Bill Easterly -the anti-Jeffrey Sachs -- needs a rock star

Tim Worstall thinks that Easterly is about to rain on Bono's parade.

The Fallacy of the Poverty Trap

A new working paper by economist William Easterly shows us what is actually the problem. First, the current proposals are based on the following analysis:

The UN Millennium Project and Jeffrey Sachs argue that it is the poverty trap rather than bad government that explains poor growth of low income countries and the failure to make progress towards the Millennium Development Goals (MDGs). Sachs says "the claim that Africa's corruption is the basic source of the problem {the poverty trap} does not withstand practical experience or serious scrutiny." Likewise the Millennium Project says "Many reasonably well governed countries are too poor to make the investments to climb the first steps of the ladder."

If this were true then the plans would have merit, so the question becomes, is this true? Easterly looks at a number of items to check:

We can check further on some of the intermediate steps in the Big Push. Sachs said that large aid increases would finance "…a 'big push' in public investments to produce a rapid "step" increase in Africa's underlying productivity, both rural and urban." Over 1970-94, there is good data on public investment for 22 African countries. These countries' governments spent $342 billion on public investment. The donors gave these same countries' governments $187 billion in aid over this period. Unfortunately, the corresponding "step" increase in productivity, measured as per capita growth over this period, was zero.

Not looking all that good, eh?

I think of this as a simple descriptive exercise to compare two alternative hypotheses: (1) Divergence Big Time was due to a savings/technology poverty trap or (2) it was due to bad government/institutions. The stylized facts emerging from this exercise support (2) strongly over (1), confirming previous literature on institutions and development.

I use three widely used measures of institutions: (1) the Polity IV measure again, now averaged over 1960-2002, (2) the Freedom House measure of political liberties (with the sign reversed, since an increase in this measure means less liberty), averaged over all available years, which are 1972-2002, and (3) Economic Freedom in the World from the Fraser Institute, averaged over all available years, which are 1970-2002. All measures of institutions are strongly significant predictors of growth 1960-2002, and make initial income negative in the regressions (significantly so in the IV regressions). The institutions story makes Divergence go away in the more recent data as well.

So which is it, bad government or the poverty trap? When we control for both initial poverty and bad government, it is bad government that explains the slower growth. We cannot statistically discern any effect of initial poverty on subsequent growth once we control for bad government. This is still true if we limit the definition of bad government to corruption alone. The recent stagnation of the poorest countries appears to have more to do with awful government than with a poverty trap, contrary to the Sachs hypothesis.

No, it really isn't looking all that good. We seem to be locking ourselves into an argument over how much we should spend on a particular type of aid when the basic problem has been misdiagnosed. As the paper concludes:

The classic narrative -- poor countries caught in poverty traps, out of which they need a Big Push involving increased aid and investment, leading to a takeoff in per capita income -- has been very influential in development economics. This was the original justification for foreign aid. The narrative became less popular during the market-oriented 80s and 90s (even then the idea of the "takeoff" remained widely accepted, as it still is), but has made a big comeback in the new millennium. Once again it is invoked as a rationale for large foreign aid programs.

However, the description of poverty traps, Big Pushes, and takeoffs as a justification for foreign aid receives scarce support in the actual experiences of economic development. The paper instead finds support for democratic institutions and economic freedom as determinants of growth that explain the occasions under which poor countries grow more slowly than rich countries.

There are various ways you can take this finding (and do remember, it is a working paper, others will no doubt wish to verify or contest the workings and conclusions), a call for more research perhaps, a vindication of pre-existing prejudices (I wrote something on the subject back here and Easterly uses similar markers for political and economic freedom as I did) or perhaps ignore it and suggest that the political capital invested in the process so far means that to rethink now is impossible.

Myself, I'm afraid I'm rather gloomy about the prospects, for once a bureaucratic bandwagon gets rolling it's almost impossible to stop it, even if it is on entirely the wrong track. I don't argue that there should be no aid, but I would take this paper as suggesting that we are about to do the wrong things with the money we have raised. If only we could get the UN, in its grand meeting this coming week, to understand two of the things about which Keynes was undoubtedly correct:

Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.

Perhaps madmen is a little cruel for those who wish to make the world a better place and perhaps practical men is a little kind for those at the UN, but could I urge upon them this (possibly apocryphal) comment from the same late great economist?

"When the facts change, I change my mind - what do you do, sir?"

If Easterly is correct in his paper then we're just about to waste $175 billion a year (roughly that 0.7% of GDP that the rich countries are pledged to) having misidentified the situation. I don't begrudge the spending (much) but I would like it spend on the correct problem.

For the last few years, Jeffrey Sachs has been given a free ride courtesy of gullible rockers like Bono. Easterly needs his own impresario. Maybe Ted Nugent is available.