The blog provides a left-wing non-partisan perspective on socio-economic issues in Russia and throughout the world. The focus is on qualitative development of national economic systems and ensuring flexibility in economic policies to meet the challenges of the 21st century. Email:


Modern economic theories believe that developed countries are rich because extensive small- and medium-size businesses are the driving force of market economy. In my article, I argue that things are quite the opposite - enormous capital inflows into developed countries cause higher profitability and breed small- and medium-size businesses as a result.

After the collapse of the Soviet economy, several countries (so-called countries in transition) have pledged their allegiance to market economy growing more and more fascinated by the developed economies of Europe and North America. The new pro-Western governments did not have to spend time convincing their people of the benefits of free market. The Bolsheviks’ economic and political experiment undertaken in 1917 had in fact turned out to be a complete fiasco and was considered worthy of nothing else but scorn and ridicule.

The preachers of free market liberalization would passionately explain that only the market free of any government intervention is capable of bringing about prosperity and successful economic development. The newly-converted countries promised to uphold liberties and private enterprise and, without further delay, inscribed them into economics textbooks as the obligatory prerequisites for any successful market economy. Nobody bothered to give the free market fundamentalism a second thought as economists were joyfully pushing political economy aside and embracing economics – the gospel of the rich. Seasoned marxists would turn into devout monetarists in a twinkling of an eye.

I admit I also shared that optimism when those changes were taking place. Eventually, the bleak reality of what was happening started standing out to me as I observed a very peculiar thing – the liberalization of markets had hardly anything to do with the enormous profits of countries proselytizing in the name of laissez-faire capitalism. There appeared to be some mechanisms (hardly ever mentioned in the new "free-speech" media) that distributed wealth globally on conditions that Adam Smith could hardly consider conductive to the unrestricted exchange of goods and services among equal and independent market players.

So is it free market that brings about prosperity and abundance? What was it that developed countries did to prosper? Was it political freedom and maximum deregulation that made those countries so successful? Let me share with you some of my observations from the standpoint of political economy. Here, I claim neither monopoly on the truth nor a comprehensive reflection of all the factors involved in this matter. If you feel like treating these thoughts of mine presented below as food for thought, be my guest. If you look at things from the standpoint of mainstream economics, there is no need for you to continue reading – you are most likely going to get upset and angry. And I will have to bid you farewell, since I do not claim any right to tell people what they should believe in or think about.

What sparked my renewed interest to the subject of what makes rich nations rich was statistical data that I needed for my term papers on the world economy. I later went to the official UNCTAD site to check the numbers for myself because I was quite stunned when I first saw it. I compared data on the stock of global foreign direct investments (FDI) for the year 2008 and saw that the developed economies’ share is 68.5%, the developing countries’ share being 28.68% with transition economies left far behind with a meager 2.82%. Since 1988, similar average proportions (70%, 29%, and 1% respectively) have been preserved unchanged. In 2008, 56.69% of global FDI flows went to developed countries, 36.57% went to developing economies, while countries in transition accounted for only 6.74%. Again, the average numbers from 1980 show that the developed world accounts for the overwhelming majority of all global FDI flows with a clear increase in FDI outflows from developing countries and economies in transition.

My initial bewilderment was not due to the size of the respective proportions. Mainstream economists explain them by the rule of law and thriving democracy in developed countries. It was something else that puzzled me – the relative stability of those proportions. They have remained almost unchanged for decades. It seems as if, no matter how much wealth is created, it ends up being channeled into the same groups of countries in exactly the same proportions. Isn’t that strange? Where are the unpredictable market forces that elevate the most efficient economies and bring down the inefficient ones?

Again, mainstream economists would now start babbling about democratic institutions installed by the developed countries in order to create conditions conductive to free entrepreneurship, which entail investments being made in countries with the most favorable business environment, etc. But, for political economy, that is not an explanation – it is utter nonsense. Political economy considers institutions, political and business environment to be derivative of underlying economic processes. In Marx’s terms, it is an economic base that determines a superstructure, not the other way around. So I dismissed the mainstream babbling and went on to investigate this subject further.

Now, let us take Marx’s general formula of capital (M – C – M’) and apply it to a hypothetical economic system (let it be called “Economy A” or “Market A”) with closed economic borders (i.e. no exports or imports, no foreign investments, no cheap illegal immigrant workforce, etc.) and the golden standard. For certain, I am going to allow certain generalizations in this model. So capital in the form of money (thus M) gets transformed into a commodity (for the sake of generalization, services are also included here) (thus C), which then gets transformed back into the money form but at a greater exchange value (thus M’). To assign some roles in this play, business owners (including the government that protects their interests) invest their money in production of goods and services, which they then sell to consumers (hired employees) directly or indirectly at a price that covers costs and brings in profit. A major portion of the sum thus returned gets re-invested again for more profits. So in this particular economic system consumer spending generates investment resources essential for financing further reproduction of profit for business owners and the governments.

So the economic cycle can be represented with a diagram (see above). Here, for the sake of further reference, I have added the (I) quadrant called “income distribution”, which is responsible for distribution of investment resources. It does not really add anything to the formula since investment resources are also in the form of money, but it will be important to separate it from the other quadrants when we open the economic borders of this closed-door economic system and change the nature of money circulating in it.

Considering constantly rising competition costs as well as the fact that hired employees in our hypothetical economic system are the only consumers and that total production costs include additional expenses besides salaries and wages, we will have to come to a logical conclusion that the economy will not eventually be able to generate enough investment resources relying solely on its domestic consumers. The total amount of salaries and wages will not be able buy all the goods and services produced in the economy. This is called the crisis of over-production (or over-accumulation) – in other words, the system’s ability to produce exceeds, in a natural way, its ability to consume what it has produced. As a result, deflation destroys profits throughout the entire economy while business owners lay off employees thus bringing consumption to even lower levels and causing even more deflation. The economic collapse triggers a financial crisis and eventually leads to social unrest and very unpleasant times for the entire economic system. This is the logic behind Marx’s criticism of capitalism.

Of course, the real economic life is more complicated then the presented model. In reality, no economic system can be utterly closed. And now we are going to see why. So now let us imaging that the elite in our hypothetical economy realizes that the system is incapable of increasing consumption thus being incapable of generating sufficient investment resources to finance further profit-making. They decide to find a nearby economic system that would be willing to buy some of their unsold products. It gets even better if that other economy (let us call it “Economy B” or “Market B”) turns out to be able to increase domestic consumption, which naturally speaks of more profits to be generated.

While Market B can still grow, Market A’s problems are temporarily solved. Businesses will proliferate, new technologies will be developed, and new institutions will be created. Why? Because somebody has paid for that? Overtime, an increased number of external markets will make Economy A indifferent towards domestic spending because foreign sales are now generating enough investment resources. The booming Economy A will create new jobs, spend more on infrastructure, raise life standards and increase domestic consumption. Like bees around a honey pot, small businesses will be swarming around the increased inflow of capital into the economy.

Economy A in relation to Economy B (and its counterparts) is thus similar to a business owner (M) in his relation to a consumer (M’). This type of relations implies a transfer of money from the (M’) quadrant to (M) quadrant via the (I) quadrant. So in other words, we can see a flow of investment resource from one economy to another at the expense of the former. Economy B, whose economic cycles (as they are renewed over and over again) ends in the (M’) quadrant, is giving away its investment resources and will not be capable to finance its further economic growth unless it relies on some other economic systems to finance its growth.

The problem is that as soon as consumption potential of Economy B is exhausted, the expanded economic system A will need to expand even further. But new economies may not be as compliant or there may be other economies looking for ways to expand their economic systems. This situation can potentially lead to military conflicts. Besides expanding an economic system is not a cheap undertaking. So other ways to provide an unceasing inflow of capital must be invented.

And they have been invented. For example, the elite in Economy A may demonetize gold and grant its central bank a monopolistic right to issue fiat currency. If effective mechanisms for removing excessive liquidity out of Economy A are introduced (implying that there is natural or artificial demand for its currency outside its borders), its central bank can constantly increase the money supply thus bringing down credit rates and boosting both (M) and (M’) quadrants through cheap credit. In this situation, some business owners will no longer be interested in the (C) quadrant at all preferring to ever stay in the (I) quadrant. As long as consumers are able to increase (M’) by taking new loans and refinancing old loans, Economy A’s problems are temporarily solved.

Once economies become deeply integrated, Economy A may decide to use its growing investment resources to finance expensive R&D projects thus obtaining a competitive advantage over Economy B by implementing newer technologies. Lack of capital will not allow Economy B to compete with Economy A in these markets, and Economy B will be permanently put on a “technology needle” paying for rapid constant innovations initiated by Economy A. As long as Economy B is lagging behind in technologies, Economy A’s problems are temporarily solved.

Another approach to integrated economies has to do with international division of labor. Economy B may be rich with natural resources but incapable, for whatever reason, to process them upon extraction. Economy A, on the other hand, may have been investing heavily in innovations to boost its processing industries. So Economy A will be able to process Economy B’s natural resources and sell processed products back to Economy B thus making it pay through the nose for its own natural resources as well as “outsourced” processing works performed by Economy A. In this situation, the winner is the economy with the largest added value of its products. As long as Economy B is lagging behind in developing processing industries, Economy A’s problems are temporarily solved.

There can be other capital-channeling mechanisms. I do not intend to discuss them all here and now. Let us now apply these theoretical models to real life and see what we will get.

As international competition pushes countries’ economic development further towards greater accumulation of capital and investment resources on the global scale, we end up living in a world different from the idolized free-market ideal – the world with a rigidly structured world economy, where countries (even entire clusters of countries) are assigned specific roles, which they play according to the rules established by those distributing investment resources in the global economy, i.e. members of the transnational financial elite.

And this is where foreign investment resources in form foreign direct investments or foreign credit come into the picture. In the modern economy, they turn out to be playing a significant role in boosting further economic development of a country they are flowing into. A developing country cannot possibly rely on its own economy to generate enough profits to get such a boost. That is why modern developed countries resorted to attracting foreign capital in one way or another in the process of economic development. Note that most of the rich and influential countries these days used to have colonies or are former colonies themselves. The colonies’ role was to provide their mother countries with cheap resources, which, in a sense, are similar to FDI’s, the only difference being the method of their extraction. Obviously, more sophisticated mechanisms are employed these days.

So a developing country has no other way but to seek inputs from outside, narrow domestic markets being unreliable as a source of economic growth. While it is true that foreign investors prefer to invest in countries with a predictable political and economic environment, we must remember the reciprocal nature of the symbiosis between an institutional climate and objective economic conditions. In other words, some institutions claimed to be prerequisite to market economy always come with a bill, which developing countries will never be able to foot. You simply cannot export democracy and the rule of law if they are backed by nothing but slogans and promises. At the outset of their economic development, modern affluent countries could hardly boast of following the noble ideals they seem to be upholding now. As their prosperity grew, so did their ability to foot the development bills. It also works the other way – if a developed country’s profits shrink for whatever reason and stay low for a long time, it can easily turn back into a developing country with all its institutional and economic problems.

Obviously, this center-periphery relationship between countries is not mutually beneficial. The economic logic of market economy proves that the best way to beat a competitor is a monopoly, so as soon as a country climbs up to a particular level of economic dominance, it always seeks ways to “kick away the ladder”, as Friedrich List, a famous German economist of the 19th century, has eloquently put it. In particular, this what he wrote about Great Britain, the maritime superpower of his time: “Any nation which by means of protective duties and restrictions on navigation has raised her manufacturing power and her navigation to such a degree of development that no other nation can sustain free competition with her, can do nothing wiser than to throw away these ladders of her greatness, to preach to other nations the benefits of free trade, and to declare in penitent tones that she has hitherto wandered in the paths of error, and has now for the first time succeeded in discovering the truth.”

I think the picture will get even clearer if we remember that Great Britain had numerous colonies throughout the world and abolished slavery a couple of decades prior to the industrial revolution. Could it be possible for tiny local markets of the 19th-century Britain, which did not yet formed a unified national market at that time, to generate enough investment resources so as to drive the industrial revolution? Obviously, it was not free market alone that was involved.

In fact, the modern developed world and the newly industrialized countries seem to have long put Adam Smith back on the shelf and pulled out Friedrich List’s Das Nationale System der Politischen Ökonomie initially published in 1841. Their rapid expansion into other markets, while their domestic markets remain safe and sound under protectionist measures, seems to be a significant factor of their economic development. That explains the enormous role of the US as the largest consumer in the world economy. As American consumers were able to constantly increase their spending (first by reducing savings, and then by running debts), many countries could boost their sales, provided that the worldwide trust in the US currency remained adamant. No wonder that business gurus cite the American experience as a prime example of how to do business. Considering the inflow of investment resources (often in the form of Fed-issued greenbacks), starting a small consumer-oriented business does not appear difficult – just find the right product, market it, and consumers are sure to run your way scattering their money all over the place. But as soon as US consumers get a bit jittery about their future spending ability, the rest of the world gets a massive bumpy ride down their market graphs.

Globally, the US alone accounted for 13% of all FDI inflows and 18% of all FDI outflows in 2006. The same indicators for the EU consisting of 27 member-states show 43% and 47% respectively. Combined, these two global market players were responsible for 56% and 65% respectively. After such an extensive analysis above, these numbers do not seem surprising – they are quite natural.

Going back to where I started, the current crisis showed once again (as in the 1930’s), that markets are neither rational nor efficient. The analysis of national economies in globalization is pretty unequivocal that there are other forces at work besides the market. A country that attributes its success to unique entrepreneurial skills it possesses can instead thank its lucky starts that there are still fools out there willing to pull out their wallets and pay its bills.
This reminds me of a story I read some time ago about a shrimp fleet and seagulls. At a sea port, generations and generations of seagulls were able to feast on shrimp stuck in the nets and they would teach their young to do the same. The gulls seemed to live the happiest life of all as no actual fishing was necessary any longer. Guess what happened when the fleet was relocated…The gulls all perished.

So it is not the market that determines economic development. On the contrary, it is economic development that conditions the market. To put it metaphorically, while it is true that a swarm of bees can bring about a pot of honey, as soon as you open a pot of honey, it quickly collects a swarm of bees around it. From the standpoint of political economy, this makes perfect sense.

Boris Anisimov