How To Achieve Growth and Prosperity

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For my Principles of Macroeconomic students, they are currently learning how living standards vary across the globe in the Production and Growth chapter of Mankiw’s Principles of Economics.  While the U.S. and Canada enjoy “rich” country status with GDP Purchasing Power Parity (PPP) per capita figures of 48,387 and 40,541, respectively, there are other countries, such as Ukraine and Indonesia, whose GDP (PPP) per capita figures are fractions of that at 7,233 and 4,666.

That might lead to this question:  What is GDP (PPP) per capita?  This measures living standards and is a proxy on how much each individual contributes to their economy.  Global comparisons are difficult to make because currency valuations differ.  For instance, a Zimbabwean could make 1 million Zimbabwe dollars, while a German makes twenty thousand Euros.  One would assume that the Zimbabwean is better off, but that is far from the case because Zimbabwe has a very weak currency relative to the Euro.  In fact, 1 million Zimbawean dollars would only be approximately 2,122 Euros.

Therefore, purchasing power parity is used to take out the bias of currency exchange rates and allows for more accurate global comparisons.  Referring back to the U.S. and Ukraine, we can make a rough estimate that the typical American contributes $48,387 to economic output, which is must higher than the typical Ukrainian, who only produces $7,233 to their economy.

What accounts for these vast differences?  One can point to these four factors to explain the wealth differences across the globe:  physical capital per worker, human capital per worker, natural resources per worker, and technological knowledge.  Typically, countries, who score high in economic freedom, also rate high in most if not all of those four factors.

In particular, a country’s score in the following four areas from the Index of Economic Freedom are drivers to high U.S. productivity and prosperity:  Rule of Law, Limited Government, Regulatory Efficiency, and Open Markets.

When comparing and contrasting countries across the world, there is a distinct relationship between economically free countries than those that are repressed.  That is because economically free countries respect private property rights, which encourages individuals to take more risk and build wealth.  In repressed economies, most decisions on producing goods and services are determined by state government officials, who lack the dynamism and expertise to adjust sufficiently to rapidly changing market forces.  Also, state-run economies have less competition and result in more corruption that erode wealth accumulation.

Though it should be pointed out that the U.S. ranking in economic freedom has declined over time as rising budget deficits and an expanding role for government to deal with the financial market crisis and rising health costs have taken its toll.  We still rank in the top 10 and are only behind Canada among advanced economies.   When looking at advanced economies, which include the U.S., Canada, Germany, Italy, United Kingdom, France, and Japan, most have economic freedom scores that rank as mostly free with the two exceptions being France and Italy, which are still considered moderately free.  It may not be a coincidence that France and Italy also has experienced more economic turmoil in Europe than Germany or the United Kingdom.

While some would dismiss these rankings and point to historical colonialism of Europe and the U.S. over much of Central America, South America, and Africa, that does not explain how developing countries in those three parts of the world who embrace economic freedom mostly enjoy greater living standards than those with lower scores.

It is noteworthy to point out that pursuit of growth often comes at the expense of equality.  That speaks to the tradeoff between equality and efficiency.  However, Canada has been able to achieve a high economic freedom score and still provide a substantive safety net, including universal health care.  Though, it is difficult to achieve both.


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