The world economies are getting ever more sophisticated and inter-reliant. Some countries struggle to grow their economies, while others prosper. Few politicians seem to be able to come up with the right economic policies to achieve long term social goals. It may help to rewind and look at macro economics in it’s simplest form.
The simplest question one needs to answer is: “How do you create wealth?”
Contrary to some conspiracy theories, wealth is not created out of nothing, it is not some abstract bubble that will burst at some point. To analyse it correctly, one would need to look at the world thousands of years ago. Just imagine a world which is divided into countries. Each country has a human population, and although smart and intelligent, are nothing more than cave dwellers. Each country has two forms of capital. The first are the natural resources. They include everything from the wild crops, to the animals and mineral deposits (such as copper and iron ore). Some countries have got more of the one or the other, but each country has got natural resources. The second form of capital is the human capital. The distinguishing feature between us humans and the rest of the animal kingdom is that we have far superior cognitive abilities, making it possible to think in abstract terms and thus create something not by chance but on purpose.
If the humans decide to gather the seeds of crops growing in the wild and grow them in fields that are easier to cultivate, resulting in higher yields, each human will have more to eat. It is not at the expense of the other humans, thereby making the society as a whole richer. It is the combination of human intellect and the natural resources, that creates a wealthier society. This process is repeated over and over again. They would build man made shelters out of natural stones, and thereby were able to live in areas that previously lacked shelter.
But at some point, the human capital would have reached its physical limit, because a highly intelligent farmer can’t be much more productive than an average farmer. There are only so many hours of sunlight to work the soil, and even though the highly intelligent farmer would be more productive, there is a physical limit on how much earth he can turn in an hour. But the humans then specialised on one activity, because the concentrated knowledge makes them more productive. The highly intelligent human would stop growing crops and rather invent farming tools, which the farmer would use to be even more productive. As a medium of exchange, money is created. The farmer is able to pay for the farming tools because he has a higher crop yield. Since it is more efficient to trade the crops with somebody who needs crops, he would trade the crops for money and give the inventor money for the farming tools. Using money as a medium of exchange is just the most efficient way of trading, and again, the society as a whole benefit and gets wealthier.
Fast forward a few centuries, and the repeated process of using the resources more efficiently generates wide spread wealth. But the constraint to this growth is the ability of using the current countries capital in a more efficient manner. So it would be a function of furthering the human knowledge, and trying to use every incremental increase to somehow make a better use of the countries natural resources.
Enter a third form of capital, namely foreign capital (both as human capital and natural resource capital – or the mean of exchange, i.e. money). With foreign capital the country doesn’t need to wait until they have generated enough surplus capital (i.e. wealth) to, as an example, build a mine. They can do it straight away. This encourages growth beyond the natural ability of a country to grow. It makes the country wealthier and its citizens more prosperous.
So what lessons can the politicians draw?
To grow the economy, the government should always focus on three aspects: Firstly, do the policies encourage further development of human capital? Does our population become more knowledgeable and more intelligent? Secondly, do you encourage companies to use the natural resources in the best possible way? Thirdly, how do we attract the most foreign capital, both human and resources (i.e. money).
Focusing on those three areas will deliver the highest possible economic growth, which in turn will generate more taxes to be spent on the poor.