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Overcoming
Barriers to Riches
Edward C. Prescott
Arizona State University
and
Federal Reserve Bank of Minneapolis
Key Development Facts
Prior to 1700, constant living standard
varied little across countries and over time.
After 1700, living standards began to
increase in some countries.
After 1850, they doubled every 35 years –
modern economic growth.
Explosive Growth Post-1800
Leader's Per Capita GDP
Relative to Pre-1800 Level
40
30
20
10
1
0
2000 bc
1000 bc
0
1000
2000
U.S. GDP per Capita
32,000
1990 U.S. $
16,000
Trend Growth
2% per year
8,000
4,000
2,000
1880 1900 1920 1940 1960 1980 2000
Source: Maddison
England entered modern growth first, U.S.
and Western Europe a little later.
Many countries entered much later (post1950).
As a result, income disparities widened to
their current huge levels.
Some late starters have caught up; some
have not.
Different Countries Start at Different Times
Per Capita GDP Trends (1990 U.S. $)
32,000
16,000
8,000
4,000
2,000
1,000
500
1800
Leader
Japan
Taiwan
China
1850
Source: Maddison
1900
1950
2000
Regional Growth Patterns
Income: Fraction of the Leader, 1800-2004
1
Western Europe
1/2
Latin America
1/4
Eastern Asia
1/8
China
1/16
1800
1850
1900
1950
2000
Theory of Pre-1700 Period
Land crucial to production. Trade-off between
living standards and population size.
Increases in stock of usable knowledge led to
increase in output. But, population increases
led to no increase in living standards.
Why: Groups maximized living standards
subject to constraint that they could defend their
land.
Theory of Post-1850 Period
No trade-off between increases in living
standards and population size.
Increases in stock of usable knowledge lead
directly to increases in living standards.
Key feature is the use of fossil fuels for
energy rather than land.
Problem with Theory
Why didn’t all countries start modern economic
growth at the same time?
Parente and Prescott’s theory: A society’s
productivity depends on the set of constraints
society imposes as well as the stock of
usable knowledge.
A country loses ground relative to leader prior
to entry into modern economic growth.
Catch-up occurs only if production efficiency
E increases.
Large increase in E leads to growth miracle
with doubling of living standards in 12 years.
Constraints That Reduce
Productivity
Constraint 1: How a technology must be operated
– Examples: Work rules, inspections and bribes. In Brazil:
Full-service gas stations; elevator operators; public
transportation. In Australia: “One-in-all-in,” patmen, one
man one forklift rule; H.R. Nichols Society, vol 3.
Constraint 2: Which technologies can be operated
– Examples: Regulation, laws, bribes. See DeSoto for
problems in opening a small Peruvian business.
Why Constraints Exist
Typically constraints exist to protect industry
insiders with vested interest in current production
processes.
Adoption sometimes leads to loss of employment
and/or earnings either because factor is
specialized with respect to current production
process, or because industry faces inelastic
demand for its product.
A Recent Example
The Segezhabumpron Paper Mill, Karelia, Russia.
(Fox and Heller 2000)
 Early 1990s, Assidoman of Sweden acquired majority
stake
 $100 million planned modernization expenditure
 Fear of job loss
 Campaign to force out Swedes
– Judicial challenge on the legality of purchase
– Threats of violence
– Refusal of regional government to co-fund working capital
Why Country Barriers Differ
Question: What type of arrangements lead to
result that it is not in best interest for industry
groups to block adoption of better technology
(either by threats and protests or by lobbying
government for protection)?
Answer: Being a member of a free
trade club.
Definition of Free Trade Club
 A set of states constitutes a free trade
club if
–
–
–
Members cannot impose tariffs and restrict
imports from other members.
Members have a considerable degree of
economic sovereignty from collective entity.
Property rights of member states are
protected.
USA’s Golden Economic Era
1865-1929
Per capita income went from two-thirds of
U.K.’s in 1865 to 100% in 1900.
Surged past U.K. and in 1928 was 1.3
times U.K.’s.
Why: USA became a free trade club.
EU Labor Productivities
Relative to U.S.
Year
1870
1913
1929
1959
1973
1983
1993
2002
Original EU
62
53
52
53
78
84
102
101
Why Did the Original EU
Countries Catch Up?
Answer: Original EU countries became a
free trade club like U.S. in 1957.
Why Being in a Free Club
Fosters Higher E
 No centralized mechanism to block
adoption of better production processes
in all member states.
 Export industries in state face elastic
demand; implies employment increases
when efficiency increases; thus, no
vested interests in inefficiency.
 Exporters have vested interest in
continual membership in club.
Another Reason
States without groups that will not be adversely
affected by introduction of some technology and
with groups that will benefit want the better
technology adopted there.
Example: Toyota in 1985 located automobile
plant in Kentucky introducing just-in-time
production in U.S. A powerful construction
industry wanted construction project.
Kentuckians wanted high paying jobs in auto
plant. The same thing happened in Wales.
Why Didn’t Latin
America Catch Up?
Latin America is not a free trade club.
If it became one, it would catch up.
What about the Asian Tigers
and other Asian economies?
South Korea and Taiwan were forced by
U.S. and defense needs to permit
efficiency.
Japan did virtually all its catching up after
World War II after occupation forces
imposed new institutions.
Singapore followed policy of openness.
In Hong Kong colonial authority did not permit
constraints that lead to large inefficiencies.
A European-like trading club has developed in Asia.
What about China? It was decentralized in late
1970s, a step in the direction of a trading club.
India has huge diversity and could evolve into a
trading club and become rich.
Conclusion
 Openness good; trade volumes not critical.
 Some reason for hope?
–
–
–
Last election Americans voted for openness.
European Union was expanded by 10 in 2004.
A number of Asian countries are becoming
open countries that are integrated with the
advanced industrial countries.
 Taiwan and four other Asian economies
have become rich.