The Problem of Development

I have had several engagements in which senior officers of a nation-state were seeking advice on how to grow and deepen its economy. I wish there was a simple formula, like “free up your markets,” or “more education.” But there isn’t. Pulling the general population out of poverty is not simple. Give food, and farmers are hurt. More modern medicine means a higher birth rate and more unemployment. Does free college education for the many help?

One experiment in education was Nasser’s education reforms in Egypt during the 1950s. Primary school was mandated for both men and women. University fees were minimized and good jobs in the government were guaranteed to all having a college degree. Yet, this idealistic program did not really work. It created generations of paper chase, with schools focusing on credentials rather than education. Yes, Egypt, poorer than Iran or Turkey, has many more college graduates per capita. But the government could not fulfill the guaranteed jobs promise. So, the lack of a vigorous private sector left huge numbers of educated young Egyptians without work or without sufficient income to marry and have a family.

The Original Industrial Revolution

Before the Industrial Revolution in about 1750, most of humanity was poor. There was no “problem of development” because no country was “developed.” Most people in the world lived in poverty at the subsistence level. They lived on the land and had little or no savings. Most were illiterate serfs, laboring for the benefit of great landowners. For most of history, all over the world, most people’s lives were a continual struggle for existence itself. By modern standards, perhaps 95 percent of humanity lived in extreme poverty. Today that number is about 10 percent, having dropped sharply in the last 20 years as China finally developed a market economy. The change from 1750 to today is astounding. It did not come about from charity or income or wealth redistribution. It came about from technology-powered surges in productivity and innovation in social systems.

The concept of “development” has its origins in the Industrial Revolution. This revolution and its aftermath produced the most significant change in the human condition since the invention of agriculture 10,000 years ago.

The Industrial Revolution started in Britian (and the Netherlands) in the 1700s. It started there because those societies had become freer, had developed a system of private property, and had thrown off the yoke of having the church or king define what was knowable or doable. Patents had evolved from being royal grants of privilege to a laissez-faire system, and finally to a clear monopoly grant for a publicly described technique.

Also, Britain was running short of wood. It had a lot of coal, but to dig up coal one had to pump water out of deep pits. Newcomb’s 1712 “atmospheric” steam pump did the job, but terribly inefficiently. That inefficiency seemed a challenge to Scotsman James Watt. In 1750 he designed and built the first real steam engine with a reciprocating piston moving in both directions. He used old canon boring machinery to shape the cylinder. By 1776, it was being installed in commercial enterprises. That machine, combined with Henry Maudslay’s later invention of precise boring and of machine tools, really ignited the industrial revolution.

Why didn’t the industrial revolution happen a thousand years earlier? And why did it first happen in Britain and not everywhere? There are five basic enemies of technological progress.

1. The first is the quasi-religious belief that all worth knowing is already known, especially as represented by some presumed earlier “golden age” or revealed divine knowledge.

2. The second is a dictatorial social order which pre-defines the roles people can take on, what they can own or take credit for, and what transactions they can undertake.

3. The third is an extractive mindset—that there is a fixed amount of wealth and that one can only advance by taking from others and that anyone’s gain is someone else’s loss.

4. The fourth is a social and political system enforcing fixed patterns of work and commerce. One cannot invent steam-driven ships if the sailing ship guild has a lock on shipbuilding. One cannot improve public education if huge unions have political control over the system. One cannot build a high-speed train in the US if hundreds of interest groups can each go to court to block it.

5. The fifth barrier is a level of social disorganization, violence, and extortion that limit returns to investment or innovation.

In Europe, before 1700, these forces quieted innovation for a thousand years as the church came to define what was acceptable knowledge. The feudal class system defined the social order. There were even sumptuary laws defining the permitted dress for different classes. Kings granted “patents” protecting different guilds and products from any competition.

In China, the “Golden Age” of invention and development ground to a halt in the 1400s as the Ming Dynasty began to exert complete control over most aspects of life. Private property laws were absent and the new code restricted travel outside of China as well as mandating heavy fines for anyone switching professions.

In the Islamic world, technological progress slowed in the thirteenth century as the literal worship of Islam’s zenith made innovation vaguely heretical.

Japan closed itself in about 1600, avoiding contact with outsiders as the aristocrats of the Edo era struggled to maintain the existing social order.

India presents a more complex case. Under the Mughal (Muslim) empire (approx. 1500-1720) India was the world’s leading exporter of textiles. Socially, the ruling Mughals regarded the conquered Hindu kings and princes as simply landowners. Plus, the Hindu social structure was divided into castes which tended to limit social and occupational mobility. With the collapse of the Mughal rule in the early 1700s, India might have been able to follow a path to development, but its internal wars, the caste system, and falling under British colonial rule (first by the East India Company) all combined to freeze things in place. Plus, Britain moved to limit imports of Indian fabrics to protect its own newly industrialized fabrics industry.

The industrial revolution began in Britain because of a unique mixture of science, education, private property, some social mobility, and trade. In Britain, a robust trade-based middle class developed which the nobility accepted rather than repressed. Thus, an educated middle-class person like James Watt could enthusiastically get his hands dirty with coal, steam, and steel and invent the steam engine.

The lessons for today are pretty clear. Society must allow smart people to work at the “coal face” where technologies advance. It must not place dogma and “accepted truth” above actual observation and manipulation. And society must permit returns of wealth and status to the innovators. And societies must permit change, even though the short-term result is that some people are worse off. And governments must invest in infrastructure that permits the safe and speedy movement of ideas, people, and goods.

Challenges to Development

Working with a government on the problem of economic development one is faced with deep issues of causality. What causes economic growth? What blocks it from happening? The theories about this abound and many are destructive. For example, the USSR’s philosophical basis was the Marxist teaching that capitalism exploited the workers. But trying to sell this proposition globally to peasant economies, where there weren’t any capitalists, was not going well. So, in the late 1960s, they changed the theory to argue that the fight was against colonialism and racism. Their recommendation was, of course, revolution, and Marxism. The modern echo of that teaching is the claim that capitalism is the source of racism, a doctrine that remains alive and well among many U.S. progressive groups. It is a doctrine that ignores Asian beliefs about ethnic superiority, the Hulu vs. Tutsi genocide in Rwanda, the slavery of Pygmies to Bantu peoples in the Congo, and the long-standing cultural obsessions with skin color in Arab countries and in much of India.

Early in my career, I spent some time talking to economists at the London School of Economics and the Harvard economics department. Their take on the issue of development was “capital formation.” Countries were poor because they didn’t have capital (investable savings). The recommendation was for specialized lending institutions that could feed capital into promising ventures.

In the 1970s I was able to visit and interview the head of the Industrial Bank of India. The head of the bank told me: “We have the capital to lend, but too few projects that warrant investment. I have plenty of Ph.D. engineers who have designed some sort of chemical or fertilizer plant, but I don’t have a team that knows how to run such a plant or operate it commercially.”

The infrastructure missing in many “developing” countries is not just capital, or schools and roads, but the whole society of skilled people we take for granted in industrialized countries. Not the concepts taught at MIT or UCLA, but hands-on skills like welding stainless steel, building a refractory furnace to melt glass without imparting impurities, multi-color precision printing on metal for a can company, cold-welding aluminum, or making many of the precision parts that go into an automobile.

The idea that the problem of development was “racism” or “capital” turned out to be an expensive and damaging intellectual error. In Asia we saw Japan, Singapore, South Korea, and now China, break the poverty barrier and develop social and technical infrastructures just as fine as any in the West. Doing this required a critical mass of powerful people to take seriously the creation of technical skills together with a sharp reduction in corruption. Surprisingly, many of these newly developed economies saw rises in agricultural productivity as millions moved off the land and into factory work.

Other poorer countries would like to emulate these Asian Tigers. Trying to give them strategy advice is frustrating because the mindset of leadership in many of these stable societies of poverty tends to be “extractive.” That is, the main pursuit of the middle and upper classes is the division of the pie. Colonialism came and displaced some of the traditional elites, but on its departure, the home-grown elites remain. There is, in these societies, a fundamental unspoken assumption that there is a certain amount of “stuff” and the issue is its division. Even when the underclass revolts and takes charge, they merely redistribute the farmland and small businesses among themselves, with no net gain to the nation. It was the same in Europe for many centuries. Mokyr and Voth note that “large parts of Europe’s early modern history read like one long tale of gridlock, with interest groups from local lords and merchant lobbies to the Church and the guilds squabbling over the distribution of output.”¹

Violence and Extortion

A further challenge to development is a high level of violence. Roving gangs, armed “rebels,” large criminal syndicates, and organized extortion blunt incentives to invest or invent. It makes little sense to spend time or capital trying to organize a business if men with guns are going to take any earnings.

Extortion is a softer form of violence. Extortioners coerce payments by threatening loss or violence. When I was in high school in Queens, New York, the younger students were shaken down each day by Gino and his two friends. We had to cough up lunch money or be beaten. My friend, Robert, complained to his home-room teacher who confronted the small gang. Gino broke the teacher’s arm. After that, the school administration put a system of hall monitors in place. The hall monitors got to skip a class in return for their work. Gino and his gang were the monitors.

Extortion and protection are always closely related because the physical or political power to protect is, at the same time, the power to coerce, and vice versa. As people have learned over and over again through the millennia, the governments, armies, and police that are created to protect also have the power to extract payments and force behavior.

After the Soviet Union collapsed, organized crime came out of the shadows and took center stage. Old smuggling routes became “supply chains” and vast tracts of previously state-owned oil, gas, and minerals were simply grabbed. At the same time, thousands of men, trained in violence by the KGB and the military, became unemployed. Some of these joined criminal organizations, and some formed the new wave of protection companies receiving fees to hold criminal gangs at bay and physically protect senior executives. As criminal activity skyrocketed in the early 1990s, protection organizations also grew in number. Roughly one-half of the CEOs of private protection firms came from the KGB, the MVD (state police), and the GRU (military intelligence).²

Many private protection companies were also closely connected with criminal groups. Adris, for example, provided protection to the Baskin & Robbins ice-cream chain while being directed by the malyshevskaya gang. Such groups engaged in an odd form of unplanned mutual support, each using violence to promote the demand for the others’ services.

Vladimir Putin, no novice at the use of force, made the control of organized crime a key priority of his administration. There were great strides at breaking the oligarchs’ hold on key industries—oil, gas, telecommunications, and weapons. Still, the roots of organized crime in Russia pre-date the 1917 revolution and the state will not totally erase them. In fact, having a certain amount of organized crime helps the central government maintain order. Stay in Putin’s favor and the state has the muscle to protect you and your interests. Fall out of Putin’s favor, the state may suddenly be too weak to protect you from the still-active criminal organizations.

In the United States, organized crime is not a major threat outside of the drug trade. On the other hand, like the Russian gangs and protection companies, the legal industry supports a system of mutually supportive extortion and protection operations. As any experienced businessperson knows, most lawsuits are threats, designed to be settled rather than tried. Much legal innovation consists of inventing new ways to threaten others with loss. To defend against these threats, expensive attorneys and experts must be retained. And, the more expensive the defense, the more effective the threat of suit. All of this is “legal,” of course, but it wastes talent and resources and lessens the returns to useful work and innovation. 

Can the Problem Be Solved?

Development is not a problem of capital shortage. Its key enemy is an extractive social system and barriers to new methods which both focus inventive minds on methods of dividing a fixed pie, skimming, extortion, and on the violent taking of property. The complete story of how a society escapes these forces has not yet been told.  

1. Mokyr, Joel, and Hans-Joachim Voth, “Understanding Growth in Europe: 1700-1870: Theory and Evidence.” In Broadberry, Stephen and Kevin H.O’Rourke, eds. The Cambridge Economic History of Modern Europe: Volume 1, 1700-1870, p.25.

2. Vadim Volkov, “Security and Enforcement as Private Business,” in V. Bonnell (Ed.) New Entrepreneurs in Russia and China, Westview Press, 2001.