The Basis of Prosperity

The Basis of Prosperity
By: Ian Welsh Saturday March 1, 2008 4:00 pm

One of the things that citizens of the first world - Americans, Canadians, Europeans and others, tend to forget, is that in most of the world there are large parts of various countries where the central government cannot reliably enforce the law, send troops, or tax. There are entire provinces in India with active rebellions. China regularly has huge job riots, and towns have risen up en masse and fought the police and army. Many South American countries don’t control large chunks of their own territory. And most African countries are elaborate jokes, divided up amongst multiple groups, with one group controlling the capital, being acknowledged by the UN, and being the official “government” in the eyes of the outside world, but often controlling less than half the country.

In the middle ages one would talk of places where “the King’s writ doth not extend.” In the modern era those places exist as well - are indeed vast, but we remark them not, because mostly they don’t matter much to those of us lucky enough to live in well ordered societies. They are places where the writ of the state is weak, or nonexistent. Sometimes any state, sometimes just any state we recognize. (Somaliland is an example of this. Virtually a nation-state, but not recognized as one.)

And it’s the sort of violence and uncertainty that occurs when the state doesn’t have a monopoly on violence that led people like Hobbes to infinitely prefer a strong state, even one that is repressive, over a weak one or anarchy.


In a weak state everything you have can be taken from you by those who are willing to use violence, or the threat of violence; and in a weak state, it is always possible for the situation to deteriorate even further. And very weak governments, contrary to what many Americans imagine, are almost as dangerous as totalitarian ones. The violence in the Congo, for example, has claimed enough people to make Stalin proud.

Likewise such uncertainty has a strong economic effect. Hernando de Soto has discussed this, after a fashion, but the finding I find most interesting is about stock returns.

Here’s the deal - stock returns make economists twitchy. They’re too high. In theory stock returns should be about equal to the bond market (maybe slightly higher, but only slightly, because the risk is only slightly higher.)

But the reason economists think this is when they look at just the US in isolation.

When you start looking at the world as a whole you suddenly find out something - stocks are very, very risky. Most of them never return a cent on an investment, viewed over the long term. This is even true in some first world nations, like Italy, where long run returns (say, take a century) are, while better than zero, barely better.

America is an anomaly. So is Canada. So is England. They are anomalies because the power of the government, having neither been used en masse against its own population (as with the USSR) or so weak as to allow for major competing brokers of violence, has allowed Einstein’s most powerful force in the universe - compound interest - to do its work.

In most countries that never gets off the ground. The government either takes too much (China and the USSR in the communist days) or can’t protect enough, and so, in fits and starts, things never quite get going.

Rational capitalism (as opposed to the sort of rabid financial speculation we have witnessed over the last few years) requires that actors be able to take a long term view. That requires the stability of law, and the belief that what one builds, one will be able to keep.

Government is always at the basis of economic prosperity. Without a good government (and good government is always strong, although a strong government can be bad) there can be no prosperity. The private sector can only make a country rich, if the government sets up the preconditions for it to do so.