Is War Obsolete?

In a recent survey of my students I asked them to identify important historical figures. On their short-list of people we had Alexander the Great, Napoleon, Hitler, and Caesar.  The common denominator here is they were all leaders remembered for their attempts at empire building as a means of acquiring greater wealth / income for themselves and their people.  One of the issues discussed was why all of the attempts at empire building failed? The students were then asked to consider the situation in China, home to one-fifth of the world's population and a country whose rulers are bent on expanding the possibilities open to China's people.  Should we be concerned about territorial grabs on the part of the Chinese as the attempt to improve the standard of living in China? 

To answer these questions we will attempt to capture their essence with a simple possibility curve diagram.  We will assume the ruler of an empire can utilize the resources to produce shelter and food and the people will always want more.  The initial possibilities open to the people can be represented by the red possibility line in the Possibility Curve diagram below.  Given existing resources it is possible to achieve point A, but it is impossible to achieve point B. The desires on the part of the people for more will keep pressure on the ruler to increase output which would be reflected in an outward shift in the possibility curve.

Option I: Resource Acquisition

In the pre-industrial, zero-sum society in which Alexander and Caesar lived, the only means to expand an empire's income (shift out the possibility curve) was the acquisition of resources through territorial expansion.  The acquisition of resources extends the nation's production possibility curve outward so B would now be attainable, but C is not yet attainable. For those aware of China's size and ambitions for growth, this is an uncomfortable view of the world.  It is also a view of the world with a fundamental flaw, if you believe Paul Kennedy's view of the rise and fall of empires. In Kennedy's view, the expansion in size necessary to raise the possibility curves also creates the need for greater expenditures on 'unproductive' ventures designed to defend and control the territory.  Stated somewhat differently, the territorial expansion sets the empire on a path where the empire eventually outgrows its ability to control itself and it implodes.

Option II: Production Efficiency

Fortunately this is not the end of the story.  Adam Smith, an English economist whose view of the world appeared in his 1776 book An Inquiry Into the Wealth of Nations, offered an alternative model of progress / growth.  According to Smith, the key to economic growth was productivity growth - the more efficient use of resources.  Territorial expansion was no longer viewed as necessary for economic growth since a nation could expand its possibilities by getting more output from existing resources.

If we look closer at Adam Smith's work we find the key to productivity growth was specialization - the division of labor. Smith used the example of the pin factory to demonstrate the potential growth associated with specialization. If we could break down the production of pins be into separate tasks where people could get 'real good' at what they do, then they could produce far more pins then they could working alone. In the diagram below we have demonstrated the impact on the possibility curve of an increase in productivity in the production of shelter. With existing resources we can now attain what was originally unattainable (pt B). Smith went beyond this observation and suggested there was an economic system well suited for producing this productivity growth, but for now let's simply look at the picture of his view.  If we had productivity growth that affected both sectors, then the curve would shift outward and the situation would look very much like the one that we saw with territorial expansion.   China could solve its appetite for growth by a more efficient allocation of its resources rather than territorial expansion.

 How has this growth in productivity been accomplished?  The growth has been accomplished as a result of a substantial reallocation of China's resources.  The mechanization of farming has freed workers from the fields and they have moved into the cities where they work in factories.  With the same resources China will thus be able to expand the level of output / income.

Option III: Trade

No surprise, but we are not at the end of the story yet. In this view of the world we would expect to find a set of self-sufficient countries with little interaction between them. But have we tapped all the possibilities of growth? Why not carry the specialization concept further-beyond national borders which economists often tend to view as somewhat arbitrary? David Ricardo, following the logic of Smith, identified trade as another means to expanded possibilities. We will look only briefly at the impact of trade on the possibility curve here, a warm-up for a more thorough treatment of trade.

The key to understanding the trade situation is recognizing we can have a distinction between the production possibility curve (what the people of the country can produce) and the consumption possibility curve (what the people of the country can consume). Without trade the two curves are the same, but with trade we can see a wedge driven between the two.

In the example below, the possibilities open to the country in isolation are represented by the red line. The combination of shelter and food at point A are attainable if resources are used efficiently, but point B and C are unattainable. Or are they? What if someone (another country maybe) came along and said you could specialize in the production of Shelter and then trade the shelter for food along the green possibility curve. Clearly we could now get to point B and the country now has a second possible means for expanding the possibilities open to its people. To understand why this deal might be on the table, we would need to delve further into the trade model.

So what about China?  There is always the concern for territorial expansion, but the prospects for growth offered by increased efficiency and trade break the link between territorial expansion and economic growth.  It is now time to turn our attention to a question which we have glossed over - how do we achieve efficiency? How can we be assured resources will be used efficiently (operating on the possibility curve), and how do we know we will see increases in efficiency (expanding the possibility curve outward)?

The answer is in the economic system? What type of economic system will produce an allocation of resources that produces both static and dynamic efficiency? One possibility would be an allocation based on tradition - choices being made the way they always have been. Another possibility would be to have a central authority make all decisions - a command system. Some possible means of allocating goods under this system would be lotteries, queues, and coupons.  A third possibility would be a market system where all decisions are made by individual decision makers (firms, individuals). It is this system we will examine more closely in the remainder of this course.