What makes a rich country rich? This was the question examined by the ‘father of economics,’ Adam Smith. An Inquiry into the Nature and Causes of The Wealth of Nations, published in 1776, explained that the wealth of a country lies not in its gold or silver (something Spain learned the hard way), but rather in its ability to produce things. A country that can produce many goods and services per person is a productive nation, and high productivity is the only way for the citizens of a country to enjoy prosperity.
In contrast, a poor country is a place of low productivity. There are many causes of this, some big reasons being a lack of technological application, poor property protections/legal systems, and low human capital. Because of this, opportunities for high-paying jobs—or even formal jobs at all—are scarce.
In poor countries, many services are incredibly cheap compared to rich countries, even if the service provided is practically identical. For example, the average haircut in Mexico costs around 90 pesos (roughly $5.) In contrast, haircuts in Oslo, Norway, cost $95 on average. Part of this can be attributed to the setting where the service is being provided—the rent and amenities for a barber shop in Oslo are much more expensive than in Mexico, which certainly raises the price of a haircut to some degree. However, a large portion of the cost comes from the labor cost. So why do Norwegian barbers charge so much more than Mexican barbers if they’re providing a nearly identical service?
“If Norwegian barbers were paid like barbers in Mexico, no one in Norway would cut hair because the job opportunities are so much greater.”
This question was studied by Hungarian economist Béla Balassa (pictured below). Balassa found that the reason Norwegian barbers charged much higher prices than Mexican barbers is that in Norway, the abundance of high productivity jobs mean that a high salary (in comparison to the Mexican barbers) is required to attract workers to cut hair. In Norway, most workers are more productive than their Mexican counterparts simply due to the political system, organization and management, private property protections, access to capital, and many other factors.
While in theory it would be efficient to outsource labor-intensive industries that can’t become more productive (like cutting hair) to low productivity countries, cutting hair isn’t a tradable commodity and thus it’s impossible. Norwegians need their hair cut one way or another, so the wages for barbers rise with the market wages of Norway, making haircuts far more expensive in Norway. If Norwegian barbers were paid like barbers in Mexico, no one in Norway would cut hair because the job opportunities are so much greater.
Béla Balassa’s principle leaves us with two important considerations. First, the most efficient outcome would be to let Mexicans move to Norway and work in a high productivity economy. Secondly, when in Mexico, get a haircut.
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Oof to colonial Spain
What a unique way to discuss what makes a country rich. Great job!