How economies die

A recent article over at jogged my memory about the way in which an economy commits suicide:
Imagine that Cuba and North Korea became, overnight, the two most free-market, limited-government countries in the world. The two countries would have immediately gained civil liberties and economic freedom, but they would still have to accumulate wealth and to develop their economies. The institutional change affects the political situation immediately, but a new economy requires time to take shape. For example, as China opened parts of its economy to international markets, the country started to grow, and we are now seeing the effects of decades of relative economic liberalization. It is true that many areas in China continue to lack significant freedoms, but it would be a much different China today had it refused to change its institutions decades ago. 
The same occurs if one of the wealthiest and developed countries in the world were to adopt Cuban or North Korean institutions overnight. The wealth and capital does not vanish in 24 hours. The country would shift from capital accumulation to capital consumption and it might take years or even decades to drain the coffers of previous accumulated wealth. In the meantime, the government has the resources to play the game of Bolivarian (i.e., Venezuelan) populist socialism and enjoy the wealth, highways, electrical infrastructure, and communication networks that were the result of the more free-market institutional realities of the past. 
Eventually, though, highways start to deteriorate from the lack of maintenance (or trains crash in the station killing dozens of passengers), the energy sector starts to waver, energy imports become unavoidable, and the communication network becomes obsolete. In other words, economic populism is financed with resources accumulated by non-populist institutions.
All of this is quite correct. Economies are most assuredly not destroyed in a day. The process of economic destruction takes years- even decades- to accomplish thoroughly. It can be accelerated, to be sure- and it can be slowed. But it only be stopped with tremendous difficulty once it is set in motion.

The best parallel that I can think of is between two crown jewels of the British Empire in the East. By the end of WWII, Calcutta- which is the name by which I think of the city, rather than what the Indian government wants us to call it- was once, without question, the wealthiest and most advanced city in the British Raj. By contrast, Singapore was something of a backwater little trading port, "an island city pimple on the arse-end of Malaysia", as one of my teachers once so picturesquely put it. Singapore was a hugely valuable territory to the British, to be sure- it controlled a highly strategic location and was considered to be one of Britain's most impregnable fortresses before the Japanese proved them quite wrong by riding in on bicycles. But to argue that Singapore would someday surpass Calcutta in terms of wealth, technology, power, and prestige would have seemed completely ridiculous in 1945.

Nearly 90 years later, the vast, yawning chasm between the wealth and advanced infrastructure of Singapore, and the poverty and backwardness of Calcutta, is so large as to defy comprehension.

If you are a frequent visitor to both cities- I am- then you might be tempted to ask what the hell happened???

The answer is very simple. Singapore used the power of the free market to grow. After independence, Lee Kuan Yew and the PAP recognised very clearly that following a closed-economy, socialist approach would only destroy the extremely vulnerable Singaporean economy and impoverish its people. They chose instead to build on Singapore's original history as a trading port and regional administrative centre to build a thriving, economically liberated metropolis. The Observer and I can both nitpick till the cows come home about how un-free Singapore's economy really is, but there is no question that when it comes to doing business, Singapore is an incredibly easy place to get things done. Its economy is freer, in terms of regulation and red tape, than America's- by a long way. And because of its infrastructure and its (relatively) free markets, Singapore has proven to be surprisingly resilient against severe economic shocks- far more so than most other Asian nations. During the Asian Financial Crisis, for instance, Singapore's property bubble did not so much burst as quietly deflate, while the shocks to one of the world's most trade-dependent economies were absorbed without the kind of extreme economic dislocation suffered by Malaysia, Thailand, and especially Indonesia. I'm not for one moment arguing that Singapore's government is non-interventionist- you'd have to be smoking something really strong to believe that- but they are vastly less inclined to meddle than, say, the Americans.

When looking at Singapore, it is vital to recognise that Singapore invested heavily in infrastructure through delayed consumption and very high savings rates- up to 50% at certain points in the late 70s and early 80s- that allowed the economy to grow rapidly for decade after decade. Without that capital investment, none of the good things outlined above would ever have come about.

Calcutta, by contrast, is a textbook case of what happens when a socialist government achieves power and then stays there for decades. For something like 50 out of the last 60 years, Calcutta has been ruled by the Communists. No, I am not making that up- and Indian Communism is really more appropriately called nationalist socialism, because that's what it is. (One of the oddest things about Indian Communism is that it infects the most highly-educated states almost universally- West Bengal and Kerala are both heavily Communist, and both are the most highly literate and educated states in the entire country. Evidently it takes a very intelligent person to believe that something as idiotic as Marxism actually works.) Calcutta, long considered the cultural centre of India, has slowly declined and died, strangled of funds and development, choking under the weight of something like 20 million people crammed into it, and ruled over by governments intent only on stripping the city of wealth in order to subsidise the rural poor.

The Communists were able to get away with this for decades, simply because Calcutta was such a wealthy city to begin with. They were able to sponge off of centuries of accumulated wealth, infrastructure, and investment. Unfortunately, what took so many years to build was torn down in far less time, because that's basically what happens when you start stripping the infrastructure of a city, or a nation.

I'll put this in very concrete terms. Let's say you stop investing in roads, deciding that the money would be better put to feeding the homeless and the indigent, because justice, or something. Sure, you'll get away with it for a few years, but the roads themselves will become potholed and dangerous. It will not take that long before they decay to the point of being virtually unusable (anyone who's driven in Manhattan knows what I'm on about). But this causes both short- and long-term knock-on effects in the process of decivilisation. For instance, goods and services can no longer move as freely or as easily, which jacks up the cost of doing business and robs people of incomes and wealth by raising prices. Those increased prices force consumers and producers- who if you think about it are one and the same- to switch to less costly factors of production. Eventually things will get so bad and so expensive that it will be cheaper for them to move to places that are investing in infrastructure, while eating the up-front cost of doing so and the dislocating longer-term effects. As the smart and the talented flee from the government's "spread the wealth" policies, the stupid and the feckless are left to squabble over the increasingly dilapidated ruins of what is left.

The astute reader might recognise, by the way, that this is literally the entire plot of Atlas Shrugged, except in one paragraph instead of 900-odd often very tedious pages. Now you don't have to read the book. You're welcome. (I still think you should, it's actually very good.)

And this is precisely what has happened to Calcutta, and is now happening in the United States. As the government in this country insists on using redistribution to "solve" (read: exacerbate) the nation's severe structural economic problems, the result will be the slow destruction of the country's basic infrastructure. The US certainly isn't replacing its infrastructure or replenishing its once vast stores of capital; the savings rate here has been zero or negative for years, and the government is spending with such reckless abandon that one might wonder if politicians even understand how to balance their own personal cheque books. Eventually, this country will consume its entire accumulated store of wealth and will be forced to impoverish future generations to such a degree that... oh wait, that's happened already.

The lesson of history is very simple: no economy dies overnight. Economies die through decades of malfeasance, stupidity, and short-sightedness in the name of "social justice". The best way to kill an economy is to rob people of the incentive to save and invest, whether through high taxes, ridiculous regulations, or stealthy (and sometimes not-so-stealthy) inflation.


  1. Funny. Ireland experienced a massive boom in the early 90s and it was driven by low corporate tax rates and free market practises before being driven overboard by shitty banks, borrowing at low interest, classic Business Cycle theory stuff. Now the country's government are becoming more and more socialist, have plenty of mates myself working in statistics department where they have toos "smooth" the figures.

    Fuck this shit ken. Economics is pretty simple in a lot of ways, and cannot be modelled with bullshit models. I've taken looks at some of them econometrics models and forecasting stuff, looking at the maths en aw, and it be all cuckoo clock stuff, or at least to me. The future is too uncertain, too messy to model (unless it be something like bonds or something). Yous lads are using crazy shit like Monte Carlos no, or whats the story? Be interesting to sees, from a nerd perspective, what are the specifications of those kind of models. Possible future post ken?

  2. Ireland experienced a massive boom in the early 90s and it was driven by low corporate tax rates and free market practises before being driven overboard by shitty banks, borrowing at low interest, classic Business Cycle theory stuff.

    Quite. The Irish did everything right- except decoupling themselves from the Euro. As a result, every single poor economy within the EU was able to finance its growth at below-market interest rates. Unsurprisingly, a huge bubble developed. I'm not saying that it could have been avoided if the Irish had their own currency- governments love to meddle with interest rates to favour their corporatist cronies- but it would have been possible to go into soft default by devaluing the currency, or go into hard default like Iceland did, without the kind of extremely slow and extremely painful recovery that Ireland is going through right now. All of this was predicted perfectly by ABCT, right down to the way the bubble itself popped.

    Yous lads are using crazy shit like Monte Carlos no, or whats the story? Be interesting to sees, from a nerd perspective, what are the specifications of those kind of models. Possible future post ken?

    Good idea. Stay tuned mate.


Post a Comment

NO ANONYMOUS COMMENTS. Anonymous comments will be deleted.

Popular Posts