Lessons From Economic History

“History is a vast early warning system.” - Norman Cousins

No one person, or even group of people, are smart enough to figure everything out on their own. We require examples, hints, and yes, warnings just to have a chance.

Below are some lessons I’ve learned after more than two decades as a wealth advisor and studying history.

Incentives influence behaviour

“Well, I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.” — Charlie Munger

A society’s structure, institutions, and philosophies heavily influence its reward system. Stores in the Soviet Union became famous for their empty shelves. Why did this happen? It’s likely a centrally planned society with few efficiency-based incentives had something to do with it. If the communist system had a way for store managers to be meaningfully rewarded for increasing sales, for example, many of them may have been more resourceful.

Charlie Munger tells a story about FedEx that is even more enlightening: “The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast. And Federal Express had one hell of a time getting the thing to work. And they tried moral suasion, they tried everything in the world, and finally somebody got the happy thought that they were paying the night shift by the hour, and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked.”

History contains countless examples of how effective incentives led to positive results, while flawed incentives, unexpectedly, led to negative ones.

Capitalism, though flawed, has outperformed all other options

In their seminal book, The Lessons of History, Will and Ariel Durante list competition as the first of the three big lessons of history. From animals on the savanna to trade, wars, and education, competition occurs in every crevice of life. In a Darwinian universe, it stands to reason that an economic system like capitalism, which is predicated on competition, would outperform all other options.

From the Dutch and British empires to America’s hegemony and the re-emergence of China and India, no country in the modern age has thrived for long without embracing some degree of free-market economy.

Success for the whole, however, doesn’t mean everyone is successful. Much like evolution, where the proliferation of a species supersedes that of the individual, capitalism does the same for societies that embrace it. In other words, although capitalist systems have constantly grown the economic pie faster than the alternatives, the pieces are rarely divided evenly, often to the point of unfairness.

Capitalism comes in various forms. Singapore and Sweden are both capitalist countries. While Singapore has chosen a laissez-faire free-market society, it’s also a somewhat restrictive democracy. Sweden, on the other hand, has embraced a relatively more egalitarian approach, with higher taxes and a more comprehensive series of social programs, while providing considerable personal freedoms.

Inequality matters

Every human is unique. We are a product of our genetics, experiences and environment. History has shown that increased freedom leads to an expansion of income inequality. This has happened with such regularity that it seems a universal law. As Will and Ariel Durant wrote in The Lessons of History, “Nature smiles at the union of freedom and equality in our utopias. For freedom and equality are sworn and everlasting enemies, and when one prevails the other dies.”

Unfortunately, although inequality has regularly increased over numerous periods, there seems to be few, if any examples, of the reverse happening as naturally. Walter Scheidel, author of The Great Leveler explains in a 2017 Atlantic article:

“Throughout history, only massive, violent shocks that upended the established order proved powerful enough to flatten disparities in income and wealth. They appeared in four different guises: mass-mobilization warfare, violent and transformative revolutions, state collapse, and catastrophic epidemics. Hundreds of millions perished in their wake, and by the time these crises had passed, the gap between rich and poor had shrunk.”

In other words, throughout history, when inequality became an issue, it was only rectified by war, revolution, state collapse, or pandemic. Not a pretty picture.

Three of these - war, state collapse, and pandemic - often occurred without direct relation to economic inequality. Revolutions, however, often seemed to have been a result of a populace no longer tolerant of the existing levels of inequality.

With the current level of inequality seen in many countries, it seems likely that either war, state collapse, pandemic, or revolution will be needed to ease this tension.

Rare events and people change history 

Similar mistakes are repeatedly made throughout history. Why is that? Likely two reasons: we have short memories, and we give more weight to personal experiences and recent events than those that happened long ago.

In his book, The Black Swan, Nassim Taleb illustrates our blindness to rare and catastrophic events through the life of a typical turkey.

Most turkeys live on a farm. And on that farm, a farmer takes care of them. With each day, the turkey is provided additional proof that the farmer is its friend. Then, on one fateful day, usually just before Thanksgiving, it realizes that everything it ever knew was wrong. Taleb believes we are often like that turkey, in that we are blinded by our personal and recent experiences when planning our future.

The current pandemic is a prime example. There have been many deadly plagues throughout history. Although knowing this wouldn’t enable one to predict when the next would occur, it should be enough warning that another would eventually occur. And in knowing that, a wise society should always be prepared for that eventuality.

Here are some other rare history-changing events to ponder:  

  • The asteroid that killed the dinosaurs, which ultimately led to humans to evolve into being
  • The fall of the Roman Empire
  • The earthquake that hit the USSR on October 5, 1948 killed 110,000 people and levelled the city of Ashgabat
  • The Great Depression of 1929
  • World War I
  • World War II
  • The stock markets crash of Monday, October 19, 1987, that caused markets to plummet more than 22%
  • The terrorist attacks on September 11, 2001
  • The 2008 U.S. housing crisis

And history-changing people:

  • Alexander the Great
  • Nero
  • Attila the Hun
  • Napoleon
  • Roosevelt
  • Gandhi
  • Einstein
  • Stalin
  • Hitler
  • Churchill
  • Martin Luther King Jr.

History is a record of extreme events and individuals that have changed the trajectory of history.

Exponential growth changes history

Growth is driven by compounding, but it takes time. In 1960, China’s GDP was US$59.7 billion. By 2019, it rose to US$14.3 trillion. That’s an increase of 246 times. It took only 59 years at a 9.7% average rate of growth to achieve that feat. If the annual growth rate were only 1.2% lower, the Chinese economy would only be half of its current level. Half.

The world would be very different if China’s economy were only 50% of its current size. Perhaps the country wouldn’t be in a major trade war with the U.S., or curtailing human rights in Hong Kong, or extending more loans to African countries than any other nation. It’s possible some, maybe all of these things would still have happened, but certainly not to the same degree.

Imagine how meaningful a different rate of exponential growth is over hundreds or thousands of years. That changes history.

Economic activity is cyclical

In 1800, China and India were the globe’s two largest economies. No others were even close. While they systematically fell behind over the following two centuries, both are in the process of reversing their fortunes. China's economy will soon surpass the U.S. and India is the world’s fifth-largest economy, on track to surpass the U.S. in the next three decades.

Economic cyclicality - perhaps best described in Ray Dalio’s video, How the Economic Machine Works - does not just extend to the economic ranking of nations. Reserve currencies come and go, the global economy ebbs and flows along with the levels of income inequality and debt levels. The economic tides roll without cessation.

Environment matters

The roaring ’20s was a period of great prosperity. Business boomed, trade expanded, and the stock market seemed to rise without pause. It was a great time to start a business and make money. The Great Depression, on the other hand, was completely different. The economy cratered, jobs dwindled, and food lines became commonplace. Times were tough. The same person with the same business idea and the same strategy could have done the exact same things in both eras, but with very different results. Environment matters.

This extends beyond boom and bust eras. From tax regimes and interest rates to the neighbourhoods people grow up in, the economic environment makes a material difference. Sometimes these landscapes are static, lasting years on end. Other times, they change in a moment. September 11, 2001 was one of those moments.

In his blog post, “Common Plots of Economic History”, Morgan Housel explains how the events of that fateful morning led to a cascade of unexpected consequences: “... 9/11 prompted the Fed to cut interest rates, which helped drive the housing bubble, which led to the financial crisis, which led to a poor jobs market, which led tens of millions to seek a college education, which led to $1.6 trillion in student loans with a 10.8% default rate. It’s not intuitive to link 19 hijackers to the current weight of student loans, but such is the power of compounding in a tail-driven world.”

Never underestimate the importance of environment. It’s proven to be one of the most powerful economic forces.

Debt is a double-edged sword

Throughout history, individuals, companies, and countries have been tasked with making do with their existing resources. With the advent of debt, the option of exceeding those resources became a possibility. This isn’t always bad. There are times when the use of debt is prudent and wise. Unfortunately, many countries have been irresponsible, using debt as a crutch that quickly became a noose.

History has provided a few lessons for nations that use debt:

  1. Debt should be used carefully to increase growth rates: Given the power of exponential growth, when borrowed funds enhance a country’s economic growth rate, their debt will decline relative to their economy. This is highly beneficial.

    However, unexpected issues regularly occur. Interest rates can surge, currency values can fall and recessions can decimate growth rates and tax revenue. When debt reaches troubling levels, interest costs can spiral out of control. In turn, funds required to help a country’s citizenry are reduced and growth rates fall, which further increases interest rates and lowers currency values.

  2. Borrowing in another currency can be dangerous: Borrowing in a foreign currency works when done judiciously and the borrowing country’s currency remains strong. However, things become problematic when the currency of the borrower falls - usually due to a serious economic issue. When it does, the borrower’s debt increases solely because the exchange rate has turned against them.

    Numerous countries, from Argentina to Zimbabwe, have experienced this to tragic effect. While in the midst of severe recessions, their revenues fell, leading to a need for more debt to cover expenses. However, when countries are in precarious positions, currencies decline and lenders charge higher interest rates to cover the additional risk of default. When severe, events like these lead to hyper-inflation and severe debt crises, ultimately causing dire repercussions for their citizens.

  3. Debt is less problematic when the world’s reserve currency is possessed - until it’s lost: Throughout history, international trade has taken place through the hegemonic power’s currency. This is referred to as the world’s reserve currency. For example, 55% of today’s global transactions occur in U.S. dollars. Given the frequency of its use, the U.S. dollar must be readily available at all times, but especially during economic turmoil. This liquidity is provided by the hegemony’s central bank, currently the U.S. Federal Reserve, which can create or “print” money as it sees fit. This demand benefits the U.S. as it can print considerably more money than other countries, without the typical repercussions, such as falling currency or hyper-inflation.

    However, a currency’s reserve status does not last forever. The Dutch possessed it in the 17th and 18th centuries, but lost it to the British, who held it in the 19th and early 20th century, before losing the privilege to the U.S. The loss of reserve status not only causes a country’s currency to fall, it also loses its ability to print money at will, creating new financial strains.

    With the relative decline of the U.S. since the 1990s and China’s economy closing the gap between their economies, it’s possible the U.S. will cede this status to China, or a basket of currencies. When this happens, the U.S. will face considerably higher financial constraints, possibly with serious repercussions given their increasing levels of debt.


The purpose of studying history isn’t to know important dates, stories, facts, or figures. It’s to provide an understanding of what could happen. Over time, a large number of events will occur, some will be good, some will be bad, and some will be awful. And like a game of cards, these events are randomly dealt, regardless of your current hand.

So the point of studying history is to prepare you. To prepare you for unexpected opportunities, pitfalls, and especially the rare occasions when the unthinkable occurs.