More Well Kept Secrets

Originally published Aug 19, 2006

I wrote about the four times expansion in world wide per capita GDP here a couple of weeks ago. It all started because I was wondering how much economic activity had expanded during the second half of the 20th century and after some searching found the web-site of Berkeley economics professor Brad DeLong who likes to develop economic statistics that give us a very broad view of human economic activity.

Here again is how that period 1950 -2000 looked on a graph.

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Now the fun begins: here is DeLong’s figures for 1750 to 1950:


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Once growth gets going about 1800 per capita wealth doubled about every 50 years or about half the rate of growth we have seen in the second half of the 20th century. It was mostly confined to Europe and North America and, at the beginning, we had little idea how these new economic forces worked or to how deal with their impact economically or socially. But we were pretty quick off the mark. Adam Smith founded the field of economics in 1776 with the publication of The Wealth of Nations. His ideas are still relevant today as can be seen from this discussion of markets taken from the article about him in Wikipedia:

One of the main points of The Wealth of Nations is that the free market, while appearing chaotic and unrestrained, is actually guided to produce the right amount and variety of goods by a so-called “invisible hand” (originally written in Moral Sentiments). If a product shortage occurs, for instance, its price rises, creating a profit margin that creates an incentive for others to enter production, eventually curing the shortage. If too many producers enter the market, the increased competition among manufacturers and increased supply would lower the price of the product to its production cost, the “natural price”. Even as profits are zeroed out at the “natural price,” there would be incentives to produce goods and services, as all costs of production, including compensation for the owner’s labour, are also built into the price of the goods. If prices dip below a zero profit, producers would drop out of the market; if they were above a zero profit, producers would enter the market. Smith believed that while human motives are often selfish and greedy, the competition in the free market would tend to benefit society as a whole by keeping prices low, while still building in an incentive for a wide variety of goods and services. Nevertheless, he was wary of businessmen and argued against the formation of monopolies.

As industrialization spread the invisible hand of the market did not solve all problems and, to skip ahead, by 1848 Marx and Engles would write in the Communist Manifesto ‘Workers of the world unite – you have nothing to loose but your chains.” The workers driven from their subsistence farms to work in urban factories were not doing well economically or socially and Marx and other reformers were intent on creating an entirely new economic and social system to force a more equitable distribution of the new wealth created by the industrial revolution. A central feature of Marx’s prescription was to seize the means of production from the owners and initially have the state run them on behalf of the workers. I mention just these two thinkers because they still define the poles of an argument that goes on to this day between ‘socialists’ and ‘capitalists’.

The argument between various forms of revolutionary socialism and capitalism raged all though the second half of the 19th century and into the 20th. But a third or middle way began to emerge because many felt that, although some kind of reform was needed, completely overthrowing the capitalist system made no sense because it was the main source of the material productivity that was transforming human life. What these middle way approaches had in common was that they proposed retaining to one extent or another the market driven economy that Adam Smith described, but use the state, not as owner of the economy, but referee to reform and regulate it. In 1914 disaster struck in the form of WW1 and in the ensuing social chaos the Russian Revolution gave Communism its big chance. Little more than an decade later capitalism crashed, confirming for many, Marx’s prediction that it was unsustainable. 1929 was also a big opportunity for Communism but it was also a chance for proponents of various middle ways to advance their solutions. My father, studying economics at Columbia in New York in the early 30s, was no fan of Communism or Fascism but at that time it looked to him like either one or the other would prevail. The middle way solutions seemed likely to be swept aside by revolutions driven by the economic and social desperation of the depression. And. indeed, that is what largely happened in Europe. Germany and Italy became Fascist and fought a proxy war with Soviet Russia to decide the fate of Spain which led on to WW2. But in the US the middle way did prevail decisively in the thirties and both France and England resisted the extremes as best they could.

After WW2 Communism seemed destined to become the dominant socioeconomic system quickly taking over eastern Europe and China. It came close to taking over Greece, Italy and even France, but the West, led by the US, managed to check Communism’s advance. In the long period of the Cold War it was not at all clear which system would prevail. When in turn I went to study at Columbia in the early 60s Eastern European style ‘command economies’ were normally presented as a kind of alternative way of doing things – neither superior nor inferior. I recall I was certainly skeptical of the more zealous partisans on both sides. It did not become clear until after the end of Communism in Eastern Europe and Russia just how poor the economic performance really had been. In one sense it was Western Europe that was pivotal. The US restarted the Western European economies destroyed by WW2 with the Marshal Plan, but it was the Europeans themselves who made the system work. We didn’t recognize it fully at the time, but by 1961 the weaknesses were becoming apparent. The Berlin Wall wasn’t built to keep the West Berliners out; it was built to keep the East Berliners from escaping to the greater political freedom and economic opportunity in the West. In my view the single biggest lesson of the fall of the Soviet empire was that Marx’s idea of total state ownership of the means of production proved, despite its theoretical appeal to many, to work very poorly indeed in comparison to market economies. While the more rapid economic recovery of the Eastern European economies, such as Poland or Hungry demonstrate that the Russians were not the most able practitioners of total state ownership, I believe it is the Chinese choice to move to a market economy that conclusively demonstrates the failure of the concept.

Although the Chinese are still Communist politically, and refer to the development of a Chinese market economy as ‘Communism with Chinese characteristics’ they started the move away from total state ownership of the means of production over ten years before the Berlin wall came down. According to Wikipedia:

Economic reforms started since 1978 have helped lift millions of people out of poverty, bringing the poverty rate down from 53% of population in 1981 to 8% by 2001.

I never thought I’d see serious economic recovery on this scale in China in my lifetime. Although the details are very different a similar change is taking place in India. Look again at this world map of GDP by region. Remember this represents total GDP or economic output as size not GDP per capita.


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In the next post in this series I want to look more closely at the reasons why market economies have succeeded since WW2 and not fallen back into the boom bust cycle that brought them to their knees repeatedly in the from 1750 to 1929.

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