The Most Important Secret of a Prosperous Economy

by Jim Powell at http://www.cato.org/publications/commentary/most-important-secret-prosperous-economy

Why has the U.S. economy been such a poor performer in recent years? The short answer is that many Washington politicians either don't understand the most important secret of a prosperous economy, or they disregard it.

President Obama, for example, imagined that pumping money into the banking system was a secret of prosperity, but the Fed pumped in trillions of dollars, and there are still fewer Americans employed in the private sector than when he took office in January 2009. Obama's $825 billion "stimulus" bill never produced the "multiplier" effect that he claimed would energize the economy.
He offered subsidies for more "green" jobs, but the result has been more "green" layoffs as subsidized companies went bankrupt. Obama touted infrastructure spending as a key to prosperity, but it would be very difficult to show how the economy benefited by taxing everybody to pay above-market union wages for repaving perfectly good roads. The Obama administration has spewed hundreds of regulations, supposedly to strengthen the economy, but the resulting uncertainty has discouraged investors and entrepreneurs from making commitments for the future.
What, then, is the most important secret of a prosperous economy? Consider the experience of Jacob Reiss and his wife Mary who started International Tailoring Company around the turn of the last century. Like other tailors, they made suits one at a time. They would take a customer's measurements and deliver a finished suit several weeks later. There were no ready-made suits. Reiss wondered how they could boost sales.
Reiss analyzed their records of customer measurements and organized them in groups, from smallest to largest. This led to his idea of "sizes." Each size involved component pieces of cloth cut to specific dimensions. Reiss organized assembly lines to manufacture suits. He persuaded merchants to stock his line in popular sizes. A customer could try on different sizes to determine the best fit. The only additional work to be done was the quick alteration of sleeve and pants length. The simple idea of sizing has helped lower clothing costs for the millions. As this example suggests, to a significant degree prosperity is the result of myriad improvements implemented from the bottom up.
Stan Mason also has remarkable story. In 1949, he was changing his baby's diapers, which made him wonder how diapers might be designed so that they didn't leak. He didn't have any special training — he graduated from State College in Trenton, New Jersey. He concluded that diapers would be less likely to leak if, instead of being formed from rectangular pieces of fabric, their shape conformed with a baby's bottom. "I took a roll of paper and cut it into a long series of back-to-back hourglass shapes," he explained. "Cut these where the broad part of each hourglass join, and you have individual diapers. Put two sticky tabs at one end of each diaper, and you don't need safety pins. Insert an absorbent pad into the middle part." These, the first disposable, pin‑free, form-fitted diapers, soon dominated the market and launched Mason's career.
Although Mason has invented brand new products like microwave cookware and granola bars, he spent much of his life improving existing products. For instance, he recalled, "Hunt Foods asked me what might be done about the gallon bottles they used for their cooking oil. The bottles were manufactured at one factory, then shipped to the oil-processing factory. This was expensive, and there was some breakage during shipment. I thought polyethylene would be a better material, because polyethylene pellets could be shipped to the oil-processing factory and molded into gallon jugs with equipment that didn't require much space. I came up with a jug design that addressed the glug-glug complaint about gallon bottles (as poured, the flow of air into the bottle disrupted the flow of oil out, resulting in spills). I designed a hollow handle and a contoured shape that makes for smoother air and liquid flows, eliminating the tendency to spill." This design became standard in billions of gallon jugs used for milk, water, cider and other liquids.
One could cite example after example of improvements that made things easier, cheaper and better, achieved by people hardly anyone has heard of. In 1858, the Jamaica-born immigrant Hymen Lipman began producing pencils with an attached eraser. He received a U.S. patent for this, the first modern pencil, and it has made life easier ever since.
That same year, Margaret Knight, of Springfield, Massachusetts, figured out how to efficiently produce the first modern shopping bag. It was well-known that a flat-bottomed bag was far better than a V-shaped bag for carrying bottles and packages, but a flat bottom was costly. Knight invented a machine that did the work of 30 people, cutting, folding and gluing bag components together, for which she received a U.S. patent.
Until 1925 there wasn't an easy way to determine which shoe size would be appropriate for a customer's feet. Then Charles Brannock, a shoemaker's son, used a child's construction set to build a simple device: one end was for measuring the right foot, the other end for the left foot. The device is used around the world.
In 1959, engineer Ernie Fraze forgot to bring his can opener to a picnic, and he ended up opening beverage cans by using his car bumper. He went on to invent pop-top cans with a removable tab.
In 1966, James Goodfellow developed a secure method — using a "PIN number" — that enabled people to withdraw money from or deposit checks into their accounts when banks were closed.
Jack Clements liked to drink coffee as he walked or rode in his car, but it wasn't until 1985 that he figured out how to substantially reduce the risk of aggravating spills. He conceived of a domed lid with an opening that made spill-free sipping easy.
Nobody could have predicted that these and countless other people would come up with improvements that helped the economy prosper. If inventing had been restricted only to individuals with political connections or individuals whom so-called experts considered worthy, there would have been far fewer people trying to make improvements. The number and value of improvements would have gone down, particularly improvements from unforeseen sources. Improvements would have come later — or not at all. Quite a few important inventions, common in one part of the world, were unknown elsewhere for centuries.
Economies prosper when multitudes of ordinary people are motivated to make improvements. This is because information and insights needed to make an economy prosper are widely dispersed. There's far more than could ever be centralized, validated and updated in a place like the federal government. The most reliable way to motivate people? Harness their self-interest: let them try making a profit by starting a business based on their information and insights. Government can best promote prosperity by, among other things, maintaining equal rights, low taxes, free trade, sound money, predictable laws and protection against force and fraud. Government should let consumers render their verdicts in open markets — no subsidies, special favors or bailouts.
Obviously not everyone will try to start a business, many efforts will fail, and successful efforts will often cease working after a while, but if opportunities for profit are wide open, it's likely that there will be an outpouring of improvements essential for prosperity.
It was hard for Americans to imagine great outcomes from the hordes of impoverished, unskilled immigrants who began arriving in very large numbers during the 19th century. For example, Chinese contract laborers performed difficult, often dangerous work that other people weren't willing to do on railroads, on farms and in mines. Chinese immigrants learned to get along in a society that used a language utterly unlike their own. There was harsh discrimination against these people. But their strong work ethic, their frugality and their culture that emphasized the importance of education enabled them to become more prosperous than most other ethnic groups. Today Chinese Americans play a crucial role in mathematics, science, technology and medicine. Where would we be without them?
Eastern European Jewish refugees, fleeing from persecution during the last two decades of the 19th century, didn't seem much more promising than the Chinese. Unlike the sophisticated German Jews who had arrived earlier, Eastern European Jews reportedly arrived with less money than any other immigrant group. Only about half were literate. Many worked as day laborers. The influx of Eastern European Jews packed more people into New York City's Lower East Side than were in the densest slums of Bombay. The strange language (Yiddish), the strange dress and religious practices of Eastern European Jews embarrassed the Germans who had embraced Reform Judaism. But bedrock values of Jewish culture — cleanliness, learning and charity — prevailed. Jews built schools, libraries, bath houses, hospitals and other community institutions. Jews minimized their exposure to diseases arising from filth. There was little alcoholism. Upward mobility was dramatic as increasing numbers of Jews entered professions. From their impoverished beginnings, Jews emerged as the most prosperous group in America.
Although it isn't possible to predict which people will do the most to help achieve a prosperous society, there are sure to be plenty of improvements if millions and millions of people have incentives to do better. This is consistent with nature's way of assuring the survival of species.
For example, a single seed-head of a common dandelion weed is reported to have approximately 180 seeds. In a good year, a mature oak tree might produce as many as 150,000 acorns, each containing one seed. Nobody knows which seeds will survive — most will end up in places without adequate sunlight, water or nutrients. But the sheer number of seeds produced is the most reliable way to make sure that enough will survive.
Similarly, female salmon lay some 5,000 eggs in a gravel riverbed. The odds are overwhelming against the survival of any particular egg, because of all the eggs that weren't fertilized, hatchlings that were suffocated by river debris, young salmon that were too weak to survive or were killed by pollution or were eaten by other fish, birds or seals, grown salmon caught by fishermen and salmon killed by otters or bears while swimming back upstream to spawn. Despite all this, the number of eggs helps assure the survival of their species.
Another example: there can be as many as 300 million sperm in a single human ejaculation. Of the sperm deposited in a woman's vagina, only a small percentage make it to the uterus, and an even smaller percentage venture into the fallopian tube and reach the egg. The health and capabilities of sperm vary, but competition to penetrate the egg makes it likely that the race will be won by the fittest.
So, there's a tremendous amount of talent and energy in human society, more than enough to achieve prosperity. It can be achieved despite a lack of natural resources. It can be achieved in small nations that have no hope of influencing world events or negotiating favorable deals with major powers. Human talent and energy can overcome devastation caused by epidemics, famines, wars or natural disasters.
But if incentives are inadequate, or if tax or regulatory obstacles to enterprise are too great, fewer people are likely to incur the risks of making improvements, commonly achieved through a business enterprise. There will be suffocating stagnation, unemployment and poverty.
Consider, for example, what it's like trying to start and operate a legal business in Singapore (atop the World Bank's Doing Business 2012 report on 183 countries) compared with Chad (at the bottom of the list). In Singapore, starting a legal business involves only 3 procedures, whereas in Chad there are 11 procedures. The process takes 3 days in Singapore, 66 days in Chad. It takes 26 days to obtain a construction permit in Singapore, 154 days in Chad. The filing fees, taxes and other costs of starting a legal business are 0.7 percent of per capita average income in Singapore, a dramatic contrast with Chad where such costs amount to 208.5 percent of per capita average income.
In Singapore, an estimated 84 hours are required each year to maintain tax-related records and prepare tax returns, versus 732 hours in Chad. Total taxes consume 27.1 percent of corporate profits in Singapore, 65.4 percent of corporate profits in Chad. Importing a container of goods costs $439 in Singapore, $8,525 in Chad. Exporting a container of goods: $456 in Singapore, $5,902 in Chad. Resolving a bankruptcy takes 9.6 months in Singapore, 4 years in Chad. In Singapore, the recovery rate (cents on the dollar) from a bankruptcy is 91.3 percent, but the recovery rate is zero in Chad. Is anyone surprised that per capita GDP is much higher in Singapore ($50,714) — about 55 times higher — than Chad ($920).
The World Bank certainly doesn't measure everything that affects incentives to make improvements needed for prosperity, but the report covers many basic things. As the findings make clear, poor countries that stay poor tend to suffer from governments with fundamentally bad policies.
How does the U.S. compare? Overall, it's high on the World Bank's ranking, number 4 out of 183 (behind Hong Kong and New Zealand as well as Singapore). In some respects, the U.S. ranks well behind Singapore. For example, the total tax rate on corporate profits is 46.7 percent, and tax-related record-keeping and preparation consumes an estimated average of 187 hours per year. Importing a container of goods costs about $1,315, while exporting a container costs about $1,050. The U.S. per capita GDP is $48,147.
The latest annual survey by the Vancouver-based Fraser Institute, Economic Freedom of the World, shows that economic freedom is rapidly declining in the United States. It's in tenth place, because of runaway government spending and debt as well as continuing government assaults on private property rights. This is alarming, since the survey repeatedly has affirmed that there can be no prosperity without economic freedom. The survey uses 42 data points to rank 141 nations according to the amount of economic freedom.
Ronald Reagan understood these issues very well, as one would expect, since he was elected amidst economic stagnation that plagued three presidents, yet he launched an era of remarkable prosperity. On September 29, 1981, he declared: "Growth, prosperity and ultimately human fulfillment are created from the bottom up, not the government down. Only when the human spirit is allowed to invent and create, only when individuals are given a personal stake in deciding economic policies and benefitting from their success — only then can societies remain economically alive, dynamic, progressive, and free."