Unfortunately, in a thorough review of both firm-level and macroeconomic data, Beck, Demirgüç-Kunt, and Levine found no evidence that SME promotion created economic growth or poverty reduction. They sensibly point out that there is nothing sacred about small firms. Firm size reflects many things, such as whether it is more efficient to handle transactions in the marketplace or inside the firm or whether a given technology is more productive at a large or small scale. Some countries and sectors may be more competitive with small firms; others with large firms. There is no reason that aid Planners should try to artificially promote one size firm versus a different size firm.
This skeptical paper caused panic in the pro-SME aid community. I myself got an e-mail from a contractor for an aid agency asking me to write a paper refuting Beck, Demirgüç-Kunt, and Levine. I declined, explaining that academic researchers usually don’t first find the defendant guilty, and then afterward hold a trial.
Other development researchers study many aspects of economic policy, institutions, and politics of poor countries to identify things that seem to contribute to development, based on statistical evidence from household-level, firm-level, and country-level data. These studies point to piecemeal ways to move toward prosperity, such as keeping roads in good condition or pursuing good monetary policies to keep inflation low—not big answers or comprehensive reforms.
Unfortunately, the stubborn survival of the legend of the Big Push, despite evidence of its failure, has continued to foster the planning approach to development. The Planners’ response to failure of previous interventions was to do even more intensive and comprehensive interventions. The next two chapters examine some more of the economic and political complexity that makes these top-down plans fail.
SNAPSHOT: TEENAGE PARAMEDIC
THE DEATH OF MOTHERS during childbirth is virtually unknown in rich countries, but it is tragically common in poor countries. Instead of the new life with childbirth that many of us in rich countries count as the most supreme moment in a lifetime, a family in a poor country must too frequently confront the death of the wife and mother (and often of the newborn baby as well). The woman herself dies in agony due to such causes as the seizures and severe agitation of eclampsia. Eclampsia (and other causes of death in childbirth) can be prevented with prenatal care that recognizes the warning signs and gets the woman to the hospital once she displays those signs. Providing such prenatal care is a major challenge in poor countries.
Feroza Yasmin Shahida is a nineteen-year-old Bangladeshi girl from a poor peasant family. She got a scholarship from a program run by USAID and the World Bank to finish secondary school. Now she is a bicycle paramedic responsible for 515 families in the countryside around Savar, Bangladesh. She is the only health worker these 515 families have. She earns twenty-five dollars a month working for Gonoshasthaya Kendra (GK), the “People’s Health Center.”
GK is the brainchild of Dr. Zafrullah Chowdhury (affectionately called Dr. Zaf ), a Bangladeshi doctor who returned from Britain after Bangladesh won its independence in 1971. Dr. Zaf trained teenage girls to treat common ailments, deliver prenatal and postnatal care to pregnant women, and refer any emergencies to the hospital that he built. Foreign donors and the Bangladeshi government gave Dr. Zaf money, but he also charged his poor patients modest fees to expand services further. He found that even the poor were willing to pay for good service. Charging the poor modest fees for health care—a notion that outrages Planners and anti-globalization activists—is a way to increase accountability for delivering health services. If the villagers don’t get good service after they have sacrificed to pay for it, they loudly complain. Dr. Zaf says, “If a woman dies, the worker has to face the village. Accountability is here.” GK has been successful in lowering maternal deaths in childbirth, infant mortality, and also the number of children that women choose to have. Maternal mortality in the area covered by GK is one fourth of the national average.
If Feroza continues to be one of Dr. Zaf’s best paramedics, she will be promoted to supervisor, with a raise to one hundred dollars a month and a scooter instead of a bicycle. Dr. Zaf searched for and found a piecemeal way to improve the lot of the Bangladeshi poor.
SNAPSHOT: THE SECRET HISTORY OF GRAMEEN BANK
MOHAMMAD YUNUS OF BANGLADESH, the founder of the Grameen Bank and the main inventor of microcredit schemes, didn’t start off with the goal of giving poor people credit. As Columbia University Business School professor Bill Duggan tells the story in a great book about people who find things that work, Napoleon’s Glance, Yunus started off with the conviction that the Green Revolution, and irrigation, was the answer to poverty in Bangladesh. His doctoral dissertation at Vanderbilt University was titled “Optimal Allocation of Multi-Purpose Reservoir Water: A Dynamic Programming Model.” His first attempt to help the poor was to sponsor tube wells for irrigation during the dry season so farmers could grow two crops a year. Yunus gave the farmers a loan out of his own money to finance the scheme. The farmers reaped a good harvest. Ironically for the founder of the idea that the poor can be a good credit risk, the farmers didn’t fully repay Yunus, and he lost money. But he persisted, with the city boy visiting as many rural villages as possible to try to understand how to help. He encountered a woman named Sufiya Begum making a bamboo stool. Begum made a pitiful two cents on every stool, mainly because a moneylender charged her a very high interest rate (around 120 percent per year) to advance her the bamboo. Yunus realized that very small loans to very poor people could make a big difference in their lives. Contrary to conventional wisdom at the time, he realized that the poor had a huge untapped demand for credit. He experimented, and found that microcredit borrowers would repay the loan in order to get access to future loans and also because of peer pressure from other microcredit borrowers. His first loan was to Sufiya Begum, who started a successful peddling business with the money, instead of making more bamboo stools. There was a huge demand for such loans, and Grameen Bank became the legend that it is today, with imitators from all over the world. Yunus was a Searcher.
Microcredit is not a panacea for poverty reduction that some made it out to be after Yunus’s discovery. Some disillusionment with microcredit has already come in response to these blown-up expectations. Microcredit didn’t solve everything; it just solved one particular problem under one particular set of circumstances—the poor’s lack of access to credit except at usorious rates from moneylenders.
CHAPTER THREE
YOU CAN’T PLAN A MARKET
The nature of man is intricate;
the objects of society are of the greatest complexity:
and therefore no simple disposition
or direction of power can be suitable
either to man’s nature
or to the quality of his affairs.
EDMUND BURKE, “REFLECTIONS ON THE
REVOLUTION IN FRANCE,” 179.1
THE FAILURE OF THE Big Push led to some soul-searching among foreign aid agencies, beginning in the 1980s. Maybe the failure was due to poor countries’ interference with free markets. After all, if one of the secrets of Western prosperity was the feedback and accountability of free markets, the most obvious thing the West could do to transform the Rest was to introduce free markets.
The next step in escalation of the White Man’s Burden was to condition aid on the Rest’s adopting a rapid transition to markets. There is usually a sharp division between those who favor free markets and those who don’t, with each camp fearful of ceding any ground to the other. This book arrives at a paradoxical finding: free markets work, but free-market reforms often don’t.
To explain this paradox, this chapter will discuss how introducing free markets from the top down is not so simple. It overlooks the long sequence of choices, institutions, and innovations that have allowed free markets to develop in the rich Western economies. It also overlooks the bottom-up perspective on how markets often don’t function well in the low-income societies of Africa, Latin America, Asia, an
d the former Communist bloc. Markets everywhere emerge in an unplanned, spontaneous way, adapting to local traditions and circumstances, and not through reforms designed by outsiders. The free market depends on the bottom-up emergence of complex institutions and social norms that are difficult for outsiders to understand, much less change.
Paradoxically, the West tried to plan how to achieve a market. Even after evidence accumulated that these outsider-imposed free markets were not working, unfortunately, the interests of the poor did not have enough weight to force a change in Western policy. Planners underestimated how difficult it is to get markets working in a socially beneficial way. People everywhere have to explore with piecemeal, experimental steps how to move toward free markets.
Russian Nights
Russia became a free-market economy on January 1, 1992. At least that’s what the West told the Russians they were becoming when the Russians removed controls on prices and soon after privatized state enterprises, with advice from us hubris-laden Western experts. Western economists wrote a prominent article in 1992 promising Russians that “enormous scope exists for increases in average living standards within a few years.2 The same economists said in December 1991 that the Russian “shock therapy” plan (the top-down imposition of markets) contained “all the essential elements necessary for rapid transition to the market.3
Russia received thirteen structural adjustment loans in the 1990s alone. Thousands of percent inflation and a decade of production collapse later, we outside experts had to admit that the market had not created “enormous scope…for increases in average living standards within a few years.” Overnight transformation to a market economy had joined the list of failed utopian schemes.
Economists like me were slow on the uptake, in that it took us a decade of failure to convince us that top-down imposition of markets did not work. With the World Bank, I was intermittently working on Russia in 1990–1995, and I confess I believed in shock therapy. Like many other Western economists flooding Moscow at the time, I had only the most superficial knowledge of Russian institutions and history. Economists more familiar with the pre-reform Soviet Union were much more prescient. University of Maryland economist Peter Murrell—a longtime student of centrally planned economies—wrote a series of articles in 1991–1993 arguing against shock therapy as utopian social engineering. At the time, he lost the argument. He wrote to me recently that to try to convince other economists of his views was itself a “utopian” project, and he turned his attention to other subjects after 1993. History vindicated Murrell’s scathing description of shock therapy: “There is complete disdain for all that exists…. History, society, and the economics of present institutions are all minor issues in choosing a reform program…. Establishment of a market economy is seen as mostly involving destruction…shock therapists assume that technocratic solutions are fairly easy to implement…. One must reject all existing arrangements.4
Murrell was quick to realize the relevance of Burke and Popper for events in Russia. His quote of Popper in 1992 is a perfect prediction of how Russian reform would fail: “It is not reasonable to assume that a complete reconstruction of our social system would lead at once to a workable system.5
Economists Clifford Gaddy and Barry Ickes, also longtime Soviet experts, closely followed the response of the old Soviet enterprises to the new environment of markets. Shock therapy predicted that those enterprises that were most competitive at the new market–determined prices would expand, while inefficient dinosaurs would go extinct. That is not what happened, according to Gaddy and Ickes. The Soviet plant managers had had a network of relationships with state bureaucrats and other plant managers that enabled the managers to survive. Using the barter and delivery of goods to offset tax liabilities, they managed to keep producing goods nobody wanted in a “virtual economy” that had no resemblance to the fantasies of shock therapists. The share of Russian enterprises that were running losses actually increased in the early years of shock therapy, to 40 percent, and has since remained stable.6
In one illustrative example, the Middle Volga Chemicals Plant in Samara Oblast managed to find a “market” for ten tons of toxic chemicals. It passed these along to the Samara Oblast government in lieu of obligations to pay into the unemployment fund. The Samara government in turn used these chemicals to satisfy its obligation as a relatively rich region to make transfer payments to poor regions. It did so by agreeing with the Russian Ministry of Labor that Samara would ship goods to the unemployment compensation fund in the poor republic of Mari-El. So the ten tons of toxic chemicals wound up in Yoshkar-Ola, the capital of Mari-El. What the unemployed workers in Mari-El did with ten tons of toxic chemicals is not known.7
As this example suggests, some Soviet enterprises were surviving even though they were using up valuable inputs to produce worthless outputs. They got subsidized electricity and gas from the state electricity and gas monopolies. The latter, Gazprom, was sitting on huge deposits of natural gas, and was one of the few sources of genuine value creation in the economy. Many other enterprises were actually destroying value rather than creating it. They could sustain the demand for their worthless output by using their Soviet-era relationships with other worthless firms. For example, enterprise A could produce some crap that enterprise B would accept as an input to produce its own crap, which B in turn would pass along to enterprise C, who would close the loop by selling its crap as an input back to enterprise A. Meanwhile, A, B, and C were all using up valuable gas and electricity. The Soviet-trained plant managers at the bottom outwitted the shock therapists at the top. The local and often the federal authorities went along with the game because they did not want to face large-scale unemployment.
As far as companies that were actually producing value were concerned, they were the target more of private looting than of private entrepreneurial activity. The Russian “free-market reforms” included privatization of former state enterprises. The reforms followed the disastrous sequence of free markets and privatization without first creating the rules that make profit-seeking behavior beneficial to society. Searchers in markets need rules or else they become opportunists who benefit at others’ expense. In 1995, in return for support of the “pro-market reformer” Boris Yeltsin, for example, Russian tycoons snatched up the valuable firms at bargain-basement prices. At the auction of the prize oil company Yukos, the Yeltsin government excluded bids from foreign buyers, eliminating most deep-pocket competitors. The Yeltsin government also allowed the banks running the auction to bid on the properties they themselves were auctioning. So Mikhail Khodorkovsky could bid on the auction of Yukos, even though he owned the bank running the auction, Menatep. Russian privatization chief Alfred Kokh alleged that Khodorkovsky used the money of Yukos itself to bid for Yukos, perhaps by pledging future oil deliveries in return for loans. He managed to buy 77 percent of Yukos shares for $309 million in December 1995.8 This was a pretty good deal for a company that by 2003 reached a market valuation of $30 billion.9 Khodorkovsky joined the top ranks on Forbes ’s annual billionaires list.
Thirteen years after the official crusade to remake Russia in the image of the United States began, the patient is ailing. This is not just a metaphor: the Russians are dying at alarming rates. After the collapse of communism, the Russian suicide rate increased by 50 percent. Life expectancy increased almost everywhere else except for AIDS-crisis countries, but it declined in Russia, especially for men (see figure 3). This trend began in the latter decades of the Soviet Union, and has continued in post-Soviet Russia.10
Fig. 3. Life Expectancy for Men in Russia and Developed Countries, from UNDP Russia Human Development Report
After the Western illusion of supporting “democratic reformers” such as Yeltsin, Yeltsin’s anointed successor, Vladimir Putin, stamped out much of the little democracy Yeltsin had left behind. In 2004, Freedom House downgraded Russia from “partly free” to “not free.” Putin went after Mikhail Khodorkovsky for alleged nonpayment of taxes (a crime that woul
d apply to most of the Russian population). A court convicted Khodorkovsky in May 2005 and sentenced him to nine years in prison.
The Russian economy has registered strong growth since the crisis of 1998, but this is only partial recovery from a deep trough. Russian per capita income in 2004 was still 17 percent below the Soviet peak in 1989. The public is underwhelmed: in a survey in December 2004, 41 percent of the population viewed the economy’s performance as “poor,” while a more sanguine 46 percent described it as “mediocre.” After seven years of “transition,” 70 percent of the Russian population in 1999 thought the country was headed in the “wrong direction.” After partial economic recovery, Russians cheered up enough that only 56 percent thought it was still going in the wrong direction in January 2005.11
The Flight of Icarus
Shock therapy was the application to Russia of what the World Bank and the IMF called “structural adjustment,” which in turn was heir to the Big Push. Structural adjustment loans were the brainchild of World Bank president Robert McNamara and his deputy, Ernest Stern, who sketched out the idea on a flight the two took together to the World Bank/IMF Annual Meeting in Belgrade in late September 1979. Structural adjustment loans were given to finance imports, and were conditional upon countries adopting free markets. The IMF, which had already been doing conditional loans for a long time, signed on to the new idea. What was the inspiration for what turned out to be a historic World Bank mistake of financing comprehensive reforms instead of financing piecemeal improvements? The idea was that developing countries needed the big reforms in order for individual projects to be productive, hence the escalation of World Bank intervention.
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