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     Feb 15, '13

Prosperity's timeless sources
By Reuven Brenner

Part one of a four-part series.

Politicians and economists promise growth, prosperity and higher standards of living. What do they mean by these terms?

Are there good, relatively objective measures by which to judge whether people in a country expect technological and political innovations (including fiscal ones) to be beneficial and lead to the creation of more wealth? How can we be sure that a financial innovation, a change in company strategy or a change in government policy makes a society better or worse off?

The answer is that changes in the total market value of firms

(value of stocks added to the value of outstanding debt) in a society added to the value of its governments' outstanding obligations would be the best estimate to make such judgment - once financial markets are well-developed, and institutions exist to hold matchmakers, be it in finance or government, accountable.

Then, when this sum increases, it means that the society's ability to generate revenues and pay back debt - whether private or public - has increased. And the contrary: when this sum drops (measured it terms of a relatively stable unit, rather than a particular currency), people signal that either their governments or the companies' management are making - or persisting longer than expected - with erroneous decisions.

The reason is simple: holding matchmakers in financial markets and governments accountable mitigate the magnitude and persistence of mistakes. By so doing they bring faster the better matching of capital and talent.

When the aforementioned sum diminishes, where does the wealth go? That depends.

The smaller is capital's and people's ability to move, the more the diminished value becomes a permanent loss. Those things that are expected to be solid - people's efforts and ingenuity - melt into thin air. More mistakes are made and they are expected to last longer. The decrease reflects diminished expectations of generating future revenues (since every mistake is a cost). Yet, generating future revenues is what "growth" and the ability to pay back debt means.

When capital and people can move, though, the wealth that disappears in one country reappears in others.

There are few better examples to illustrate these points than the wealth created by the various diaspora - Armenian, Chinese, the Huguenots, Jew - as well as the poorer immigrants of Europe, who built the newer continents. (Few of the rich left Europe. The emigrants were driven out of their homelands by politics and regulations). Let us briefly look in the first part of this series at how the movement of the most gifted and energetic of those people led to many of the world's economic "miracles".

Facts behind miracles
The Cinderella stories of poor or impoverished societies suddenly and quickly leapfrogging others have provoked admiration, envy, and intense discussions about why the outdone stumbled, and the humbler rose. The riches of oil-producing Middle East countries do not provoke such discussions because those countries fit the "finding treasure" pattern. But how do societies do it when they not only lack natural resources, but are even endowed with natural disasters? Can other countries emulate them and achieve similar degrees of prosperity?

The miracle of 17th century Europe was neither Spain, nor Portugal - both of which fit the "finding treasure" mold - but below-sea-level Amsterdam and Holland, whose riches were created despite natural obstacles. Later there was West Germany rising miraculously from the ashes of world war. There are some Asian miracles that deserve attention, such as Hong Kong and Singapore. And there was the somewhat forgotten example of Scotland's unique experience - about which in Part 3 of this series.

What's common between these miracles? The Dutch were the first European republic, both tolerant toward all religion (when the rest of Europe was still severely discriminating against many), and with sound rights to property, which opened opportunities for relatively unhindered trade and financial innovation.

But it would be misleading to say that "the Dutch" did it - these and other myths have been created by nationalist mythologies. The openness of the new republic attracted to Amsterdam well-connected and educated immigrants, merchants and moneymen; Jews and Huguenots, discriminated against elsewhere in Europe, were prominent among them. They helped turn Amsterdam to the financial and trading center of the 17th century world. The city had the world's first stock market, where French, Venetians, Florentines, Genoese, as well as Germans, Poles, Hungarians, Spanish, Russians, Turks, Armenians and Hindus traded not only in stocks but also in sophisticated derivatives.

Much capital active in Amsterdam was foreign-owned, or owned by Amsterdammers of foreign birth. There was "globalization" during the 17th century, even if nobody bothered to use the term.

Max Weber didn't bother to look at migratory patterns when he came up with his speculation that somehow religion - the Protestant Ethic - had much to do with Amsterdam's spectacular success. Although academics quoted Weber's idea frequently enough for it to pass for fact, it wasn't true in Amsterdam or in any other prosperous trading city or state. Educated and ambitious trading immigrants, with networks around the world, disciplined brains and trust, turned 17th century Amsterdam to a "miracle".

The same factors have been behind other miracles. The histories of Hamburg, Hong Kong, Singapore, Taiwan and West Germany have much in common with Amsterdam's, but shared religion is not a factor. In each of these places, the state provided an umbrella of law and order, had relatively low taxes, and gave people a stake in what the business society was doing - attracting immigrants and entrepreneurs from around the world. These critical talents' influence radiated around the world.

Sir Stamford Raffles designed Singapore as a port at the beginning of the 19th century, and backed it with administrative, legal and educational system that was open to its multiracial population. From a small settlement Singapore rose, attracting Chinese, Malays, and Europeans. Trade and security brought prosperity to the penniless immigrants from Indonesia, and, in particular China.

Taiwan (after the 17th century), Singapore and Hong Kong offered immigrants opportunities denied them by the Chinese hinterland, which was dominated at first by warlords and a status-conscious bureaucracy, and later by communist bureaucracy.

Hong Kong benefited from waves of emigration from China, in particular from the inflow of Shanghai merchants and financiers when Mao Zedong "liberated" China in 1949 - much as Amsterdam rose to prominence when merchants and financiers fled the Iberian Peninsula in earlier centuries, when the Huguenots fled France, and when Jews fled from many parts of Europe.

Immigrants from Shanghai initiated Hong Kong's textile and shipping industries. These Chinese emigrants established the network of merchants, traders, moneymen, and manufacturers - as Jewish, Italian, Armenian, Parsee and other immigrant groups did throughout history in various parts of the world - and as the present Chinese Diaspora of about 55 million brings its network to the more open China today.

Briefly, wealth that disappeared in one place reappeared in another. And as for the "vital few" who stayed behind, under regimes denying opportunities, their talents were lost forever.

Next: The myth of government aid

This series of articles draw on Reuven Brenner's recent speeches and on his Force of Finance, History - the Human Gamble, and other books.

Reuven Brenner holds the Repap Chair at McGill University's Desautels Faculty of Management, and serves on the Board of the McGill Pension Fund, and is member of its investment committee. Professor Brenner this month was awarded the Queen Elizabeth II Diamond Jubilee Medal for his dedication to his peers, his community, and to Canada.

(Copyright 2013 Reuven Brenner)




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