¹ Wealth is the value of all pecuniary and nonpecuniary goods that yield income to a person. In addition to assets that yield money (pecuniary) incomes, people derive nonpecuniary income from a number of specific “goods” such as leisure, a pleasant environment, clean air, a good football team in town, friendly neighbors, and so on. The value of satisfaction from nonpecuniary goods is subjective and has its monetary equivalent.

² Economic development and economic growth are not identical concepts. Economic development means changes in the value of people's total wealth. Economic growth measures changes in the value of goods and services included in various accounting categories such as gross national product (GNP). The former is all-inclusive and subjective. The latter is easier to quantify. However, it leaves out of the calculation many of the (nonpecuniary) goods that determine the value of people's wealth.

³ This essay is about technological innovations by business firms. I prefer to use the term “technological innovation”; the term “scientific innovation” might fail to convey a clear distinction between invention and innovation—that is, between creating new knowledge (which is generally but not exclusively done by scientists) and using it (which is done by nonscientists as well). Examples of technological innovation are modern airplanes, computers, the Internet, etc. For all practical purposes, the two terms (“technological innovation” and “scientific innovation”) could be used interchangeably.

⁴ Brunner, Karl, “The Limits of Economic Policy” in Socialism: Institutional, Philosophical, and Economic Issues, ed. Pejovich, Svetozar (Dordrecht: Kluwer Academic Publishers, 1987), pp. 41–42.Google Scholar

⁵ For example, Douglass North has demonstrated a strong link between different types of property rights and economic development (and has received a Nobel prize for his research).

⁶ Most innovations, especially technological innovations, are likely to take place within business organizations. For example, an independent innovator has incentives to create a firm before carrying out his or her innovation, in order to reduce the costs of negotiating contracts across markets, to limit liabilities to creditors, and to exploit tax advantages.

⁷ The bundle of property rights that define the privately owned firm includes the owner's right to appropriate the residual after all cooperating inputs are paid their contractual prices, the owner's right to hire and fire cooperating inputs, and the owner's right to sell those two rights in competitive markets.

⁸ The bundle of rights that define the labor-managed firm includes the state's ownership of capital assets held by the firm, the employees' right to appropriate (and distribute among themselves) the return from those assets, and the employees' right to govern the firm. The employees' rights specified above are not transferable; they are contingent on their employment by that firm. It is important not to confuse the labor-managed economy with producers' cooperatives in capitalism. In a free-market, private-property society, producers' cooperatives emerge spontaneously and have to survive competition from other types of firms. The fact that producers' cooperatives have not happened on any significant scale in capitalism is evidence of their relative inefficiency. I am always puzzled when some colleagues say that I have tried, in some of my works, to show that the labor-managed firm is inefficient. Nothing could be further from the truth. Competitive markets have done that. All that an economist can do is to try to determine why the labor-managed firm is inefficient.

⁹ Codetermination means that employees join shareholders on the boards of directors of corporate firms and take an active role in decision making. Germany has been a leader in promoting codetermination in the West. For example, the Codetermination Act of 1976 requires that in business firms employing more than two thousand employees, one-half of the members of the board of directors (in Germany it is called the “supervisory board”) must be labor representatives.

¹⁰ See Brunner, , “The Limits of Economic Policy.”Google Scholar

¹¹ The labor-managed firm is a socialist version of codetermination: labor participation in decision making without private property rights. Former Yugoslavia is the only social ist country that has tried this type of firm on a large scale and over a long period of time. A major academic advocate of this method for organizing production in the West has been professor Jaroslav Vanek of Cornell University; see, e.g., Vanek, Jaroslav, The General Theory of Labor-Managed Market Economies (Ithaca, NY: Cornell University Press, 1970).Google Scholar See also note 8 above.

¹² The shortness of time horizons is due to the nontransferability of assets held by the group. In the context of the labor-managed firm, the nontransferability means that workers have the right to use assets held by their firm and to appropriate returns (earnings) from those assets, but not to sell the assets or change their value (i.e., workers must reinvest each year an amount approximately equal to the assets' wear and tear).

¹³ Johnson, Bryan and Sheehy, Thomas, The Index of Economic Freedom (Washington, DC: Heritage Foundation, 1995).Google Scholar The study does not discuss political and civic freedoms.

¹⁴ Johnson and Sheehy classify Eastern European countries along with all other countries and do so on the basis of their institutional arrangements prevailing in the early 1990s.

¹⁵ Both tables are reproduced from Johnson, and Sheehy, , The Index of Economic FreedomGoogle Scholar, by permission of the Heritage Foundation. In Figure 2, the 1965 figures are from the Agency for International Development and first appeared in Hudgins, Edward and Johnson, Bryan, “Why Asia Grows and Africa Doesn't,” Heritage Foundation Backgrounder No. 756 (03 2, 1990)Google Scholar; the 1991 figures are from the United Nations Development Programme's Human Development Report 1994; the figures for Taiwan are for per-capita GNP.

¹⁶ Richburg, Keith, “Why Is Black Africa Overwhelmed while East Asia Overcomes?” International Herald Tribune, 07 14, 1992, pp. 1 and 6.Google Scholar Informal institutions in a community are parts of its heritage which have passed the test of time. They stem from the experiences, traditional values, religious beliefs, and all other factors that influence the subjective perceptions that individuals form about survival requirements in the world in which they live. Those informal rules are frequently referred to as the ethos, the hand-of-the-past, or the carriers of history.

¹⁷ The purpose of copyrights, patents, etc., is to extend this lag over a long enough period not to discourage innovations.

¹⁸ In addition to a potential loss of income due to demotion, the innovator's private costs in a Soviet-type economy also include potential loss of nonpecuniary benefits such as better housing, subsidized vacation, access to special stores, etc.

¹⁹ Balcerowicz, Leszek, “The Soviet-Type Economic System and Innovativeness,” Institute for Economic Development, Warsaw, 1988, paper no. 19.Google Scholar

²⁰ To alleviate the effects of these conditions, some writers have proposed various immunizing stratagems (e.g., giving workers who leave the firm some future rights in the residual) which either ignore the costs of those stratagems, or ignore transaction costs specific to the labor-managed economy, or tend to privatize labor-managed firms, or all of the above. See Flakierski, Henryk, The Economic System and Income Distribution in Yugoslavia (New York: M. E. Sharpe, 1989), pp. 67–70.Google Scholar

²¹ See Pejovich, Svetozar, “Why Has the Labor-Managed Firm Failed?” Cato Journal, vol. 6, no. 2 (Fall 1992), pp. 461–73.Google Scholar The study shows that the employees of the labor-managed firm have incentives to make investments that would shift the firm's profits forward (benefiting current employees), and to negotiate investment loans with repayment schedules that are as lengthy as the banks are willing to provide (shifting costs to future workers).

²² Dudintsev, Vladimir, Not by Bread Alone (New York: E. P. Dutton and Co., 1957).Google Scholar

²³ Albert, Hans, “Is Socialism Inevitable? Historical Prophecy and the Possibility of Reason,”Google Scholar in Pejovich, , ed., Socialism (supra note 4), p. 69.Google Scholar

²⁴ That is, by making the innovator and those who choose to imitate his or her innovation bear the costs and capture the benefits of their actions.

²⁵ Governments have tried to capture a share of profits from innovations via various devices such as progressive taxes on profit, windfall taxes, etc. The (observable) effect of those profit-sharing schemes is to reduce incentives to innovate.

²⁶ I am assuming here that a larger flow of innovations tends to produce a larger flow of successful innovations.

²⁷ Imagine the list of all families and unattached individuals ranked in terms of their income in a given year. Then, separate them into five equal groups, add incomes within each group, and divide them by the total income for the country. The numbers in Table 1 are the percentages of total national income in current prices captured by each of those five groups. The reader should bear in mind that a relative stability of income shares by five income groups does not affect the flow of people between income groups from one period to another. (The figures in Table 1 are from U.S. Bureau of the Census, Current Population Report, Series P-60, No. 174, 1993.)Google Scholar

²⁸ Gallaway, Lowell, “The Folklore of Unemployment and Poverty,” in Government Controls and the Free Market, ed. Pejovich, Svetozar (College Station: Texas A&M University Press, 1976), pp. 41–69.Google Scholar

²⁹ There is no economic theory that says that more equality in the distribution of money income is better than less equality. All that economists can do is try to identify and analyze the factors that account for income differences between individuals and groups and the circumstances upon which those factors depend. For example, in the early 1990s, median income for Asian Americans, whose work ethic and entrepreneurship are exemplary, was $36,784, and median income for whites was $31,435 (New York Times, 07 24, 1992, p. A16Google Scholar). Also, any attempt at income redistribution creates at least two problems. First, a society in which incomes are not related to performance is going to be a poor society. This is so because adverse incentives reduce the production of future wealth. Second, the administrative costs of redistribution eat up current incomes. As Richard Posner writes: “Involuntary redistribution is a coerced transfer not justified by high market-transaction costs; it is, in efficiency terms, a form of theft. Its justification must be sought in ethics rather than in economics” (Posner, Richard, Economic Analysis of Law, 4th ed. [Boston: Little, Brown, and Company, 1992], p. 461).Google Scholar

³⁰ Buchanan, James, “General Implications of Subjectivism in Economics,” paper presented at the Conference on Subjectivism in Economics, Dallas, Texas, 1976, p. 8.Google Scholar

³¹ Many countries, especially developing countries, tend to attribute their low rate of economic development to a variety of causes, such as exploitation by former colonial rulers, an inadequate resource base, shortage of capital, and/or poor planning. None of these alleged causes of “poverty” makes much sense. After several decades of political sovereignty, the exploitation argument is increasingly becoming an embarrassing one for developing countries to offer as an excuse for economic stagnation. If an inadequate resource base is responsible for poverty in India, why is a resource-poor country like Japan doing well? If overpopulation is a problem in China, why are people in Hong Kong so much better off? A shortage of capital is not holding back economic development in Eastern Europe, Africa, South America, etc. The flow of capital is held back by political instabilities, currency controls, restrictions on the right of ownership, discriminatory taxes, and corrupt governments. Compare the level of capital flowing into Japan with that flowing into India, or the level in East Asia with that in Africa, or the level in the Czech Republic with that in Romania.