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A Question of Prosperity

Who's in with the in-crowd? In poor countries, it may be groups with vested interests in maintaining the status quo.

"Over the last 200 years, international incomes have diverged so that the richest countries are now over thirty times richer than the poorest countries."

- Stephen L. Parente

To protect these groups' interests, the state makes the adoption of more productive technologies prohibitively expensive, primarily through excessive regulation.

Such is the thesis of Barriers to Riches (forthcoming from MIT Press), written by Stephen L. Parente, who recently joined the economics faculty as an assistant professor. With co-author Edward C. Prescott, Parente attempts to account for the pattern of economic development — including the huge current disparity in international incomes — using modeling techniques to explore how various factors such as differences in savings rates, human capital, and physical capital contribute to the overall pattern. "Over the last 200 years, international incomes have diverged so that the richest countries are now over thirty times richer than the poorest countries," Parente noted in a recent interview with InSight.

So — will that trend continue? Not according to Parente, who said that the gap has already started to narrow over the past fifty years. "The West grew rich first, so that by 1950 the average person living there was about eight times richer than the average person living in the East. But, since then, this difference has decreased substantially."
"Knowledge is critical," said Parente. "Technology is key. Some countries don't make use of the available knowledge — or, if they do, they don't do it efficiently. The key question, then, is why don't poor countries use the readily available technologies that are out there?" According to Parente, it's because of government policies that impose constraints on firms, making it costly or impossible to bring in new technology or even change work practices. The government of Peru is one example, said Parente, with its "incredibly expensive, bureaucratic process — paperwork, even paying bribes along the way." India, too, is "notorious for making it difficult for firms to enter and expand." Trade barriers that make it expensive to import machines, for example, protect groups that have vested interests associated with current production processes. The upshot is high income for a small, powerful group, and extremely limited opportunities — and attendant poverty — for most of the rest of the population.
Parente's thesis is not a new one — in The Lever of Riches, published in 1990, Joel Mokyr investigates these ideas in terms of economic history. However, from the standpoint of economic modeling, Barriers to Riches may break new ground. "Our approach is very different," Parente said. "We build models and look at the quantitative implications. We are led to conclude that government policies that make it costly for firms to adopt better technologies explain much of the pattern of development. These policies lead to differences in Total Factor Productivity across countries — that is, differences in output per unit of composite input."

The analysis suggests that it will be more difficult in the future for countries to protect the interests of groups in maintaining the status quo. "This is a very optimistic view of growth and development," he continued. "We expect a lot more narrowing in the standard of living across countries in the next thirty years. Knowledge has been increasing steadily, and with its increase, the cost of protecting the interests of groups tied to the status quo increases. At some point in time, the protection has to stop. Once it does, poor countries can realize huge increases in productivity since there is so much knowledge out there that they currently do not use." He noted that the best thing poor countries could do today to increase living standards is to eliminate barriers to competition and privatize state enterprises. "By promoting competition, the state lessens the amount of protection to these interest groups. It also decreases the incentive for new groups to form in the future and gain the state's protection."

The work is the culmination of research Parente began as a doctoral student at the University of Minnesota. "It's been a fun project to work on. I've learned a lot," he concluded. "When you start thinking about why some countries are so rich and some are so poor, everything else in economics seems sort of, well — trivial."