In our January column ("A Sensible Strategy") we suggested gradually increasing allocations to emerging markets. We cautioned, though, that not all emerging markets are created equal. "Transparency is always a concern, and whether citizens are increasingly free is probably the most critical variable to evaluate and monitor."
This month we'll elaborate on that most critical variable-the condition of personal freedom, which is always and everywhere the sine qua non of economic progress. Take, for example, the U.S., the world's largest economy, and China, its fastest growing.
One of the principles of classical economics is that a society's standard of living improves when its members are free to pursue a better life for themselves and their families by working hard, saving, taking economic risks and reaping the rewards of their efforts. A corollary to this principle is that when the motivation for these efforts is diminished by outside forces (usually some form of government control or taxation) then the whole economy languishes.
In the United States, personal economic freedom has always been secured by a democratic form of government and a rule of law designed to protect the rights of workers and investors. This combination of political and economic freedom is widely credited with the unprecedented prosperity achieved in America and in nations that have adopted a similar construct. More repressive social models have never produced a steadily rising standard of living for the general population ... think Cuba, much of Africa and the Middle East, North Korea, Venezuela, the USSR, and communist China. But, wait a minute ...
In 2009, the economy of the United States, the guardian of Western democracy and champion of free-market capitalism, shrank by a record 2.6% despite massive credit injections by the federal government. In that same year, China's avowedly Marxist economy, despite the contraction of its major export customer, grew by a solid 8.7%, continuing 25 years of growth in which it has averaged over 9% a year, a pace unheard of in the modern free-market West. This disparity raises some questions: Is it that personal freedom is on the wane in America or that China is experiencing an expansion of personal freedom? Or, if it's neither, is it that the freedom-growth principle is an inadequate explanation of economic progress?
We saw in the 20th century the boundless creativity of the human spirit. Unconstrained by cultural and institutional prohibitions, and free to enjoy the fruits of their efforts, human beings have multiplied the productivity of their farms, made air travel commonplace, practically eradicated polio and malaria, and distributed one billion 2-inch digital screens with free access to the libraries of the world. Personal freedom is critical to the exercise of our inherent creativity and powers of adaptation.
Freedom And Growth In America
Jamestown and Plymouth Colony were settled in the early 1600s by small numbers of people seeking economic opportunity and religious freedom; their expenses were underwritten by investors hoping to profit by developing trade with the New World (which is olde English for "emerging markets.")
Efforts by the English crown to tax the colonists in the late 1700s were regarded as a power grab and violation of what Americans believed was their right to be taxed only by their own representatives. The Boston Tea Party and other organized protests coalesced in the First Continental Congress in Philadelphia (1774). One year later, a Minutemen confrontation with the "Red Coats" launched the American Revolution, and the birth of the freest country in the history of the world. Today, America's 5% of world population accounts for nearly a quarter of global GDP.
Much has changed in the United States in the last 60 years. The national pride that unified citizens during World War II has faded into a polarizing disagreement about the American Dream and the role of government. But another significant change is that our savings instinct has all but disappeared. Since 1965, savings in the U.S. has steadily declined from 12.5% of GDP each year, to negative 2.5%.
Even as we have saved less, we have borrowed more. Total debt in the United States (both private and public) equals 370% of GDP. In 1985 it was half that. Public and private U.S. debt in the last decade has been growing six times faster than GDP, and this will have consequences. The cost of servicing it will limit our economic freedom and restrict our growth until we correct the imbalance.