Dani Rodrik's weblog

The weirdest two sentences together

.... courtesy of an op-ed from Greg Clark:

The African environment has always created high disease mortality. This was a blessing for Africa's living standards.

The rest of the article is not any better. Clark takes Jeff Sachs to task for overlooking the Malthusian situation in which Clark claims Africa finds itself.  But it doesn't look like he has read Sachs carefully. In fact, the Malthusian trap is part of the big-time poverty trap Sachs' big push aims to tackle.  

More from Subramanian on foreign aid

By Arvind Subramanian, guest blogger

Referring to Nancy Birdsall’s response to my Wall Street Journal piece on foreign aid, Dani says that the real issue is not whether aid works but figuring out when it works, and how the aid apparatus can be improved to make aid more effective. I would put it slightly differently. 

The real issue is figuring out the most effective ways that the rich world can help in boosting living standards and improving the other conditions of underdevelopment (poor health, education, sanitation etc.) in developing countries. Aid, by which I mean transferring financial resources to developing country governments, could be one of these ways. But, on the evidence, at least in relation to improving living standards (economic growth), it is by no means the best or even an effective way of providing the help. Yet aid-giving has attracted most of the attention in rich countries. In fact, these are the central messages of a piece in Foreign Affairs, written by Nancy Birdsall, Dani Rodrik, and myself called “How to Help the Poor?” In this piece, we discuss the many other (i.e. non-aid) measures that rich countries could undertake with potentially large impacts, and why these should be pursued at least as seriously, if not more so, than aid. Nancy’s view is that there is no trade-off between doing these other things and giving more aid, and that governments in the rich world can do more of everything. Even if the impulse to help is inexhaustible, I find it difficult to believe that governments and the political process in rich countries—like anywhere else in the world—are not limited in their capacity, time, and attention span, not to mention their willingness to convert this impulse into policy actions.

But leave aside these intuitive arguments and look at some past evidence on other ways in which rich countries have acted (or not). For example, many demonstrably effective ways of helping the poorest, such as financing research to create new agricultural technologies for Africa, have been, and remain, neglected. More tellingly, even if better ways of helping have not been pursued, rich countries have flouted even the Hippocratic rule of doing no harm—and that too on an issue such as improving health and saving lives—while being ostensibly generous with providing aid. I have in mind here the WTO’s intellectual property rules (TRIPs), legislated into being by rich countries, which significantly impede access to low-cost drugs. If health in poor countries were a real concern, especially during these AIDS-ravaged years, TRIPs should never have been legislated. And, while it is true that TRIPs has been recently revised to take account of poor country concerns, that was pretty long in coming and the real effects of the revisions remain uncertain.

I agree with Nancy that celebrities have helped raise awareness of some of the problems of underdevelopment. But the generous impulse to help that such awareness elicits needs to be consistently translated into actions which have a real impact in developing countries. Then we can be more confident that aid is not like looking for the lost key under the lamp post and also that it is not a distraction from the search for the best solutions to help the poorest.

Exporting hazardous products

Suppose a large trading nation is found to export huge quantities of products which have not been subject to proper regulatory oversight at home and create important risks for the buyers. And suppose further that importing nations have had to face serious repercussions as a result. When pressure is brought on the exporter of hazardous products to tighten its act and to increase regulatory cooperation with other nations, the country scoffs and says: "this is a domestic matter; we do not need any international oversight or pressure."

No I am not talking about Chinese toys. I have in mind instead complex financial instruments sold by the U.S.--which having been improperly evaluated by U.S. rating agencies and hence mispriced, and having been marketed abroad in huge quantities, are now wreaking havoc in financial markets everywhere. 

The New York Times reports today that other countries are calling for a say in U.S. regulatory practices:

Politicians, regulators and financial specialists outside the United States are seeking a role in the oversight of American markets, banks and rating agencies after recent problems related to subprime mortgages.

Their argument is simple: The United States is exporting financial products, but losses to investors in other countries suggest that American regulators are not properly monitoring the products or alerting investors to the risks.

...

In general, Washington’s reaction has been that it wants “no form of oversight,” said Kenneth Rogoff, an economics professor at Harvard and a former chief economist of the International Monetary Fund.

...

Banks and investment funds from China to France suffered losses after buying mortgage-related securities and complex financial products based on them in the United States.

In many cases, investors were caught by surprise because American rating agencies had given the products top ratings, leading buyers to believe there was little risk. International investors are also asking why American lenders were allowed to give mortgages to home buyers who could not repay them.

The NYT does not note the parallel with Chinese exports of hazardous toys and other consumer products, but the parallel is too obvious to miss.

Once again, the globalization trilemma rears its head: If you want more economic globalization, you must either accept more global regulation or be willing to pay a higher political cost for adverse side-effects. 

Getting it right on foreign aid

The Center for Global Development's Nancy Birdsall takes on her colleague Arvind Subramanian on foreign aid.  Subramanian had argued in the Wall Street Journal that aid destined for health and other social projects may detract resources and attention from economic growth. Birdsall argues these trade-offs don't really exist.

I feel that the debate on aid is stuck on an unproductive track, revolving around the question of whether it works or not. Yet at closer look, both the advocates and detractors seem to me to be saying something different. So, Jeff Sachs is hardly a fan of the foreign aid system as it currently exists, and he has tons of ideas about how it should be improved in order to become effective (start by cutting back the amount that is returned to rich countries in the form of technical assistance, streamlining the process, and involving the recipients more in the decisions). And Bill Easterly's book on White Man's Burden is full of examples of aid that actually worked (from fighting river blindness to Marshall Plan to the Polish stabilization).

So the real debate is not about whether aid works or not, but about (a) under what circumstances it actually works; (b) how it can be reformed, in principle, to become more effective; and (c) how likely is it that the requisite reforms can in fact be undertaken. The disagreements among Sachs, Easterly, Subramanian, Birdsall et al. are about these questions, but they are often left implicit in the discussion.

We can begin to make progress if we start focusing on these real issues.

Leadership in economics

I teach in a public policy school, so hear constantly about leadership. But economists don't even have the language to talk about how or why leadership matters in economics--even though I guess that deep down most of them think it is very important.

Recently there has been some interesting work that may signal a change.  In an empirical paper, Ben Jones and Ben Olken link shifts in growth performance in countries to changes in the national leader. They find that exogenous leadership transitions (induced by the natural death of existing leaders) generate  effects on policy and growth, particularly in autocracies.  Surprise, surprise, right? Well, at least it has drawn economists' attention to it.

And now, there is a theoretical paper by Sumon Majumdar and Sharun Mukand which looks at how individual characteristics and "objective" circumstances interact in creating leadership "opportunities." Here is the abstract:

Individual leaders have been central to the transformation of organizations, political institutions and many instances of social and economic reform. In this paper we take a first step towards analyzing the role of leadership to ask: when and how does a leader engineer change? We show that while underlying structural conditions and institutions are important, there is an independent first-order role for individual agency in bringing about change and thus transforming the institutions. We emphasize the key nature of the symbiotic relationship between followers decisions' to willingly entrust their faith in the leader and the leader's initiative at leading them. This two-way interaction can endogenously give rise to threshold effects; slight differences in the leader's ability or the underlying structural conditions can dramatically improve the prospects for successful change. Given the centrality of this leader-follower relationship, we further explore conditions under which an individual may deliberately prefer to follow an ambitious leader with divergent interests rather than a benevolent one with congruent preferences. Thus by virtue of having followers, both `good' and `bad' leaders may be effective at bringing about change.

A couple of nice things about the paper. One is that it shows how bad leaders can emerge in equilibrium as well as good leaders. Mugabe versus Mandela, in other words.  Another is that it identifies an important threshold effect: small differences in leaders' ability and in circumstances can make a big difference to the possibility of reform.

Give "A Farewell to Alms" credit

by Ricardo Hausmann, guest blogger

I read Greg Clark's book [A Farewell to Alms] and really liked it. The book is much more effective in destroying previous explanations for the transition to modern growth than it is in proposing a viable alternative. But this is something that Clark acknowledges. He explicitly states that we know very little of the causes behind the transition to high growth. I learned several very important insights from this book. I will list a few:

1- The typical dating of the transition out of the Malthusian equilibrium is probably off by a century or two. This is so because the high productivity growth sectors had a very low weight in output (because productivity increases in the largest sector - agriculture - were low). Weighting growth by the sectoral weights of a later date reveals a break in productivity trends somewhere back in the 17th century. To me this is interesting because I think that what was key was the emergence of activities much less intensive in land and so more scalable. But at low levels of income people spend most of their income in food, thus trapping the economy in an agricultural-centered process, where the Malthusian mechanism of population growth causing declines in income more chance to work. This opens up other explanations for the Industrial Revolution that remain to be explored.

2- It is hard to argue that the lack of diffusion of the industrial revolution in the XIX century was any of the usual suspects in today's most wanted list: poor institutions, lousy finance, lack of human capital. Within the British empire (e.g. in India) property rights were secure, financial markets were pretty open and efficient and there was quite massive transfers of managerial know-how through out-migration of British managers and skilled workers. The slow spread of the industrial revolution in the XIX century is an important puzzle to which the current development debate - which gets most of its intuitions from the post 1960 datasets needs to propose a convincing explanation. Contrary to Dani's opinion, I do find Clark's evidence of the textile industry in the XIXth century interesting, even if today cars in South Africa or textiles in China are produced with world-class productivity. It points, in my mind, to some other missing factor that is not a usual suspect.

3- It would be a pity if the Clark book is dismissed because of his Darwinian argument. I find very interesting the following two facts. First, in olden days incomes were stagnant. Second, in those days, as opposed to now, the rich had substantially more surviving children than the poor. This means that on average there was a rather strong downward social mobility that lasted a pretty long time. I think these are facts and are very convincing as such. I find the idea that this lead to some form of genetic or cultural (why cultural?) selection that triggered changes in something related to the industrial revolution as completely unsubstantiated in the book. Economists use the subjective rate of time preference as a parameter explaining behavior that they take as exogenous. I know of no work that has established whether this is a genetically or a culturally determined parameter or whether it would buy much in terms of triggering a transition to high growth. Clark does show that there was a decline in interest rates, but this was a global phenomenon and not obviously related to the mechanism he has in mind.

My first guest blogger

... is Ricardo Hausmann, my colleague, collaborator and friend.  He didn't know that is what he was doing when he submitted a comment on a previous post, but I thought the comment deserved its own separate entry. So there it is.

New York Times blooper of the day

From today's editorials:

In the absence of policies to boost domestic savings--and thereby slow the build up of debt--a steady decline of the dollar implies a steady decline in American living standards.

What is wrong with this is that it overlooks that a reduction of the U.S. current account deficit necessarily requires a reduction in U.S. expenditures relative to income--and so it entails a reduction in (current) American living standards regardless of whether the adjustment is achieved through currency depreciation or not. In fact, a depreciation reduces the adverse impact on incomes because it raises demand for U.S. tradables.

Iraq, economics, and common sense

Mark Thoma is one of the few commentators who has drawn attention to the non-sensical economic policy imposed on Iraq by the U.S. administration.

Common sense should have dictated that, after the destruction of its infrastructure and the dismantling of its (brutal but stable) government, Iraq didn't need to become a laboratory for neoliberal economics. It needed jobs and basics like electricity, water and sewage systems, and it needed them quickly.

And in response to a Washington Post article describing the failure of efforts to get Iraqi businesses to sell more to the U.S. market, Thoma writes:

Suppose Bush had engaged in a no holds barred attempt to get [American] firms to cooperate in this venture, used his bully pulpit at every opportunity to tell firms it's their patriotic duty and used all the usual slime machine tricks against those who don't cooperate. If he had gone all out and asked his business buddies to sacrifice for the cause (for once), told them that if young men can give their lives, can't you help as well, could that have made a difference? Or was it always hopeless? I've always thought we tried this much too late, so we'll never know for sure.

Why did we wait? The idea initially was that the free market would work its magic and somehow provide the jobs that were needed, so there was no need to protect former state-run enterprises -- those needed to be replaced in the name of efficiency. I wonder if adherence to that ideology rather than adopting a top-down planned approach that kept formerly state-run enterprises open and running (and opened more if needed) from the start would have changed the subsequent course of events. Forget efficiency, there was plenty of time ahead to worry about that, just put people to work doing something, anything. There was plenty that needed to be done.

Thoma is right of course. And it gives me pleasure to welcome him to the industrial policy sympathizers club...

Should the WTO have "property rights" over domestic policies?

The best definition of property rights is the one developed by Grossman, Hart, and Moore, which says that ownership of an asset implies residual control rights--the right to do with the asset as you please subject to restrictions you may have already accepted via a prior contract. Similarly, we can define property rights over domestic policies as the right to formulate them in any way the nation pleases, without violating rights already granted to other nations through pre-existing international agreements.

Now suppose you enter into a contract with the WTO to open up one of your markets. Suppose further that due to changes over time in technology or other conditions which no-one could have foreseen at the time of the initial contract, the substantive implications of the agreement changes. That is, the agreement generates new market access benefits to other countries, and begins to impinge on rights you had not thought (or wished) to have granted away. Who then has residual control rights over these additional benefit flows generated by the exogenous and unforeseen change in circumstances? The WTO or the domestic polity?

This in essence is the question increasingly raised by the "new" trade issues in the WTO. When countries first signed into GATT/WTO, GMOs, currency manipulation, child labor, environmental concerns and a range of other issues did not loom large, either because trade and outsourcing remained small or because the technology was not yet on the horizon. If we now insist on folding these new areas under a literal reading of pre-existing agreements, we risk giving undue property rights to the WTO over domestic policies. 

The case of online gambling, described here, provides an interesting illustration of this process at work. The tiny Caribbean nation of Antigua has taken the U.S. to court in the WTO over the U.S. prohibition of gambling on internet casinos hosted in Antigua. And Antigua has won its case! The WTO ruled that U.S. policies were discriminatory since the country does permit other forms of gambling online, such as "the purchase of lottery tickets, participation in Web-based pro sports fantasy leagues and off-track wagering on horse racing." Now the U.S. either has to rewrite its rules in a way that would de-legalize these forms of gambling as well, or offer compensation to Antigua.

Now, what is interesting here is that according to the New York Times, the WTO agrees that the U.S. did not originally intend to include online gambling when it opened its market to similar services: 

The W.T.O. allowed that Washington probably had not intended to include online gambling when it agreed to the inclusion of “recreational services” and other similar language in agreements reached during the early 1990s, when the W.T.O. was first established. But the organization says it has no choice but to enforce the plain language of the pacts.

So the question is precisely who gets allocated the residual rights in this instance: the international trading regime, or the domestic polity?

This leaves the WTO in a bind. For taking these rules at face value results in decisions such as these that are deeply counterintuitive. As the Harvard law professor Charles Nesson puts it, "people [at the WTO] must be scared out of their wits at the prospects of enforcing a ruling that would instantly galvanize public opinion in the United States against the W.T.O.”

To me, this is another example of how existing WTO practices are leading to the narrowing of policy space to the detriment of legitimacy (and economic logic). When the system serves to enforce new restrictions on domestic policy autonomy that would be wildly unpopular at home, it is time to rethink the system.

My solution would be to redress the balance by restoring the residual rights to the domestic polity, but to do so under multilaterally designed and monitored institutional safeguards (to minimize risks of protectionist capture). See this paper for the details.  

UPDATE: Jim Leitzel over at Vice Squad offers a useful and complementary perspective on the WTO decision, looking at the issue from the perspective of domestic regulatory policy. He writes (in an e-mail to me) "I believe that as a matter of policy, the US should have won this case, even on the horseracing. As a matter of WTO law, I doubt that the US should have won.... I find fault with the US's legal tactics, it is true, but I support their position." Jim explains why in his book Regulating Vice: Misguided Prohibitions and Realistic Controls, forthcoming from Cambridge University Press:

...the pre-existing discriminatory approach is defensible. Allowing (perhaps a handful) of in-state producers to operate under liberalized vice rules is a form of licensing – and restricting the number of licenses in an effort to reduce vice consumption is consistent with a robust policy approach. Perhaps it is best if the licensing restriction is simply numeric, where in-state and out-of-state producers can bid on an even footing for the limited number of licenses. But allowing
free trade commitments to overturn an existing implicit, geographically-based licensing regime presents the possibility that in the short run, there will be no effective constraint on the granting of licenses. Any resulting increase in vice-related problems could provoke a vice prohibition, or a step back from free trade, as opposed to paving the way for the implementation of a theoretically pure, evenhanded-but-numerically-restricted, licensing system.

In a lot of policy areas, governments face similar trade-offs. A purely non-discriminatory approach, even if ideal, may run into practical and administrative difficulties. And when there exists some ambiguity as to whether prior commitments to the WTO have explicitly ruled out non-discrimination in that specific area, letting trade rules trump domestic practices seems to me to be a bad idea.