What the wealth of nations is really built upon

12th December, 2009

It is an old question: why are some countries rich and others poor? Sir Partha Dasgupta, a hugely accomplished economist, born in Dhaka and educated in Delhi and Cambridge, is as well qualified as anyone to come up with an answer – which he did, delivering this year’s Royal Economic Society public lecture.

Dasgupta began by inviting his audience, many of whom were A-level students, to consider the lives of two girls – Becky, an American, and Desta, an Ethiopian.

Becky lives in a country with a gross domestic product per head of $46,000, life expectancy of 78 years and near-universal adult literacy. GDP per head in Desta’s country is $780; life expectancy is 53 years, adult literacy 36 per cent, and most women spend about 15 years bearing or taking care of children, with average fertility of more than five live births per woman.

Familiar as this sort of data is, the numbers never fail to shock. As Dasgupta pointed out, Ethiopia is not notably richer than it was 5,000 years ago. Why?

Economists haven’t been short of answers. Rich countries have more physical capital – better roads, bigger buildings, more machines. They also have more human capital – their citizens are better educated and trained, and healthier. And they have more technological capital, with more scientists, more advanced technology and more intellectual property.

But these are symptoms of something deeper. After all, as China is now demonstrating, it is possible to expand all three types of capital at speed. Many poor countries don’t. Why not?

The fashionable answer is that rich countries have better institutions. It sounds profound, but nobody really agrees on what it means. Dasgupta pointed out that in a variety of circumstances – from buying fresh-seeming food at a supermarket to getting married, from walking the streets in safety to writing a country’s constitution – we need to be able to rely on other people to play their part in a deal that may be explicit but is often entirely implicit. And he devoted much of his lecture to answering the question of when we can expect other people to keep to these agreements and quasi-agreements.

Relying on game theory analysis, Dasgupta reached two conclusions. The first is that stable societies – that is, where cheats can be found and punished, if only by a refusal to do business with them in future – are a precondition for successful institutions. If every interaction is a one-off, co-operation is impossible, and all those wonderful investments in machinery, education and innovation will simply never happen.

The second conclusion was that co-operation is extremely fragile. Dasgupta’s game theory suggested that even a successful, co-operative society is always at risk of breaking down. “It is easier to destroy institutions than to build them,” he argued, and cited the Watts riots and the decline of many pre-modern civilisations. The credit crisis is, arguably, another example.

If true, this is very disturbing: it suggests that we should perhaps spend less effort thinking about how to develop poor countries, and more effort holding together our own fragile societies.

I was not totally convinced. Perhaps I am complacent, but the past 200 years of economic history contain far more examples of poor countries becoming rich than of rich countries becoming poor.

As Sir Partha patiently explained his algebra to a gaggle of admiring schoolchildren, I was left with more questions than answers about why we trust each other and our institutions, and how such trust is created and destroyed. That, I think, was exactly his aim.

Also published at ft.com.

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