Naked Economics (39 page)

The Internet has a huge potential to improve transparency everywhere, but particularly in poor countries. Something as simple as posting on-line the amount of money allocated by the central government for a specific local project, such as a road or a health clinic, can enable citizens to compare what they were supposed to get to what actually showed up. “We got $5,000 for a community center? That doesn’t look like a $5,000 community center. Let’s go talk to the mayor.”

Human capital.
Human capital is what makes individuals productive, and productivity is what determines our standard of living. As University of Chicago economist and Nobel laureate Gary Becker has pointed out, all countries that have had persistent growth in income have also had large increases in the education and training of their labor forces. (We have strong reasons to believe that the education causes the growth, not the other way around.) He has written, “These so-called Asian tigers grew rapidly by relying on a well-trained, educated, hard-working, and conscientious labor force.”
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In poor countries, human capital does all the good things we would expect, and then some. Education can improve public health (which is, in turn, a form of human capital). Some of the most pernicious public health problems in the developing world have relatively simple fixes (boiling water, digging latrines, using condoms, etc.). Higher rates of education for women in developing countries are associated with lower rates of infant mortality. Meanwhile, human capital facilitates the adoption of superior technologies from developed countries. One cause for optimism in the development field has always been that poor countries should, in theory, be able to narrow the gap with richer nations by borrowing their innovations. Once a technology is invented, it can be shared with poor countries at virtually no cost. The people of Ghana need not invent the personal computer in order to benefit from its existence; they do need to know how to use it.

Now for more bad news. In Chapter 6, I described an economy in which skilled workers generate economic growth by creating new jobs or doing old jobs better. Skills are what matter—for individuals and for the economy as a whole. That is still true, but there is a glitch when we get to the developing world: Skilled workers usually need other skilled workers in order to succeed. Someone who is trained as a heart surgeon can succeed only if there are well-equipped hospitals, trained nurses, firms that sell drugs and medical supplies, and a population with sufficient resources to pay for heart surgery. Poor countries can become caught in a human capital trap; if there are few skilled workers, then there is less incentive for others to invest in acquiring skills. Those who do become skilled find that their talents are more valuable in a region or country with a higher proportion of skilled workers, creating the familiar “brain drain.” As World Bank economist William Easterly has written, the result can be a vicious cycle: “If a nation starts out skilled, it gets more skilled. If it starts out unskilled, it stays unskilled.”
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As a side note, this phenomenon is relevant in rural America, too. Not long ago, I wrote a story for
The Economist
that we referred to internally as “The Incredible Shrinking Iowa.”
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As the working title would suggest, parts of Iowa, and other large swathes of the rural Midwest, are losing population relative to the rest of the country. Remarkably, forty-four of Iowa’s ninety-nine counties had fewer people in 2000 than they had in 1900. Part of that depopulation stems from rising farm productivity; Iowa’s farmers have literally grown themselves out of jobs. But something else is going on, too. Economists have found that individuals with similar skills and experience can earn significantly higher wages in urban areas than they can elsewhere. Why? One plausible explanation is that specialized skills are more valuable in metropolitan areas where there is a density of other workers with complementary skills. (Think Silicon Valley or a cardiac surgery center in Manhattan.) Rural America has a mild case of something that deeply afflicts the developing world. Unlike technology or infrastructure or pharmaceuticals, we cannot export huge quantities of human capital to poor countries. We cannot airlift ten thousand university degrees to a small African nation. Yet as long as individuals in poor countries face limited opportunities, they will have a diminished incentive to invest in human capital.

How does a country break out of the trap? Remember that question when we come to the importance of trade.

Geography.
Here is a remarkable figure: Only two of thirty countries classified by the World Bank as rich—Hong Kong and Singapore—lie between the Tropic of Cancer (which runs through Mexico across North Africa and through India) and the Tropic of Capricorn (which runs through Brazil and across the northern tip of South Africa and through Australia). Geography may be a windfall that we in the developed world take for granted. Development expert Jeffrey Sachs wrote a seminal paper in which he posited that climate can explain much of the world’s income distribution. He writes, “Given the varied political, economic, and social histories of regions around the world, it must be more than coincidence that almost all of the tropics remain underdeveloped at the start of the twenty-first century.”
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The United States and all of Europe lie outside the tropics; most of Central and South America, Africa, and Southeast Asia lie within.

Tropical weather is wonderful for vacation; why is it so bad for everything else? The answer, according to Mr. Sachs, is that high temperatures and heavy rainfall are bad for food production and conducive to the spread of disease. As a result, two of the major advances in rich countries—better food production and better health—cannot be replicated in the tropics. Why don’t the residents of Chicago suffer from malaria? Because cold winters control mosquitoes—not because scientists have beaten the disease. So in the tropics, we find yet another poverty trap; most of the population is stuck in low-productivity farming. Their crops—and therefore their lives—are unlikely to get better in the face of poor soil, unreliable rainfall, and chronic pests.

Obviously countries cannot pick up and move to more favorable climates. Mr. Sachs proposes two solutions. First, we ought to encourage more technological innovation aimed at the unique ecology of the tropics. The sad fact is that scientists, like bank robbers, go where the money is. Pharmaceutical companies earn profits by developing blockbuster drugs for consumers in the developed world. Of the 1,233 new medicines granted patents between 1975 and 1997, only thirteen were for tropical diseases.
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But even that overstates the attention paid to the region; nine of those drugs came from research done by the U.S. military for the Vietnam War or from research for the livestock and pet market.How do we make private companies care as much about sleeping sickness (on which no major company is doing research) as they do about canine Alzheimer’s (for which Pfizer already has a drug)? Change the incentives. In 2005, British Prime Minister Gordon Brown embraced an idea that economists have long kicked around: Identify a disease that primarily afflicts a poor part of the world and then offer a large cash prize to the first firm that develops a vaccine that meets predetermined criteria (e.g., is effective, is safe for use in children, doesn’t need refrigeration, etc.). Brown’s plan was actually more sophisticated; he proposed that rich governments precommit to buying a certain number of doses of the “winning” vaccine at a certain price. Poor people would get lifesaving drugs. The pharmaceutical company would get what it needs to justify the vaccine research: a return on investment, just as it does when developing drugs that consumers in rich countries will buy. (The British government has been thinking this way for a long time. In 1714, after two thousand sailors drowned when a fleet got lost, crashed into the rocky coast, and sunk, the British government offered 20,000 pounds to anyone who developed an instrument for measuring longitude at sea. The prize led to the invention of the chronometer.)
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The other hope for poor countries in the tropics, says Mr. Sachs, is to step out of the trap of subsistence agriculture by opening their economies to the rest of the world. He notes, “If the country can escape to higher incomes via non-agricultural sectors (e.g., through a large expansion of manufactured exports), the burdens of the tropics can be lifted.”
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Which brings us once again to our old friend trade.

Openness to trade.
We’ve had a whole chapter on the theoretical benefits of trade. Suffice it to say that those lessons have been lost on governments in many poor countries in recent decades. The fallacious logic of protectionism is alluring—the idea that keeping out foreign goods will make the country richer. Strategies such as “self-sufficiency” and “state leadership” were hallmarks of the postcolonial regimes, such as India and much of Africa. Trade barriers would “incubate” domestic industries so that they could grow strong enough to face international competition. Economics tells us that companies shielded from competition do not grow stronger; they grow fat and lazy. Politics tells us that once an industry is incubated, it will always be incubated. The result, in the words of one economist, has been a “largely self-imposed economic exile.”
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At great cost, it turns out. The preponderance of evidence suggests that open economies grow faster than closed economies. In one of the most influential studies, Jeffrey Sachs, now director of The Earth Institute at Columbia University, and Andrew Warner, a researcher at the Harvard Center for International Development, compared the economic performance of closed economies, as defined by high tariffs and other restrictions on trade, to the performance of open economies. Among poor countries, the closed economies grew at 0.7 percent per capita annually during the 1970s and 1980s while the open economies grew at 4.5 percent annually. Most interesting, when a previously closed economy opened up, growth increased by more than a percentage point a year. To be fair, some prominent economists have taken issue with the study on the grounds (among other quibbles) that economies closed to trade often have a lot of other problems, too. Is it the lack of trade that makes these countries grow slowly, or is it general macroeconomic dysfunction? For that matter, does trade cause growth or is it something that just happens while economies are growing for other reasons? After all, the number of televisions sold rises sharply during extended spells of economic growth, but watching television does not make countries richer.

Conveniently for us, a recent paper in the
American Economic Review,
one of the most respected journals in the field, is entitled “Does Trade Cause Growth?” Yes, the authors answer. All else equal, countries that trade more have higher per capita incomes.
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Jeffrey Frankel and David Romer, economists at Harvard and UC Berkeley, respectively, conclude, “Our results bolster the case for the importance of trade and trade-promoting policies.”

Researchers have plenty left to quibble about. That is what researchers do. In the meantime, we have strong theoretical reasons to believe that trade makes countries better off and solid empirical evidence that trade is one thing that has separated winners from losers in recent decades. The rich countries must do their part by keeping their economies open to exports from poor countries. Mr. Sachs has called for a “New Compact for Africa.” He writes, “The current pattern of rich countries—to provide financial aid to tropical Africa while blocking Africa’s chances to export textiles, footwear, leather goods, and other labor-intensive products—may be worse than cynical. It may in fact fundamentally undermine Africa’s chances for economic development.”
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Responsible fiscal and monetary policy.
Governments, like individuals, will get themselves in serious trouble if they consistently overspend on things that do not raise future productivity. At a minimum, large budget deficits require the government to borrow heavily, which takes capital out of the hands of private borrowers, who are likely to use it more efficiently. Chronic deficit spending can also signal other future problems: higher taxes (to pay back the debt), inflation (to erode the value of the debt), or even default (just giving up on the debt).

All of these problems are compounded if the government has borrowed heavily from abroad to finance its profligate spending. If foreign investors lose confidence and decide to take their money and go home—as skittish global investors are wont to do—then the capital that was financing the deficit dries up, or becomes prohibitively expensive. In short, the music stops. The government is left on the brink of default, which we have seen in countries ranging from Mexico to Turkey. (There is, by the way, some modest concern that this could happen to the United States.)

On the monetary side, Chapter 10 made clear the dangers of letting the money party get out of control. It happens often anyway. Argentina is the poster child for irresponsible monetary policy; from 1960 to 1994, the average Argentine inflation rate was 127 percent per year. To put that in perspective, an Argentine investor who had the equivalent of $1 billion in savings in 1960 and kept all of it in Argentine pesos until 1994 would have been left with the equivalent spending power of one-thirteenth of a penny. Economist William Easterly has noted, “Trying to have normal growth during high inflation is like trying to win an Olympic sprint hopping on one leg.”