaries or to their local subcontractors. These subcontractors are usually local workers and managers who have previously worked for and been trained by global corporations and then encouraged by the same global corporations to set up their own companies to do contract manufacturing for the original equipment manufacturers (OEMs). The OEMs directly transfer to local companies the technologies necessary to make the components they wish to purchase from the local companies. Over time the components produced by the local companies become larger and larger portions of the total product being sold to the foreign company. Local companies move up the supply chain to become what are called tier one suppliers. As can be seen in the case of Taiwan, eventually these local companies are producing the entire product (laptops, scanners, etc.), and only the brand names of the OEMs remains.
Ultimately, local third world firms need to acquire direct foreign market access and their own brand names. In many ways market access seems to be harder to obtain than technology. In principle one of the new technologies, electronic retailing, should make it easier to acquire foreign markets. Potential exporters do not need to build up a brick-and-mortar infrastructure of retail stores. Before the Japanese downturn stalled the process, it looked like L.L.Bean would make catalogue and electronic retailing models work in Japan, but as yet no one has succeeded in using electronic retailing as a method for penetrating foreign markets. The real problem is not local distribution but brand name. Stores like Wal-Mart make it easy to distribute foreign products, but they do so under their own brand name in arrangements where Wal-Mart essentially gets all of the profits.
Within the developing world it is skilled workers who have the most to gain from globalization. As foreign investments flow into a country, average wages rise but skilled wages rise more than those of the unskilled. In both China and India the incomes of relatively skilled urbanites are rising rapidly vis-à-vis the stagnant incomes of their unskilled rural hinterlands.31 The net effect is higher but more unequal wages.
As they search for the cheapest places to make their products, firms move technology around the world. But technology can flow only to developing countries that have the human resources to absorb them. This is why China gets a lot of FDI and Africa gets almost none. The result is a harsh reality. Those who need technology the most get it the least.
This problem is only going to get worse. Of the 6 billion people on the planet, 1 billion are illiterate using the most basic definition (you can read and write your own name), 2 billion are illiterate on a slightly tougher definition (you can read and write a sentence about your own daily life), and probably more than half of the world is functionally illiterate (you can operate at a fourth grade level of performance).32 Half of Sub-Saharan Africans and 60 percent of the Indian subcontinent are illiterate on the second definition. Yet fifty years from now there will be little demand for illiterate workers in either the first or the third world. Robots to mow our lawns already exist, and robots to clean our houses will soon exist. As long as most of the workers in the world are unskilled, global inequality is going to rise.
In principle the shift from industrial economies to knowledge-based economies should make the catch-up process easier. There are places where the new technologies should be able to speed up the development process enormously. Normally, creating an educated workforce is a slow process since teachers are not available in the large numbers required for K–12 education and most of the existing workforce is too old for conventional education. If a workable system of electronic education could be developed to reduce the number of classroom teachers required in K–12 education and to reach the adult workforce, the upgrading of educational skills could occur at a much faster rate than has ever been possible in the past.
Industrial economies to a great degree depended upon having a lot of natural resources relative to population densities. It is not surprising that Asia lagged behind when this was the only reality. Economies poor in natural resources cannot become rich in natural resources, but economies poor in human resources (education and skills) can become rich in human resources. There are many examples of countries—Taiwan, Korea, and Singapore—doing just this. It is possible to leapfrog technologies and make it into the developed world. China, with one-quarter of all the people in the developing world, seems to be in the middle of such a leap.
If one looks at the statistics on national per capita incomes, an interesting pattern jumps out from the data. Some countries succeed, others fail, and a very few remain in between. The world’s richest countries have per capita GDPs approaching $40,000, and there are twenty-eight countries with 847 million people where per capita GDPs are between $15,000 and $40,000.* At the same time there are 169 countries with 5 billion people where per capita incomes are below $7,500. In between there are only eleven countries with 130 million people whose per capita incomes is between $7,500 and $15,000.33
Any normal distribution has many more countries in the middle than in either the upper or the lower tails. The sparsely populated middle-income group of countries is not hard to explain. If the basics of development are present, it is not difficult to stay in the first world. If the basics are present, countries catch up. Japan, Taiwan, South Korea, Singapore, Hong Kong, Ireland, and Finland have done it. China, Malaysia, and Thailand are doing it. If a country does not have the basics, it stays in the bottom group. Many don’t have the basics, and that is why the bottom group is so large. The few countries in the middle-income category all have the basics and are in the process of moving into the developed world. Being successful, they will soon leave this middle income classification. No country stays a middle income country very long. That is why the group is small.
In the end the world knows what to do when it comes to economic development. The doing is hard, but the “what to do” is both straightforward and well known.
Since China is the current great success story among developing countries, it is worth looking at the sources of its success. What should other developing countries and those interested in promoting economic development learn from its success? Unfortunately, China is more feared than emulated because it has the size to be everyone’s major competitor in the third world. Talk to business leaders or government officials in any developing country and the conversation quickly turns to worries about Chinese competition and stories about local industries that are moving to China. China is the “great sucking” sound. Scare headlines abound: “Asian Tigers Fear Last Supper Thanks to Ravenous China”34 and “Seoul Feels the March of Chinese Capitalism.”35
China does look formidable as a competitor. It is attracting most of the foreign direct investment that is going to the developing world. In 2003 it may attract more FDI than the United States. Because of its huge size China’s supply of low wage labor won’t quickly disappear, even if China grows very rapidly. Its supply of educated labor is large enough that with the injection of the technology, management, and markets that come with foreign direct investment, it can quickly make products now made in the developed world. As China’s growth speeds up, those who fear China see the rest of the developing world’s growth slowing down.
The fears and competitive threats are grossly exaggerated. The Chinese story must begin with both an injection of reality and the understanding that China’s economic success does not threaten the rest of the world. But when a country the size of China (20 percent of humanity) that had cut itself off from most of the rest of the world for thirty years suddenly decides to rejoin the global system, it does change the game—as we shall see later.
Some analysts see a military threat flowing from China’s economic success. China is already an important military power, perhaps number two in the world behind the United States and certainly number three behind the United States and Russia.36 China will be a great power politically and militarily in the 21st century. No one should doubt it. It is the dominant regional military power now if one leaves out the United States. Absolute size determines military power, and China is very large. But the growth of this threat is only very loosely connected to economic development. The problem is not China’s capabilities but its military intentions vis-à-vis its neighbors.
Economic power is a very different matter. It depends upon per capita GDP—not absolute GDP. Leading edge products are sold to leading edge consumers, and leading edge consumers have to be high income consumers. In 2000 China’s per capita GDP was $847 using exchange rates to convert yuan to dollars. America’s was $36,868. Economic change starts in America precisely because America has those high income consumers. China may become an important economic power in the future, but that future is distant.
To demonstrate this latter point to yourself, take out your hand calculator and key in both China’s per capita GDP and America’s per capita GDP. Then key in the speed at which you expect the United States to grow over the next century (in the last century per capita GDP grew at 2.1%) and the growth rate you expect from China over the next century. Remember that no country has ever averaged more than 3 percent per year per capita over a full century. Then calculate what China’s per capita GDP will be in the year 2100 relative to that of the United States.
Unless you key in something quite unlikely for China’s growth rate over the next century, you will find that in 2100 China will still have a per capita GDP far below that of the United States. Since China has more than four times as many people as the United States, its absolute GDP will probably be above that of the United States in 2100, but that fact is irrelevant. Per capita GDP is the name of the game. There may be a Chinese economic century, but if there is, it will be the 22nd and not the 21st century.
These calculations take nothing away from China’s current or future economic success. They are simply to say that economic success goes to the marathon runners, not to the sprinters, and that China has yet to prove that it is a marathon runner and not a sprinter. And even if it is a marathon runner, it has a marathon that it must run—and win.
It is also important to understand the strengths and weaknesses of China’s current position. China’s past growth rates are not as good as they look, current growth rates are not as high as announced, and future growth rates will not be as good as those in the past.
The Chinese economic miracle is found not in the booming cities everyone visits but in its countryside. In 1978 China began its reforms by abolishing the communes and giving every peasant family a piece of land. Technically, the peasants were given fifteen-year leases for annual crops and fifty-year leases for tree crops with the right to transfer (sell) land leases under the “family responsibility” system. But in reality every peasant knows that the land is permanently theirs and that the state isn’t going to get it back. Abolishing the communes improved the incentive structure and led to a big jump in agricultural output with no investments in irrigation, fertilizer, machinery, pesticides, or transportation. In just six years, from 1978 to 1984, China’s agricultural output rose by two-thirds.
The service of a porter carrying someone else’s bags at the airport was not a legitimate activity in the eyes of communism. Services were part of the old feudal and capitalist systems of exploitation. The linguistic roots of “services” after all are found in the Latin words for slaves and slavery. As a result, services weren’t valued under communism, weren’t counted as output in Communistic statistics, and were grossly underprovided. Count what was always there, let the private sector provide the services communism would not let them provide, and there will be a one-time boom in service production with almost no required investment.
Communism made massive investments that did not pay off because of poor incentive systems. A hotel building that long existed can, if given good management and good service, easily become a real productive hotel. Correct communism’s industrial inefficiencies with better incentive systems, and the investments of the past can often be made to pay big returns with very little new investment. The effect is a little like repairing the bridges across the Rhine River after the World War II. A single bridge repair allows a lot of previously existing investment to go back into production. But this is a one-time, unrepeatable, leap in output. Eventually the amount of investment necessary to support any particular growth rate soars.
Count what was happening in services, add to it what was happening in agriculture, improve incentives in existing industries, and China’s reported double-digit growth rates in the 1980s become eminently believable—but not repeatable.
But in China’s economic statistics they were repeated. Published annual growth rates of 9.7 percent grossly exaggerate Chinese success in the decade of the 1990s. A detailed investigation of Chinese statistics and correlations with variables that are closely related to GDP growth, like electricity consumption, point to a growth rate of 4 to 5 percent.37 This is a great result for a big country, but it also has the advantage of being a believable result.
If China can sustain something close to a 5 percent growth rate combined with a 1 percent growth in population for a century, it will come to hold the record for the highest long-term growth rate in per capita income in human history—4 percent. Japan, the previous record holder, managed to grow its per capita income at only 3 percent over the course of its first century of industrial development.
The exaggerated numbers for the 1990s do not mean that anyone in Beijing is deliberately inflating the data. Local officials in China get bonuses and promotions depending upon the growth rate of their regions. Those same local officials are in charge of calculating and reporting local economic statistics. Local officials write down the numbers they think their bosses in the central government want to hear. Who wants to be the first to send in negative data? You’d have to be a saint not to exaggerate your own success, and local Chinese officials are not saints.
Periodically, Beijing punishes some local official for exaggerating his area’s economic performance just to keep the whole system quasi-honest. In 2001 there were 60,000 admitted violations of reporting procedures, and the head of central statistics admitted that every province but one reported growth rates of more than 8.5 percent in 2001 and that he marked the average down to 7.3 percent—but on what basis was not reported.38
Parts of the Chinese economy are clearly booming and other parts are just as clearly stagnating.
No one denies that its export production economy is booming or that China’s large coastal cities are doing very well. Exports from China to the United States have grown at 82 percent over the course of the last five years, and one can visibly see the boom in the coastal cities.39 What is less visible is what is happening in the countryside, where most Chinese still live. With 73 percent of Chinese employment in agriculture and 80 percent living in the countryside, it is difficult to have a rapid national rate of growth unless agriculture is advancing rapidly. Yet in the last decade, by the admission of Beijing, agricultural output has stagnated. With incomes not growing for 80 percent of the population, mathematically a national growth rate of 10 percent requires the incomes of the remaining 20 percent to grow at 50 percent per year. It is not possible.
Even a 5 percent growth rate will be difficult to match in the years ahead. China has some big economic problems looming ahead.
Communism invested in a lot of projects that are simply making things that people don’t want at costs that would dictate losses in a capitalistic society. Many of these factories are losing massive amounts of money and can survive only with public subsidies. These plants have no long-term future. State industries own 63 percent of China’s industrial assets, produce 70 percent of industrial sales, employ 40 percent of the urban workforce, and most important, pay 74 percent of its taxes.40 At least one-third of these state industries will eventually have to be shut down. When these big state-owned enterprises (SOEs) are shut down, they will become a subtraction from the statistics of economic growth.
The potential shutdowns are not limited to the firms that now officially lose money. Under communism many things (transportation, raw materials, energy) were free or heavily subsidized by the state. When China completes its movement to the market, many of the inputs industries buy will rise dramatically in price and what now look like profitable firms will quickly become unprofitable ones that must be shut down.
The nonviable state-owned firms continue to exist courtesy of subsidies that come via the banking system. Banks are forced to make huge loans to money-losing large state industries to stop urban unemployment from soaring. On the day they are made, the loans are known to be bad loans that will not be repaid. As a result, China’s banking problems with the SOEs are sometimes described as a big Enron waiting to happen. The banking system will implode because of bad loans that aren’t repaid. Depositors will lose their money.
It won’t happen. The depositors can easily be repaid. The government simply provides the banks with the cash to repay the depositors. Since the government prints money, there is no shortage of cash. Since the local banks in China are all government banks, there are no private shareholders to be wiped out. The real problem is finding alternative work for the hundreds of millions of urban people employed in the SOEs. Twenty-seven million people were laid off from these firms between 1998 and 2002, but tens of millions more will need to be laid off.41 The problems with SOEs are economic and social, not financial.
For those firms that can be made viable, the necessary restructuring costs will be huge. The investment funds to maintain current levels of output for these viable SOEs will have to come from somewhere else, and growth will slow down in the areas where investments are reduced.
Initially, growth could be allowed to occur along the coast, where little infrastructure was needed, especially along that part of the coast that could use the infrastructure of Hong Kong. But China is a big continental country where large investments in infrastructure will have to be made if incomes are not to stagnate in the interior of the country. Because of its history, China has less infrastructure (communications, transportation, and electrification) than have even smaller, poorer countries such as India. China is three times as large as India yet has 20 percent fewer miles of railways. In India the British army built railroads in the 19th century so that it could efficiently garrison the country. China had the disadvantage of being a quasi-colony, where none of the colonizing countries—among them Britain, France, Russia, Germany, and Japan—took responsibility for building its national infrastructure.
In addition, because of Chairman Mao’s experience in fighting the Japanese during World War II, he believed in regional self-sufficiency and did not build the transportation infrastructure that was built in other Communist countries such as the Soviet Union. China’s regions were to be self-sufficient, so that no country could conquer China militarily. Using resources from these self-sufficient regions, the Chinese army would simply retreat until the invader did not have enough soldiers to occupy the country.
Infrastructure problems are made worse by what can be described only as regional economic warlords. Regional officials attempt to monopolize economic growth for their areas by being unwilling to spend their money on cooperative regional infrastructure projects that would in the long run lower the costs for everyone. Although China needs more ports and airports, it already has ports and airports that are grossly underutilized because they were built in the wrong places. The four new airports in southern China near Hong Kong are the best example of this. Building just one airport with high-speed rail connections to the major towns in the area would have been cheaper and would have provided an area-wide transportation grid. But it did not happen. What is going to emerge is a lot of debt and a lot of unused capacity located at the wrong places. China cannot afford to spend money on duplicative facilities or poorly located facilities.
China is also wasting a lot of money by not using the money flowing from its foreign trade surpluses for something more important than foreign exchange reserves. In the last decade China has consistently run big trade surpluses and had accumulated $331 billion in foreign exchange reserves in early 2003 (Hong Kong has an additional $114 billion).42 China is too poor to run such trade surpluses. It does not need anything like that sum of money squirreled away to run its international economic affairs. Fifty billion dollars in reserves would be more than enough to support China’s international trade. When China runs a big trade surplus, poor Chinese are essentially making loans to rich Americans. It does not make economic sense.43
Instead of being accumulated in foreign exchange reserves, the money should have been invested in projects that would have employed millions of people doing useful things. Fifteen million people are unemployed in urban areas of China, and no one knows how many people are unemployed or underemployed in rural areas.44 Some estimates place the number in excess of 100 million people.
Large investments need to be made in both infrastructure and plants and equipment to close the large income gaps now emerging right across China. Within the eastern cities, incomes are growing four times as fast at the top as at the bottom.45 At the start of its market reforms, China had a 4 to 1 gap between the top and bottom quintiles of its population. That gap is now 13 to 1.46 Much of it is a rural-urban gap. Rural incomes are stagnant, falling from a peak of 58 percent to 38 percent of urban incomes. There is a 14 to 1 gap between China’s richest province and its poorest province.
Funds are needed to roll the boom out of the eastern cities into the countryside, where 80 percent of the people live. Massive investments in fertilizers, pesticides, machinery, transportation, communications, and electrification will have to be made to raise rural productivity and incomes if the Chinese who live in rural areas are not to move to urban areas (as many as 50 million may already have moved). Funds are needed to roll the boom off the east coast into the center and west of the country.
Looking forward, we can foresee that even if China uses the money now in its foreign exchange reserves efficiently, it will need to take some of the investment funds that are now going into light manufacturing or services with rapid payoffs and use them to make long-term investments in infrastructure and agriculture. When that happens, growth slows down. Since infrastructure requires large capital investments per dollar of output, the shift to infrastructure investment raises China’s capital-output ratio. For any given investment level, it gets less growth in output.
For all of these reasons, China’s growth rate will be lower in the future than it has been in the past.
Outsiders should view the Chinese economy as three different economies.
(1) There is the supply chain economy where components are manufactured to be assembled into products ultimately sold in the wealthy industrial world. This is a very profitable economy, since Chinese wages are very low given its exchange rate and its internal costs of living.
(2) There is a second economy where capital equipment is sold to the Chinese. Here the initial sales are profitable, but further sales depend upon whether the sellers can protect their intellectual property rights. Equipment sold has a way of being copied by local suppliers, who both take over the local market and become an export competitor for the initial seller. Those who sell and wish to continue selling must hold something back that the Chinese cannot duplicate.
This local competition does not arise by accident. Foreigners are forced to operate in China using joint ventures. Joint ventures are part of a Chinese strategy for getting technological spillovers so they can eventually learn how to make by themselves the products they start off making with their joint venture partners.
These joint ventures produce a major set of problems for the foreign partners. How do they make joint ventures with Chinese firms work when joint ventures generally don’t work even when they are between American firms where cultural differences are small? Western joint ventures quickly end in one of three ways: One firm buys out the other firm. One firm becomes a silent financial partner with all of the management being done by only one of the original partners. Or the two firms are at war with each other and in that war destroy their joint venture. Every firm entering the Chinese market should have an exit (prenuptial) agreement with their Chinese partners. Few do.
(3) In the third Chinese economy, foreign firms sell directly to Chinese customers. This economy is mostly a mirage. Foreign firms see a huge market, but when they get to China the market isn’t there or it doesn’t last for very long. Products made in the first world are too expensive for Chinese incomes, and local firms have a way of edging aside foreign firms who attempt to produce in China. Few foreign firms make money selling products to the Chinese consumer.
China’s advantages are many. Communism and a Confucian culture have reinforced each other’s interest in education. Illiterate parents want their children to be educated. Relative to other big developing countries such as India, Indonesia, or Brazil, China is both better educated and more broadly educated. Teaching modern production skills to those with a good basic education is simply much easier than teaching the illiterate.
Management functions are very different under communism and capitalism. Under communism managers are essentially quasi-militaristic economic officers. There is a central economic plan, the battle plan, established in Moscow or Beijing. Managers are told what to make and are sent the necessary materials, components, people, and money for wages. They are notified as to when a flatcar will arrive to take what they have produced to some unknown location. They will be punished (court-martialed) if their required production is not ready. Communist managers never buy anything, never sell anything, never negotiate with anyone, never study market information, never worry about profits and losses, and never talk to a customer. They are colonels in an economic army doing what their general staff tells them to do. Business requires a completely different mentality.
In China this problem was solved by the overseas Chinese. They knew how to play the capitalistic game because they were raised in capitalistic societies. They replaced the old economic colonels of communism and headquarter functions could be performed in Hong Kong. These overseas Chinese, from Hong Kong, Taiwan, the United States, Southeast Asia, and Singapore, brought with them money and technology, but of more value, what they really brought was the knowledge and contacts necessary to play the capitalistic game. They were important to China’s economic success. They were part of its social capital.
China’s entry into the World Trade Organization has been widely discussed inside and outside of China. An important psychological event, it signaled to everyone inside and outside of China that the leaders in Beijing want to play the global capitalistic game. But by itself joining the WTO was not an important economic event. China’s entrance into the WTO should be seen as an instrument the leaders in Beijing could use to persuade middle and lower levels of the bureaucracy to continue reforming China’s economic institutions. Reforms could be defended as necessary to ful-fill WTO requirements (blame the foreigners) when, in fact, the leaders in Beijing see them as necessary to keep economic progress going. If the Chinese leadership did not believe that these reforms were necessary for their own future success, they would not have joined the WTO. China was doing very nicely outside of the WTO.
In the future, if China’s leaders don’t believe that WTO requirements are in their long-run self-interest, they just won’t conform to these requirements—just as Europe does not conform to the requirements on hormones in meat and the United States does not follow the rules when it comes to offshore tax advantages for its companies. The Chinese know they will not be kicked out of the WTO. Fines are small, just a few billion dollars, for not following the rules, and one can always find clever ways around the rules without violating the rules. Korea gave tax audits to those buying Ford Taurus cars when Korea thought too many imported Fords were being sold. Nothing in the WTO rules says anything about who can be given a tax audit.
China had a brilliant economic development strategy and executed it well. China initially limited its experiments with free markets to special economic zones rather than trying to implement market reforms in some economic big bang that would cover the entire country. As the special economic zones expanded, the geographic scope of the market expanded. The privatization of agriculture led to the privatization of services, which led to the privatization of small-scale retailing, which led to the privatization of small-scale manufacturing. The export sector was freed before the import sector. The Chinese strategy was to move forward gradually with success feeding upon success.
Step back and think about the previously discussed mechanics of development. How do they fit the Chinese case? China understands that the economic catch-up process is a long-term process. When it comes to social capital and social capabilities, China has both. The role of the overseas Chinese in China’s economic development is what is meant by social capital. China has an effective government that can design strategies and can, once those strategies have been agreed upon, make and enforce decisions. It has a consistent long-run strategy that has been well executed over the last few decades. It has demonstrated its organizational abilities in setting up and expanding the special economic zones. The rural communes have been abolished and the state-owned enterprises are being privatized. Individual incentive systems are in place. China is investing vast sums in infrastructure—the big dam on the Yangtze River is only the most visible project.
China’s population growth rate is under control, growing at about 1 percent per year. China’s government has mobilized the factor in scarce supply, capital, and has created a poor society with a 30 percent savings rate. Although education and health standards are far better in urban than rural areas, relative to other large developing countries China has good education and health care systems. Ensuring better rural education is probably the country’s biggest need, but it is not its biggest priority.
Women are fully utilized. They are educated and hold important positions in the economy and in the government.
Terrorism isn’t a threat. Foreign business people have physical safety. They don’t get kidnapped or murdered on a regular basis. There is corruption, but China’s leaders know they have a problem and are working to control it.
The government knows it must sell China as a good place to do business. It goes after foreign direct investment.47 Among emerging countries it gets three times as much as the next biggest recipient, Brazil, and thirty times as much as India.* By insisting on joint ventures, local firms have a better chance of learning from the outsiders.
When it comes to fitting the profile of what is necessary to develop, China fits. Because it fits, it succeeds. Successful economic development is not mysterious. What has to be done is clear. Successful working models exist.
If China is a 10 when it comes to the beauty of its economic development, Sub-Saharan Africa is a minus 1. Output is up but population growth is even higher and, as a result, real per capita GDP is falling and below where it was in the mid-1960s. The denominator of the equation is simply growing much faster than the numerator. In Africa nine out of ten people live on less than $2 per day, and in the Congo more than nine out of ten live on less than $1 per day.48 Of those in the world living under $1 per day, 66 percent live in Africa.
It wasn’t always thus. When Africa received its postcolonial independence in the mid-1960s, it was substantially wealthier per capita than Asia. Today it is poorer. In the last thirty years Africa’s percentage of the world’s very poor has gone up from 11 percent to 66 percent, whereas in Asia the fraction has gone down from 76 percent to 15 percent.49
Africa is a continent geographically located in the wrong place where everything that could go wrong has gone wrong.
Physically Africa is a block continent with the world’s shortest coastline relative to its area, yet economic development is a coastal phenomenon. Almost 70 percent of the world GDP is produced within 100 km of the seashore. Africa has few natural harbors. Since Africa is a large plateau with most rivers falling over escarpments in falls or rapids near the shore; rivers are navigable for only short distances. The Nile is the only exception.
Except for a few miles extending inland along the Mediterranean and Nile River, North Africa is a harsh desert.50 South of the northern deserts Africa is almost all tropical. Except for the city-states of Hong Kong and Singapore, there are no examples of successful economies anywhere in the tropics. In countries such as Brazil that have both tropical and temperate zones, the temperate zones are much richer.
There are real physical reasons why tropical development is difficult. To get economic development started, food surpluses must be generated in rural areas and used to feed city populations. Technology advances occur in urban cultures. But productivity is very low in tropical agriculture. Lacking the necessary rural food surpluses, cities developed much later in tropical Africa than elsewhere.
The problems in generating rural food surpluses start with plant and animal pests. Winter is the great executioner, and when it is absent, controlling these plant and animal pests is almost impossible. No one anywhere has succeeded. Agricultural problems continue with heavy seasonal rains that leech the soil and make it unproductive. The soil ends up containing little organic matter. The rainy season is followed by a season of extreme drought. Soil becomes hard and difficult to cultivate. The extent of animal life depends on how many animals can be supported in these dry months. Historically, nomadic cultivation was the only way to keep animals alive during the dry season. No one could stay in a fixed location.
Diseases like trypanosomiasis carried by the tsetse fly meant that horses and oxen could not be used to pull plows. Human power could not be augmented by animal power in Africa. Porters and human power had to be used for commercial travel, and this is the most costly and least efficient of all transportation systems. The trading patterns that developed before industrialization elsewhere never developed in Africa where there was very little trade except for slavery. Slaves could travel on their own legs.
Human diseases are similarly hard to control. A large number of diseases either don’t exist elsewhere or are much easier to control elsewhere. River blindness and malaria are just two of many examples.
Much later the green revolution that worked agricultural miracles in temperate countries such as China and India failed in the tropics. It, too, was defeated by the soils, rainfall, pests, and diseases of Africa.
Colonial borders were set where the British and French armies met in the 19th century. There was nothing sensible about them, neither language, nor ethnic groups, nor geographic conditions, but they could not be changed politically after independence. No one felt attached to “their” country. The local governments that followed the colonial governments were disasters everywhere. Political systems became ethnic jousts between different competing groups rather than social systems for advancing the interest of everyone.
At the bottom of the hierarchy civil servants, such as the police, receive salaries so low that they have to collect bribes to survive. Systems of law and order first became corrupt and then broke down entirely as they lost legitimacy. Why should anyone support a government that cannot deliver the most basic of public services—personal safety?
Countries where there are small educated elites—as was true under British and French systems of colonialism—easily fall prey to bad government and corruption. Small in-groups end up running the country. The in-group sees and wants the standards of living that exist in the developed world. In a poor country this requires exploitation. The sight of these in-group leaders promising to do better in exchange for more foreign aid at the G-7 summit in Canada in 2002 would have been laughable were it not so sad.
The mechanics of development, the criteria that China meets, Africa fails to meet. It does not have social capital, social capabilities, or leaders who have long-run consistent economic strategies. Population growth rates are high, personal safety is low, and the infrastructure inherited from colonialism is melting away. Savings are low, education is limited, and women are not fully utilized. Chaos destroys personal incentives to invest in one’s self or one’s business. Africa attracts little foreign direct investment except for its extractive industries. American firms put two-thirds of their African investments in mining. Instead of selling themselves to potential investors, countries do everything possible to repel them. Outsiders see Zimbabwe’s treatment of its white farmers, for example, and stay away.
It is not hard to say what Africa should do. Reverse all of the above. It needs to start by educating its citizens and controlling its population growth rates. Only one-third of the children that should be in school are in school. Africa has to make itself attractive to foreign direct investment. To the extent that borders are in the wrong places, it either has to move the borders or teach different ethnic groups to live with each other. Corruption must be reduced and personal safety restored.
In a word, Africa must change its political and social culture. Easy to say, but how is it to be done? Where are the starting points and the points of leverage that allow it to be done? No one knows.
On average the third world is catching up with the first world. But this reality is the product of two conflicting trends. China is closing the gap with the first world economically while other smaller areas such as Sub-Saharan Africa are falling behind. When it comes to economic development the global issue is being left out, not crushed, by globalization. This reality can be seen in a China that participates in globalization and a Sub-Saharan Africa that does not.
As China and Sub-Saharan Africa illustrate, the mechanics of development are known. Countries just have to be able to execute. Most simply put, countries have to make themselves attractive to foreign direct investment. If they are attractive, they will be taught the technologies they need to advance. If they are attractive for foreign direct investment, they will also be good places for local entrepreneurs to do business.
*Just to reference these numbers, the World Bank thinks that a GDP of $5,000 per capita is necessary for a country to provide its citizens with the basics—food, shelter, education, health care. Above this level countries are buying luxuries, not necessities.
*Some fraction of what is measured as FDI in China is clearly local Chinese money that goes abroad and then comes back as FDI because FDI gets more favorable treatment from government at all levels and is under less pressure from corruption than is local investment.