Naked Economics

by Wheelan, Charles

  If you think it is to curtail trade, let me present a slightly different version of the same basic challenge. China and India are sending more and more of their citizens to university (while extending basic education more widely, too). Education is making China and India richer. As they get richer, they use more energy…Do you see where this is going? Should we ban education?

  No. The answer to the CO2 problem is to promote growth—in India, China, the United States, and everywhere else—in ways that minimize the environmental damage. The best way to do that is to discourage the use of dirty fuels by imposing some kind of carbon tax that is harmonized across countries—sooner rather than later, because India and China are making development decisions, such as building power plants, that are going to be with us for fifty years.

  The case for keeping people poor because it’s good for the planet is economically and morally bankrupt.

  Poverty is a bitch. The principal of a high school near Chicago’s Robert Taylor housing projects once told me that when I was writing a story on urban education. He was talking about the challenges of teaching kids who had grown up poor and deprived. He might as well have been talking about the state of the world. Many parts of the world—places we rarely think about, let alone visit—are desperately poor. We ought to make them richer; economics tells us that trade is an important way to do it. Paul Krugman has nicely summarized the anxiety over globalization with an old French saying: Anyone who is not a socialist before he is thirty has no heart; anyone who is still a socialist after he is thirty has no head. He writes:

  If you buy a product made in a third-world country, it was produced by workers who are paid incredibly little by Western standards and probably work under awful conditions. Anyone who is not bothered by those facts, at least some of the time, has no heart. But that doesn’t mean the demonstrators are right. On the contrary, anyone who thinks that the answer to world poverty is simple outrage against global trade has no head—or chooses not to use it. The anti-globalization movement already has a remarkable track record of hurting the very people and causes it claims to champion.22

  The trend toward more global trade is often described as an unstoppable force. It is not. We’ve been down this road before, only to have the world trading system torn apart by war and politics. One of the most rapid periods of globalization took place during the end of the nineteenth century and the beginning of the twentieth. John Micklethwait and Adrian Wooldridge, authors of A Future Perfect, have noted, “Look back 100 years and you discover a world that by many economic measures was more global than it is today: where you could travel without a passport, where the gold standard was an international currency, and where technology (cars, trains, ships, and telephones) was making the world enormously smaller.” Alas, they point out, “That grand illusion was shot to pieces on the playing fields of the Somme.”23

  Political boundaries still matter. Governments can slam the door on globalization, as they have before. That would be a shame for rich countries and poor countries alike.

  CHAPTER 13

  Development Economics:

  The wealth and poverty of nations

  Let us briefly contemplate the life of Nashon Zimba, a twenty-five-year-old man who lives with his wife and baby daughter in Malawi. There is no question that Mr. Zimba is a hardworking man. He built his own home, as The Economist describes:

  He digs up mud, shapes it into cuboids and then dries it in the sun to make bricks. He mixes his own cement, also from mud. He cuts branches to make beams, and thatches the roof with sisal or grass. His only industrial input is the metal blade on his axe. Working on his own, while at the same time growing food for his family, Mr. Zimba has erected a house that is dark, cramped, cold in the winter, steamy in summer and has running water only when tropical storms come through the roof.1

  For all that work, Mr. Zimba is a poor man. His cash income in 2000 was roughly $40. He is hardly alone. Malawian GDP per capita was less than $200 at the time that story was written. Even today, the nation’s entire annual economic output is only about $12 billion—or about half the size of Vermont’s economy. Lest anyone naively believe that there is something pleasantly simple about this existence, it should be pointed out that 30 percent of young children in Malawi are malnourished; more than two of every ten children will die before they reach their fifth birthday.

  According to the UN’s Food and Agriculture Organization, there are a billion people in the world who don’t get enough to eat. The vast majority are in the developing world; roughly half are in India and China. How is that possible? At a time when we can split the atom, land on the moon, and decode the human genome, why do 2 billion people live on less than $2 a day?2

  The short answer is that their economies have failed them. At bottom, creating wealth is a process of taking inputs, including human talent, and producing things of value. Poor economies are not organized to do that. In his excellent book on economic development, The Elusive Quest for Growth, World Bank economist William Easterly describes a street scene in Lahore, Pakistan:

  People throng the markets in the old city, where the lanes are so narrow that the crowds swallow the car. People buying, people selling, people eating, people cooking. Every street, every lane crammed with shops, each shop crammed with people. This is a private economy with a lot of dynamism.3

  It is also, he notes, a country that is largely illiterate, ill housed, and ill fed. The Pakistani government has built nuclear weapons but is unable to conduct an immunization program against measles. “Wonderful people,” writes Mr. Easterly. “Terrible government.” And it is a terrible government that has become increasingly dangerous for the rest of the world. We can (probably) safely ignore Malawi. Not Pakistan.

  Every country has resources, if only the wits and hard work of the people who inhabit it. Most countries, including some of the poorest nations on earth, have far more resources than that. Let me get the bad news out of the way: Economists do not have a recipe for making poor countries rich. True, there have been some fabulous success stories, such as the original Asian “tigers”—Hong Kong, Singapore, South Korea, and Taiwan—which saw their economies grow more than 8 percent a year for nearly three decades. China and India have had a terrific decade, much to the benefit of hundreds of millions of people. But we do not have a proven formula for growth that can be rolled out in country after country like some kind of development franchise. Just think about China and India: One is the world’s largest democracy; the other is not democratic at all.

  On the other hand, we do have a good understanding of what makes rich countries rich. If we can catalog the kinds of policies that functional economies have in common, then we can turn our attention to Nobel laureate Douglass North’s common-sense query “Why don’t poor countries simply adopt policies that make for plenty?”4

  The following is a sample of the kinds of policies and, in some cases, lucky geographical endowments that development economists have come to believe make the difference between the wealth and poverty of nations.

  Effective government institutions. To grow and prosper, a country needs laws, law enforcement, courts, basic infrastructure, a government capable of collecting taxes—and a healthy respect among the citizenship for each of these things. These kinds of institutions are the tracks on which capitalism runs. They must be reasonably honest. Corruption is not merely an inconvenience, as it is sometimes treated; it is a cancer that misallocates resources, stifles innovation, and discourages foreign investment. While American attitudes toward government range from indifference to hostility, most other countries would love to have it so good, as New York Times foreign affairs columnist Tom Friedman has pointed out:

  I took part in a seminar two weeks ago at Nanjing University in China, and I can still hear a young Chinese graduate student pleading for an answer to her question: “How do we get rid of all our corruption?” Do you know what your average Chinese would give to have a capital like Washington today, with its reasonably h
onest and efficient bureaucracy? Do you know how unusual we are in the world that we don’t have to pay off bureaucrats to get the simplest permit issued?5

  The relationship between government institutions and economic growth prompted a clever and intriguing study. Economists Daron Acemoglu, Simon Johnson, and James Robinson hypothesized that the economic success of developing countries that were formerly colonized has been affected by the quality of the institutions that their colonizers left behind.6 The European powers adopted different colonization policies in different parts of the world, depending on how hospitable the area was to settlement. In places where Europeans could settle without serious hardship, such as the United States, the colonizers created institutions that have had a positive and long-lasting effect on economic growth. In places where Europeans could not easily settle because of a high mortality rate from disease, such as the Congo, the colonizers simply focused on taking as much wealth home as quickly as possible, creating what the authors refer to as “extractive states.”

  The study examined sixty-four ex-colonies and found that as much as three-quarters of the difference in their current wealth can be explained by differences in the quality of their government institutions. In turn, the quality of those government institutions is explained, at least in part, by the original settlement pattern. The legal origin of the colonizers—British, French, Belgian—had little influence (though the British come out looking good because they tended to colonize places more hospitable to settlement).

  Basically, good governance matters. The World Bank rated 150 countries on six broad measures of governance, such as accountability, regulatory burden, rule of law, graft (corruption), etc. There was a clear and causal relationship between better governance and better development outcomes, such as higher per capita incomes, lower infant mortality, and higher literacy.7 We don’t have to love the Internal Revenue Service, but we ought to at least offer it some grudging respect.

  Property rights. Private property may seem like a province of the rich; in fact, it can have a crucial impact on the poor. The developed world is full of examples of informal property rights—homes or businesses built on land that is communal or owned by the government and ignored (such as the shantytowns on the outskirts of many large cities). Families and entrepreneurs make significant investments in their “properties.” But there is a crucial difference between those assets and their counterparts in the developed world: The owners have no legal title to the property. They cannot legally rent it, subdivide it, sell it, or pass it on to family. Perhaps most important, they cannot use it as collateral to raise capital.

  Peruvian economist Hernando de Soto has argued convincingly that these kinds of informal property arrangements should not be ignored. He reckons that the total value of property held but not legally owned by poor people in the developing world is worth more than $9 trillion. That is a lot of collateral gone to waste, or “dead capital” as he calls it. To put that number in perspective, it is 93 times the amount of development assistance that the rich countries provided to the developing world over the past three decades.

  The Economist tells a story of a Malawian couple who make a living slaughtering goats. Since business is good, they would like to expand. To do so, however, would require an investment of $250—or $50 more than the average annual income in Malawi. This couple “owns” a home worth more than that. Might they borrow against the value of their land and the bungalow they have built on it? No. The home is built on “customary” land that has no formal title. The couple has a contract signed by the local village chief, but it is not enforceable in a court of law. The Economist goes on to note:

  About two-thirds of the land in Malawi is owned this way. People usually till the land their parents tilled. If there is a dispute about boundaries, the village chief adjudicates. If a family offends gravely against the rules of the tribe, the chief can take their land away and give it to someone else.8

  Those informal property rights are like barter—they work fine in a simple agrarian society, but are woefully inadequate for a more complex economy. It is bad enough that poor countries are poor; it is all the worse that their most valuable assets are rendered less productive than they might be.

  Property rights have another less obvious benefit: They enable people to spend less time defending their possessions, which frees them up to do more productive things. Between 1996 and 2003, the Peruvian government issued property rights to 1.2 million urban squatter households, giving them formal ownership to what they had previously informally claimed as their own. Harvard Economist Erica Field determined that property rights enabled residents to work more hours in the formal labor market. She surmises that property rights give more flexibility to people who previously had to stay home, or had to operate improvised businesses out of their home, in order to protect their property. She also makes another important point: Most programs designed to help the poor reduce their work effort. (This is the Samaritan’s dilemma; if I ease your hardship, you have less incentive to help yourself.) Providing formal property rights does the opposite: It encourages work.9

  No excessive regulation. Government has plenty to do—and even more that it should not do. Markets must do the heavy lifting. Let’s talk about articles 575 and 615 of the Russian civil code. These regulations would be very important if you were a firm in Moscow doing something as simple as installing a vending machine. Article 575 forbids firms from giving anything away free, which includes the space that a firm “gives” to Coca-Cola when a vending machine is installed. Meanwhile, article 615 forbids subletting property without the landlord’s consent; the square meter taken up by the vending machine can be construed as a sublease. In addition, the tax collector forbids commercial enterprises (e.g., vending machines) to operate without a cash register. And since selling soft drinks from a machine constitutes retail trade, there are assorted fire, health, and safety inspections.10

  Excessive regulation goes hand in glove with corruption. Government bureaucrats throw up hurdles so that they can extort bribes from those who seek to get over or around them. Installing a vending machine in Moscow becomes much easier if you hire the right “security firm.” What about opening a business elsewhere in the developed world? Again, Peruvian economist Hernando de Soto has done fascinating work. He and fellow team members documented their efforts to open a one-person clothing stall on the outskirts of Lima as a legally registered business. He and his researchers vowed that they would not pay bribes so that their efforts would reflect the full cost of complying with the law. (In the end, they were asked for bribes on ten occasions and paid them twice to prevent the project from stalling completely.) The team worked six hours a day for forty-two weeks in order to get eleven different permits from seven different government bodies. Their efforts, not including the time, cost $1,231, or 31 times the monthly minimum wage in Peru—all to open a one-person shop.11

  Chapter 4 outlined all the reasons government should stick to the basics. Harvard economist Robert Barro’s classic study of economic growth in roughly one hundred countries over three decades found that government consumption—total government spending excluding education and defense—was negatively correlated with per capita GDP growth. He concluded that such spending (and the required taxation) is not likely to increase productivity and will therefore do more harm than good. The Asian tigers, the all-star team in the economic development league, made their economic ascent with government spending in the range of 20 percent of GDP. Elsewhere in the world, high tax rates that are applied unevenly distort the economy and provide opportunities for graft and corruption. Many poor governments might actually collect more revenue if they implemented taxes that were low, simple, and easy to collect.

  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 c
ompare 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.”12

  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.