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The Austrian Contribution to Development Theory

January 21, 2004

It is probably safe to assume that the so-called Third World has always been difficult for those in more developed Western-style countries to understand. There have been several recent efforts with ground-level views of problems in these areas. Hernando De Soto and Jim Rogers have both written books in recent years that show many facets of third-world existence. What they both have in common is a view that many of the prevailing opinions and theories about the Third World are mostly wrong.

Rogers' book gives us portraits of political corruption and snippets about how little foreign aid money actually winds up in the hands of those it was intended for. De Soto's book examined the lack of Western-style property rights and the tangled legal mess that the poorest members of these societies find themselves in and which prevents them from engaging in basic contracts, thereby stifling any significant growth of capital.

Given the level of distortion in what we read in mainstream media outlets, any thinking contrary to those ideas should be valued highly. Sudha Shenoy is the author of a wonderful little paper titled "Austrian Theory and the Undeveloped Areas: An Overview," first published in 1991 and recently made available by the Mises Institute. Shenoy provides an explicitly Austrian view of many issues associated with these relatively poor regions and her paper deserves a much wider audience.

The focus of the paper is on the lesser developed countries, or LDCs. The LDCs are defined not so much as by what they have in common as by what they lack in comparison to more developed nations. Therefore, the composition of the study is a diverse mixture that includes Latin American countries such as Argentina and Brazil, African countries such as Chad and Niger, and Asian countries such as Thailand and India.

The economic and social peculiarities of these regions, Shenoy notes, are far greater than the differences found between developed countries. Therein lies a warning for the danger in using any but the most broadened of generalizations. Meaningful understanding of Third World countries is to be found in country-specific analysis. Nonetheless, certain common threads do exist.

Much of our misunderstanding is rooted in myth. And much of that myth emanates from a faulty methodology. The predilection of the economics profession for numbers and statistics over rigorous logical analysis has been its undoing in many fields of inquiry. Here, it is no different, especially since much of LDC research, in Shenoy's words "must rely completely and without question on the statistics produced by the governments of these areas," a fatal weakness, in my estimation. Nonetheless, many mainstream comparisons between the poorer countries and their richer cousins begin with the comparison of national income accounts. Shenoy trenchantly shows the shortcomings of this approach.

Shenoy uses the example of the per capita income figure of $140 per annum, a 1985 figure for one of the poorest LDCs. Obviously, this figure is absurdly low from an American perspective, but, "it seems that in the poorest countries, people not only live on such an annual income, they multiply themselves at what we hear is a disastrous rate." Given the wide gulf between the comparison of per capita income figure and the reality of living people, how meaningful is such a comparison?

For Shenoy, it is not meaningful. This is a classic comparison involving the proverbial apples and oranges. Per capita figures show only the physical output and cannot take into account obvious qualitative differences. As Shenoy points out "the absolute figures cannot capture reality: that the vast majority of the population in the undeveloped world produce and consume goods and services that differ in nature and in type from those found in the developed regions." There exist extreme differences in the types of goods produced in LDCs compared to more developed countries.

Shenoy uses the example of the diets of people living Thailand, who consume mainly rice and subtropical products, and the people of Tunisia, who eat mostly millets, dates and produce found only in arid regions. There are wide differences in dietary habits and also tremendous variety in what is available to eat. Foods in LDCs often have to be processed by consumers before they can be eaten, in sharp contrast to many foods available in the developed countries. So, while certain broad comparisons of a qualitative nature might be possible about the prosperity or lack thereof in these regions, it is hard to fathom what a quantitative comparison of incomes would achieve.

In addition to per capital figures, certain other social indicators are often used, such as literacy rates or the age at which one enters the workforce. These too, Shenoy shows, are not unambiguous signs of prosperity and use of these statistics can result in instances in which the per capita figures and social indicators contradict each other.

Shenoy's approach is so levelheaded and her arguments so logical, that it is almost surprising that they are not more frequently heard or used in other mediums. They overwhelm with their simplicity. For example, there is perhaps no more frequent criticism of LDCs than their use of "child labor." Yet Shenoy simply takes into account the life expectancies in many LDCs and the lower levels of capital to explain the use of what we deem as improper child labor. Life expectancies in the developed areas (around 75 years of age) are much longer than what we find in LDCs, where 55–60 yeas of age is a more common number and where in some of the poorest regions, it may be as low as 40–50 years of age.

Most people in developed countries don't begin to work until they are around 15 years of age. Shenoy points out that 15 years is about 20% of a life expectancy in the more developed areas. Using the life expectancies in LDCs, though, and applying the 20%, gives us a number between 8 and 12 years of age—a span of time at which many in the LDCs begin to work. Shenoy writes, "If they could afford to delay until they were as old as 15, then some 25 to 37 percent of their life expectancy would have passed; and if this same scale were applied to the developed areas, then people would be assumed to enter the workforce only between the ages of 19 and 28." 

In the early history of the developed countries, the working age was only delayed as capital was accumulated and living standards raised. Shenoy gives us the example of England during the seventeenth and eighteenth centuries, where work began at 8 years of age. She concludes, "where life ends early, it also has to begin early."

We often hear too about illiteracy rates in LDCs. Literacy, we know, cannot be a prerequisite for economic progress and advancement, otherwise mankind would never have advanced beyond the level of slovenly cave dwellers. Illiterate populations, history shows us, have made astounding leaps in progress and development. It is the same story, in essence, as child labor. When people say that the LDCs are poor and attribute some of that to illiteracy, they are putting the proverbial cart before the horse (the fallacy at the core of this New York Times piece on Brazil). Shenoy writes, "literacy, in short, is a form of investment," an investment that becomes possible only as living standards improve.

Population growth is also cast as a great evil, but Shenoy shows us how to think differently about this issue. She gives us histories that show how population growth often accompanied rapid economic development. Shenoy is also careful to keep population growth numbers and statistics within the historical context of the region begin studied, a step which yields startling conclusions. For example, India's populations increased 3.6 times between 1871 and 1987, whereas "Britain achieved this same percentage increase in 104 years, i.e., 12 years less than India."  A very important difference is that Britain achieved its growth about 100 years earlier.

The startling conclusion is that "if we compare the demographic features of Britain (from 1801 to 1914) with those of India (during the years 1871 to 1987), then we find the following: British population growth was faster and proportionately greater, and its urban ratio was about three times higher..." Since living standards in Britain today are relatively high, it would seem to weaken the anti-population crowd's arguments that population growth should be of great concern. Shenoy makes clear that population growth is a manifestation of improving living standards and that economic growth is required to support it.

There are many other comparisons and issues tackled in the paper. The above give only a flavor of some of her thinking.

One final aspect of Shenoy's work is that using Austrian capital theory leads to certain inescapable conclusions concerning the plight of the Third World. Pre-eminently among these is the idea that the growth and extension of capital is a necessary building block in raising the living standard of the LDCs (a fact that is true everywhere), a process that is facilitated by free markets. Austrian capital theory teaches that capital is a varied mix of goods that fit into a chain of production, and that production takes time. Lengthening and deepening this process means extending the time between investment and consumption.

Shenoy writes, "As the capital structure is extended, so the flow of final goods and services is increased in quantity, improved vastly in quality, and becomes evermore diverse."  This is an amazing process and lies at the very root of market activity. This extended capital structure also creates increased specialization and greater exchange.

Shenoy notes that the Western-style market economies developed in a unique historical process where legal and social developments supported market exchange. Therefore, what is required to raise the standards of living in the LDCs is the evolution or development of societies that support market exchange. Once again, the vitality, and richness of free markets as a problem-solver is evident. Shenoy's paper shows us that in the area of LDC development, "we find in the writings of the older Austrians a penetrating analytical framework whose potential remains yet to be discovered."

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Christopher Mayer is a commercial lender for Provident Bank in the suburbs of Washington, D.C. Send him  MAIL and see his Mises.org Articles Archive. Read an interview with Shenoy here.


Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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