What developing countries need most

Published at FreeMarketFoundation.com, March 16, 2010

What developing countries need most

Dr Richard J. Grant

A characteristic shared by all countries, whether “developing” or “developed,” is that their economies grow faster the freer they are from government regulation. A “developing” country is generally characterized by a greater level of poverty. This makes the need for economic growth seem much more urgent. Given that, it would follow that a developing country more urgently needs to be freed up from government control – and from government regulations, spending, and taxes.

The developed countries are more advanced in many ways: higher incomes, lower crime, healthier people, better-educated people, fewer restrictions on their ways of life, and more choices of goods, services, and associations. These societies did not get that way because of government actions; they got that way because of government inaction. Had their governments grown and interfered in the economy sooner, then it is unlikely that we would be calling them “developed countries” now.

When looking at the United States, many people make the mistake of blaming its problems on free markets. But the United States, at present, is not the best example of a free-market economy. It was in the past, although it has never been totally free of excessive government interference.

At present, the United States has many problems that are clearly the result of excessive government interference in its economy and the lives of its residents. The recent recession, the difficulties of which are still being felt, was not caused by market freedom. It was caused by a multitude of government policies and actions that created an artificial boom in the economy that directed resources into unsustainable activities.

The US Federal Reserve (the central bank, a government agency) used its power to create money and pushed interest rates down to artificially low levels. This caused many people and businesses to believe that their investments would be more profitable than they could possibly have been. That is one of the reasons why many of these investments later failed. Had the Federal Reserve not manipulated interest rates, but had let them be determined by market interactions, then people would not have made so many investment errors.

There has also, for many years, been an attempt by politicians to please certain voters by making housing appear more affordable. Toward this end, the government gave tax breaks to promote home ownership. The US government also created several agencies that subsidised and guaranteed mortgage bonds for millions of homeowners. The guarantees encouraged the banks and other mortgage bond lenders to give loans to people that might have difficulty repaying the loans. In other words, government policy encouraged the financial institutions to take greater risks than they would have in a free-market where there would be no government guarantees.

The government also was party to more heavy-handed regulations that intimidated the banks into making loans that they never would have made in a free market. That was the cause of what we call the "subprime crisis."

What failed in the United States was not free markets, or a private property system, or what might be called “capitalism.” What failed was government intervention. It is not correct to contrast this with socialism and to say that “both extremes” have failed. Socialism has clearly failed and always will. Countries like the United States, and also South Africa, get into trouble whenever they move toward socialism.

A Public-Private Partnership should not be the first choice for any country. Such ventures in the United States have resulted in a terrible waste of resources. Wherever they are tried, they always result in the politicization of business and in greater corruption.

When PPP ventures are imposed on the mining industry, it is usually in places where property rights are poorly defined and poorly protected. The failure to define and protect property rights is one of the most serious causes of low or stagnant economic growth. It is, perhaps, a defining characteristic of the Third World. Such countries might be “developing,” but they will never achieve their full potential.

PPP ventures might be better than an economy subjected to full socialism. But any kind of government intervention, even in a relatively free economy, will create significant problems that might not be recognized as the result of the previous intervention. If the problems attract political attention, the government might impose more regulations or taxes and subsidies in an attempt to correct them. This, in turn, will lead to further problems that could attract more government intervention – and so on in the direction of socialism.

Although it might appear to be a simple matter for the government to provide services, there are very few services that the government can provide with less difficulty than the private sector. The government has no special advantage in the provision of electricity and transportation services, even though it has the power to expropriate land. The private sector, had it been allowed to compete freely, would now be providing electricity and transportation far more cheaply and in more appropriate forms than has ever been achieved by Eskom or Transnet.

The special protections granted to both companies have created the illusion of low cost. But these companies have been judged only by the visible prices, not by the real cost in resources and lost opportunities. This is why Eskom has been asking for large increases in electricity rates. Regulation has burdened South Africans with high, hidden costs. Had private companies been allowed to develop and to provide these services, South Africa would now be a much wealthier country, and the electricity and transportation systems would be far better developed. The solution is to allow that freedom now.

Development takes time, so the sooner a country frees up its economy and gives definition and protection to private property rights, the sooner will the people enjoy the benefits that only freedom can bring.

Author: Dr Richard J. Grant is Professor of Finance & Economics at Lipscomb University in Nashville, Tennessee, and is Publications Editor at the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.

FMF Feature Article / 16 March 2010

Note: The foregoing article is a response to a comment by one of our readers on the article Nationalisation: The Public Always Loses. He wrote: “While I agree with Dr Grant on this issue of Nationalisation, however, I still believe that for a developing economy like that of ours in South Africa, there is a need for the government's intervention in some cases. For instance, in the mining sector, I still believe that we (South Africans) may have to adopt the model practised in Botswana where a government is a shareholder but the actual mine is run by a private company. This would help in leaving the government with its job – to govern and service delivery to its citizens while also ensuring that ordinary citizens also benefit from revenues derived from their country's mineral wealth. In a nutshell, such model is Public Private Partnership (PPP) and it has proven, both in countries like Botwana and in South Africa, to be the viable business model as it strikes a balance between leaving everything in the hands of private companies and pure socialism. Both of these extremes have failed in the US and USSR. I believe that such model would also work for entities like Eskom and Transnet with their current infrastructure developmental requirements that our government /general public cannot afford!”