Does health aid to governments make governments spend more on health?

If you’re not an economist, you might reasonably assume that the answer to this question is yes. The story might go something like this: aid agencies give money to poor country governments to distribute bed nets or give vaccinations, and those additional funds are added to whatever money the country was able to scrape together to spend on health before the donor came along. As a result of the health aid, the total amount of money spent on health increases. There is new evidence, from a study from the Institute for Health Metrics and Evaluation published in the Lancet last week, showing that this story doesn’t describe what’s really going on. Overall, global public health financing shot up by 100 percent over the last decade, but the study’s authors found that on average, for every health aid dollar given, developing country government shifted between $.43 and $1.17 of their own resources away from health. The trend is most pronounced in Africa, which received the largest amount of health aid.

The finding that health aid substitutes for rather than complements existing government health spending has caused a mini- scandal in the press precisely because it runs so counter to people’s optimistic expectations, perpetuated by aid agencies’ fund-raising campaigns, about the level of control that donors can exert over the spending of developing country governments.

Economists, on the other hand, have been beating the dismal drum for a long time on this issue. In 1947, Paul Rosenstein-Rodin, then a deputy director at the World Bank, famously said, “When the World Bank thinks it is financing an electric power station, it is really financing a brothel.” Economists expect that aid will be at least partially fungible (that is, that aid money intended by donors for one sector or project can and will be used by governments interchangeably with funding for other priorities), and this prediction is borne out by empirical studies from the late 1980s on. The authors of a 2007 paper in the Journal of Development Economics observed, “While most economists assume that aid is fungible, most aid donors behave as if it is not.”

You might argue (as Owen Barder does in depth here) that recipient governments are acting rationally in response to erratic donor funding, which ebbs and flows according to donor priorities and how well the global community mobilizes fundraising around a particular issue in any given year. After all, doesn’t the donor community’s insistence on country ownership mean that they want poor country governments to be able to set their own budget priorities?

The problem is that aid agencies have long used the argument that earmarking aid for a specific project or sector is a credible way to force recalcitrant recipient country priorities into line with donor priorities—to coerce bad governments into making good decisions.

If  governments that don't prioritize their people's welfare respond to an influx of aid money by simply shifting their existing resources around to circumvent donor priorities (and we don’t know what is happening to the resources shifted away from health—they could be going to private jets and presidential palaces, or to education, infrastructure, or loan repayments, or really anything at all),  then the aid agency argument for project aid falls apart. The burden of proof correctly lies with the aid agencies to show that aid isn’t freeing up funds for bad governments to use badly.

The Lancet findings are scandalous, relative to the naïve but widespread belief that donors can use earmarked aid to force bad governments to behave.

Gujarati hotels and Chaldean liquor stores

UPDATE 2 (3/27, 8:24am EDT) Great academic paper on Jewish domination of the diamond trade (see end of post) UPDATE (3/26, 12:34EDT) Great NYT mag article explaining the details of the Gujarati hotel story (see end of post)

I’ve long been fascinated by the Vietnamese nail salon phenomenon. My female friends report a remarkably high concentration of Vietnamese women in nail salons in US cities. I even heard there was a nail trade magazine for the US market that is in Vietnamese. Alas I was never able to do more to document this systematically. Today I happened to stumble over a University of Chicago Ph.D. dissertation by Martin Mandorff that finally nailed it (bad pun was unavoidable).

Mandorff shows that ethnic specialization is remarkably widespread among US immigrants. The following table from 2000 census data shows the leading specializations (the OVER is how much males from that group are over-represented in the industry,* is for self-employed and ** is for employees).

Gujaratis (already famous worldwide as entrepreneurs and traders) are even more specialized as hotel owners. And then there is a group that I had only vaguely heard of: Chaldeans – they are Aramaic-speaking Roman Catholics from northern Iraq. They’ve got the liquor franchise.

It’s amazing how something so unexpected appears from the spontaneous efforts and social interactions of ethnic entrepreneurs. Mandorff of course has much more detailed and analytical explanations, which you should check out.

The phenomenon of ethnic business networks is of course not new, but it’s far more widespread than most people realize (almost every African nation has an indigenous group known as the entrepreneurs and traders –the Hausa in Nigeria, Gurage in Ethiopia, Serahule in the Gambia, etc.) And it’s too well known to even bother mentioning the famous merchant diasporas like the Jews, the Lebanese, East African Indians, overseas Chinese in SE Asia, and so on. Thomas Sowell has written at least TWO insightful books on the phenomenon: Race and Culture, and  Migrations and Cultures.  Avner Greif's now standard explanation  (at least partial explanation) for ethnic networks was that small ethnic clusters could use the the threat of explusion from the group to enforce contracts and other trustworthy behavior (a more precise version was worked out in his  famous article on the experience of Mediterranean traders called Maghribis --11th century Jews in Cairo).

It’s all a very big hint that social and family relationships, culture, and self-organizing networks are an important part of economic development that has been much neglected by previous generations of development economists. Now the tide is turning – I gave a whole two-hour Ph.D. class on Wednesday that only scratched the surface of recent research by economists on culture, social norms, and development.

UPDATE: just received link to an NYT article by the always amazing Tunku Varadarajan (formerly at Wall Street Journal, now colleague of mine at NYU) explaining where the Gujarati dominance of hotels came from:

70 percent of all Indian motel owners -- or a third of all motel owners in America -- are called Patel, a surname that indicates they are members of a Gujarati Hindu subcaste. ... ''In some American small towns they think 'Patel' is an Indian word for 'motel.'"

{Patels are members of a caste called} vaishyas, or traders, who were once employed to calculate the tithes that were owed to medieval kings by farmers in Gujarat, an Indian state on the Arabian Sea.

More great details follow in Tunku's article on how the "Patel Motel Cartel" came about in America.

UDPATE 2: An academic paper that traces the origins of Hasidic Jews dominating the 47th Street Diamond District in Manhattan all the way back to the 11th century, with some suggested explanations.

Stop panicking: Capitalism repeatedly recovers from financial crises

UPDATE 2 (3/24, 12:59PM EDT) Tyler Cowen is almost convinced (see end of this post) UPDATE (3/23, 2:30 EDT): see GREAT responses by Ross Levine and Mark Thoma at the end of this post

I am just beginning to dive into the awesome book by Carmen Reinhart and Ken Rogoff, This Time is Different: Eight Centuries of Financial Folly. Along with great analysis, they have some wonderful pictures, evidence, and data. What I say here is my own take on it.

First, financial crises are remarkably common. Their Figure 5.1 shows the number of countries that have defaulted on their external debt (one possible dimension of a financial crisis) over the last two centuries. The numbers come in episodic waves of defaults and involve a remarkably high number of countries in each wave:

Second, the global capitalist system does well in the long run anyway.  Average per capita income in the world (a shaky estimate, but probably right order of magnitude) increased by a multiple of 12 over 1800-2008, despite repeated epidemics of financial crises.

The US is arguably the country with democratic capitalism the longest, and it also shows a steady upward trend from 1870 to the present, despite repeated banking crises (using those identified by Reinhart and Rogoff), with usually little effect of each crisis on output relative to trend (except for the Great Depression).

I don’t mean to minimize the short run pain that the current financial crisis has caused. It’s horrible. But there is no reason to panic about the long run growth potential looking forward.

The obvious rejoinder is Keynes’ “in the long run, we are all dead.” But we can’t ignore that Capitalism already survived repeated financial crises and has made us all vastly better off despite them. So here’s a counter-quote: “In the long run, we are all better off because our dead ancestors stuck with capitalism.”

UPDATE (3/23, 2:30PM EDT) Ross Levine, the scholar whom I trust most about addressing financial crises, sent me the following comment by email when I asked him his opinion:

This is a great summary! I would, however, point out that this crisis could be different, depending on your view of the adaptability and elasticity of institutions.  In particular, this crisis, including the build-up and the resolution, involved a massive redistribution of wealth to the very wealthy.  It also involved an unprecedented decline in market discipline through government policy.  Thus, from my perspective, to get the Reinhart and Rogoff result over the next decade or so, this must involve an institutional adjustment to correct the distorted incentives that currently exist.  What are the forces that lead to this type of adjustment in some economies and not in others?

Mark Thoma, on his great blog Economist's View, responded to my request for a comment. A summary (see his post for his full response):

My take is a bit different. The graph of per capita income from 1870 - 2008 seems to say we shouldn't worry that aggressive intervention to stimulate the economy will cause long-run problems. It may help substantially in the short-run, but the graph above indicates it's unlikely to have long-run consequences. So, I agree, let's not panic. Let's not panic and start reducing stimulus measures too soon, or be too timid with stimulative policies, out of fear it might harm long-run growth.

....

Finally, on the general "stop panicking" message, when people are hurting -- and they are -- we ought to panic. Legislators have given little indication that the understand the urgency of the employment problem we face. We need more panic, not less, about the employment situation.

UPDATE 2: Tyler Cowen on a view he "toys with but does not (yet?) hold":

Financial panics and economic crises are nearly inevitable...

More and more, people will turn to the wisdom of the great 19th century economists on financial panics, bank runs, and the like.  It was an intellectual mistake to think we had ever left that world for good.

Economics tells countries to specialize…including specializing in economics

One of the most venerable and I think most powerful wealth-creating ideas in economics is the package of comparative advantage, gains from specialization, and gains from trade. As we all know, different countries just do different things well: the Swiss give us chocolates, the Germans give us beer, the French give us wine, and the British give us…um…they give us … um…um… Oh wait, the British were the ones who gave us the ideas of comparative advantage & gains from specialization & trade in the first place!

These thoughts were prompted by a Greg Mankiw blog that advised potential Econ Ph.D.  students where to go to school based on rankings of economics departments. One of the rankings was global, which allowed you to see where in the world are the best economics departments. I knew of course that the US does well in Economics Graduate Programs (we are only good at two things, the other being Hollywood movies, so please don’t begrudge us this). The UK itself is a bit shrunken from its former Economics self but still does well, but I was struck particularly how well Canada and Australia do (see picture). Hence, almost 90 percent of the best economics departments in the world are in just four places, all of which were settled by the British if they are not actually British.

Adam Smith’s descendants cast a long shadow….

The Economist Debate on Finance for Good or Evil: Round 2 Turns Up Heat

The debate now going on at the Economist is providing one of the most exciting and insightful looks at What We Learned about Finance from the Crash. The debate is very relevant for the role of finance in development (which Levine has devoted his career to studying). Debate is now on round 2 and you can vote for your favorite. Stiglitz has a small lead at this point; my vote still goes to Levine. Joe Stiglitz:

while many of the recent innovations may well have contributed to the bonuses of those in the financial sector, or even the short-run profits of the industry, the link between these innovations and overall economic performance remains unproven....Naked credit default swaps (CDS), betting on the death of other firms, opened up new incentives for doing mischief, with a greater chance of not being caught and less certain punishment....The contrast between the surfeit of so-called innovations that are socially unproductive or worse, counterproductive, and the dearth of innovations in {more productive} areas is striking....

Ross Levine:

There is no reason to believe that the centuries-old synergistic connection between financial and economic development recently ended... Mr Stiglitz overemphasises the impact of financial innovations on the crisis and underemphasises the role of policymakers in triggering financial abuses....Repeatedly, and many years before the crisis, a prominent task force organised by Timothy Geithner (then president of the NY Federal Reserve) warned of the dangers {of Credit Default Swaps (CDSs)}. But senior officials did nothing. This was not a failure of information, nor of regulatory power; and, it does not reflect an inherent evil with CDSs. It was a failure of high-level policymakers to respond....In contrast to Mr Stiglitz, what has disturbed me the most is the resistance of some within the financial policy apparatus to recognise the malfunctioning of the regulatory regime during the decade before the crisis. The authorities failed miserably to fulfil their core responsibility...

The power of searchers

The Defense Department just sponsored a contest in which they randomly placed 10 large red balloons across the United States and challenged teams to find them all. The one who found all 10 first would get $40,000.

The National Department of Supervisory Agencies for Universal Surveys for Many Different Types of Objects took on the challenge from its massive Washington DC headquarters. It dispatched instructions by secure mail pouch Circular #10-A643 to its 135 regional offices, notifying them to add large red balloons to the Watch List in their multiyear project for surveying the entire United States for Many Different Types of Objects. When last we heard, the regional offices were contacting Washington headquarters for clarification as to what diameter balloon should be considered “large.”

The winning team, at the MIT Media Lab, found all 10 balloons in 8 hours and 56 minutes. They used decentralized search through the Internet, spreading the message through web sites and social networks that there would be cash rewards to any chain of people that resulted in a balloon find. In the end, they drew on the efforts  of 4,665 people.

As Dr. Riley Crane, the leader of the MIT group, explained:

If you heard about our Web site and went to sign up directly, and you found a balloon, you would get $2,000…. If instead you signed up and then you told your friends, and one of your friends found a balloon, that person would still get $2,000 because they found the balloon. And you, because you signed someone up who found the balloon, would also be rewarded with $1,000...

Wow, the Defense Department has just simulated an entrepreneurial economy! Entrepreneurs search for things that will pay off, or search for other people who will find things that pay off.

Searchers also work in aid, finding techniques or projects that work where you least expect to find them. That’s how aid found microcredit, conditional cash transfers, mobile banking, water purification tablets, nutritional supplements, oral rehydration therapy, and on and on.

The first and only time I met Bill Gates, he complained about my book “what is all this nebulous crap about searchers?” The funny thing about very successful Entrepreneurs is that not even they realize that they are part of a decentralized search network. They think it was all their brilliance – the equivalent of the 10 -- out of the 4,665  --who actually spotted the balloons thinking “we are so brilliant at balloon finding.”

Hat tip to the great searcher Michael Clemens, for drawing our attention to the story.

World Map of Remoteness vs. Connectedness (HT Tyler Cowen)

The terror and triumph of free markets

The Wall Street Journal featured this awesome chart yesterday. Only 8 of top global 25 companies in 1999 are still in top 25 in 2009, and some of them have shed a lot of market cap.  One reaction is that free markets are very scary if you were an employee or shareholder of one of the 1999 companies that crashed. OK this kind of destruction scares ALL of us.

Another reaction is that creative destruction is one of the triumphs of the market. The consumer is king: in 2009, the consumer wants iPhones in their Xmas stocking and not whatever Worldcom had been pretending to be producing. The radical uncertainty of how to please consumers is an argument FOR free markets:

It is because every individual knows so little and… because we rarely know which of us knows best that we trust the independent and competitive efforts of many to induce the emergence of what we shall want when we see it. (Friedrich Hayek)

Is “Delivering as One” failing to deliver? The case for a market-based approach to UN reform

The following post is co-written by Sandra Sequeira, Professor of Development Economics at the London School of Economics and visiting scholar at DRI, and Christian Schornich, who works for the United Nations. The proportion of aid channeled through the UN system shrank from ten percent to five percent over the last eight years. And yet the UN’s massive bureaucratic machinery is not being downsized accordingly. In fact, a complicated web of programs and agencies with a whopping 7,000 overlapping mandates—sometimes even working at cross-purposes— have in recent decades defied numerous bouts of reform.

Three years ago, the UN launched a new initiative entitled “Delivering as One,” meaning that in each country there would be one leader coordinating all agencies in the field, one budgetary framework, and one operational support system. The goal was to increase efficiency, cut waste and pass on administrative savings to programs.  Eight countries from Mozambique to Cape Verde volunteered to pioneer this reform. While cutting the fat out of the UN system is a commendable goal, a deeper issue failed to make it to the discussion table: should reform only represent a centripetal force towards becoming one, or a centrifugal force that propels multiple agencies to compete in the market for aid and justify their relevance?

Since the beginning of “Delivering as One,” no departments have been merged and not a single program has been cut. Three years into the process, administrative savings are yet to be calculated because there is no budgetary framework that clearly accounts for the overhead costs of the different agencies and programs.

There is a real danger that the search for “Oneness” has already become just another episode in a series of floundering reforms, where “harmonization” and “integration” really mean covering up inefficiencies and keeping underperforming agencies and programs afloat. But here’s an alternative: the UN could seize the opportunity to rethink its mandate based on its comparative advantage in the current market for aid, and stick to it.

What would happen if the UN stopped thinking of itself as a world government in the business of only providing public goods, where cost-effectiveness is not necessarily the bottom line, and started thinking of itself as an organization actively competing with other agencies in the market for aid? The landscape of aid agencies has changed dramatically since 1945—the UN is now forced to compete against McKinsey when providing technical support to Latin American governments, with the Gates Foundation when fighting HIV/AIDS in Africa, and with the US military when building schools in the foothills of Afghanistan.

The aid market is segmented by fields, and competition varies significantly across them. There are "natural monopolies" which require agencies like the UNHCR to secure the rights and well-being of refugees across political borders, UNRWA, the International Atomic Energy Agency, the International Court of Justice or the WTO. In these fields, a UN monopoly is justified by the high political and fixed costs of setting up an inter-governmental cooperation mechanism, by decreasing marginal costs of providing the service, and by positive network effects.

Other agencies like the United Nations Industrial Development Organization (UNIDO) and the United Nations Development Program (UNDP) operate in highly competitive markets. In more extreme cases, the UN even competes against itself via the International Fund for Agricultural Development (IFAD), the Food and Agriculture Organization (FAO) and the World Food Program (WFP); the United Nations Development Fund for Women (UNIFEM), the Joint United Nations Program on AIDS (UNAIDS), and the United Nations Population Fund (UNFPA); the United Nations Conference on Trade and Development (UNCTAD) and the International Trade Center (ITC), among others.

The UN's search for comparative advantage could be compared to a government deciding which services to provide directly and which services to privatize. Areas in which the benefits of competition can be high through the creation of incentives to deliver high-quality services at the lowest cost possible are prime fields for “privatization.” In these segments of the market for aid, the UN could act as the "aider of last resort" instead of a frontline participant. This would mean specializing in areas in which there is a clear need for large-scale interventions, but where no private corporations, NGOs, civil society or development consulting agencies dare to go. While this would be the path less traveled, it may be the only one that leads to meaningful reform.

Tiger Woods thoughtfully explodes “Halo Effect” myth in development (editorial note)

For anyone who noticed or got confused by Google Reader: A preliminary draft of the Tiger Woods post accidentally went live at midnight on Saturday night. We took it down again on early Sunday morning, and the absolutely correct analysis of Tiger Woods was re-posted early this morning, taking into account any late-breaking news on this major world news story.

Population Wars: Adam Martin replies to Global Population Speak Out

by Adam Martin I appreciate the thoughtful GPSO reply to my blog post. But I respectfully decline the offer to sign their pledge. Here is why:

Projections of population into the future that fail to account for the power of changing incentives are intellectually sterile explanations and policies that deny the rational response of individuals to incentives will prove impotent or worse.

Why are market-oriented economists so confident that population will be self-regulating? Well, under a regime of property rights, as we use up any scarce global resources, they will become relatively more scarce. This will put upward pressure on their prices. The first response is for individuals to cut back their consumption, but that's not the most important adjustment (that's only short term, after all).

The more important response is the one Julian Simon pointed out: the increase in resource prices creates an incentive to find more efficient means to use them or to come up with substitutes. Innovation of what we use and how we use it is the best path we know of to sustainability in development. Institutions such as property rights, the family, and, yes, even money are preconditions for aligning incentives with conservation and unleashing systematic resource-saving innovations.

Here both our deepest moral commitments, as well as sound economics, overlap with the professed beliefs of GPSO: certainly women should not have reproductive decisions forced upon them. So the message is not that nothing can go wrong. Absent secure individual rights, individual responsibility, and free markets, quite a bit can: first and foremost for the victims of injustice. However, simply admitting that these problems are real is a long way from endorsing statements like this (from the email I was sent):

the current size and growth of human population [is] a sustainability issue no less crucial than over-consumption in developed nations and all the resultant emissions, habitat loss and toxic pollutants. [emphasis in original]

I want to raise two problems with these sorts of statements. First, admitting that population growth can have adverse consequences is a long way from admitting that anyone has the knowledge to determine the "right" population size, even roughly. Statements like the one above, not to mention the affiliations of some of GPSO's signees--convince me that they believe otherwise. And I'm not arguing that sustainable population size is a difficult calculation to make, I'm arguing that it's meaningless. Sustainability means a balance between what present and future individuals want to do and can do. When human capacities and desires are by their nature heterogenous and changing over time--as in the long run that sustainabilitistas worry about--then what counts as sustainable is simply not knowable unless one knows current and future capacities and desires.

Second, I want to raise the question as to whether a "public discussion addressing the size and growth of human population" is compatible with those individual rights. If governments decide what the right population size is, and the actions of free and responsible individuals give rise to a different population size, either the population target or individual rights must be sacrificed. I believe--I hope--that the GPSO signees would abandon their plan. History has shown too many willing to do the opposite. It is for this reason that, while I obviously do not believe women should be coerced, I cannot sign onto "population justice" as defined by GPSO.

If it is excessive procreation we are worried about, we would do well to remember the words of Henry Simon: "Academic economics is primarily useful, both to the student and to the political leader, as a prophylactic against popular fallacies."

Malthus vs. Malthusian Population Scares

This post is by Adam Martin, a post-doctoral fellow at DRI. The laws of economics are more powerful than the laws of physics. I once saw Deirdre McCloskey illustrate this by placing a $100 bill on the table. The laws of physics, she reminded the class, dictate that an object at rest tends to stay at rest. Economics tells us that errant $100 bills laying out in the open do not remain unattended for long. She assured the students that, were she to leave the room for several hours, economics would better predict Mr. Franklin's fate.

But how do the laws of economics fare against a tougher opponent: the laws of sexual attraction? Against them, economists--especially those march under the Malthusian banner--have been willing to cede more ground. Everyone knows, after all, that Malthus judged the "passions between the sexes" as both universal and powerful. Everyone knows that this passion leads to "geometrical" increases in population that inexorably outpace "arithmetical" increases in food. Everyone knows this is why economics is called the "dismal science." But what everyone "knows" is dead wrong.

This is not another argument about how ol' Tom-Bob got it all wrong. No, the problem with Malthus--a problem for both his self-proclaimed friends and foes--is that he we wasn't a Malthusian. Ross Emmett offers a detailed and trenchant analysis. Malthus was not arguing in a vacuum. He was responding to William Godwin's proposal to overthrow basic social institutions like private property and the family.  In a free love-fest where no one is responsible for the offspring resultant from their passions, Malthus argued, population growth would run amok. If individuals don't bear the cost of procreation, they will procreate too much. If they do bear costs of offspring, "preventative checks" such as birth control and delayed marriage will make population self-regulating. In his own words:  "Impelled to the increase of his species by an equally powerful instinct, reason interrupts his career, and asks him whether he may not bring beings into the world, for whom he cannot provide the means of subsistence." (An Essay on the Principle of Population, Chapter II). Reproductive choices respond to incentives. The laws of economics are more powerful than the laws of attraction.

Note that Malthus does not say that the incentives for procreation are automatically aligned with the common interest. If individuals do not bear the full costs of their offspring, such as any effects of Junior on the environment, they may make irresponsible decisions. But parents are no more socially responsible if they fail to account for the benefits their children will generate for others (such as new ideas on technology). What matters is that, when discussing population, we do not forget the basic lessons of economics. A top-down perspective on population that treats individuals like mindless lemmings will panic: "Unless we reduce the human population humanely through family planning, nature will do it for us through violence, epidemics or starvation."

Malthus gets right what both his followers and his more technocratic critics get wrong: the institutions within which individuals make reproductive decisions matter. The way to increase GDP per capita is not to cut the denominator. And while today’s scare tactics (Mali is “really in for a Malthusian disaster,”) and recommendations to stop having babies are not as monstrous as those of yesteryear, we should be wary of those who would intrude on one of the most personal and sacred choices individuals confront – whether to have a child. Nor is population sustainability a mere horse race between libido and technology. Consistent with the approach of classical economists, Malthus treats human nature as constant. Different institutions drive differences in fertility outcomes. In this we should all be Malthusians.

P.T. Bauer, Development Prophet

This post is by Claudia Williamson, a post-doctoral fellow at DRI. P.T. Bauer was a brilliant development economist who began writing in the 1940s, and published many influential works throughout the 50s, 60s and 70s, when most of his profession favored central planning and government solutions.*  Bauer preferred bottom-up solutions and focused on the importance of institutions to align incentives and provide information to promote social cooperation and economic growth.

Relying on basic economic principles and logic, Bauer made bold arguments that are surprisingly relevant today.

Bauer said: The vicious circle of poverty “is in obvious conflict with simple reality.”

Proponents of the “poverty trap” explanation argue that underdeveloped countries are so poor that individuals can’t save enough to support the investment necessary to generate economic growth.  The only way to break out of the cycle is through external funding.

Bauer argued that the poverty trap cannot be a binding constraint.  The mere existence of prosperous individuals and societies—most of which have emerged from poverty without the assistance of foreign aid—flies in the face of the poverty trap.    While it is true that poor people can’t save as much relative to rich people, if the right incentives are in place, small scale savings will lead to small scale investment, which in turn will generate marginally higher incomes leading to medium scale savings and investment, thus creating a “friendly circle of wealth.”

Bauer said: “Guilt-ridden people hope to assuage their feelings simply by giving away money…without questioning the results: what matters is to give away money, not what results from this process.”

At the recent World Bank annual meeting, the Development Committee praised the World Bank’s “vigorous response” to the global financial crisis, which they quantified as “a tripling of IBRD commitments to $33 billion this year and IDA reaching a historic level of $14 billion.”

While most development agencies profess a commitment to measurable results and outcomes, “results” in development are puzzlingly often equated with volume of loans given or number of grants handed out. According to Bauer, the reason for this apparent contradiction is that collective guilt has replaced individual responsibility. Because the West feels responsible for the lack of development in the rest of the world, what matters is to give away money, not actually see results.

Bauer said: “Foreign aid is demonstrably neither necessary nor sufficient to promote economic progress in the so-called Third World and is indeed much more likely to inhibit economic advancement than it is to promote it.”

Foreign aid inflows alter the incentives of recipient governments, argued Bauer, increasing the power of the (often dictatorial) government, promoting dependency and encouraging rent seeking.  Aid ignores the fundamentals that are necessary for economic development: the primacy of property rights and the importance of informal norms and culture for economic change.

Bauer said: There is a “need to restate the obvious.”

If Bauer said it all, why is it still so vital that new research follow in his footsteps?

Bauer’s answer comes from George Orwell, who lamented in 1939: “we have sunk to such a depth that the restatement of the obvious has become the first duty of intelligent men.”  What may be obvious to some is counterintuitive for many.

There is a need to restate the obvious.

---

*Update:  Thanks to astute readers for prompting us to be more precise on the time when Bauer began writing. As a few of you pointed out, Bauer's influence spanned many decades: he published his first major work, "The Working of Rubber Regulation," in 1946,  and continued publishing through the 1990s. A collection of Bauer's essays, entitled "From Subsistence to Exchange," with an introduction by Amartya Sen, was published in 2000, two years before his death.  The opening sentence of the blog has been changed to more accurately reflect this. - Eds.

Misunderstanding Randomness

In next week's New York Review of Books, Korean development economist Ha-Joon Chang responds to a review of his new book, Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism. Chang defends his argument that the majority of rich nations today benefited from infant industry protection, and stands by his analysis that developing countries under an interventionist regime grew faster than those with neoliberal policies, looking at the period from 1980 to 2000. Pointing  to Switzerland, which didn't give women the vote until 1971, he disputes his reviewer's argument that representative democracy was a key to the economic development of Western countries. Chang concludes:

Mr. Easterly says that economic growth does not come from "experts" like me but entrepreneurs, like Ju-Yung Chung, the legendary founder of Hyundai. He conveniently omits the details that prove my point: before it succeeded in the world market, Chung's auto venture was supported by decades of import bans, export subsidies, and tariff protection.

For  Easterly, these salvos only strengthen his original argument that Chang finds "spurious patterns in partially random economic outcomes." Chang's rebuttals on infant industry protection and growth rates under neoliberal vs. interventionist regimes are further examples of  "selective use of evidence (confirmation bias) and excessive reliance on too little data."

Easterly continues:

Chang misses the point on how the evidence for any one good thing—like representative democracy—is only reliable in the very long run (lots of data) and cannot be confirmed or rejected with only a few examples (too little data). So he refutes my case for democracy with lots of data—by reliance on too little data (whether women in one country—Switzerland—could vote after 1971? Of course this is not trivial from a moral standpoint, but its weight as evidence is minuscule). The now-rich countries have been more democratic than the rest of the world on average in the long run and have been steadily increasing in democracy.

Mlodinow's book [The Drunkard's Walk, reviewed in the same article] warned that our brains are so hard-wired to misunderstand randomness that we make the same mistakes even after somebody points out the mistakes. I have been guilty of this myself in my own career, and unfortunately Chang now does the same with this letter.

Find the full exchange here.

Explaining Slavic female tennis comparative advantage mystery

A reader had a provocative explanation, posted as an anonymous comment on the blog post on the Slavic tennis women mystery:

Soviet-bloc eugenics. If you look at the biographies of the Russian tennis players, like Kuznetsova and Petrova, they are the product of the marriage of two Olympic athletes.

Nadia Petrova: Petrova's father Victor was a leading hammer thrower, while her mother Nadezhda Ilyina won a bronze medal at the 1976 Montreal Olympics in the 400 meter relay.

Kuznetsova: Her father, Alexander Kuznetsov has coached five Olympic and world cycling champions. Her father's protégés include her mother, Galina Tsareva, a six-time world champion and holder of 20 world records, and Svetlana's brother, Nikolai Kuznetsov, a silver medalist at the 1996 Summer Olympics in Atlanta.

Think about it. The Communists selected hundreds of young male and female athletes to train for the Olympics, and located them at training centers. Inevitably, many of them married. And their daughters grew up to be some fearsome athletes too. The reason they never win is that they were raised to be athletes, not champions. In the US, it's the real competitors who rise to the top out of nowhere, like Oudin

The question still might be why is the advantage more pronounced in women than men? My amateur guess is that the Communists were much better than Capitalists in developing female athletes, since the former wanted to maximize Olympic medals (who cares if they are male or female?), while the profit motive reined in the latter, and female athletics just doesn't pay very well in the free market. This legacy may still matter even after the Communists (mostly) disappeared.

Africa desperately needs trade links: a pictorial essay

In all the debates about free trade, we can forget sometimes that international trade is not optional for a very small, very poor country. If there are any kinds of returns to scale at all in many sectors, and casual observation and much research suggests there are, then a tiny domestic market will rule out any serious domestic production in many, many sectors (is the Gambia going to be making refrigerators any time soon?) So trade will be a necessity, specializing in what each small, poor country can do, and importing everything else. And what continent is full of small, poor countries? Africa, of course. Then it’s all the more distressing that Africa does not have much in the way of trade links – shipping routes, air connections, Internet connections (for both communication and moving goods) – with the global economy. This is best seen in a series of pictures.

Lack of shipping routes going to Africa (except South Africa and Nigerian Oil):

Click here for a larger image.
Source: the excellent 2009 WDR “Reshaping Economic Geography” of the World Bank, Chapter 6

Scarcity of Airline Routes to Africa compared to rest of World (except South Africa):

Source

Scarcity of Internet Connections except South Africa (map of # of IP addresses in 2007):

Source

In short, Africa is disconnected from the global economy, which is very bad news for a continent that desperately needs international trade (the disconnection is both symptom and cause of the lack of trade). Lack of international trade = poverty for small economies.

This lack of trade links reflects many factors: rich country protectionism, domestic policies on customs & tariffs & foreign investment, poor port and road infrastructure, thus very high land transport costs within Africa, barriers crossing borders within Africa, Africa stereotypes that discourage foreign investors and out-sourcers, and so on.

There is some hope on the horizon for the Internet and communications issues, at least. High-speed fiber optic cables are connecting the east and west coasts of Africa to the rest of the world. And we all know about the famous cell phone revolution happening within Africa. Comparative advantage reflects your infrastructure quality and transport costs as well as your other endowments and experience. Perhaps the new broadband Internet connections will make possible all kinds of new businesses that economize on physical transport and use the Internet and cell phones instead. How about some kind of e-Africa.com, ready to open for business?

Harvard President’s proposed fix for The University: more Bad Economics?

Drew Gilpin Faust writes on “The University’s Crisis of Purpose” in the current NYT book review. Most of the essay is superb, about not just justifying college education by its vocational payoff, but also the study of truth & beauty for their own sakes. I liked also this: “Universities are meant to be producers not just of knowledge but also of (often inconvenient) doubt…to serve…as society’s critic and conscience.” (wow, thanks for justifying my own approach towards the society of foreign aid!)

Alas, after that high point, the Harvard President recommends what is already everybody’s favorite form of social criticism: amateur economics!

As the world indulged in a bubble of false prosperity and excessive materialism, should universities – have made greater efforts to expose the patterns of risk and denial? Should universities have presented a firmer counterweight to economic irresponsibility? … Has the market model become the fundamental and defining identity of higher education?

I don’t think the President is talking about the technical study of perverse incentives in financial markets and regulation, such as those that caused the crisis. I’m not sure WHICH academics in WHICH department she is calling upon to supply shallow moralizing and bad economics (certainly not the superb Harvard econ dept or the great economists at the Kennedy School).

I don’t mean to pick on the Harvard President in particular, many heavyweight figures are dispensing sophomoric rhetoric ever since the crisis made it open season on economics. I'm just following her counsel to supply some inconvenient doubt about the social value of such rhetoric.

Slavic Tennis Women and Aid Agency Specializations

A recent post talked about the advantages of specialization in general, and for aid agencies in particular. But what should you specialize in? Obviously, in your “comparative advantage,” which is economists’ laborious jargon for “what you’re good at.” But where does comparative advantage come from and how do you find your own? These thoughts were prompted by watching US Open tennis on TV, where anyone who can read their –ova’s and –ieva’s is struck by the amazing predominance of Eastern European women in pro tennis. To be precise, 48 of the 128 women in the singles draw were Slavic (there’s a few Slavic men in the US open too, but it’s far more pronounced with women). Where does Eastern Europe’s comparative advantage in female tennis come from?

(Marginal Revolution asks a related question about where all the pretty Russian women (fashion models, tennis, etc.) suddenly came from, but here at Aid Watch we NEVER use cheap, sexist promotional tactics like discussions or pictures of beautiful women.)

National stereotypes are NOT OK, but SOMETIMES they MAY reflect SOME little underlying comparative advantage (which is obviously cultural rather than racial). According to a really old and lame joke, which OTHER people have made, and I am repeating here under duress only for educational purposes:

Heaven is where the police are British, the cooks French, the mechanics German, the lovers Italian, and it is all organized and run by the Swiss. Hell is where the police are German, the cooks British, the mechanics French, the lovers Swiss, and it is all organized and run by the Italians.

The classic economist’s explanation of comparative advantage is that it reflects what you possess in abundance relative to what you lack, compared to others. So a fertile-land-abundant country like the US has a big comparative advantage in agriculture –DUH.

Another (not mutually exclusive) explanation is that you develop comparative advantage by “learning by doing,” which is economists’ laborious jargon for “practice.” In Malcolm Gladwell’s entertaining new book Outliers, the explanation for Bill Gates’ success is that, by some accidents of fate, he happened to be one of the few 8th graders in the nation with almost unlimited access to a powerful computer in 1968. When you’ve been writing software since the 8th grade (plus possessing IQ in abundance, even if you lack everything else) you have a comparative advantage when you launch a software company 8 years later.

So some hints for aid agencies or NGOs deciding what is their comparative advantage is (1) what do you have in abundance compared to the others, and (2) what have you been practicing at already for 8 years?

And now let's crowd-source the question: how did Slavic women get a comparative advantage in tennis?

Beyonce's Secret for Greater Aid Effectiveness

One of the oldest ideas in economics is gains from specialization. Adam Smith talked about it 233 years ago. All of us are good at a small number of things and suck at most everything else. The economy as a whole produces more because we each specialize in what we do best and then trade with everyone else. We see Beyoncé specializing in music videos, which she trades to Bill Gates for his specialized production of software. We will get more of both music videos and software from Beyoncé and Gates than if each (without the possibility of trade) had been forced to supply their own needs for software and music videos.

Beyoncé would be forced to take time away from videos to try to figure out her own software, and Gates would have to divert time from software to learning how to sing and dance in a swimsuit.

Economists are often congratulated for their impressive grasp of the obvious. Yet if this principle is so obvious, why is it routinely violated in the aid world? It’s gotten worse with the Millennium Development Goals. Each aid organization tries to meet all MDGs and each fails to specialize. Therefore some aid agencies are forced to supply things they are bad at – the equivalent of Gates’ music videos – for which there is no demand.

UNICEF is working on swine flu, the traditional province of WHO, who is distracted by trying to do development research, which is the traditional specialty of the World Bank, who is in turn distracted by a new emphasis on children, which is the strength of – just to complete the circle – UNICEF.

Even very small aid agencies fail to specialize – Luxembourg’s $141 million aid budget was divided among 30 different sectors (out of a possible 37). The tiny Luxembourg budget also went to 87 different countries.

With high overhead costs for each separate activity for each country, the ratio of overhead costs to funds for the activity gets extremely high, sometimes over 100 percent. UNDP has one of the very LEAST specialized aid budgets by country and by sector, and it actually does have a ratio of overhead costs to aid disbursed of 129%.

One suspects overhead costs devoured even more of program costs for the $20,000 Greece spent on worldwide post-secondary education, the $30,000 the Netherlands spent on promoting worldwide tourism to developing countries, the $5,000 Denmark spent on worldwide emergency food aid, or the $30,000 Luxembourg spent on conflict, peace, and security. (Remember, these small sums may have been split even further among country recipients.)

One could think of many political economy reasons why aid agencies resist specialization. From my casual experience in a large bureaucracy (the World Bank), the primeval bureaucratic instinct is to give a tiny piece of the pie to every possible lobby group (internal or external). But what’s most clear is that it shows aid agencies lack of accountability, because it is such a wasteful practice that also drives the aid recipients crazy with duplication of efforts by every aid agency in every sector in every country.

So please, aid agencies, go back to Adam Smith, and try to capture some of those enormous gains from specialization. And NGOs, kudos for doing a much better job than official aid at specializing at what you do best, and please resist pressures to have a piece of everything.