Title: How Rich Countries Got Rich… and Why Poor Countries Stay Poor
Author: Eric S. Reinert
Scope: 4 stars
Readability: 3 stars
My personal rating: 4.5 stars
See more on my book rating system.

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Topic of Book

Reinert argues that the economics profession completely misunderstands what poor countries need to do to become rich.

If you would like to learn more about how rich nations became rich, read my book From Poverty to Progress: How Humans Invented Progress, and How We Can Keep It Going.

Key Take-aways

• There are two main economic canons:
  • One focuses on theory and quantitative models, free trade, perfect competition, and comparative advantage. This includes Adam Smith, David Ricardo and the vast majority of economists.
  • The other focuses on a study of history to understand how rich nations actually became rich in practice. This canon includes Friedrich List, Alexander Hamilton, Thorsten Veblen, Josef Schumpeter and some economic historians.
• The first economic tradition is dominant in the economics profession and within development organizations. It states that poor nations should embrace free trade and institutional reform (“The Washington Consensus”)
• In fact, free trade traps poor nations in poverty because they are forced to concentrate on agriculture and raw materials with little value added.
• The path to prosperity requires manufacturing.
• Rather than listening to what rich nations say, poor nations should copy what rich nations actually did to become wealthy in the past.
• Rich nations became rich by intervening in their economy to shift from raw materials to manufacturing. Poor nations should do the same today.
• The typical strategy for enrichment includes:
  • a virtual monopoly in an important raw material
  • government-promotion of manufacturing
  • profitable overseas trade
• Once poor nations become rich via manufacturing exports, then they can embrace free trade (in order to expand markets) and institutional reform.
• Current trade agreements have outlawed the key tools poor countries need for copying what rich countries did in the past.

Important Quotes from Book

“The gap between the rich and the poor on this planet is larger than ever before and still growing – at least by most methods of measuring. Even after massive economic transfers during three `Development Decades’ that began in 1970, and trillions of dollars of `development assistance’, the situation is still dismal and getting worse in many places.”

“The aim of this book is to explain the mechanisms that have produced this result, in a way that is accessible to `the interested layperson’ in any part of the world. The book must not be mistaken for an attempt to popularize ruling economic thought. On the contrary, it is an attempt to contribute to an ongoing process of refuting current policy orthodoxy and to resurrect a long-standing economic tradition, from the only laboratory available to economists – history.”

“Since the fall of the Berlin Wall in 1989, our world economic order has – in a more fundamental way than ever before – been based on an economic theory which `proves’ the opposite of what in fact can be observed. World free trade is supposed to level out any differences in wages among rich and poor countries. If humankind does not interfere with the `natural forces’ of the market – if we apply the principle of laissez-faire – progress and economic harmony will reign. As”

“The World Trade Organization’s first Secretary General, Renato Ruggiero, declared that we should unleash `the borderless economy’s potential to equalize relations between countries and regions’. This belief is at the core of the ideology of the International Monetary Fund (IMF) and the World Bank, and from the early 1990s, for all practical purposes, these Washington institutions took over the management of the affairs of most poor countries. For many parts of the globe, the result has been a shambles.”

“An abyss now separates Third World reality from the vision of Ruggiero and the Washington institutions. Where the prophets of the new world order predicted harmony, we see famine, war and progressive environmental collapse. Today we are slowly beginning to take reality into account once again.”

“Neo-liberal economists argued that economic growth and welfare would be the default condition if market interventions were removed, rather than the result of a long-term process of building a particular form of economic structure. ”

“We must move away from a theory which poses economic harmony as an automatic outcome of divinely or mathematically premeditated harmony, and move back to one in which economic harmony is a product of conscious policies.”

“The alternative theory that some of us are trying to revive is built up from below, based on observations of a reality that very often does not favour economic development. Rather than seeking to `remove the obstacles’ to prosperity, development must be seen for what it has always been: the outcome of conscious and deliberate policy.”

“But harmony is not the natural state of society. ”

“This book begins by describing different types of economic thinking and goes on to argue why the virtual world monopoly of the current dominant theory should be broken. English economist David Ricardo’s trade theory, dating from 1817,1 has become the linchpin of our world economic order.”

“I argue that what Enlightenment economists called emulation,2 rather than `comparative advantage’ and `free trade’, lies at the heart of successful development. In this context emulation means imitating in order to equal or excel. ”

“Today we have totally dismissed the idea that a strategy of emulation was a mandatory passage point for all nations that are presently rich: we have outlawed the key tools needed for emulation.”

“Today in many poor countries we can observe the opposite of development and progress, that is, retrogression and primitivization.”

“We cannot make the poor rich merely through our direct and naive kindness. ”

“This book argues that a deal should be struck by which the First World is allowed to protect its own agriculture (but prevented from dumping its surpluses on the world markets) while the Third World is allowed to protect its manufacturing and advanced service sectors. This is the only policy that can be consistent with successful development policy over the last 500 years.”

“I argue that both the Millennium Goals and the campaign to `Make Poverty History’ are far too heavily biased towards palliative economics, aimed at easing the pains of poverty rather than at making the fundamental structural changes that result in true economic development. Rather than creating democracy and development, this approach – regardless of the nobility of the intentions – will produce a crippling welfare colonialism in which rich countries maintain their political power over poor countries.”

“Tightly packed into the language of economics – which the book will attempt to demystify – is the incontrovertible fact that rich countries got rich because for decades, often centuries, their states and ruling elites set up, subsidized and protected dynamic industries and services. They all emulated the most prosperous countries at the time, bringing their productive structures into those areas where technological change was being focused. In this way they created rents (a return above `normal’ income) that spread to capitalists in the form of higher profits, to labour in the form of higher wages, and to governments in the form of higher taxes. At its core, colonialism is a system that seeks to prevent these types of effects from being produced in the colonies. Poor countries specialize in activities that have one or more of the following three characteristics: (a) they are subject to diminishing rather than increasing returns, (b) they are either devoid of learning potential; and/or (c) the fruits of learning – rather than producing local wealth – are passed on to their customers in the rich countries in the form of lower prices. ”

“In this way some nations may specialize in being wealthy while others specialize according to their comparative advantage in being poor.”

“Both these audiences must appreciate that the main difference between rich and poor countries is that rich countries have all moved through a stage without free trade, which – when successful – subsequently made free trade desirable. This mandatory passage point in the history of all presently developed countries – allowing poor countries to emulate the economic structures of rich countries – is currently outlawed.”

“If you take anything from this book, let it be this: if you want to understand the causes of American and European prosperity, study the policies of those who created it, not the advice of their forgetful successors.”

“Why are they so poor? My Peruvian sojourn was only into its second day and the question was gradually taking form. The background for my question was that most of the people I observed at work – the luggage handlers at the airport, the bus drivers, the hotel personnel, the barbers, the shop attendants – did not seem to be any less efficient than the people performing the same tasks back in Norway. The mature formulation of the question gradually developed into: `What is it about this “market” that rewards people with the same level of productivity with such different real incomes in different countries?”

“No one seemed to have any clear ideas about the causes of poverty. I decided to look up the explanation in an encyclopaedia when I got home, but without success. My curiosity had been whetted. Why is the real wage of a bus driver in Frankfurt sixteen times higher than the real wage of an equally efficient bus driver in Nigeria, as the World Bank recently calculated? I set out to find an answer, and this book is the result.”

“The strange thing was that so few people seemed even to be interested in the question.”

“Free trade is seen as a system with all winners and no losers. ”

“Standard economics too often trains people to see the world through sets of methodological and mathematical lenses, and such methods create important blind spots. In contrast, the historical approach broadly gathers evidence whereby relevance is the only valid criterion for inclusion. This book analyses globalization as a Harvard Business School case study, but with the aim of maximizing real wages rather than profits.”

“Rich countries display generalized imperfect competition, activities subject to increasing returns, and, as I gradually began to understand, all have become rich in exactly the same way, through policies steering them away from raw materials and diminishing returns activities into manufacturing, where the opposite laws tend to operate. ”

“Most important in my view were several mechanisms that emerged from Europe’s large diversity and fragmentation (geographical, climatic’20 ethnic and political). This diversity and fragmentation – which tended to be absent in the large Asian empires – created a large pool of alternative ideas and approaches in the `market’ for ideas, and was the starting point for the rivalry that created the continuous emulation among the different states. Above all, Europe’s history is a history of how economic policy was able to overcome the formidable barriers to wealth that had been created by geography, climate and also culture.”

“The basic strategy that made Europe so evenly rich was what Enlightenment economics called emulation,21 and the extensive toolbox that was developed for the purpose of emulating. ”

“Europeans observed early on that generalized wealth was found only in areas where agriculture was absent or only played a marginal role, and came to be seen as an unintended by-product when many diverse branches of manufacturing were brought together in large cities. Once these mechanisms were understood, wise economic policy could spread wealth outside these few ‘naturally wealthy’ areas. Policies of emulation could, indeed, also spread wealth to formerly poor and feudal agricultural areas, but they involved massive market interventions. For laggard nations market interventions and wise economic policies could substitute for the natural and geographical advantages that produced the first wealthy states.”

“Thus rivalry, war and emulation in Europe created a dynamic system of imperfect competition and increasing returns. New knowledge and innovations spread in the economy as increased profits and increased wages, and as larger bases for government taxation. European economic policy was based for centuries on the conviction that the introduction of a manufacturing sector would solve the fundamental economic problems of the time, creating much-needed employment, profits, higher wages, a larger tax base and a better circulation of the currency.”

“Compared to textbook economics, economic development is a giant failure of perfect markets.”

“Cumulative factors and path dependencies cause the winds of the market to blow towards progress only when a high level of development has already been reached. The poorer the nation, the less the winds of laissez-faire blow in the right direction. For this reason, the issue of free trade and other policy decisions is one of context and timing.”

“The doctrine of comparative advantage, originating with Ricardo, is the bedrock of today’s international economic order.”

“The United States has always been torn between two traditions, the activist policies of Alexander Hamilton (1755-1804) and Thomas Jefferson’s (1743-1826) maxim that `the government that governs least, governs best’. Alexander Hamilton was a key figure behind the establishment of the first central bank of the United States in 1791, while Thomas Jefferson fought it and contributed to its closing down in 1811. With time and usual American pragmatism, this rivalry has been resolved by putting the Jeffersonians in charge of the rhetoric and the Hamiltonians in charge of policy. Today’s economic theorists have an important mission in producing Jeffersonian/Ricardian rhetoric, which, as Paul Krugman points out above, is not very influential on the domestic market.”

“Therefore the American maxim of the 1820s, `Don’t do as the English tell you to do, do as the English did’, may today be safely updated to `Don’t do as the Americans tell you to do, do as the Americans did’.”

“Wealthy nations have a tendency to force upon poor nations theories they themselves never have followed and probably never will. ”

“Following England’s practice rather than her theory, the United States protected their manufacturing industry for close to 150 years. ”

“One result of the twentieth-century development of economics is the loss of two important dimensions: time (history) and space (geography). ”

“Modern international trade theory insists that free trade between a Neolithic tribe and Silicon Valley will tend to make both trading partners equally rich. Other Canon trade theory, on the other hand, insists that free trade is beneficial to both parties only when they have both reached the same stage of development.”

“It was very clear to people early on that most wealth was to be found in the cities, and particularly in certain cities…. Gradually, the wealth of the cities was perceived to be a result of synergies: people of many different trades and professions sharing a community. ”

“Aristotle’s view of the world as a zero-sum game slowly gave way to an increasing understanding that new wealth could be created – not only conquered – through innovation and creativity.”

“England’s story is the prototype of how a country goes from poor to rich.”

“At the very core of the process of economic progress is the dynamic combination of synergies and innovations under conditions of a substantial specialization and division of labour.”

“For Europe’s poor nations it became clear that there was an important connection between the production structure of the few wealthy city-states and their riches. The wealthiest city-states – Venice and those in Holland – had dominant market power in three different areas. In economic terms they enjoyed the type of rents we have referred to earlier, allowing increasing profits, real wages and taxable income. Both had very large and diversified manufacturing and craft sectors..

Each controlled an important market for a raw material, salt in Venice and fish in Holland. Even in its early stages of development, and still relatively poor, Venice always fought hard to keep its dominant position in the salt markets. In Holland the invention of salted and pickled herring (an early fourteenth-century invention) had created a huge market that was controlled by the Dutch. Third, both had built up a very profitable overseas trade. “This first prosperity in Europe was based on triple rents – a triple market power in types of economic activities that were all conspicuously absent in the poorer European states: manufacturing, a virtual monopoly in an important raw material and profitable overseas trade. Wealth had been created and maintained behind huge barriers to entry created by superior knowledge, by possessing a large variety of manufacturing activities that created systemic synergies, by market power, by low costs created through innovations and increasing returns – both in individual industries and as systemic effects – by the sheer scale of their operations, and by the economies of scale in the use of military might. After 1485, England emulated the triple rent structure that had been created in the resourceless city-states of Europe. Through very heavy-handed economic intervention, England created its own triple rent system: manufacturing, long-distance trade and a raw-material rent based on wool. The success of England would eventually lead to the demise of the city-states and the growth of the nation-states: synergies found in the city-states were extended to a larger geographical area. This was to be the essence of the mercantilist project in Europe.”

“History’s first deliberate large-scale industrial policy was based on an observation of what made the rich areas of Europe rich: that technological development in one field in one geographic area could extend wealth to an entire nation. King Henry VII of England, who came to power in 1485, had spent his childhood and youth with an aunt in Burgundy. There he observed great affluence in an area with woollen textile production. ”

“Henry VII created quite an extensive economic policy toolbox. His first and most important tool was export duties, which ensured that foreign textile producers had to process more expensive raw materials than their English counterparts. Newly established wool manufacturers were also guaranteed tax exemption for a period, and were given monopolies in certain geographical areas for certain periods. There was also a policy to attract craftsmen and entrepreneurs from abroad, especially from Holland and Italy. As English wool-manufacturing capacity grew, so did the export duties, until England had sufficient production capacity to process all the wool they produced. Then, about a hundred years later, Elizabeth I could place an embargo on all raw wool exports from England.”

“For several hundred years Europe’s trade policy was based on the principle of maximizing the industrial sectors of each country, while often at the same time damaging the industry of other countries.”

“ To be wealthy, countries like England and France would have to emulate and copy the economic structures of Venice and Holland, but not necessarily their economic policies. Countries already wealthy could afford a very different policy from those ”

“of countries still poor. In fact, once a country had been solidly industrialized, the very same factors that required initial protection – achieving increasing returns and acquiring new technologies – now required bigger and more international markets in order to develop and prosper. Successful industrial protection thus carries the seeds of its own destruction”

“The first US Secretary of the Treasury, Alexander Hamilton, with his 1791 Report on the Manufactures of the United States, recreated a toolbox very similar to that of Henry VII. Hamilton’s stated goals were the same: a larger division of labour and a larger manufacturing sector.”

“The toolbox of economic emulation and development:

1. Observation of wealth synergies clustered around increasing returns’ activities and continuous mechanization in general. Recognition that `We are in the wrong business’. Conscious targeting, support and protection of these increasing returns’ activities.

2. Temporary monopolies/patents/protection given to targeted activities in a certain geographical area.

3. Recognition of development as a synergic phenomenon, and consequently the need for a diversified manufacturing sector 4. A manufacturing sector solves three policy problems endemic to the Third World simultaneously: increasing national value added (GDP), increasing employment and solving balance of payments problems.

5. Attracting foreigners to work in targeted activities (historically, religious persecutions have contributed to this in an important way).

6. Relative suppression of landed nobility and other groups with vested interests based in the production of raw materials.

7. “Tax breaks for targeted activities.

8. Cheap credit for targeted activities.

9. Export bounties for targeted activities.

10. Strong support for the agricultural sector, in spite of this sector being clearly seen as incapable of independently bringing the nation out of poverty.

11. Emphasis on learning/education (UK apprentice system under Elizabeth I, Francis Bacon’s New Atlantis, scientific academies, both in England and on the Continent).

12. Patent protection for valuable knowledge (Venice from 1490s).

13. Frequent export tax/export ban on raw materials in order to make raw materials more expensive to competing nations.”

“The fundamental idea here – that a finished product might cost from ten to a hundred times the price of the raw material needed for the product – would recur for centuries in European literature on economic policy. Between raw materials and the finished product lies a multiplier: an industrial process demanding and creating knowledge, mechanization, technology, division of labour, increasing returns and – above all – employment for the masses of underemployed and unemployed that always characterizes poor countries… The `manufacturing multiplier’ was the key both to progress and political freedom.

From the end of the fifteenth century until after the Second World War the main theme in economic policy – if not in economic theory – was therefore what we can call `the cult of manufacturing industry’.”

“An indispensable part of this process of development were the institutions that `got the prices wrong’ compared to what the market would have done if left alone: the patents that created a temporary monopoly for new inventions and the tariffs that distorted the prices for manufactured goods and enabled new technologies and new industries to be established away from the place they were first invented.”

“Diversity per se came to be understood as a key ingredient in economic growth, and this diversity was not to be found in agricultural communities where people tended to produce the same things. This has been recognized as one of the problems of areas producing raw materials: they have little to trade between them.”

“if you wish to estimate the wealth of a city, count the number of professions found within its walls. The larger the number of professions, the wealthier the city. The diversity of economic activities was a goal in itself that made it possible for new knowledge to `jump’ from one sector to the other”

“The goal for economic policy thus became the emulation of the economic structure found in Venice and in Holland, the bringing together of as many diverse professions as possible, all subject to increasing returns and technological change.”

“Since you are an economist, however, you are professionally trained to disregard certain aspects:

1. You are not allowed to claim that any qualitative differences exist between economic activities, i.e. that it is better for a group of people to produce platforms for software than to herd animals. If left alone, the market will take care of evening out such differences.

2. As a consequence of the above, you are not allowed to recommend any change in specialization. Every nation should specialize according to its comparative advantage, be it herding animals or producing software, which will produce factor-price equalization.

3. Your tools prevent you from observing any synergies. You may not say that people who herd animals but “live among people who produce software are wealthier than herders living only among other herders.’

4. You are not allowed to refer to history. History and the future have both been collapsed into `the here and now’. Consequently the argument that the country where Silicon Valley is located did, for 150 years or so, follow a strategy subsidizing and protecting itself away from rural activities into the mechanical arts and high-tech is not valid. With reference to points 1 to 3 it is obvious that the United States grew rich in spite of, not because of these policies.’

5. You are no longer allowed to use unemployment and underemployment – factors that were important after the Second World War – as arguments for policy. Factoring in unemployment would require using something called `shadow prices’ which are very messy and would, anyway, lead to market-unfriendly policies. The Washington institutions assume full employment in their economic models.’

6. “You are not allowed to claim any arrows of causality running from the structure of the economy to the political structure. Parliamentary democracy, or any other institution for that matter, is as likely to appear in a hunting and gathering tribe as under feudalism or in an urban society.”

“Prevented from challenging the six interlocking assumptions listed above, the Washington Consensus developed along the following path, so that each discovery tended to be celebrated as if it had provided the final solution to poverty:

1. `get the prices right’

2. `get the property rights right’

3. `get the institutions right’

4. `get the governance right’

5. `get the competitiveness right’

6. `get the innovations right’

7. `get the entrepreneurship right’

8. `get the education right’

9. `get the climate right’

10. `get the diseases right’.”

“The pursuit of the MDGs seems to indicate that the United Nations institutions, following several failed development decades, have abandoned the effort to treat the causes of poverty, and have instead concentrated on attacking the symptoms of poverty.”

“I claim that many of today’s problems are as a result of the Washington institutions classifying the tools needed to create increasing returns activities – tools employed by all countries that developed after Venice and Holland – as `illegal activities’.”

Related Books

• “One Economics, Many Recipes” by Dani Rodrick
• “Kicking Away the Ladder” by Ha-Joon Chang
• “The Tyranny of Experts” by William Easterly
• “Knowledge and Competitive Advantage” by Johann Peter Murmann
• “Asia’s Next Giant: South Korea and Late Industrialization” by Alice Amsden

If you would like to learn more about how rich nations became rich, read my book From Poverty to Progress: How Humans Invented Progress, and How We Can Keep It Going.