A few months ago, the White House released its “New Strategy Toward Sub-Saharan Africa,” which contains four key bullets summarizing its approach. The first, and most important, goal is one that has been a pillar of American foreign policy for decades: “Strengthening democratic institutions.” The State Department has tried to use a variety of carrots and sticks to make this a reality, including providing incentives for implementing democratic reforms in the form of of financial and in-kind aid. In the most recent Economist, one of the lead articles calls for Western nations (specifically, the United States and Great Britain) to withhold aid from Rwanda, in protest of the Kagame government’s alleged human rights abuses in his own country and in the neighboring Democratic Republic of the Congo.
But, in this post, I’m less interested in discussing how to achieve democratic reforms than explaining why they are important. With China’s model of “state-run capitalism” running circles around paralyzed developing-world democracies like India – a country whose legislative gridlock and inept bureaucracy produced a two-day blackout – and a largely-autocratic government in Rwanda producing remarkable reforms (I saw them firsthand in the beautifully-run capital of Kigali), some people have challenged the notion that democracy is the answer. But, if democracy is executed well, as it is in Ghana, the rewards are increased wealth, though not in the form you might expect.
There is a concept called “intangible wealth,” which refers to the wealth created by functioning institutions. And, according to a study by the World Bank, intangible wealth accounts for a huge part of a country’s overall wealth. In an article titled “The Secrets of Intangible Wealth,” Reason magazine explains the concept in greater detail:
Two years ago the World Bank’s environmental economics department set out to assess the relative contributions of various kinds of capital to economic development. Its study, “Where is the Wealth of Nations?: Measuring Capital for the 21st Century,” began by defining natural capital as the sum of nonrenewable resources (including oil, natural gas, coal and mineral resources), cropland, pasture land, forested areas and protected areas. Produced, or built, capital is what many of us think of when we think of capital: the sum of machinery, equipment, and structures (including infrastructure) and urban land.
But once the value of all these are added up, the economists found something big was still missing: the vast majority of world’s wealth! If one simply adds up the current value of a country’s natural resources and produced, or built, capital, there’s no way that can account for that country’s level of income.
The rest is the result of “intangible” factors—such as the trust among people in a society, an efficient judicial system, clear property rights and effective government. All this intangible capital also boosts the productivity of labor and results in higher total wealth. In fact, the World Bank finds, “Human capital and the value of institutions (as measured by rule of law) constitute the largest share of wealth in virtually all countries.”
Once one takes into account all of the world’s natural resources and produced capital, 80% of the wealth of rich countries and 60% of the wealth of poor countries is of this intangible type. The bottom line: “Rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity.”
Intangible wealth helps explain why some countries are rich and others are poor. At some level, natural resources, climate, strategic geography, and proximity to water and coastline are important. But it is not hard to see why well-designed and functioning institutions are critical to growth. Let’s dissect the components.
According to the report, the rule of law accounts for 57% of a country’s intangible wealth – by far the largest percentage. So how does the rule of law facilitate economic growth? One big reason is the enforcement of contracts. Businesses and individuals need to have confidence that, when they enter into an agreement, the terms of the agreement will be respected by the other party. Contracts enable investment, which provides capital to allow business to expand. In the United States, the legal resources for lenders and negative repercussions for borrowers have led to a financial system that offers the cheapest credit in the world (perhaps too cheap). In contrast, in Africa, interest rates on a business loan might be 10-20% or more, since the legal channel for dealing with default is obscure or corrupt or non-existent. As a result, investment capital is difficult to source and businesses find it more difficult to grow.
Another example is corruption. In Kenya, the port in Mombasa, a coastal city, competes with Dar es Salaam, the capital of Tanzania, for ocean cargo throughout East Africa. Both ports operate at a fraction of their capacity because of the corruption that has prevented their modernization and the streamlining of the process. Here are a few illuminating statistics:
- It takes 19 days to move a container from Singapore to Kenya, and another 20 days to move it by road from Mombasa to Nairobi. It takes 71 days to get a container from Burundi to anywhere in East Africa.
- The cost of shipping in East Africa is 70% higher than in the United States and Europe.
- The port in Singapore processes more cargo in one week than the Mombasa port does in a year.
If the government of Kenya invested money in modernizing the port, rather than embezzling the money intended for improvements, and ran the port at the same level of efficiency as Dubai, Singapore, or Hong Kong, it would add several points to the country’s GDP. Better yet, if it privatized the port, which is what most shippers would prefer, and enforce anti-corruption laws, the amount of wealth generated would be massive.
The second largest component is education, which accounts for 37% of intangible wealth. It is not difficult to see why investment in human capital pays dividends for an economy in the long-run. Providing a strong primary and secondary education to all students, and establishing a robust post-secondary education system prepares people to compete in an increasingly global marketplace. This, in turn, generates greater income and accrues more wealth for a country.
The American Enterprise Institute – a thinktank that I don’t typically agree with – provides a list of some other reforms that facilitate the generation of intangible wealth and alleviate poverty:
- Establish and maintain the rule of law.
- Focus the jurisdiction of government primarily on maintaining the rule of law, and limit its jurisdiction over the economy and the institutions of civil society.
- Implement a formal property system with consistent and accessible means for securing a clear title to property one owns.
- Encourage economic freedom.
- Encourage stable families and other important private institutions which mediate between the individual and the state.
I do not think that democracy has a monopoly on producing a strong legal system and a good education system. I do, however, think that the United States has one of, if not the best, legal systems in the world, and a good education system, despite the glaring inequities I discussed the other day. Despite its shortcomings, of which there are many, the American democratic system has produced an immense amount of intangible wealth for the country. It is a good model for other countries to emulate. And, if executed well, the potential dividends are huge.
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