Myths of Economic Development

Susumu YOSHIDA (Senior Coordinator, Sumitomo Chemical Co., Ltd.)

"What separates wealthy nations from poor nations?" Alternatively, more specifically, "why have many economies in East Asia succeeded in taking off, while most African nations have stayed mired in poverty?" These are among the basic questions with regard to global economic development, for which many industrialized countries, as well as international organizations such as the World Bank, are still struggling to find clear answers.

"The Oxford Encyclopedia of Economic History" which was published last year by the Oxford University Press, seems to offer some important clues. Dr. James Mokyr of North Western University, the chief editor claimed that this five-volume encyclopedia covered the entire material existence of human beings.

Recently, I had a chance to take a look at it in a bookshop in Oxford, and noted that the encyclopedia certainly provided lots of details, though I must say that some of them are perhaps of trivial importance to the general public today. For example, Somalian farmers used sulfur compounds to kill insects and mites 4500 years ago; and in 1850, the largest employer in the United States was the shoe manufacturing industry.

Based on numerous facts, however, Dr. Mokyr pointed out several very significant propositions. One is that 90% of the income growth in England and the United States after 1780 was mainly due to "technological innovation" rather than "capital accumulation." This presents a major challenge to the well-known proposition described in the classic "The Protestant Ethic and the Spirit of Capitalism" by the German sociologist Max Weber.

According to a new finding of Dr. Mokyr, Protestant thrift, which contributed to generating savings over several centuries, has not been the most important factor for capital growth. This is a striking proposition, and it would be worthwhile to consider the validity or invalidity thereof, as it relates to the fundamental causes of the world's economic development.

The issue here is; what triggered the virtuous accumulation of capital? According to John Maynard Keynes who wrote "The General Theory of Employment, Interest and Money (1936)", from the earliest recorded times, i.e. from 2000BC through the beginning of the 18th century, there was no significant change in the standard of living for the average man across the world; ups and downs certainly, due to visitations of plaque, famine, and war, but no great progressive change.

In general, the vast majority of the population of the classical world and medieval ages were destitute. This lack of economic progress was primarily due to: 1) the failure to accumulate capital; and 2) the absence of important technical improvement.

The modern age opened with the accumulation of capital in the 16th century. This process of accumulation of capital was initiated by the rise of prices and the resultant profits generated by the treasure of gold and silver, which Spain brought to Europe from the New World. It coincided with the beginning of the great age of science and technology.

From that time to the present day, the power of accumulation and compound interest has worked continuously, providing society with the foundation of modern capitalism. The economic pie of Europe started growing in spite of occasional interruptions caused by both natural and man-made catastrophes.

The power of compound interest is mighty. At an annual interest rate of 5 percent, for example, monetary assets will multiply 11.5 times in 50 years. Over the same period of time, however if the interest rate is just 0.25 percent per annum, the same amount of monetary assets will multiply only 1.13 times.

As a footnote, it is interesting that the beginning of Great Britain's foreign investment can be traced back to the huge spoils which Sir Francis Drake brought back to England on the Golden Hind in 1580. Queen Elizabeth was a shareholder in the syndicate, which extended financial support to this secret expedition. She paid off England's entire foreign debt, balanced her budget, and invested the remaining money in the Levant Company. Out of the profits from this venture, the East India Company was founded, and the profits accrued from such venture's operations laid the foundation for England's subsequent dynamic economic growth by means of foreign investments.

Broadly speaking, one of the essential ingredients for the development of modern capitalism is that society must be organized so as to bring about maximum accumulation of capital for incessant growth of the economic pie. For this, society must save, and the people must work diligently, as if it were an end to itself. In America, a culture of hard work, savings and education can be traced back to Benjamin Franklin, and even earlier, to the Pilgrims.

In Japan's case, people had little exposure to Protestantism, but a group of thinkers in the 18th century, including Shozo Suzuki and Baigan Ishida, preached the virtue of diligence and hard work as part of religious practice. They preached that devotion to work was a concrete means to religious enlightenment, and that making and saving money were not immoral. Thus, hard work and saving money became a virtue, and economic growth became a national objective.

In a capitalist society, saving has been encouraged by various means, and it has been expanding through the compounding of interest. The proper functioning of this system is based on the acceptance by society in general that wealth is not equally distributed, and that those who take the lion's share are least likely to consume but will instead save (at least for the time being), and their savings will be invested and multiplied by the mechanism of compound interest year after year. In other words, under the modern capitalistic system, the justification of the "inequality" of the distribution of income is based on the tacit assumption that the corporate management works diligently not for the small pleasure of today, but for the future security, progress and prosperity of society and the people.

This implies that, contrary to what Dr. Mokyr said, for healthy economic development, both the accumulation of capital and technical innovation are essential. An efficient functioning organization, which is run by disciplined and respected management, is definitely another essential ingredient for economic development, but is often missing in a majority of poverty-stricken countries struggling for reconstruction and development.