Imagine living on a dollar a day. According to the World Bank, more than one fifth of all the world's population does just that, and half live on less than $2. Per capita income in the highest-income countries is more than 60 times the per capita income of the lowest income countries.
But why are the United States and other developed nations so wealthy while many other nations are destitute? This is among the oldest and most central questions of economics. Adam Smith, who many consider the father of economics, titled his most famous book "An Inquiry into the Nature and Causes of the Wealth of Nations."
There are many perspectives on this issue and trying to come up with a quick answer is daunting. Nonetheless, it is one of the most important issues facing humanity. The question is central to determining the quality of life for current and future generations, and in some cases it can be a matter of life or death. It is for these reasons that the Federal Reserve Bank of Minneapolis has chosen to ask the following question for its 2004-2005 student essay contest:
In approaching this question, it will be helpful to use economic concepts. Essays will be judged in part by how well they adhere to the economic concepts listed in Economic Principles to Keep in Mind. These reflect some of the general points on which practically all economists agree.
While economists agree on these points, they approach the issue of the wealth of nations in different ways. For example, Robert Solow and others focus on technology as the key factor in economic growth and may consider most of the differences in national incomes to be accounted for by differences in productivity. Economists like Jeffrey Sachs and Paul Krugman, however, may focus more on geography and trade in accounting for these differences.
These differing perspectives are not in necessarily opposition, as academics tend to specialize in narrow fields so they can better understand the issues at hand. Economists studying this issue focus on different aspects. These different approaches can be complementary and should be understood together. The rest of this primer introduces four perspectives and the ways in which they can help explain why some nations are wealthier than others.
One important factor contributing to the material wealth of a society is its productivity. Imagine two nations that were exactly identical in every respect—resources, population, culture, etc—except that one society had higher productivity. We would expect the more productive society to produce a greater output of goods. Productivity is not an aggregate number (like output), but a rate (like output per capita). Higher productivity means more can be produced for a given amount of people, raising the wealth of a typical person. For most of human history, productivity has changed very little. While history has seen important advances like the compass and the printing press, it wasn't until the industrial revolution, beginning in the late 1700s, that productivity really began to grow.
The source of productivity is technology. Advances in technology, like automation or telecommunications, make it possible to produce more with less. However, some elements in society resist adopting new technologies. Examples span from management at large companies that want to prevent competition, to labor unions that fear losing members to automation, to nations that prevent the spread of modern farming practices because they fear a threat to traditional culture. In these cases, groups can use their power to impede change. Doing so may be good for those groups in the short-run, but it can harm the long-run well-being of the society. We expect societies that are less resistant to change to end up being more productive, and therefore wealthier.
Technology is as much about the way tools are used as it is about the tools themselves. The way we use tools is a consequence of our institutions, which effect how we organize our activity. The earliest advances of the industrial revolution were specialization and the division of labor. These developments are not mechanical, but organizational. Institutions—businesses, governments and other organizations—are another important factor in explaining why some nations are richer than others.
Governments play many roles in ensuring economic growth, the most prominent of which is protecting property rights. Political stability is also important for a healthy economy; crime, poverty, income disparity and armed conflicts can be both a cause and result of poor economic growth. Governments can help mitigate these problems. Government can also play a role in the economy by correcting for market failures: dealing with unwanted side effects of economic activity like pollution, and providing important public services like roads and other infrastructure. Countries that support research and development, education and scientific research are likely to improve their supply of technology.
There are many opinions an how large and what kind of a role government should play in an economy. What is uncontroversial is that government has the ability to help society by addressing market failures and by providing essential services that facilitate economic activity, but governments that are corrupt or overly bureaucratic often end up impoverishing their citizens. Beyond government and business, there are other institutions that shape economies. These include labor unions, civic organizations and schools. At an even more abstract level are what economist Kenneth Arrow called the "invisible institutions" of morals, customs and social norms.
Even a nation that is open to trade and technological change, one that has strong institutions and growth-friendly policies, might have a hard time reaching the standard of living of wealthier nations, because not all nations are created equal in terms of geography and natural resources.
Consider the world's wealthiest country, the United States. There are many historical and social factors leading to this success, but the U.S. also has two large coastlines, thousands of miles of navigable rivers, millions of acres of fertile soil and huge deposits of minerals and other natural resources. All of these factors increased the potential for the U.S. to become the economic powerhouse it is today.
As importantly, the U.S. and Europe have temperate climates. Tropical countries must deal with diseases that flourish in their climates, soil and ecosystems that are less ideal for agriculture, and other problems like extreme heat and long rainy seasons. However, this point is tempered by the success of a number of nations with warmer climates, particularly those in Southeast Asia. Since there are other factors to growth, a country's fate is not sealed by its geography. This is a reminder that differing perspectives should be considered together.
Although freedom is an abstract concept that can be difficult to measure, it is hardly worth disputing that historically freer nations have also developed into wealthier nations. The "freedom" to which economists often refer is free enterprise. Freedom also refers to the many political and civil liberties that are central in modern democracies, and these too have economic benefits. A free press, for example, helps spread information vital to economic decision making, and makes government activity transparent.
Freedom can also be defined in terms of capabilities. A person may have freedom to pursue the creative end in which they are most interested or to which they are best suited. In this sense, public policy can enhance freedom through education, literacy campaigns, public health and poverty reduction programs. By promoting the capabilities of individuals, society as a whole can benefit from what that individual then produces.
This introduction has discussed a number of factors that influence economic growth. Now it is your turn to use resources available on the Internet, in libraries and your school and community to research and write this year's essay. Remember to consider the various elements that influence growth, and how they work together, or don't work at all, to determine whether a nation will be prosperous or impoverished. Don't forget, your essay will be judged partly by how well you apply economic concepts described in Economic Principles to Keep in Mind. You can join the ranks of economists around the world and throughout history who have spent centuries trying to answer the question: Why are some countries rich and some countries poor?