2004-2005 Essay Contest

Second Place Essay - Advanced Economics

Securing Investment: The Key to Economic Growth

Carl Forsberg
Saint Thomas Academy
Mendota Heights, Minnesota


Every society across the globe shares the common resource of the entrepreneur. From the twelve-year-old lemonade stand owner in suburban America to the research team in India, from the auto plant start-up in Romania to the Hong-Kong rickshaw carrier to the commercial farmer in Zimbabwe, individuals with the will and daring to start new businesses are present in every nation. Entrepreneurs drive growth, utilizing resources to "create jobs, provide the goods and services needed to improve living standards, and contribute taxes necessary for public investment."1 Even when they have few natural resources, as in the cases of 17th century Holland and 19th century Japan, nations with a newfound entrepreneurial spirit have seen huge strides in wealth and prosperity. If every nation has its natural entrepreneurs, though, why have some nations seen periods of economic growth while others have lapsed into poverty?

The World Bank answers this question by identifying the importance of "investment climate."2 As important as the entrepreneur is for creating the factories, revenue, and jobs necessary for growth, entrepreneurship cannot flourish if it is not supported by capital investment. The entrepreneur's initiative and the investor's funding form the engine of growth in market economies, directing resources towards innovation and capital investment. As Douglas North puts it, these factors are "not merely the causes of growth; they are growth."3 Capital investment, though, is not universal. Since investors rationally evaluate profit potential, an insecure investment climate discourages them from investing their capital.4

Adam Smith, in The Wealth of Nations, identified the major factors limiting a nation's transfer of capital: "Commerce and manufacturing can seldom flourish long in any state which does not enjoy a regular administration of justice, in which the people do not feel themselves secure in the possession of their property, in which faith of contracts is not supported by law."5

Property rights are essential for investment. Without security of private property, wrote Jean-Baptist Say, "it is impossible to conceive any considerable development of the productive power of man, or land, and of capital; or even to conceive the existence of capital at all."6 Property rights boost investor confidence and allow long-term planning of resource allocation. The World Bank confirms this, reporting that firms in the former Soviet Union which "believe their property rights are secure reinvest between 14 and 40% more of their profits in their business than those that don't," and that "farmers in Thailand with more secure rights invested so much more in their land that their output was 14-25% higher."7 China offers a prime example of the importance of property rights. China's rapid economic growth was accompanied by a "two-decade long journey of phenomenal lawmaking and institution building" in which "private ownership has been formally elevated in China."8 In 2004, the Chinese government formalized this process as it made protection of property a constitutional right. National Peoples Congress Deputy Zong Qingou expressed Chinese optimism for the constitutional change as he promised that the new rights would "prompt people to make more fortunes in the future."9

It is not only large corporations that are affected by property rights. Hernando de Soto argues that Say's statement rings most true for the poor, whose investment is often stifled by lack of recognized property ownership.10 De Soto points out that the poor throughout the world have de facto access to considerable property, but inadequate ownership rights and arbitrary seizure mean that these resources "cannot readily be turned into capital."11 Lack of property rights thus denies a potential source of capital equal to "forty times all foreign aid received since 1945."12 Drawing on a vast store of econometric data, Bernard Heitger concludes that property rights are so essential that they should be classified "among the ultimate sources of economic growth."13

Since the fall of the Soviet Union, Russia has seen one of the most dramatic expansions of property rights in modern history. Despite this, the Russian economy has struggled to realize the rapid growth predicted with the introduction of capitalism. Radygin and Entov identify an ineffective judicial system and poor enforcement as the primary barriers to rapid economic growth in Russia. Without a strong rule of law in Russia, they write, "all other efforts to protect property rights will be wasted."14 Developing countries often share Russia's predicament—they legally recognize property rights but are unable to secure them because of ineffective administration of justice. Ineffective contract enforcement is one example of how poor rule of law discourages investors and entrepreneurs in developing nations. For example, the time required to enforce a contract, while only 48 days in the Netherlands, averages 1,459 days in Guatemala, and in the Congo contract enforcement costs 250% of the contract's value.15

Ineffective rule of law not only discourages investment, but can cause a much more blatant and outright decrease in productivity by distorting market equilibrium. In Tanzania, crime, corruption, and contract enforcement cost firms up to 25% of total sales,16 and in Milosevic's Serbia, bribes alone are estimated to have cost 35% of all working hours.17 Reducing corruption, points out Jeffrey Sachs, can facilitate another type of investment, as it "allow[s] government to focus on the real public goods—internal political order, the judicial system, basic public health and education, and monetary stability."18

The forces of the emerging global economy offer a golden opportunity for economic development in impoverished nations. The investment flow from wealthier nations to developing nations is increasing,19 offering entrepreneurs new capital resources. Globalization has already allowed the dissemination of the information and innovations that allow capital investment to translate into greater productivity. As pointed out in Barriers to Riches, "Poor countries do not need to create new ideas in order to increase their standard of living. They need only apply existing ideas to the production of goods and services."20 The resources needed for development, including the ever valuable entrepreneur, are available throughout even the poorest of nations. The key for these nations is to create an environment in which these resources can be effectively utilized. Firm property rights and an effective judicial system can unleash the economic growth that raises poor nations from poverty to prosperity.

Endnotes

1/ World Bank, Interview with Chief Economist Francois Bourguignon, World Bank Group. November 2003, 13 March 2005.

2/ International Bank for Reconstruction and Development/World Bank, World Development Report 2005: A Better Investment Climate for Everyone (New York, Oxford University Press, 2004) 1.

3/ North, D.C., and Thomas, R.P., The Rise of the Western World: A New Economic History (London: Cambridge University Press, 1973) 2.

4/ Heitger, Bernard, "Property Rights and the Wealth of Nations: A Cross-County Study." Kiel Institute for World Economics, Working Paper 1163 (2003) 395.

5/ Smith, A. An Inquiry into the Nature and Causes of the Wealth of Nation. Ed. E. Cannan (Chicago: University of Chicago Press, 1776, 1976) 445.

6/ Say, J.B., A Treatise on Political Economy. 6th edition (Philadelphia: Grig and Elliott, 1803, 1934) 135.

7/ Doing Business. World Bank Database, 12 March 2005.

8/ Huang, Frank, "The Path to Clarity: Development of Property Rights in China." Columbia Journal of Asian Law (2004) 2.

9/ Cody, Edward, "China Codifies Property Rights; Historic Guarantees Underscores Move Away from Doctrinaire Communism." Washington Post, March 15, 2004, A14

10/ Coy, Peter, "Why the World's Poor Stay That Way." Businessweek, Nov. 13, 2000. (Book review/synopsis: The Mystery of Capital)

11/ De Soto, Hernando, The Mystery of Capital (New York, Basic Books, 2000) 5.

12/ De Soto, 5.

13/ Heitger, 399-400.

14/ Ratygin, Alexandr and Entov, Revold, "Enforcement of Property Rights and Contractual Obligations." Voprosy Economiki (2003) 1.

15/ Doing Business. World Bank Database.

16/ Doing Business, World Bank Database.

17/ Fantaye, Dawit, "Fighting Corruption and Embezzlement in Third World Countries." Journal of Criminal Law 68.2 (2004)172.

18/ Sachs, Jeffrey, "It Can Be Done." The Economist,
339.7972 (1996)19.

19/ International Bank for Reconstruction and Development/
World Bank, 5.

20/ Prescott, Edward and Parente, Stephen, Barriers to Riches (Cambridge: MIT Press, 2002) 32.

Top of document

 
Latest

Narayana Kocherlakota

Related Links
Federal Reserve Consumer Help