I, The Absolute

Till I came to ISB, I always thought that the biggest differentiator between developed economies and developing ones was availability of capital. I thought given more capital, developing economies would develop, which would lead to convergence or catching up of these economies with developed economies. My thinking was not without any basis. Look around, and we can find a lot of loans being doled out by World Bank and the developed nations to the developing economies. The developing economies are to a good extent dependent on this capital. I thought that by giving capital to the developing nations, they are making available what differentiates developed nations from developing nations.

But as I cover ‘Global Economics’ during Term II, I realize it is the Total Factor Productivity (TFP), contributed mainly by education levels, new technology, openness of economy, etc, which is the biggest differentiator. This is slightly different from pure labor productivity. What it means is that the higher the TFP, the better the utilization of capital and labor. As the developing economies keep getting more capital and have a lot of cheap labor, what would happen is not increase in economic strength, but increase in debt. With the same levels of TFP, beyond a point increased capital will not result in any further development. The key to development is how well we utilize the resources of capital and labor.

But TFP can happen only if we improve out levels of education, improve or import technology, improve law and order, encourage our financial markets, etc. These things are not going to happen in short run; nor are the developed nations willing to be too active in improving the TFPs of the developing nations. It is a lot cheaper for them to keep giving developing economies capital and giving them some jobs (outsourcing) than transfer technology and improve TFP. So, keep looking around. The best way to improve performance is not by putting longer labor or even by investing hugely in physical capital, but by focusing on productivity.

Even for individuals, there is a lesson to learn. Do not work hard (labor); work smart (TFP).

PS: For further reading, please refer to the Economist. This is the best magazine one can subscribe to. I learnt a lot more of economics by reading this magazine than our standard text book