Strengthening Globalization's Invisible Hand: What Matters Most? Developed Financial Markets, Human Capital, Access to Technology, and Strong Legal Systems Are Essential for Healthy Economic Growth

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In this paper, we investigate what matters most to sustaining strong economic growth in today's more globalized, knowledge economy. An examination of 2005-2006 statistical and survey data across 52 countries reveals that economic growth is driven mainly by developed and trustworthy financial markets, a well-educated and skilled workforce, and access to information and communications technologies. Moreover, we find that creditworthy financial markets are strengthened by free and open economies based on the rule of law and legal protections. Our findings support the notion that innovative ideas and entrepreneurship are at the heart of economic growth. However, these ideas need support from institutional policies and practices that create and sustain growth by providing needed protections and a market in which to finance them.

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Understanding the forces driving economic growth and the wealth of nations has been hotly debated and contested since at least the days of Adam Smith and the dawn of economics. Smith's An Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776, is a stylish masterpiece that provides deep insights on the underlying framework for understanding the role of markets and institutions to maximize output and minimize disruptions. As capitalism's prophet, Smith argued that a society composed of individuals acting in the pursuit of their own interests would result in a more stable, free, and prosperous economy than one planned by the state.

For Smith, economic growth comes from the division and specialization of labor, and nations that allow market forces to generate such growth will become better-off. Smith's idea of the invisible hand to describe the market's ongoing process in efficiently and effectively organizing prices and quantities is a powerful metaphor of how competitive markets successfully create wealth.

Following Smith, in 1817, David Ricardo stressed the importance of free trade in his theory of comparative advantage. Ricardo showed that through specialization and trade, two nations could produce more output using the same factor inputs than if they tried to produce the same output in isolation. Since Ricardo's exposition, the importance of comparative advantage--allowing individuals, businesses, and nations to do what they do best and trade for the rest--has been one of the most compelling insights in understanding the forces driving economic growth.

The theme of the 2006 NABE Annual Meeting and Edmund A. Mennis Contributed Paper Competition is "Comparative Advantage in the 21st Century: Information Technology and the Professional Network." In this paper, we examine what matters most to sustaining strong economic growth in today's more globalized, knowledge economy. While the thoughts put forth by Smith and Ricardo roughly 200 years ago still ring true, strengthening globalization's invisible hand today requires understanding ideas, education, technological change, finance and national policies on freedom and trade in a new light.

Ideas matter. Perhaps more than anything else, new ideas that allow firms to have a comparative advantage over their competitors and thereby increase productivity and output are the keys to increasing prosperity and living standards around the world. Trademarks, formulas, business processes, designs, copyrights, computer algorithms, intellectual property rights, patents, recipes, trade secrets, and the like all present opportunities for comparative advantage--at least temporarily.

In today's fast-paced global economy, information travels fast. And maintaining one's comparative advantage is becoming increasingly difficult as the benefits of good ideas can be rapidly disseminated more easily through vastly improved information and communications technologies. Today, with a computer, an Internet connection, and a little know-how, individuals and companies in the remotest ends of the earth can compete and collaborate globally. …