Dysfunctional Institutions Hinder Wealth Creation

Insights from Niall Ferguson's The Great Degeneration which I started writing about yesterday.

"A Postmodern Man"

Understanding (past) Western success helps us understand more urgent questions about the recent past, the present and potential futures. 

Nogales, bisected by U.S-Mexican border, is an example of how differing economic and government institutions produce different outcomes for the masses. The difference in living standards for the two halves of the city is shocking. 

Similarly, Germany and Korea have been object lessons in the disparity of outcomes that occur based on the institutions that rule them. South Korea and West Germany had Capitalist institutions. North Korea and East Germany had Communist ones. The divergence in outcomes "within a few decades was enormous." When the walls came down in Germany, many Western observers were eager to see how far behind East Germany was from it West German counterpart. The consensus expectation was that GDP in East Germany would be about 70-75% of West. The pundits were shocked to find East German GDP to be 35% of the Germans who experienced freedom and Capitalism.

Botswana in Africa illustrates how wealth and growth can take place when its people are not plagued by corruption or civil war, like what has been occurring in the Democratic Republic of Congo. The difference in wealth between the two Sub-Saharan nations was directly related to the institutions that ran them.

Ferguson cites The Mystery of Capital by Peruvian economist Hernando De Soto, who analyzed the barriers to wealth that bad institutions erect. 

In Lima, Peru, we see a diabolical dilemma that occurs in many places around the world. The problem is that though the poor living in shanty towns have a lot of property, it is not legally recognized as theirs by the governing officials. Getting legal title to a house or workshop is near impossible. To get a permit for a garment workshop on the outskirts of Lima took 289 days. To get the legal documents to build a house took six years and 11 months, during which time they were forced to deal with 52 different government offices. 

In short, dysfunctional institutions force the poor to live outside the law. The amount of real estate owned but not legally held by the poor of developing countries is more than 9 trillion dollars. This is pretty much dead money because if they owned their properties they could borrow against it and leverage it to generate more wealth.

DeSoto's research in cities around the world demonstrates that wealth creation has less to do with cultural differences than with the establishment of good legal structures and property rights. As one reviewer notes, "This book clearly states the importance of legal property ownership and the value of using the equity of owned real state to have access to capital." Or as Ferguson puts it, "Only in a working system of property rights can a house become collateral and its value be properly established by the market."

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Later in the book Ferguson details how institutions have slowly become barriers to economic development in this country. He cites the example of a lemonade stand in New York City that took six months to get permits and approvals from the innumerable city gatekeepers. 

Here in Duluth we have a similar bundle of barriers. One contractor whom I spoke with recently said, "I'm so frustrated with the city that I won't do business here any more. 99% of the problems come from City Hall." He told me it took three months to acquire a permit to raise a (garage) foundation two feet. "In Hermantown (an adjacent city just over the hill) it would take one day."

This is an issue I will be zeroing in on in more detail sometime in the near future.

 

Links

The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else

 

Why Civilizations Fail: Niall Ferguson Sounds A Wake-Up Call

I just finished reading, for the second time, The Great Degeneration: How Institutions Decay and Economies Die, by Niall Ferguson. Ferguson, who hails from Scotland, is one of the world's foremost historians. He's a senior fellow at the Hoover Institute, Stanford University, and a faculty fellow at Harvard. 

The titles aren't what make his writing interesting. Rather, it is the clarity of thought and the scope of his ideas. To best understand what is happening in the world today, historians help bring perspective that most everyone has lost sight of because they are so focused on being "up to the minute," making sure we're in the loop with the latest statements or faux pas of the politicians we love or hate. 

One of the matters that this book addresses has to do with Western Civilization. Since there have been all kinds of civilizations over the ages, why do some rise up above the rest at various times? And how did Western Europe grow in strength and influence so that it came to dominate the world? 

There has been a lot of well-deserved criticism of the evils committed by the nations of Western Europe, not the least of which was the slave trade and exploitation of others' natural resources. Ferguson's book provides insights on how Western Civilization achieved the power that it did, and why this occurred in Europe and not elsewhere. 

Explaining the Great Divergence

People suggest a variety of explanations for the divergence in outcomes in quality of life for various people groups. For Ferguson, "Institutions, more than geography, natural resources, climate or even the incidence of disease, have a greater impact on societal outcomes."

Why did Western Civilization fair so much better than other civilizations? Ferguson writes that from the 1500s to the late 1970's there was an astonishing diverging in global living standards.

"As of 300 years ago the average Asian achieved the same as the average Westerner. As of 1978, the average American was 22 times richer. Why?"

Not only in wealth but also in health did we see this. In 1960, life expectancy in China was in the late 40s, whereas in the U.S. it had reached 70.

"A minority of mankind had both a material and political dominance over the rest. Why?" 

It had nothing to do with racial superiority, he notes. Nor did it have to do with natural resources, geography, climate or topography.  In other words, there were no outward signs to indicate Europe would outshine the great Oriental empires. 

Nor can the achievements of Western Europe be explained in terms of imperialism. Other empires did plenty of that as well. 

In point of fact, from 500 to 1500, which we now refer to as the Dark Ages, there was really nothing to suggest that this corner of the world would break out and expand its rule over a majority of the known world.

Ferguson believes that the reason for disparity in the great divergence between the Western end of Eurasia and the Eastern end has to do with the institutions that developed.

England was the first nation to embrace pluralistic rather than extracted political institutions. Spain was not and as a result, the political systems exported to the New World (North and South America) produced different outcomes. Protestantism was also a part of this influence.

Institutions are what matter. 

Here are a few points he makes early in the book:

--Dysfunctional institutions are what force the poor to live outside the law.

--The "rule of law" has no analogue in the non-human world.

--Good institutions are hard to achieve. Bad institutions are easy to get stuck in.

And then there's the big question that seems to be the overarching theme of this book: WHY DO INSTITUTIONS FAIL? 

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Niall Ferguson concluded that the rise of the West was due to four things, which he calls the Four Black Boxes. The bulk of this book is comprised of a deep dive into the meaning of these four elements.

1. Democracy -- the consent of the governed.

2. Capitalism -- and the vibrant society healthy markets produce.

3. Rule of law -- secure property rights, fairness and (in theory) equality.

4. Civil society -- how we treat one another.

The book was published ten years ago, and much of what we're seeing today is the crumbling of our culture. A very real degeneration is occurring right before our eyes. For the past half century we have been in decline and the evidence is all around us. 

Here are four areas where we have been failing.

--Failure to enforce property rights.

--Failure to uphold the rule of law

--Failure to understand economics, and defend the wealth creation capabilities of Capitalism.

--Failure to support the foundations of civil society.

As time permits I hope to share a more details regarding the Four Black Boxes of Civilization and why we need to wake up. To defend what really matters we need to understand what's really happening.   

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Related Link
Decline of the West: Historian Niall Ferguson Sounds Wake Up Call