Gambler’s Ruin

More than 200 years after Adam Smith, economists remain wedded to the idea that sustained periods of economic growth require the availability of large-scale investment capital. But, for poor countries, liberalization of international capital flows has failed to deliver the goods.

San Francisco – From Adam Smith (1776) until 1950 or so, capital was considered by economists to be absolutely essential for economic growth. You also needed a few good basic institutions. “Security of property and tolerable administration of justice,” as Smith put it.

If these fundamental institutions were right, then landlords, merchants, and manufacturers would invest and improve. In investing and improving, they would add to the capital stock: “In all countries where there is a tolerable security [of property], every man of common understanding will endeavor to employ whatever [capital] stock he can command, in procuring either present enjoyment or future profit... A man must be perfectly crazy, who, where there is a tolerable security, does not employ all the stock which he commands, whether it be his own, or borrowed of other people...”

A larger capital stock would mean thicker markets, a finer division of labor, and a more productive economy. A highly productive society based on a sophisticated division of labor was how you secured “the wealth of nations.”

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