Friday, December 12, 2014

The Importance of Human Capital -- Some Cross-Counrty Comparisons

Note: The Assignment here was "What Makes a Country Successful?" I tried to fit in the box I was anticipating the professor was expecting. Otherwise, I would not have used anything that touched the heritage foundation. When I was in DC this summer, I was drinking at a bar on Capitol Hill two doors down from the Heritage offices. I gave them a two-finger salute. If I was a smart phone type of person, I'd have proof it happened. Sadly it is all in my mind. So I tangentially tied in their "Economic Freedom Index" because the professor pushed it so hard. In an exchange with Dean Baker, I joked about how Econ 101 WAS ABOUT gains from trade. He pointed out that those gains aren't evenly spread. In truth I'm all for infant industry protection and trade barriers that don't let developing countries be eaten up by the market. But this was an intro class and we didn't learn that and I just kept my head down and didn't want to push it. Anyways, veritas sequitur.



                                      "Growing a Successful Country"

     To say a country is successful, economists will look at some simple data points. First, they may look at GDP, the total output within the nation’s borders adjusted by net imports. If that is not specific enough, they will look at the GDP per capita, or the amount of goods and services totaled but divided by the country’s population. This will give economist a rough estimate of the amount of goods that an average citizen of that country can call his or her own. This number gives a raw number but it is not good enough to compare how the people of the country will live their lives, a further adjustment is necessary. Most goods are seen as operating in a world market; services are tied to place. No Boston barber is giving haircuts in Kinshasa. Thus, there is an adjustment for good and services that an individual in the Democratic Republic of the Congo can receive as opposed to a direct dollar amount, called “Purchasing Power Parity” or “PPP” for short. In this example, the World Bank PPP adjusted GDP per capita is $747 as of 2013, where the straight dollar amount of the GDP per capita is $454 for the Democratic Republic of the Congo. The PPP is an attempt to show the real buying power of a population. Comparatively, in the United States, the GDP per capita is $53,143 in both absolute and PPP terms because the adjustments are made in reference to the number of the United States (“GDP per capita”). Economists will tell you that GDP is not enough. The people of the country need to share in the wealth of the nation, or there is a chance at political unrest – just ask the Romanovs. There is a measure of how that GDP is distributed, called the Gini index. The Gini index is shorthand for how well the wealth is spread. A Gini index of one means that one person in the country receives all the income and no one else gets any, where a Gini of zero means that the income is perfectly divided (“Measuring Inequality”). A successful country will not have a Gini near one, but will instead have an environment where there is an opportunity to share in the wealth the nation generates. For example, the Democratic Republic of the Congo most recently was calculated as having a Gini of 44.4 where in the U. S. it was 41.1, meaning income is spread amongst the citizens of the United States more equally than the DRC. (“Gini Index”).
The above comparison show us that using just these two numbers that the Congo is poor and the United States, in comparison is vastly richer. Ultimately, the exercise can be repeated with every possible set of nations. Ultimately, such comparisons are only looking at the results. To make a successful country is more than just saying that a successful country needs a high GDP per capita: look at Luxembourg, Norway, and Japan! The path needs to be considered.
A country looking at becoming successful in the nineteenth century would want certain things geographically. It would need protected bays, like that of Boston or San Francisco to handle international trade and fishing fleets, and to protect the fleet from storms and marauders. Some European countries even put their capitols up a river, like Paris on the Seine, London on the Thames, and Lisbon on the Tagus. In the hinterlands, the country would want fertile lands, as Russia enjoyed with the Ukraine when it was part of that empire, and that helped the United States grow from scratch. Natural resources would be paramount – forests or coal to heat homes and the boilers of steam engines, like England extracted from the coalfields of its north. Growth today is a little different. What is underground can help. Paul Krugman, in his textbook, compares the difference between the nations of Kuwait and Germany. Both have similar GDP per capita, but Germany is at a great advantage because the wealth of the German people is based on generations of developing knowledge in the manufacturing sector (Krugman & Wells p. 251).  There may be a day when oil runs out or is supplanted by another energy source. There is no similar to peak oil when it comes to knowledge. There is no peak knowledge. The question then becomes, “How do you get there from here?” The ultimate answer is that a nation becomes successful by investing in its people. By investing in its people, a nation can grow the GDP based on expertise and a cumulative growth in productivity. This investment in people helps grow human capital, defined as “the improvement in labor created by the education and knowledge embodied in the workforce” (Krugman & Wells p. 247). To achieve this growth in human capital, the people of a country need to be healthy, educated, and employed. In the sections that follow, each of these will be examined in turn.
To have a successful country, the first thing that is necessary is to have healthy people. There are various ways to measure this. One way to measure a population’s health is to look at its overall life expectancy. This measure tells you how long a person born in a certain year is expected to live. The United Nations keeps track of these numbers. Currently, a child born in the most developed countries will live eighty years or more. For example, the child that will the live the longest is a Japanese female at 87 years. The child that will live the shortest is a male from Sierra Leone who will live only 45.3 years (Malik table 5). The oldest lived average child will live almost twice as long as the shortest lived child. The difference between the two is the stability of the government and the institutions that serve the people. Sierra Leone has been through civil wars recently, and a large number of its population is young, with a median age of 19. Only 0.02 physicians per 1000 people serve this young population. This is a very low number of doctors in the face of the public health issues facing the people of Sierra Leone, from bad water to infectious diseases like malaria, dengue fever, and yellow fever. This is not to say that government is not trying to keep the population healthy. Expenditures on healthcare in Sierra Leone are 18.8% of the GDP. The problem is that the country is very poor. The main industry of its workers is subsistence agriculture (“CIA Sierra Leone”).  That means the percentage spent on health, though high as a percentage of the GDP is low in absolute numbers. The overall poverty and the lack of trained physicians means the population of Sierra Leone dies at an age that is much younger than the rest of the world except for some of its geographic neighbors. Decolonialization led to revolutions and wars and strongmen throughout sub-Saharan Africa, meaning the public health crises have not been dealt with from malaria to HIV/Aids. 
In contrast with Sierra Leone is the nation of Japan. The people of Japan have enjoyed relative political stability under a new constitution after their involvement in the Second World War. Before that, however, they went through a century of modernization after 1854 when Tokyo was opened up to trade and Japan went from a feudal nation to a modern industrial state. It has homogeneous population, with a vast majority of its people being of Japanese descent. These people are also an older population, with Japan’s median age being 46.1 years old – older than Sierra Leone’s expected lifespan for males. This older population takes care of itself. Even though it only spends half of what Sierra Leone does on healthcare in terms of GDP at 9.3% of GDP, Japan has a hundred times as many doctors per thousand of population, with 2.14 doctors per every thousand Japanese citizens. (“CIA Japan”). Having medical care and clean water is a huge advantage in keeping people alive. Having people live a long time means that human capital has time to be built up within generations. Sierra Leone is working on it, but there is a lot to be said for political stability like Japan has had for the past 70 years. It allows institutions and corporations to flourish. 
Once a country has a healthy population, the next goal for a country to build hu
man capital is to educate the people. The nature of the education process is a fraught political potato with predictable left right divides. The most important thing for a country’s is not if the teachers are on the government payroll or not, but that the students are in school. In terms of anticipated length of time students will stay in front of a teacher, the nation of Australia is in the global lead, where the average student is expected to have 20.3 years of schooling for their women and 19.4 years of schooling for the males (Malik table 5). Compare this to Eritrea. The students in Eritrea are anticipated to spend 3.7 years in the classroom for females and 4.6 years for males. For context, that means that every Australian student will have schooling from preschool to a bachelor’s degree, on average. The student from Eritrea will have the equivalent formal education of an elementary school dropout.
What makes Australia so successful in this metric has a lot to do with other factors. Australia, though a relatively new country, inherited many of the institutions of its English settlers while taking advantage of the vast emptiness of the continent and the fertile agricultural land on the continent’s southeast shore. Australia has large land mass but a relatively small, mostly urban population that now lives largely on that coast. The people have a long life expectancy to go along with the education. They have more doctors than even Japan, and enjoy a low instance of chronic infectious diseases such as AIDS. The most notable thing about Australia is that it has enjoyed political stability, having an independent constitution since 1901 and exercises the English common law system. (“CIA Australia”) They were able to piggyback off the success of the English system while also looking to the United States for inspiration in the governing structure. The monarch of England nominally still heads the nation, but the real power is vested in the Prime Minister and the bicameral legislature. 
Compared to the institutions Australia inherited from its former colonial guardians, Eritrea inherited a many issues. The nation, on the eastern coast of Africa, won independence from the Italian government after the Second World War. Peace lasted for about ten years before thirty years of war between it and Ethiopia erupted. In the 90’s the war ended, and since then it has been run by the same strong man whose rule has been described as “autocratic and repressive” (“CIA Eritrea”).  Because of this instability and one-man rule, many of the metrics used to describe a successful nation have suffered. It has one of the world’s lowest life expectancies, anticipated by its abysmal spending on health, which at only 2.6% of GDP places it 184th amongst all nations. This ill health and poor level of education leads to a low literacy rate. Though suffrage is nominally universal, there has not been a presidential election since 1993. The lack of markets in the country’s command economy inhibits growth, leaving 80% of the nation’s workers scratching the dirt for subsistence agriculture. Its goods are very low on the value chain, exporting raw materials and importing finished goods. The people of Eritrea suffer because of the lack of real democracy and the policies brought down buy their strongman. He keeps them uneducated, unhealthy, and poor.
Once a country’s people are healthy and educated, the next thing that is needed to grow human capital is to give them jobs so that they can gain experience and move up the ladder in their careers. The best comparison is how many people in the labor force do not have work. This is measured through the unemployment rate. Globally, the country with the highest unemployment in the last year that the UN tracks is the former Yugoslavia Republic of Macedonia at 31%, while amongst the lowest is Qatar at 0.4%. (Malik table 11). There is a vast disparity between these two nations.
Macedonia is doing many things right. It has advantageous geography and is surrounded by the European Union member states. The nation is relatively healthy and educated, with a 97% literacy rate. The biggest issue is that the nation has lack stability. Of the former communist bloc states, Yugoslavia has the messiest transition to the free market. The Balkan Peninsula was embroiled in a decade of war until about 2001. It was not until that point where adoption of more market friendly policies could take place, and they are slowly working their magic. In fact, some observers say that the high rate may be overstated because the nation has an abnormally large grey economy. Off-book employment may approach 40% of GDP (“CIA Macedonia”). If true, this is an issue for the future of the country, as tax collections help drive infrastructure development, including the much-needed health and education facilities. The health and education of the people is the health of the state. With the people either not working or working in the gray economy, the future is at stake. 
Conversely, in Qatar, everyone who wants a job has a job. Unemployment is at 0.4%. A large part of that is Qatar sits on vast hydrocarbon reserves. These have not been sufficient for employment in the whole course of the nation’s history. The nation has been run by the same ruling dynasty since the seventeenth century, but for most of that time the wealth from the ground was taken by the ruling family and the people did not have jobs. It was not until 1995 when a more people-friendly ruler came to power. His rule had been notable for the development of Qatar as a hub of stability in the Arab region, along with some political modernization. Even more notable was his peaceful handing over of power without his having to die (“CIA Qatar”). The problem is that even thought at this point Qatar is importing labor, there is a definite lack of institutions to look out for the people of Qatar. Formerly the ruling family expropriated all the wealth from the ground. That changed to be friendlier to the people of Qatar, but it can easily be changed back to the old way of doing things at the whim of an absolute ruler. The populace is healthy and well educated, and they are now poised to grow after the global economy moves away from oil as an energy source.
In the end, just having a healthy and educated populace is not enough for success. The metrics for success have some commonalities. The very best countries in terms of education, life expectancy, and unemployment rate have a history of political stability. Other than Qatar, the best countries are democracies. Qatar started to gain success when it started to act as if a democracy would act in terms of spreading the fruits of the ground. The royal family remains well off, but everyone is well off. Qatar in fact has the highest global GDP per capita because of its oil wealth, and it shares its wealth comparably to the United States, with a Gini coefficient of 41.1 (Malik table 3). Conversely, the countries that have failed at the metrics examined have much more political instability. They have suffered long wars in recent memory and have only just begun to recover from those scars. Macedonia has an established democracy, but Sierra Leone and Eritrea suffer under autocratic rulers who expropriate what little wealth is created for themselves and their cronies. These political institutions, and the lack of them, are so important in the success of a country. Even the healthiest, smartest, most hard working population could not succeed under the conditions that exist in the least successful countries. Success is not economic, but the result of choices the government makes. The closer the government is to the people, the more the government will make policy decisions that benefit the people as a whole and allow success of the people to make the whole pie bigger instead of taking most of a small pie. The Heritage foundation defines this autonomy of the individual as economic freedom, with three fundamentals: “empowerment of the individual, non-discrimination, and open competition” (Miller & Kim).  They maintain their own ranking of how economically free a country is based on their fundamentals, and looking at their rankings show that economic freedom goes hand-in-hand with the other metrics examined. A nation that builds human capital is one that is free. For example, Australia, Qatar, and Japan all rank near the top of the rankings. The Australians are third after Hong Kong and Singapore. On the other end, the poor African countries are near the bottom. The only outlier is Macedonia, which ranks fifty-second (“Country Rankings”). However, that is to be expected with the large gray economy noted earlier. Therefore, it is easy to see that economic freedom as measured by the Heritage foundation is highly correlated with growth and development.
In the end, if a country wants to be successful, it needs to grow its people. Nevertheless, to do that, it needs stability and the institutions in place that will facilitate its growth. It needs to avoid long and drawn out wars that take resources from economic development. The country must also have open markets that are accessible to the people. If these conditions are met, then the country will be on the road to success.

References

CIA. (2014). Australia. CIA World Fact Book. Retrieved from  https://www.cia.gov/library/publications/the-world-factbook/geos/as.html
CIA. (2014). Eritrea. CIA World Fact Book. Retrieved from  https://www.cia.gov/library/publications/the-world-factbook/geos/er.html
CIA. (2014). Japan. CIA World Fact Book. Retrieved from https://www.cia.gov/library/publications/the-world-factbook/geos/ja.html
CIA. (2014). Macedonia. CIA World Fact Book. Retrieved from  https://www.cia.gov/library/publications/the-world-factbook/geos/mk.html
CIA. (2014). Sierra Leone. CIA World Fact Book. Retrieved from  https://www.cia.gov/library/publications/the-world-factbook/geos/sl.html
CIA. (2014). Qatar. CIA World Fact Book. Retrieved from  https://www.cia.gov/library/publications/the-world-factbook/geos/qa.html
Heritage Foundation. (2013, November). Country Rankings. 2014 Index of Economic Freedom. Heritage Foundation. Retrieved from http://www.heritage.org/index/book/chapter-7
Krugman, P. & Wells, R. (2013). Macroeconomics. New York, NY : Worth Publishers
Malik, K. et al. (2014). Statistical Tables. United Nations Development Report. United Nations. Retrieved from http://hdr.undp.org/en/2014-report/download

Miller, T. & Kim, B. (2013, November). Defining Economic Freedom. 2014 Index of Economic Freedom. Heritage Foundation. Retrieved from http://www.heritage.org/index/book/chapter-7

World Bank. (2014). GDP per capita (current US$). World Bank Databank. Retrieved from http://data.worldbank.org/indicator/NY.GDP.PCAP.CD

World Bank. (2014). GDP per capita, PPP (current international $.) World Bank Databank. Retrieved from http://data.worldbank.org/indicator/NY.GDP.PCAP.PP.CD

World Bank. (2014). Gini Index. World Bank Databank. Retrieved from http://data.worldbank.org/indicator/SI.POV.GINI?order=wbapi_data_value_2013+wbapi_data_value+wbapi_data_value-last&sort=desc

World Bank. (2011). Measuring Inequality. Poverty Reduction and Equality. World Bank. Retrieved from http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTPOVERTY/EXTPA/0,,contentMDK:20238991~menuPK:492138~pagePK:148956~piPK:216618~theSitePK:430367,00.html