Naked Economics (41 page)
Authors: Charles Wheelan
Easterly says that traditional development aid has been a mistake—because we still haven’t figured out how to do it.
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He writes in the
American Economic Review:
Economists are reasonably confident that some combination of free markets and good institutions has an excellent historical track record of achieving development (as opposed to, say, totalitarian control of the economy by kleptocrats). It is just that we don’t know how to get from here to there; which specific actions contribute to free markets and good institutions; how all the little pieces fit together. That is, we don’t know how to achieve development.
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Easterly doesn’t think we should give up trying to help people in poor countries. Instead, we should do small, context-sensitive projects with measurable benefits. He writes, “[Aid] could seek to create more opportunities for poor individuals, rather than try to transform poor societies.”
To be fair, the primary stumbling block to development in poor countries is not bad advice from rich countries. The best ideas for economic growth are quite simple, yet, as this chapter has pointed out, there are plenty of leaders in the developing world doing the economic equivalent of smoking, eating cheeseburgers, and driving without their seat belts. A study done by the Harvard Center for International Development of global growth patterns between 1965 and 1990 found that most of the difference between the huge success of East Asia and the relatively poor performance of South Asia, sub-Saharan Africa, and Latin America can be explained by government policy. In that respect, foreign aid presents the same kind of challenges as any other welfare policy. Poor countries, like poor people, often have very bad habits. Providing support can prolong behavior that needs to be changed. One study came to the unsurprising conclusion that foreign aid has a positive effect on growth when good policies are already in place, and has little impact on growth when they are not. The authors recommended that aid be predicated on good policy, which would make the aid more effective and provide an incentive for governments to implement better policies.
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(Similar criteria have been proposed for relieving the debts of heavily indebted poor countries.) Of course, turning our backs on the neediest cases (and denying bailouts to countries in crisis) is easier in theory than it is in practice. In 2005, the World Bank published a document that might qualify as bureaucratic introspection—
Economic Growth in the 1990s: Learning from a Decade of Reform.
Policymakers were a lot more confident that they knew how to fix the world in 1990 than they are today. Harvard development economist Dani Rodrik describes the tone of the report, which seems to incorporate William Easterly’s skepticism without abandoning Jeffrey Sach’s resolve: “There are no confident assertions here of what works and what doesn’t—and no blueprints for policymakers to adopt. The emphasis is on the need for humility, for policy diversity, for selective and modest reforms, and for experimentation.”
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Last, much of the world is poor because the rich countries have not tried very hard to make it otherwise. I realize that pointing out the failure of development aid and then arguing for more of it is like Yogi Berra criticizing a restaurant for having bad food
and
small portions. Still, things become better when there is an overwhelming political will to make them better. That is bigger than economics.
Life in 2050: Seven Questions
E
conomics can help us to understand and improve an imperfect world. In the end, though, it is just a set of tools. We must decide how to use them. Economics does not foreordain the future any more than the laws of physics made it inevitable that we would explore the moon. Physics made it possible; humans chose to do it—in large part by devoting resources that might have been spent elsewhere. John F. Kennedy did not alter the laws of physics when he declared that the United States would put a man on the moon; he merely set a goal that required good science to get there. Economics is no different. If we are to make the best use of these tools, we ought to think about where we are trying to go. We must decide what our priorities are, what trade-offs we are willing to make, what outcomes we are or are not willing to accept. To paraphrase economic historian and Nobel laureate Robert Fogel, we must first define the “good life” before economics can help us get there. Here are seven questions worth pondering about life in 2050, not for the sake of predicting the future, but because the decisions that we make now will affect how we live then.
How many minutes of work will a loaf of bread cost?
It’s the productivity question. From a material standpoint, it’s pretty much all that matters. Nearly everything else we’ve discussed—institutions, property rights, investment, human capital—is a means toward this end (and other ends, too). If productivity grows at 1 percent a year over the next four decades, our standard of living will be some 50 percent higher by 2050. If productivity grows at 2 percent a year, then our standard of living will more than double in the same time frame—assuming we continue to work as hard as we do now. Indeed, that leads to a subquestion that I find more interesting: How rich is rich enough?
Americans are richer than most of the developed world; we also work harder, take less vacation, and retire later. Will that change? There is something in labor economics called the “backward-bending labor supply curve.” Thankfully, the idea is simpler and more interesting than the name would suggest. Economic theory predicts that as our wages go up, we will work longer hours—up to a point, and then we will begin to work less. Time becomes more important than money. Economists just aren’t quite sure where that curve starts to bend backward, or how sharply it bends.
Productivity growth gives us choices. We can continue to work the same amount while producing more. Or we can produce the same amount by working less. Or we can strike some balance. Assuming Americans continue to grow steadily more productive, will we choose to work sixty hours a week in 2050 and live richly (in a material sense) as a result? Or will there come a time when we decide to work twenty-five hours a week and listen to classical music in the park for the balance? I had dinner not long ago with a portfolio manager for a large investment company who is convinced that Americans are going to wake up one day and decide that they work too hard. Ironically, he was not planning to work less hard himself; he was planning to invest in companies that make leisure goods.
How many people will be sleeping under Wacker Drive?
This is the pie-slicing question. In 2000, I was assigned by
The Economist
to write a story on poverty in America. With the economy still booming, I sought some way to express the striking dichotomy between America’s rich and poor. I found it right outside the front door of my office building:
A stroll down Wacker Drive, in Chicago, offers an instant snapshot of America’s surging economy. Young professionals stride along, barking orders into mobile phones. Shoppers stream towards the smart shops on Michigan Avenue. Construction cranes tower over a massive new luxury condominium building going up on the horizon. All is bustle, glitter and boom.
But there is a less glamorous side to Wacker Drive, literally below the surface. Lower Wacker is the subterranean service road that runs directly beneath its sophisticated sister, allowing delivery trucks to make their way through the bowels of the city. It is also a favourite refuge for the city’s homeless, many of whom sleep in cardboard encampments between the cement props. They are out of sight of all that gleams above, and largely out of mind. As Wacker Drive, so America.
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What are we willing to promise the most disadvantaged? The market economies of the developed world lie along a continuum, with America at one end and the relatively paternalistic European economies, such as France and Sweden, at the other. Europe offers the kinder, gentler version of a market economy—at some cost. In general, the European nations are more protective of workers and have a more substantial safety net. Generous benefits are mandated by law; health care is a birthright. This leads to a more compassionate society in many ways. European poverty rates, particularly for children, are far lower than those in the United States. Income inequality is lower, too.
It also leads to higher unemployment and a slower rate of innovation and job creation. Workers, bundled with lots of mandatory benefits, are expensive. Since employees cannot be fired easily, firms are slow to hire them in the first place. Meanwhile, generous unemployment and welfare benefits make workers slower to take jobs that might be offered. The result is what economists refer to as a “sclerotic” labor market. During normal economic times, European unemployment rates tend to be significantly higher than the American rate, particularly for youth.
The American system is a richer, more dynamic, more entrepreneurial economy—and harsher and more unequal. It is conducive to creating a big pie in which the winners get huge slices. The European system is better at guaranteeing at least some pie for everybody. Capitalism comes in all kinds of flavors. Which one will we choose?
Will we use the market in imaginative ways to solve social problems?
The easiest and most effective way to get something done is to give the people involved a reason to want it done. We all nod, as if this were the most obvious point in the world—and then we go out and design policies that do just the opposite. We have an entire public school system that still does not really reward teachers and principals when their students do well (or punish them when their students do poorly). We talk about how important education is, but we make it difficult and time-consuming for smart people to become teachers (despite evidence that this training has little impact). We don’t pay good teachers more than bad ones.
We make it artificially cheap to travel by car, implicitly subsidizing everything from urban sprawl to global warming. We assess most of our taxes on productive activity, like work, savings, and investment, when we might raise revenue and conserve resources with more “green taxes.”
If we get the incentives right, we can use markets to do all kinds of things. Consider the case of rare diseases. However bad it is to have a serious illness, it is worse to have a serious illness that is also rare. At one point, there were some five thousand diseases considered so rare that drug companies ignored them because they had no hope of recovering their research costs even if they found a cure.
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In 1983, Congress passed the Orphan Drug Act, which provided incentives to make such work more profitable: research grants, tax credits, and exclusive rights to market and price drugs for rare diseases—so-called orphan drugs—for seven years. In the decade before the act, fewer than ten orphan drugs came to market. Since the act, roughly two hundred such drugs have come to market.
Or something as simple as deposits for cans and bottles. Not surprisingly, recycling rates are much higher in states with deposits than in states without. There is also less trash and litter. And if landfill space is at a premium—which it is in most places—shouldn’t we be paying to dispose of our household trash based on the volume we generate? What effect do you think that would have on the quantity of consumer packaging?
Markets don’t solve social problems on their own (or else they wouldn’t be social problems). But if we design solutions with the proper incentives, it feels a lot more like rowing downstream.
Will we have strip malls in 2050?
Nothing says that we must accept what the market tosses us.
New York Times
columnist Anthony Lewis paid homage to the beauty of Italy’s Tuscany and Umbria regions (“The silvery olive groves, the fields of sunflowers, the vineyards, the stone houses and barns”) and lamented that such small farms are not economical in a world of corporate agriculture but says they should be preserved anyway. He wrote, “Italy is evidence that there is more to life—a civilized life—than the unregulated competition of the market. There are values of humanity, culture, beauty, community that may require deviations from the cold logic of market theory.”
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There is nothing in economics that says he’s wrong. We may well collectively decide that we would like to protect a way of life, or something that is aesthetically pleasing, even if it means higher taxes, more expensive food, or less economic growth. To an economist, and to Mr. Lewis, life is about maximizing utility, not income. Sometimes utility means preserving an olive grove or an old vineyard—just because we like the way it looks. As we grow wealthier, we are often more willing to put aesthetics above the pocketbook. We may invest resources in rural America because it’s important to our identity as a nation. We may subsidize small farms in Vermont because they’re beautiful, not because it will make milk cheaper. And so on.
That point comes with several heavy doses of caution. First, we must always make explicit the costs of fiddling with markets, whatever those costs may be. How is the outcome different than it would have been, and who pays? Second, we should take care that these costs fall most heavily on those who enjoy the benefits. Last and most important, we should make sure that one group (such as those of us who think that strip malls are hideously ugly) does not use the political and regulatory process to impose its aesthetic preferences on another group (those who own strip malls and the people who enjoy the cheap and convenient shopping there). That said, there is nothing to stop us from dreaming of a world without strip malls.
Do we really have monetary policy figured out?
I asked that question in the first edition of this book, back in 2002. Here is part of the answer: “The Japanese economy—that miracle of the 1980s—remains stubbornly resistant to traditional monetary and fiscal fixes, prompting what the Wall Street Journal has called ‘one of the great economic debates of the age.’”
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Could something similar happen here?
It did, beginning in 2007. That doesn’t make me a genius (as I’ve also predicted that the Cubs will win the World Series on multiple occasions). It does prove that we have not conquered the business cycle (the economic ebb and flow that leads to periodic recessions). We thought we had it tamed, and then the financial crisis nearly took us right off the rails. These swings in the economy take a lot of innocent victims with them.
Ben Bernanke and the Fed seem to have done a lot of things right. What have they done wrong that we don’t know about yet? Remember, Alan Greenspan was a genius (keeping inflation in check) until he wasn’t anymore (because loose money fueled the asset bubbles).
There is a regulatory challenge as well. (The discussions have started, but we’re not anywhere near a solution.) How do we manage the “systemic risk” in an interdependent financial system? The iron law of capitalism is that firms that fail should fail. We did that with Lehman Brothers and it nearly took all of us with them. The global financial system does not look like a textbook model where strong firms thrive in a crisis and weak firms fail; it’s more like a group of mountain climbers tethered together on the edge of a precipice. How do we allow the market to punish wrongdoers without sending all of us spilling down the mountain?
In forty years, will “African tigers” refer to wildlife or to development success stories?
Here is an exercise: Find a young child, say age eight or nine, and try to explain to him or her why much of the world lives comfortably, even luxuriously, while millions of people elsewhere on the planet are starving to death and billions more are barely getting by. At some point, the explanation just starts to feel inadequate. Clearly we do not have a silver bullet for economic development. We don’t have one for cancer either, but we haven’t given up. Will the world be significantly less poor in 2050? That answer is not obvious. We can imagine an East Asian scenario in which countries transform themselves in a matter of decades. Or we can imagine a sub-Saharan Africa scenario in which countries stumble from decade to decade without any significant economic growth at all. One scenario will lift billions of people out of poverty and misery; the other won’t.
When we ask whether poor countries will still be poor four decades from now, the question seems distant and abstract, almost as if the answer will be determined by some future alignment of the stars. But when we break that question into its component parts—when we ask about the things that we know will distinguish rich countries from poor countries—then global poverty seems more tractable. Will governments in developing countries create and sustain the kinds of institutions that support a market economy? Will they develop export industries that enable them to break out of the trap of subsistence agriculture—and will the United States open its huge market to those products? Will the rich countries use their technology and resources to fight the diseases that are ravaging the developing world, especially AIDS? Will the family of a baby girl born tomorrow in rural India have an incentive to invest in her human capital?