Arnold Kling  

Intangible Wealth and Institutional Economics

The Fear Factor... Digging Out the Fundamental Di...

In a new book, a team of World Bank economists writes,

most of a country's wealth is captured by what we term intangible capital...Intangible assets include the skills and know-how embodied in the labor force. The category also includes social capital, that is, the trust among people in a society and their ability to work together for a common purpose. The residual also accounts for all those governance elements that boost the productivity of labor. For example, if an economy has a very efficient judicial system, clear property rights, and an effective government, the effects will result in a higher total wealth and thus a higher intangible capital residual...human capital and rule of law account for the majority of the variation

In an article about the World Bank study, Ron Bailey writes,

So if every American has $513,000 in capital, where is it? The vast majority of it is amassed in our political and economic institutions and our educations. The natural wealth in rich countries like the U.S. is a tiny proportion of their overall wealth—typically 1 to 3 percent—yet they have higher amounts of natural capital than poor countries. Cropland, pastures and forests are more valuable in rich countries because they can be combined with other capital like machinery and strong property rights to produce more value. Machinery, buildings, roads, and so forth account for 17 percent of the rich countries' total wealth. And 80 percent of the wealth of rich countries consists of intangible capital. "Rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity," argues the World Bank study.

Development economics has changed a lot in 50 years. After World War II, economists equated economic development with physical capital. One could argue that the World Bank was founded on the basis of that belief.

Robert Solow was the first to point out the importance of the "residual" in economic growth, meaning increases in the standard of living that could not be accounted for by capital. That view has been accepted for quite some time, but textbook "growth economics" still tends to consists largely of mathematical models of capital accumulation.

Even fifteen or twenty years ago, the role of institutions received little play. The new institutional economics is still somewhat under-appreciated in the profession.

It seems to me that the new World Bank study is important. The empirical work seems thorough and interesting. The fact that it comes from the World Bank, of all places, seems to underline the triumph of the new institutional economics.

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The author at Cafe Hayek in a related article titled The Intangible Wealth of Nations writes:
    Judging from this post by Arnold Kling, and this summary by Ron Bailey, this new book from the World Bank makes a point that's vital and all but completely overlooked, even by the very best economists. (The point is very [Tracked on December 20, 2005 6:07 AM]
The author at The Club for Growth Blog in a related article titled Tuesday's Daily News writes:
    Time for a Supply-Side Revival - Jack Kemp, Some (Belated) Fiscal Restraint - Washington Times Editorial Canadian Health-Care is No Paradise - Anthony Dick, NRO Who is We? - Don Boudreaux, Cafe Hayek Who Benefits From ‘Fair’ Tr... [Tracked on December 20, 2005 10:40 AM]
COMMENTS (14 to date)
spencer writes:

This study sure plays havoc with Bryon's arguments that education adds no value.

AJ writes:

As a very young economist at M.I.T. 25 years ago, I thought all of this was patently obvious. Yet the profession seemed to be locked into post WWII leftism. Even Solow, after his basic model showed that about 2/3 of growth could not be accounted for by capital accumulation, still talked as if policies related to capital accumulation were the key to labor productivity. Even 25 years ago, a simple comparison of countries around the world showed the role of entrepreneurial capitalism vs. either natural resources or government programs to generate quality living stands. What's amazing is that the the profession has taken so long coming to this point - if it is indeed believed widely.

rakehell writes:

Gary Jefferson at Brandeis teaches a course on NIE and growth issues: Comparative and Institutionalist Economics.

jn writes:

One of the difficulties for the NIE has been formalizing and mathematizing the core insights of Coase, North, Olson, etc. Even when they said useful things, the NIE was kept out of the top journals and is still mostly absent except tangentially through Acemoglu, Robinson, and Shleifer's more mainstream work on institutions.

Fortunately, the US academic network has always been broad enough that the big three above plus Buchanan, Williamson, Barzel, and early rational choice pioneers (in polisci) such as Ostrom, Riker, Bates, Weingast, Ferejohn, etc. continued to produce good work and train students in the period from around 1965-1990 even when they weren't members of the top five departments.

It just took awhile for the insights to be absorbed, and it helped to relabel all of them into an NIE "movement". I think that the World Bank and other big money centers will be spinning off empirical work based on the core NIE ideas for at least another generation.

Roger M writes:

The International Society for New Institutional Economics has a good reading list at

Roger M writes:

The lack of concern for institutions is what caused the failure of Sachs's reforms in Russia. His ideas would have worked well had the country possessed the institutions of the rule of law, honest judges and police, and protection of private property. At the time, Russia didn't even recognize private property. Had Sachs understood the importance of institutions, he would have encouraged the Russians to work on those before implementing the financial reforms.

John P. writes:

Roger -- Thanks for the link and for the info on the other thread as well.

jaimito writes:

The next step shall be quantify the value of political leadership.

I am not sure if it is relevant, but Sharon doubled the value of the Israeli stock exchange. Come a cleptocrat leader like Mobutu and the million sq. km. of Zaire (Congo) with its diamond mines and other natural resources, is soon worth - nothing.

daveg writes:

I like this discussion.

What is the definition of an institution?

Is General Motors an institution?

Is Marriage an institution?

What are the forces that seek to tear down our institutions?

Roger M writes:

Institutions can be formal, such as our Constitution, structure of government, laws, the Supreme Court, etc., or informal, such as attitudes toward the law, education, bribery, trust, etc. The World Bank book cited above has good definitions.

There's a small group of sociologists led by Lawrence Harrison and Samuel Huntington that link culture as the source of institutions. They've written the book Culture Matters: How Values Shape Human Progress.

jaimito writes:

A reliable social arrangement is an institution. Anything you can say with confidence that it will be valid in the future.

Marriage, a steady arrangement between two partners, with sexual and reproductive and children rearing etc. understandings (normally carrying social rewards and punishments) is an institution. Should be hunger in the land, my wife and me will share our food.

Chris Bolts writes:

According to Encarta Dictionary an institution is:

1. Important Organization(s) such as a bank, college, or hospital

2. Established Practice (Supreme Court Precedents, Marriage)

3. Starting of Something (a bill being instituted in Congress)

4. Long-established person or thing (Our Constitution or belief in the rule of law)

There are two more, but they can be fitted under #1.

jaimito writes:

Reading Terry Pratchett, institution may be defined as a shared, accepted fantasy.

nn writes:

The Encarta definitions are not those used in the NIE. The usual definitions are closer to #2 and #4 (persons are excluded). See North's work. Number 1 is usually considered an Organization not an institution. So the US legal system is an institution, but the World Bank is an organization.

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