The principles of economic thought tell us that investments would flow to places with less capital accumulation, the reason being is that there would be less competition, thus a higher rate of return on investments. Indeed, as Adam Smith noted in the Wealth of Nations, capital accumulation would be the inevitable hindrance to economic growth.
However, this not as we have it in the real world. Many countries, especially those in the Global South, have very little capital, but yet aren’t flooded with investments. The reason for this is simple: there is no assurance that their property and investment would be protected by the law.
Picture this, why would someone invest in a piece of property, plot of land, or share in a business when there is a high probability that a random bandit, even worse, the government, could steal it at any time without assurance of compensation? This is certainly the norm in many authoritarian countries. For example, a report from the Business Anti-corruption Portal described the police in Nigeria “as the most corrupt institution in the country”, as they often impede on businesses and act above the law. If a country wants to attract foreign direct and portfolio investments, there ought to be a framework that holds people accountable to the arbitrary use of force: this is the rule of law.
This also goes hand-in-hand with property rights since the rule of law is the necessary condition under which property rights can be successfully employed. Indeed, as James Robinson points out in his essay, “Property Rights and African Poverty,” the lack of property rights has been the number one obstacle to economic prosperity in Sub-Saharan Africa. This is contrary to most prevalent views which blame the legacies of colonization and also the geographical location of sub-Saharan Africa to its economic shortcomings.
In addition, most of these countries are filled with an abundance of natural resources — for or example the diamonds in Congo, gold in Ghana, and oil in Nigeria — but yet are not flooded with investments. Some commentators have called this phenomenon the “resource curse.” This occurs when governments focus solely on natural resources as a means to get revenue while ignoring other parts of the economy, consequently making the country worse off as a whole.
Although there is some truth in this statement, the fact that these countries don’t possess or uphold a framework of laws which protect persons and property from arbitrary government interference is still the key explanation to this problem. As Thomas Sowell puts it brilliantly in his book, Basic Economics, “ Countries whose governments are ineffectual, arbitrary, or thoroughly corrupt can remain poor despite the abundance of natural resources, because neither foreign nor domestic entrepreneurs want to risk the kinds of large investments which are required to develop natural resources into finished products that raise the general standard of living.”
On the other hand, we could take a country, Hong Kong, which does not have an abundance of natural resources, but has been flooded with capital in recent times. Furthermore, Hong Kong has been continuously ranked as one of the freest places in terms of economic freedom by think-tanks such as the Fraser Institute and the Heritage Foundation.
What is also fascinating about Hong Kong is the pace upon which their rapid development occurred. The late economist, Milton Friedman, noted that “from 1960 to 1996, Hong Kong’s per capita income rose from about one-quarter of Britain’s to more than a third larger than Britain’s.”
What was undeniably the catalyst for this economic development was the establishment of the rule of law and property rights. Friedman, who had been studying Hong Kong since the 1950s, said that unlike other nations like India who looked to socialism as a model for economic development, Hong Kong, under the influence of John Cowperthwaite, a “disciple of Adam Smith”, pursued laissez-faire economics which included respect for property rights, free trade, and low taxes.
Moreover, countries in Sub-Saharan Africa that are starting to get some transaction in terms of foreign investments — for example Botswana and Ghana — tend to have relatively stable elections, accountable officials, and freer markets compared to other African nations.
Incidentally, as Thomas Sowell observed in his book, Intellectuals and Race, it is not uncommon for less-economically developed countries to target successful expatriate populations—dubbed “Middlemen Minorities”—and use their success as a reason for their country’s failures. This has been seen with the Chinese in Southeast Asia, Lebanese in West Africa, Indians in East Africa, and the Jews in Eastern Europe. This is extremely counterproductive in fostering economic growth, and has often had devastating repercussions as exemplified by the collapse of the Ugandan economy when the Indians were expelled in the 1970s.
It is fair to say that concepts like the rule of law and property rights are not innate to any civilization; indeed, countries like the United States and Britain, which we could say have civil institutions, underwent violent revolutions in order to put these principles in place. This is not to say that current less-economically developed countries need to follow a similar path. Needless to say, there is a need to change the intellectual climate in these nations. This could be done by being less dependent on foreign aid, imposing checks and balances on politicians, and implementing free-market economic policies such as free trade and lower taxes.