Money and Power: Pondering Economic Growth and Decline

Money and Power: Pondering Economic Growth and Decline

Mini Teaser: A trio of books proposes intriguing reasons for economic growth--national pride, surplus labor and investment security--but none parses the novelty of the virtual state.

by Author(s): Richard Rosecrance

Niall Ferguson, The Cash Nexus: Money and Power in the Modern World, 1700-2000 (New York: Basic Books, 2001), 552 pp., $18.

Liah Greenfeld, The Spirit of Capitalism: Nationalism and Economic Growth (Cambridge: Harvard University Press, 2001), 541 pp., $45.

Kenneth Pomeranz, The Great Divergence: China, Europe and the Making of the Modern World Economy (Princeton: Princeton University Press, 2000), 382 pp., $16.95.

Aside from preventing terrorism, there are two cottage industries in the policy community these days. One aims to develop Third World states-aspiring to remove at least some of the causes of terrorism. The other, somewhat less in the public eye recently, seeks to prevent the decline of major powers, particularly the United States. These two industries are linked by their concern to understand the relationship between economic structures, motives and performance, on the one hand, and political structures, motives and performance on the other. In other words, both are about the nexus between money and power.

As to the first of these industries, no one quite understands what causes states to grow economically, and if we ever knew-judging by existing outcomes-we may well have forgotten. Max Weber claimed Protestantism created an ethic that fostered capitalist development. But that religion could scarcely be responsible for facilitating growth in Japan or China, or even in Catholic southern Germany and Italy. Recoiling from sociological theory, modern economists have turned to more practical explanations. They argue that superior education, property rights, large social coalitions, abundant capital and technology have been the essential conditions leading to growth. They also stress the economic infrastructure of ports, airfields, communications facilities, canals and highways as well as investment funding by banks and governments as important foundations for development.

But we know that these economic elements of success can be in place and growth may still not occur. What is it, after all, that motivates economic upsurge? Why do individuals in heretofore agrarian societies decide to risk their capital in what might become a foolish gamble? Liah Greenfeld, University Professor at Boston University, argues in The Spirit of Capitalism that "nationalism" provides the key missing ingredient: it is the spark that ignites economic growth. The English had it in the 18th century, but the Dutch did not and therefore underwent only the "commercial" but not the "industrial" revolution. As a result, the Netherlands did not achieve full industrialization until after 1870. On the other hand, nationalistic zeal drove Germany and Japan to match the achievements of west European nations: even though they started only in the mid-19th century, these two countries had become powerful industrial economies by 1914.
Greenfeld chronicles the "developers" and their thoughts in a series of countries-Japan, France, Germany, England and the United States, while also occasionally focusing on the Dutch national and economic failure. In each case she finds a constant association between economic growth and nationalism: unless economic developers were imbued with passion for the state or sought to bring all members of an ethnic group into it, they did not succeed in building an industrial society.

All the early developers were rivals with someone else-the English with the Dutch, the French and Germans with the English, and Japan with the West as a whole. The United States also measured itself against England and Germany. As Alexander Gerschenkron showed in his Economic Backwardness in Historical Perspective (1962), the "later" industrializers worked hard because they had the desire to catch up economically. Greenfeld, however, is not offering an economic analysis. Unlike her mentor, David Landes, she does not explain growth by economic factors, nor ask why the German, American and Russian trajectories were more rapid than the early industrializers, Britain and France. She is making a political argument.

Greenfeld does not claim that nationalism and growth were perfectly correlated in time. Sometimes nationalism peaked first (the French case), other times (as in Britain) it crowned economic change already in progress. There was a lot of growth in the German states after the Zollverein (customs union) was formed in 1833, even though full-blown nationalism and consolidation did not flower until later. In general, however, Greenfeld makes a good case that nationalism spurs economic development. It is unfortunate, perhaps, that she did not inquire into Ernest Gellner's conclusions in Nations and Nationalism, that industrialism creates the social interdependence that makes nationalism possible. The two influences may be self-reinforcing: French nationalism in the 18th century appears to antedate industrialism and British industrialism in that same century antedates nationalism. But thereafter the two went hand in hand, suggesting that in more general terms Greenfeld and Gellner share a compatible analysis.

Greenfeld is aware, too, that not all kinds of nationalism correlate with economic performance. Only a specific form of national sentiment-economic nationalism-is linked with growth. She understands that although political nationalism has surged through Africa and the Middle East, most of these newly nationalistic countries wallow in slow growth or stagnation. Thus nationalism, and perhaps even economic nationalism, needs help. It may be a necessary condition, but it is hardly a sufficient one for economic growth to occur. Here, Kenneth Pomeranz, in his The Great Divergence, adds an important additional element.
Following a line of argument pioneered by Arthur Lewis, the late economics Nobel laureate from Princeton University, Pomeranz shows in The Great Divergence that industrial development depends upon countries overcoming the "land constraint." This means that countries must increase productivity on the land to free labor to work in factories and mines. They need a surplus on the farms to support consumption in the cities, and they also must raise capital to invest in industry.

The great divergence lies in the historical fact that England did this during the 17th and 18th centuries, but China, though relatively prosperous as late as 1750, did not undergo an agricultural revolution until the 1950s. In the 18th century, neither India nor China could enter the Industrial Revolution, for both were dependent on labor-intensive agriculture and had no surplus workers to send to the cities and their factories. There was also no demand for Asian fabricated goods in world markets. While 18th- and 19th-century England used world demand for low-cost products to power its production of machine-made textiles, Qing China and early-modern India had no foreigners clamoring for their manufactured wares. Neither was there a burgeoning middle class to buy such goods at home.

According to Pomeranz, it was not until the land constraint could be overcome-in the late 20th century-that industrialization could take off in China and India. Fortunately-for them, at least-the rest of the world today needs Chinese and Indian manufacturing capacities to satisfy its consumer demand, and this helps these rising nation-states to achieve high growth rates. The great divergence is thus becoming less great.

While Greenfeld and Pomeranz both look at the causes of economic growth, Niall Ferguson, Professor of Political and Financial History at Oxford, ponders the decline of already developed countries. In The Cash Nexus, he asks what prevents growth-and what does not-and aims his shafts at Yale historian Paul Kennedy and the apostles of decline. Mancur Olson (The Rise and Decline of Nations) and Patrick O'Brien (Imperialism and the Rise and Decline of the British Economy, 1688-1989) also forecast industrial decline with the buildup of empire, militarization and special interest groups. Ferguson jousts with them all, claiming that it was not military spending or too many overseas commitments that held back Victorian Britain or that threatens the contemporary United States. Even as its defense budget rises and its security perimeter expands, he believes, the United States need not worry about incipient "decline."

As far as Britain is concerned, had London tried to deter Germany by amassing a large land army before 1914, World War I might have been avoided. Equally, a deterrence policy might have worked against Hitler in 1936-38. Larger military spending beforehand might have prevented war and the decline of the British economy that subsequently ensued. Britain could then have gone from strength to strength. Fortunately, too, Great Britain had deep pockets-limpid pools of capital that could underwrite any imperial or military endeavor. Low interest rates made it easier for the British (and the United States) to finance the two world wars than any of their opponents.

Nor does Ferguson believe that high military spending interposes a barrier to growth. He denies Kennedy's claim that military expenditures in excess of 5 percent of gdp are likely to translate into low growth or spur decline. Ferguson points out that the Reagan Administration's military spending did not hold the U.S. economy back, and that, under Clinton, American economic growth surged ahead despite still high levels of defense spending. If the United States had to increase its military spending from 3 to 5 percent of gdp, growth would probably not even pause.

The reason that neither Britain nor the United States have fit the declinist portrayal, Ferguson argues, is that the British and American bond markets have offered investors new security and guarantees of repayment. Because parliament and Congress have stood behind the public debt, attractive U.S. and British bond markets drew new sources of capital into the exchanges and ensured very low rates of interest. Under these conditions, Ferguson reasons, government financing did not "crowd out" private capital, and private investment therefore could proceed largely unaffected. From this, he concludes that the United States can undertake "imperial" responsibilities and still not pay a premium in lost economic growth. Thus the Bush Administration does not have to worry about "declinist" dangers in charting its policies in the Middle East or against terrorism internationally. In Ferguson's view, economically powerful democratic countries can have both butter and guns as long as their financial institutions and policies remain sound.

These arguments are well and good, but they do not entirely come to grips with new industrial trends in the world economy. They do not observe, for example, that smaller but economically productive states are now seizing the baton from the previous great powers. The nationalism expounded by Greenfeld is grafted these days onto small, vigorous East Asian and European states. Countries such as Taiwan, Switzerland, Singapore and the Netherlands are virtual states: they design production at home but manufacture their goods elsewhere. Put a bit differently, these are state equivalents of the virtual corporation-a Silicon Valley-style offshoot that does research, development and product design, but gets another company to manufacture its goods. The virtual state similarly concentrates on high-value research and development services and allots production to other countries. It also, very importantly, coordinates the activities of virtual corporations in its midst and derives benefits from their more efficient production elsewhere. Both the virtual state and its virtual corporations within capitalize on highly educated managerial talent and workforces.

The United States is also moving toward virtual status. More than 70 percent of U.S. GDP is now derived from "services" as opposed to about 15 percent from manufacturing. Those choosing the virtual path have gained striking economic successes in recent years. The countries that have utilized far-away markets and production sites have actually fared better than the more self-sufficient economies of the past. Japan and Germany are also moving in the virtual direction, with most of their new production located abroad.

Does the advent of the virtual state mean that economic nationalism is now an outmoded strategy for gaining growth? Here the Greenfeld thesis confronts many new questions. While the original economic development of many significant states may have been motivated by nationalism, how can they now achieve the benefits of advanced technology-driven growth? Here it would seem that too much nationalism is an impediment. Instead, both advanced and advancing economies must crown their achievements in association with other nations. They need open trade and communication routes, low tariffs, alliance protections, and secure borders to purvey their wares internationally. They need protection from terrorism. They require capital from other countries to keep up with new technologies. They particularly demand foreign direct investment to stay abreast of the latest manufacturing designs in advanced markets. Greenfeld's nationalism must be modified by a practical internationalism in its contemporary, and presumably future, application.

Yet it would be premature to write an obituary on economic nationalism as the expression of an outmoded fad. The national state is still the primary factor directing economic fortunes in most countries, not least in China. A particular culture and the Islamic resurgence may join to castigate states in the Muslim world as parochial and corrupt entities that fail to serve broader religious and social needs, but even in the Arab world the state cannot go away. And in ways that Greenfeld forecasts, it is precisely where cultural traditionalism dominates the state that economic development grinds to a halt. The Islamic movement today is thus like 18th-century Holland.

And contrary to what the avatars of globalization predict, the state is reasserting itself. In the Middle East, Turkish, Egyptian and ultimately Palestinian nationalisms presumptively offer an answer to the challenge of radical transnational Islam. Even in a "Europe without borders", Russia, as well as Britain, France and Germany trumpet national claims to influence. In China and Japan, too, as Greenfeld asserts: "nationalism shows no signs of weakening its grip on the souls of men." This leaves, however, a final unanswered question: Will the excesses of nationalism shift industrialism into an unregulated militarism, culminating in war, as they did in the past?

Rapid developers in the past-Russia, Germany and Japan-succumbed to rabid nationalism and in so doing helped to bring about both the First and Second World Wars. Even the transition toward, if not all the way to, democracy may be fraught with violence, as witnessed in Weimar Germany and Czarist Russia. Interdependence and the virtual state today direct nationalism, but they do not squelch it. Even though Japan remains in fiscal crisis at home, it contends as vigorously in its industrial strategy abroad as it did in military terms half a century ago. The Chinese state's communist leaders are as wedded to China's ethnic and national superiority as were its Middle Kingdom forebears centuries ago. But something important has changed: military and territorial expansion is no longer viewed as the means to national success. Thus, in one of the many ironies of history, nationalism does not disappear, but is instead sublimated by military as well as economic requirements. As more nations go "virtual", at least some degree of international cooperation becomes a minimum policy, as a form of insurance for economic health. As the world digests the pervasive influence of terrorism on all states, it becomes aware that cooperation is the basic solution to the problem. The violation of national security by non-state agents of terror requires international solidarity, not a hodge-podge of one-sided chauvinisms.

How, then, can emergent and residual nationalisms and necessary cooperation be brought together? To start, it seems clear that competitive urges-though necessary for economic growth-need to be reined in. This need take different forms in different situations. In the Middle East, for example, a first step would be to move away from atavistic forms of political Islam to firmer nationalisms based upon separate states. As suggested above, this is already in process. Beyond that, the new state nationalisms of the Middle East need to be confined to competition in the economic sphere. If this occurs, the long-term measure of success will likely be that of productivity and gdp, not the outmoded conquest of territory.

But even this will not occur, as Pomeranz shows, until Middle Eastern countries overcome the "land constraint" and shift workers from agriculture and the oil fields to urban and industrial occupations. This is possible. One forgets that Iran once had the capacity to do mid-level manufacturing. Jordan is now setting up assembly plants financed by U.S. foreign direct investment. As Greenfeld contends, a modest nationalism will assist this process and motivate a new industrialism. Pomeranz tells us where it will prevail. Ferguson suggests that in countries in which this process fails and breeds trouble in its wake, the United States can still lead an international coalition to defeat terrorism and spread general economic benefit. The three together offer new perspectives on why economic transformation has been relatively slow in the past but could still speed up in the future-and perhaps without quite the level of social and political breakage that such transformations have often caused in the past.

Richard Rosencrance is the author of The Rise of the Virtual State: Wealth and Power in the Coming Century (Basic Books, 1999).

Essay Types: Book Review