Category Archives: Economics

Alleviating Poverty – Poor Economics by Banerjee & Duflo (2)

Part 1 of Review available here.

“To progress, we have to abandon the habit of reducing the poor to cartoon characters and take the time to really understand their lives, in all their complexity and richness.”

I’d heard before that on average, tall people earn more money. What I hadn’t heard was that apparently if you control for IQ, that difference disappears – tall people are smarter and so have higher wages. A suggested explanation is malnutrition, which both reduces height and lowers IQ, and poses a significant challenge to poverty. This and other fascinating studies make up the bulk of Poor Economics, as Banerjee and Duflo follow their own advice and turn to the data to understand the challenges of development.

If you want to help the poor, say Banerjee and Duflo, you need to give up grand theories and ideas of structural change, no matter how appealing a silver bullet may be. Rejecting Why Nations Fail, they argue that poverty is not the product of grand institutional failures, but rather is an individual or local condition, making cookie-cutter remedies useless. Development must be achieved by a series of small, well-thought out and well-tested steps, gradually accumulating into big changes, not grand designs with little relevance to the lives of the poor.

To do so, they point out, it is essential to first actually understand the lives of the poor. Arguments often rage over whether the poor are in a poverty trap, the concern being that had they only a little more money for health, schooling, or business, they could invest and increase their wages, starting a positive cycle of investment and returns. B&D, however, dismiss the arguments of Sachs, Easterly, and others, and point out that the answer can only be found in the data, through randomized control trials and empirical work, not through theory or ideological debates.

They do make some broader claims. Without a stable job, for example, they suggest there is little incentive to save, invest, or plan for the future. As a result, the creation of jobs with job security may be justified even if it is an inefficient method of job creation, because of the indirect benefits. I’m not sure if I agree or not, but it’s an interesting point.

Perhaps the one criticism I have of Poor Economics is that their attempt to stick to economic rationality, though understandable, can feel forced. At several times in the book, as when they’re discussing how some households will borrow at a 24% rate of interest in order to save it at 2%, psychological or behavioural explanations seemed like a natural next step in the discussion, and I was disappointed when they neglected them. Still, the book adds a much-needed voice in the discussion of economic development, one driven by data, not ideology.

Still interested? You can read my summary of their lessons for development here, or sign up for the Subtle Illumination reading list to your right! Or, you could always head to Amazon and get the book your yourself (or in the UK or Canada).

Poor Economics by Banerjee and Duflo (1)

Part 2 of review available here.

“The ladders to get out of the poverty trap exist but are not always in the right place, and people do not seem to know how to step onto them or even want to do so.” – Banerjee and Duflo

I’ll be posting a review of Poor Economics on Sunday, but it’s looking like a long one, so in the interim I thought I’d post a summary of their five lessons for economic development, and leave discussion to Sunday.

The poor often lack information or have false beliefs, leading them to do things like ignore potentially useful dietary advice.
The poor are responsible for far more decisions than comparable households in the West, to their cost. We take sanitization of water or the removal and treatment of sewage, for example, for granted: for the poor it can be a conscious choice. Too many conscious choices can be overwhelming, and reducing the number of decisions that need to be consciously made is no more patronizing than sanitizing household water in the US.
There are often good reasons for some markets for the poor to be missing, and so we can’t assume they will always self-form or should be formed. A health insurance market for the poor, for example, though of potential benefit, has struggled to form because the insurance options that can be sustained by the market are not what the poor want.
Poor countries are not doomed to failure because they are poor. We often hear of the failures of aid programs, but in many cases those failures are avoidable through small design fixes, rather than grand institutional change of the social and political structures.
Expectations of outcomes can often become self-fulfilling prophecies. Children drop out of school because they don’t expect to be good at it; adults stay in debt because they don’t expect to be able to stay out of it. Getting a virtuous cycle started can be enormously powerful.

Number 5, I would argue, is a lesson for life, not for development, but nevermind.

As we’ll find out on Sunday, the foundation of their book, however, is that these are not general rules applicable everywhere. Instead, they argue that development cannot be conducted by universal rules and general theories. It must be adapted to suit context, culture, and location, all of which require data, not ideological theorizing.

You can read part 2 of the review here. In the meantime, keep reading (or in the UK or Canada). Or, join the Subtle Illumination email list to your right!

(Honest) Truth About Dishonesty by Dan Ariely

“The gates of hell are open night and day / Smooth the descent, and easy is the way” – Virgil, The Aeneid

Are you a liar? We tend to assume some people just are: that they consistently cheat in life. An Enron theory of dishonesty, if you will. Ariely, though, argues in The (Honesty) Truth About Dishonesty that the reality is that almost everyone cheats a little given the right circumstances. The key, he says, is to still be able to tell ourselves that we’re a good person: after all, we haven’t cheated that much.

Unfortunately, this means we can’t just assume people cheat when the money is good. Instead, he points to experiments where people cheat more when they’re knowingly wearing counterfeit brand clothes, when they’re representing a cause that doesn’t benefit them, and when tokens exchangeable for cash, not cash, is the prize. What’s worse, he also shows we usually aren’t aware of the effect, with individuals unconsciously preferring art from one gallery over another if they’ve been told the funding for the experiment came from that gallery (and even showing increased activity in their brain’s pleasure centers when they see “their” logo), while remaining completely certain of their objectivity.

There is hope, however. Dishonesty diminishes when it becomes harder to self-justify an act: we might take a coke but we wouldn’t take a dollar bill from a fridge, for example. Even small reminders of morality reduce cheating, whether trying to remember the Ten Commandments (even if you only remember one or two), or signing a commitment to an honour code at the top of the page (even if the honour code is fictional). If we can stop the small acts of dishonesty, he argues, we can prevent it from gathering momentum and becoming contagious.

For me, the implication is that if we’re trying to stop a firm from committing fraud or a politician from lying, the answer isn’t to fire the bad apples or even have them declare conflicts of interest. It’s environmental and psychological factors that encourage us to cheat, and environmental and psychological factors that can help discourage us from doing so. All of us run the risk of drifting into dishonesty, a little bit at a time, while remaining convinced that we are acting morally. In a high paced, modern lifestyle, we may never get the chance to stop, reflect, and reset those patterns, but it may be ever more important that we try.

Interested? Keep reading (or in the UK or Canada). Readers might also like Ariely’s earlier books, Predictably Irrational and The Upside of Irrationality, about the irrationalities that drive us and their potential benefits. Or, join the Subtle Illumination email list to your right!

Explaining Why Nations Fail – Acemoglu and Robinson

Acemoglu and Robinson present in Why Nations Fail: The Origins of Power, Prosperity, and Poverty an important idea: that it is institutions that determine whether countries are rich or poor. When institutions concentrate power in the hands of only a few, nations fail. Unfortunately, their book can also be frustrating – their focus on institutions can feel like it blinds them to other possibilities, and as a result their examples, though fascinating, can feel repetitive.

A&R argue that political and economic institutions can be extractive (designed to extract resources and centralize power in an elite who will then oppose change or progress) or inclusive (decentralizing power and allowing individuals economic autonomy). Both types of institutions, they argue, must be inclusive for long run prosperity. It’s an important division, and one that has a lot of explanatory power: anyone who’s crossed the American border with Mexico can’t deny that it is the institutions, not the fifty feet of distance, which matters.

The bulk of the book provides examples. Their studies are both well written and compelling, but they also make me wonder whether institutions are really the distal cause: apart from the simple case of countries with a colonial past, there is little discussion of what leads to good institutions. When they do raise the issue, they seem to implicitly assume that institutions are chosen rationally by elites, based on the cost and benefits of each type, an assumption that seems unconvincing.

Economists and development experts often underrate the importance of institutions, and so Why Nations Fail makes a critical contribution. It also makes a strong argument against the centralization of political power, which can be tempting in the short run but corrupts institutions and social norms in the long run. It’s engagingly written and full of interesting facts, and so is well worth the read for anyone remotely interested in these issues (and everyone should be). It just doesn’t seem to entirely meet its (admittedly ambitious) mandate: to explain why some nations fail and some succeed.

Want more enlightenment? Keep reading (or order from the UK or Canada). Why Nations Fail is certainly worth a look.