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Centennial Review
Principled Ideas from the Centennial Institute
Volume 3, Number 4 • April 2011
FREEDOM CURES POVERTY
WHERE GOVERNMENT FAILS
By Benjamin Powell
Why do some nations become rich
while others remain poor? This has
been a central question in economics
since at least the time of Adam Smith.
Today China, India, and Botswana are
booming, and in the process lifting
hundreds of millions of people out of
wretched poverty. Yet most of sub-Saharan Africa not only
fails to get rich, but is instead actually getting poorer.
Traditional mainstream economic-growth theory
doesn’t help us much to answer the question.
Through most of the 20th century it focused on
models that assumed growth was a simple function
of labor, capital, and technology. The new growth
theory looks more to institutions and policy.
How well does a nation protect its entrepreneurs? In
what countries do you get rich by inventing a new product?
Or in what countries do you get rich by wresting control of
government from your rivals?
Entrepreneurs drive the market toward efficient outcomes
by exploiting profit opportunities and causing the market
process to (as we economists say) tend toward equilibrium.
Entrepreneurs also play a central role in the market’s
process of “creative destruction,” where new innovations
constantly replace old technologies. The interaction of
these two roles of the entrepreneur drives the process of
economic development.
Incentives and Institutions
Entrepreneurs exist in almost all cultures and historical
contexts. Why then doesn’t the process of economic
development occur in all countries equally? Because human
decision making responds to perceived costs and benefits,
and not all societies have an environment that rewards
productive entrepreneurship.
Look at the case of imperial China in bygone days: A brilliant
young man would devote all of his energies to studying
law in preparation for the exams that gave entrance into
the upper echelons of the ruling bureaucracy. That same
young man today may study electrical engineering with
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the dream of one day opening his own firm, because now
Chinese businessmen can earn greater prestige and profits
than they could in the past. It’s obvious in which society we
can expect greater economic growth.
In recent years, geography and other explanations for
economic growth have begun to be pushed aside as
institutions have become increasingly recognized as the
main driver of economic success. Some in the economics
profession have moved toward detailed analytical narratives
to explain individual cases in economic development.
There has also been a virtual explosion in research
measuring economic freedom and using it to explain
economic performance.
People in policy circles in Washington,
Why are D.C., now generally, though incompletely,
acknowledge the need for private-property
China, India, rights and the rule of law for economic
and Botswana development. To see why, let’s look at how
some of today’s greatest development
booming? success stories happened and why other
regions languish in poverty.
China’s Dramatic Gains
China provides a perfect example of how improvements
in institutional quality, no matter how poor the initial
institutional environment is, can improve economic
performance. China is still far from a full-fledged market
economy. Its 2010 economic-freedom ranking was still
only 82nd out of 141 countries ranked, according to the
authoritative Fraser Institute index, Economic Freedom of the
World by James Gwartney and Robert Lawson. However,
its improvement over the last 25 years is dramatic.
China’s freedom score has improved more than 66 percent
from its 1980 level. The non-state sector produces two-
thirds of industrial output today, up from one-third when
Benjamin Powell (Ph.D., George Mason University) is an assistant professor of
economics at Suffolk University and a senior economist with the Beacon Hill
Institute. This essay is based on his lecture at Colorado Christian University
on January 21, 2011, and on the introduction to Dr. Powell’s 2009 book, Making
Poor Nations Rich: Entrepreneurship and the Process of Development.
Centennial Institute sponsors research, events, and publications to enhance
public understanding of the most important issues facing our state and nation.
By proclaiming Truth, we aim to foster faith, family, and freedom, teach citizen-
ship, and renew the spirit of 1776.
 India was finally able to exceed its chronically low (or as
some have called it, “Hindu”) rate of economic growth.
One of India’s biggest areas of reform has been in its
freedom to trade with foreigners. Tariffs have been
dramatically lowered, the number of goods on which
there are other restrictions has fallen, and foreign direct-
investment and capital flows have been liberalized.
Individual industries, including telecommunications and
airlines, have seen the introduction of competition.
India’s stock markets have become increasingly
competitive with the introduction of a new exchange.
Two key industries—information technology and back-
office processing/call centers—have emerged and remain
relatively unregulated. These sectors benefited greatly from
the improvements in the international trade environment.
reforms began in 1978. The reforms in China still have a Unfortunately, India’s reforms still have a long way to go.
long way to go, but the initial changes in the entrepreneurial
While new industries engaged in internationally traded
environment created profit opportunities for productive services have emerged that are free from India’s industrial
entrepreneurship to exploit, and this has led to the growth licensing, much of the domestic economy remains heavily
China has achieved. regulated. Getting approval to start a business still takes a
Much of the reform has taken place long time and entails significant costs.
spontaneously at the local level and then has Markets have freed Many small-scale enterprises remain
often been sanctioned after the fact by the subject to licensing that restricts the
national government. Reforms in the ownership 400 million Chinese number of legal vendors and forces
of small enterprises and agriculture started this from poverty. many to work in the black market.
A host of agricultural restrictions
way. A major area of reform has been in freeing
trade with foreigners and allowing foreign investment into remain.
the country. Of particular importance have been special While India has made many improvements and its growth
enterprise zones where more freedom is granted. has accelerated, a more comprehensive change in the
The regions of China with the highest degree of mindset of Indians that more fully embraces markets will
“marketization” are the areas where most of the economic be necessary to get across-the-board reform.
growth has occurred. With the opening of trade, 35,000 How Botswana Took Off
Chinese firms had the right to engage in foreign trade by Botswana is a surprising success story that many people are
2001. In 1978 only 12 state-owned enterprises had this unaware of. It transformed itself from one of the poorest
privilege. Since the start of reforms, it is estimated that nations in the world in the early 1960s to an upper-middle-
400 million people had been lifted out of poverty in China income nation today. Botswana was a landlocked British
by 2001. protectorate with few natural resources, an arid climate,
Although many reforms have been made, China still has little infrastructure, and widespread poverty. Upon gaining
much untapped potential. Large state-owned enterprises independence in the 1960s, they embarked on a series of
still exist, interest rates are regulated, and the bulk of reforms that reduced the size of the government in the
investment funds are allocated to state-owned enterprises economy and promoted economic freedom.
through state-owned banks. The challenge for China is to
more fully embrace the market mechanism and to spread
the economic freedom that has been achieved out from
CENTENNIAL REVIEW is published monthly by the Centennial Institute at
the coastal zones to the rest of the country. Colorado Christian University. The authors’ views are not necessarily those of
CCU. Designer, Danielle Hull. Illustrator, Benjamin Hummel. Subscriptions free
India’s Rising Index upon request. Write to: Centennial Institute, 8787 W. Alameda Ave., Lakewood,
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India, much like China, still remains heavily interventionist
in economic policy, but the country has made significant Please join the Centennial Institute today. As a Centennial
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Index by nearly 33 percent. During the period of reform, - John Andrews, Director
Centennial Review, April 2011 ▪ 2
Unlike other African governments, Botswana kept much
of the British common law. Meanwhile, government
spending as a percent of GDP fell from 23 percent in the
mid ’60s to 15 percent by the early ’70s, while an overall
environment of openness, toleration, and respect for the
rule of law promoted economic development. The result
was a near-trebling of real per-capita income from $372 in
1965 to $1,032 a decade later.
Since 1975, Botswana has
Vampire states remained more free than most
suck their of its African neighbors and
has continued to increase its
people dry. standard of living. Over the
period from 1966 through
1996, Botswana was the fastest-growing nation in the
world, averaging 7.7 percent for the period.
The success of all three nations we have examined—from
China, the proud giant, to Botswana, small and obscure—
depended crucially on embracing a greater role for free
markets in ordering economic activity. Yet, in too many
other places around the world, markets remain repressed,
with the result that growth is elusive and poverty common.
Much of Africa and Latin America suffer from the failure
of countries in these regions to embrace economic
freedom.
Socialist Devastation in Africa
Africa has been the biggest failure in the quest for economic
development over the last 50 years. Africa is mired in
poverty, famine, disease, and illiteracy. Not only are most
African countries extremely poor, but they’re getting
poorer. Since 1975, sub-Saharan Africa has averaged a
one-percent annual decrease in per-capita GDP. That is a
35-percent cumulative reduction over 35 years in those
countries’ output relative to their population!
Under colonial rule, African institutions contained
elements of capitalism, but they were far from perfect.
They often focused on resource extraction rather than
development. Then after gaining independence in the
post-war era, many African countries rebelled against all
things colonial—including capitalism. Africa’s worsening
situation today stems from having embraced socialist
ideologies after independence. economic freedom and the willingness of its citizens to play
The failure of socialist policies led to African governments
transforming into what economist George Ayittey terms
“vampire states.” The vampire state exists only to enrich
the rulers. The general population has little or no say in
state activities, finding themselves impoverished as the
rulers suck the wealth from the economy. Ayittey argues
that these states follow a general pattern of evolution to
their own collapse. As people begin to exit and move into
the informal economy, governments resort to inflation
to raise revenue. As the situation of the common people
Voices of CCU
BRING PRODUCTIVITY
OUT OF THE SHADOWS
By Tamara Hannaway
As Tax Day approaches on April 15,
consider this: Last year, 313 million
Americans produced $14.7 trillion in
goods and services. Each of us earned,
on average, about $46,900–or at least that
is what we reported. In U.S. equivalent
dollars, each Canadian earned $39,600 and each Mexican,
$13,800, officially. In Paraguay the average citizen earned
$4,900, and in Zimbabwe just $400.
America ranks among the most fiscally transparent countries
in the world, jockeying for first place with Switzerland,
Luxembourg, Austria, Japan, and the U.K. Yet no country
is able to capture more than 92 percent of its overall
productivity in its official GDP figures, and some capture
less than 31 percent. The rest flows through institutions in
the “informal economy.”
Those informal institutions, as described by Nobel
Laureate Douglass North, are the ad hoc decision makers
and organizations that operate outside a country’s legal
framework and actually make its rules of the game. Action
by government to tax or regulate economic activity brings
forth an opposite institutional reaction aimed at avoiding
such taxation and regulation. Each new obstacle to an
unfettered market sparks the devising of a workaround.
The more burdensome the obstacle, the more resolute the
institutional reaction.
I pay the neighbor boy $20 to mow my lawn, hoping he puts
it into a college fund and assuming the IRS will never know.
But what about the $8,500 I paid for my new roof ? Was
that also unreported? About 9 percent of the earnings by
U.S. citizens go unreported, funding our informal economy
to the tune of $1.3 trillion. Just think what the income-tax
revenue on those shadow dollars would buy, like books for
our inner-city schools.
In Canada, 15 percent of earnings are not reported, 30
percent in Mexico, 40 percent in Paraguay; the international
average is 35 percent. In sub-Saharan Africa, to underscore
Benjamin Powell’s point, over half of all productivity funds
the institutional evasions described by North.
There is a direct correlation between a country’s level of
by official rules and pay fair taxes, thereby increasing the
prosperity of its legally recognized economy. Dr. Powell’s
essay is exactly right: What makes poor nations rich is the
freedom to pursue and keep individual gain. ■
Tamara Hannaway (MBA, Westminister
College) is an associate professor of econom- Centennial
ics and public policy at Colorado Christian Institute
Colorado Christian University
University and a Ph.D. candidate from the
University of Colorado at Denver. This essay draws on research for
her doctoral dissertation.
Centennial Review, April 2011 ▪ 3
 Centennial Review Centennial Institute
April 2011 Colorado Christian University
8787 W. Alameda Ave.
Freedom Cures Poverty Lakewood, CO 80226
Where Government Fails
By Benjamin Powell Return Service Requested
Many millions have been lifted from
poverty by marketization in China,
foreign trade in India, and the rule
of law in Botswana. But socialism
has impoverished other African
countries. America’s proudest
export should be economic
freedom.

deteriorates, they finally rise up and rebel. Then the Even Hong Kong, which consistently ranks 1st in the
struggle for political power eventually plunges the country economic-freedom indexes, has interventions that distort
into civil war. housing markets. The United States and Western European
The West has played a role in prolonging Africa’s poverty by nations all have numerous interventions that distort
sending aid to leaders of these vampire states, and through entrepreneurial incentives, preventing those economies
programs that have displaced indigenous institutions. from reaching their full potential.
What Africa needs is investment in order to develop. But Whether in Africa or the United States, institutional
to get that investment, Africa needs an enabling economic reforms that promote economic freedom will not fail to
environment of property rights, the rule of law, and promote higher standards of living. ■
freedom.
How can this be achieved? We must first stop the aid/ “Crazy great,” said one attendee last year
reform dance with African leaders who continually game
Western donors. We can trade more freely with Africa
by lowering tariffs. There is evidence that freedom is
“contagious”—when a more-free country trades with a
less-free country, the less-free country tends to improve
its freedom.
Dick Morris Dana Perino John Bolton
Hearts and Minds
But ultimately the transformation of Africa will depend on
the hearts and minds of Africans. They need to understand,
embrace, and enforce on their leaders an ideology of
freedom. While Africa is the most extreme example, these
same lessons apply to much of Latin America and Asia,
Arthur Brooks Dennis Prager Bill Armstrong
as well.
Foreign aid and state planning have failed to promote You’re Invited • Register Today
economic growth in impoverished regions of the world. Western Conservative Summit 2011
Countries that are poor suffer from too much government
“Fulfilling America’s Promise”
intervention, not too little. Countries that have developed
rapidly have done so by improving the institutional
environment in which entrepreneurs operate. They July 29-31 • Denver Marriott City Center
achieved growth by better respecting private-property Confirmed speakers are shown. More to come.
rights and granting greater levels of economic freedom. Individuals $200 • Host a Table $2,500
As we have seen, this lesson is crucial for the poorer Centennial Institute’s second annual rally on the right
countries of the world where increased economic growth will be even bigger than 2010. Don’t miss it if you love liberty!
can literally be a matter of life and death. But it is also
important for the more-developed countries. No country For tickets and information go to
has a perfect institutional environment. WesternConservativeSummit.com
Centennial Review, April 2011 ▪ 4