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

 

Tech Tuesday: Mark Cuban Predicts AI Entrepreneur Trillionaires

Would it be fun to be a trillionaire? I don't know. I have enough stuff on my plate. And besides, what can you do with a trillion dollars that you can't do with a billion?

This article at CNBC.com makes the sensational claim that one day there will be people who are trillionaires. Is that really possible? The only time I hear the word Trillion thrown around is when journalists and politicos remind us that the U.S. National Debt is getting out of hand.

How much is a trillion dollars? This visualization will help put it into perspective.

The article, though, begs a follow up question. Does Mark Cuban really believe there will be trillionaires someday? Or is he simply building his own personal brand by getting another sound byte?

Another question. Is this first trillionaire making his or her money by actually generating wealth? Or will it simply be generated by skimming foam off all the world's financial markets, exploiting market inefficiencies?

Will this massive wealth accumulation result in improving the standard of living for the world's poor and disadvantaged?

There's another way we can end up with a trillionaire in our lifetimes. That would be for a massive hurricane-force hyper-inflation to set in. Suppose that the government were to start printing hundred dollar bills and everyone received a Ben Franklin for every penny they turned in. Whoever had the most billions at that point would be the first to become a trillionaire. Minimum wage would be raised to 7000 dollars an hour. Would everyone be happy?

Not really. Multiply everything by 10,000 and see what things will cost then and what will be different? A one dollar Reese's Buttercup would suddenly cost ten thousand dollars. One thing that would be changed is our tax brackets. We'd all be paying more taxes until our legislators resolved that matter satisfactorily.

It would also be the end of foreign trade because other countries would not be able to afford our products. They would be quite expensive to produce.

It's hard to wrap my head around the idea of a trillionaire. How bad do we really need fifty car garages?

Maybe Mr. Cuban was simply inviting us to consider that if AI machines can beat the best minds at chess, poker, Go and Jeopardy, that it's only inevitable that they will find ways to "beat the market." I had the same thought last month. How do I get me an AI machine that can do that?

The Markets don't take a shine to being beaten, though. Back in the late 70's the Hunt brothers found a way to corner the silver market. Unfortunately, the Commodities Exchange changed the rules of the game and the boys lost their shorts.

Fortunately, at this point in time, AI machines are not emotional and vindictive when they lose.

In re-reading Cuban's comments I get the feeling he's just trying to wake people up. The power of AI is already being demonstrated, and it's going to make an impact on our world.

So, what if instead of making a few people into trillionaires we instead use its power to create wealth for everyone?

If this topic interests you, check out my interview last year with Calum Chace, author of The Economic Singularity.

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Meantime, life goes on all around you. Get into it.