Economist's View

"Escaping the Fossil Fuel Trap"

Michael Spence says developed countries should pay the cost of reducing carbon emissions, including paying for abatement measures in developing countries:

Escaping the Fossil Fuel Trap, by Michael Spence, Project Syndicate: ...[The] use of fossil fuels, and hence higher CO2 emissions, seems to go hand in hand with growth. This is the central problem confronting the world as it seeks ... to combat climate change. Compared to the advanced countries, the developing world now has both low per capita incomes and low per capita levels of carbon emissions. Imposing severe restrictions on their emissions growth would impede their GDP growth and severely curtail their ability to climb out of poverty.

The developing world also has a serious fairness objection to paying for climate-change mitigation. The advanced countries are collectively responsible for much of the ... carbon in the atmosphere... As a consequence, the developing world’s representatives argue, the advanced countries should take responsibility for the problem.

But a simple shift of responsibility to the advanced countries by exempting developing countries from the mitigation process will not work. ... If developing countries are allowed to grow, and there is no corresponding mitigation of the growth in their carbon emissions, average per capita CO2 emissions around the world will nearly double in the next 50 years, to roughly four times the safe level... Advanced countries by themselves simply cannot ensure that safe global CO2 levels are reached. ...

So the world’s major challenge is to devise a strategy that encourages growth in the developing world, but on a path that approaches safe global carbon-emission levels by mid-century. ...

These considerations suggest that no emission-reduction targets should be imposed on developing countries until they approach per capita GDP levels comparable to those in advanced countries. ...[A]dvanced countries ... should be allowed to fulfill their obligations, at least in part, by paying to reduce emissions in developing countries (where such efforts may yield greater benefits). ...

The best way to implement this strategy is to use a “carbon credit trading system” in the advanced countries, with each advanced country receiving a certain amount of carbon credits to determine its permissible emission levels. If a country exceeds its level of emissions, it must buy additional credits from other countries... But an advanced country could also undertake mitigation efforts in the developing world and thus earn additional credits...

Such a system would trigger entrepreneurial searches for low-cost mitigation opportunities in developing countries, because rich countries would want to pay less by lowering emissions abroad. As a result, mitigation would become more efficient...

Conflict between advanced and developing countries over responsibility for mitigating carbon emissions should not be allowed to undermine prospects for a global agreement. A fair solution is as complex as the challenge of climate change itself, but it is certainly possible.

Can Better Logistics Ease Harsh Labor Market Conditions in Developing Countires?

This argues that better workflow logistics can be an effective means of alleviating harsh working conditions:

Saving labor, by Peter Dizikes, MIT News Office: The existence of harsh labor conditions in factories around the world is a pressing moral issue. But to improve those conditions, we should regard it as a logistical issue, too.

Consider the case of ABC, a giant clothing manufacturer whose products are made in more than 30 countries, and the subject of a new study led by Richard Locke ... of the MIT Sloan School of Management. After being accused of poor labor practices in the early 1990s, Locke notes, ABC became a leader among corporations in addressing labor conditions. The firm adopted a code of conduct for all factories providing it with goods, including those owned and run by local suppliers. ABC developed a system to monitor labor conditions, and hired a large compliance staff to enforce its policies world-wide.

And yet for all of its efforts, just 24 percent of the roughly 200 factories in ABC's global supply chain met its own labor standards in 2006, as Locke and some colleagues reveal in a recently published paper based on a study of the firm's own audit data and practices. Garment workers at plants supplying ABC in the Dominican Republic were exposed to noxious chemicals and forced to work in overheated conditions, according to Locke and his co-authors; as they detail it, other laborers, from Honduras to India, were asked to work overtime shifts in excess of ABC's own established limits.

The traditional system of setting labor standards and attempting to enforce them, through periodic checks by corporate compliance officers, has not worked well enough, Locke and his colleagues conclude. ... "My original view was that the compliance system could make conditions better, if it were just better-designed or better-funded," says Locke. "In the process of research, I realized that just checking on factories and threatening them doesn't work." In this view, multinational firms cannot just diagnose factory problems and expect them to vanish, but must take the lead in changing them. ...

Basic policing of factories has "yet to deliver on its promise of sustained improvement in labor rights," the authors say, while by contrast, factory monitors who take a problem-solving approach, have created "sustained improvements in working conditions and labor rights" around the world.

The authors were able to conduct the study because ABC (a pseudonym chosen to protect its identity) allowed them to study its data on labor conditions, and granted the researchers access to numerous factories where ABC's suppliers actually make its clothes.

While evaluating the firm, Locke, Amengual, and Mangla saw with their own eyes evidence that a pragmatic, trouble-shooting mode of enforcement has rapid effects. To solve the problems of exposure to fumes overheating in the Dominican Republic, for instance, compliance officers suggested moving the relevant equipment to the edge of the building space. Ventilation improved and the problem diminished significantly.

To help the factory in Honduras, ABC persuaded its management to re-orient its machinery and workers' schedules, to better handle the short-term "rapid replenishment" orders that had led to excess overtime. The improved logistics cost the factory little financially and let it comply with ABC's standards. The MIT researchers found a similar result at a factory supplying ABC in Bangalore, India, where better workflow logistics also eliminated an overtime problem.

"We know from years of research that when you implement certain kinds of systems in the advanced industrial countries, you get better results," says Locke. But the managers of factories supplying ABC, he notes, often lack "real training or understanding of production techniques and high-performance systems."

Labor-rights advocates applaud Locke's ideas. "People have looked to codes and auditing as a way to force accountability," says Chris Jochnick, director of Private Sector Development at Oxfam America. "But Rick was one of the first people to see that the way improvement happens is probably a lot more nuanced. His work is a valuable way of looking at the problem."

As Locke notes, this logistics-based approach to factory violations is just one piece of a still larger problem; the demands global brands put on local factories must be addressed as well. And as he readily acknowledges, some practical solutions could be expensive for factories, making managers reluctant to implement them. In those cases, a hard-line approach may yet be useful. "Sometimes you do need a bit of a threat," he says. "It's that blend that seems to matter." ...

Later this month, Locke will host a conference of executives both from non-governmental organizations and athletic-wear firms — including Nike, Adidas, New Balance, Puma and Asics — to discuss ways to use this problem-solving approach. ...

Firms must have the desire to set a code of conduct that they are serious about enforcing (as opposed to using the code to gain positive publicity with no real intent of forcing firms to comply), and they must also have the means to enforce compliance. This focuses on the ability to enforce or induce compliance, but the incentive to establish the code and then make a serious attempt to change things when suppliers are in violation of the rules is another important aspect of the problem.

In a competitive marketplace where buyers do not consider the labor market conditions of suppliers when purchasing a good, and where there are no regulations preventing firms from transacting with suppliers who are in violation of minimal standards (something that would be difficult to monitor), firms will have no incentive beyond their own moral values to enforce labor market standards.

I'm sympathetic to the argument that low wage jobs in many developing countries provide opportunities that wouldn't exist otherwise, but there are bounds that shouldn't be crossed.

Should Health Care be a Human Right?

William Easterly says defining health care as a human right "has made global healthcare more unequal":

Human rights are the wrong basis for healthcare, by William Easterly, Commentary, Financial Times: The agonizing US healthcare debate has taken on a new moral tone. President Barack Obama recently held a conference call with religious leaders in which he called healthcare “a core ethical and moral obligation”. Even Sarah Palin felt obliged to concede: “Each of us knows that we have an obligation to care for the old, the young and the sick.”

This moral turn echoes an international debate about the “right to health”. Yet the global campaign to equalize access to healthcare has had a surprising result: it has made global healthcare more unequal.

The notion of a “right to health” has its origins in the United Nations’ Universal Declaration of Human Rights in 1948. But in the decades that followed, foreign aid’s most successful efforts in health – such as the World Health Organization and Unicef campaigns on vaccines and antibiotics – were based on a more limited goal: obtaining the largest possible health benefits for the poor from finite foreign aid budgets.

The moral argument made a big comeback in the new millennium. One of its most eloquent advocates is Dr Paul Farmer, who earned fame with heroic efforts to give people access even to complex medical treatment amid extreme poverty in Haiti and Rwanda, saying that healthcare was “a fundamental human right, which should be available free”. The WHO shifted from pragmatic improvement of health outcomes towards “the universal realization of the right to health”. Even Amnesty International ... added a new section to its human rights report in 2009 on the “right to health”.

So what is the problem? It is impossible for everyone immediately to attain the “highest attainable standard” of health... So which “rights to health” are realized is a political battle. Political reality is that such a “right” is a trump card to get more resources – and it is rarely the poor who play it most effectively.

The biggest victory of the “right to health” movement has been the provision of aid-financed antiretroviral treatment for African Aids patients, who include the upper and middle classes. ...

Saving lives in this way is a great cause – except to the extent that it takes resources away from other diseases. Alas, many observers fear that is exactly what it did.

An evaluation by the World Bank in 2009 faulted the bank for allowing Aids treatment to drive out many other programs. Global deaths due to either tuberculosis or malaria stood at 2m in 2008, around the same as those from Aids. Yet Aids accounted for 57 per cent of World Bank projects on communicable diseases from 1997 to 2006, compared with 3 per cent for malaria and 2 per cent for TB. Other big killers of the poor – such as pneumonia, measles and diarrheal diseases, which together accounted for more than 5m deaths in 2008 – received even less attention. ...

The lesson is that, while we can never be certain, the “right to health” may have cost more lives than it saved. The pragmatic approach – directing public resources to where they have the most health benefits for a given cost – historically achieved far more than the moral approach.

In the US and other rich countries, a “right to health” is a claim on funds that has no natural limit, since any of us could get healthier with more care. We should learn from the international experience that this “right” skews public resources towards the most politically effective advocates, who will seldom be the neediest.

This is not my area, but I do wonder if the problem is the designation of the right, or something more systemic within these countries. That is, the implicit assumption is that with a different goal - a "pragmatic approach" of directing resources where they will have the most benefits - the poor would have fared better, but are we sure that's the case? Who decides what defines "the most benefits"? My guess is that the same people who diverted resources before would manage to do so again by defining the benefits appropriately, i.e. in a way that benefits the same groups of people as before. If so, then the problem is not the designation of a right to health care.

Paul Romer: New Systems versus Evolution

Paul Romer responds to questions from Chris Blattman about his proposal to establish charter cities, in particular, how to construct dynamic rule sets that maximize the chance of success:

New Systems versus Evolution, by Paul Romer: At a recent talk in London, Chris Blattman asked if a charter city could fail in the same way that public housing failed in Chicago. After the seminar and in his follow up post, we started a discussion of the deeper issue: What kind of dynamics would be desirable in the space of rules?

To frame the discussion, it helps to have some vocabulary. A rule set is a large collection of rules that are tightly linked. Rule sets can improve through what I will call an evolutionary dynamic based on small, incremental changes or through a new-system dynamic in which an entirely new rule set enters and competes with an existing one.

Chris and I agree that an evolutionary dynamic can lead a vibrant neighborhood but that it can also lead to a dangerous slum with no roads, sewers, safe water, electricity or other utilities.

We also agree that there is a risk associated with new systems. Sometimes they don’t work, as the public housing projects in Chicago demonstrate. Sometimes they work remarkably well. Architecturally similar high-rise buildings in Hong Kong and Singapore provided livable housing for large numbers of working poor in the 1960s and 1970s. ...

The challenge that Chris posed to me, one that several others have also suggested, but not as precisely, is how to assess the tradeoff between faster growth and higher risk that the new-system dynamic seems to offer. A related question is who bears that risk. These are important questions. Here are some provisional answers.

Start with the distinction between catch-up growth and frontier growth. Catch-up growth is based on copying existing ideas. Frontier growth involves the discovery and implementation of new ideas.

In catch-up growth, the new-system dynamic can be used to copy existing rule sets. This allows faster growth without the additional risk that comes from using the new-system dynamic at the frontier. ...

The concept of a charter city does rely on the new-system dynamic, but in the context of economic development, charter cities can adopt a new rule set made up of rules that are known to work well. It can accelerate catch-up growth with little of the risk associated with the development of new systems at the frontier.

A charter city could be also used, perhaps in the United States, to encourage innovation at the frontier of urban living. An entirely new city could introduce changes to transportation systems or energy systems that are improbable along an evolutionary path. ... But in this case, faster growth would involve more risk.

It is important to recognize that new systems typically need evolutionary improvement after they are introduced. As existing charter cities compete with each other, they will evolve in precisely this sense. ...

A new city could still fail, just as Detroit is failing in the United States. The risk of a failure falls primarily on the owners of the fixed assets that can’t leave, not on the labor income of workers who can leave. This seems like just the right allocation for incentives and risk sharing. If the development authority with administrative responsibility for the city owns the land and collects revenue as rent on long-term leases, it has a strong incentive to get the rules right early on and to help the rules evolve in the right direction thereafter. ...

An arrangement with many cities that compete with each other is present today in China. Many new or rapidly growing cities compete for residents and investors. Local officials receive a substantial portion of their revenue from gains in the value of land that they own. To my knowledge, none of the new or rapidly growing cities in China has failed to the degree that public housing failed in the United States.

Finally, it is worth noting that roughly 3 billion people will move to cities in the next 50 years. If this growth takes place by an evolutionary dynamic that expands existing cities, many of these cities will fail as badly as the public housing projects did in Chicago. In fact, particularly many of them already do.

The right question to ask is not whether the new-system dynamic, as applied by charter cities, is subject to some risk. Rather, it is whether the risk of failure in charter cities is any greater than along the status quo path. Because charter cities use the new-system dynamic to copy best practice and create strong competitive pressures for rapid evolutionary improvement after they are built, I’m convinced that they offer the prospect of both faster growth and less risk.

"The Essential Pillars of a New Climate Pact"

Sheila Olmstead and Robert Stavins argue that three essential elements must be present in the successor to the 1997 Kyoto Protocol:

The essential pillars of a new climate pact, by Sheila M. Olmstead and Robert N. Stavins, Commentary, Boston Globe: The climate change summit at the United Nations on Tuesday is aimed to build momentum for ... a successor to the 1997 Kyoto Protocol, which expires in 2012. To be successful, any feasible successor agreement must contain three essential elements: meaningful involvement by a broad set of key industrialized and developing nations; an emphasis on an extended time path of emissions targets; and ... policy approaches that work through the market, rather than against it.

Consider the need for broad participation. Industrialized countries have emitted most of the ... man-made carbon dioxide in our atmosphere, so shouldn’t they reduce emissions before developing countries are asked to contribute? While this seems to make sense, here are four reasons why the new climate agreement must engage all major emitting countries - both industrialized and developing.

First, emissions from developing countries are significant and growing rapidly. ... Second, developing countries provide the best opportunities for low-cost emissions reduction... Third,... industrialized countries may not commit to significant emissions reductions without developing country participation. Fourth, if developing countries are excluded, up to one-third of carbon emissions reductions ... may migrate to non-participating economies through international trade, reducing environmental gains...

The second pillar of a successful post-2012 climate policy is an emphasis on the long run..., and major technological change is needed to bring down the costs of reducing CO2 emissions. The economically efficient solution will involve firm but moderate short-term targets to avoid rendering large parts of the capital stock prematurely obsolete, and flexible but more stringent long-term targets.

Third, a post-2012 global climate policy must work through the market rather than against it. ... One market-based approach, known as cap-and-trade, is emerging as the preferred approach ... among industrialized countries. ...

Cap-and-trade systems can be linked directly, which requires harmonization, or indirectly by linking with a common emissions-reduction credit system; indeed, this is what appears to be emerging... Kyoto’s Clean Development Mechanism allows parties in wealthy countries to purchase emissions-reduction credits in developing countries by investing in emissions-reduction projects. These credits can be used to meet emissions commitments...

A new international climate agreement missing any of these three pillars may be too costly, and provide too little benefit, to represent a meaningful attempt to address the threat of global climate change.

"The Origin of Development as Cover for Imperialism and Racism"

Bill Easterly says economic development was "a new justification for colonial rule to replace the unpopular and increasingly implausible idea that they were a superior race destined to rule inferior races":

How the British Invented “Development” to Keep the Empire and Substitute for Racism, by William Easterly: During the early years of World War II, Japan won major victories (such as the capture of Singapore) against the British and threatened India. Japanese propaganda pointed to British racism and offered themselves as the defenders of non-white peoples. The British feared that non-white people in the colonies might side with the Japanese rather than their colonial masters. The British had to come up with a new justification for colonial rule to replace the unpopular and increasingly implausible idea that they were a superior race destined to rule inferior races. In response, they invented the concept of economic development.

This story is told in an undeservedly obscure book by Suke Wolton, 2000, Lord Hailey, the Colonial Office, and the Politics of Race and Empire in the Second World War, (I have this thing for obscure development history books; this one is ranked #4,399,430 on Amazon)

The Japanese charge of British racism was certainly correct. They were so racist they thought even nonwhites acknowledged their own inferiority, like when Julian Huxley referred to the natives’ “childlike belief in the white as an inherently superior being.” After World War I, the Americans and British shot down a League of Nations resolution for Racial Equality proposed by the Japanese. The Colonial Office said in 1939 “most Africans are still savages.”

But during the dark days when the British were losing World War II, the racism was no longer allowed to be so explicit. The Labor Minister in 1941 banned the N word for Africans and “coolies” for Indians. The Colonial Office further told the BBC that the N-word should be “discouraged” on the radio. A further breakthrough caused the BBC to drop the word “native.”

But something more positive was needed to put the Empire in a good light. A long-time colonial official, Lord Hailey came up with the idea in 1941 of redefining the Empire’s mission as “promotion of native welfare.” (I guess he didn’t get the BBC memo about “native.”) And he argued the colonies could only develop with Britain’s help (sound familiar?) In short, Hailey said:

A new conception of our relationship…may emerge as part of the movement for the betterment of the backward peoples of the world, which stands in the forefront of every enlightened programme for …postwar conditions.

To repress independence movements, however, Hailey made a distinction between political development and economic development: “Political liberties are meaningless unless they can be built on a better foundation of social and economic progress.” (A line that autocrats have been using ever since.) The Colonial Office thought many colonies “little removed from their primitive state,” so “they will probably not be fit for complete independence for centuries.”

Of course, changing the language from racist to economic development did not mean racism suddenly disappeared. As Wolton shows, “the white Western elites still believed in their fundamental superiority.” In the end, Wolton says, “The major powers would continue to be able to determine the future of the colonial territories – only this time the source of their legitimacy was based less on racial difference and more on their new role as protector and developmental economist.” After the war, even more officials went out to the Empire in what became known as the “second colonial occupation.”

Why does this history matter today? After all, the Empire fell apart much sooner than expected, and racism did diminish a lot over time. And I do NOT mean to imply guilt by association for development as imperialist and racist; there are many theories of development and many who work on development (including many from developing countries themselves) that have nothing to do with imperialism and racism.

But I think the origin of development as cover for imperialism and racism did have toxic legacies for some. First, it meant that the concept of development was determined to fit a propaganda imperative; it was NOT a breakthrough in thought by economists. Second, it followed that development from the beginning would stress the central role of Western aid to help the helpless natives (which shows up in the early development theories like the “poverty trap” and the “Big Push,” and the lack of interest in local entrepreneurs and market incentives). Third, the paternalism was so extreme at the beginning that it would last for a long time – I still think it is widespread today, especially after today’s comeback of the early development ideas in some parts of the aid system. And this history also seems strangely relevant with today’s “humanitarian” nouveau-imperialism to invade and fix “failed states” like Iraq and Afghanistan.

Membership in the development elites is far more diverse than in Lord Hailey’s time, but I fear that, to use Wolton’s words, “in the end, the elites still believe in their fundamental superiority.”

"Would Growth in the U.S. Debt be Inflationary?"

David Andolfatto explains why a worldwide shortage of safe, liquid assets may help the U.S. to avoid the inflationary consequences of high debt levels:

Why the Growing Level of U.S. Debt May Not be Inflationary, by David Andolfatto: History shows that high levels of government debt are frequently associated with inflation. The reason for this seems clear enough. At some point, maturing debt needs to paid back. At high enough levels of debt, rolling the debt over is no longer feasible. Cutting back government spending and raising taxes is politically difficult. The easy way out is simply to print new money. As the money supply expands, inflation results.

Let us consider the U.S. Unlike most other economies, there appears to be a huge worldwide demand for U.S. Treasuries and U.S. dollars (which can be thought of as zero-interest Treasuries). A large scale increase in the supply of these government debt instruments need not lead to a depreciation in their value if there is a correspondingly large scale increase in the worldwide demand for these objects. What is the evidence that this may be happening?

Foreigners Snap Up Treasuries Even as US Debt Keeps Rising

But why should this be so? What accounts for what appears to be an insatiable demand for US debt, especially in the wake of the recent financial crisis?

Ricardo Caballero of MIT offers some hints in a very interesting piece entitled: On the Macroeconomics of Asset Shortages. After reading this paper, I started thinking in the following way. Tell me what you think.

There is a high and growing demand for low-risk assets, both as a store of value, and as collateral objects in payment systems (e.g., repo and credit derivatives markets). This growth has exploded over the last 20 years or so; and stems from the demand from emerging economies and innovations in the financial sector. There is a worldwide "shortage" of good quality (low-risk) assets, like U.S. Treasuries (which explains their relatively low yield). Indeed, many of the innovations in the financial sector can be interpreted as the private sector's response to this shortage: the creation of "low-risk" tranches of MBSs allowing these objects to substitute for U.S. Treasuries as collateral in the rapidly expanding repo market. ...

If this is more or less true, then the implication is this: The massive increase in the supply U.S. Treasury debt may very be "socially optimal" in the sense that the U.S. government is simply supplying the world with an asset that is in very high demand (which, in turn, means that the demanders obviously find some value in the existence of such an asset). To the extent that this "new demand regime" remains stable, the added supply of U.S. Treasuries will impose no financial burden on the U.S. (indeed, they make off like bandits, as the Treasuries are ultimately purchased by exporting goods and services to the U.S.).

The million dollar question, of course, is whether the high world demand for U.S. debt will persist long into the future (and whether the U.S. government will "overissue" debt beyond what is called for by this new high-demand regime). Who knows what will happen. But it appears to me that IF the U.S. government plays its cards right, it may very well enjoy its higher debt levels without the prospect of inflation. U.S. citizens will benefit (from the sales of Treasuries for goods) and the world will be grateful to hold a stable asset.

Well, maybe. But that was a big IF. What could possibly go wrong?

The future level of the debt in the U.S. is not a worry if we get effective health care reform (rising health care costs are the major source of projected future deficits). But if a debt problem does exist, I'm not sure the main risk is inflation since I expect the Fed to hold the line on debt monetization. If so, if the Fed does hold the line, then the pressure would be on government spending and taxes. If congress cannot solve the debt problem by cutting spending and/or raising taxes, the result would likely be high interest rates that crowd out private investment. In any case, what this says to me is that to the extent that this demand for safe assets exists, debt levels can be carried at a lower interest rate than otherwise, and this reduces concerns about crowding out (perhaps this is one of the reasons why long-term interest rates have remained relatively low, financial markets recognize this demand exists, believe the demand is large enough to matter, and believe it will continue for some time into the future).

"Tell me what you think."

*****

[On the relationship between debt and inflation, much of the evidence comes from developing countries. Here's one story about why debt and inflation might be related. Often a developing country will decide to run a government deficit to, say, build new roads, bridges, dams, etc. They are trying to build up the infrastructure. The idea is that the future growth that will come from this spending will allow the debt to be paid off. It's an investment in the future of the country -- borrow now, invest the money in needed infrastructure projects, and then use the resulting increase in future economic output to pay for spending (though much less noble motives for increasing debt exist as well).

How can this debt be paid for in the interim, i.e. during the time period when the projects are being built and before the expected growth is realized? The alternatives are to increase taxes, print the money, or borrow the money.

The countries can't increase taxes, these are developing countries and the tax base is insufficient. The whole point of the infrastructure projects is to begin to change that through economic growth.

If they can't tax, then can they borrow the money? Probably not domestically since, again, they are a developing country with little wealth. The necessary funds aren't available domestically. So that leaves borrowing from foreigners. Is that possible? Not if they have defaulted in the past. If they have defaulted, nobody may be willing to take the risk of lending them money, and if the money comes from international agencies such as the IMF, it may come with so many restrictions that it does no good. And even if the money can be borrowed, at some point it must be paid off, and if the promised growth does not materialize (and overly optimistic promises make this likely), investors will be unwilling to allow the debt to be rolled over. The point is that, for developing countries, supporting government spending through taxes or borrowing may not be feasible. This leaves only two choices, giving up on the spending projects, or printing money to pay for them. Printing money - and the inflationary consequences that follow - is often the choice that is made.

Developed countries are not so constrained. They have much more latitude to borrow from their own citizens or from foreigners, they have the ability to raise substantial sums through taxation, and often their infrastructure and other needs aren't as dire. In addition, they can generally count on future growth to help to pay for the borrowing. For all these reasons, developing countries aren't necessarily forced to pay for spending by printing new money and creating inflation.]

"A Breakthrough in the Fight against Hunger"

Jeff Sachs seems relatively pleased and cautiously optimistic:

A breakthrough in the fight against hunger, by Jeffrey D Sachs, Commentary, Project Syndicate: The G-8’s $20bn initiative on smallholder agriculture, launched at the group’s recent summit in L’Aquila, Italy, is a potentially historic breakthrough in the fight against hunger and extreme poverty. With serious management of the new funds, food production in Africa will soar.

Indeed, the new initiative, combined with others in health, education, and infrastructure, could be the greatest step so far toward achieving the Millennium Development Goals, the internationally agreed effort to reduce extreme poverty, disease, and hunger by half by 2015. ... One cornerstone of the project was “smallholder farmers”, meaning peasant farm families in Africa, Latin America, and Asia – working farms of around one hectare (2.5 acres) or less. These are some of the poorest households in the world, and, ironically, some of the hungriest as well, despite being food producers.

They are hungry because they lack the ability to buy high-yield seeds, fertiliser, irrigation equipment, and other tools needed to increase productivity. As a result, their output is meagre and insufficient for their subsistence. ...

The Millennium Project recommended a big increase in global funding for this purpose. ... Now the key is to make this effort work. The lessons of history are clear. ... Not only will food yields rise in the short term, but farm households will use their higher incomes and better health to accumulate all sorts of assets: cash balances, soil nutrients, farm animals, and their children’s health and education. ...

Thomas Schelling on Climate Change

Conor Clarke interviews Thomas Schelling on the implementation of climate change policy (the excerpts run across several questions):

An Interview With Thomas Schelling, Part Two, by Conor Clarke: This is the second part of my interview with Nobel Prize-winning economist Thomas Schelling. Part one is here. In this part we talk very generally about climate change...

...It's not obvious that averting global climate change is in the rational self-interest of anyone ... alive today. The serious consequences probably won't occur until 2080 or 2100 or thereafter..., [and] those consequences are going to be distributed in a radically uneven way. The northwest of the United States might actually benefit. So how does a negotiation process work? How does a generation today negotiate on behalf of future generations? And how do we negotiate when the costs are distributed so unevenly?

Well I do think that one of the difficulties is that most of the beneficiaries aren't yet born. More than that: Most of the beneficiaries will be born in ... the developing world. By 2080 or 2100 five-sixths of the population, at least, will be in places like China, India, Indonesia, Africa and so forth. And what I don't know is whether Americans are really willing to understand that and do anything for the benefit of the unborn Chinese.

It's a tough sell. And probably you have to find ways to exaggerate the threat. And you can in fact find ways to make the threat serious. I think there's a significant likelihood of a kind of a runaway release of carbon and methane ... that will create a huge multiplier effect, and it could become very serious. ...

If I were to come clean to the American public I would say that, except for a very low probability of a very bad result -- which is the disintegration of the West Antarctic ice sheet, which would put Washington DC under water -- we are probably going to outgrow any vulnerability we have to climate change. ... You know, very little of the US economy is susceptible to climate. All of agriculture is less than 3% of our gross product. Forestry may be endangered. Fisheries may be endangered. But recreation might actually benefit!

So if we can double our GDP in the next 70 or 80 years,... -- even if we lose 10% of our GDP from climate change -- we're still ahead so much that the effect of climate change wouldn't be noticed. But it would be pretty disastrous in a lot of the less developed parts of the world. And that's why I think it's crucially important not to demand anything of China, India and so forth that will significantly impede their economic progress. ...

[I]f the developed countries ... are really serious, they'll tell India and China and Brazil, "we're going to provide enormous assistance to help reduce your dependence on fossil fuels. And we don't expect you to pay for it yourselves. We will pay for it because we're rich and you're not." ...

But while people talk about this..., nobody that I know of is thinking about how in the world you organize so that the rich countries can agree what you do with the poor. You need to know who divides the money, and who the monitors is. We're going to need a whole new set of institutions...

It's very hard to get Americans to engage in what they think will be suffering not just for the polar bears but for the poor around the world who will indeed suffer if they can't outgrow their vulnerability to climate change. ...

I think you have to realize that most people have very strong moral feelings. I think in a lot of cases they're misdirected. I wish moral feelings about a two-month old fetus were attached to hungry children in Africa. But I think people have very strong moral feelings. In fact, I'm always amazed by the number of people who at least pretend they're worried about the polar bears.

And one thing that I think ought to help but doesn't is that -- and my impression is that maybe this is slightly changing -- the organized churches in America don't take seriously preserving the heritage that God gave us. ... I get no impression that Protestants and Catholics are sermonizing on the importance of preserving the bounty of the earth, the richness of the species, or preserving the planet as we would like to know it. ... I think the churches don't realize that they could have a potent effect in not letting so much of gods legacy -- in terms of flora and fauna -- be destroyed by climate change.

But I tend to be rather pessimistic. I sometimes wish that we could have, over the next five or ten years, a lot of horrid things happening -- you know, like tornadoes in the Midwest and so forth -- that would get people very concerned about climate change. But I don't think that's going to happen.

Exaggerating the threat won't help. When people find out that you are doing that -- and they will at some point -- you lose credibility and end up further behind than when you started. Also, though this is a bit picky -- this qualification is often omitted to simplify the discussion -- the costs are not fully captured by the loss of GDP. If, for example, some species become extinct due to climate change, that is only included in the costs to the extent that it lowers the output of goods and services. But our concerns are broader than that. Finally, I don't think we should, even just sometimes, wish that horrid things would happen to people no matter how much good might come of it. There are better ways to get there.

Are Small Banks the Answer for Developing Countries?

This week at The Economist:

Justin Lin, the World Bank’s chief economist,... in his guest Economics focus column ... argues that developing countries should base their financial systems on small, local banks:

The size and sophistication of financial institutions and markets in the developed world are not appropriate in low-income markets. Small local banks are the best entities for providing financial services to the enterprises and households that are most important in terms of comparative advantage—be they asparagus farmers in Peru, cut-flower companies in Kenya or garment factories in Bangladesh. The experiences of countries such as Japan, South Korea and China are telling. Those countries managed to avoid financial crises for long stretches of their development as they evolved from low-income to middle- and high-income countries. It helped greatly that they adhered to simple banking systems (rather than rushing to develop their stock markets and integrate into international financial networks) and did not liberalise their capital accounts until they became more advanced.

Mr Lin concludes:

Leave the developed markets to worry about how to reform their highly evolved financial systems. To make sustained progress in lifting the weight of the extreme poverty that will remain after the crisis has subsided, low-income countries need to make their financial institutions small and simple.

Over the course of the next week, we will devote this blog to a discussion of Mr Lin’s column, posting responses from our correspondents, invited experts from the academic and policy worlds, and our commenters. We'll be collecting the entire series of posts here. Do stop by and contribute to the debate.

Here is the lead Essay: Walk, Don't Run by Justin Lin

Here are the responses so far:

• Big bank advantages, by The Economist: London
• Why favour local tiddlers?, by The Economist: London
• Is small really beautiful?, by Asim Khwaja
• Passive voice, by Tyler Cowen
• Difficult trade-offs, by Abhijit Banerjee
• Leave room for growth, by Luigi Zingales
• Function, not form, by Ross Levine
• Scale matters, by Antoinette Schoar

Here is my response:

Small banks need help, by Mark Thoma: I agree with many of the points in the article regarding the potential that small and simple banks provide. But while small and simple banks can help to overcome many problems, by themselves they may not be enough fully serve the financial needs within developing countries.

There are two issues here. The first is to determine the types of financial products that best suit the needs of people and businesses within developing countries, and the second is how to best deliver those products to the people and businesses who could benefit from using them.

Small banks and microfinance of the type emphasised in the article can meet many of the financial needs in developing countries, for example the need that farmers have to borrow funds to purchase seed and fertiliser, and then repay the loans at harvest, can be met in this way. But other needs require more sophisticated financial products. The ability to hedge price risk through futures markets, the need for insurance against crop failure, the need to purchase farm equipment through pooling arrangements that share the costs among end users, and the problems brought about by seasonality require more sophisticated products and arrangements. The point is that not all of the financial needs in agricultural, small scale manufacturing, and services are simple, even in developing countries.

Can these more complex financial needs be satisfied, or are there important barriers within developing countries that prevent these products from being used?

Stiglitz: The UN Takes Charge (Update: and The Economic Lessons of the Iraq War)

Joseph Stiglitz says the UN has a key role to play in "reforming the global financial and economic system":

The UN Takes Charge, by Joseph Stiglitz, Commentary, Project Syndicate: ...On June 23, a United Nations conference ... reached a consensus both about the causes of the downturn and why it was affecting developing countries so badly. It outlined some of the measures that should be considered and established a working group to explore the way forward...

The agreement was ... in many ways ... a clearer articulation of the crisis and what needs to be done than that offered by the G-20, the UN showed that decision-making needn’t be restricted to a self-selected club, lacking political legitimacy, and largely dominated by those who had considerable responsibility for the crisis in the first place. Indeed, the agreement showed the value of a more inclusive approach – for example, by asking key questions that might be too politically sensitive for some of the larger countries to raise, or by pointing out concerns that resonate with the poorest, even if they are less important for the richest.

One might have thought that the United States would have taken a leadership role, since the crisis was made there. Indeed, the US Treasury (including ... members of President Barack Obama’s economic team) pushed capital- and financial-market liberalization, which resulted in the rapid contagion of America’s problems around the world. ...[M]any participants were simply relieved that America did not put up obstacles..., as would have been the case if George W. Bush were still president. ...

The most sensitive issue touched upon by the UN conference – too sensitive to be discussed at the G-20 – was reform of the global reserve system. ... On the last day of the conference, as America was expressing its reservations about even discussing ... this issue..., China was once again reiterating that the time had come to begin working on a global reserve currency. Since a country’s currency can be a reserve currency only if others are willing to accept it as such, time may be running out for the dollar.

Emblematic of the difference between the UN and the G-20 conferences was the discussion of bank secrecy: whereas the G-20 focused on tax evasion, the UN Conference addressed corruption, too, which some experts contend gives rise to outflows from some of the poorest countries that are greater than the foreign assistance they receive.

The US and other advanced industrial countries pushed globalization. But this crisis has shown that they have not managed globalization as well as they should have. If globalization is to work for everyone, decisions about how to manage it must be made in a democratic and inclusive manner... The UN, notwithstanding all of its flaws, is the one inclusive international institution. This UN conference ... demonstrated the key role that the UN must play in any global discussion about reforming the global financial and economic system.

Update: Just noticed something else from Stiglitz, along with Linda J. Bilmes, on the economic lessons of the Iraq war:

The U.S. in Iraq: An economics lesson, by Linda J. Bilmes and Joseph Stiglitz, Commentary, LA Times: Tuesday, the U.S. "stood down" in Iraq, finalizing the pullout of 140,000 troops from Iraqi cities and towns -- the first step on the long path home. ...

But not so fast. The conflict that began in 2003 is far from over..., and the next chapter -- confronting a Taliban that reasserted itself in Afghanistan while the U.S. was sidetracked in Iraq -- will be expensive and bloody. ...

Meanwhile, in Iraq,... U.S. officials have said we are likely to station 50,000 troops at military bases in the country for the foreseeable future. This is because the ... country ranks high on lists of the most dangerous places on Earth, with a continual stream of suicide bombings and murders...

Moreover, the U.S. has barely begun to face the enormous financial bill for the war.

"The Revival of the Big Markets vs. State Planning Debate"

The possibility of an outbreak of protectionism has been raised frequently as a potential byproduct of the recession, but that may not be the biggest concern with regard to developing countries. When Stiglitz and Easterly agree, that's noteworthy:

Joe Stiglitz preaches markets to poor countries!, by William Easterly: Stiglitz in the current issue of Vanity Fair is afraid how poor countries will respond to the global crisis and the record of American hypocrisy on economic policy (like what America prescribed for itself in 2008-2009 vs. what it prescribed for Asia during 1997 crisis). All of this will tarnish market economics so much, fears Stiglitz, that poor countries will turn away from markets altogether in favor of some heavy-handed state planning and socialism. Stiglitz, who is not usually considered market economics’ best friend, is right to be scared. ...

One of the reasons to be worried is the precedent from the 1930s Depression – not the usual worry about a huge wave of global protectionism. No, the worry is about the intellectual precedent that the Depression so discredited markets that government planning and intervention became the default model of development economics for the next 30 years – the 1950s through the 1970s.

I’m thrilled to have a heavyweight like Joe Stiglitz to make this case better and more credibly than I could.... The issue now is not subtleties about the right type of financial regulation, global vs. local standards, or calibrating fiscal stimulus. The issue in development now is the revival of the big markets vs. state planning debate. Let’s hope it comes out differently this time than it did for early development economics after the Depression.

Here's a small part of Stiglitz' essay:

Wall Street’s Toxic Message, by Joseph Stiglitz: ...[N]o crisis, especially one of this severity, recedes without leaving a legacy. And among this one’s legacies will be a worldwide battle over ... what kind of economic system is likely to deliver the greatest benefit to the most people. Nowhere is that battle raging more hotly than in the Third World... In much of the world,... the battle between capitalism and socialism—or at least something that many Americans would label as socialism—still rages. While there may be no winners in the current economic crisis, there are losers, and among the big losers is support for American-style capitalism. This has consequences we’ll be living with for a long time to come. ...

I worry that, as [other countries] see more clearly the flaws in America’s economic and social system, many in the developing world will draw the wrong conclusions. A few countries—and maybe America itself—will learn the right lessons. They will realize that what is required for success is a regime where the roles of market and government are in balance, and where a strong state administers effective regulations. They will realize that the power of special interests must be curbed.

But, for many other countries, the consequences will be messier, and profoundly tragic. The former Communist countries generally turned, after the dismal failure of their postwar system, to market capitalism, replacing Karl Marx with Milton Friedman as their god. The new religion has not served them well. Many countries may conclude not simply that unfettered capitalism, American-style, has failed but that the very concept of a market economy ... is ... unworkable under any circumstances. Old-style Communism won’t be back, but a variety of forms of excessive market intervention will return. And these will fail. The poor suffered under market fundamentalism—we had trickle-up economics, not trickle-down economics. But ... these new regimes ... will not deliver growth. Without growth there cannot be sustainable poverty reduction. There has been no successful economy that has not relied heavily on markets. ... The ... governments brought to power on the basis of rage against American-style capitalism ... will lead to more poverty. ...

Faith in democracy is another victim. In the developing world, people look at Washington and see a system of government that allowed Wall Street to write self-serving rules which put at risk the entire global economy—and then, when the day of reckoning came, turned to Wall Street to manage the recovery. They see continued re-distributions of wealth to the top of the pyramid, transparently at the expense of ordinary citizens. They see, in short, a fundamental problem of political accountability in the American system of democracy. After they have seen all this, it is but a short step to conclude that something is fatally wrong, and inevitably so, with democracy itself. ...

Francis Fukuyama ... was wrong to think that the forces of liberal democracy and the market economy would inevitably triumph, and that there could be no turning back. But he was not wrong to believe that democracy and market forces are essential to a just and prosperous world. The economic crisis, created largely by America’s behavior, has done more damage to these fundamental values than any totalitarian regime ever could have. ...

"The Army's Development Delusions"

Bill Easterly is worried that the Army's "utopian dreams" for conquered societies will lead to the "excessive use of military force, which kills real human beings":

J’accuse: the US Army’s Development Delusions, by Bill Easterly: A wise economist that I met recently tipped me off that I would find the latest Army field manual interesting reading. He was more than right about that. The 2009 US ARMY STABILITY OPERATIONS FIELD MANUAL (available in a University of Michigan paperback as well as an earlier version online ) is remarkably full of utopian dreams of transforming other societies into oases of prosperity, peace, and democracy through the coordinated use of military force, foreign aid, and expert knowledge.

My usual MO is to ridicule such documents. But my wells of satire are starting to run dry after years of deployment against utopians like Jeffrey Sachs and Paul Collier. More in sorrow than in anger, I see the utopian social engineering craze might affect actions of people with guns. I am sad for Iraqis and Afghans that the U.S. Army is operating in their countries guided by such misguided ideas.

To document a little of what seems utopian, the foreword by Lieutentant General William B. Caldwell IV, Commander, US Army Combined Arms Center, says:

Mud Wrestling Score Sheet

Is this the end of the mud wrestling (for now)?:

How to Reach Closure after Bloodstained-Car Wreck-Level Trauma of Debating Sachs?, Aid Watch: In an attempt to wrap up the endless back and forth on the Huffington Post (my latest post went up today), here is a cheat sheet of how the debate proceeded. Since this was produced by one of the debate participants, it might be a trifle one-sided:

"Moyo's Confused Attack on Aid for Africa"

More "Mud-Wrestling on African Aid":

Moyo's confused attack on aid for Africa, by Jeffrey Sachs, voxeu.org: Ms. Dambisa Moyo's recent Huffington Post article exposes the confusions that underlie her slashing attacks on aid. Most importantly, she seems to believe that sub-Saharan Africa was economically prosperous and then was pushed into poverty by aid. She makes the following statement: "No surprise, then, that Africa is on the whole worse off today than it was 40 years ago. For example in the 1970's less than 10% of Africa's population lived in dire poverty -- today over 70% of sub-Saharan Africa lives on less than US$2 a day."

Let's parse that statement for a moment. World Bank researchers Shaohua Chen and Martin Ravallion (2007) prepare the benchmark under-$2-a-day historical headcount data going back to 1981. According to their figures, headcount poverty under $2 a day was 74% of the population in sub-Saharan Africa in 1981 and 73% in 2005. Other prominent estimates that go back to 1950 or 1970 also contradict Moyo's statement, by showing high and persistent poverty. All of the macroeconomic time series by Maddison (1995), Summers and Heston (1988), and others tell the same story; the majority of Africa's population started out impoverished at the time of national independence in the 1960s and 1970s, and a majority remains impoverished till today.

"Mud-Wrestling on African Aid"

Jeff Sachs:

Aid Ironies: The debate about foreign aid has become farcical. The big opponents of aid today are Dambisa Moyo, an African-born economist who reportedly received scholarships so that she could go to Harvard and Oxford but sees nothing wrong with denying $10 in aid to an African child for an anti-malaria bed net. Her colleague in opposing aid, Bill Easterly, received large-scale government support from the National Science Foundation for his own graduate training. I certainly don't begrudge any of them the help that they got. Far from it. I believe in this kind of help. And I'd find Moyo's views cruel and mistaken even she did not get the scholarships that have been reported...

Bill Easterly responds:

Sachs Ironies: Why Critics are Better for Foreign Aid than Apologists: Official foreign aid agencies delivering aid to Africa are used to operating with nobody holding them accountable for aid dollars actually reaching poor people. Now that establishment is running scared with the emergence of independent African voices critical of aid, such as that of Dambisa Moyo. Jeffrey Sachs, the world's leading apologist and fund-raiser for the aid establishment, has responded here with a ferocious personal attack on Moyo and myself, "Aid Ironies." Allow me to defend myself (I'll let the formidable Moyo handle herself). It's not so much my pathetic need to correct slanders, as if anybody cared. Sachs' desperation shows when he peddles what I will show he knew were falsehoods. Besides, the sight of two middle-aged white men mud-wrestling on African aid may entertain the audience. ...

Dambisa Moyo:

Aid Ironies: A Response to Jeffrey Sachs: Ahead of the publication of my book Dead Aid, an author friend of mine cautioned me about responding to opponents who found it necessary to color their criticism with personal attacks. This, he argued, is a tried and tested way of side-stepping the issues and providing a smoke screen when faced with a valid argument. Jeffrey Sachs's latest posting is just the latest example of using this tactic to obfuscate the facts and avoid addressing the fundamental issues regarding aid's manifest failure to deliver on its promise of generating growth and alleviating poverty in Africa. And though I am responding here in order to refute his arguments, as a fellow economist, I intend to rely on logic and evidence to make my argument and show Mr. Sachs the professional courtesy that he has failed to show to me. ...

And, again from Bill Easterly:

Am I attacking Sachs too much?: ...Let me respond to those concerned about the tone and divisiveness of this debate (and a little bit about my levity). ...

First, in the intellectual world as in the legal one, the accused has a right to face his accusers and mount a proper defense.

Second, the purpose of debate is to facilitate the emergence of the best ideas and to shoot down the worst ideas. I'm not always so cocksure I am right, but it is clear to me intellectually that Sachs' ideas are wrong, and I will combat them accordingly. An artificial consensus that stops the process of shooting down bad ideas is not a healthy intellectual practice. Sachs himself seems to keep trying to shut down the debate. ...

Finally, about my occasional levity. I believe in the maxim I heard long ago: "Take your work seriously and yourself lightly." The levity is because I don't take myself too seriously (if I ever do, please let me know). I take the work very seriously indeed. ...

"How to Help the Poor Have More Money?"

Are there reasons to oppose this general approach to emergency aid beyond those noted below?:

How to help the poor have more money? Well, you could give it to them, by Laura Freschi: In 2007, people in the Western Province of Zambia lost their homes, their livestock and their crops when heavier-than-normal flash floods swept through their area. USAID’s office of disaster assistance stepped in with $280,000 worth of with seeds and fertilizer, training for farmers, and emergency relief supplies.

Two NGOs working in Zambia, Oxfam GB and Concern Worldwide, tried a different approach: they handed out envelopes stuffed with cash—from $25 to $50 per month per affected family, with no strings attached. An evaluation found that common fears about cash transfers—that the cash infusion will cause inflation in the market, that the money will be squandered, or that men will take control of the money—were unrealized.

What did people buy with the money? The list includes maize, beans, salt, cooking oil, meat, vegetables, clothes and blankets, paraffin, transport, soap and body lotion, and lots of other mundane household items. They also loaned it to friends, used it to pay back debts, purchased health care, education and transport, and rebuilt their homes. Only a very small fraction of the money (less than .5%) was spent on “unproductive” items, like liquor for the men.

De-globalization and Development

Dani Rodrik says growth in international trade is likely to slow down, but that doesn't have to "spell doom for developing countries":

A De-Globalized World?, by Dani Rodrik, Project Syndicate: It may take a few months or a couple of years, but one way or another the United States and other advanced economies will eventually recover from today's crisis. The world economy, however, is unlikely to look the same.

Even with the worst of the crisis over, we are likely to find ourselves in a somewhat de-globalized world, one in which international trade grows at a slower pace, there is less external finance, and rich countries' appetite for running large current-account deficits is significantly diminished. Will this spell doom for developing countries? Not necessarily. ...

[I]t is no surprise that the countries that have produced steady, long-term growth during the last six decades are those that relied on ... promoting diversification into manufactured and other "modern" goods. By capturing a growing share of world markets for manufactures and other non-primary products, these countries increased their domestic employment opportunities in high-productivity activities. ...

China exemplified this approach. Its growth was fueled by an extraordinarily rapid structural transformation toward an increasingly sophisticated set of industrial goods. In recent years, China also got hooked on a large trade surplus vis-a-vis the U.S. ― the counterpart of its undervalued currency. But it wasn't just China. ...

It is now part of conventional wisdom that large external balances ― typified by the bilateral U.S.-China trade relationship ― played a major contributing role in the great crash. Global macroeconomic stability requires that we avoid such large current-account imbalances in the future.

But a return to high growth in developing countries requires that they resume their push into tradable goods and services. In the past, this push was accommodated by the willingness of the U.S. and a few other developed nations to run large trade deficits. This is no longer a feasible strategy for large or middle-income developing countries.

So, are the requirements of global macroeconomic stability and of growth for developing countries at odds with each other? ... There is in fact no inherent conflict, once we understand that what matters for growth in developing countries is not the size of their trade surpluses, nor even the volume of their exports. What matters is their output of modern industrial goods (and services), which can expand without limit as long as domestic demand expands simultaneously.

Maintaining an undervalued currency has the upside that it subsidizes the production of such goods; but it also has the downside that it taxes domestic consumption ― which is why it generates a trade surplus. By encouraging industrial production directly, it is possible to have the upside without the downside.

There are many ways that this can be done, including reducing the cost of domestic inputs and services through targeted investments in infrastructure. Explicit industrial policies can be an even more potent instrument.

The key point is that developing countries that are concerned about the competitiveness of their modern sectors can afford to allow their currencies to appreciate (in real terms) as long as they have access to alternative policies that promote industrial activities more directly.

So the good news is that developing countries ... growth potential need not be severely affected as long as ... developing countries ... substitute real industrial policies for those that operate through the exchange rate. ...

"Rats Outperform Humans in Interpreting Data"

Bill Easterly sent me a link to the post The Vortex of Vacuousness that I posted the other day, but I like this one better:

Maybe we should put rats in charge of foreign aid research, by William Easterly: Laboratory experiments show that rats outperform humans in interpreting data... The amazing finding on rats is described in an equally amazing book by Leonard Mlodinow. The experiment consists of drawing green and red balls at random, with the probabilities rigged so that greens occur 75 percent of the time. The subject is asked to watch for a while and then predict whether the next ball will be green or red. The rats followed the optimal strategy of always predicting green (I am a little unclear how the rats communicated, but never mind). But the human subjects did not always predict green, they usually want to do better and predict when red will come up too, engaging in reasoning like “after three straight greens, we are due for a red.” As Mlodinow says, “humans usually try to guess the pattern, and in the process we allow ourselves to be outperformed by a rat.”

Unfortunately, spurious patterns show up in some important real world settings, like research on the effect of foreign aid on growth. Without going into any unnecessary technical detail, research looks for an association between economic growth and some measure of foreign aid, controlling for other likely determinants of economic growth. Of course, since there is some random variation in both growth and aid, there is always the possibility that an association appears by pure chance. The usual statistical procedures are designed to keep this possibility small. The convention is that we believe a result if there is only a 1 in 20 chance that the result arose at random. So if a researcher does a study that finds a positive effect of aid on growth and it passes this “1 in 20” test (referred to as a “statistically significant” result), we are fine, right?

Alas, not so fast. A researcher is very eager to find a result, and such eagerness usually involves running many statistical exercises (known as “regressions”). But the 1 in 20 safeguard only applies if you only did ONE regression. What if you did 20 regressions? Even if there is no relationship between growth and aid whatsoever, on average you will get one “significant result” out of 20 by design. Suppose you only report the one significant result and don’t mention the other 19 unsuccessful attempts. You can do twenty different regressions by varying the definition of aid, the time periods, and the control variables. In aid research, the aid variable has been tried, among other ways, as aid per capita, logarithm of aid per capita, aid/GDP, logarithm of aid/GDP, aid/GDP squared, [log(aid/GDP) - aid loan repayments], aid/GDP*[average of indexes of budget deficit/GDP, inflation, and free trade], aid/GDP squared *[average of indexes of budget deficit/GDP, inflation, and free trade], aid/GDP*[ quality of institutions], etc. Time periods have varied from averages over 24 years to 12 years to to 8 years to 4 years. The list of possible control variables is endless. One of the most exotic I ever saw was: the probability that two individuals in a country belonged to different ethnic groups TIMES the number of political assassinations in that country. So it’s not so hard to run many different aid and growth regressions and report only the one that is “significant.”

This practice is known as “data mining.” It is NOT acceptable practice, but this is very hard to enforce since nobody is watching when a researcher runs multiple regressions. It is seldom intentional dishonesty by the researcher. Because of our non-rat-like propensity to see patterns everywhere, it is easy for researchers to convince themselves that the failed exercises were just done incorrectly, and that they finally found the “real result” when they get the “significant” one. Even more insidious, the 20 regressions could be spread across 20 different researchers. Each of these obediently does only one pre-specified regression, 19 of whom do not publish a paper since they had no significant results, but the 20th one does publish their spuriously “significant” finding (this is known as “publication bias.”)

But don’t give up on all damned lies and statistics, there ARE ways to catch data mining. A “significant result” that is really spurious will only hold in the original data sample, with the original time periods, with the original specification. If new data becomes available as time passes you can test the result with the new data, where it will vanish if it was spurious “data mining”. You can also try different time periods, or slightly different but equally plausible definitions of aid and the control variables.

So a few years ago, some World Bank research found that “aid works {raises economic growth} in a good policy environment.” This study got published in a premier journal, got huge publicity, and eventually led President George W. Bush (in his only known use of econometric research) to create the Millennium Challenge Corporation, which he set up precisely to direct aid to countries with “good policy environments.”

Unfortunately, this result later turned out to fail the data mining tests. Subsequent published studies found that it failed the “new data” test, the different time periods test, and the slightly different specifications test.

The original result that “aid works in a good policy environment” was a spurious association. Of course, the MCC is still operating, it may be good or bad for other reasons.

Moral of the story: beware of these kinds of statistical “results” that are used to determine aid policy! Unfortunately, the media and policy community don’t really get this, and they take the original studies at face value (not only on aid and growth, but also in stuff on determinants of civil war, fixing failed states, peacekeeping, democracy, etc., etc.) At the very least, make sure the finding is replicated by other researchers and passes the “data mining” tests. ...

I saw Milton Friedman provide an interesting example of avoiding data mining. I was at a SF Fed conference where he was a speaker, and his talk was about a paper he had written 20 years earlier on "The Plucking Model." From a post in January 2006, New Support for Friedman's Plucking Model:

Friedman found evidence for the Plucking Model of aggregate fluctuations in a 1993 paper in Economic Inquiry. One reason I've always liked this paper is that Friedman first wrote it in 1964. He then waited for more than twenty years for new data to arrive and retested his model using only the new data. In macroeconomics, we often encounter a problem in testing theoretical models. We know what the data look like and what facts need to be explained by our models. Is it sensible to build a model to fit the data and then use that data to test it to see if it fits? Of course the model will fit the data, it was built to do so. Friedman avoided this problem since he had no way of knowing if the next twenty years of data would fit the model or not. It did.

The other thing I'll note is that there is a literature on how test statistics are affected by pretesting, but it is ignored for the most part (e.g. if you run a regression, then throw out an insignificant variable, anything you do later must take account of the fact that you could have made a type I or type II error during the pretesting phase). The bottom line is that the test statistics from the final version of the model are almost always non-normal, and the distribution of the test statistics is not generally known.

[One more note. I wrote a paper on Friedman's Plucking Model, and had a revise and resubmit at a pretty good journal. I satisfied all the referee's objections, at least I thought I had, and it was all set to go. I had sent the first version of the paper to Friedman, and he wrote back with a long, multi-page letter that was very encouraging, and I incorporated his suggestions into the revision (a reason I'll always have a soft spot for him, his time was valuable, yet he took the time to do this). But the final results weren't robust, and had come about through trying different specifications until one worked. The final specification worked well, very well in fact, but the results were pretty fragile. As a result, I pulled the paper and did not resubmit it. The paper was completely redone and rewritten, but after thinking it over I decided it wasn't robust enough to publish. I find myself regretting that sometimes, the referees would have probably taken the paper since the final version satisfied all their objections, and it was a good journal - I told myself I had simply done what everyone else does, etc. But, hard as it was for an assistant professor in need of publications to pull a paper, especially one Friedman himself had endorsed - this was just before going up for tenure so it could have mattered a lot - pulling the paper was the right thing to do. The only way to solve this problem - and data mining in economics is a problem - is for the people involved in the research to self-police the integrity of the process.]

Update: Seems like a good time to rerun this graph on publications in political science journals:

Lies, Damn Lies, and....: Via Kieran Healy, ...It is, at first glance, just what it says it is: a study of publication bias, the tendency of academic journals to publish studies that find positive results but not to publish studies that fail to find results. ...

The chart on the right shows G&M's basic result. In statistics jargon, a significant result is anything with a "z-score" higher than 1.96, and if journals accepted articles based solely on the quality of the work, with no regard to z-scores, you'd expect the z-score of studies to resemble a bell curve. But that's not what Gerber and Malhotra found. Above a z-score of 1.96, the results fit the bell curve pretty well, but below a z-score of 1.96 there are far fewer studies than you'd expect. Apparently, studies that fail to show significant results have a hard time getting published.

So far, this is unsurprising. Publication bias is a well-known and widely studied effect, and it would be surprising if G&M hadn't found evidence of it. But take a closer look at the graph. In particular, take a look at the two bars directly adjacent to the magic number of 1.96. That's kind of funny, isn't it? They should be roughly the same height, but they aren't even close. There are a lot of studies that just barely show significant results, and there are hardly any that fall just barely short of significance. There's a pretty obvious conclusion here, and it has nothing to do with publication bias: data is being massaged on wide scale. A lot of researchers who almost find significant results are fiddling with the data to get themselves just over the line into significance. ... Message to political science professors: you are being watched. And if you report results just barely above the significance level, we want to see your work....

"The Vortex of Vacuousness"

Bill Easterly says "you might find this entertaining":

The vortex of vacuousness, by William Easterly: A tragic law of global poverty is that the efforts of many well-meaning and accomplished people somehow get sucked down into meaningless activities and empty rhetoric.

Yesterday’s Wall Street Journal carried an oped by uber-heavyweights Madeline Albright and Colin Powell about how we should not forget about the world’s poor during the crisis. Their solution – another summit! Addressing the previously unappreciated shortage of summits by the UN, the World Bank, the International Monetary Fund, the G-7, the G-20, U2, and Bob Geldof, there is a two day summit starting today of something called the Initiative for Global Development (IGD) National Summit 2009 in Washington DC.

The closest thing to novelty about this summit is that the IGD includes (and was started by) leading business executives, some of whom apparently want to learn from diplomats and aid bureaucrats how to make compassionate statements about global poverty with no content. So Carly Fiorina on the IGD website proclaims “Reducing global poverty is in our nation’s best interest, and a sustained collaboration between the private sector and the government is needed in this regard.” (Presumably she had to be a tad more specific to get things done at HP.)

The IGD has been around since 2003, and includes a lineup of really big names from the worlds of business, government, and aid. Chairpersons Albright and Powell were able to distill all of this experience and talent in their signature Journal oped yesterday into new ideas like “we have to focus our efforts where they can have maximum impact, and draw on the strengths of the public and private sectors alike.”

(Maybe we should subject this statement to the NOT test for meaningful content we discussed in a previous blog post: Briefly consider whether there is anyone arguing “we need to focus our efforts where they can have MINIMUM impact, and draw on the WEAKNESSES of the public and private sectors alike.”)

The IGD helpfully provided Aid Watch some background materials on the 2009 Summit, which has the subtitle “Business leaders advance a bold strategy to reduce global poverty.” They acknowledge the critical need for foreign aid reform, so “Congress and the administration should work together to define a coherent strategy for U.S. foreign assistance and streamline its implementation.” (Reader exercise: apply the NOT test to this statement.) They only get a bit more specific when they endorse the ritual call for a doubling of foreign aid.

Something that sounds slightly more promising is that the IGD summit invited some 20 African CEOs of private businesses. Let’s hope they can get the things that real businessmen want, new deals and investments, in return for being subjected to two days of summiteering. Maybe a few CEOs at IGD are starting to get a glimmer of insight – business leaders should not imitate aid bureaucrats, it should be the other way around.

Leaving aid to the goodwill of corporate America is not going to work. Things are better than they were with the last administration, but we still need more leadership from the new administration on this issue, and the US needs to step up to the plate and quit shirking its obligations in this area. The politics of foreign aid aren't great during a recession, sending money overseas when there is unemployment and other problems at home isn't popular. That's why leadership is important, to explain why it's often in our best interest to help, and to explain that even if it doesn't provide net domestic benefits to the US, it's the right and compassionate thing to do.

"Washington Consensus a Thing of the Past Now"

Is the "Beijing Consensus" on the rise, even within the U.S.?:

‘Washington Consensus’ a thing of the past now, by Jonathan Holslag, Project Syndicate: ...[T]he “Washington Consensus” about how the global economy should be run is now a thing of the past. The question now is what is likely to replace it.

Although China is often said to lack “soft power”, many of its ideas on economics and governance are coming into ascendance. Indeed, in pursuit of national economic stability, the Obama administration is clearly moving towards the kind of government intervention that China has been promoting over the past two decades.

In this model, the government, while continuing to benefit from the international market, retains ... strict control over the financial sector, restrictive government procurement policies, guidance for research and development in the energy sector, and selective curbs on imports of goods and services. All these factors are not only part of China’s economic rescue package, but of Obama’s stimulus plan as well. ...

Rather than obsessing about elections, the US now seeks to build pragmatic alliances to buttress its economic needs. This requires, first of all, cozying up with China and the Gulf states – the main lenders to the US Treasury – as well working with Iran and Russia to limit the costs of the wars in Afghanistan and Iraq.

As the US backtracks on its liberal standards, it is flirting with what can be called the “Beijing Consensus”, which makes economic development a country’s paramount goal and prescribes that states should actively steer growth in a way that suits national stability. What matters in this worldview is not the nature of any country’s political system, but the extent to which it improves its people’s wellbeing. ...

This ... realism is ... a reversal of the neo-conservative muscle-flexing of the George W Bush years. ... For example, in times of crisis it is no shame for a government to be mercantilist, but by behaving in this way, the US has lost the moral high ground as a champion of free trade. ...

As we move from a unipolar international order to one with multiple regional powers,... [t]he result will be a new concert of powers... Instead of entrusting America with the arduous task of safeguarding international stability on its own, the BRICs (Brazil, Russia, India, and China) will assume a more prominent role in policing their own backyards. Russia can have its Caucasus, and if the generals in Myanmar should go mad, it would become China’s and India’s problem to sort out. ...

Whether America is able to strengthen its global influence in the future will depend not so much on its moral esteem, but on the extent to which it succeeds in revamping its economy and forging new alliances. The same will apply for other powers.

But this rising Beijing Consensus offers no guarantee of stability. A concert of powers is only as strong as its weakest pillar, and requires a great deal of self-discipline and restraint. It remains to be seen how the American public will respond to its national U-turn.

If one main player slides back into economic turmoil, nationalism will reduce the scope for pragmatic bargaining. ... And, if China comes out of the crisis as the big winner and continues to boost its power, zero-sum thinking will soon replace win-win co-operation. 

I don't agree with every word of this, but I have to hit the road in a few minutes and will have to leave the response to all of you.

Calvo: We Need a Global Lender of Last Resort

Guillermo Calvo argues that we need to establish a global lender of last resort (see also "Central Authority Necessary" and Brad DeLong's "We Need a Hegemon Who Won't Drive Us Crazy..."):

Lender of last resort: Put it on the agenda!, by Guillermo Calvo, Vox EU: The subprime crisis is a massive failure of the shadow banking system that has affected all corners of the capital market and triggered worldwide deleveraging. We are in a severe credit crunch. Savers distrust private-sector dissavers, which gives rise to a fall in aggregate demand and a search for safe assets (“flight to quality”).

Therefore, the first priority should be to increase credit to the private sector. The trouble is that the process of deleveraging – partly explained by the virtual disappearance of investment banks – induces banks to lower their risk exposure. This is evident in the failure to produce noticeable credit expansion, despite bank recapitalisation and the US Federal Reserve’s absorption of commercial paper. Moreover, the credit crunch depresses asset prices and further discourages credit expansion, launching the economy into a vicious cycle.

Fiscal stimulus packages are second-best. These packages can help restore liquidity in the private sector and consequently increase capacity utilisation and employment. But rapid effects are unlikely, because output is credit-constrained and liquidity accumulation is time-consuming. Thus, solutions should aim directly at restoring credit availability.

Positive Trends in Economic Development

William Easterly:

When Will There Be Good News?, William Easterly: In the midst of the general doom and gloom, fears about how the crisis will affect poor countries, and fierce criticism of markets, states, and aid agencies, perhaps it’s healthy to step back to the big picture, to recognize there has already been some very real good news. The graph below shows some overall statistics for the developing world:

This graph has a mixture of good news that all of the much-criticized triad of markets, states, and aid can take partial credit for. Markets obviously get at least some credit for the reduction in global poverty and increase of global average income. States supply public goods like education, water, and health, and there has been progress on all of these. Aid deserves some credit for successes in health, as already stressed in a previous blog post.

One group that doesn’t deserve much credit is “development experts,” because there is a terrible crisis of confidence in development economics now, where we all freely confess we don’t really know what to advise governments on how to speed up development. ...

Yes, there is a terrible crisis now, not to mention that all of these indicators are still deeply unsatisfactory, so we all keep criticizing and holding accountable the market, state, and aid actors who fall so woefully short. But let none of us forget how much development already happened over the last half-century, which may inspire us with hope that more step-by-step improvements in markets, states, and aid could make even more development possible.

Easterly: I am Not an Ideologue

William Easterly says he is not a market ideologue as he argues against a "knee-jerk rejection of markets":

Why So Scared of “Free Markets”?, by William Easterly: The debate of the last few days on this blog reminded me again of how strong is the visceral negative reaction to an argument for “free markets” (those dreaded words are practically an epithet by now) in development. Part of this may be justified; let’s explore this in a Q and A.

Q. Isn’t the case for markets a purely ideological one, which just serves to protect the interests of the rich?

A. True, it often has been. There is an ideological camp that will twist evidence to support free markets. They overpromise on how soon and how much development "markets" will deliver. They coerce other countries to accept "markets," bypassing the democratic process, which leads to a xenophobic backlash. And some in this camp do just want to defend the rich against ANY policy that hurts the rich even if it is a “free market” policy, so some are hypocritical.

However, beware of the fallacy called “Affirming the consequent.” ... If you are a free market ideologue, Then you will defend free markets. However, it does not follow that If you defend free markets, then you are an ideologue. My posts presented evidence for markets as a development strategy. Feel free to disagree with the evidence, but don’t jump to the “ideologue” conclusion...

A Breakthrough Against Hunger?

Jeff Sachs:

A Breakthrough Against Hunger, by Jeffrey D. Sachs, Project Syndicate: Today's world hunger crisis is unprecedentedly severe and requires urgent measures. Nearly one billion people are trapped in chronic hunger - perhaps 100 million more than two years ago. Spain is taking global leadership in combating hunger by inviting world leaders to Madrid in late January to move beyond words to action. ...

The benefits of some donor help can be remarkable. Peasant farmers in Africa, Haiti, and other impoverished regions currently plant their crops without the benefit of high-yield seed varieties and fertilizers. The result is a grain yield ... that is roughly one-third less than what could be achieved with better farm inputs. African farmers produce roughly one ton of grain per hectare, compared with more than four tons per hectare in China, where farmers use fertilizers heavily.

African farmers know that they need fertilizer; they just can't afford it. With donor help, they can. ... Dozens of low-income, food-deficit countries, perhaps as many as 40-50, have elaborated urgent programs for increased food production by small farms, but are currently held back by the lack of donor funding. ... Hundreds of millions of people, in the meantime, remain trapped in hunger.

Many individual donor countries have declared that they are now prepared to increase their financial support for smallholder agriculture, but are searching for the appropriate mechanisms to do so. The current aid structures are inadequate. The more than 20 bilateral and multilateral donor agencies for agriculture are highly fragmented and of insufficient scale individually and collectively. ...

My colleagues and I, serving on an advisory committee for the Spanish initiative, have recommended that donors pool their funds into a single international account, which we call the Financial Coordination Mechanism (FCM). These pooled funds would enable farmers in poor countries to obtain the fertilizer, improved seed varieties, and small-scale irrigation equipment that they urgently need.

Poor countries would receive prompt and predictable financing for agricultural inputs from a single account, rather than from dozens of distinct and fragmented donors. By pooling financial resources into a single-donor FCM, aid programs' administrative costs could be kept low, the availability of aid flows could be assured, and poor countries would not have to negotiate 25 times in order to receive help.

The time for business as usual is over. The donors promised to double aid to Africa by 2010, but are still far off track. Indeed, during the past 20 years, they actually cut aid for agriculture programs, and only now are reversing course.

Meanwhile, a billion people go hungry each day. ... History can be made in Madrid at the end of January... The lives of the billion poorest people depend on it.

Perhaps, with a new administration, we'll see more emphasis and leadership on these issues. That would be a welcome change.

Does Peacekeeping Cause Peace?

William Easterly says:

I confess that I am still moved as much as anyone else by the compassionate case for saving civilians from horrific violence. But we have to ask the tough questions: Even if the war proceeds from humanitarian motives, does it actually have humanitarian consequences?

This question arises in Easterly's review of Paul Collier's book The Bottom Billion:

Clash of the titans, by Chris Blattman: Bill Easterly takes on Paul Collier's Bottom Billion today in the NY Review of Books.

These may sound like arcane statistical debates when you are trying to decide whether to save a poor country. But if you are going to recommend military intervention based on social science research—in short, if you are going to read Collier's book and draw conclusions from it—then you have to face up to the technical fallacies that may lurk behind research findings.

Alas, we have now seen two common fallacies appearing in the book, "correlation equals causation" (which spuriously concluded that UN peacekeeping forces cause peace) and "selection bias" (which made it appear that the Bottom Billion were trapped in low income and low growth, when no such conclusion is established by historical evidence).

The (gated) review is here, but with luck a version will pop up soon on Bill's webpage. [note: and it has]...

Bill ... takes aim at the melding of foreign aid and military intervention over the past decade.

One should never say never—there may be cases where foreign forces can rescue innocents from horrors. But as generalized doctrine, as Alex de Waal says eloquently, "philanthropic imperialism is imperial nonetheless." In the end, one cannot hide all the political and ethical complexities of foreign military intervention behind a neutral façade of Collier-type statistical analysis. The hubris of the military imperialists was bad enough without adding to it the hubris of the aid imperialists.

...I'm worried that Bill's advice will be taken too literally and simplistically by those who would advocate a divorce of the humanitarian and the military. ... In short,... let's not take Collier as the definitive word on foreign aid and military intervention.

Look instead to scholars like Page Fortna and her new book, Does Peacekeeping Work?. Page's work is among the best I have read on post-conflict stabilization. She moves from cross-country statistical analysis to deep and insightful analysis of specific missions: Sierra Leone, Mozambique, and Bangladesh. International intervention dramatically reduces the risk that war resumes, she argues, because of the change in incentives, perceptions and institutions it engenders. Surely peacekeeping is no panacea, but it certainly helps to learn when and why it works.

Is a Currency Crisis Next?

Paul Krugman says there are "clear signs of currency crises throughout the world of emerging markets":

The mother of all currency crises, by Paul Krugman: ...I’ve been reading reports from Stephen Jen, a former student of mine who’s now the chief currency strategist at Morgan Stanley. He points out that since the fall of Lehman, we’ve been seeing clear signs of currency crises throughout the world of emerging markets, including Eastern Europe. This time, it’s not an Asian crisis or a Latin American crisis, it’s a global crisis. ...

Dani Rodrik calls for the IMF to take immediate action to avoid "the mother of all currency crises," and the potential for a "vicious cycle of unemployment and protectionism":

Urgent need for IMF action, by Dani Rodrik: Paul Krugman frets that we are about to witness the mother of all currency crises in emerging markets, and I am afraid that he is right. As I wrote in my previous post, the financial crisis in the developing world has just started and there are indications that it will get a lot, a lot worse.  What is different with this phase of the crisis is that it cannot be addressed by governments in the affected countries issuing their own fiscal guarantees and domestic currency. These countries need external lines of credit, and they need it fast before the scale of the problem becomes truly unmanageable.   

The solution is clear. The IMF, possibly along with central banks of the G7, has to act as a global lender of last resort to emerging markets. These countries have to have ample access to liquidity in reserve currencies--quickly and with few strings attached--for them to be able to fend off what may otherwise become a historic rout of their currencies.  And China should join in: it should make a portion of its near-$2 trillion of reserves available in support of this global enlargement of credit lines.

Emerging markets have every right to say that they are being swept under by a crisis that is not their own doing. But the real reason the rest of the world needs to move on this front is naked self-interest. Combine a deep recession in the advanced countries with an uncontrolled depreciation of emerging-market currencies, and the pressure to erect trade barriers in the U.S. and Europe will be impossible to withstand.  A vicious cycle of unemployment and protectionism feeding on each other a la 1930s could transform the deep recession everyone is already expecting into a second great depression. It can get worse...

I have a feeling that this will be the make-it-or-break-it week for emerging markets. I hope the IMF will make an announcement in time to make a difference.

Update: See also Currency crisis is gathering storm from Edward Harrison at Credit Writedowns. Also, "Waiting for G7 Currency Intervention: It Won’t Be Long by Simon Johnson.

"Free Trade with a Human Face"

Because I know how much you like talking about immigration and free trade:

Free trade with a human face, by Jorge G. Castañeda, Project Syndicate: ...For many Latin American nations, not just Mexico, immigration is the single most important issue in their relations with the US. The Caribbean islands all have a similarly high proportion of their citizens residing in the US and depend as much as Mexico on remittances. The same is true for much of Central America. And no part of South America is exempt from this pattern.

So almost all of Latin America is deeply affected by the current immigration climate in the US, and would benefit greatly from the type of comprehensive immigration reform that both John McCain and Barack Obama have supported. The Bush administration’s regrettable decision to build fences along the US-Mexico border, raid workplaces and housing sites, detain and deport foreigners without papers, is viewed in Latin America as being hypocritical and offensive. The issue is all the more painful and disappointing since most Latin American foreign ministries know full well that these attitudes are pure politics, nothing more. ...

If immigration is to become a less heated issue, the US must address the needs of Latin America’s economies. Here, one of the key challenges facing the next US administration lies in the existing and pending free-trade agreements between the US and Latin America. ...

If recession drags on and Americans continue to blame trade agreements – erroneously – for growing unemployment, falling wages, and yawning inequality, opposition to these deals will grow. Instead of waiting for the pressure to mount, the next president would do well to preempt it with an ambitious agenda on free-trade reform that would benefit everyone. ...

First, clear and explicit human rights and democracy clauses should be included, along the lines of similar clauses in the Mexican and Chilean Economic Association treaties with the EU. Second, more specific provisions on labor, the environment, gender equality, and indigenous rights are needed, as well as anti-trust, regulatory, and judicial reform provisions, for reasons both of principle and political expediency.

Although there have been enormous improvements in most of these areas, there remains a huge agenda, particularly with regard to breaking up or regulating monopolies – public, private, commercial, trade union-based – that plague nearly every country in the region.

These revised agreements should include bold, enlightened provisions for infrastructure and “social-cohesion” funds, since these can make the difference between muddling through and true success. Free-trade advocates should not view Obama’s demand that these deals be revisited as a mistake, but rather as an opportunity to improve and deepen them; McCain’s supporters should not see the incorporation of all of the aforementioned inclusions as “European nonsense,” but rather as a way to narrow the gap between the agreements’ promise and their actual results.

Improving Mexican and Central American infrastructure, education, and rule of law, or improving Colombian and Peruvian drug-enforcement efforts and respect for labor laws and human rights, are all in America’s interest, and-free trade agreements can help rather than harm such efforts.

If the US and Latin America can face up to the challenges of trade and immigration together, the next US president may leave a weightier mark on the hemispheric relationship than any American leader in three generations.

"A Chance to Crack Down on Africa's Loot-Seeking Elites"

Paul Collier says the financial crisis presents a chance to stop looting in Africa:

A chance to crack down on Africa's loot-seeking elites, by Paul Collier, Comment is Free: ...A criminal can safely be put in charge of a fish-and-chip shop but not of a bank. The former has virtually no assets: if the criminal runs off with the day's fish he cannot retire to Bermuda. But a criminal banker can make a fortune if only he can loot the money that the bank has borrowed: the returns from criminality dwarf running the bank well.

In an ideal world the criminals would run fish-and-chip shops, where they could do no harm, and the honest would run the banks. But the market will allocate people in precisely the opposite way: the criminals will move heaven and earth to get into the banks... That is why vigilant public scrutiny is essential to prevent looting.

Vigilant public scrutiny is, of course, precisely what we have not had. In its absence the business model of our financial sector, while not literally criminal, has been to tap our wealth in its custody by shifting it into opaque assets for high fees. Manifestly, wealth-owners did not adequately understand what was going on. We had been lulled into misplaced trust by decades of regulation-enforced decent behaviour.

The regulation which had worked well enough was dismantled because of the recent mantra that finance is the engine of growth as long as it is given free rein. Hence Gordon Brown's emasculation of financial regulation in the UK and Alan Greenspan's era of neglect in the US. This mantra radically exaggerates the upside potential of finance. At best, the contribution of the financial sector to the growth of an economy is second order: it facilitates the creativity of other sectors. Only at its worst is finance first order: as we are now seeing, it can be catastrophic. ...

At last, we have a chance for change. Because the banks do well out of secrecy, to date they have successfully opposed proper scrutiny. ... But now that we have the banks on the run there is an opportunity to extend scrutiny, not only to help ourselves, but to help Africa.

The loot-seeking elites that control parts of Africa illicitly send capital out of the region to the tune of $20 to $28bn per year. ... Capital flight of this magnitude is roughly equivalent to the entire aid inflow to the region...

Money flows out of Africa into our banks, and into the offshore banks that depend for their existence upon being able to transact with our banks. US rules on banking transparency are even weaker than the European rules: vast sums looted from the public purse in Africa are being held in nominee accounts and moved around the world at greater speed than our cumbersome legal processes can track them down. ...

The silver lining in this grim cloud is that we have a ... chance to clean up the banks. Which takes me back to where I began. There is one thing that a dirty fish-and-chip shop and a dirty bank have in common: they both stink.

"Is Export Led Growth Passé?"

Dani Rodrik wonders if the era of export-led growth as a path to economic development is coming to an end:

Is Export Led Growth Passé?, by Dani Rodrik, Project Syndicate: For five decades, developing countries that managed to develop competitive export industries have been rewarded with astonishing growth rates: Taiwan and South Korea in the 1960’s, Southeast Asian countries like Malaysia, Thailand, and Singapore in the 1970’s, China in the 1980’s, and eventually India in the 1990’s.

In all these cases, and a few others — also mostly in Asia — domestic reforms would surely have produced growth regardless of international trade. But it is difficult to see how the resulting growth could have been as high ... without a global economy able to absorb these countries’ exports.

Many countries are trying to emulate this growth model... [D]eveloping countries have been falling over each other to establish export zones and subsidize assembly operations of multinational enterprises. The lesson is clear: export-led growth is the way to go.

But for how long? While reading the economic tea leaves is always risky, there are signs that we are at the cusp of a transition to a new regime in which the rules of the game will not be nearly as accommodating for export-led strategies. 

The most immediate threat is the slowdown in the advanced economies. Europe and the United States are both entering recession... All this is happening at a time when inflationary pressures hamper the usual monetary and fiscal remedies. ...

On top of this is the almost certain unwinding of global current-account imbalances. Emerging markets and developing countries ran a surplus of $631 billion in 2007... This amounts to 4.2% of their collective GDP. The US alone ran a current-account deficit of $739 billion (5.3% of its GDP). Neither the economics nor the politics of this pattern of current-account balances is sustainable, especially in a recessionary environment. 

The politics is clear to see. Nothing works as potently to inflame protectionist sentiment as large trade deficits. According to a December 2007 NBC/Wall Street Journal poll, almost 60% of Americans think globalization is bad because it has subjected US firms and workers to unfair competition. If globalization has acquired a lousy reputation in the US, the external deficit deserves much of the blame. ...

As the US and other advanced economies become less hospitable to developing-country exports, rapidly growing emerging markets, help as they may, are unlikely to take up the slack... Import tariffs tend to be higher in developing countries, making it more difficult to gain access to them. Moreover, developing countries compete in similar products ...

So exporting will become an even tougher business. Countries like China that have large surpluses will have to rely much more on domestic demand to fuel their economies. ... But the impact will extend beyond the surplus countries. If exporters from Brazil, Turkey, South Africa, and Mexico – all deficit economies – were already struggling to compete with China..., imagine how they will fare under less hospitable conditions.  ...

None of this implies a disaster for developing countries. Long-term success still depends on what happens at home rather than abroad. What is moderately bad news at the moment will become terrible news only if economic distress in the advanced countries – especially the US – is allowed to morph into xenophobia and all-out protectionism; if large emerging markets such as China, India, and Brazil fail to realize that they have become too important to free ride on global economic governance; and if, as a consequence, others overreact by turning their back on the world economy and pursue autarkic policies. Absent these missteps, expect a tougher ride on the global economy, but not a calamity.

Development Authoritarianism

Is the world having an "authoritarian moment"?:

What does this authoritarian moment mean for developing countries?, by Pranab Bardhan, Commentary, Financial Times: As the petro-authoritarianism of Russia flexes its muscles and the economic prowess of China struts in Olympic glory, developing countries ... might start rethinking the lectures on democracy and development they have heard all these years from the West. ...

The Chinese case in particular is reviving a ... myth of how ... development authoritarianism delivers much more than democracy. This is also backed by the memory of impressive economic performance of other East Asian authoritarian regimes (like those in South Korea and Taiwan...). The lingering hope of democrats had been that as the middle classes prosper in these regimes, they then demand, and in the latter two cases got, the movement toward political democracy.

But... Authoritarianism is neither necessary nor sufficient for economic development. That it is not necessary is illustrated ... by scattered cases of recent development success: Costa Rica, Botswana, and now India. That it is not sufficient is amply evident from disastrous authoritarian regimes in Africa and elsewhere. ...

[I]t is worth reiterating the several advantages of democracy from the point of view of development. Democracies are better able to avoid catastrophic mistakes, (such as China’s ... massive mayhem in the ... Cultural Revolution), and have greater healing powers after difficult times. Democracies also experience more intense pressure to share the benefits of development among the people, thus making it sustainable, and provide more scope for popular movements against industrial fallout such as environmental degradation. In addition, they are better able to mitigate social inequalities ... that act as barriers to social and economic mobility and to the full development of individual potential. Finally, democratic open societies provide a better environment for nurturing the development of information and related technologies, a matter of some importance in the current knowledge-driven global economy. ...

All that said,... democracy can also hinder development in a number of ways. Competitive populism– short-run pandering and handouts to win elections– may hurt long-run investment, particularly in physical infrastructure... Finally, democracy’s slow decision-making processes can be costly in a world of fast-changing markets and technology.

The hopes of democrats relying on the middle classes in authoritarian regimes have not always borne fruit. Latin American or South European history has been replete with many episodes of middle classes hailing a supreme caudillo. The police state in China shows no signs of loosening its grip soon... Most people in the Chinese middle class are complicit in this in the name of preserving social stability, as long as opportunities for money-making and wallowing in nationalist pride keep on thriving.

So markets and capitalism will not do their political cleansing job automatically. On the contrary, markets often sharpen inequality, and the resultant structures of political power, buttressed by corporate plutocrats and all-powerful lobbies, may even hijack or corrupt the democratic political process, a phenomenon not unknown in some industrial democracies. Thus both for democracy and development, other social forces and movements for civil and economic rights for the common people have to be pro-active and eternally vigilant.

Industrial policy is, essentially, economic authoritarianism. Is it the industrial policy component of the more general authoritarianism in place in many countries that helps with development? If so, couldn't it work just as well, maybe even better, in a democracy?

(Also see, "Is the Washington Consensus Dead? Growth, Openness, and the Great Liberalization, 1970s-2000s" [open link].)

The Internet, Cell Phones, and Economic Development

Jeff Sachs says that when it comes to ending extreme poverty, cell phones and the internet will prove to be "the most transformative technology of economic development of our time":

Internet and mobile phones spur economic development, by Jeffrey D Sachs, Project Syndicate: The digital divide is beginning to close. The flow of digital information – through mobile phones, text messaging, and the Internet – is now reaching the world’s masses, even in the poorest countries, bringing with it a revolution in economics, politics, and society.

Extreme poverty is almost synonymous with extreme isolation, especially rural isolation. But mobile phones and wireless Internet end isolation, and will therefore prove to be the most transformative technology of economic development of our time. ...

Mobile phone technology is so powerful, and costs so little per unit of data transmission, that it has proved possible to sell mobile phone access to the poor. There are now more than 3.3bn subscribers in the world, roughly one for every two people on the planet. ... Probably a significant majority of Africans have at least emergency access to a cell phone, either their own, a neighbour’s, or one at a commercial kiosk. ...

The rural poor in more and more of the world now have access to wireless ... systems... The information carried on the new networks spans public health, medical care, education, banking, commerce, and entertainment, in addition to communications among family and friends. ...

On the fully commercial side, the mobile revolution is creating a logistics revolution in farm-to-retail marketing. Farmers and food retailers can connect directly through mobile phones and distribution hubs, enabling farmers to sell their crops at higher “farm-gate” prices and without delay, while buyers can move those crops to markets with minimum spoilage and lower prices for final consumers.

The strengthening of the value chain not only raises farmers’ incomes, but also empowers crop diversification and farm upgrading more generally. ...

Education will be similarly transformed. Throughout the world, schools at all levels will go global... Universities, too, will have global classes, with students joining lectures, discussion groups, and research teams from a dozen or more universities at a time. 

In my book The End of Poverty , I wrote that extreme poverty can be ended by the year 2025. A rash predication, perhaps, given global violence, climate change, and threats to food, energy, and water supplies. But digital information technologies, if deployed co-operatively and globally, will be our most important new tools, because they will enable us to join together globally in markets, social networks, and efforts to solve our common problems.

Democratic versus Authoritarian Capitalism

Robert Reich is back from vacation:

The Real Competition Behind the Olympic Games, Robert Reich: The real competition lurking behind the upcoming Olympic games is between democratic capitalism and authoritarian capitalism.

For years American policy toward China assumed that trade and economic growth would generate a large Chinese middle class, and this middle class would demand democratic reforms. We were right on the first part. ... But we were wrong about the democracy part. We thought capitalism and democracy went hand in glove. They don't. Economic reforms are well underway in China. Individual Chinese can own property and invest, trade and buy almost whatever they want. Private enterprise is in, collectives are out. But when it comes to civil and political rights, China today is where it was almost two decades ago at the time of Tiananmen Square.

Authoritarian capitalism works wonders if all you care about is getting ahead economically... Never before in history have so many people gained economic ground so fast as in China over the last two decades. But if you're someone with a grievance, or you want to criticize those in power, or you're a Tibetan or ethnic minority, or you happen to like clean air, you're out of luck.

Democratic capitalism should win in the end because it responds far better to what people want -- not only as consumers but also as citizens. Yet right now the outcome of the competition doesn't seem so clear. The Chinese economy is booming while we're in deep trouble. Eighty percent of Chinese are optimistic about the future but only 20 percent of Americans say this nation is on the right track. And most Americans tell pollsters they don't trust politicians and believe our government is run by big corporations and the rich.

In terms of this large underlying competition, think of our upcoming presidential election is our own Olympic games. It will showcase to the world whether, and how well, democratic capitalism still works.

Will authoritarian capitalism become the next economic development model as other countries try to mimic China's success? If so, is that a good thing? Will democracy, in fact, win in the end?

The Perplexing Paradox of Plenty

I assume you are familiar with the "natural resource curse":

The idea that natural resources might be more an economic curse than a blessing began to emerge in the 1980s. In this light, the term resource curse thesis was first used by Richard Auty in 1993 to describe how countries rich in natural resources were unable to use that wealth to boost their economies and how, counter-intuitively, these countries had lower economic growth than countries without an abundance of natural resources. Numerous studies ... have shown a link between natural resource abundance and poor economic growth. This disconnect between natural resource wealth and economic growth can be seen by looking at an example from the oil-producing countries. From 1965-1998, in the OPEC countries, gross national product per capita growth decreased on average by 1.3%, while in the rest of the developing world, per capita growth was on average 2.2%.

Well, maybe there is no curse:

Debunking the ‘curse of oil’, IU News: A paper co-written by an Indiana University economics professor takes issue with the widespread idea that there is a "natural resource curse" that puts countries with oil or mineral wealth at a disadvantage when it comes to economic growth.

The paper also shows that a common explanation for the curse -- that an abundance of oil or other point-source resources causes countries to have lower-quality civic institutions -- isn't true.

Having such resource wealth "may not improve institutions, but it doesn't make them worse. It doesn't affect them one way or another," said Michael Alexeev, professor of economics at IU Bloomington and co-author of the paper with Duke University economist Robert Conrad.

The paper, titled "The Elusive Curse of Oil," has been accepted for publication in the Review of Economics and Statistics.

In the 1990s and early 2000s, a series of economics publications made the claim that an abundance of point-source resources, such as oil, gas, gold and diamonds, was associated with weak economic performance. The idea came to be widely accepted, and the term "natural resource curse" was coined to describe it. Further research focused on the reason for the curse, and the most convincing answer seemed to be that, for a variety of reasons, nations with an abundance of point-source resources tended to have worse-than-average governments and other institutions.

But Alexeev and Conrad found no correlation between natural resource endowments and the quality of institutions if the calculations are done correctly. Previous analyses that found such a link, they say, were skewed by using per-capita gross domestic product (GDP) as a controlling variable. That approach resulted in comparing countries with high GDP and strong institutions with those that have high GDP purely because of resource wealth: comparing Portugal with Kuwait, for example.

"In essence," Alexeev said, "the logic of the earlier work was as follows: Most countries with high GDP have good institutions. Natural resource-rich countries, however, have high GDP but poor institutions. Therefore, natural resources must lead to poor institutions."

In their analysis, the authors calculated what they believed countries' GDP would be if they didn't have oil. With oil-driven increases in GDP removed from the equation, the presence or absence of oil had no impact on the quality of national institutions.

The authors also made use of "a kind of natural experiment," comparing Russia, Ukraine and Belarus, three geographically similar Slavic countries created by the break-up of the Soviet Union. Russia has extensive deposits of oil, gas and minerals; Belarus has almost none; and Ukraine is in between. If there were a natural resource curse, Russia would be expected to have the worst institutions and Belarus the best. In fact, Russia and Ukraine have similar scores for institutional quality, and Belarus scores much worse.

"The fact that growth based on natural resource wealth does not improve institutions is a drawback of this type of growth," Alexeev said. "But it does not make it a curse."

The paper also disputes the very concept of a natural resource curse... While resource-rich countries may not have experienced strong economic growth in recent years, they write, those countries did grow at a faster rate when their oil or other resources were being developed.

"After all," Alexeev said, "long-term growth is everything until now," not just growth that has taken place since an arbitrary starting point of 1960 or 1970.

Alexeev said it's important to have an accurate understanding of the effect of point-source resource wealth on economic growth and institutional quality. The World Bank and other institutions make decisions about guiding and encouraging the development of point-source resources based in part on whether officials believe there is a natural resource curse, he said.

A preliminary copy of the paper: "The Elusive Curse of Oil".

This research says that resource wealth doesn't make institutions any worse, but it doesn't make them any better either. That leads me to wonder if the discovery of resource wealth solidifies the institutions that are already in place, institutions that are, due to the low initial level of wealth, generally of poor quality. Does resource wealth create the means for those in power to freeze the institutional structure that gives them control over the wealth? If so, then in that sense, resource wealth could still be a curse.

A Political Economy Perspective on the Failure of the Washington Consensus

Why did the Washington Consensus reforms fail to improve economic performance in many developing countries?:

When does policy reform work? The case of central bank independence, by Daron Acemoglu, Simon Johnson, Pablo Querubín, and James A Robinson, Vox EU: Institutional and policy reforms are promoted as a way to improve economic performance and growth in poor countries. Reforms that have received substantial attention over the past decade or so are often referred to as the "Washington consensus". These include trade opening, financial liberalisation, judicial reform, privatisation, reduction of entry barriers, tax reform, removal of targeted industrial subsidies and central bank independence. Although there are sound economic theories suggesting why these reforms might be important in improving economic performance, the experience of many developing nations that have embraced these reforms over the last two decades shows that the gains anticipated by the proponents of reform have often not materialized.

Why do seemingly sensible reforms fail to generate the benefits that they promise?

Although one can undoubtedly dream up reasons why sensible reforms will lead to bad economic outcomes because of "second best" reasons, it is fairly implausible that the removal of the very high entry barriers and the corruption-ridden targeted industrial subsidies or putting an end to hyperinflation will be counterproductive. So why has the result of the Washington consensus reforms been so dismal?

A New Washington Consensus?

Dani Rodrik seems pleased with the emerging consensus on the "do's and don'ts for policymakers in developing countries":

Is there a new Washington consensus?, by Dani Rodrik, Project Syndicate: ...Two and a half years ago,... the World Bank approached the Nobel laureate Michael Spence to ask him to lead a high-powered commission on economic growth. The question at hand could not have been more important. The "Washington consensus" — the infamous list of do's and don'ts for policymakers in developing countries — had largely dissipated. But what would replace it? ...

Thus was born the Spence Commission on Growth and Development, a star-studded group of policymakers ... whose final report was issued at the end of May.

The Spence report represents a watershed for development policy... Gone are confident assertions about the virtues of liberalisation, deregulation, privatisation, and free markets. Also gone are the cookie cutter policy recommendations unaffected by contextual differences. Instead, the Spence report ... recognises the limits of what we know, emphasises pragmatism and gradualism, and encourages governments to be experimental. ...

The Spence report reflects a broader intellectual shift within the development profession, a shift that encompasses not just growth strategies but also health, education, and other social policies. ...

[T]he new policy mindset starts with relative agnosticism about what works. Its hypothesis is that there is a great deal of "slack" in poor countries, so simple changes can make a big difference. As a result, it is explicitly diagnostic and focuses on the most significant economic bottlenecks and constraints. Rather than comprehensive reform, it emphasises policy experimentation and relatively narrowly targeted initiatives in order to discover local solutions, and it calls for monitoring and evaluation in order to learn which experiments work. ... This approach is greatly influenced by China's experimental gradualism since 1978 — the most spectacular episode of economic growth and poverty reduction the world has ever seen.

The Spence report ... has no "big ideas" of its own, and at times it tries too hard to please everyone and cover all possible angles. But... It is quite a feat to have achieved the degree of consensus he has around a set of ideas that departs in places so markedly from the traditional approach.

It is to Spence's credit that the report manages to avoid both market fundamentalism and institutional fundamentalism. Rather than offering facile answers such as "just let markets work" or "just get governance right," it rightly emphasises that each country must devise its own mix of remedies. Foreign economists and aid agencies can supply some of the ingredients, but only the country itself can provide the recipe.

If there is a new Washington consensus, it is that the rulebook must be written at home, not in Washington. And that is real progress.

"This Global Show Must Go On"

Tyler Cowen on globalization:

This Global Show Must Go On, by Tyler Cowen, Economic View, NY Times: The last 20 years have brought the world more trade, more globalization and more economic growth than in any previous such period in history. ... More than 400 million Chinese climbed out of poverty between 1990 and 2004... India has become a rapidly growing economy, the middle class in Brazil and Mexico is flourishing, and recent successes of Ghana and Tanzania show that parts of Africa may be turning the corner as well.

Despite these enormous advances, however, there is a backlash against globalization... Ordinary people often question the benefits of international trade, and now many intellectuals are turning more skeptical, too. Yet the facts ... show that the ... doom and gloom simply isn’t warranted. ...

The globalization process has had its bumps, of course, as reflected recently by rising commodity prices... Countries like China have become richer so fast that global production of energy and food have been unable to match the pace. But rapid economic growth is the right direction, even if some of the remaining poor are suffering from high food prices. ...

Trade advocates focus on the benefits of goods arriving from abroad, like luxury shoes from Italy or computer chips from Taiwan. But new ideas are the real prize. By 2010, China will have more Ph.D. scientists and engineers than the United States. These professionals are ... are creators, whose ideas are likely to improve the lives of ordinary Americans, not just the business elites. ...

We urgently need new biotechnologies, a cure for AIDS and a cleaner energy infrastructure, to name just a few. Trade is part of the path toward achieving those ends. A wealthier China and India also mean higher potential rewards for Americans and others... A product or idea that might have been marketed just to the United States and to Europe 20 years ago could be sold to billions more in the future.

Those benefits will take time to arrive, but trade with China has already eased hardships for poorer Americans. A new research paper by Christian Broda and John Romalis ... has shown that cheap imports from China have benefited the American poor disproportionately. In fact, for the poor, discounting in stores such as Wal-Mart has offset much of the rise in measured income inequality from 1994 to 2005.

Despite all these gains, the prevailing intellectual tendency these days is to apologize for free trade. A common claim is that trade liberalization should proceed only if it is accompanied by new policies to retrain displaced workers or otherwise ameliorate the consequences of economic volatility.

Yes, the benefits of a good safety net are well established, but globalization is not the primary source of trouble for most American workers. Health care problems, bad schools for our children or, in recent times, bad banking practices have all produced greater disruptions — and these have been fundamentally domestic failings.

What’s really happening is that many people, whether in the United States or abroad, are unduly suspicious about economic relations with foreigners. These complaints stem from basic human nature — namely, our tendency to divide people into “in groups” and “out groups” and to elevate one and to demonize the other. ...

One approach is to appease these sentiments by backing away from trade just a bit, or by managing it, so as to limit the backlash. Giving up momentum, however, isn’t necessarily the right way forward. ...

It is wrong to play down the costs of globalization, but the reality is that we’ve been playing down its benefits for a long time. Politicians already pander to Americans’ suspicion of foreigners. There is no need for the rest of us to jump on this bandwagon. Instead, we need more awareness of the cosmopolitan benefits of trade and the often hidden — but no less real — gains for ordinary Americans. ...

I agree on the benefits from trade. But I would quarrel with the conclusion concerning the net impact on the welfare of middle and lower income households. Because I believe that the net impact is more negative than Tyler indicates (both from new technology and from globalization, the effects of which are difficult to disentangle), I am more convinced than he is that maintaining political support for increased openness will require that the gains from trade and technological change be shared more equitably, and that economic risk be dispersed across a much broader swathe of the population through risk transfer mechanisms such as enhanced social insurance.

We can, as Tyler is doing, try to convince people they are wrong in their beliefs:

Gallup Daily: Negative Economic Ratings Hold Steady: ...[C]onsumer views of the economy ... rate among the worst Gallup has measured in any polling it has done historically. The latest Gallup Poll Daily tracking update [polling conducted June 4-6] finds 44% of Americans rating current economic conditions as poor and 86% saying the economy is getting worse. The most negative ratings thus far this year are a 47% poor rating and an 88% getting worse score.

But I don't think they are going to be convinced by the Wal-Mart argument. Over the longer run, I share the view that education is a key factor in determining how well we will be able to compete in the world economy, and that we need to do everything we can to maintain open access to quality educational opportunities for middle and lower income households. I agree wholeheartedly that we need to fix health care, and that "bad banking practices" have been a problem. These are structural issues that I hope we can address and fix, but that will take time. However, at present we also need to listen to what people are telling us and address their concerns, and they do not believe that the economy as it is currently functioning is working for them. Telling people they just don't understand how much trade benefits them is just as likely to produce a negative backlash as it is to convince people that their views are wrong.

Update: See the follow-up discussion in response to comments from Brad Delong, and there is more from Tyler Cowen.

Brad DeLong: Gambler’s Ruin

Should developing countries keep betting on neo-liberal growth policies?:

Gambler’s Ruin, by J. Bradford DeLong, Project Syndicate: From Adam Smith (1776) until 1950 or so, capital was considered by economists to be absolutely essential for economic growth. You also needed a few good basic institutions. “Security of property and tolerable administration of justice,” as Smith put it. ...

For Smith and his successors over the first 175 years, any episode of sustained economic growth overwhelmingly required investment capital. We economists were by and large capital boosters, and our magic formula for economic development was saving, investment, thrift, and wealth accumulation. ...

Then Robert Solow and Moses Abramovitz challenged this near-consensus. They calculated that 75% to 80% of economic growth did not come from increasing the capital-output ratio... Instead, the keys to growth and development appeared to ...[be]: skills, education, technology broadly understood, and improvements in organizational management.

Yet capital continued to be seen as necessary, if not sufficient. In the framework developed by ... Dani Rodrik, a shortage of capital can be a binding “growth constraint”: the place where “the biggest bang for the [policy] reform buck can be obtained.” ...

The problem is that for poor economies, raising the capital needed to relax binding growth constraints is difficult. That’s why the world took the neo-liberal bet in the 1990’s: international capital mobility would come to the rescue by relaxing capital constraints where they were binding, and by reducing the scope for corruption and rent-seeking, which was often a more significant binding growth constraint.

The hope was that, like the pre-1913 era of British overseas investment, ... net capital outflows from the industrial core would finance much late twentieth and twenty-first century industrialization.

But we all know the outcome: ... the large net flow of capital from rich to poor countries simply never materialized. In fact, the principal outcome was an enormous flow of capital from the periphery to the rich core. ...

The reason is not that the periphery offers an attractive labor force from which capital profits, but rather that the core – especially the United States – offers a form of protection for capital against unanticipated political disturbances.

But even though net international capital flows are going the wrong way, there are still substantial gross capital flows outward from the world economy’s core to its periphery. And we can hope that these capital flows will carry with them the institutions and managerial expertise that have made the core so wealthy.

Nevertheless, a dispassionate observer might point out that for someone with limited resources and opportunities for policy reform to keep betting double-or-nothing on neo-liberalism is a strategy that has a well-deserved name: “Gambler’s Ruin.”

Aid to Poor Countries: "Cruel Joke" Week

Is the opening paragraph serious?:

Bread and Bush-bashing, by Chris Patten, Project Syndicate: I feel a little sorry for President Bush. Whatever his other many failings, he has a pretty good record on aid to poor countries, particularly in healthcare. True to form, he recently announced a big increase in US food aid -- good for the hungry poor and good for American farmers. ...

What made me feel a little sorry for Bush was the reaction to his announcement. Bush referred to the reasons for shortages and price hikes. He did not dwell on the diversion of American corn from food to heavily subsidized bio-fuels. Nor did climate change feature prominently in his argument, although many experts suggest that this may be the cause of the droughts and floods that have ruined wheat harvests in Australia and vegetable oil production in Indonesia and Malaysia.

Bush pointed his finger primarily elsewhere. Food prices had responded to growing demand. In Asia, economic growth had stimulated food consumption. The Chinese and Indians were eating more and eating better. ...

What Bush said is of course true. ...

But many Indians are still wretchedly poor. Too many. They have a miserable diet -- not least when compared with Bush’s Texan neighbors. Grain consumption per head in India has remained static, and is less than one-fifth the figure for the US, where it has been rising. I do not imagine you will find too many vegetarians in Crawford, Texas, and the meat consumed by the average American is way ahead of the figure for any other country. Think of all those T-bone steaks.

Bush’s partial explanation of the world food crisis, accurate as far as it went, brought the anger of India’s media and of many politicians... According to India’s Defense Minister, A.K. Anthony, presumably an expert on butter as well as guns, Bush’s statement was “a cruel joke.”...

Later in the “cruel joke” week, Bush’s White House compounded the sin. According to Bush’s press spokesman, the growth in world demand for oil -- in Asia, for example -- was one of the causes of the high price of filling the tanks of gas-guzzling sports utility vehicles ... at America’s pumps.

Meanwhile, the US government papered over the fact that Americans, who make up less than 4 percent of the world’s population, own and drive 250 million of the world’s 520 million cars. More outrage around the world at American double standards.

Now, all this is more than the knock-about of international politics. One day soon, Bush and Cheney will be out of office. But we will still be left with the most difficult global issue we have ever faced: as more of us prosper, how do we deal fairly with some of the economic and environmental consequences?

What do we do about the bottom billion in the world who remain in grinding poverty while the rest of us live better and longer lives? How do we deal with equity on a global scale when we cannot even deal with it country by country?

This conundrum will lie at the heart of the diplomacy next year to find a successor to the Kyoto agreement. Can we prevent a calamitous increase in global warming in a way that is fair,... and that does not thwart legitimate hopes for a better life everywhere? We have never faced a more difficult political task.

Meanwhile, there is a food crisis to solve. We have already seen many examples of how not to deal with it. Stopping food exports is stupid. If we restrict market forces, there will be less food and higher prices. We should also avoid the cheap political trick of holding down what we pay to poor farmers in order to benefit poor city dwellers.

Why do governments do this? The answer is obvious: city dwellers riot; in the countryside, people just starve. The best way to deal with the problem is to subsidize food for the poor; we should not cut the price we pay farmers for growing it. ...

Here's the reason I asked. This is Africa, not India, but I don't suppose the story is any different:

Food Relief For Africa 'Insufficient,' GAO Says, by Anthony Faiola, Washington Post: Efforts by the United States and multilateral agencies including the World Bank to reduce hunger in sub-Saharan Africa have been "insufficient," with foreign aid to the region failing to flow into agricultural development projects vital to the ability of poor countries to feed themselves, according to a report to be released this morning by the U.S. Government Accountability Office. ...

The report, a draft copy of which was obtained by The Washington Post, additionally describes U.S. aid efforts in sub-Saharan Africa as fragmented and misdirected. It says, for instance, that a Bush administration initiative to "end hunger in Africa" launched in 2002 effectively amounted to a repackaging of existing programs and came with no new funding. ...

The report comes on the heels of another released by the GAO last year sharply criticizing U.S. food aid programs. That report called them "inherently inefficient" because they rely on the sale of American-grown food that is costly to transport overseas, as opposed to food purchased closer to the troubled regions themselves. ...

"The Rich Get Hungrier"

Amartya Sen analyzes the food crisis:

The Rich Get Hungrier, by Amartya Sen, Commentary, NY Times: Will the food crisis that is menacing the lives of millions ease up — or grow worse over time? The answer may be both. The recent rise in food prices has largely been caused by temporary problems like drought in Australia, Ukraine and elsewhere. Though the need for huge rescue operations is urgent, the present acute crisis will eventually end. But underlying it is a basic problem that will only intensify unless we recognize it and try to remedy it.

It is a tale of two peoples. In one version of the story, a country with a lot of poor people suddenly experiences fast economic expansion, but only half of the people share in the new prosperity. The favored ones spend a lot of their new income on food, and unless supply expands very quickly, prices shoot up. The rest of the poor now face higher food prices but no greater income, and begin to starve. Tragedies like this happen repeatedly in the world. ...

There is also a high-tech version of the tale of two peoples. Agricultural crops like corn and soybeans can be used for making ethanol for motor fuel. So the stomachs of the hungry must also compete with fuel tanks.

Misdirected government policy plays a part here... In 2005, the United States Congress began to require widespread use of ethanol in motor fuels. ... Ethanol use does little to prevent global warming and environmental deterioration, and clear-headed policy reforms could be urgently carried out, if American politics would permit it. ...

The global food problem is not being caused by a falling trend in world production, or for that matter in food output per person (this is often asserted without much evidence). It is the result of accelerating demand. However, a demand-induced problem also calls for rapid expansion in food production, which can be done through more global cooperation. ...

What is most challenging is to find effective policies to deal with the consequences of extremely asymmetric expansion of the global economy. Domestic economic reforms are badly needed in many slow-growth countries, but there is also a big need for more global cooperation and assistance. The first task is to understand the nature of the problem.

"Solving the Food Crisis"

Nobel Peace Prize winner Muhammad Yunus outlines steps that need to be taken to solve the world's food crisis:

Solving the food crisis, by Muhammad Yunus, Commentary, Comment is Free: The global food crisis is a dire reality for millions of the world's poor and a major test for the international community. ... Rising food prices have created tremendous pressure in the lives of poor people, for whom basic food can consume as much as two-thirds of their income. ...

UN Secretary-General Ban Ki-Moon deserves credit for convening the leaders of 27 UN agencies and programs to organize a coordinated response. They have agreed to establish a high-level task force under Ban's leadership, with sound immediate objectives.

A comprehensive global plan should include the following six elements:

First, the international community must rapidly mobilize at least $755m, identified by the World Food Programme and UN leaders as necessary for emergency food relief. ...

Second, we must ensure that farmers are equipped to produce the next harvest. Farmers in many areas cannot afford seeds to plant or natural gas-based fertilizer, whose price has risen along with the price of oil. The International Fund for Agricultural Development is delivering $200m to poor farmers in the most affected countries... The Food and Agriculture Organization needs an additional $1.7bn to help provide seed and fertilizer. ...

Relative to the size and gravity of the crisis, these sums are very modest and affordable for the international community. In the US alone, high prices have been a boon to farmers and have saved the government billions in crop support payments. The world should respond promptly and generously to help those struggling to survive what the UN calls a "silent tsunami."

Third, beyond these immediate actions, new policies are needed to address the underlying causes of the crisis. Crop subsidies and export controls in many important countries are distorting markets and raising prices; they should be eliminated. In particular, subsidies for ethanol ... cannot be justified...

Fourth, the current crisis should not deter the world's search for long-term global solutions to poverty and environmental protection. For example, we should continue efforts to move to second-generation fuels made from waste materials and non-food crops without displacing land used food production. Even the limited amount of biofuels on the market today have been credited with reducing the price of oil, and next-generation fuels can be economically advantageous for poor countries with much less effect on food production. As bad as the impact of high food prices has been, the impact of high oil prices has been worse...

Fifth, the world must develop a new system of long-term investments in agriculture. A new "green revolution" is required to meet the global demands, even as climate change is increasing the stresses on agriculture. More productive crops are needed, but also ones that are drought-resistant and salt-tolerant. ...

Sixth, to help fund these important initiatives, I propose that each oil-exporting country create a "poverty and agriculture fund", contributing a fixed amount - perhaps 10% - of the price of every barrel of oil exported. This would be a small fraction of the windfall they have been gaining from higher prices. The funds would be managed by the founding nations and devoted to overcoming poverty, improving agricultural yields, supporting research for new technology, and creating social businesses to help solve the problems of the poor, such as health care, education and women's empowerment.

Just as the US should return a portion of its windfall from grain exports through increased support of food aid, so too should oil-exporting countries contribute a portion of the greatest wealth transfer the world has ever known to help feed the poor. ...

[T]he pressures of a growing and more prosperous population will not go away - demand for food and energy will grow, and the poor will suffer most. The need for long-term investment in agriculture and food aid will grow as well.

''Governance Writ Small''

Dani Rodrik argues that development strategies emphasizing good governance instead of specifically targeting binding constraints on growth are unlikely to be effective:

Getting Governance Right Is Good for Economic Growth, by Dani Rodrik, Project Syndicate: Economists used to tell governments to fix their policies. Now they tell them to fix their institutions. Their new reform agenda covers a long list of objectives, including reducing corruption, improving the rule of law, increasing the accountability and effectiveness of public institutions, and enhancing the access and voice of citizens.

Real and sustainable change is supposedly possible only by transforming the ''rules of the game'' - the manner in which governments operate and relate to the private sector.

Good governance is, of course, essential..., the intrinsic importance of the rule of law, transparency, voice, accountability, or effective government is obvious. We might even say that good governance is development itself.

Unfortunately, much of the discussion surrounding governance reforms fails to make a distinction between governance-as-an-end and governance-as-a means. The result is muddled thinking and inappropriate strategies for reform.

Economists and aid agencies would be more useful if they turned their attention to what one might call ''governance writ small.''

This requires moving away from the broad governance agenda and focusing on reforms of specific institutions in order to target binding constraints on growth.

Poor countries suffer from a multitude of growth constraints, and effective reforms address the most binding among them.

Poor governance may, in general, be the binding constraint in Zimbabwe and a few other countries, but it was not in China, Vietnam, or Cambodia - countries that are growing rapidly despite poor governance - and it most surely is not in Ethiopia, South Africa, El Salvador, Mexico, or Brazil.

As a rule, broad governance reform is neither necessary nor sufficient for growth. ... As desirable as the rule of law and similar reforms may be in the long run and for development in general, they rarely deserve priority as part of a growth strategy.

Governance writ small focuses instead on those institutional arrangements that can best relax the constraints on growth.

"Soaring Food Prices Mean Less Education for Poor"

I recently talked about aid programs in developing countries that target women (actually, the discussion was about the lack of such programs). Soaring food prices make it more difficult to provide the programs that do exist to keep kids, especially girls, in school:

Soaring Food Prices Mean Less Education for Poor: Gene Sperling, by Gene Sperling, Bloomberg: ...Among the casualties of the food crisis will be the schooling of millions of the world's poorest children. The connection is as simple as a school lunch. Ensuring that children get a free meal at school not only is a powerful tool for combating malnutrition for 350 million hungry kids, it is also one of the best education strategies.

Studies have shown that children who are fed at school have increased concentration, stronger short-term memory, increased verbal fluency and improved cognition. ...

Beyond improved learning, school feeding can also work as an incentive to get extremely poor parents to enroll many of the 72 million children and 226 million teens who aren't attending school in developing countries. Each year in school may lead to a wage increase of 10 percent or more when a child enters the workforce. But parents coping with extreme poverty often find the immediate costs of paying for school, as well as the opportunity costs (lower family income and less help fetching firewood or water and caring for sick or young relatives) too burdensome.

It is often girls who are left out of school due to reliance on them for family chores and because in some cultures, parents under-invest in daughters since they are expected to marry and enter their husbands' families. The best way to improve the cost- benefit analysis for such impoverished parents is to eliminate school fees, lower the costs of school uniforms and reduce the time spent traveling to and from school.

A small incentive -- such as a free school lunch or being able to bring home a bag of rice -- can also have a powerful impact on encouraging such poor parents to enroll their sons and daughters in school.

The World Food Program finds that during a school-feeding program's first year, average enrollment increases by 28 percent for girls and 22 percent for boys. In Niger, schools with feeding programs saw enrollment increases of 66 percent for girls and 23 percent for boys. During 2005, Rwandan schools with feeding programs saw attendance rise from 73 percent to 94 percent, while absenteeism was halved and dropout rates were cut by more than two-thirds.

While the WFP tries to find $3 billion more annually to provide school feeding to all poor children, the organization's vice president, Nancy Roman, recently told me that the WFP needed $750 million just to prevent a significant cut in existing school feeding programs amid a 55 percent increase in prices for rice, wheat, cereals, and legumes last year. ...

Paul Krugman: Grains Gone Wild

Can anything be done to alleviate the food crisis?:

Grains Gone Wild, by Paul Krugman, Commentary, NY Times: These days you hear a lot about the world financial crisis. But there’s another world crisis under way — and it’s hurting a lot more people.

I’m talking about the food crisis. Over the past few years the prices of wheat, corn, rice and other basic foodstuffs have doubled or tripled, with much of the increase taking place just in the last few months. High food prices dismay even relatively well-off Americans — but they’re truly devastating in poor countries, where food often accounts for more than half a family’s spending. There have already been food riots around the world...

How did this happen? The answer is a combination of long-term trends, bad luck — and bad policy.

Let’s start with the things that aren’t anyone’s fault.

First, there’s the march of the meat-eating Chinese —... the growing number of people ... who are, for the first time, rich enough to start eating like Westerners. Since it takes about 700 calories’ worth of animal feed to produce a 100-calorie piece of beef, this change in diet increases the overall demand for grains.

Second... Modern farming is highly energy-intensive... With oil persistently above $100 per barrel, energy costs have become a major factor driving up agricultural costs. High oil prices ... have a lot to do with ... China and other emerging economies ... competing ... for scarce resources..., driving up prices for raw materials...

Third, there has been a run of bad weather in key growing areas. In particular, Australia, normally the world’s second-largest wheat exporter, has been suffering from an epic drought.

O.K., I said that these factors ... aren’t anyone’s fault, but that’s not quite true. The rise of China and other emerging economies is the main force driving oil prices, but the invasion of Iraq ... has ... reduced oil supplies... And bad weather, especially the Australian drought, is probably related to climate change...

Where the effects of bad policy are clearest, however, is in the rise of demon ethanol and other biofuels. ...[E]ven on optimistic estimates, producing a gallon of ethanol from corn uses most of the energy the gallon contains. But ... even seemingly “good” biofuel policies, like Brazil’s use of ethanol from sugar cane, accelerate ... climate change by promoting deforestation.

And meanwhile, land used to grow biofuel feedstock is land not available to grow food, so subsidies to biofuels are a major factor in the food crisis. You might put it this way: people are starving in Africa so that American politicians can court votes in farm states.

Oh, and in case you’re wondering: all the remaining presidential contenders are terrible on this issue.

One more thing: Governments and private grain dealers used to hold large inventories..., just in case a bad harvest created a sudden shortage. Over the years, however, these precautionary inventories were allowed to shrink, mainly because everyone came to believe that countries ... could always import the food they needed.

This left the world food balance highly vulnerable to a crisis affecting many countries at once — in much the same way that the marketing of complex financial securities, which was supposed to diversify away risk, left world financial markets highly vulnerable to a systemwide shock.

What should be done? The most immediate need is more aid to people in distress: the U.N.’s World Food Program put out a desperate appeal for more funds.

We also need a pushback against biofuels, which turn out to have been a terrible mistake. But it’s not clear how much can be done. Cheap food, like cheap oil, may be a thing of the past.

NAFTA

Continuing with the discussion on illegal immigration and economic development in Mexico, Froma Harrop says to quit bashing NAFTa:

NAFTA Gets a Bum Rap, by Froma Harrop, Commentary, RCP: "NAFTA bad" has become Democratic shorthand to explain the misery spreading through America's industrial heartland. ...

May I suggest a "time out" on bashing free trade with our Canadian and Mexican neighbors? Life would be awfully easy if NAFTA were the problem. All you'd have to do is pull out.

The evidence points to NAFTA being mostly good for the countries involved. And if American factory workers want to see where their jobs have gone, they'd do better to look east than south. Labor may be cheaper in Mexico, but it's cheaper still in Asia. Chinese workers make about a quarter of what their Mexican counterparts earn. ...

When China joined the World Trade Organization in 2001, Mexico lost much of any advantage that NAFTA gave it. Hundreds of Mexican factories have since closed and also moved to China.

But somehow the populist anger against trade tends to get trained on Latin America. We saw all the outrage heaped on the Central American Free Trade Agreement (CAFTA) in 2005. The combined economies of those five poor countries, plus the Dominican Republic, roughly equaled that of New Haven, Conn.

More recently, the free-trade agreement with Peru has been denounced as "a NAFTA-style trade deal." Peru's gross domestic economy is the size of Utah's. Clinton and Obama, despite their campaign rhetoric, voted for the accord, and were right to do so.

NAFTA knockers who fear sounding anti-Mexican often argue that free trade has been bad for Mexico, as well. They offer vivid examples, such as the peasant farmers protesting the end of tariffs on U.S. corn. Corn production is easily mechanized and relies on abundant water. That gives U.S. farmers a competitive advantage.

But NAFTA has opened the enormous U.S. market to Mexican avocado growers -- who now call their fruit "green gold." For avocados and other produce that requires picking by hand and therefore much farm labor, Mexicans have an advantage. In fact, Mexican farm exports to the United States and Canada have tripled since 1994.

Mexico's gross domestic product has doubled in the last 10 years, poverty is down, and the march to social liberalization continues. Mexico is no longer a very poor country -- it just seems so next to us.

Revisiting NAFTA won't fix what hurts the Ohio River Valley. A better approach would be universal health coverage that protects laid-off workers from total economic meltdown. A more vigorous program for job retraining would also help. ...

The sight of closed American factories -- those broken windows and weed-covered parking lots -- sickens the soul. The inescapable reality, though, is that the jobs that were going were going, if not to the Caribbean and Latin America, then to Asia. Wouldn't it be in America's interests to help our neighbors get the work?

What Caused the 'Great Divergence'?

What caused the 'Great Divergence' in per capita income over the last 200 years, i.e. why did some countries industrialize while other countries lagged behind? This research finds that the divergence is due to a difference in the incentive to invest in human capital. In particular, international specialization "encouraged industrialising economies to invest in human capital, while non-industrial economies experienced population growth" instead:

Trading population for productivity, by Oded Galor and  Andrew Mountford, Vox EU: The past two centuries have not only seen a 'Great Divergence' in the levels of income per capita across countries; they have also witnessed a dramatic change in the distribution of population across the globe. In the time period 1820-1998, the ratio between income per capita in Western Europe and Asia grew nearly three-fold, whereas the ratio between the Asian population and the Western European population grew nearly two-fold (Maddison 2001). This striking contrast between the development paths of large subsets of the world economy gives rise to fundamental questions about the growth process and its implications for current and historical development patterns. Notably, has the pace of transition to sustained economic growth in advanced economies adversely affected the process of development in less-developed economies? Have the forces of international trade contributed to the divergence in the timing of the demographic transition and the emergence of sustained economic growth across countries?

The origin of the 'Great Divergence' in income per capita (Pritchett 1997) has been the subject of an intense debate, with notable advocates for the importance of geographical and institutional factors, human capital formation, ethnic, linguistic and religious fractionalisation, colonialism and globalisation.[1] In recent research, we suggest that international trade has played a significant role in the differential timing and pace of the demographic transitions across countries and has been a major determinant of the distribution of world population as well as the 'Great Divergence' in income per capita across countries.[2] International trade has an asymmetrical effect on the evolution of industrial and non-industrial economies: While in the industrial nations the gains from trade have been directed primarily towards investment in education and growth in output per capita, a greater portion of the gains from trade in non-industrial nations has been channelled towards population growth.

Did the World Bank's Development Efforts Fail in Kenya?

What does Kenya tell us about economic and social development?:

Did Development Fail in Kenya?, by Jean-Michel Severino, Project Syndicate: A month ago, Kenya fell prey to a sudden burst of post-electoral violence... The intensity and scale of the violence have stunned the world. ...

[T]hings seemed to be going well recently. This year's campaign was exceptionally peaceful... Perhaps more fundamentally, Kenya was unanimously seen as the "good student" of development, sometimes referred to as a symbol of an African renaissance.

The "Kenya vision 2030 framework," a set of ambitious macroeconomic, legal, and constitutional reforms, was being implemented in close partnership with the World Bank. Cherished by the donor community, Kenya received almost $1 billion of official development assistance in 2006 - up by 250% since 2002. Its booming horticulture and tourist industries were hailed as models for other African states...

The country's economic expansion, which averaged 5.5% in the last four years and fuelled the progress of neighbouring economies, appeared to prove that vigorous growth is possible in Africa even without mineral or fossil resources. Today, this economic miracle is up in the air. All is not lost, and there are strong reasons to believe that Kenyans will ... put the country back on its promising track.

Nevertheless, as we sit on the brink of the abyss, it is worth re-examining our assumptions that since poverty breeds conflict, socio-economic development must foster political stability and reduce recourse to violence.

All's Not Quiet on the Easterly Front

Google isn't the only one coming after Bill Gates, William Easterly sounds his usual theme - capitalism is the answer - to refute Bill Gates recent call for "creative capitalism" to meet the needs of the world's poor that are being overlooked by the market system. I have my doubts about Gates' vision, but I can say the same thing about Easterly's ideas:

Why Bill Gates Hates My Book, by William R. Easterly, Commentary, WSJ: This newspaper reported recently that Bill Gates hates my ideas. I have no hurt feelings... Mr. Gates, after all, has allied himself with the foreign aid establishment. This establishment is notoriously sensitive to criticism from people like me, who find no evidence that the aid industry's grand schemes are actually lifting anyone out of poverty.

Mr. Gates has now put forward his own scheme -- "creative capitalism" -- in a speech at the recent World Economic Forum in Davos. He argues that today's capitalism does not benefit the poor. For Mr. Gates, regular capitalism works "only on behalf of those who can pay." While entrepreneurs fall all over themselves trying to meet the needs of the rich, "the financial incentive to serve [the poor is] zero." As a result, basic needs such as food and medicine go unmet.

Mr. Gates seems to believe that the solution is to persuade for-profit companies to meet the poor's needs by boosting the "recognition" of corporate philanthropy. But the dossier of historical evidence to suggest this would work is ... thin... First of all, the recognition motive has proven to be awfully weak compared to the profit motive. Otherwise we would have had a lot more than the $5.1 billion of annual American corporate philanthropy to the Third World... Is it really the poor's only hope that the Gap will donate a few pennies per sexy T-shirt for AIDS treatment in Africa?

Profit-motivated capitalism, on the other hand, has done wonders for poor workers. Self-interested capitalist factory owners buy machines that increase production, and thus profits. Capitalists search for technological breakthroughs that make it possible to get more output for the same amount of input. Working with more machinery and better technology, workers produce more output per hour. In a competitive labor market, the demand for these more productive workers increases, driving up their wages. The steady increase in wages for unskilled labor lifts the workers out of poverty.

The number of poor people who can't afford food for their children is a lot smaller than it used to be -- thanks to capitalism. Capitalism didn't create malnutrition, it reduced it. ...

The parts of the world that are still poor are suffering from too little capitalism. Foreign direct investment in Africa today, although rising, amounts to only 1% of global flows. That's because the environment for private business in Africa is still hostile. There are some industry and country success stories in Africa, but not enough. ... The main obstacles to exports in poor countries are domestic ones like corruption and political strife, not lack of interest from rich-country buyers...

Moreover, how do philanthropists choose just which product is going to be the growth engine of a country? Much research suggests that "picking winners" through government industrial policy hasn't worked. Winners are too unpredictable to be discovered by government bureaucrats, much less by outside philanthropists. ...

Sure, let those who have become rich under capitalism try to do good things for those who are still poor, as Mr. Gates has admirably chosen to do. But a New-Age blend of market incentives and feel-good recognition will not end poverty. History has shown that profit-motivated capitalism is still the best hope for the poor.

William Easterly is no stranger to the editorial pages, and he is often responding with his own brand of snark to some perceived slight or challenge to his development framework. So I find it amusing that he accuses his intellectual opponents of being "notoriously sensitive to criticism." Everyone else is shrill!!!

When Iceland was Ghana

Thorvaldur Gylfason "assesses African development prospects using Iceland’s economic ascent over the last century as a benchmark":

When Iceland was Ghana, by Thorvaldur Gylfason, Vox EU: Believe it or not: in 1901, Iceland’s per capita national output was about the same as that of Ghana today. Today, Iceland occupies first place in the United Nations’ ranking of material success according to the Human Development Index that reflects longevity, adult literacy, and schooling as well as the purchasing power of peoples’ incomes. Can Iceland’s rags-to-riches story be replicated in Africa and elsewhere in the developing world? If so, what would it take?

Grandmother-verifiable statistics

In 1901, my grandmother was twenty-four. She had six children, as was common in Iceland at the time, even if the average number of births per woman had decreased from almost six in the early 1850s to four around 1900, like in today’s Ghana. In fact, the number of births per woman in Iceland was four in 1960, so Iceland and Ghana are separated in this respect by a half-century or less. It took Ghana less than fifty years, from 1960 to date, to reduce the number of births per woman by three, from almost seven to four. It took Iceland a century and a half, from the late 1850s to date, to reduce the number of births per woman by three, from five to two (or 2.1 to be precise, the critical number that keeps the population unchanged in the absence of net immigration).

True, Ghana has made more rapid progress on the population front than many other African nations. The average number of births per woman in Sub-Saharan Africa has decreased from 6.7 in 1960, as in Ghana, to 5.3 in 2005. These averages, however, mask a wide dispersion in fertility across countries. Mauritius is down to two births per woman compared with almost six in 1960. Botswana is down to three, from seven in 1960. The women of Kenya, Tanzania, and Uganda now have five, six, and seven children each on average compared with eight, seven, and seven in 1960.[1]

Goodbye to short lives in large families

The point of this comparison of demographic statistics is that social indicators often provide a clearer view than economic indicators of important aspects of economic development. Moreover, several social indicators of health and education – fertility, life expectancy, literacy, and such – are readily available for most countries and in some cases reach farther back in time than many economic statistics. Fertility matters because most families with many children cannot afford to send them all to school and empower them to make the most of their lives. Families with fewer children – say, two or three – have a better shot at being able to offer a good education to every child, thus opening doors and windows that otherwise might remain shut. Reducing family size, therefore, is one of the keys to more and better education and higher standards of life. As Hans Rosling has pointed out very vividly, short lives in large families are no longer a common denominator in developing countries.[2]

Around the globe, including in many parts of Africa, there is a clear trend toward smaller families and longer lives. In Ghana, for example, life expectancy at birth has increased by more than three months per year since 1960, from 46 years in 1960 to 58 years in 2005. In Sub-Saharan Africa on average, all 48 countries included, life expectancy increased less rapidly, from 41 years in 1960 to 47 years in 2005. Average life expectancy is now on the rise again in Africa, having reached a peak of 50 years in the late 1980s and then decreased mostly on account of the HIV/AIDS epidemic.

Iceland’s economic history through African eyes

Let us now return to Iceland and briefly trace its economic history since 1901 through African eyes, as it were. In 1901, Iceland’s Gross Domestic Product (GDP) per capita was about the same as that of Ghana today, measured in international dollars at purchasing power parity. This observation, illustrated in Figure 1, follows from two simple facts:

Jeff Sachs: Solving the Crisis in the Drylands

Jeff Sachs has ideas about how to solve the "crisis in the drylands," but first this is Dani Rodrik noting that Sachs' views on distributing insecticide treated bed nets for free to populations threatened by malaria appear to have been vindicated:

Jeff Sachs vindicated: On insecticide-treated bed nets (ITNs), at least. There has been an ongoing battle between Sachs and segments of the global public health community on ... whether ITNs should be distributed free (the Sachs position) or at a positive, albeit subsidized price. Those who favor the latter argue, in part, that charging a fee makes the program more sustainable and that it reduces wastage from giving away the nets to those who do not need or will not use it. See the arguments here (gated, unfortunately).

A new randomized experiment carried out by Jessica Cohen and Pascaline Dupas reaches striking and unambiguous results:

Taken together, our results suggest that cost-sharing ITN programs may have difficulty reaching a large fraction of the populations most vulnerable to malaria. ...[W]e find that ... free distribution is more cost-effective than partial-but-still-highly subsidized distribution... We also find that ... the number of infant lives saved is highest when ITNs are distributed free.

Finally, we do not find that free distribution generates higher leakage of ITNs to non-intended beneficiaries. To the contrary, we observed more leakage and theft (by clinic staff) when ITNs were sold at a higher price. We also did not observe any second-hand market develop in areas with free distribution. .

This is randomized experiments at its best: it addresses an important policy question and significantly changes (or should change) our priors on it.

Here's more from Jeffrey Sachs, but on a different topic, solving the ongoing crisis in the drylands:

Crisis in the Drylands, by Jeffrey Sachs, Scientific American: The vast region of deserts, grasslands and sparse wood lands that stretches across the Sahel, the Horn of Africa, the Middle East and Central Asia is by far the most crisis-ridden part of the planet. With the exception of a few highly affluent states in the Persian Gulf, these dryland countries face severe and intensifying challenges, including frequent and deadly droughts, encroaching deserts, burgeoning populations and extreme poverty. The region scores at the very bottom of the United Nations’ Index of Human Development...

As a result of these desperate conditions, the dryland countries are host to a disproportionate number of the world’s violent conflicts. Look closely at the violence in Afghanistan, Chad, Ethiopia, Iraq, Pakistan, Somalia and Sudan—one finds tribal and often pastoralist communities struggling to survive deepening ecological crises. Water scarcity, in particular, has been a source of territorial conflict...

Washington looks at many of these clashes and erroneously sees Islamist ideology at the core. Our political leaders fail to realize that other Islamic populations are far more stable economically, politically and socially—and that the root of the crisis in the dryland countries is not Islam but extreme poverty and environmental stress.