Exploring the Reasons Behind the Rich-Poor Country Gap by Erik S. Reinert

In the thought-provoking book “How Rich Countries Got Rich…and Why Poor Countries Stay Poor,” Erik S. Reinert dives deep into the stark disparities between wealthy and impoverished nations. This eye-opening work uncovers the hidden truths behind the economic divide that shapes our world.

Discover the eye-opening revelations that will challenge your understanding of global wealth distribution. Keep reading to gain invaluable insights into the complex dynamics of economic success and stagnation.

Genres

Economics, Political Economy, Economic History, International Development, Globalization, Economic Policy, International Trade, Economic Growth, Poverty Alleviation, Wealth Inequality

“How Rich Countries Got Rich…and Why Poor Countries Stay Poor” by Erik S. Reinert is a groundbreaking exploration of the stark economic disparities between wealthy and impoverished nations. Reinert challenges conventional economic theories and argues that the key to understanding the wealth gap lies in the history of industrialization and the role of government intervention.

He contends that rich countries achieved prosperity through a combination of protectionist policies, strategic investments, and a focus on high-value-added industries. In contrast, poor countries often remain trapped in a cycle of poverty due to their reliance on raw material exports and the absence of effective industrial policies.

Reinert’s analysis spans centuries of economic history, drawing upon examples from Europe, the United States, and the developing world to illustrate his points. He critiques the dominant neoliberal economic paradigm and argues for a more nuanced approach that takes into account the unique challenges faced by different countries.

The book offers a thought-provoking perspective on the complex factors that contribute to global wealth inequality and provides insights into potential strategies for promoting sustainable economic development in poor countries.

Review

“How Rich Countries Got Rich…and Why Poor Countries Stay Poor” is a must-read for anyone interested in understanding the root causes of global economic inequalities. Erik S. Reinert’s engaging and accessible writing style makes complex economic concepts easy to grasp, even for readers without a background in economics.

The book’s historical approach provides a fresh perspective on the development of the global economy and challenges readers to question commonly held assumptions about the path to prosperity. Reinert’s critique of mainstream economic theories is well-argued and supported by a wealth of historical evidence.

He convincingly demonstrates how the success of rich countries has been built on a foundation of strategic government intervention and the cultivation of high-value-added industries, rather than the free-market policies often prescribed to poor countries.

While some readers may find Reinert’s arguments controversial, the book provides a valuable counterpoint to the dominant neoliberal narrative and encourages readers to think critically about the policies and practices that shape the global economy. One of the strengths of the book is its emphasis on the importance of context in understanding economic development.

Reinert argues that there is no one-size-fits-all solution to the problem of poverty and that successful strategies must take into account the unique historical, cultural, and geographical factors that shape each country’s economy. This nuanced approach is a refreshing departure from the simplistic policy prescriptions often offered by mainstream economists.

Overall, “How Rich Countries Got Rich…and Why Poor Countries Stay Poor” is a compelling and thought-provoking read that offers valuable insights into the complex dynamics of global wealth and poverty. It is a must-read for policymakers, economists, and anyone interested in understanding the root causes of economic inequality and the potential paths to a more equitable and prosperous world.

Recommendation

Experts have long pondered why some national economies grow while others languish. Economist Erik S. Reinert looks at history to dispute the assumptions of neoclassical theories in regard to economic development. His ideas are based on what he calls “evidence amassed in the laboratory of the international economy.” Mainstream economics, for instance, can’t explain China’s dramatic growth or other countries’ economic failures. Students of economics and public policy will find this an important reference book.

Take-Aways

• Pre-modern writings on economic development highlight issues that today’s mainstream economics neglects.
• History shows that rich countries got rich by emulating the industrial policies of countries that had succeeded before them.
• Only some economic activities generate the explosions in productivity that drive strong growth and development.
• Economists of old understood that preventing a colony from producing manufactured goods consigned it to poverty.
• The economic establishment preaches free markets and free trade, but it doesn’t always stick to its own rules.
• There’s a case for more regional trade agreements as a halfway point to more competition.
• Economic migration must be understood in the context of nonindustrial countries being subject to the laws of diminishing returns.

Summary

Pre-modern writings on economic development highlight issues that today’s mainstream economics neglects.

Harvard Business School teaches students to approach a problem by gathering broad evidence and then focusing on the mismatches and dissonances between reality and existing theories. Economic development is one area in which a mismatch between past reality and current theory is obvious. But you can find reasons for these inconsistencies in long-forgotten books and obscure publications, such as the 19th-century political pamphlets that documented the policy debates going on within the United States as it grew into an economic superpower.

“It became increasingly clear to me that the mechanisms of wealth and poverty had, during several historical periods, been much better understood than they are today.”

Many early writers recognized that cities with a diverse mix of manufacturing activities had created a “common weal” of rising prosperity. For example, Naples, despite its bountiful surrounding farmland, remained poor, while Venice, built on a swamp, became rich from its trade and arts. Early thinkers also grasped the dynamic that manufacturing could deliver increasing returns to scale, as investment in mechanization meant that subsequent units produced would need less labor per unit. Greater production volumes could make cheaper goods for more profit. Contrast this phenomenon with agriculture, in which more people trying to live off farming see diminishing returns. More marginal land brought into cultivation and extra labor applied to existing farmland bring lower returns per person.

“Among economists, ‘mercantilist’ is about the worst imaginable insult. This is in spite of the fact that the 20th century’s two most famous economists – John Maynard Keynes and Joseph Schumpeter – both defended mercantilism and pre-Smithian economics in its context.”

Mainstream economics focuses on the theoretical bartering of labor hours and on maximizing consumption through the use of free markets and free trade. Econometric models consider labor hours to be the same, whether they were in the Stone Age or in Silicon Valley. Abstract assumptions posit frictionless “perfect markets,” which ignore synergies among economic activities, time factors affecting economic capabilities, and increasing returns. But as the old writers understood and the best business schools teach, economic growth is about being able to escape the mechanically frugal discipline that free markets impose.

History shows that rich countries got rich by emulating the industrial policies of countries that had succeeded before them.

Every economically developed country has mimicked the protectionist policies that Britain used to build its manufacturing sector. England emulated, starting with its wool industry, the policies of successful city-states like Florence. Britain collected more tariff duties than France in the first 100 years after Adam Smith’s time, and Smith himself gave measured praise for the protectionist Navigation Acts. All the American leaders now depicted on US banknotes supported infant-industry policies. Even the Bible seems to understand the qualitative differences between different economic activities, when it implies the curse of being “hewers of wood and drawers of water” (Joshua 9:23), a quotation often cited in the 19th-century US debates over protecting manufacturing.

“In 19th-century America, Irish immigrant workers were keenly supporting the ‘American System of Manufactures,’ the protective system that allowed the country to industrialize. They remembered that Ireland had had her industry stolen from her.”

A large variety of economic activities will create knowledge diversity, synergies, cluster effects, structural connections and practical capabilities. These will generate innovations and multiply the opportunities for jumps from one sector to another. All these factors are ignored or left outside modern textbook explanations of development, as their theories assume that technological change and new innovations are available free of charge to all.

Only some economic activities generate the explosions in productivity that drive strong growth and development.

Thinkers of the 18th and 19th centuries understood that countries prosper when their economic activities show improvements in productivity and innovation. These windows of opportunity are limited. Products that are introduced through technology or mechanization create barriers to entry for competitors, and this allows an escape from the dynamic of competition and lower profits. Innovators can enjoy abnormally high profits, providing scope for higher wages and greater tax revenues. Benefits are thereby dispersed throughout the community. Rising wages serve to both increase consumer demand for goods and make mechanization a more viable investment, leading to a virtuous spiral of further productivity gains.

“The toolbox of standard textbook economics does not contain tools to record the fact that at any time there are only a few industries behaving as shoe production did at the end of the 1800s, as car production did 75 years later, and as the production of mobile phones does now.”

Cotton spinning and manufacturing in the north of England were important early examples of these finite windows of opportunity that allow for high profits. St. Louis, Missouri, benefited from a productivity explosion in shoemaking.Thanks to innovation and mechanization, the labor hours for a standard pair of men’s shoes dropped from 15.5 hours in 1850 to 1.7 hours in 1900. In this period, St. Louis’s manufacturers were drastically cutting their costs but were not under pressure to cut their prices – and the city prospered: It held both a World’s Fair and the Olympics in 1904. Standard neoclassical economics would be able to mathematically calculate the consumer benefits of shoes made cheaper through competition. But it would miss the advantages that a community would experience in these boom times, before competition gradually creeps up and eventually reduces profits to normal levels.

Economists of old understood that preventing a colony from producing manufactured goods consigned it to poverty.

Countries with colonies limited or prohibited them from partaking in manufacturing, ensuring that the sovereigns kept the benefits of increasing returns and productivity explosions at home. Classical economic texts understood the seriousness of this prohibition, but later, free market thinking obscured and downplayed the harm it caused. Beginning with the work of Adam Smith and David Ricardo, these economists taught that if a developing country was less efficient at producing manufactured goods, then it was better for the developing country to specialize in agriculture and raw materials. It was now all about maximizing present consumption in a static world, rather than the older emphasis on the dynamic advantages of a country’s population engaging in certain types of production.

“Before David Ricardo, there was little doubt that emulation would be the best strategy, and historically the most important contribution of Ricardo’s trade theory was that, for the first time, it made colonialism morally defensible.”

The contrast between golf ball production and baseball production illustrates the sorting dynamic that perpetuates the divide between rich and poor nations. Golf ball production is highly mechanized, taking place in the United States with a few highly paid engineers managing complex, expensive machinery. Baseballs, in contrast, have no potential for mechanization and need to be hand stitched, so they are produced in Haiti by low-paid workers. With today’s internationally fragmented production outsourcing, advanced nations specialize in the capital- and innovation-intensive parts of the production chain and the part of the life cycle of products in which the learning curves are steep, so they can skim off the benefits. In the case of the St. Louis shoe production, the productivity explosion slowed drastically in the 20th century, and shoe manufacturing moved abroad, to where labor was cheaper.

“Nations are forced to specialize in economic activities where there are no possibilities for innovation, only to be accused later of not innovating enough. These are countries that have specialized in being poor within the international division of labor.”

Innovations in desirable economic activities often come in the form of “product innovations” that can erect barriers to entry, such as a specific technological advancement that a company has mastered or even patented. This means that others can’t enter the same market and bring down profits by competing. But the innovations achieved in less beneficial economic activities tend to be “process innovations” that can be easily copied by competitors. This means the end result will not be higher wages and profits, but lower prices for consumers, including the rich countries that purchase developing country exports.

The economic establishment preaches free markets and free trade, but it doesn’t always stick to its own rules.

Mainstream economists working in international institutions have, especially in the decades right after the collapse of the Soviet Union, promoted policies of free trade and free markets for ex-communist and other developing countries. Their medicine was ideologically “one size fits all” and harsh, with many businesses in former communist countries going bust before they even had a Western-type accounting system in place to understand their costs. The “Vanek-Reinert Effect” asserts that the first casualties of instant free trade in countries that have been trying to industrialize are the most technologically advanced sectors in the least advanced countries.

“Together with the rhetoric-reality gap, economic assumption-juggling is an important tool in the power game that keeps poor nations poor: Economics, power and ideology intertwine.”

The negative experience of Ecuador in the early 1990s showcases the pressures put on developing countries over recent decades. The advice and promised inducements from international organizations and trade agreements was that Ecuador should give up its infant-industry policies and specialize in its areas of comparative advantage, one of which was exporting bananas. But when Ecuador increased its banana exports, that affected Greek and Canary Island producers, as well as smaller Caribbean-island exporters that were former French and British colonies. The European Union then moved to put a heavy import tax on Ecuadorian bananas to repair the situation. So even when a developing country follows the prescriptions of the economic establishment, other participants can undermine the possible benefits such policies could bestow.

There’s a case for more regional trade agreements as a halfway point to more competition.

The most successful efforts at economic development create the right balance between protecting a sector targeted for domestic expansion and maintaining pressure on the companies in that sector to become more efficient over time, with the ultimate goal being world-competitive production. Japan and South Korea are extreme examples: They both heavily protected their car industries at the beginning and are now world leaders. The flaw in much of the protectionism that took place in less successful countries, as in South America, was that the pressure to become world-class only came about late and as shock therapy, and businesses remained small-scale and inefficient. The missing middle ground between domestic protection and world competition can be regional trade agreements that can give companies the potential to produce on a larger scale and be exposed to more competition from countries at a similar level.

“[Friedrich] List [1789-1846] argued for the formation of an intermediate continental free trade area before globalization. This is the step that Latin America never took…it degenerated into superficial industrialization and monopolistic competition.”

But even when the manufacturing that these countries engaged in wasn’t world-class, it was usually still producing growth for a time, holding up wage levels and creating some synergies and cluster effects within these countries. This is in contrast to the crash in wages that happens after structural adjustment policies end protectionism completely. Russia and Peru lost half of their industrial jobs in a short period of time. Australia’s history provides an interesting example in which world-competitive wool exports provided much-needed foreign exchange, while at the same time, Australia’s protected, non-world competitive manufacturing sector kept wages high.

Economic migration must be understood in the context of nonindustrial countries being subject to the laws of diminishing returns.

After World War II, the Morgenthau Plan had proposed to redesign Germany as a less threatening nonindustrial country. But a few years of catastrophic economic trends showed that Germany’s population was too large for this to be viable – hence the reindustralizing Marshall Plan. This way of thinking also casts a new light on the 1990s genocide in Rwanda. Although a political minority invented and spread hateful ideas, Rwanda also had a very high population density for a country with little industry. A crowded nation with thousands of young men without access to land helped fuel the explosion of violence.

“Mongolia was thus welcomed into the 21st century by a mechanism already proclaimed in the Book of Genesis, but no longer at work in the industrialized world: ‘The Land could not Bear them All’.”

Mongolia is an example of a country that obediently followed the advice of Western economists, resulting in the loss of most of its uncompetitive industries, such as bread and book production, in the early 1990s. In the following years, a mass starvation of livestock occurred, which closer study revealed was the result of a lack of alternative employment, pushing more and more people into subsistence farming. It was an example of the ancient dynamic of diminishing returns.

“The father of neoclassical economics, Alfred Marshall, correctly points to the fact that diminishing returns is ‘the cause of most migrations of which history tells’.”

The growing issue of economic migration must therefore be seen through the lens of people migrating from countries with no significant industrial sectors to nations whose favorable economic activities have made them rich and created more jobs and opportunities.

About the Author

Erik S. Reinert, a Norwegian citizen, is a professor at Tallinn University of Technology, Estonia, and at University College London. He is also the executive chairman of The Other Canon Foundation, a center for heterodox economists. How Rich Countries Got Rich…and Why Poor Countries Stay Poor has been translated into more than 20 languages.