Friday, May 09, 2008


Why is a country rich

A country is rich when it's labour productivity is higher. What is 'labour productivity' ? Simply put labour productivity of a country is its output divided by the number of people involved in producing it. So a rough approximation is GDP divided by population. Any country which produces more 'stuff' (output) using the minumum number of people will be rich. Simply, the surplus will account for the 'richness' of the country.

Lets take an example and the most intuitive one i have come accross is one by Atanu Dey ( While you can go and read the full text at his site, i will lay out the essential points. Suppose a 100 person economy produces 100 units of stuff. The average income of such a population will be 1. Now say 2 people from this population do some research and find out ways/invent machines which enables the population to make 300 units using only 90 people. The average income will jump to 3 with 8 more people freed up for further research. Now these 10 people working find out better ways of making 1000 units of stuff using 75 people...The average income will jump to 10 - a ten-fold rise over the first case where the average income was 1.

The miracle lies in the fact that machines can increase the productive capacity of humans manifold. This is an immutable truth and there is no escaping this. One can argue that the same amount of stuff can be produced by substituting labour for capital. While that will increase production, it will not increase productivity. So while more stuff is being produced, it is produced by a proportionate increase in the number of mouths to feed and thus average income remains static - i.e. the country does not grow richer. Richness is determined by productivity of a country.

Now the classic question arises : Should a labour-excessive country focus on policies that promote employment or productivity ? Maximising employment is promoting more of status-quo. In fact the country might become poorer in the future if more number of people are producing the same amount of stuff (more mouths to feed with the same output). A country therefore has to focus on production - and here not absolute production by employing proportinately more labour but more capital. Why ? As machines and technology are the ONLY way in which production can be boosted manifold increasing incomes for all as we saw in the example. Technology has only a positive 'arrow of time'.

Also to support this constant improvement in technology, there has to be more and more education and R&D efforts. In our example we saw that the average income could not improve without technological innovation. Innovation and improvements do not drop from the sky but they have to be painstakingly built grounds-up. It requires systematic and widespread education. And it also requires an ecosystem. The hardware of this ecosystem can be the universities, academies, centers-of-excellence etc. But more importantly innovation feeds on freedom. It also requires free thinking - and challenging authority. It requires incentives for innovation. It also requires a society tolerant of disruptions as any technological adaptation will involve change. Knowledge cannot thrive in an environment which is completely closed to new ways.

So without going into ideologies, a society can be richer (higher labour productivity) if it has the following characteristics :
1. Able to master techniques of production (including intangibles like services) employing technology
2. Able to transfer these techniques in some systematic manner in subsequent generations (widespread education) and also have an ecosystem of improvement. This ecosystem should both have the 'hardware' and 'software'
3. Able to best utilise talents of entire workforce -including women - and allocate people according to merit. (the non-employment of women seriously hampers prosperity as the number of mouths to feed goes up without full productive engagement)
4. Have a socio-cultural-political organisation geared to maximum production :-
- provide property rights to encourage investment and saving
- reduce transaction costs of doing business by having relatively honest public institutions
- have a continuity in economic policies i.e. political consensues on economic issues

Any society which is able to do the above will be on it's path of richness.

India performs poorly on almost all counts in the above analysis. Without going into details of every one of them, the most fundamental problem is that Indian polity and policy makers have not yet grasped the fundamental point : If we want to be rich, it is not employment that needs to be maximised but production (and hence productivity). Also india traditionally scores low on the 'software' required for innovation : a free thinking society, attitudes to women, being suspicious of wealth and woefully corrupt public institutions.

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