Good Economics for Hard Times

by Abhijit V. Banerjee

  And yet all of these economists were also wrong, because they thought of economic growth and of a country’s resources as aggregate things (the “labor force,” the “capital,” the “GDP”), and in doing so they probably missed the key point. Everything we have learned about misallocation tells us we have to step beyond the models and think of how the resources are used. If a country starts by using its resources very badly, like China did under communism or India did in its days of extreme dirigisme, then the first benefits of reform may come from moving resources to their best uses. Perhaps the reason why some countries, like China, can grow so fast for so long is that they start with a lot of poorly used talent and resources that can then be harnessed. This is neither Solow’s nor Romer’s world, in which a country would need either new resources or new ideas to grow. It might also suggest the growth could slow down rapidly, once those wasted resources have all been put to good use, and growth becomes dependent on additional resources. Much is being written about the economic slowdown in China; growth is definitely slowing down and that is probably to be expected. This trend will almost surely continue, whatever Chinese leaders do now. China accumulated resources rapidly, as it had plenty of room to catch up; in the process, the most blatant sources of misallocation were eliminated, which means there is less room to improve now. The Chinese economy relied on exports to provide know-how, investment, and endless (for a while) global demand. But now they are the largest exporter in the world, so they cannot possibly continue to grow their exports much faster than the world is growing. China (and the rest of the world) will have to come to terms with the reality that their era of breathtaking growth is likely coming to an end.

  In terms of what is to come, it looks like the United States can relax a bit. In 1979, Harvard professor Ezra Vogel published a book, Japan as Number One, that predicted Japan would soon overtake all other countries to become the number one economic superpower. Western countries, he argued, needed to learn from the Japanese model. Good labor relations, low crime, excellent schools, and elite bureaucrats with long time horizons was the new recipe Vogel identified for permanently faster growth.119

  Indeed, had it continued to grow at its average growth rate over the decade 1963–1973, Japan would have overtaken the United States in terms of GDP per capita by 1985, and in overall GDP by 1998. It did not happen. What happened instead is enough to make one superstitious. The growth rate crashed in 1980, the year after Vogel’s book came out. And it never really recovered.

  The Solow model suggests a simple reason. Due to a low fertility rate and the near complete absence of immigration, Japan was (and still is) aging rapidly. The working-age population peaked in the late 1990s and has been declining. This means TFP must grow all the more rapidly to keep fast growth going. Another way to say this is that Japan would have to find some miracle for its existing labor force to become more productive, since we still have no reliable way to boost TFP.

  In the euphoria of the 1970s, some believed this to be possible, which may explain why people continued to save and invest in Japan in the 1980s, despite the slowdown. Too much good money chased too few good projects in the so-called bubble economy of the 1980s, with the consequence that banks ended up with many bad loans and a huge crisis in the 1990s.

  China faces some of the same problems. It is aging fast, partly as a result of the one-child policy, which has proven difficult to reverse. It might still eventually catch up with the United States in per capita terms, but the slowing growth means it will take quite a while. If China slows to 5 percent per year, which is not implausible, and stays there, which is perhaps optimistic, and the United States continues to bounce around 1.5 percent, it will take at least thirty-five years for China to catch up with the US in terms of per capita income. Meanwhile, the Chinese authorities may also want to relax and accept the writ of Solow. Growth will slow.

  They are aware of it, and have made a conscious attempt to alert the Chinese people to this fact, but the growth targets they have set may still be too high. The danger is that it could put the leadership in a bind and lead them to make bad decisions in an effort to make growth come back, as Japan did before them.

  If a fundamental driver of economic growth is resource misallocation, it opens the door to various unorthodox strategies to make growth happen. Such strategies are meant to respond to the particular way in which resource use in a country is distorted. The Chinese and the South Korean governments did a good job of identifying sectors that were too small and therefore not meeting the economies’ needs (they tended to be heavy industry providing basic raw materials to other industries, like steel and chemicals) and directed capital toward them through state investments and other interventions. This might have sped up the transition to efficient resource use.120

  That it worked in those two countries does not necessarily mean it is something every country should emulate. Economists tend to be very wary of industrial policy, for good reasons. The history of state-directed investments is not one that inspires confidence; judgments are frequently bad even when they are not actually deliberately distorted to benefit someone or some group, which is often. These are “government” failures just as there are market failures, and there are so many instances of these that it would be very dangerous to blindly rely on governments to pick the winners. But there are also so many market failures that it makes no sense either to rely on the market alone to allocate resources to the right use; we need an industrial policy designed that keeps in mind these political constraints.

  Another implication of the idea that growth is slowed down by misallocation is that countries like India that are growing fast right now should fear complacency. It is relatively easy to grow fast, starting from a spectacularly messed-up economy, because of the gains from better resource use. In Indian manufacturing there was a sharp acceleration in technology upgrading at the plant level, and some reallocation toward the best firms within each industry after 2002. This appears to be unrelated to any economic policy, and is described as “India’s mysterious manufacturing miracle.”121 But it is no miracle. At its root, it is a modest improvement from a dismal starting point, and one can imagine various reasons it happened. Perhaps a generational shift, as control passed from the parents to their children, often educated abroad, more ambitious, and savvier about technology and world markets. Or the effect of the accumulation of modest profits that eventually made it possible to pay for the shift to bigger and better plants.

  But as the economy sheds its worst plants and firms, the space for further improvement naturally shrinks. Growth in India, like that in China, will slow. And there is no guarantee it will slow when India has reached the same level of per capita income as China. When China was at the same level of per capita GDP as India is today, it was growing at 12 percent per year, whereas India thinks of 8 percent as something to aspire to. If we were to extrapolate from that, India will plateau at a much lower level of per capita GDP than China. The growth tide does raise all boats, but it doesn’t lift all boats to the same level—many economists worry that there may be such a thing as the middle-income trap, an intermediate-level GDP where countries get stuck or nearly stuck. According to the World Bank, of 101 middle-income economies in 1960, only 13 had become high income by 2008.122 Malaysia, Thailand, Egypt, Mexico, and Peru all seem to have trouble moving up.

  Of course, there are many pitfalls in any such extrapolation, and India should treat it as what it is: no more than a warning. It is quite possible that India’s growth, in spite of all of its problems, has very little to do with some special Indian genius. Instead, it has a lot to do with the flip side of misallocation: the opportunities of being an economy with a large pool of potential entrepreneurs to draw upon and lots of unexploited opportunities.

  CHASING THE GROWTH MIRAGE

  If this is the right story, India should start to worry about what happens when those opportunities begin to run out. Unfortunately, just as we don’t know much about how to make growth
happen, we know very little about why some countries get stuck but others don’t—why South Korea kept growing but Mexico did not—or how one gets out. One very real danger is that in trying to hold on to fast growth, India (and other countries facing sharply slowing growth) will veer toward policies that hurt the poor now in the name of future growth. The need to be “business friendly” to preserve growth may be interpreted, as it was in the US and UK in the Reagan-Thatcher era, as open season for all kinds of anti-poor, pro-rich policies (such as bailouts for overindebted corporations and wealthy individuals) that enrich the top earners at the cost of everyone else, and do nothing for growth.

  If the US and UK experience is any guide, asking the poor to tighten their belts, in the hope that giveaways to the rich will eventually trickle down, does nothing for growth and even less for the poor. If anything, the explosion of inequality in an economy no longer growing has the risk of being very bad news for growth, because the political backlash leads to the election of populist leaders touting miracle solutions that rarely work and often lead to Venezuela-style disasters.

  Interestingly, even the IMF, so long the bastion of growth-first orthodoxy, now recognizes that sacrificing the poor to promote growth was bad policy. It now requires its country teams to include inequality in factors to take into consideration when providing policy guidance to countries and outlining conditions under which they can receive IMF assistance.123

  The key ultimately is to not lose sight of the fact that GDP is a means and not an end. A useful means, no doubt, especially when it creates jobs or raises wages or plumps the government budget so it can redistribute more. But the ultimate goal remains one of raising the quality of life of the average person, and especially the worst-off person. And quality of life means more than just consumption. As we saw in the previous chapter, most human beings care about feeling worthy and respected; they suffer when they feel they are failing themselves and their families. While better lives are indeed partly about being able to consume more, even very poor people also care about the health of their parents, about educating their children, about having their voices heard, and about being able to pursue their dreams. A higher GDP may be one way in which this can be given to the poor, but it is only one of the ways, and there is no presumption that it is always the best one. In fact, the quality of life varies enormously between middle-income countries. For example, Sri Lanka has more or less the same GDP per capita as Guatemala but maternal, infant, and child mortality are much lower in Sri Lanka (and are comparable with those in the United States).124

  DELIVERING WELL-BEING

  More generally, looking back, it is quite clear that many of the important successes of the last few decades were the direct result of a policy focus on those particular outcomes, even in some countries that were and have remained very poor. For example, a massive reduction in under-five mortality took place even in some very poor countries that were not growing particularly fast, largely thanks to a focus on newborn care, vaccination, and malaria prevention.125 And it is no different with many of the other levers for fighting poverty, be it education, skills, entrepreneurship, or health.We need a focus on the key problems and an understanding of what works to address them.

  This is patient work; spending money by itself does not necessarily deliver real education or good health. But the good news is that by contrast to growth we know how to make progress here. One big advantage of focusing on clearly defined interventions is that these policies have measurable objectives and therefore can be directly evaluated. We can experiment with them, abandon the ones that do not work, and improve the ones with potential.

  The recent history of malaria is a good example. Malaria is one of the biggest killers of small children and a disease preventable by avoiding mosquito bites. Since the 1980s, the number of malaria deaths had been rising every year. At the peak in 2004 there were 1.8 million deaths from malaria. Then in 2005 there was a dramatic turning point. Between 2005 and 2016, the number of deaths from malaria declined by 75 percent.126

  Many factors probably contributed to the decrease in the number of malaria deaths, but the widespread distribution of insecticide-treated bed nets almost surely played a key role. Overall, the benefits of nets are well established. In 2004, a review of the evidence from twenty-two carefully done randomized controlled trials found that, on average, one thousand more nets distributed contributed to a reduction of 5.5 deaths per year.127 As we described in Poor Economics, however, there was a big debate at the time on whether nets should be sold to beneficiaries (at a subsidized price) or given for free.128 But an RCT by Pascaline Dupas and Jessica Cohen,129 replicated since then by several other studies, established that free nets are in fact used just as much as nets that are paid for, and free distribution achieves a much higher effective coverage than cost sharing. Since Poor Economics was published in 2011, this evidence eventually convinced the key players that massive distribution was the most effective way to fight malaria. Between 2014 and 2016, a total of 582 million insecticide-treated mosquito nets were delivered globally. Of these, 505 million were delivered in Sub-Saharan Africa and 75 percent were distributed through mass distribution campaigns of free bed nets.130 The magazine Nature concluded that insecticide-treated net distributions averted 450 million malaria deaths between 2000 and 2015.131

  The accumulation of evidence took some time, but it worked. Even the skeptics were convinced. Bill Easterly who in 2011 was an outspoken critic of free bed net distribution, gracefully acknowledged in a tweet that his nemesis Jeff Sachs was more right than he was on this particular issue.132 The right policy choices were made, leading to tremendous progress against a terrible scourge.

  The bottom line is that despite the best efforts of generations of economists, the deep mechanisms of persistent economic growth remain elusive. No one knows if growth will pick up again in rich countries, or what to do to make it more likely. The good news is that we do have things to do in the meantime; there is a lot that both poor and rich countries could do to get rid of the most egregious sources of waste in their economies. While these things may not propel countries to permanently faster growth, they could dramatically improve the welfare of their citizens. Moreover, while we do not know when the growth locomotive will start, if and when it does, the poor will be more likely to hop onto that train if they are in decent health, can read and write, and can think beyond their immediate circumstances. It may not be an accident that many of the winners of globalization were ex-communist countries that had invested heavily in the human capital of their populations in the communist years (China, Vietnam) or countries threatened with communism that had pursued similar policies for that reason (Taiwan, South Korea). The best bet, therefore, for a country like India is to attempt to do things that can make the quality of life better for its citizens with the resources it already has: improving education, health, and the functioning of the courts and the banks, and building better infrastructure (better roads and more livable cities, for example).

  For the world of policy makers, this perspective suggests that a clear focus on the well-being of the poorest offers the possibility of transforming millions of lives much more profoundly than we could by finding the recipe to increase growth from 2 percent to 2.3 percent in the rich countries. In the coming chapters, we will go one step further and argue that it may even be better for the world if we did not find that recipe.

  CHAPTER 6

  IN HOT WATER

  IN 2019, IT IS IMPOSSIBLE to think about economic growth without confronting its most immediate implication.

  We already know that over the next hundred years the earth will become warmer; the question is by just how much. The costs of climate change would be quite different if the planet got warmer by 1.5°C, or 2°C, or more. According to the Intergovernmental Panel on Climate Change (IPCC) October 2018 report, at 1.5°C, 70 percent of coral reefs would vanish. At 2°C, 99 percent.1 The number of people directly impacted by the rise in sea levels and the transforma
tion of cultivable land into desert would also be quite different under the two scenarios.

  The overwhelming scientific consensus is that human activity is responsible for climate change, and the only way to stay on a course to avoid catastrophe is to reduce carbon emissions.2 Under the 2015 Paris Agreement, nations set a target to limit warming to a limit of 2°C, with a more ambitious target of 1.5°C. Based on the scientific evidence, the IPCC report concludes that in order to limit warming to 2°C, CO2 equivalent (CO2e) emissions3 would need to be reduced by 25 percent by 2030 (compared to the 2010 level) and go to zero by 2070. To reach 1.5°C, CO2e emissions would need to go down by 45 percent by 2030 and to zero by 2050.

  Climate change is massively inequitable. The lion’s share of CO2e emissions are being generated either in rich countries or to produce what people consume in rich countries. But the greatest share of the cost is, and will be, experienced in poor countries. Does it make it an intractable problem, given that those who must solve it have no strong impetus to do so? Or is there some hope?

  THE 50-10 RULE

  The IPCC report details everything that would have to be done to cut emissions and limit warming to 1.5°C. Some steps could already be taken; switching to electric cars, constructing zero-emissions buildings, building more trains would all help. But the bottom line is that, even with technological improvements, and even if we could wean ourselves off coal entirely, without any movement toward more sustainable consumption, any future economic growth will have a large direct impact on climate change. This is because as consumption rises we need energy to produce all the things that are consumed. We generate CO2 emissions not only when we drive our cars, but also when we leave them in our garages, since energy was used in producing the car and the garage. That is true even for electric cars. There are many studies that attempt to look at the relationship between income and carbon emissions. The answer varies with climate, family size, and so on, but the two always track each other closely. The average estimate implies that when your income increases by 10 percent, your CO2 emissions increase by 9 percent.4