Naked Economics Chapter 13 Summary: development Economics

Posted: April 7, 2009

DEVELOPMENT ECONOMICS: Governments can sometimes improve market outcomes.

Why does half the world’s population live on less than $2 a day? In Chapter 12, Wheelan’s thesis is an answer to this question; “their economies have failed them.” He goes on to show “that government can sometimes improve market outcomes (Mankiw 7)”, and conversely when economies fail their people so do governments. Wheelan draws several more conclusions, based on his second thesis.

The first, “Excessive regulation goes hand in glove with corruption (p. 211).” Harvard economist Robert Barro has found that government consumption, excluding education and defense, is negatively correlated with per capita GDP, (p. 211). A less benign corollary is that excessive regulation allows for government officers the opportunity to take bribes from those seeking a way around the regulation. Hernando De Soto’s documented study of opening a business in Peru revealed that it was impossible to start a business legally without bribes. The process was exhaustive and posed a significant barrier to entry in the Market. (p. 211) Governments interference stifles growth in this case.

His second conclusion, informal property rights render real estate property less productive, (p. 210). This means that real property cannot be collateralized. This stifles growth. The Economist tells such a story of a Malawian business that cannot raise capital to grow its business despite their “ownership” of a home that would cover the cost. De Soto reports that such situations result in $9 trillion in uncollateralized real property. (p. 210) If government would formalize property rights then citizens would be able to collateralize real property stimulating their economies. Drawing a parallel between these two conclusions shows that government must balance its role.

SUPPORT FOR FORMAL PROPERTY RIGHTS

        De Soto’s argument support reform for formalized property rights.  Wheelan doesn’t directly discuss why this issue persists.  There must be reasons, possibly such as protectionist logic or politics.  At the heart of the issue could be that if property is leveraged to incur debt it would be possible for foreign micro lenders to foreclose on the property in the case of default.  Clearly foreign investors would have an advantage.  Even with formal property rights land still belongs to government.  To illustrate lets assume that an owner of land in the US stops paying taxes on that land.  The property will be seized.  Data that would flesh this out would be valuable to De Soto.  Show the benefits through an analysis comparing the benefit to the risk.  Fundamentally the benefit must outweigh the risk because real property cannot be exported to another country. 

CHALLENGING GDP AS A MEASURE OF OUR COLLECTIVE WELL-BEING

GDP is a good measure of a countries standard of living because it directly measures production. A country’s standard of living depends on its production, Mankiw 8. GDP like any statistic has its limits; Wheelan sympathizes with other social scientists, he illustrates GDP’s shortcomings. He explains alternatives to the use of GDP as a measure of our standard of living such as, “Bennett’s index of leading cultural indicators”, the United Nation’s “Human development index” and Miringhoff’s “social health index” (p. 155). He subtly points out that any measure is a statistic and has limitations. He doesn’t however go on to explain that GDP is an actionable statistic as opposed to these other indexes. He could highlight the direct, causal, relationship between production and standard of living. Allso these other measures are direct or causal. They measure symptoms not causes.

Notes

We can split that atom, land on the moon, decode the human genome, yet two billion people live on less than $2 a day. Their economies have failed them. Creating wealth is a process of taking inputs, including human talent, and producing things of value. Why can Pakistan build nuclear weapons but is unable to conduct immunization programs against measles? What does a government need for effective institutions? Rule of law. Law enforcement, courts, infrastructure, a government capable of collecting taxes, and a healthy respect for these institutions. Corruption is a cancer that misallocates resources, stifles innovation, and discourages foreign investment. There is a clear and causal relationship between better governance and better development outcomes such as higher per-capita income, lower infant mortality, and higher literacy. Property Rights. Dead Capital: DEF Human Capital Trap Dutch Disease Explain how poor countries are like poor people. What can the developed world do to provide more effective aid for these countries? Books: Hardworking Mr. Zimba, a 25-year-old man in Malawi Poor: $40 in 2000. Today, the Malawian entire annual economic output is about $12 billion; half the size of Vermont

Africa United Republic of Tanzania, Mozambique, Zimbabwe, Zambia, Democratic Republic of the Congo, Malawi Malawi

Gross Domestic Product - GDP US$ 5.727 billion (2009 estimate)

GDP (Purchasing Power Parity) 14.68 billion of International dollars (2010 estimate )

Real GDP growth

2000 2001 2002 2003 2004 2005 2006 2007 0.8% -4.1% 1.7% 5.5% 5.5% 2.6% 7.7% 5.8% 2008 2009 2010 2011 2012** 8.8% 9% 6.5% 5.5% 4.3%

*Estimate **Forecast

GDP per capita - current prices US$ 344 (2009 estimate)

GDP per capita - PPP $883 International Dollars (2009 estimate)

South Korea

Gross Domestic Product - GDP US$ 1.164 trillion (2010 estimate) GDP(Purchasing Power Parity) 1.63 trillion of International

dollars (2010 estimate )

Real GDP growth

2000 2001 2002 2003 2004 2005 2006 2007 8.8% 4% 7.2% 2.8% 4.6% 4% 5.2% 5.1% 2008 2009 2010 2011 2012

2.3% 0.3% 6.3% 3.6% 3.5% GDP per capita - current prices US$ 23,680 (2010 estimate) GDP per capita - PPP $33,172International Dollars (2010 estimate)

Source:

http://www.gfmag.com/gdp-data-country-reports/241-south-korea- gdp-country-report.html

In Malawi, 30% of the young children are malnourished; 2/10 will die before their 5th birthday

We can split the atom, land on the moon, decode the human genome, yet 2B people live on less than $2/day, 1B are hungry Their economies have failed them Creating wealth is a process of taking inputs, including human talent, and producing things of value Poor countries are not organized to do that

Pakistan; busy, dynamic private economy, yet most are illiterate, ill housed and ill fed

They can build nuclear weapons, but cannot conduct an immunization program against the measles

“Wonderful people. Terrible government” writes World Bank economist William Easterly

William Easterly

An economist at the New York University, specializing in economic growth and foreign aid

Published books: The Elusive Quest for Growth, and White Man’s Burden

Distinguishes two types of foreign aid donors; the Planners and the Searchers

Planners are top down approach; modern incarnations of colonialism Searchers look for bottom up solutions Easterly believes Searchers are more likely to succeed Every country has resources Bad news: Economists do not have a recipe for making poor countries rich. Some successes: the Asian tigers, China, India; yet no proven formula We know what makes rich countries rich; if we can catalog those successful policies, maybe we can have poor countries simply adopt them?? The following are kinds of policies, and geographical endowments, that developmental economists believe make the difference between wealth and poverty

Effective Government Institutions Law, law enforcement, courts, infrastructure, and a government capable of collecting taxes – and a healthy respect of these institutions The tracks on which capitalism runs Corruption is a cancer that misallocates resources, stifles innovation, and discourages foreign investment Economists studied how the economic success of developing countries were affected by the quality of the institutions colonizers had left behind If it was hospitable, they built institutions; if not, it became an “extractive state” Of 64 colonies, 3⁄4 of the current wealth can be explained by the quality of their government institutions, which, in turn, can be explained by the original settlement pattern

Good governance matters

There is a clear and causal relationship between better governance and better development outcomes such as higher per capita incomes, lower infant mortality, and higher literacy

Property Rights There are many homes and businesses built on communal land or owned by the government or ignored. The crucial difference between the developed and the developing world? – owners have no legal title to the property; cannot rent it, subdivide it, sell it, or pass it on to family, or use it as collateral to raise capital In the developing world, informal property arrangements are very common, and should not be ignored (Peruvian economist Hernando de Soto) Value of property held but not legally owned by poor people: $9trillion – it’s “dead capital” Malawian couple wants to expand business, “owns” a house, but cannot borrow against it as they don’t have an official title Informal property rights are inadequate in a modern complex economy Property rights also frees us people’s time; less time spent defending their possessions People may leave their home, rather than setting up improvised businesses to protect their property Extending property rights gives the incentive to work No Excessive Regulation Red tape; excessive bureaucracy Goes hand in hand with corruption Peruvian study: trying to set up a one person shop; group vowed not to pay bribes, asked for bribes 10 times, had to pay twice to avoid complete failure To set up a shop, it cost $1,231, or 31 times the monthly minimum wage Governments should limit spending; Barro’s study found government consumption, excluding education and defense, was NEGATIVELY correlated with GDP per capita growth Asian tigers government spending during growth was in the range of 20% of GDP High tax rates applied unevenly distort the economy; low, simple and easy to collect may improve government revenue South Korea – Government consumption expenditures as % of GDP from 1967-2012, with future trend line, from tradingeconomics.com The Netherlands - Government consumption expenditures as % of GDP from 1967-2012, with future trend line Human Capital This makes individuals productive, and productivity determines our standard of living Countries with persistent growth have had large increases in education and training of labor forces Education improves public health Associated with lower rates of infant mortality Facilitates the adoption of superior technologies (may borrow innovations) They don’t have to invent the computer, just learn how to use it The problem: skilled workers need other skilled workers to succeed IE. A surgeon needs trained nurses, anesthesiologists, firms that sell drugs and equipment, and a population that can afford it If there are few skilled workers, there is less incentive to invest in skills

The skilled workers would leave: the “brain drain” If a country is skilled, it gets more skilled This happens in areas of America as well

Geography

Two of the 30 rich countries lie between the Tropic of Cancer and the Tropic of Capricorn; Hong Kong and Singapore

Tropical weather good for vacation, not so great for development

High temperatures and heavy rain are bad for food production and conducive to the spread of disease

Winter kills mosquitoes

Tropics are filled with low-production farmers Jeffrey Sachs’ two solutions:

1. More technological innovation aimed at the unique ecology of the tropics

-scientists go where the money is

-of 1,233 new drugs between 1975 and 1997, 13 were for tropical diseases; 9 of those done by the US for the war in Vietnam

-British PM suggested a $ prize

2. Opening the economies to the rest of the world

-get out of the trap of subsistence agriculture

-higher incomes in non-agricultural sectors

Openness to Trade Despite the benefits, many are still protectionist Trade barriers “incubate” industries and let them get strong enough to compete? –but they grow fat and lazy

Open economies grow faster In a study of tariffs and other restrictions, closed countries grew at 0.7% per capita in the 1970s and 1980s, while open countries grew at 4.5% annually A closed economy opened up: 1% increase

Is it lack of trade that makes them grow slowly, or other macroeconomic dysfunction? Does trade cause growth, or is the an activity of a growing economy?

In a paper in American Economic Review by Jeffrey Frankel and David Romer, the authors say, “Yes. Trade causes growth; our results bolster the importance of trade and trade-promoting policies.”

Need a different approach: we offer financial aid while blocking trade!

Responsible Fiscal and Monetary Policy

Governments must spend to raise future productivity

Large deficits crowd out private borrowers Chronic deficit spending signals future

problems Problems are compounded if governments borrow from abroad; foreign investors may lose confidence Don’t be like Argentina; from 1960 to 1994, the average inflation rate was 127%!! Natural Resources Matter Less than You Think Israel GDP ($28,300) is far richer than its oil-rich neighbors, Saudi Arabia ($20,500) and Iran ($12,800) \ Japan and Switzerland are resource-poor, but have done better than resource-rich Russia

Angola is oil-rich, but is in a civil war, has the highest rate of civilians maimed by land mines, 1/3 children die before 5, and life expectancy is 42 May actually be a detriment (?!) One study of 97 countries over two decades found of the top 18 fastest-growing nations, only 2 are rich with things that can be taken out of the ground. And growth was higher in those countries less endowed with natural resources. Why? Diverts resources from other industries like manufacturing and trade that is beneficial to long- term growth Vulnerable to wild swings in commodity prices Perverse effects of abundant natural resources known as “Dutch disease” The Netherlands found natural gas; natural gas exports drove up the value of the Guilder; life was difficult for exporters Gas revenues expanded social spending, raising employers’ social security contributions and production costs The discovery and exploitation of the natural gas distorted the economy and became a mixed blessing for a trading nation Finally, a country should use the resource income to make things better, but often don’t The president of Chad, upon receiving 4.5 million USD for oil revenues as a result of a new pipeline, spent it on weapons to fight rebels Education, public health, sanitation, immunizations, infrastructure; there a better ways to spend that money! Democracy Is a check on egregious economic policies Amartya Sen, Harvard professor awarded the Nobel Prize in Economics in 1998, studied famines Famines are not caused by crop failure, but by faulty political systems that prevent the market from correcting itself Minor agricultural disturbances became catastrophes because imports were not allowed, prices were not allowed to increase, farmers were not allowed to grow alternatives Politics interfered with the market’s ability to correct itself Famines “never materialized in any country that is independent, that goes to elections regularly, that has opposition parties to voice criticism and that permits newspapers to report freely and question the wisdom of government policies without extensive censorship.”

-Amartya Sen Barro’s study found basic democracy is associated with higher economic growth, while advanced democracies suffer from slightly lower growth Consistent with what we know of interest groups War is Bad Many poor countries are involved with armed conflicts 3⁄4 of the world’s billion poorest are caught in a civil war or have recently been in one It’s hard to run a business or get an education while at war Natural resources can make things worse by financing the weapons Two ways to run a business in Somalia... Woman Power

Leaving one half of the land fallow Women do better, smarter things with money More money on family nutrition, medicine, and housing; men spend it on alcohol and tobacco Development officials have learned to give cash to the woman; it will do much more good Other Factors? Saving and investment rates, fertility rates, ethnic strife, colonial history, cultural factors... We know what’s good, then why is it so hard to get out of poverty? It’s one thing to say it, yet it’s another thing to DO it Effective government institutions are easier to build if the people are literate and educated What should rich countries do to help the poor countries? Broad continuum of ideas Jeffrey Sachs says only capital from the developed world will rescue them Spend more there, and you jump-start the development process Should undertake a comprehensive program to fight AIDS in Africa Invest for humanitarian reasons, AND the remote countries in turmoil become outposts of disorder to the rest of the world William Easterly says the development aid process is broken The peasant, his dying chickens, and the priest... Results are miserable at the micro level (mosquito nets become fishing nets or wedding veils) and macro (there is no evidence that current policy is working) We know free markets and good institutions are good, but we don’t know how to get from here to there Easterly says to stop helping poor countries, but focus on creating opportunities for individuals; small, context-centered projects with measurable benefits One study by Harvard Center for International Development found success rates can be explained by government policy Poor countries have bad habits; aid needs to be predicated by good policy This will make aid more effective and provide incentives to governments to improve policy It’s hard to turn away from the neediest case. From 2005 World Bank “Economic Growth in the 1990s: Learning from a decade of reform”:....no confident assertions, no policies to adopt; we need humility, policy diversity, for selective and modest reforms, and for experimentation. We need political will from rich country governments