This is a series of conversation between two Economists, Akhilesh Verma and myself, Garima Dhir as we try to unravel and simplify various concepts of economics. In the previous post, we had discussed how the economy and formal markets came into being, how was money born and what exactly is the role of an economist? We take our conversation forward and discuss how the modern economy was formed, when did countries start trading and what led to some countries being rich, while others poor.
The tables have turned this time as Dr. Akhilesh Verma grills me with his volley of questions and I make a feeble attempt to answer them.
Akhilesh Verma: Ok! So before you tell us the reason why some countries are rich and others are poor, maybe we could discuss how the modern economy came into being?
Garima Dhir: You are right, before we answer the main question, it is important to understand how the world today took form. Interestingly, journey of the modern economy can be linked to the time when Vasco Da Gama sailed to India and Columbus discovered the Americas in the late 15th century. These two discoveries opened up new market destinations, trade routes, and channels for trade relations among countries. Since then, an era of globalization started and the last 500 years were crucial in transforming the world economy and led us to where we are today.
Akhilesh Verma: Why do you say that the last 500 years were crucial?
Garima Dhir: To understand this, let’s divide the last 5 centuries into three parts.
- The first phase lasted from the 15th to the 18th century. It started with the voyage of Vasco Da Gama and Columbus and ended with the industrial revolution in Europe and the United States of America. The main characteristic of this phase was initiation of international trade and structured manufacturing. For example, during this time, USA settled as a country and began exporting silver, sugar, and cotton to other parts of the world. Similarly, Asians sent spices, textiles, and porcelain to Europe. On the other hand, European countries acquired colonies, which were used to promote manufacturing.
- The next phase was in the 19th century, when major economies of the world began to rise. Britain became the biggest industrial hub in the world and outcompeted other countries; At the same time, Western Europe and USA also made tremendous economic development.
- Finally, the last phase of modern economic transformation occurred from the 20th century onwards, which witnessed the growth of countries in the East. This happened when relatively poor countries of that age like Japan, Taiwan, South Korea, and the Soviet Union adopted new technologies innovated in rich countries and began catching up with the West.
Akhilesh Verma: This makes me ask you our main question, if countries followed a similar path then why are some countries rich and other poor?
Garima Dhir: Though we finally come to this question, the irony is that there is no one answer to this question, but we can still attempt to answer this by looking at the role played by geography, institutions, culture, and a few accidents of history. Let’s take these factors one by one to understand their role better.
- Geography played an important role, be it for mortality rate, disease spread, or discovery of rich minerals in certain countries. For instance, tropical countries (close to equator; with high temperature) were more ridden with diseases and had lower agricultural productivity than temperate countries (between tropics and polar regions; with moderate temperatures) which led to their lower economic growth and development. Then again, coastal countries with access to waterways and sea routes were more likely to grow than landlocked countries which had limited trade routes. Similarly, large coal deposits that were found in Britain underpinned its industrial revolution and likewise, oil rich countries were naturally wealthier than oil scarce countries
- Culture has also been a successful explanation for economic success. According to Max Weber’s theory of Protestant Work Ethics – hard work and thriftiness – resulted in Protestants to be more productive than Catholics. This contrast can be seen in countries like Britain and Germany compared to Spain, Portugal and Italy during the 16th to 18th century.
- Strong institutions such as political and legal foundations in the form of property rights, low taxes, and minimum government have proved to be important for economic growth and development. For example: Relative to developed countries, most of the developing countries have inefficient legal systems, lower quality health and education infrastructure and lower economic outcomes.
Please let me caution you that these explanations do not completely explain the economic success of the nation and there are many exceptions to these factors.
Akhilesh Verma: Where do you place India in terms of being a modern economy?
Garima Dhir: Well, given our association with the country, it is quite natural to wonder about India. India was under the colonial rule till 1947 and only recently, 75 years back, got its independence. India with its late start went through several ups and downs. Let me give our readers quick brief.
Initially, India walked the path of a planned economy, on lines of the Soviet Union. This involved designing and implementing five-year plans that defined the focus areas for the government. These plans included spending on industrialization, setting up educational institutions, poverty eradication programs, bank nationalization for a robust financial system, the green revolution for achieving self-reliance for food grain consumption, to name a few. For the first 4 decades after independence, many restrictions were put on trade with other countries, and the Indian economy experienced a modest growth. In the 1990s when our policymakers decided to open up the economy and link it with the world. India became globalized.
This step made the Indian economy more attractive to the world. Foreign companies in several sectors started investing in India, imported goods become cheaper, global food chains/supermarkets/malls opened up, entrepreneurial spirit kicked in and led to many domestic innovations and Indian companies and households got access to products based on advanced foreign technologies. In summary, post-1991, India got closer to the concept of a modern economy, and went on the path of catching up with the rest of the world.
- ‘Guns, Germs, and Steel’, Jared Diamond, 1997
- ‘Contours of the World Economy 1-2030 AD’, Angus Maddison, 2007
- ‘The World Economy: A Millennial Perspective’, Angus Maddison, 2001
- ‘Global Economic History: A Very Short Introduction’, Robert C Allen, 2011