DETERMINANTS ADDENDUM
Stage 2: Stage 2: People and Their Countries Are Rich but Still Think of Themselves as Poor. Because people who grew up with nancial insecurity
typically don’t lose their nancial cautiousness, people in this stage still work hard, sell a lot to foreigners, have pegged exchange rates, save a lot, and invest e ciently in real assets like real estate, gold, and local bank deposits, and in
bonds of the reserve currency countries. Because they have a lot more money, they can and do invest in the things that make them more productive—e.g., human capital development, infrastructure, research and development, etc. This generation of parents wants to educate their children well and get them to work hard to be successful. They also improve their resource-allocation systems, including their capital markets and their legal systems. This is the most productive phase of the cycle.
Countries in this stage experience rapidly rising income growth and rapidly rising productivity growth at the same time. The productivity growth means two things: 1) in ation is not a problem and 2) the country can become more competitive. During this stage, debts typically do not rise signi cantly relative to incomes and sometimes they decline. This is a very healthy period and a terri c time to invest in a country if it has adequate property rights protections.
You can tell countries in this stage from those in the rst stage because they have gleaming new cities next to old ones, high savings rates, rapidly rising incomes, and, typically, rising foreign exchange reserves. I call countries in this stage “late-stage emerging countries.” While countries of all sizes can go through this stage, when big countries go through it, they are typically emerging into great world powers.
Stage 3: People and Their Countries Are Rich and Think of Themselves as Rich. At this stage, people’s incomes are high, so labor becomes more expensive. But their prior investments in infrastructure, capital goods, and research and development are still paying o by producing productivity gains that sustain their high living standards. Priorities shift from an emphasis on working and saving in order to protect oneself from bad times, to savoring the ner things in life. People become more comfortable spending more. Arts and sciences typically ourish. This change in the prevailing psychology is reinforced as a new generation of people who did not experience the bad times become an increasingly large percentage of the population. Signs of this change in mindset are re ected in statistics that show reduced work hours (e.g., typically there is a reduction in the workweek from six days to ve) and big increases in
expenditures on leisure and luxury goods relative to necessities. At their best, these periods are early- and mid-stage “Renaissance periods.”
Large countries in this stage almost always become world economic and military powers.2 Typically, they develop their militaries in order to project and protect their global interests. Prior to the mid-20th century, large countries at this stage literally controlled foreign governments and created empires from them to provide the cheap labor and cheap natural resources they needed to remain competitive. Starting in the early to mid-20th century, when the US Empire began ruling by “speaking softly and carrying a big stick,” American
“in uence” and international agreements have allowed developed countries to have access to emerging countries’ cheap labor and investment opportunities without directly controlling their governments. In this stage countries are on top of the world and are enjoying it. I call countries in this stage “peak health countries.” The United States was in this stage from 1950 to 1965. China is now moving into it. The key is to maintain the determinants leading to strength for as long as possible.
Stage 4: People and Their Countries Are Poorer and Still Think of Themselves as Rich. In this stage, debts rise relative to income. The psychological shift behind this leveraging up occurs because the people who lived through the rst two stages have died o or become irrelevant and those whose behavior matters most are used to living well and not worrying about the pain of not having enough money. Because the workers in these countries earn and spend a lot, they become expensive, and because they are expensive, they experience slower real income growth rates. Since they are reluctant to constrain their spending in line with their reduced income growth rates, they lower their savings rates, increase their debts, and cut corners. Because their spending continues to be strong, they continue to appear rich, even though their balance sheets are deteriorating. The reduced level of e cient investments in infrastructure, capital goods, and research and development slows their productivity gains. Their cities and infrastructure become older and less e cient than in the two previous stages. They increasingly rely on their reputation rather than on their competitiveness to fund their de cits. Countries typically spend a
lot of money on the military at this stage to protect their global interests, sometimes in very large amounts because of wars. Often, though not always, countries run “twin de cits”—i.e., both balance of payments and government de cits. In the last few years of this stage, bubbles frequently occur.
Whether because of wars3 or bursting nancial bubbles or both, what typi es this stage is an accumulation of debt that can’t be paid back in non-depreciated money. I call countries in this stage “early declining countries.” While countries of all sizes can go through this stage, when big countries go through it, they are typically approaching their decline as great empires.
Stage 5: People and Their Countries Are Poor and They Think of