Poor nations work harder than rich ones. Why then are they still poor?
In this episode you’ll learn:
- What is GDP per capita and why it is the best way to compare wealth between nations.
- What is purchasing power parity.
- How physical capital, labor and total factor productivity contribute to economic growth.
- Why the mix of economic sectors impacts the wealth of a nation.
- How exponential growth leads to a radically unpredictable economy.
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Why Are Some Nations Wealthier Than Others
We were walking home from dinner the other night in the city of Merida on the Yucatan Peninsula in Mexico. It was around 7PM, and we came upon some laborers working on the walls inside the courtyard of a school. We had passed them earlier on the way to the restaurant, and I noticed they didn’t seem to be wrapping up their work for the day.
I asked one of the workers how long he works each day. “From eight in the morning until eight in the evening,” he said.
“Every day?” I asked. He clarified it wasn’t every day. He gets Sunday off. He showed me a piece of decoration he was hanging in the courtyard. It was a stone relief carving of plants and fruits.
“It’s pure rock,” he said. “We work on the stone in the shop for much of the day and then hang it later in the afternoon in places like this school.”
If you spend much time in Mexico, you will notice people seem to work a lot. Many work in the informal economy selling flowers, newspapers, and backpacks on street corners. Others like the construction workers I met who work in more formal employment toil away into the evening.
According to the OECD, the average annual hours worked per year per worker in Mexico is 2,246. That includes both full time and part time employment. In the U.S., the average annual hours worked per year per worker is 1,790. The weighted average across 36 nations around the world is 1,766.
The OECD suggests caution in comparing one country to another because of different data sets, but at face value it appears Mexican employees work longer hours than any other OECD country.
But even though Mexicans work more they earn less.
According to Mexico’s Observatorio Laboral, a petroleum engineer in Mexico earns about $12,000 per year while an accountant earns about $6,000 per year.
Petroleum engineers in the U.S. earn upwards of $100,000 or more per year while the median accountant annual salary is around $67,000.
Professional salaries in the U.S. are roughly ten times higher than Mexico but living expenses in the U.S. are not ten times higher than their southern neighbor.
According to the website Numbeo, consumer prices in the U.S. are only about 2.5 times higher than Mexico, and when I compared prices with where I live in Idaho to Merida, Yucatan prices in Idaho are not even twice as high as Merida.
Mexicans are much poorer than Americans because they get paid less and their salaries don’t buy as much. That probably doesn’t come as a surprise, but the question is why? Why are some countries wealthier than others?
The most common measure for comparing wealth between nations is per capita gross domestic product or GDP. GDP measures the value of a nation’s output in terms of goods produced and services rendered. GDP per capita measures the value of that output per person.
Government statisticians estimate GDP by calculating the value of goods and services purchased in a country, or they look at the value of income earned by households and businesses within a country during a given period.
That makes sense because every dollar or peso spent on goods and services within the U.S or Mexico is someone else’s income.
In 2015, per capita GDP in Mexico was $9,510 compared to $51,638 in the U.S. That number is a little misleading because at current exchange rates a dollar goes further in Mexico in terms of purchasing goods and services.
A more accurate measure is purchasing power parity which derives an exchange rate based on the number of Mexican pesos it would take to purchase a basket of goods and services in Mexico compared to the number of dollars it would take to buy the same basket of goods and services in the U.S.
Mexico’s per capita GDP based on purchasing power parity is $18,864 versus $57,294 for the U.S.
Mexicans earn less than Americans because they produce less value in terms of goods and services per person as reflected in per capita GDP. Why do Mexicans produce less value per hour worked than Americans?
There are three primary reasons: lower levels of education, inefficiencies and a different mix of goods and services produced.
In 2010, people age fifteen and over in Mexico had about 8.8 years of education compared to 13.2 years in the U.S. according to research by Robert Barro and Jong-Wha Lee.
A more educated workforce is better able to utilize new technology and develop new ideas that lead to the production of more, higher value output in terms of goods and services.
Inefficiencies that lead to lower productivity also contribute to the difference in wealth between nations.
Charles I. Jones in a 2015 paper “The Facts of Economic Growth” wrote, “development accounting tells us that poor countries have low levels of inputs, but they are also remarkably inefficient in how they use those inputs.
Examples of inefficiencies include a high level of corruption, deficiencies in the rule of law, inefficiencies and inequality within the judicial system, and a lower quality educational system.
Inefficiencies also arise due to the misallocation of worker talent in terms of barriers for women and minorities to pursue certain professions.
Finally, inefficiencies result from a lack of automation. For example, 13% of Mexican employees or approximately 7.8 million work in agriculture compared to 2% of U.S. workers or approximately 2.3 million. Yet, according to the USDA, the U.S. produces six times as much food as Mexico.
A final reason wealthy nations produce more value per worker than poor nations is their economies are tilted toward producing higher cost services versus the lower cost production of commodity goods.
In 1967, the value of U.S. manufacturing output was $217 billion, comprising 25% of GDP and employing 18 million workers. In 2015, the value of U.S. manufacturing output was $2.2 trillion, comprising 12% of GDP and employing 12 million workers.
Of course, much of that increase in value was due to inflation, but even after adjusting for inflation, the U.S. is producing more manufacturing output with fewer workers.
Yet, manufacturing is a much smaller part of the U.S. economy as workers and the economy have shifted into financial services, real estate, healthcare, sciences and other services.
Those specialized areas garner higher prices and their employees earn higher incomes than lower skilled manufacturing. The result is greater wealth for nations whose economies are tilted toward more complex, highly skilled areas.
A return to an economy that is 25% manufacturing would result in a poorer nation because incomes would decline as citizens would be unwilling to pay the higher product costs to support the higher wages manufacturing workers would need to live in such a wealthy country.