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In From Poverty to Prosperity, Arnold Kling and Nick Schulz explore the causes and implications of economic growth. After citing studies which show how the unprecedented economic growth in the last two centuries has made us healthier, wealthier, smarter and afforded us more leisure time, the authors investigate why so many countries are lagging behind. This leads to results from a study by the World Bank where researchers calculated what proportion of each country’s wealth was due to tangible assets (natural resources and physical capital) by comparing wealth per capita with what it would be given an unskilled workforce. The study found that the tangible resources in the richest countries accounted for only a fraction of the countries wealth – approximately 15% compared with 50% in the poorest countries. Most of our prosperity is due to intangible assets such as technology, know-how, a well functioning legal system and trust. Surprisingly, many poor countries actually have negative intangible assets: political, social and economic institutions in these countries are actually doing more harm than good. These destructive factors are the hidden liabilities which impede growth.

The authors argue that conventional economics does an inadequate job of explaining growth as it is too focussed on maximising “static efficiency”. In this framework the level of technology is taken for granted and we try to grow the economic pie by reducing market failures and eliminating inefficient regulations in pursuit of the ideal of perfectly competitive markets. The authors instead advocate an Economics 2.0 which promotes “dynamic efficiency”. This requires an economic environment that is conducive to innovation and adaptive to the unforeseeable changes that developments in technology will produce. Firms should be free to enter and exit markets and those that cannot keep pace with innovation should be allowed to fail to free up resources.

The highlights of the book are undoubtedly the interviews with great economists who offer insights into the nature of economic growth and innovation. Take William Lewis on why multinationals cannot always compete against far less productive domestic rivals in developing countries:

Our interview with [hypermarket chain] Carrefour in Russia was really a watershed, because Carrefour said, “Well, we know all about Russia. We can handle most of the problems in Russia. We don’t have trouble with red tape and bureaucracy. We can handle bribes. We know all about bribes. We can even handle any threat to our physical security. We’ve been in tough situations and we can make our people feel secure. What we can’t handle is not making money. And you can’t make money in Russia.”

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We found that Carrefour’s competitors were doing a number of things that Carrefour could not, or would not, do in their business practices. Imports were flooding into Russia and many of the local domestic producers were selling smuggled goods, on which they had not paid import tariffs, and counterfeit goods. McKinsey did a study of the vodka industry in Russia and found that 40 percent of the vodka sold in Russia was not made by the company whose label appeared on the bottle – so much for the value of the brand. And then we looked at taxes. Taxes have to be collected on the final sales price, what the customer pays at the cash register. Carrefour, as with virtually all multinationals, pays its taxes because they cannot afford to do otherwise. And it was not just the profit taxes; it was, in fact, other taxes that made the difference. The sales tax, the value-added tax, the employment tax – all of these would be rolled into what the consumer would pay Carrefour for any given goods or services. When you added all that up and compared it with what their competitors were doing – competitors who by and large were not paying these taxes – Carrefour could not make money.

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But then you might say: the rich countries today have high taxes and big government. Why doesn’t that matter? The reason it doesn’t matter today is that everybody is formal. [...] The no-man’s-land that the poor countries have gotten into now is having gone to big governments before they can afford it, before informality has been phased out or driven out by high-productivity operations so that they can have both big government and informality.

The authors’ own insights are also interesting with discussions about the nature of entrepreneurship and a useful analogy of the intangible assets being the software layer of the economy and the physical capital the hardware. However I would have liked more from the authors themselves as I felt their arguments always fell short of delivering a truly new viewpoint. What role is there for antitrust in promoting dynamic efficiency? Many of the interviewees consider this important yet the authors only briefly mention that competition regulation is often too slow or captured by incumbent firms. The section on intellectual property, which I fear will become a roadblock to dynamic efficiency, seemed unambitious: just stating the standard arguments for and against IP.

From Poverty to Prosperity is a fascinating read filled with insights from Schumpeterian thought, new institutional economics and economic history. Highly recommended.