DRI-162 for week of 2-1-15: It Happens Every Season

An Access Advertising EconBrief:

It Happens Every Season

The Super Bowl has come and gone. And with it have come stories on the economic benefits accruing to the host city – or, in this case, cities. The refrain is always the same. The opportunity to host the Super Bowl is the municipal equivalent of winning the Powerball lottery. Thousands – no, hundreds of thousands of people – descend on the host city. They focus the world’s attention upon it. They “put in on the map.” They spend money, and that money rockets and ricochets and rebounds throughout the local economy with ballistic force, conferring benefits left, right and center. We cannot help but wonder – why don’t we replicate this benefit process by bringing people and businesses to town? Why wait in vain on a Super Bowl lottery when we can instead run our own economic benefit lottery by offering businesses incentives to relocate, thereby redistributing economic benefits in our favor?

It happens every winter. In fact, publicity about economic development incentives (EDIs) is always in season, for they operate year-round. Nowadays almost every state in the union has a government bureau with “economic development” on its nameplate and a toolkit bulging with subsidies and credits.

For years, the news media has mindlessly repeated this stylized picture of EDIs, as if they were all repeating the same talking points. Both the logic of economics and empirical reality vary starkly from this portrait.

EDIs In a Nutshell

The term “EDIs” is shorthand for a variety of devices intended to make it more attractive for particular businesses to relocate to and/or operate in a particular geographic area. The devices involve either taxes or subsidies. Sometimes a business will receive an outright grant of money to relocate, much as an individual gets a relocation bonus from his or her company. Sometimes a business will receive a tax credit as an inducement to relocate. The tax credit may be of specified duration or indefinite. Sometimes the business may receive tax abatement – property tax abatements are especially favored. Again, this may be time-limited or indefinite. Sometimes the tax or subsidy is implicit rather than explicit. Sometimes businesses will even receive production subsidies in excise form; that is, a per-unit subsidy on output produced.

Various forms of implicit or in-kind benefit are also offered. These include grants of land for production facilities and exemption from obligations such as payment for municipal services.

These do not exhaust the EDI possibilities but the list is representative and suggestive.

A Short, Sour History of EDIs

Proponents of EDIs indignantly reject the charge that their ideas are new. On the contrary, government favors to business trace back to the early years of the republic, they insist.

It is certainly true that the early decades of the 19th century saw a boom – today, we would call it a “bubble” – in the building of canals, primarily as transportation media. The Erie Canal was the most famous of these. Although the canals were privately owned, they were heavily subsidized and supported by government. Are we surprised, then, that the canal boom went bust, sinking most of its investors like sash weights? Railroads are traditionally given credit for spearheading U.S. economic development in the 19th century, and the various special favors they won from state and local governments are legendary. They include subsidies and extravagant rights of way on either side of their trackage. But economist Robert Fogel won a Nobel Prize for his downward revision of the importance of railroads to the economic growth of 19th-century America, so there is less there than meets the mainstream historical eye.

The modern emphasis on EDIs can be traced back to the state industrial finance boards of the 1950s. These became more active in the late 1960s and 70s when the national economy went stagnant with simultaneous inflation and recession. Like European national governments today, state and local governments were trying to steal businesses from each other. They lacked central banks and the power to print money, so they couldn’t devalue their currencies as European nations are now doing serially. Instead, they used selective economic benefits as their tools for redistributing businesses in their favor. And, like Europe today, they found that these methods only work as intended when employed by the few. When everybody does it simultaneously, they cancel each other out. One state steals Business A from another, but loses Business B. How do we know whether that state has gained or lost on net balance? We don’t, but in the aggregate nobody wins because businesses are simply being reallocated – and not for the better. Of course, we haven’t yet stopped to consider whether the state even gained from wooing Business A in the first place.

We can look back on many celebrated startups and relocations that were midwived by EDIs. In Tennessee, Nissan got EDI subsidies for relocating to the state in 1980. Later, GM built its famous Saturn plant there. In both cases, the big selling point was the large number of jobs ostensibly created by the project. We can get some idea of the escalation in the EDI bidding sweepstakes by comparing the price-tag per job over time. The Nissan subsidies cost roughly $11,000 per job created. At this price, it is hard to envision an economic bonanza for the host community, but compare that to the $168,000 per job created that went to Mercedes Benz for relocating to Alabama in 1993. In 1978, Volkswagen promised 20,000 jobs for the $70 million it got for moving to Pennsylvania, but ended up delivering only about 6,000 jobs before closing the plant within a decade.

There is every reason to believe that these results were the rule, not the exception. Economists have identified the phenomenon known as the “winner’s curse,” in which winning bidders often find that they had to bid such a high price to win that their benefits were eaten up. Economists have long objected to the government practice of setting quotas on imported goods because the quota harms domestic consumers more than it benefits domestic producers. Moreover, governments customarily give import licenses to politically favored businesses. Economists plead: Why not open up the licenses to competitive bid? That would force would-be beneficiaries of the artificial shortage created by the quota to eat up their monopoly profits in the price they pay for the import license. Then taxpayers would benefit from the revenue, making up for what they lose in consumption of the import good. This same principle prevents cities from benefitting when they “bid” against other cities to lure firms by offering them subsidies and tax credits – they have to offer the firm such lucrative benefits to win the competition against numerous other cities that any benefits provided by the relocating business are eaten up by the subsidy price the city pays.

The Economics of Business Location

The general public probably envisions an economic textbook with a chapter on “economic development” and tips on how to lure businesses and which types of business are the most beneficial, as well as tables of “multiplier” benefits for each one.

Not! The theory of economic development is silent on this subject. The only applicable economic logic is imported from the theory of international trade. The case of import quotas provided on example. The specter of European nations futilely trying to outdo each other in trashing the value of their own currencies is another; international economists use the acerbic term “beggar thy neighbor” to characterize the motivation behind this strategy. It applies equally to states and cities that poach on businesses in neighboring jurisdictions, trying to lure them across state or municipal boundaries where they can pay local taxes and provide prestigious photo opportunities for politicians.

What about the Keynesian theory of the “multiplier,” in which government spending has a multiple effect on income and employment? Even if it were true – and all major Keynesian criticisms of neoclassical theory have been overturned – it would apply only under conditions of widespread unemployment. It apply only to national governments that can control policies for the entire nation and have the power to control and alter the supply of money and credit and rates of interest. Thus, the principle would be completely inapplicable to state and local governments anyway.

Economists believe that there is an economically efficient location for a business. Typically, this will be the place where it can obtain its inputs at lowest cost. Alternatively, it might be where it can ship its output to consumers the cheapest. If EDIs cause a business to locate away from this best location by falsely offsetting the natural advantages of another location, they are harming the consumers of the goods and services produced by the businesses. Why? The business is incurring higher costs by operating in the wrong location, and these higher costs must be compensated by a higher price paid by consumers than would otherwise be true. That higher price combines with the subsidies paid by taxpayers in the host community to constitute the price paid for violating the dictates of economic efficiency.

Why do economists obsess over efficiency, anyway? The study of economics accepts as a fact that human beings strive for happiness. In order to attain our goals, we must make the best use of our limited resources. That requires optimal consumer choice and cost minimization by producers. When government – which is a shorthand term for the actions of politicians, bureaucrats and lower-level employees acting in their own interests – muck up the signaling function of market prices, this distorts the choices made by consumers and producers. Efficiency is reduced. And this effect is far from trivial. A previous EconBrief discussed an estimate that federal-government regulations since 1949 have reduced the rate of economic growth in the U.S. by a factor of three, implying that average incomes would be roughly $125,000 higher today in their absence.

EDIs are a separate issue from regulation. They are more recent in origin but growing in importance. In 1995, the Minneapolis Federal Reserve published a study by economists Melvin Burstein and Arthur Rolnick, entitled “Congress Should End the Economic War Between the States.” At about the same time, the United Nations published its own study dealing with a similar phenomenon at the international level.

Borrowing once again from the theory of international trade, these studies view production in light of the principle of comparative advantage. Countries (or states, or regions, or cities, or neighborhoods, or individual persons) specialize in producing goods or services that they produce at lower opportunity cost than competitors. Freely fluctuating market prices will reflect these opportunity costs, which represent the monetary value of alternative production foregone in the creation of the comparative-advantage good or service. Free trade between countries (or states, regions, cities, neighborhoods or persons) allows everybody to enjoy the consumption gains of this optimal pattern of production.

Burstein, Rolnick, the U.N., et al felt that politicians should not be allowed to muck up free markets for their own benefit and said so. That debate has continued ever since in policy circles.

The Umpires Strike Back: EDI Proponents Respond 

Responses of EDI proponents have taken two forms. The first is anecdotal. They cite cases of particular successful EDI regimes or projects. The cited case is usually a city like Indianapolis, IN, which enjoyed a run of success in luring businesses and a concurrent spurt of economic growth. A less typical case is Kansas City, KS, which languished for several decades in prolonged decay with a deserted, crumbling downtown area and crime-ridden government housing projects and saw its tax base steadily disintegrate. The city subsidized a NASCAR-operated racing facility on the western edge of its county, miles away from its downtown base. It also subsidized a gleaming shopping and entertainment district slightly inward of the racetrack. Both NASCAR and the shopping district have benefitted from these moves, and politicians have claimed credit for revitalizing the city by their efforts. A recent Wall Street Journal column described the policy has having revamped “the city and its reputation.”

The second argument consists of a few studies that claim to find a statistical link between the level of spending on EDIs and the rate of job growth in states. Specifically, these studies report “statistically significant” relationships between those two variables. This link is cited as justification for EDIs.

Both these arguments are extremely weak, not to say specious. It is widely recognized today that most investors are foolish to actively manage their own stock portfolios; e.g., to pick stocks in order to “beat the market” by earning a rate of return superior to the average rate available on (say) an index fund such as the S&P 500. Does that mean that it is impossible to beat the market? No; if millions of investors try, a few will succeed due to random chance or luck. Another few will succeed due to expertise denied to the masses.

Analogous reasoning applies to the anecdotal argument made by EDI proponents. A few cities are always enjoying economic growth for reasons having nothing to do with EDIs – demographic or geographic reasons, for example. With large numbers of cities “competing” via EDIs, a few will succeed due to random chance. But this does not make, or even bolster, the case for EDIs. Indeed, the use of the term “competition” in this context is really false, because cities do not compete with cities – only concrete entities such as businesses or individuals can compete with each other. It is really the politicians that are competing with each other. And this form of competition, quite unlike the beneficial form of competition in free markets, is inherently harmful.

This sophisticated rebuttal is overly generous to the anecdotal arguments for EDIs. Even if we assume that the EDIs produce a successful project – that is, if we assume that Saturn succeeds at its Tennessee plant or NASCAR thrives in Kansas City, KS – it by no means follows that one company’s gains translate into areawide gains in real income. A study by the late Richard Nadler found no gains at all in local Gross Domestic Product for Wyandotte County, in which Kansas City, Kansas resides, years after NASCAR had arrived. The logic behind this result, reviewed later, is straightforward.

The studies claiming to support EDIs lean heavily on the prestige of statistical significance. Alas, this concept is both misunderstood and misapplied even by policy experts. Its meaning is binary rather than quantitative. When a relationship is found “statistically significant,” that means that it is unlikely to be completely random or chance but it says nothing about the quantitative strength or importance of the relationship. This caveat is especially germane when discussing EDIs, because all the other evidence tells us that EDIs are trivial in their substantive effect on business location decisions.

For decades, intensive surveys have indicated that business executives select the optimal location for their business – then gladly take whatever EDIs are offered. In other words, the EDI is usually irrelevant to the actual location decision. But executives seal their lips when it comes to admitting this fact openly, because their interests lie in fanning the flames of the Economic War Between the States. That war keeps EDIs in place and subsidizes their moves and investments.

Thus, a statistical correlation between EDIs and job growth is not a surprise. But no case has been made that EDIs are the prime causal mover in differential job growth or economic growth among states, regions or cities.

Perhaps the best practical index of the demerits of EDIs would be the economic decline of big-spending blue states in America. These states have been high-tax, high-spending states that heavily utilized EDIs to reward politically favored businesses. This tactic may have improved the fortunes of those clients, but it has certainly not raised the living standards of the populations of those states.

If Not EDIs, What? 

It is reasonable to ask: If EDIs do not govern the wealth of states or cities, what does? Rather than offer selective inducements to businesses, governments would do better to offer across-the-board inducements via lower tax rates to businesses and consumers. Studies have consistently linked higher rates of economic growth with lower taxes on both businesses and individuals throughout the U.S.

Superficially, this strikes some people as counterintuitive. The word “selective” seems attractive; it suggests picking and choosing the best and weeding out the worst. Why isn’t this better than blindly lower taxes on everybody?

In fact, it is much worse. Government bureaucrats or consultants are not experts in choosing which businesses will succeed or fail. Actually, there are very few “experts” at doing that; the best ones attain multi-millionaire or billionaire status and would never waste their time working for government. Governments fail miserably at that job. Better to allow the experts at stock-picking to pick stocks and relegate government to doing the very, very few things that it can and should do.

States and municipalities typically operate with budget constraints. They cannot create money as national governments can and are very limited in their ability to borrow money. So when they selectively give money to a few businesses with subsidies or tax credits, the remaining businesses or individuals have to pay for that in higher taxes. If lower taxes for a few are good for that few, then it follows that higher taxes for the rest must be bad for the rest. And this means that even if the subsidies promote success for the favored business, they will reduce the success of the other businesses and reduce the real incomes of consumers. In other words, the “economic development” promoted by government’s “subsidy hand” will be taken away by government’s “tax hand.” What the government giveth, the government taketh away. Oops.

Lower taxes for everybody work entirely differently. They change the incentives faced at the margin, causing people to work, save and invest more. The increased work effort causes more goods and services to be produced. The increased saving makes more financial resources available for investment by businesses. The increasing investment increases the amount of capital available for labor to work with, which makes labor more productive. This increased productivity causes employers to bid up wages, increasing workers’ real incomes.

Lest this process sound like a free lunch, it must be noted that unless the increased incomes are self-financing – that is, unless the increased incomes provide equivalent tax revenue at the lower rates – government will have to reduce spending in order to fulfill the conditions for stability. Since modern government is wildly inflated – heavily bureaucratized, over-administered and over-staffed as well as obese in size – this should not present a theoretical problem. In practice, though, the willingness to achieve this tradeoff is what has defined success and failure in economic development at the state and local level.

Markets Succeed. Governments Fail

EDIs fail because they are an attempt by government to improve on the workings of free markets. Free markets have only advantages while governments have only disadvantages. Free markets operate according to voluntary choice; governments coerce and compel. Voluntary choice allows people to adjust and fine-tune arrangements to suit their own happiness; compulsion makes no allowance for personal preference and individual happiness. Since human happiness is the ultimate goal, it is no wonder that markets succeed and governments fail.

Free markets convey vast amounts of information in the most economical way possible, via the price system. Since people cannot make optimal choices without possessing relevant information, it is no wonder that markets work. Governments suppress, alter and distort prices, thereby corrupting the informational content of prices. Indeed, the inherent purpose of EDIs is exactly to distort the information and incentives faced by particular businesses relative to the rest. It is no wonder, then, that governments fail.

Prices coordinate the activities of people in neighborhoods, cities, regions, states and countries. In order for coordination to occur, people should face the same prices, differing only by the costs of transporting goods from place to place. Free markets produce this condition. Governments deliberately interfere with this condition; EDIs are a classic case of this interference. No wonder that governments, and EDIs, fail.

DRI-312 for week of 6-15-14: Wealth and Poverty: Blame and Causation

An Access Advertising EconBrief:

Wealth and Poverty: Blame and Causation

Among the very many cogent distinctions made by the great black economist Thomas Sowell is that between blame and causation. Blame is a moral or normative concept. Causation is a rational, cause-and-effect concept. “Sometimes, of course, blame and causation may coincide, just as a historic event may coincide with the Spring equinox,” Sowell declared in Economic Facts and Fallacies. “But they are still two different things, despite such overlap.”

Unfortunately, blame has overtaken causation in the public perception of how the world works. This is bad news for economics, which is a rational discipline rather than a morality play.

Economic Development

There is a specialized branch of economics called economic development. Not surprisingly, its precepts derive from the principles of general economic theory, adapted to apply in the special case of areas, regions and nation states whose productive capabilities rise from a primitive state to advanced status.

The public perception of economic development, though, is that of a historical morality play. Developed Western nations in Europe engaged in a practice called “imperialism” by colonizing nations in South America and Africa. Then they proceeded to exploit the colonial natives economically. This exploitation not only reduced their standard of living contemporaneously, it left them with a legacy of poverty that they have been subsequently unable to escape. Only government aid programs of gifts or loans, acting as analogues to the welfare programs for impoverished individuals in the Western countries, can liberate them and expiate the sins of the West.

The idea that moral opprobrium attaches to acts of national conquest has a considerable appeal. The conventional approach to what is loftily called “international law” – or, more soberly, “foreign policy” – is that military force applied aggressively beyond a country’s own international boundaries is wrong. But the impact of wrongful acts does not necessarily condemn a nation to everlasting poverty.

In fact, world history to date has been overwhelmingly a tale of conquest. For centuries, nations attained economic growth not through production but through plunder. Only since the Industrial Revolution has this changed. It is worthwhile to question the presumption that defeat automatically confers a legacy of economic stasis and inferiority.

That is why we must distinguish between blame and causation. We may assign blame to colonizers for their actions. But those actions and their effects occurred in the colonial era, prior to independence. Cause-and-effect relationships are necessarily limited to relationships in the same temporal frame; the past cannot hold the present prisoner. Even if we were to claim that (say) inadequate past investment under colonization is now responsible for constraining present economic growth, we would still have to explain why current investment cannot grow and eventually stimulate future economic growth.

Great Britain was the world’s leading economic power during the 18th and 19th centuries. She conquered and held a worldwide empire of colonies. She must have commanded great wealth, both military and economic, in order to achieve these feats. Yet Great Britain herself was conquered by the Romans and spent centuries as part of the Roman Empire. The “indigenous peoples” of the British Isles (perhaps excluding the Irish, who may have escaped the Roman yoke) must have recovered from the pain of being subjugated by the Romans. They must have overcome the humiliation of bestowing upon William the title of “Conqueror” after his victory at Hastings in 1066. They must – otherwise, how else could they have rebounded to conquer half the world themselves?

Great Britain’s legacy of military defeat, slavery and shame did not thwart its economic development. It did not stop the British pound sterling from becoming the vehicle currency for world trade, just as the U.S. dollar is today. If anything, Great Britain and Europe prospered under Roman domination and suffered for centuries after the collapse of the empire.

Germany has been an economic powerhouse since the 19th century. It survived utter devastation in two world wars and calumniation in their wake, only to rise from the ashes to new heights of economic prominence. Yet its legacy prior to this record of interrupted success was a history of squabbles and conflict between regional states. They, too, were subjugated by Rome and arose from a long period of primitive savagery. Why didn’t this traumatize the German psyche and leave them forever stunted and crippled?

It is hard to think of any nation that had a tougher road to hoe than China. True, China was the world’s greatest economic power over a millennium ago. But centuries of isolation squandered this bequest and left them a medieval nation in a modern world. As if this weren’t bad enough, they reacted by embracing a virulent Communism that produced the world’s worst totalitarian state, mass famine and many millions of innocent deaths. At the death of Mao Ze-Dong in 1976, China was a feeble giant – the world’s most populous nation but unable to feed itself even a subsistence diet. Yet this legacy of terror, famine, defeat and death failed to prevent the Chinese from achieving economic development. Less than 40 years later, China is a contender for the title of world’s leading economic power.

It is certainly true that some countries in Africa and South America were colonized by European powers and subsequently experienced difficulty in raising their economic productivity. But it is also true that there are “countries mired in poverty that were never conquered.” Perhaps even more significantly, “for thousands of years, the peoples of the Eurasian land mass and the peoples of the Western Hemisphere were unaware of each other’s existence,” which constitutes a legacy of isolation even more profound and enduring than any residue left by the much shorter period of contact between them.

Economists have identified various causal factors that affect economic development much more directly and clearly than military defeat or personal humiliation suffered by previous generations. Most prominent among these are the geographic factors.

Mankind’s recorded history began with settlements in river valleys. A river valley combines two geographic features – a river and a valley. The river is important because it provides a source of water for drinking and other important uses. Rivers also serve as highways for transportation purposes. Finished goods, goods-in-process and primary inputs are all transported by water. In modern times, with the advent of swifter forms of transportation, only commodities with low value relative to bulk travel by water. But throughout most of human history, rivers were the main transportation artery linking human settlements. Oceans were too large and dangerous to risk for ordinary transportation purposes; lakes were not dispersed widely enough to be of much help.

If we contrast the kind and quality of rivers on the major continents, it is not hard to see why North America’s economic development exceeded that of Africa. Not only is North America plentifully supplied with rivers, but its largest rivers, the Mississippi and the Missouri, tend to be highly navigable. Its coastline contains many natural harbors. Africa’s rivers, in contrast, are much more problematic. While the Nile is navigable, its annual floods have made life difficult for nearby settlers. The Congo River’s navigability (including its access from the ocean) is hindered by three large falls. The African coastline contains comparatively few natural harbors and is often difficult or impossible for ships to deal with – a fact that hindered international trade between Africa and the outside world for decades. The Congo is the world’s second largest river in terms of water-volume discharged; the Amazon River in South America is the largest. Yet the tremendous hydropower potential of both rivers has hardly been tapped owing to various logistical and political obstacles.

Valleys contrast favorably with mountainous regions because they are more fertile and easier to traverse. Sowell quotes the great French historian Fernand Braudel’s observation that “mountain life lagged persistently behind the plain.” He cites mountainous regions like the Appalachians in the U.S., the mountains of Greece, the RifMountains in Morocco and the ScottishHighlands to support his generalization. Not only do both Africa and South America contain formidable mountain barriers, their flatlands are much less conducive to economic development than those of (say) North America. Both Africa and South America contain large rainforests and jungles, which not only make travel and transport difficult or impossible but are also hard to clear. As if that weren’t a big enough barrier, both continents face political hurdles to the exploitation of the rainforests.

South America differs from its northern neighbor particularly in topography. The AndesMountains to the west have traditionally divided the continent and represented a formidable geographic barrier to travel and transportation. One of the great stories in the history of economic geography is the tale, told most vividly by legendary flier and author Antoine de Saint-Exupery in his prize-winning novel Night Flight, of the conquest of the Andes by airline mail-delivery companies in the formative days of commercial North America, the flatlands of South America do not consist primarily aviation.

Climate has similar effects on economic development. A priori, temperate climate is more suitable for agriculture and transportation than either the extremes of heat or cold. Both Africa and South America contain countries located within tropical latitudes, where heat and humidity exceed the more temperate readings typical of North America and Europe. Indeed, Africa’s average temperature makes it the hottest of all continents. While North America does contain some desert land, it cannot compare with northern Africa, where the Sahara approaches the contiguous U.S in size. The barrenness of this climate makes it less suitable for human habitation and development than any area on Earth save the polar regions. Speaking of which, subarctic climates can be found on the highest mountain regions on each continent.

The economic toll taken by geographic barriers to trade can be visualized as akin to taxes. Nature is levying a specific tax on the movement of goods, services and people over distance. The impact of this “transport tax” can extend far beyond the obvious. As Sowell points out, the languages of Africa comprise 30% of the world’s languages but are spoken by only 13% of the world’s population. The geographic fragmentation and separation of the continent has caused cultural isolation that has produced continual fear, hatred, conflict and even war between nations. The civil war currently raging between Sunni, Shiite and Kurd is the same kind of strife that T.E. Lawrence sought to suppress during World War I almost a century ago. Thus, an understanding of basic geography is sufficient to convey the severe handicap imposed on most countries in Africa and South America compared to the nations of Europe and North America.

Political Economy

It is certainly true that geography alone placed Africa and South Africa behind the economic-development 8-ball. Still, each continent does contain a share of desirable topographies and climates. History even records some economic-development success stories there. Argentina was one of the world’s leading economic powers in the 19th century. Not only was its national income ranked among world leaders, its rate of growth was high and growing. Its share of world trade also grew. Today, its status is dismal, exactly the reverse of its prior prosperity – its GDP is barely one-tenth of ours. But it was not conquered by a colonial power, nor was it “exploited” by “imperialism.”

Argentina won its independence from Spain well before it rose to economic prominence. Unfortunately, its political system gradually evolved away from free-market economics and toward the dictatorial socialism epitomized by Juan Peron and his wife, Evita. This produced inflation, high taxes, loss of foreign trade and investment and a steady erosion of real income.

Elsewhere in South America, economic evolution followed a similar course, albeit by a different route. Most countries lacked the same experience with free markets and institutions that lifted Argentina to the heights. Even when independence from colonial rule brought republican government, this quickly morphed to one-party rule or military dictatorship. Although the political Left insists that South America has been victimized by capitalism, South America’s history really reeks of the same “crony capitalism” that reigns supreme in the Western nations today. This means authoritarian rule, unlimited government and favoritism exerted in behalf of individuals or constituent groups. Moreover, erosion of property rights has weakened a key bulwark of free-market capitalism in the West today, just as it did throughout the history of South America.

In Africa, the situation was even worse and has remained so until quite recently. After crying out for independence from colonial oppressors, native Africans surrendered their freedom to a succession of dictators who proved more oppressive, brutal and bloodthirsty than the colonizers. Now, with the rise of the Internet and digital technology, Africans at last possess the ability to exist and thrive independently of government. They also can overcome the costs of transacting to protest against dictatorship.

The importance of markets and institutions can be divined from a roll-call of the most successful countries. Great Britain, Japan, Hong Kong, Singapore and Scandinavia are all small countries that lack not only size but also abundance of natural resources. One thing that Africa and South America did possess in quantities rivaling that of Europe and North America was resource wealth. But the ability to turn resources into goods and services requires the other things that Africa and South America lacked: not only favorable geography and climate, but also favorable institutions, laws and mores. Even in North America, the U.S. had all the favorable requisites, while Mexico lacked the legal and institutional environment and Canada lacked the favorable geography and climate.

Viewed in this light, it is not chauvinism to invoke a principle of “American exceptionalism;” it is just clear-eyed analysis. The country that later became the United States of America was blessed with ideal geography and climate. While it faced aboriginal opposition, that was much less fierce than it might have been. Great Britain’s colonial stewardship allowed the colonies to develop economically, albeit in a restricted framework. Moreover, the colonists developed a close acquaintanceship with British laws and institutions. This proved vital to the eventual birth of the American Declaration of Independence and Constitution. The U.S. was indeed the exception when it came to economic development because it faced few of the obstacles that hampered the development of almost all other countries. Coupled with the most favorable constitution ever written for free markets and a century and a half of virtually free immigration, the result was the growth of the world’s greatest economy.

Culture

Through the ages, historians have accorded culture an increasing emphasis in their studies. Oddly, though, it has seldom been linked to economics in general and almost never to economic development in particular. Yet even a cursory glance suggests it as an explanation for some of what otherwise would stand as paradoxes.

India has long ranked as the “phenom” of economic development – perennially expected to bust loose to assume its rightful place among the world’s economic powerhouses, and perennially a disappointment. As a legacy of centuries of colonial rule by Great Britain, it inherited a cadre of well-trained and educated civil servants. The world’s second-largest population provided a ready source of labor. The country did not lack for capital goods despite the abject poverty of most of its citizens, thanks to British investment. What, exactly, was holding India back?

The political left supplied its standard answer by attaching blame for India’s poverty to its “legacy of colonialism.” Movies like Gandhi portrayed British behavior toward Indians as beastly and sanctified Gandhi’s policy of passive resistance within a framework of civil disobedience. These answers were less than complete, however. They did not explain how the U.S., also a British colony and occasional victim of British beastliness for a century and a half, was able to succeed so brilliantly while India failed so dismally. Nor did they explain why India failed while employing the same socialist economic policies that England had incubated throughout the early 1900s before installing them at home just before granting India’s independence.

India’s adoption of socialism was the political complement to its cultural reverence for poverty, created and nurtured by Gandhi. India could hardly have picked a worse symbol for hero worship. Fortunately, India’s independence was delayed until after World War II, in which India refused to embrace Gandhi’s pacifism and participated significantly in her own defense and that of the Eastern theater. Then, after independence, India continued to stoke regional hostilities with neighbors China and Pakistan in subsequent decades, ignoring Gandhi’s views in the one context in which they might have done some good. Meanwhile, the country’s steadfast unwillingness to adopt a commercial ethic, root out public corruption and eradicate traditional taboos against the unhindered opposition of markets foreclosed any possibility of real economic growth.

If there was ever a culture that seemed impervious to economic growth, it was India’s. Even China never seemed such a hopeless case, for Chinese who emigrated became the success story of Southeast Asia; clearly Chinese institutions were holding up economic development, not her culture. Well, India’s cultural head is still buried in the sands of the past, but her institutions have changed sufficiently to midwife noticeable economic growth beginning in the late 1990s.

Foreign Aid and Foreign Investment

Two great myths of economics relate to foreign aid and foreign investment. For decades, intellectuals and governments sang the praises of foreign aid as a recipe for prosperity and cure for poverty. Alas, institutions like the World Bank and International Monetary Fund – both of which were created for completely unrelated purposes – have failed miserably to promote economic development despite decades of trying and billions of dollars in loans, grants and consulting contracts.

The failures have been particularly glaring in Africa, where real incomes were the lowest in the world throughout the 20th century. In retrospect, it is not easy to figure out why international aid should have succeeded in raising real incomes. After all, one of the signature measures employed by newly independent regimes in Africa and South America was to expropriate wealth owned by foreigners through nationalization. This raised the incomes of government officials and their cronies but did not raise real incomes generally. As Sowell observes, “there is no more reason to expect automatic benefits from wealth transfers through international agencies than from wealth transfers through internal confiscations.” And indeed, “the incentives facing those disbursing the aid and those receiving it seldom make economic development the criterion of success.” Aid agencies simply strive to give money away; host governments simply strive to get money. And that is pretty much what happened.

Lenin developed a theory of imperialism to explain why capitalism did not succumb to revolution on schedule. When the declining profit from capital threatened their viability, capitalists would turn to the less-developed nations, where their foreign investment would earn “super profits” at the expense of the host peoples. Unfortunately, his theory was overturned by experience, which showed that capitalists in developed countries invested mostly in other developed countries. (Today’s neo-Marxism has returned full-circle to the exploitation theories of original Marxism with the newly popular theory of French economist Piketty. His theory postulates a return to “capital” that is greater than that from investment in labor, which promotes a greater level of (hypothesized) inequality in income and wealth. Having failed to sell a theory of inequality based on a declining rate of profit, the Left is switching tactics – the return on capital is too high, not declining.)

The real recurring example of successful “foreign investment” has come through immigration. Welsh miners have come to the U.S. and mined successfully. Chinese entrepreneurs have migrated throughout Southeast Asia and dominated entrepreneurship in their adopted countries. Jews have migrated to countries throughout the world and dominated industries such as finance, clothing, motion pictures and education. German workers helped Argentina become a world leader in wheat production and export. Indian immigrants have become leading entrepreneurs in motels and hotels in the U.S. Italian and Lebanese immigrants migrated to Africa and the U.S. and achieved entrepreneurial success in various fields. Yet, ironically, immigration has typically been opposed by natives in spite of the consistent benefits it generates.

Causation, not Blame

History is a record of strife and conflict, of conquest and submission. At one time or other, practically every people have been conquered and subjugated. Colonial status has sometimes been disastrous to natives, as with some countries colonized by Spain in the Age of Exploration. Sometimes it has been relatively beneficial, as it was in the early stages of the American colonies. Often it turned out to be a mixed bag of benefits and drawbacks. But economic development has never been either guaranteed or foreclosed by the mere existence of a colonial past. Economic logic lists too many causal factors affecting development for us to play the blame game.