Economics is the study of managing the resources of a people and government encompassing the laws of *production and distribution of wealth according to Adam Smith, 18th century Scottish economist and philosopher who penned the 'Wealth of Nations', the first masterpiece in economics.
(*Factors of production include labour, land, capital and enterprise.)
Economics is a dynamic subject which studies changes in an economy and which itself changes as old and new ideas battle for influence. And it is the economy which is held by many to hold the key to any government's re-election prospects as former US president Bill Clinton knew all too well when asked about the chances of securing a second term in 1996 'it's the economy, stupid!'
It is not intended here to visit all the complexities of economics but instead set out what are considered successful measures in laying the foundations for strong economic development which is necessary for producing the revenues which can be used to spend on social welfare and infrastructure.
However, first let us look at make up of the world economy and recent developments.
According to the World Bank, in 2016, the total value of the world Gross Domestic Product (GDP) - basically the value of all goods and services produced - was $75,600,000,000,000 or simply $75.6trillion (£58.1trillion). With an estimated world population of 7.4bn people GDP per capita works out at $10,216 (£7,858). The composition of world GDP is made up as follows - services 63%, industry 31% and agriculture 6% whilst the world labour force is occupied - 32% in agriculture, 45% in services and 23% in industry.(In rich countries only 1-3% of the labour force work in agriculture)
The largest economy in the world is that of the US with GDP valued at US$18.6tn followed by China with US$11.2tn and Japan with US$4.9tn. In fourth place comes Germany with US$3.5tn followed by UK with US$2.6tn and France with US$2.5tn. The seventh largest economy is India with US$2.3tn followed by Italy with US$1.8tn, Brazil with US$1.8tn and Canada with US$1.5tn. Russia in 12th place has contracted by 25% in the last year - a catastrophic reduction in GDP. This means that US is responsible for 24.6% of total world GDP up from 22.5% in 2014. In the same comparison China has increased to 14.8% from 13.3%. The countries comprising the European Union had 22.1% down from 22.7% in 2014. Another grouping which has gained prominence recently is the BRICS (Brazil, Russia, India, China and South Africa) which currently represents 22.3% of world GDP.
The ten largest economies by GDP in Africa in 2016 were, in 26th place, Nigeria with US$405bn, 31) Egypt US$336bn, 38) South Africa US$294bn, 53) Algeria US$156bn, 58) Morocco US$101bn, 60) Sudan US$95bn, 62) Angola US$89bn, 66) Ethiopia US$72bn, 68) Kenya US$70bn, 81) Tanzania US$47bn.
*According to the World Bank, in 2016, the following countries had the highest GDP per capita in the world (in US$) :-
26. UK 42,100
At the turn of the millennium world economic growth slowed after the frenetic technology boom of the late 1990's and the attack on the USA on 9/11 (2001) leading to large declines in most world stock markets. However, thanks to a combination of low inflation and easy credit, economic activity soon picked up again in the North. At the same time in the South, led by China and India, many developing economies were growing rapidly sparking a huge demand for raw materials and commodities. As a result the world economy has probably never seen such balanced growth as it did in the years 2003-7.
This universal fast-track growth, however, began to show worrying signs of coming apart towards the end of 2007 with easy-lending, particularly in the US, provoking a sub-prime mortgage crisis. Encouraged by politicians, many US banks literally threw lending criteria out of the window as they fell over each other to lend money to people who would not normally qualify for a mortgage in the mistaken belief that the laws of economics had been usurped and there would no longer be cycles of boom and bust. Where the US leads, other advanced countries are not usually long in following, and property lending exploded in UK too. With so much new business coming through the banking system and profits booming, US banks now started to 'splice and dice' their mortgage books in order to give other banks a part of the action and to pass on risk. This was literally pass the brown paper parcel big time and when the music stopped some of the most respected banks in the world had been found to have failed to realise what they had been buying into, and share prices slumped. Some banks like Lehman Brothers in the US were allowed to go under; others like the Royal Bank of Scotland, a bastion of conservative banking in Scotland since 1727, but run by megalomaniac Fred Goodwin who lacked any banking qualifications, suffered the ignominy of being baled out by the UK government and now, some 9 years on, UK taxpayers still hold 73% of the bank.
The resulting credit crunch affected most rich countries and led to dramatic cuts in interest rates in the West along with huge government support for the ailing banking sector. Meanwhile commodity prices which had risen to record levels started to fall back rapidly from the third quarter of 2008 leading to a huge fall in inflation throughout the world. With low interest rates in place coupled with benign inflation, and with China and India still expanding rapidly, OECD countries slowly started to pull out of recession. However, the debts built up by Western governments through the 'naughties' were now becoming unsustainable and investors started to become concerned for their investments.
Some countries in the Eurozone (Italy, Greece, Ireland, Portugal) now had debts which exceeded annual GDP and there was concern, too, about Spain being able to service its loans. Dramatic cuts in public expenditure were now the order of the day leading to a sharp increase in unemployment and civil unrest in those European countries bordering the Mediterranean. Pre-euro these Mediterranean countries would have devalued their currencies as part of a solution but being part of the Eurozone this was no longer an option. Instead huge cuts in public services were demanded by northern Eurozone members in return for massive amounts of bailout funds delivered through the European Central Bank. With the Euro crisis still simmering below the surface and with many nations in the Eurozone still trying to reduce budget deficits, the pace of economic growth across the region became sclerotic. Although in 2017 many EU economies are starting to show some signs of life.
During this period of low interest rates the the US and UK economies picked up a head of steam though China, looking to increase domestic living standards, started to slow from annual double digit growth to 5-7%.
(In the West, most governments seem to take the view that the revenue generated from taxation is not enough to provide the services they believe their people need and want. This means resorting to borrowing. But in so doing they could be said to be giving their people a standard of living which they are not entitled to for borrowing can only ever be taxation deferred: for governments can only ever repay money borrowed from future taxation which means that future generations will have to pick up the bill. In many countries in the West this borrowing binge has now become excessive and, with little or no economic growth, the burden is now reaching the limit for many lenders. For example, in 2001 the UK's debt-to-GDP ratio stood at 30%; and in 2017 it is now 89%. In Germany it is currently 81% and in France 84%. In the US the ratio is 100% and in Japan 225%. And to compound the problem the US has just lost its prized AAA rating from US credit rating agency Standard and Poor's which the country had held since 1917)
The best way to promote economic growth is considered by most economists to be in the form of a mixed market economy where government provides the essential services like health, education and infrastructure and private enterprise is encouraged to set up businesses. In order for private enterprise to flourish it is considered that the capitalist system based on private ownership of property, business and industry directed towards making the greatest possible profits will create the largest number of jobs and provide the tax revenues needed by governments to invest in social services. In this way it is left to individuals and companies to decide what to produce, how to do it and for whom. And the best way to forge strong working relationships in companies is to pay workers a fair wage, provide good working conditions and to keep employees informed.
As well as providing essential services governments also have the duty to regulate both the private and public sectors ensuring that the rule of law is always adhered to. At the same time governments must guard against monopolies being created where lack of competition means that consumers pay exorbitant prices. Governments should also seek to help enterprise to flourish by keeping taxes low and fair and balancing budgets over the economic cycle. But the hand of government should be as light as possible for the freer the economy, the higher the growth and the richer the people. And monetary policy which incorporates adjustments in money supply, controlling inflation and setting interest rate levels is best left to an independent central bank so that politics does not get in the way when, for example, a presidential or general election approaches.
The World Bank produces annually a set of world governance indicators including one which assesses the ability of individual governments to formulate and implement sound policies and regulations that permit and promote private sector development. And the following countries are considered to have the firm but lightest of touches in facilitating and regulating economic activity:- Denmark, Luxembourg, Hong Kong, Singapore, UK, Ireland, New Zealand, Netherlands.
At the other end of the scale stand those countries where Communism or state control raises an iron fist over most aspects of economic activity:- North Korea, Zimbabwe, Burma, Turkmenistan, Eritrea, Cuba, Afghanistan, Timor-Leste, Iran, Belarus, Venezuela. In these nations, with most industries in state control, innovation and enthusiasm for work is limited and pay is usually unified across each sector.
A further comparison can be made here if we look at West and East Germany in 1989 after 40 years of separation under 2 different systems from the end of World War II. The capitalist West Germany was a modern dynamic country whereas East Germany, through state direction, produced second-rate goods for markets which no longer existed. Further comparisons can be made between South and North Korea which have been separate countries for 50 years. GDP per head in free South Korea is $27,600 whereas in totalitarian North Korea, where hunger is a recurring problem, GDP per head is just $620.
Capitalism, then, as an economic system has much to recommend it but there does seem to be a problem - capitalism doesn't seem to export successfully to poor countries. Numerous attempts have been made but most have ended with failure. So what can the problem be?
In his book ‘The Mystery of Capital’ economist Hernando de Soto suggests that the main problem for the developing world in trying to establish capitalism is the actual raising of capital itself. And yet he goes on to say that the poorest people in the developing world are sitting on phenomenal amounts of savings. However, they are generally held in imperfect forms in the shape of homes built on pieces of land which are not recorded, crops growing in fields with no title deeds and businesses set-up outside the law.
He compares this situation to life in rich countries where every house, business and piece of land is registered and therefore recognised under the law. As a result loans and mortgages can be raised against them thus enabling owners to inject life into their fixed assets.
Countless millions of people in the developing world live in makeshift homes in great urban slums on government owned land. Most of these homes are probably unregistered and even if anyone wanted to come within the law, it could take years to cut through all the red tape and probably cost too much. So these people perch perilously side-by-side on the wrong side of recognition, destined to remain in poverty. Even in many villages, homeowners cannot get title to their house as the land is only lent to them by the chief for, as all land is owned by the tribe, he has no authority to dispose of it.
A permanent recognised address is important for other reasons too. It gives access to credit, insurance and utility services. It also acts as an indicator to the authorities about where there is a need for schools and medical centres.
In conclusion, de Soto estimates that as many as 80% of the people in developing countries may hold assets that are unregistered by the authorities. Keeping this potential capital locked-up out of the system is an huge drag on improving living standards throughout these countries. Poor countries should work to free up the system, recognise these unofficial homes and bring order and potential benefits out of chaos and decrepitude.
There also needs to be land redistribution in many countries - it cannot be right for 1% of the people to own 50% of the land whilst 50% of the people often only own 1%. Many of these large estates include land that is perfectly able to be farmed but is left barren. Here, these tracts of land should be purchased by the state for a nominal price and divided up amongst interested families. Encouraging people back into villages with the promise of a plot of land will help ease urban squalor whilst at the same time increasing the supply of food and giving the promise of a better quality of life to those willing to move. The worst culprits here are Namibia, South Africa, Comoros and Seychelles.
Carrying through these reforms should help desperately poor countries lay the basis that will enable them to develop mixed market economies. However, it will not be easy and success will require strong leadership by government ministers and civil servants. But the rewards are huge and there are no greater success stories of mixed market economies alleviating poverty than the recent transformation of China and, to a lesser degree, India.
In the 30-35 years since it opened up, the Chinese economy has grown 8 fold, incomes have quadrupled and the rate of absolute poverty has fallen from 88% to just 2%. When the agricultural communes were disbanded, the Chinese government started to separate business from government and encouraged the setting up of small companies. The economy flourished with economic growth for the period from 1980 to 2010 averaging over 10%. China has also achieved huge current account surpluses with low inflation. With its extraordinary pool of labour and educated graduates and a social welfare programme to help those thrown out of work, this momentum behind the Chinese economy has now made it the second largest in the world.
In the same time frame, in India absolute poverty has fallen from 50% to 20% in a country that has never quite embraced the same enthusiasm for mixed market economics as its near neighbour.
*Citigroup has recently produced estimates for 2050 of countries with the highest GDP per capita (in US$)
Looks like the balance of world economic power could be shifting east!