The Big Push Déjà Vu: A Review of Jeffrey Sachs s The End of Poverty: Economic Possibilities for Our Time - PDF

Journal of Economic Literature Vol. XLIV (March 2006), pp The Big Push Déjà Vu: A Review of Jeffrey Sachs s The End of Poverty: Economic Possibilities for Our Time William Easterly Jeffrey Sachs

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Journal of Economic Literature Vol. XLIV (March 2006), pp The Big Push Déjà Vu: A Review of Jeffrey Sachs s The End of Poverty: Economic Possibilities for Our Time William Easterly Jeffrey Sachs s new book (The End of Poverty: Economic Possibilities for Our Time, Penguin Press: New York, 2005) advocates a Big Push featuring large increases in aid to finance a package of complementary investments in order to end world poverty. These recommendations are remarkably similar to those first made in the 1950s and 1960s in development economics. Today, as then, the Big Push recommendation overlooks the unsolvable information and incentive problems facing any large-scale planning exercise. A more promising approach would be to design incentives for aid agents to implement interventions piecemeal whenever they deliver large benefits for the poor relative to costs. 1. Introduction Jeffrey Sachs is the economics profession s leading advocate of megareform. Whether it is stabilization of hyperinflation in Bolivia, shock therapy to leap from Communism to capitalism in Poland and Russia, or a Big Push to end world poverty, Sachs s recommendation throughout his career has been to do it fast, do it big, do it comprehensively, and do it with lots of Western money. Sachs s approach, as set out in vivid detail in his fascinating new book, raises an interesting debate for economists about the merits of the Big Push versus incremental reform. This carries on the debate begun Easterly: New York University. fifteen years ago about shock therapy versus gradualism in the ex-communist countries. It taps into a long-standing intellectual debate about social change in general, dating at least as far back as Edmund Burke s critique of the French Revolution. Burke preferred gradual reform to revolution, just as in the twentieth century Karl Popper argued for piecemeal democratic reform as opposed to utopian social engineering. Earlier in the twentieth century, there was a debate about planning versus markets. 1 This debate is particularly relevant for economic development, where utopian 1 A recent treatment of economic reform, in light of this intellectual tradition is John McMillan (2004), who discusses shock therapy in particular. McMillan is one of those who inspired me to go back and read Popper s writings. 96 Easterly: The Big Push Déjà Vu 97 social engineering has attracted more intellectual support than in other fields of economics. Because the tragedy of the world s poorest peoples is so heartbreaking, an appropriately large response is more appealing in development economics than in more emotionally neutral areas like, say, the efficiency of the stock market. The Big Push appeals because it seems to promise a quick end to the tragedy. Perhaps it is also seductive to us as economists because it suggests our analysis and recommendations can have a large effect. As Sachs says: I have also gradually come to understand through my scientific research and on the ground advisory work the awesome power in our generation s hands to end the massive suffering of the extreme poor... (p. 2). To unleash this power, Sachs proposes the Big Push for poor countries. The principle element in the Big Push would be a doubling of foreign aid, to about $100 billion a year, then nearly doubling again by Foreign aid would fill a financing gap between what a country needs and what it can afford on its own, making it possible for each of the poorest countries to break out of the poverty trap and begin growing on its own (p. 250). Another big element in ending the poverty trap is a comprehensive package of interventions covering virtually all of the needs of poor people. This is because Sachs sees specific areas of underinvestment as particularly critical, like insufficient spending on health and soil fertility. Sachs identified these interventions as part of his work leading the UN Millennium Project, which commissioned ten task forces that mobilized 250 experts. Sachs presents a fifty-four-item checklist of barriers to development (p. 54) that must be overcome with the comprehensive package. In a separate report, the UN Millennium Project listed 449 interventions that it recommended to end world poverty (UN Millennium Project, Millennium Development Goals Needs Assessment). The book discusses many of these interventions in detail, many of which sound plausible: insecticide-treated bed nets to protect children from malarial mosquitoes, fertilizer for crops, and health clinics. Sachs believes you must do everything to accomplish anything: These interventions need to be applied systematically, diligently, and jointly since they strongly reinforce one another (p. 208) and success in any single area, whether in health, or education, or farm productivity, depends on investments across the board (p. 256). Who would actually implement this package and how? This is really the critical part of the book, and here Sachs seems to back social engineering against Popper s piecemeal democratic reforms. The book says We need plans (p. 227). Sachs many times seems to suggest that aid agency officials and national government leaders should do planning from the center to make everything happen. Professor Sachs has subsequently objected to the characterization of his arguments as topdown planning, so I will give some quotes from his book that led many readers (including this reviewer) to this interpretation. In a section titled: Planning for Success : The UN Secretary General should oversee the entire effort the secretary general should ensure that the global compact is put into operation (p. 269) Each country should have 5 plans, including an Investment Plan, which shows the size, timing, and costs of the required investments (p. 273) Getting from here to there is a matter of routine planning, not heroics (p. 274) Each low-income country should have the benefit of a united and effective UN country team, which coordinates in one place the work of the UN specialized agencies, the IMF, and the World Bank. In each country, the UN country team should be led by a single UN resident coordinator, who reports to the United Nations Development Program, who in turn reports to the UN secretary-general (p. 285). The book clearly does not advocate that any economy switch over to central planning 98 Journal of Economic Literature, Vol. XLIV (March 2006) as an economic system; Sachs is obviously a believer in free markets in general. Yet he argues in the book that free markets do not offer much hope for the poorest countries, and that a comprehensively planned set of interventions is needed to get the poorest one-sixth of humanity out of poverty. 2. Sachs and Development Economics How are we to place Sachs s prescriptions for ending world poverty into the development economics literature? The first thing that stands out is how familiar Sachs s argument sounds. He is restating almost exactly the arguments of development economists made in the 1950s and 1960s, even using the same words. Then, as now, there were economists who advocated a Big Push to get countries out of a poverty trap, foreign aid to fill the financing gap, and action on all fronts through comprehensive planning. To be sure, development economists at that time advocated far more state intervention in the poor economies than Sachs does now. Yet otherwise the concepts are remarkably similar between then and now. The 1960 counterpart to Sachs s The End of Poverty was Walt Rostow s best-selling The Stages of Economic Growth, which argued that countries could emerge out of stagnation into self-sustained growth thanks to an aidfinanced increase in investment. Over the intervening forty-five years, many academic development economists abandoned these ideas as simplistic, realizing that economic development is a complicated interplay of markets (with many imperfections), politics, social norms, institutions, and government policies, social services, and microeconomic interventions. Nevertheless, the idea of an aid-financed takeoff into growth has maintained its appeal in the development policy community. The second thing Sachs has in common with the generation of fifty years ago is to promise great results. Sachs certainly does promise a lot. Since Sachs is a gifted political campaigner as well as an economist, perhaps we can indulge a slogan that we will be able to to heal a divided planet, to end the suffering of those still trapped by poverty, and to forge a common bond of humanity, security, and shared purpose across cultures and regions (p. 3). However, Sachs reiterates the promises of great results so frequently that it seems to be more than political rhetoric. The end of poverty is at hand within our generation but only if we grasp the historic opportunity in front of us (p. 25). The success in ending the poverty trap will be much easier than it appears (p. 289). Referring to the old Enlightenment dream of world peace, democracy, and prosperity, Sachs says many of its sweetest fruits are within our reach (p. 352). 3. Big Solutions in Other Contexts The book includes Sachs s successful experiences in Bolivia and Poland in stabilizing high inflation through shock therapy. Here perhaps is a clue to the book s confidence in the power of policymakers. You can solve high inflation with some top-down actions by policymakers fix the exchange rate and stop printing money. Unfortunately, the topdown solutions do not translate well into fixing whole societies that are at one-sixtieth of U.S. per capita income and with very different institutions, social norms, and economic arrangements. The promise of a big solution to a very big problem is an outlier in the practice of economics, where usually economists study marginal changes to existing systems or policies to generate marginal improvements. No serious economist that I know of is proposing a big plan to triple U.S. per capita income or to end poverty in the United States. However, there are arguments in economics in favor of more comprehensive packages. The theorem of the second best says that we cannot know whether a partial movement toward a free-market equilibrium will be beneficial. Coordination problems Easterly: The Big Push Déjà Vu 99 and models with multiple equilibria have attracted a lot of interest from economists over the past decades, although there has been much more theory than empirics. It does make sense that one policy change will only be effective if other policies are satisfactory for example, privatization without laws to enforce good corporate governance and property rights could backfire. These arguments were particularly popular after the Berlin Wall fell and economists were called in to advise governments how to move from Communism to capitalism, which was when Sachs s shock therapy became famous. Why was shock therapy in the ex- Communist countries so disappointing, with output collapses, high inflation, and political backlash? It turned out in the ex-communist countries not to be feasible to do all the possible complementary reforms at once. There was a similar failure in developing countries with the attempt by the IMF and World Bank to implement comprehensive structural adjustment. The relevant choice turned out to be between a big partial reform and a small partial reform. The big partial reforms failed on an equally big scale. Gradualism and incremental reform has more appeal now after the chastening experience of transition economics and structural adjustment, as well as the consistent failure of Big Push economics in foreign aid to poor countries. Why are comprehensive big reforms not advocated in rich countries? In rich countries, the small partial reforms have been the source of progress over time, and economists studying rich countries sensibly stick to such marginal improvements rather than big reforms. 4. Sachs s Theory of Aid and the Poverty Trap Nevertheless, Sachs argues forcefully that the poor countries badly need a Big Push. The intellectual foundation for this is the idea of the poverty trap. Sachs has many ideas on how the poverty trap happens. I highlight three that are familiar, because development economists first highlighted them almost half a century ago. The first is that poor people do not save enough: When people are... utterly destitute, they need their entire income, or more, just to survive. There is no margin of income above survival that can be invested for the future. This is the main reason why the poorest of the poor are most prone to becoming trapped with low or negative economic growth rates. They are too poor to save for the future and thereby accumulate the capital that could pull them out of their current misery (pp ). Sachs s second reason for a poverty trap is a demographic trap, when impoverished families choose to have lots of children (p. 65). Population growth is so high that it outpaces saving (which was already too low, according to the first reason). The third element in the poverty trap is a nonconvexity in the production function. Sachs suggests there are increasing returns to capital at low initial capital per person (and low income per person): An economy with twice the capital stock per person means an economy with roads that work the year round, rather than roads that are washed out each rainy season; electrical power that is reliable twenty-four hours each day, rather than electric power that is sporadic and unpredictable; workers who are healthy and at their jobs, rather than workers who are chronically absent with disease. The likelihood is that doubling the human and physical capital stock will actually more than double the income level, at least at very low levels of capital per person (p. 250). Sachs gives the example of a road with half of the road paved and half impassable due to missing bridges or washed out sections. Repairing the impassable sections would double the length of road, but would much more than double the output from the road. This is an example of a threshold effect, in which the capital stock becomes useful only when it meets a minimum standard (p. 250). 100 Journal of Economic Literature, Vol. XLIV (March 2006) These three mechanisms have been prominent in the development policy community because they seem to create a simple way in which aid can break the poverty trap. The role of foreign aid is to increase the capital stock enough to cross the threshold level: if the foreign assistance is substantial enough, and lasts long enough, the capital stock rises sufficiently to lift households above subsistence.... Growth becomes self-sustaining through household savings and public investments supported by taxation of households (p. 246). The poverty trap story is theoretically intriguing and may well give insights into poor development outcomes. There is a large literature discussing evidence for poverty traps (see the excellent survey by Costas Azariadis and John Stachurski 2004, who point out the difficulty of drawing unambiguous conclusions about the existence of poverty traps). 2 I concentrate more narrowly on whether aid has had the effects that the Sachs poverty trap model would predict. The main prediction is that aid would have large and positive growth effects in poor countries. Decades of research on aid and growth has failed to generate evidence for this prediction (I summarize some of this research in William Easterly 2003). The big stylized facts certainly do not support the prediction that aid has big growth effects, helping countries to escape from poverty traps: (1) aid has been highest as a percent of income in Africa, but African growth is lowest of any continent, (2) aid has risen over time as a percent of income in poor 2 Aart Kraay and Claudio Raddatz (2005) have recently tested directly whether the savings and increasing returns mechanisms hold in the data. They point out that saving would have to follow an S-curve to generate a poverty trap, first increasing little with income, then increasing steeply, then flattening out again. They reject the S-curve in the data on saving and per capita income. They also fail to find evidence of the technological nonconvexities that also are necessary to create the poverty trap. They conclude there is little evidence for a poverty trap based on these mechanisms. countries, but their growth rate has fallen over time. The evidence that Jeffrey Sachs adduces for the poverty trap in The End of Poverty is from the period since This is indeed the period where the stylized facts are most consistent with a poverty trap, as the poorest countries had per capita growth around zero, in contrast to positive growth in richer countries. However, the poorest countries did have significant positive growth To make things worse, the poorest countries were getting more in foreign aid as a percent of their income in the last twenty years, compared to the previous period. Foreign aid is supposed to be helping the poor countries escape from the poverty trap; hence the poorest countries in the recent decade should have been LESS likely to be stuck in poverty than the previous decades with lower foreign aid. In sum, the evidence for an aid-induced Great Escape from poverty is less than overwhelming. 5. Poverty Traps versus Bad Government Sachs argues that it is the poverty trap rather than bad government that explains poor growth of low income countries over recent periods. For example, 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 (p. 191). Yetalarge literature argues that bad institutions and policies ARE a part of the problem of low growth. Let us do a quick test of bad government against the poverty trap as a story for poor economic growth. The earliest rating we have on corruption is from 1984, from the International Country Risk Guide. We have a rating on democracy for the same year from a research project at the University of Maryland called Polity IV. Let s take countries that have the worst ratings on both corruption and democracy, and call these countries bad governments. While poor countries did worse, it s also true that Easterly: The Big Push Déjà Vu 101 the twenty-four countries with bad governments in 1984 had significantly lower growth 1985 to the present: 1.3 percentage points slower than the rest. There is some overlap between these two stories, as poor countries are much more likely to have bad government. 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. The coefficient on initial per capita is not significantly different from zero, 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. Sachs is very insistent that bad government is not the problem in poor countries. This is an important part of his case for increased aid, in that he imagines skeptics asking If the poor are poor because... their governments are corrupt, how could global cooperation help? (p. 226). He wants to reassure potential aid donors that the poor... are also ready to govern themselves responsibly, ensuring that any help that they receive is used for the benefits of the group rather than pocketed by powerful individuals (p. 242). Even where he sees some corruption, he thinks more aid can solve the problem Part of the corruption {in Kenya} is new and completely avoidable, but only if donors help Kenya to improve the functioning of the public administration... by the installation of computer systems, published accounts, job training and upgrading, higher pay for senior managers (p. 237). Unfortunately, there is an ex
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