Wednesday, October 27, 2010

Economic Expansion and Development: To What Extent a Mystery?

William Easterly has a noteworthy post on his excellent blog Aid Watch in which he links to a New York Times article arguing that "Development is an unpredictable business." Consequently policies that seemed to work in one time and place did not work in others. The author the the Times piece notes:
For all its temptations, however, the search for a policy toolkit toward development is fraught with pitfalls. Over the last 60 years or so, the international development community has come up with model after model, theory after theory, in search of just such a toolkit.
While it is certainly true that one state plan after another has failed, Easterly is also right to warn that, when analyzing economic policy as it relates to economic development, we don't want to ignore fundamental economic principles merely because of a seeming lack of rhyme and reason.

As I explain in the last chapter of Foundations of Economics, economic theory has a lot to teach us about the engines of prosperity. Sustained economic expansion and development is the result of increased productivity. To achieve increases in productivity, we need to take advantage of the market division of labor, capital accumulation, and wise entrepreneurship. Such activity requires an institutional framework of private property. Economic law, consequently, constrains us from achieving lasting prosperity through state intervention and central planning.

The tricky thing about economic development, however, is that even an environment of private property will not guarantee economic development. In a free society people are not forced to save and invest in capital accumulation or to undertake entrepreneurial activity. Private property only allows for the operation of the engines of prosperity; it does not guarantee that they will operate. Whether they do so ultimately will be decided by people acting on their subjective preferences. 

That explains the mystery. The very freedom required for economic development also allows for the possibility that economies will not develop. Different people may act differently in the same institutional environment. Changing the rules will not necessarily change outcomes exactly like we want. What economic expansion and development requires is not that mysterious. The uncertainty that remains stems from personal values.

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