During one of my trips to
Peru, the school, where I have been giving talks on economics, invited me to
attend a conference that the school was hosting for high school students. At
the beginning of the conference the teachers showed the student’s a power point
presentation. The first slide was a bid’s eye view of Hong Kong’s busy harbor.
The second slide was of downtown Manhattan. During the third slide, the
teachers asked all the students, ‘why doesn’t Peru look like that?’
During a lecture, Adam Smith explained
that, “little else is requisite to carry a state to the highest degree of
opulence from the lowest barbarism, but peace, easy taxes, and a tolerable
administration of justice: all the rest being brought about by the natural
course of things.”[i] Even though Smith articulated this nearly 257
years ago, there are still some countries that do not embrace what many
economists, and advocates of liberty, have so well articulated. Today, the
differences prosperity between countries provide social scientists with the
contrast class needed to determine which key factors contribute to prosperity;
the answer is clear: prosperous countries embrace and protect individual’s
economic freedom. Specifically, some countries prosper because they have
institutions that protect the three ‘P’s’ – property, prices, and profit- and have
laws that don’t interfere with the three ‘I’s’ – incentives, information, and
innovation.
Once
well-established property rights are defined, exchange can take place. Property
rights give actors an incentive to care for what is theirs and to trade for
what is not. Trade incentivizes citizens to produce what is easiest for them to
produce and trade for what we cannot make profitably ourselves, which
simultaneously encourages a peaceful social order. Trade also gives us an
incentive to peruse our comparative advantages in production: as people produce
what they are good at producing, their capabilities to produce improve and
their actions become more specialized. Division and specialization of labor
allow for producers to be more productive, which encourages yet more trade.
Because voluntary exchange is mutually beneficial, this process simultaneously
increases the wealth of all who participate.
As
trade becomes more complex, prices arise. Though they are often only 3-4
digits, prices are incentives wrapped in an immeasurable amount of knowledge.
Prices constantly signal consumer demand, along with the relative scarcity of a
product’s inputs, to producers. This information allows producers to produce
more of what consumers demand, allowing the trading process to generate even
more wealth. As Hayek explained to us, these price signals are part of a system
so dynamic that the order cannot possibly be ‘planned’ and therefore should not
be tampered with. Thus, once property rights are well established, prosperous
countries must permit prices to fluctuate freely in order to continue on the
path to prosperity.
Freely
moving prices and the increased information and trade that result from them will
allow producers to earn larger profits. These profits are not just ‘spent’ in
the economy but ‘re-invested’ as producers seek to experiment with new products
and research new ideas. The innovative process, permitted by the existence of
profits, leads to even greater profits for producers and better products for
consumers. Better products do not necessitate ‘higher quality’ since often they
are simply ‘less expensive’ or some how save consumers time. Innovation allows
producers to start creating wealth on an endless number of vectors, all while a
country’s prosperity increases. The most prosperous countries minimize taxes on
profits and restrictions on innovation since these things deter the
entrepreneurial process.
One
final element is key in explaining why some countries are prosperous and others
are not and that is the stability of their political institutions. Political
and legal institutions that are free of corruption, just in their decisions,
and principled in their actions, are an important cornerstone to a country
seeking to achieve and maintain high levels of prosperity. Predictable legal
institutions create a stable investing environment that encourages investment
and allows contracts to be predictably enforced. Both of these benefits lower
the transactions costs of the trading- wealth generating- process.
Even
though ‘trade’ typically provokes a mental image of material things and
professional services, free trade, and its requisite institutions, create more
than just material prosperity. In prosperous countries citizens that are
typically happier, have more freedom to peruse their dreams, receive better
healthcare, and ultimately have more autonomy over the direction of their
lives. Economic freedom is a requisite to all of these ‘non-material’ measures
of prosperity, and in fact these ‘non-material’ measures of prosperity don’t
exist in countries that do not have high levels of economic freedom.
To the
high school students in Peru, why some countries were wealthy and others poor
seemed like a mystery, almost a fact of nature: it isn’t. In fact, even though we live in a highly
developed country, our political debates seem to suggest that only after you
have an advanced understanding of statistics and economic planning are you
qualified to legislate in rules in Congress or manipulate the money supply at
The Federal Reserve in such a way that will bring about wealth. Don’t let what
seem to be highly intellectual public policy debates confuse you- creating a
just and prosperous society is much less complicated. Well
established and enforced property rights combined with unrestricted rules to
determine prices and make profits, lead to the incentives, information and
innovation that that make prosperity possible- anywhere.
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