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CHAPTER 1

THE GOAL

Produce More Goods And Services

In order to solve the problem of poverty in a poor nation, it is important to have the correct goal in mind. To discover this goal, we must first understand two economic concepts that determine whether a country is rich or poor: per capita income and gross domestic product. Once those concepts are understood, it becomes evident that if we want to solve poverty, the correct goal is that a nation continually produces more goods and services per person each year.

A. What makes a country rich or poor?

1. The standard measure of wealth and poverty: per capita income

The standard measurement of whether a country is rich or poor (in economic terms) is called "per capita income" ("per capita" means "per person"). Per capita income is calculated by dividing the total market value of everything produced in a nation in a year by the number of people in the nation.

If we sort countries by per capita income, we get an idea of the differences in economic conditions between rich and poor countries.

For example, some "low-income" nations in 2012 were the Democratic Republic of the Congo ($400 per capita income, which is about $1 per day per person), Somalia ($600), Ethiopia ($1,200), Haiti ($1,300), Uganda ($1,400), Nigeria ($2,700), and Pakistan ($2,900). These are average income figures, which included a small number of high-income people within each country (whose income numbers pulled the "averages" up). That means that more than half of the people in these countries were below these average levels of income.

"Low-middle-income" nations included Ghana ($3,300), India ($3,900), Honduras ($4,600), Guatemala ($5,200), Ukraine ($7,600), and El Salvador ($7,700). The next group, "high-middle–income" nations, included Albania ($8,000), China ($9,100), Jamaica ($9,100), Peru ($10,700), Colombia ($10,700), Brazil ($12,000), Mexico ($15,300), Chile ($18,400), and Hungary ($19,800).

Finally, in the "high-income" category were nations such as Poland ($21,000), Israel ($32,200), South Korea ($32,400), Japan ($36,200), the UK ($36,700), Germany ($39,100), Canada ($41,500), Sweden ($41,700), Switzerland ($45,300), the United States ($49,800), and Norway ($55,300). (The world map on the front cover of this book uses a color code to indicate per capita income for every country.)

Per capita income does not tell us everything we need to know about a nation. For instance, it does not measure important things that are not sold in the market, such as leisure time, religious faith, or strong families. But per capita income is the best numerical measure of whether a country is rich or poor in an economic sense.

Per capita income also does not tell us about the distribution of income — whether a large number of people share in the wealth of the nation or whether it is concentrated in the hands of a wealthy few. Increasing per capita income is not an adequate solution if only a few wealthy people benefit. Therefore, in the material that follows, we discuss several steps that countries must take to prevent a small, wealthy elite from controlling all the wealth and power in a nation, as happens too often in poor countries today. We recommend numerous policies and values that enable a genuinely free market to function and thereby permanently open opportunities for any poor person to rise from poverty to an adequate income or even to prosperity (see chapter 4, section D; chapter 5, sections B, F, and G; chapter 6, sections B and C; all of chapters 7 and 8; and chapter 9, values 4, 5, 8, 9, 14, 15, 18, 21–24, and 29).

But increasing per capita income is very important, for as long as it remains low, the country remains poor. And higher per capita income is strongly correlated with some undeniably important factors, such as longer life expectancy, lower incidence of disease, higher literacy, and a healthier environment (for example, clean air and water, and effective sanitation).

If a country wants to move up the scale from "low-income" to "middle-income" to "high-income," what must it do? It must increase the total amount of goods and services that it produces, which means there will be more to go around. Remember that per capita income is calculated by dividing the total market value of everything produced in a nation in a year by the number of people in the nation.

To understand what is needed in more detail, it is necessary to understand the concept of gross domestic product (GDP).

2. The standard measure of what a country produces: gross domestic product (GDP)

The standard economic measurement of what a nation's economy produces is called the gross domestic product (GDP). It is "the market value of all final goods and services produced within a country in a given period of time." The period of time ordinarily used is one year.

This definition includes "goods and services." "Goods" include all the shoes, clothing, vegetables, bicycles, books, newspapers, cars, and every other material thing that is produced and then sold in the market. "Services" include things such as classes taught by teachers, examinations given by doctors, or the work of paid housecleaners.

"Market value" means that goods and services counted in GDP are sold legally in markets. A loaf of bread baked and eaten at home is not counted in GDP because it is not sold in a market. But loaves of bread baked in a home and then sold in public are counted, because they have been sold in a market and a monetary value can be attached to them.

The size of a nation's GDP is the main factor that determines its wealth or poverty. This is because per capita income is calculated by dividing the GDP by the total population. If the population does not change much from year to year but the GDP grows, the per capita income goes up.

For example, in 2011, Honduras had a GDP of $36,100,000,000 (about $36 billion) with a population just over 8 million people. If we divide $36 billion by 8 million, we have a per capita income (in round numbers) of about $4,500.

But if Honduras could somehow double its GDP from $36 billion to $72 billion and still have a population of 8 million, its per capita income would double to about $9,000 per person ($72 billion divided by 8 million people). The "average" person in Honduras would be twice as wealthy as before. Increasing a nation's GDP is what moves it along the path from poverty to greater prosperity.

3. What will increase a country's GDP?

The most important question, then, is this: What will increase a country's GDP?

The answer is complex, involving as many as seventy-eight factors, all of them contributing to or hindering the growth of GDP. Answering this question in detail is what the rest of this book is about.

But we can briefly say here that GDP is increased when a nation continually creates more goods and services that have enough value to be sold in the marketplace. Therefore, the focus of efforts to overcome poverty must be on increasing the production of goods and services.

The correct goal for a poor nation, then, is to become a nation that continually produces more goods and services each year. If a nation is going to succeed in overcoming poverty, it must be willing to examine its official policies, laws, economic structures, and cultural values and traditions to see whether they promote or restrain increases in the goods and services that the nation produces.

B. Other goals that have been suggested

As we have spoken to various audiences about the solution to poverty, we have heard many people propose other goals for eliminating poverty. Each of these will be discussed more fully in a later chapter, but we can mention them briefly here:

(1) More aid. Some people argue that wealthy countries need to give massive amounts of additional aid money to jump-start the economies of poor nations. Unfortunately, aid has not proven helpful in increasing GDP in the long run (see the discussion of aid in the next chapter). To focus on aid as the solution is to focus on the wrong goal. The goal must be to increase a nation's GDP.

(2) More equal distribution of wealth. Others say that the solution to poverty is using the power of government to redistribute wealth from the rich to the poor. They argue that greater economic equality is a matter of simple justice that governments should enforce. We certainly agree with the goal of helping the poor share in more of the wealth of a nation, and in several sections of the following chapters we discuss ways this can happen through fair, open, market-based solutions. The goal of this entire book is finding truly workable, sustainable ways to overcome poverty. However, some nations have tried to bring about more economic equality in economically harmful ways, not through opening up free markets but through brute use of government power. Making equality a more important goal than overall economic growth is a mistake for a government, because merely distributing the same amount of wealth in different ways does not change the total amount of wealth a nation produces each year, which is the only way that any nation has grown from poverty to prosperity.

Economic freedom and government-forced economic equality are opposing goals, and when government forces economic equality (for example, through heavy taxes on the rich), it can actually diminish economic incentives and harm the GDP. This can be seen in the history of every nation ruled by communism, whether the former Soviet Union, Cuba, North Korea, or China before it implemented many free-market reforms. Milton Friedman rightly said: "A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both." A nation must produce wealth before it can distribute or enjoy it. The goal must be to increase a nation's GDP.

(3) Natural resources. Some believe that poor nations need to discover new natural resources, perhaps oil, precious metals, or rare earths. This solution has some merit, because when minerals are "produced" from the ground, their value directly increases GDP. But this is too narrow a focus, both because some nations have few resources (therefore this solution does not help them) and because some nations with almost no natural resources (Japan, Singapore) have become very wealthy. In addition, long-term prosperity in a nation cannot be preserved by resource wealth alone. As we will see later, many economists consider natural resources a disguised curse, creating immediate income but hurting the conditions for building the institutions that produce long-term growth. The goal must be to increase a nation's GDP.

(4) Debt forgiveness. Others say that rich nations need to forgive the impossibly high debts that have been incurred by poor nations, because the costs of repaying these loans are a crippling burden. Unfortunately, this suggestion is similar to the proposal that more aid be given to poor countries, because it simply changes a loan into a gift, which is more aid. Debt forgiveness is at best a means to an end, not the end itself. It helps only if a nation produces more goods and services in the long run. The goal must be to increase a nation's GDP.

(5) Better terms of trade. Still others advocate negotiating more favorable prices for international trade between rich and poor nations. This would increase the value of a country's exports (total exports are added to GDP, since a country produced these things) and decrease the cost of its imports (imports are subtracted from GDP, since a nation did not produce these things but bought them from abroad). Therefore, if some sellers or buyers in a nation can negotiate more favorable terms of trade in dealing with many thousands of buyers and sellers on a world market, we agree that this would bring some benefit.

But no single poor nation is likely on its own to exert much of an effect on world prices of its goods (as we explain below, here). Focusing one's hope and effort on something that one probably cannot change is not a wise strategy. The goal must be to focus on something that a nation can certainly change: producing more goods and services, and so increasing its GDP.

(6) Restrain multinational corporations. Others believe that the solution is to break up or somehow restrain the power of large multinational corporations that are unfairly taking advantage of poor nations. But those who focus on multinational corporations seldom evaluate their actual overall impact on a nation's production of goods and services (see next chapter, here). The goal should not be to hurt productive firms or make them less powerful. The goal must be to make every person and every company within the nation more productive, and thus increase a nation's GDP.

(7) Fair trade coffee. Others seem to think that the solution is to persuade Starbucks customers to buy "fair-trade" coffee, and then to expand "fair-trade" agreements to other products and other companies. This is a form of the "better terms of trade" approach, and we analyze it below, but we can say here that most economists believe that the fair-trade movement mostly benefits a small number of producers while it harms others (see below, here), and very little of the higher retail price actually reaches the farmers themselves. In any case, we doubt that this movement can succeed in persuading more than a small portion of the overall world market to pay more than the world price of a commodity, which is determined by the continual interplay of supply and demand. The effect is limited in scope, so this practice does not have a really significant impact on a nation's overall production of goods and services.

As we will explain below, some of these proposals provide some help and others are harmful. But none of them provides an overall, sustainable solution to poverty. That comes only through increasing a nation's GDP.

C. The amazing process of creating value that did not exist before

When we talk about producing more goods and services, we are referring to an amazing process by which human beings are able to better their own economic situation by creating valuable things that did not exist before. When they do this, they add not only to their own wealth but also to the wealth of their nation. They do this not by taking something of value from someone else (which would not increase total GDP), but by creating new products or services that no one ever had because they previously did not exist.

1. Examples of the creation of products of value

To take a simple example, think of a woman in a poor country who has a piece of cotton cloth that cost her $3. If she sews it into a shirt that she sells for $13, then she has created a new product of value. She has made a shirt that did not exist in the world before she made it. She has made the piece of cotton cloth to be $10 more valuable than it was when she bought it.

She has also contributed something to the total value of everything that her nation will produce in that year (the GDP). If the total value of everything produced in her nation that year was $2,000,000,000 before she made the shirt, then after she made the shirt the total value of everything produced was $2,000,000,010. She moved her nation $10 along the path toward prosperity.

This amazing process of increasing GDP by creating products of value is at the heart of the means by which nations can grow from poverty to increased prosperity. If this creative process can be expanded to thousands of people making thousands of kinds of products, then the total value of everything in the nation increases day after day. If a nation can increase the value of what it produces each year, GDP will grow, and the nation will become more prosperous each year. This is the process that brings nations from poverty to prosperity.

We can also note at this point that the $10 profit this woman earned when she sold the shirt is a measure of the value that she added to the economy. The buyer of the shirt voluntarily decided that the shirt was worth $13 to him. Therefore (in economic terms), it is worth $13. But the cloth cost the woman only $3. Her $10 profit is important because it shows that new value has been created. We discuss profits more fully below (see), but it is important to note here that her profit is not immoral, but is a measure of morally positive value that has been added to the nation.

When a baker uses $3 worth of flour and other ingredients to make a loaf of bread that he sells for $4, he has suddenly added $1 to the GDP. When a shoemaker uses pieces of leather that cost him $5 to make a pair of shoes that he sells for $30, he has added $25 to the GDP.

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Excerpted from "The Poverty of Nations"
by .
Copyright © 2013 Wayne Grudem and Barry Asmus.
Excerpted by permission of Good News Publishers.
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