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Economists' Adventures and Misadventures in the Tropics
By William R. Easterly; August 2, 2002
Why economists' attempts to help poorer countries improve their economic well-being have failed.
Since the end of World War II, economists have tried to figure out how poor countries in the tropics could attain standards of living approaching those of countries in Europe and North America. Attempted remedies have included providing foreign aid, investing in machines, fostering education, controlling population growth, and making aid loans as well as forgiving those loans on condition of reforms. None of these solutions has delivered as promised. The problem is not the failure of economics, William Easterly argues, but the failure to apply economic principles to practical policy work.
In this book Easterly shows how these solutions all violate the basic principle of economics, that people—private individuals and businesses, government officials, even aid donors—respond to incentives. Easterly first discusses the importance of growth. He then analyzes the development solutions that have failed. Finally, he suggests alternative approaches to the problem. Written in an accessible, at times irreverent, style, Easterly's book combines modern growth theory with anecdotes from his fieldwork for the World Bank.
The Elusive Quest for Growth: Economists' Adventures and Misadventures in the Tropics
by William Easterly (Cambridge, Mass: MIT Press, 2002); 342 pages; $29.95.
POVERTY, UNFORTUNATELY, is the natural condition of man. And through most of his time on earth, as best as historians can determine, his standard of living has been meager and poor. But slowly over the centuries certain societies, mostly in what we generally refer to as “the West,” there evolved and developed a variety of political and economic institutional arrangements that heralded a change in the human condition. They provided the social structures that enabled men to begin their slow but sure escape from wretchedness.
Institutional arrangements and order are not easily quantified or measured, but they nonetheless serve as the societal rules and patterns of human conduct that make material and cultural improvement possible for mankind. As Douglas C. North, the 1993 Nobel Prize winner in economics has expressed it, “We cannot feel, touch, or even measure institutions; they are constructs of the human mind…. [Yet] they are the underlying determinant of the long-run performance of economies…. The major role of institutions in a society is to reduce uncertainty by establishing a stable … structure to human interaction.” North has emphasized that the most important of these institutions is private property rights, without which individuals could have neither security nor incentives in the pursuit of their material and cultural improvement.
The theme of William Easterly’s book The Elusive Quest for Growth is that besides the natural barriers to man’s improvement, governments have imposed and enforced various institutional rules and regulations that have undermined both incentives and opportunities for economic development in various “Third World” countries around the globe. And in addition, he explains, international agencies such as the International Monetary Fund and the World Bank have tended only to make matters far worse by establishing aid and loan programs that often have rewarded bad policies and political arrangements in those nations. And he should know, since he was a senior advisor at the World Bank.
Almost the first half of the book is a summary and critical analysis of the economic theories and policies that have guided the activities of these international organizations during the 50 years following the Second World War. At first, Easterly explains, “development economists” focused on the importance of “capital accumulation” for improving the economic condition of the world’s poor. Estimates and calculations were made and plugged into mathematical models about the minimum average annual increase in capital accumulation that was necessary to lift poor countries out of their poverty. This, in turn, led to a calculation of the amount of foreign aid Western nations needed to transfer to poor countries to finance this minimum amount of capital investment for growth in excess of the countries’ own low rates of savings.
But as Easterly points out, the capital investment rates that were introduced in various Third World countries produced no corresponding gains in economic growth. In fact, in some of the countries growth rates fell or even went into the negative figures.
Education and population
Another panacea that development economists latched on to was “education.” A more educated population would be a better-skilled and more-productive work force, creating incentives for foreign investors to move their capital to poor countries, again helping to accelerate investment and growth. Once more, however, the poor countries that poured the most into literacy programs often did not see any substantial improvement in their rates of economic growth.
The economic development theorists then argued that poverty prevailed in Third World countries because of overpopulation that could only be counteracted by spending on birth control. Thus, international programs were set up to sell and distribute condoms to overcome the “unmet need for contraceptives.” Easterly points out that one could as easily refer to the “unmet need” for Coca-Cola in those countries; yet somehow people find the money out of their modest incomes to buy the Coke they desire to drink. He suggests that there is a fundamental elitist arrogance in many development theorists and international policy managers for them to assume that they know what unmet needs require aid or whether people are having a vast number of “unwanted” children. And once again, contraceptive campaigns and use in many countries are not necessarily related to any improvement in the rate of economic growth.
Finally, Easterly details the numerous cases in which international agencies have extended loans or loan guarantees to poor countries, when it was soon clearly obvious that the funds were being squandered and wastefully spent by recipient governments. As a result, huge debts accumulated that were never going to be funded out of the low and limited export earnings of those countries on the world market. The loans were the cause of the debt and financial crises that have periodically rocked Asia, Africa, and Latin America over the last 20 years.
The key to prosperity
Easterly then turns to a detailed discussion of what factors are important to foster and create the conditions for economic growth and improvement. The
key is the right incentives for people to want and to be able to apply themselves in productive and profitable lines of market activity. Just investing in “capital” is pure waste unless those using the scarce resources to create capital are guided by market price signals that ensure that what is being produced with the capital are goods that consumers may actually desire and for which they will pay a price that covers the costs of the investment plus, one hopes, a profit with which future investments can be undertaken.
Forcing people into schools does not educate them. People will want to learn and will desire to acquire an education when they see future income and profit possibilities from acquiring various types of knowledge and skills. And people are able to make their own decisions as to the “optimal” size of the families they want, and often they freely choose to have fewer children as economic opportunities are opened to them in a vibrant market setting.
Growth on the free market does come from capital investment and serves as a stimulus to make further, complementary investments as profitable niches develop and are exploited. So, too, this stimulates people to take an interest in obtaining the kinds of knowledge and skills that productively match the capital investments being undertaken, so the growth in these economies can increase even more than proportionally to the increase in physical and human capital.
Easterly also emphasizes Joseph Schumpeter’s idea of “creative destruction.” All improvements and innovations in a society involve replacing the existing ways of doing things with new ones. This necessarily pressures those employed in the more traditional methods of producing to adjust to the changed economic environment, requiring some people to learn new skills, change their place of work and residence, and even accept lower-paying employment for a period of time. But that is the price of progress and longer-run rising standards of living for all, including those negatively affected by the innovative and competitive changes in the short run.
However, as Easterly carefully explains, “Governments can kill growth.” Inflation, high taxes, supply-side regulations and controls, and trade and investment restrictions are all policy tools that retard and inhibit people’s free ability to find market avenues for economic betterment. The politically regulated and manipulated economy inevitably creates an environment of corruption and privilege that wastes people’s time, labor, income, and resources in just trying to bribe those with power. The political powers become wealthier and the society becomes that much poorer.
Easterly, therefore, argues that good institutions are the basis for economic growth by creating the right market-based and market-guided incentives. And these institutions are: rule of law, competitive markets, low taxation, noninflationary monetary policies, and free trade. These institutions then foster other cultural patterns of conduct, hard work, savings and industriousness, honesty and trustworthiness, creativity, and self-responsibility. These are the bases of the wealth of nations.
