Economic Growth

Why Some Countries Are Rich and Others Aren't

Looking at economic growth, from the Industrial Revolution to the "Asian Tigers," we see how building up things like factories and equipment (physical capital), the skills of the workforce (human capital), and new inventions (technology) made some nations wealthy while others didn't improve.

Why are some countries rich and others poor? In 1820, the richest countries were about three times wealthier per person than the poorest. But by 2020, that difference had grown to over 100 to 1. An average American makes approximately 50 times as much as someone in the Democratic Republic of the Congo. Someone born in Norway can expect to live past 80, whereas in Sierra Leone, life expectancy is past 55.

The simple answer to why these differences exist is economic growth, meaning continuing increases in real GDP per person over a period of time. Countries with consistent growth over many years have gotten much further ahead of those that haven't. This difference in progress became much more noticeable after 1800 when the Industrial Revolution in Britain led to a huge increase in capital and technology which eventually reached Western Europe, North America and parts of East Asia.

In 1960, South Korea and Ghana had roughly the same GDP per person ($1,100 in today's money). But by 2020, South Korea's was over 20 times higher. They started at the same place, but went in very different directions. South Korea invested a lot in education, built industries that produced goods for export under Park Chung-hee's government in the 1960s, had a steady government and economy, and quickly used technology from other countries. For a long time, Ghana faced many difficulties: military governments taking over, not enough being spent on the country, and relying too much on what it could sell as raw materials. Whether a country has good, modern hospitals or doesn't, and whether most kids finish school or have to leave to work, all comes down to how much it grows. And figuring out why things grow is probably the most important question in all of economics.

Physical Capital and Human Capital

Let's look at physical capital and human capital. A farmer using a John Deere tractor gets ten times as much food as one with a hand plough. That tractor is physical capital - the tools, machines, factories, buildings, and equipment that people use to create goods and services. When each worker has more capital to use, they produce more. This idea is very old, but the Industrial Revolution really showed it off; between 1780 and 1830, steam engines and power looms increased how much cloth Britain made many, many times over.

But having capital isn't enough by itself. The farmer also needs to know how to drive and fix the tractor, understand what the soil reports say, and decide the best way to plant the crops. That's human capital - the skills, education, training and good health of workers that make them effective.

These two kinds of capital grow in different ways. Physical capital increases when a society puts money into building things. China, after Deng Xiaoping's changes in 1978, invested nearly 45% of all the value it produced for many years, building roads, factories and even whole cities at a rate that has never happened before. Human capital grows with education and training. Countries where nearly everyone can read and write, with good universities and healthy people, consistently get more out of each worker. In fact, economic studies repeatedly show that an extra year of schooling typically increases someone's income by around 8 to 13%, across all countries and over time.

Both types of capital eventually have diminishing returns. The first tractor on a farm makes a huge difference. The tenth doesn't do much. A country that started with very little capital (China in the 1980s, Japan in the 1950s) will grow quickly as it starts to invest. A country that already has lots of capital will see far smaller improvements from each new investment. The United States adds factories and equipment every year, but each extra one adds less and less to the total amount produced. This is why poorer countries can grow at a faster rate than richer ones - economists call this "catch-up growth."

Technology and Total Factor Productivity

If growth depended only on having more capital and workers, those diminishing returns would eventually stop growth altogether. But Britain has been growing since the 1780s, and the United States for over two centuries. Something else is keeping things going.

That "something" is technology, and we can define it as any improvement in what we know that creates more output from the same amount of input. Norman Borlaug's Green Revolution of the 1960s had better kinds of seeds. Google's search engine uses more efficient algorithms. Amazon's warehouses have smarter ways of managing goods. New medicines keep workers fit and productive. Technology expands the limit of what is possible.

Economists measure this leftover element as Total Factor Productivity (TFP) - the part of growth in how much is produced that can't be explained by more workers or more capital. Robert Solow came up with this idea in 1956 and won the Nobel Prize for it in 1987. If a country doesn't get any more workers or machines, but still manages to produce 2% more, that 2% is TFP growth. It means doing things more cleverly, not just doing more of them.

Over the very long term, TFP is what sets rich countries apart. The U.S. makes far more per worker than it did in 1900 and it isn't because people are working longer hours or have a much higher number of machines. It's the technology within those machines, and the knowledge the workers have.

Developing countries have a significant advantage: they can use technology, they don't necessarily have to create it. South Korea didn't originate the semiconductor; they obtained the knowledge (often through licensing and figuring things out by taking apart existing products in the 1970s and 80s) and then developed a whole industry around it - Samsung's first memory chip was in 1983. The flow of technology from wealthier to poorer nations is a very effective way for a country to rapidly improve.

The Rule of 70 and the Power of Compounding

The 'Rule of 70' helps to show how compounding works in a clear way. Small differences in how quickly an economy grows don't seem like much in a single year, but over many years they have a huge effect. The Rule of 70 is:

Doubling time = 70 / annual growth rate (%)

So, with 1% growth, GDP doubles in 70 years. At 2%, it's every 35 years. At 7%, every ten. And at 10%, it's every seven.

For example, if Country A grows by 2% a year, and Country B by 5%, and both begin with a GDP per person of $10,000…

Country A's doubling time is 70 / 2 = 35 years.
Country B's doubling time is 70 / 5 = 14 years.

After 35 years, Country A will have doubled to $20,000. Country B will have roughly doubled 2.5 times, reaching around $56,000. They started in the same place, but after one generation, Country B is almost three times as wealthy.

If you go out to 70 years, the difference is enormous. Country A gets to $40,000, while Country B goes over $250,000. China's average 10% growth between 1980 and 2010 lifted hundreds of millions out of poverty in just over a generation; at that rate the economy doubled every seven years (compared to 35 years with a 2% growth rate). Compounding really is powerful. A difference of only three percentage points in yearly growth, continuing for a long time, creates a completely different type of society and it's impossible to overemphasize this point.

Policies That Promote Growth

Economists have been thinking about what governments can do to encourage growth since at least the Physiocrats in France in the 1700s. There are a number of government actions that have been shown to work well, although people strongly disagree about the specifics.

Encourage investment. Building up capital requires people to save and then invest those savings. The Investment Tax Credit in the US (started by Kennedy in 1962) gave companies a direct reduction in their taxes when they bought equipment. China's government put huge amounts of state money into infrastructure for many years. Lower taxes for businesses, incentives to invest, and a generally steady economy all help to create more capital.

Invest in education and health. People's skills and knowledge (human capital) are improved by schools, colleges, training programs, and public health services. During its period of becoming industrialized, South Korea spent a lot of money on education, and by the 1990s had one of the highest rates of people going to university in the world. Conversely, a workforce badly affected by malaria or HIV can't be productive, and this is part of the reason for the difficulties in growth in parts of sub-Saharan Africa in the 80s and 90s.

Fund research and development. Technology is what drives growth in the long run, and R&D is how new technology is created. Most fundamental (basic) research has 'spillover effects' - benefits which go far beyond the company that paid for the research. The internet, for example, came from research funded by DARPA in the 1960s. Private companies can't get all the benefit from research, so they don't do enough of it. Government funding for basic scientific research, patent protection (which has existed in the US since the Patent Act of 1790), and tax breaks for R&D help to address this.

Develop strong institutions. Things like property rights, a working legal system, the ability to enforce contracts, low levels of corruption, and political stability are essential for investment and innovation to flourish. If you don't have secure property rights, no one will build a factory which might be taken from them. Without reliable courts, businesses can't be sure their agreements will be honored. Economist Daron Acemoglu (Nobel Prize in 2024 for this work) argues that institutions are the most important factor in the differences in income between countries.

Encourage free trade. Growth is faster when you have access to larger markets, cheaper ways to get things you need, and technology from other countries. Japan after the 1860s, South Korea after 1961, Taiwan, Singapore and China from 1978 onward all really depended on growing their economies by selling things to other countries. Trading allows countries to be really good at making certain things and buy everything else, which is just David Ricardo's idea of 'comparative advantage' used for entire nations.

Nothing is enough by itself to make an economy grow. Growth is the result of lots of things all helping each other over a long time. However, the facts of the last two hundred years pretty consistently point to the same basics: invest in your people, have a government that is steady, use new technology, and trade with the rest of the world.