Two millenia of growth in a couple of equations

Many scientists dream of finding a unified theory of something, a theory that would encompass others and explain, with a few equations, a large number of observations. Physicists in particular have been looking for fundamental equations. In economics, there is currently a drive among growth theorists to find a unified growth theory, although here the focus is not on a single equation, but rather a model. Indeed, one has to realize that explaining several thousand years of economic growth involves some complexity.

And now the physicists get interested in the topic. Andrey Korotayev and Artemy Malkov actually go beyond a simple one equation model and use some theory, linking surplus output to population growth à la Malthus. Up to 1970, population is hyperbolic, while GDP is quadratic-hyperbolic (in both cases levels, and not growth as the authors assert). They conclude from this that technological progress is expanding because of the larger number of inventors as population grows. That seems a bit simplistic, as one should also bear in mind that there are decreasing returns to inventing, as documented by rather constant long-run growth rates for total factor productivity in modern history despite an increasing share of a growing population dedicated to research and development. But one can get misled when one looks only at few indicators.

About agricultural policies in developing economies

Policy advice and intervention in the poorest developing economies are all about agricultural policy. How to increase crop yields, how to select crops, how to empower various players, how to get them onto markets. The results, overall, have been dismal: the poorest countries have grown less than the world average, thus they are getting even poorer in relative terms. The reaction to this? Thinking even harder about agricultural policy and intervention.

A recent example is a paper by Erik Jonasson, Mateusz Filipski, Jonathan Brooks and Edward Taylor that builds an elaborate model that tries to understand why some farmers do not participate in markets, which should help in specialization and reaping gains from it. They then evaluate the impact of various policies, and find some could lead to improvements in welfare, but nothing dramatic.

Yet, the most important change that should be contemplated is completely absent from this paper: getting subsistence farmers away from agriculture altogether. Obviously, they are not living in areas that are good for farming, so why to reinforce their dependence on the wrong trade. Countries with excess of labor supply should rather industrialize and import if necessary food. This is where the gains from specialization (and trade) are.

Do remittances create credit?

Remittances from foreign workers to their families at home are an important source of income in some countries. Whether this is a good solution for the long term is debatable, though, as it may create a dependency. Thus it is important to understand whether these remittances end up not just fueling consumption but build the basis for investment in various forms of capital and future domestic income.

Christian Ambrosius looks at Mexico and finds that receiving remittances is strongly associated with the ownership of a savings account, especially in rural areas. So at least all of the remittances are going into consumption. More interesting is that there is also evidence that it also builds up some borrowing capacity, especially in microfinance banks. Once more, it is not the big financial institutions that seem to be the key to the development of the poorest, but the small institutions that rely on the local social network. And remittances are perfect to finance that.

Why does Angola invest in Portugal?

Standard theory tells us that a country with a low capital endowment, relative to its labor endowment, should have high capital returns and thus should be attracting foreign capital until capital returns are equal at home and abroad. While there is foreign direct investment from the North to the South, it is by far as high as it should be, and capital returns are far from being equalized. There are proposed answers to this puzzle, from mismeasurement to country-specific risk, but that does not explain why there would be foreign direct investment from the South to the North.

Carlos Pestana Barros, Bruno Damásio and João Ricardo Faria look at the case of Angola investing substantially in its former colonial master, Portugal. They build a model of a open economy subject to corruption practices. It is not quite clear to me how this model maps into the linear equation that is estimated (partly because not all equations display in the paper). But at this points, the interesting results is that this FDI is driven by exports and mostly by corruption. One has to understand that corruption in Angola is among the world's highest. For example, there is an unexplained residual in the country's fiscal account that corresponds to about a quarter of its GDP, which is absolutely mind boggling. This corruption is so big that not only does it dry out the FDI flow from Portugal, it reverses it.

Predation, labor share and empirical evidence

When you look at national accounts, one striking fact is that the labor income share is remarkably stable in each country. And the average level of this labor income share varies quite dramatically across countries. These differences vanish to a large extend once you allocate proprietor's income (these are business owners) to labor income and capital income, but some differences remain.

Carlos Bethencourt and Fernando Perera-Tallo try to explain these differences. They build a model where workers can choose to produce or predate. If the labor income share is high, they rather produce, if it is low, predating is more interesting. With an increase in productivity, the labor income share increases, and this amplifies the impact on output as fewer people predate. This mechanism can thus make it easier to explain GDP/capita differences across countries from total factor productivity differences.

But for all this to happen, you need an elasticity of substitution between capital and labor in the production function below one, or the labor income share would not change. Empirical evidence for that is not that compelling though (hence the attractiveness of the Cobb-Douglas production function). And if the elasticity is above one, all results are reversed. But assume it is lower than one for a moment. Then it means that any attempt to improve institutions to make predation less rewarding should improve output. That would be anti-corruption campaigns, for example. Yet, I am not convinced that corruption actually lowers output. As I posted before, the empirical literature is not conclusive on this. And that empirical result would be consistent with the elasticity of substitution being close to one, if this model were not to be rejected.

Are rickshaw pullers myopic?

It is sometimes difficult to imagine why some people take decisions that make no economic sense. Take those that accept to receive payday loans at interest rates that defy any reason. Yet it can make economic sense, under some circumstances. In a similar vein is the observation that some people pay rent that seems to be far too high compared to the intrinsic value of the good.

Magnus Hatlebakk reports about one such example, rickshaw pullers in Nepal. They typically rent their rickshaws, and the rent cumulated over a year corresponds to the price of the rickshaw. It is particularly puzzling as microcredit is available, although at a different payment schedule: rent is 40 rupees a day, while servicing a loan would be 240 rupees a week. From a survey, Hatlebakk concludes that rickshaw pullers are not myopic, excessively impatient or financial completely illiterate: their income is simply so close to subsistence consumption that they cannot save up the 240 rupees for the loan service. At least this is what Hatlebakk argues, which I do not understand. If they do not pay rent, they could have save 40 rupees a day and be able to pay the weekly 240 rupees after six days. I suspect what is at play is more something like what makes ROSCAs so popular in many developing economies: people unable to keep significant amounts of cash, either because of the risk theft, misuse or, yes, myopia.

It would have helped the paper if it mentioned what the average lifespan of a rickshaw is, and whether rental provided some form of insurance, for example by providing a replacement in the event a rented rickshaw breaks. Indeed, the insurance aspect could also be important if there is substantial risk, or if the owner provides for repairs.

Africa should finally industrialize

Africa is frustrating, as it seems to be regressing in many ways despite substantial development aid. Several have pointed out that the problem is with this aid, for example because it provides perverse incentives. But I think an important aspect is this obsession with improving agriculture on a continent where land is simply not good for agriculture. While the development stage in development in the rest of the world went first through a boost in agricultural productivity followed by industrialization, I see no reason why Africa cannot skip straight to industrialization. It has a lot of labor. There is the problem with poor transportation and low education, but they will improve if demand increases through industrialization, which little growth in agriculture cannot.

I am mentioning this after reading the report of John Page, who shows that, if anything, Africa is deindustrializing. While one can discuss whether the strategies he advocate can work, the fact is that the climate is not the best for investment into industry in almost all of Africa. Maybe charter cities could be the right trigger?

Religion and the quality of public institutions

It is now well established that good institutions are crucial for a healthy economy. But you do not create good institutions with a magic wand, and they do not export well from one country to the next. So what makes good institutions? For one, former colonial masters matters, in particular former English colonies tend to have better institutions than other former colonies. At least for those countries, the origin of the legal system matters. For more developed economies, this is less obvious.

Niclas Berggren and Christian Bjørnskov find that religiosity, as measured by how important religion is in daily life, has an impact on institutional quality, especially in democracies. A negative impact. This seems to indicate that religion has some devious implications on the democratic process. How still needs to be established, though, but seeing how churches try to influence the political process, especially by getting poor people to vote against their interests, that does not surprise me too much.

Nation building and economic growth

A major component of US foreign policy has been "nation building" through military and economic aid. This policy is of course not disinterested, and the ultimate goal is to secure commercial outlets for American businesses, and over some decades, to prevent the spread of the red menace, which is in fact related to the first goal. In terms of resources, this policy has been tremendously expensive, as the latest episode in Iraq has demonstrated. Is it worth it? That is difficult to measure, but if you think that what the us cares for is access to larger markets, then GDP growth should be a good metric for nation building success.

Ellyn Creasey, Ahmed Rahman and Katherine Smith find that nation building is moderately good for growth during a conflict, but quite bad thereafter. The latter result is not inconsistent with quite a bit of literature that shows that economic aid is not particularly useful, also absent nation building. What is new here is the stark contrast during and after the conflict. And if you wondered how they could measure a nation building effort: they look at economic aid conditional on military aid and the existence of a conflict currently or within the past seven years.

Incidentally, check out this promising new book and new blog about failed nations.

Coping with the crisis in transition and developing countries

The recent crisis is a truly global phenomenon, yet we hear only about how the developing economies are struggling. There were some reports about food riots over the surge in primary good prices, and then these economies faded away from the limelights. While the BRIC have not relatively very well, what about the others?

Rasmus Heltberg, Naomi Hossain, Anna Reva and Carolyn Turk report that the fluctuations in the terms of trade and prices in general have been very hard on developing and transition economies. Using households level data from 17 countries, they observe that the crisis was in fact harder than in the developed economies where it originated. Indeed, there is mention of skipped meals, reduced education, increased crime and societal issues. While I would have expected the export sector to be most affected, it appears the informal sector, which mostly caters to domestic needs was hit the hardest. And we can only hope this will be over soon, as the impact seems profound and long-lasting.

Being landlocked and making it worse

No matter how you specify your growth regression, it always turns out that being landlocked is bad for a country. The lack of direct access to the sea and thus world markets seems to hurt the capacity to specialize for exports and acquire cheap imports. As a consequence, it stands to reason that any landlocked country should try to circumvent this physical hurdle by creating institutions that foster trade, say by joining free-trade agreements.

Well, the reality seems to be the exact opposite. Ingo Borchert, Batshur Gootiiz, Arti Grover and Aaditya Mattoo find that landlocked economies in general have more restrictive policies in anything that relates to trade and interacting with the rest of the world, such as telecommunications and transportation. And with such policies, international policy assistance is unlikely to have much impact. But one make also ask oneself whether landlocked countries naturally tend to shun the rest to the world, an attitude that is difficult to overcome.

How to fight corruption

Conventional wisdom tells us corruption is bad (except for a few people). The evidence is surprisingly mixed (see old post), but that has not deterred every government or international agency to at least pretend to do something about it. Eradicating or attenuating corruption rarely works, maybe it is because the approach is wrong.

Martin Dufwenberg and Giancarlo Spagnolo verify an innovative angle to attack bribing, as proposed by Kaushik Basu and widely discussed in the Indian press: make bribing legal, but levy heavy fines on accepting bribes. That is somehow similar to the situation in some countries where consuming some drugs is legal, but their commerce is not. The conundrum the proposal tries to resolve is that briber and bribe-taker are usually partners in crime and unlikely to report the activity. By guaranteeing immunity to one party with return of the bribe, it is more likely that the corruptive transaction will be reported. But it turns out to optimize it, immunity should only be granted to those who report a bribe. Indeed, this gives stronger incentives to report. Also, granting immunity to any briber would have made it morally acceptable to bribe. To this I would have added that one also offer the repented briber a commission on top of the returned bribe. Then it would become profitable to report bribes, even when the requested service is ultimately not provided.

Women's rights and economic growth

Women have few rights in poor economies. They enjoy much more rights in rich economies. There is no doubt the correlation is positive, but what is the causation? Asking this question puts you on a slippery slope, as advocates of women's emancipation are quick to dismiss any hint that underlying economic forces could be the origin of new rights for women, rather than an exogenous political push. What does the literature have to say about this? Luckily, two surveys came out within a week of each other, with contrasting views.

Matthias Doepke, Michèle Tertilt and Alessandra Voena start from two observations consistently documented in the literature. 1) Giving women more rights refocuses private and public spending towards children, in particular health and education. Both lead to more growth. 2) Technological progress increased the costs of a male-dominated society and encourage females to join the labor force. Both lead to women's emancipation. And not put 1) and 2) together, and you have a theory of growth with female empowerment, where males are willing to step back for their own good. If technological progress initiates this virtuous cycle, it is actually not necessary once the cycle started spinning, and we have endogenous growth.

The other survey is due to Esther Duflo, who does not see anything self-sustaining in this cycle. In particular, one needs a constant exogenous push for women's equal rights to keep it going. While the paper above looks at long trends, the second focuses on natural and artificial experiments where the analysis is rather short-term. It is thus not clear to me whether it is really about growth or development. I am thus more convinced by the first paper and hopeful that the virtuous cycle will continue feeding itself.

More on the long term consequence of slavery in Africa

Since the start of this blog, one of the most popular posts has been one that analyzes the long-term costs of slavery in Africa. Of course, it is about the consequences in regions where slaves were taken from. There is also a region where they have been taken to, that is South Africa. What has been the impact there?

Johan Fourie writes that farmers taking slaves prospered thanks to economies of scale of specialization, to the point that they were considered by some to be the richest in the world at the time. But this advantage did not last long, as the use of slave labor discouraged further immigration from Europe. And as education opportunities were limited to (free) whites, large inequalities were maintained through a period where human capital became more important. These inequalities and the large fraction of poorly educated citizens, even after emancipation and the end of apartheid, stills drags the South African economy down, because institutions emerged to perpetuate these inequities.

This persistent impact of inequality in human capital is consistent with evidence from the US, as I reported in a previous post, with a recent update by the same authors just published recently. Graziella Bertocchi and Arcangelo Dimico expand on their use of US panel data. In short, they find that the education gap between whites and blacks at the county level today is determined by the initial gap in 1940, with only little convergence since. And the initial gap is largely explained by prevalence of slavery in earlier years.

Malthus visits Rwanda

Rwanda has always struck me as the perfect example of a Malthusian economy. A dense population where land is systematically divided up among descendants, leading to tiny lots that are barely sufficient for survival.Lots are so small that new capital for its exploitation is not relevant, and no technological improvements have any significant bite. In the end the land can only support a population at the edge of famine.

Marijke Verpoorten brings an intriguing connection between the Malthusian theory as applied to Rwanda and the genocide of 1994. Using regional data, she finds that the areas where there was the most urgent population pressure (through density or growth) were also the ones with the most killings. In a way, society was taking care of a business nature and famine could have.

Growth by saturation

When you compare rich and poor economies, you notice that many things differ between them One of them is that rich countries enjoy a much larger diversity of goods. It is not just that they carry more broads categories of goods, there are also more variations of a given good. For example, rich countries may have more car types and each model is sold with many more variations than in poor countries. Explaining this could be interesting.

This may be the motivation of Kozo Kunimune who builds a growth model with three essentially characteristics: there is constant growth in factor productivity, there is a ranking of goods with respect to the utility they provide, and consumers have a saturation point for each good. This implies that once they are saturated with a good, any "excess" production capacity can be dedicated to another good. As there is a strict ordering, goods are satisfied in succession and the number of goods defines the level of development. Also, the time needed to satisfy a new good decreases if the growth rate is constant, a feature that sounds empirically correct. But of course, there is no evidence whatsoever that we have such "lexicographic cum Leontieff" preferences. The model also violates elementary principles of Economics, such as local non-satiation. Not a particularly useful model.

Physiology and Malthus

The Malthus model of economic growth (or the lack thereof) is now standard fare in undergraduate education. Basically, it shows that there is a limit to the size of an economy that hinges on decreasing returns to labor in production and on mortality increasing as standards of living, as measured by GDP per capita, decrease. Those two critical assumptions are based on observations that were certainly valid at Malthus' times, and are likely to still be true today.

Carl-Johan Dalgaard and Holger Strulik go a little bit further in this theory. As more food is available, people grow taller. But being tall requires more food to sustain the body, which provides an additional reason for stagnation. This makes it more difficult to break loose from this "development trap" and may explain why economies stagnated for so long. But as Malthusian theory, this dies not explain why the economy suddenly exploded in the 19th century.

Is index-based weather insurance useful?

Whenever you are facing a risk, you want to be able to hedge against it (at least if you are risk averse). For this, there are all sorts of insurance policies. There are also markets in all sorts of instruments that allow you to find the right contingent claim for your situation. This includes farmers (and others) who want to hedge against meteorological risks. If you crop yields depend on weather patterns, you are looking for securities that pay out depending on some weather statistic. And they are available and have been heavily pushed by aid agencies in developing countries.

Chiratan Banerjee and Ernst Berg say they may not be such a great idea. They take the examples of rice farmers in the Philippines who bought wind-speed based indexes on the hypothesis that rice yields are lower when there are typhoons. But rice is remarkably resistant to typhoons and wind in general, the reason why it is so popular in the region in the first place. This means that rice farmers are heavily over-insured. That is especially bad and farmers are now confused about the concept of insurance as it looks like they face more risk than before.

Unemployment insurance in developing economies?

There is no doubt that absent moral hazard, insuring against unemployment shocks is welfare improving. But moral hazard, either through the unemployed not searching hard enough or rejecting job offers, can have a vicious effect on welfare if it is sufficiently widespread and successful. In addition, as unemployment insurance contributions typically do not depend on unemployment risk, only bad risks want to participate, and the insurance collapses without mandatory participation. With all this in mind, does it make sense to implement unemployment insurance in developing economies, where there is a large informal sector that makes mandatory contributions difficult to enforce and where moral hazard is, of course, rampant?

David Bardley and Fernando Jaramillo show that introducing unemployment insurance actually makes the formal sector more attractive and that we should thus not worry that much about the current level of informality. The presented model, however, does not allow for someone to collect UI benefits while working in the informal sector, a very real possibility that could easily overturn the results.

No convergence in the Caribbean

I have always found the Caribbean fascinating because it is a microcosm of the world, with tiny countries trying to get a workable government without the economies of scale the rest of the world enjoys. But as a readers of Economics research, the presence of this myriad of too-small countries lead to many frustrations, as they bias results in cross-country regressions. But sometimes, these micro-countries can be useful for research.

Roland Craigwell and Alain Maurin use them to study whether there is convergence in the Caribbean. It is well established that there is no convergence on world-wide country data, but it is very visible on subsets, such as US states. In the later case, all US states are under the same currency and roughly the same laws and government systems, there is some cross-state redistribution and no trade barriers. As you drop these features, which one gets you lack of convergence. In the case of the Caribbean, there is a partial monetary and trade union, laws and governments are more dissimilar than in the US and there is no redistribution. And as Craigwell and Maurin show, that is sufficient to make convergence disappear. Once more, it looks like once more institutions and to a lesser extent globalization are the keys to development for the poorest economies.