Thoughts on economics and liberty

Free societies are wealthy

I just realised that I have a lot of material in the Online Notes of BFN that I can use in short blog posts without much editing.  Plus, of course, I've got tons of material on TAGI (my editorials) that should find a place on this blog. So here goes. This is from the Online Notes (material that could not be included in BFN given size constraints on the book).


         Free society are necessarily wealthy; ie, it is impossible for a free society to remain poor. That doesn’t mean that societies which are not free can’t be rich. Some shackled societies like Saudi Arabia, Russia, and Kuwait have become temporarily rich based on natural resources. Wealth, absent other information, is therefore a necessary but not sufficient indicator of a free society.

            The main drivers of wealth in a free society are its openness through free trade, and robust internal competition and innovation. Later in this chapter we will examine how free societies churn out literally infinite amounts of wealth. It is not very hard, really. Ever since Adam Smith explained it in his 1776 book, it is a well known secret.[1] On the other hand, countries like Saudi Arabia are equally guaranteed to collapse into poverty after their oil runs out unless they unshackle their society: that includes completely changing its culture.

India’s wealth

            What do we know about India’s wealth? We must look at wealth using international comparisons, else it doesn’t make sense. A useful comparison can be made with South Korea’s wealth.

·          South Korea’s GDP was one-twentieth of India’s in 1965 using the exchange rate measure of comparison (ie, not using PPP[2] for the moment). In other words, the South Korean economy was smaller than an average Indian state back then, but the average per capita incomes of  an Indian and South Korean were roughly the same. By 2005, the South Korean GDP had become a little greater than India’s, both being around $790 billion (World Bank estimates). In other words, South Korea grew 20 times more than India did in the last 40 years!

·          If we use a more appropriate measure, the PPP measure, then India’s 2005 GDP was $3.8 trillion and Korea’s $1 trillion. Comparable calculations for 1965 are not readily available for this indicator. An average Korean now earns $21,850, six times what the average Indian earns, at $3,650.  Assuming that per capita incomes in the two countries were very similar 40 years ago, we see that the Korean per capita income has grown six times faster than India’s in the last 40 years.

            Using either measure, we note that South Korea significantly outperformed India in the past 40 years, in just over one generation. At this stage we should not fall into the trap of explaining India’s poor relative performance by pointing to our large population, or to our ‘special’ problems, or otherwise waving our hands about the air. Given that South Korea has 500 lakh (or 50 million) people, it would be wrong to think of it as a small country. Our socialism was responsible for our poor growth rates. Period.

            This case study provides excellent proof that Adam Smith’s formula works. South Korea merely followed—initially very imperfectly—the standard text book model of economic and political freedom. It has later become a more genuine capitalist democracy and is considered to be one of the most innovative societies of the world.[3] Comparing South Korea with North Korea teaches an even more powerful lesson!

[1] Notwithstanding the extremely minor aberrations which may occur if the society suddenly discovers a disproportionately large natural resource endowment—the so-called Dutch disease.

[2] Purchasing power parity (PPP) takes into account the relative prices of goods and services such as haircuts. For example, I most recently paid $20 (Rs.650) in Melbourne and Rs. 30 in an air-conditioned saloon in Janakpuri, Delhi for haircuts. If price differences such as these are factored in, we may find that an Indian earning Rs.10 lakhs is richer ‘overall’ by perhaps a factor of 5 (my guess, not a scientific comparison), than a person earning the equivalent $30,000 in Australia.

[3]Asia’s Great Science Experiment” in Time, October 23, 2006.

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