Chapter 2: The Sources of Economic Growth
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In chapter 2, Sobel and Bolen discuss the conditions that must be in place for an economy to achieve sustained growth. First, they clarify that “an economy is a process by which economic inputs and resources, such as skilled labor, capital, and funding for new businesses, are converted into economic outcomes.” This relationship between inputs and outputs are determined by an economy’s “rules of the game” – what economists refer to as “institutions” – as the authors illustrate in Figure 2.1.
Figure 2.1
Using examples like the rules of basketball or the board game Monopoly, the authors explain how a society’s institutions shape the incentives that individuals participating in the economy face and thus the choices they make. Adam Smith, in his seminal work The Wealth of Nations explored how institutions explain why some nations are rich while others are poor. The authors sum up Smith’s conclusions with the following: “an economy becomes prosperous when it uses unregulated private markets to the greatest extent possible and when the government plays the important but limited role of protecting liberty and property and enforcing contracts.” Sound political and legal institutions that guarantee personal and economic freedom are necessary to ensure that economic growth can occur through capitalism. The authors list the key ingredients of economic freedom as the following:
- Personal choice and accountability for damages to others
- Voluntary exchange, with unregulated prices negotiated by buyers and sellers
- Freedom to become an entrepreneur and compete with existing businesses
- Protection of persons and property from physical aggression, theft, lawsuits, and confiscation by others, including by the government
Since institutions are primarily shaped by government policy, it is imperative that a state like Wisconsin pursue institutions that protect personal and economic freedom. In other words, it is necessary to ensure that the state provides sound political and economic institutions while also not infringing on personal and economic freedoms. The authors discuss how economists have developed indexes to measure and rank economic freedom at the national, state, and metropolitan levels. At the national level, they point out how nations with higher rankings of economic freedom experience higher rates of economic growth – on average – as indicated in Figure 2.7.
Figure 2.7
In the chapter, the authors refer to the Economic Freedom of North America index published by the Fraser Institute, which measures economic freedom at the state-level in the United States, Canada, and Mexico. This subnational index is made up of three primary components: government spending, taxes, and labor market freedom. At the state level, the authors show how states which rank higher on economic freedom have higher per capita incomes, lower poverty rates, and generate greater investment and innovation. Thus, to encourage economic growth, Wisconsin must pursue policies that limit government interference in the marketplace and create incentives for capitalist entrepreneurship.
