Dedication
This book is dedicated to the miracle of the Rosary and to my grandchildren Alex, Jordon, Mikaela, Ellie, Catie, Adelai, Kaelyn, Danny, Ryleigh and Lauren. May the knowledge and work of your generation advance the spiritual and material well-being of all.
Introduction
The most important issue in economics is why some nations are wealthy while others are poor. Providing policymakers and advocates with the answer to this question can help to raise living standards and reduce poverty throughout the world.
Two and half centuries ago, Adam Smith answered the question by explaining how economic freedom was the key force in determining the wealth of nations. In 1980, Milton Friedman illustrated the power of freedom and free markets in his book and TV series Free to Choose. Smith and Friedman provided anecdotal evidence showing how people prospered in free countries, but suffered greatly in countries without such freedom.
Anecdotal examples can provide important insights into the wealth and poverty of nations. However, a more systematic, policy-oriented history of the creation and destruction of wealth among countries can provide both greater insights and more persuasive evidence.
In recent years there has been an outpouring of new data and information bearing on this very issue. Economists and statisticians have painstakingly sought to provide better measures of both economic progress and economic freedom throughout the world. Their work has led to important new data and information as well as many academic studies using this new information.
In spite of a massive amount of new data, there has been no popular, systematic analysis of the implications this data for the wealth and poverty of nations. This book provides such an analysis of the implications of this data.
Thomas Piketty’s book, Capital in the Twenty-First Century, is an example of a popular analysis using some of the new data. Unfortunately, Piketty doesn’t attempt to address the question of how nations generate wealth. Instead, Piketty focuses on the distribution of wealth. His work is devoted to measuring, explaining and criticizing the inequitable distribution of wealth both within and among various countries.
As with many economists, Piketty assumes the creation of wealth simply happens as a result of innovations. His main contribution to explaining the creation of wealth is one sentence— Knowledge and skill diffusion is the key to overall productivity growth as well as the reduction of inequality both within and between countries.
Saying knowledge and skill diffusion are the keys to creating wealth misses the key issue. The creation of wealth is an extremely complex process. Knowledge, skills and innovation are only a few of the many elements associated with this process. In order to begin to understand the impact of economic policies on wealth, we must first fully understand the process itself.
Focusing on the distribution of income and wealth can lead us to miss the forest for the trees. For example, Piketty refers to the sharp reduction in inequality in the US from 1913 to 1948 as good news. As I show in my analysis, this period includes the worst economic performance in US history. The good news of a reduction in income inequality was certainly lost on the poor souls standing in line at soup kitchens during the Great Depression.
There are other fundamental problems with focusing on greater equality of incomes as a policy objective. To begin with, wealth must first be created before it can be distributed. Inequality of incomes is a natural consequence of the successful creation of wealth. When a country prospers and incomes rise, the gap between those with more income and wealth and those with no income and wealth becomes progressively larger. This isn’t economics. It’s math.
One consistent conclusion from my analysis is how destructive Piketty’s recommendations of higher taxes would be for any country foolish enough to pursue them.
The approach in this book is first to define the concept of wealth, and then to describe the process by which wealth is created and destroyed. The next step is to establish criteria for policies associated with the concept of economic freedom. These criteria help us to quantify the extent to which specific government policies either advance or retard freedom. Given the appropriate definitions and criteria for policies, we can proceed to observe the extent to which changes in these policies have been associated with either the creation or destruction of wealth.
The analysis of wealth in the United States goes into more detail than for other countries. This is due to the availability of more detailed historical data as well as to my greater familiarity with US policies and data. For countries outside the US there is a broad overview of policies and economic performance. The overview relies mainly on historical measures of economic freedom provided by the Fraser Institute and the Heritage Foundation. Measures of economic conditions rely on estimates of output per person based on data from the International Monetary Fund and Angus Maddison’s The World Economy.
Throughout this book, the primary focus of the analysis is on long-term growth trends. There is no attempt to deal with short-term cyclical movements in the economy. Short-term changes in business conditions are often associated more with changes in monetary policy than with changes in government spending, regulations and taxes. Monetary policy and its impact on business cycles is a topic for another book.
With respect to terminology, the words nation and country are used interchangeably, as are the terms classical principles and free-market classical principles. The latter terms denote a specific set of policies designed to promote economic freedom described in previous works by the author.
For purposes of readability, sources, data and notes regarding the data are placed in the data appendix and on the author’s website — classicalprinciples.com.
Organization and Summary
Perfect freedom is as necessary to the health and vigor of commerce as it is to the health and vigor of citizenship. — Patrick Henry
Why are some nations rich and others poor? Why do some rich nations, such as the US, at certain times enjoy periods of strong growth and prosperity, while at other times struggle with little or no growth?
These are the very questions economists have attempted to answer for at least two and a half centuries. To be useful, any attempts to answer these questions should be policy oriented. They should provide policymakers and advocates with a clear, practical guide to policies that promote the creation of wealth, as well as those that impede it.
One potential policy-oriented answer is the one provided by the world’s two most famous economists— Adam Smith and Milton Friedman. Both viewed economic freedom as the key to the wealth of nations. Economic freedom involves placing the main power and authority over economic issues with individuals instead of with government.
An alternative policy for enhancing wealth is to give more power and control over economic decisions to government. Increasing the government’s power and authority over economic decisions produces a corresponding decrease in the economic freedom of individuals. This alternative policy direction has been termed progressivism, socialism and communism, depending on the degree to which government controls economic decisions.
The underlying assumption behind increasing government control over economic decisions is the belief that governments make better decisions than individuals operating in a free market environment. With the collapse of the Soviet Union there has been a greater recognition of the problems associated with the extreme lack of economic freedom under communism. There is less widespread recognition of how less extreme moves to restrict freedom, from either progressive or socialist policies, might also erode wealth and promote poverty. Analyzing the economic performance of various countries under different policy regimes can provide insights into this important issue.
The objective of this book is to provide systematic, historical evidence of the extent to which policies promoting or impeding economic freedom have been associated with the rise and fall of the wealth