Nurturing Growth

Getting the ingredients right is essential to economic growth, but so is the environment that the

government creates in order to foster its development. Like the temperature on the oven, the wrong

setting can ruin the recipe. So, what do governments do that matters most?

? Human Capital. It’s no use equipping workers with the most advanced equipment in the

world if they can’t read the instructions. Education and training, both forms of human capital, are

essential to productivity. Korea went from third world status to the ranks of the industrialized

nations in a generation in part by rigorously educating all its children. Its high school graduation

rates now exceed those of the United States.

? Rule of Law. Economic growth needs investors to know that if they invest today, they get

to keep the rewards years later. That requires transparent laws, impartial courts, and the right to

property. The United States’ army of lawyers sue at the drop of a hat and wrap every transaction

in legalese, but in a maddening way that signifies its respect for laws.

Small government is better than big government, but size is less important than quality. For

example, Sweden’s government spends more than half of gross domestic product (GDP) while

Mexico’s spends only a quarter of its GDP. But Swedish government is efficient and honest

while Mexico’s is inefficient and rife with corruption. That’s one reason Sweden is rich and

Mexico is poor.

Does government have to be democratic for growth? There’s no firm rule. The authoritarian

governments of China, Korea, and Chile ran smart policies that produced strong growth early in

their development. Conversely, sometimes democratic governments are pressured by voters to

expropriate private property, run up unsupportable debts, or shelter politically favored groups at

everyone else’s expense. But dictators have done all those things and worse, bringing on social

unrest that ruins the investment climate. Democracy provides essential feedback to government

just as free markets do to companies, and elections are generally less disruptive than civil wars.

? Letting Markets Work. Entrepreneurs and workers get rich coming up with new,

cheaper ways to make things. In the process, they drive someone else out of business. Joseph

Schumpeter, the Austrian-born Harvard economist, called this “creative destruction.”

Governments squelch creative destruction by forbidding new companies from entering a market,

granting monopolies, restricting imports or foreign investment, or making it hard for companies

to lay off workers. A financial system that would rather lend to government-owned companies

than small entrepreneurs also holds back growth.