“Zambia is a rich country inhabited by the poor,” says Edith Nawakwi. She’s right.
Many people mark the birth of economics as the publication of Adam Smith’s The Wealth of Nations in 1776. Actually, this classic’s full title is An Inquiry into the Nature and Causes of the Wealth of Nations, and Smith does indeed attempt to explain why some nations achieve wealth and others fail to do so. Yet, in the 243 years since the book’s publication, the gap between rich countries and poor countries has grown even larger. Economists are still refining their answer to the original question: Why are some countries rich and others poor, and what can be done about it?
In common language, the terms “rich” and “poor” are often used in a relative sense: A “poor” person has less income, wealth, goods, or services than a “rich” person. When considering nations, economists often use gross domestic product (GDP) per capita as an indicator of average economic well-being within a country. GDP is the total market value, expressed in dollars, of all final goods and services produced in an economy in a given year. In a sense, a country’s GDP is like its yearly income. So, dividing a particular country’s GDP by its population is an estimate of how much income, on average, the economy produces per person (per capita) per year. In other words, GDP per capita is a measure of a nation’s standard of living.
Therefore, having plenty natural resources – minerals, water, good soils and so on and so forth – which are not exploited doesn’t make a country and its people rich. We have many resource rich countries like ours whose people are poor.
Escaping poverty requires increasing the amount of output (per person) that their economy produces. In short, economic growth enables countries to escape poverty.
Economic growth is a sustained rise over time in a nation’s production of goods and services. How can a country increase its production? Well, an economy’s production is a function of its inputs, or factors of production (natural resources, labour resources, and capital resources), and the productivity of those factors (specifically the productivity of labour and capital resources), which is called total factor productivity (TFP).
And higher TFP will result in a higher rate of economic growth. A higher rate of economic growth means more goods are produced per person, which creates higher incomes and enables more people to escape poverty at a faster rate. But, how can we increase TFP to escape poverty? While there are many factors to consider, two stand out.
First, institutions matter. Institutions are the “rules of the game” that create the incentives for people and businesses. For example, when people are able to earn a profit from their work or business, they have an incentive not only to produce but also to continually improve their method of production. The “rules of the game” help determine the economic incentive to produce. On the flip side, if people are not monetarily rewarded for their work or business, or if the benefits of their production are likely to be taken away or lost, the incentive to produce will diminish. For this reason, institutions such as property rights, free and open markets, and the rule of law provide the best incentives and opportunities for individuals to produce goods and services.
Second, international trade is an important part of the economic growth story for most countries. When poorer nations use trade to access capital goods (such as advanced technology and equipment), they can increase their TFP, resulting in a higher rate of economic growth. Also, trade provides a broader market for a country to sell the goods and services it produces. Many nations, however, have trade barriers that restrict their access to trade.
The removal of trade barriers could greatly reduce the income gap between rich and poor countries.
Clearly, differences in the economic growth rate of nations often come down to differences in inputs (factors of production) and differences in TFP – the productivity of labour and capital resources. Higher productivity promotes faster economic growth, and faster growth allows a nation to escape poverty.
Factors that can increase productivity (and growth) include institutions that provide incentives for innovation and production. In some cases, government can play an important part in the development of a nation’s economy. Finally, increasing access to international trade can provide markets for the goods produced by less-developed countries and also increase productivity by increasing the access to capital resources.