DESTIN-STICERD joint seminar part II

The second DESTIN-STICERD joint seminar. (See here for the first one held last November.)

This time, the main theme is "Aid and the End of Poverty". As it suggests, the background is Jeffery Sach's recent book The End of Poverty (see 9th April for Sach's basic argument) and a recent political initiative undertaken by the British government to end poverty in Africa (see Commission for Africa website).

The first speaker is Francesco Caselli, representing development economists. His main point is that the effectiveness of aid depends on which world the poor live in, the nonconvex one or the convex one.

In the nonconvex world (or the world endowed with increasing return technology), the poor cannot get richer because of (1) minimum consumption to survive (therefore they can't save at all), (2) lack of education, (3) lack of healthiness, and (4) lack of infrastructure. But if your wealth exceeds a certain level, then these problems are suddenly solved, hence you start getting richer and richer. This is the world Jeffery Sachs envisions, and the rationale for more aid as aid money brings the poor immediately above the threshold level of wealth.

In the convex world (or the world endowed with decreasing return technology), on the other hand, the poorer you are, the higher the investment return. In this case, aid is wasteful because at the end of the day everyone reaches the equilibrium level of wealth (remember the Solow growth model). What matters is the curvature of production function, which is affected by, say, governance.

Therefore, the question is which world the poor live in. Based on evidence available, the convex world seems more likely as empirical studies have shown that return to education is higher in poorer countries and that return to physical capital is also higher in poorer countries (see Professor Caselli's own working paper).

He also raises two questions. Are the middle class people (whose wealth level is above the threshold in the non-convex world) becoming richer fast? If so, the world is non-convex. Is there any evidence that aid triggered the take-off of the economy? If so, the world is non-convex.

The second speaker is Dr. Teddy Brett from DESTIN. He points out quite a few countries where aid worked because the government was good (Uganda after the 1980s, India, Botswana, Ghana, Mozambique, Morocco, and, to a lesser degree, Egypt). So we shouldn't be so pessimistic. His main point is that aid is effective with good governance, which consists of bureaucratic capacity and the government's commitment.

Now it's PhD students' turn. The third speaker is Masa Kudamatsu from STICERD.

Yes, I was the speaker. :) I talked about under what conditions self-interested political leaders are willing to use aid money to tackle poverty. I introduced two theories in the literature of policy-making in autocracy.

The first one is Mancur Olson's stationary bandit theory (see McGuire and Olson 1996). According to this theory, political leaders tackle poverty by using aid money if both of the following two conditions are met: (1) The government is capable of collecting taxes (Self-interested politicians are assumed to consume tax revenue for their own benefit, and therefore we need to have a positive correlation between poverty reduction and tax revenue); (2) Political leaders won't be ousted in the near future (otherwise leaders cannot reap the benefit from poverty reduction even if the first condition is met).

The second one is the agency model approach (or what is sometimes called the political accountability model), first proposed by Barro (1973) "The Control of Politicians: An Economic Model", Public Choice, 14, pp.19-42, and Ferejohn (1986) "Incumbent Performance and Electoral Control", Public Choice, 50, pp.5-25. Although these two authors had in mind democratic politics, the basic idea can be applied to autocracy as well (see Gallego and Pitchik 2004, for example). This theory tells us again that we need both of the two conditions to be satisfied so that self-interested political leaders are willing to tackle poverty out of aid money: (1) the poor can play a role in leadership selection (otherwise political leaders will stay in office without tackling poverty); (2) the poor can trust a potential new leader who will assume office after the current leader is ousted (otherwise, the poor are happy with the incumbent who takes poverty serious only marginally because the alternative to the current leader is even worse). (The second point was brought to attention by Bueno de Mesquita et al. 2002, and Padro-i-Miquel 2004 applied it to African ethnic politics.

I couldn't effectively connect these ideas to the points raised by the two faculty members earlier in the seminar. That was my regret. But I guess the presentation went well overall as Robert Wade, a professor from DESTIN, told me it was interesting and crisp. (I didn't know the meaning of "crisp". Later I looked it up in the Collins Cobuild English Dictionary; it says, "If you describe someone's writing or speech as crisp, you mean they write or speak very clearly, without mentioning unnecessary details.") Special thanks goes to Paolo, who gave me comments on my slides, saying, "Difficult to understand." :)

The last speaker is Elliot Green from DESTIN. He is a specialist of Uganda. He points out that the headcount ratio (the percentage of the poor over the total population) in Uganda had been in decline during the 1990s but went up around 2000. He attributes this dynamics to the coffee price in the world market. If you look at the headcount ratios by region, the number of poor people is falling mainly in the central region, where coffee beans are produced. Plus, the world coffee price was on the rise durng the 1990s and began falling until 2002. He also mentions that democratic elections for regional governments in Uganda actually caused a fall in tax revenue because the governments cut taxes in order to win votes. This is detrimental to good governance in his view (and, it seems, in the view of most development studies researchers) because the link between the government and citizens is broken without tax collection. (This argument is shared by The Economist magazine as well. See this article.)

So there seemed to be a consensus between me and Elliot (and some DESTIN students) that tax collection is key to poverty reduction.

During the floor discussion that followed, a couple of interesting interactions between economics and development studies emerged. In relation to Professor Caselli's question - is the middle class people getting richer quick? - Bettina, a DESTIN student, pointed out the fact that middle class people in poor countries simply invest their money overseas or emigrate to rich countries. Prof. Caselli's response was that it indicates the return to investment for middle class people is low, supporting the idea of the convex world.

Also in response to Professor Caselli's comment that good governance comes with a good leader, which is more or less a matter of luck, Dr Brett raised an interesting point. President Yoweri Museveni of Uganda and former President Charles Taylor of Liberia were both rebel leaders who succeeded in defeating the government forces. But under Museveni's rule Uganda has seen improvements in the economy (with caveats pointed out by Elliot, though) while Charles Taylor just brought another civil war to Liberia (see this BBC article). The difference between these two cases is, in Dr Brett's view, higher education. Uganda received a lot of aid money to improve its higher education system in the 60s and 70s, which President Museveni enjoyed before turning to be a rebel leader. This didn't happen in Liberia. So Dr Brett welcomes one suggestion made by the Commission for Africa that aid should target higher education in order to bring about good governance. This point is revealing to me as development economists all ignore the role of higher education in development.

The seminar ended with this argument on the quality of leadership. This is somehow encouraging to me because that's what I'm now trying to figure out: how the quality of leadership is determined in nondemocratic countries.

Overall, I benefited a lot from this seminar though other STICERD people didn't seem to (plus, none of STICERD professors attended the seminar)...

Polarization and Conflict

Debraj Ray's LSE public lecture titled "Polarization and Conflict". One of the best lectures I've ever attended, in the sense that it synthesizes theoretical and empirical works done by economists (including the lecturer himself, of course) to answer a practical question.

The lecture begins with the following question: Does ethnic division matters for civil war? Although there are quite a few reasons you can think of in favour, statistical analysis done by economists and political scientists has failed to identify the effect of ethnic division on the occurrence of civil war (see Fearon and Laitin (2003) "Ethnicity, Insurgency, and Civil War", American Political Science Review, 97, pp.75-90). This does not exclude the possibility that ethnic division indirectly affects civil war through, say, poverty. But the consensus emerging from the empirical literature is that ethnic fragmentation does not have a direct impact on civil war.

Professor Ray now asks this: Is the measure of ethnic division appropriate? The measure those empirical researchers have used is called "ethnolinguistic fractionalization index", which measures the probability that two people randomly picked up from a country belong to different ethnic groups (a good reference is probably Easterly and Levine 1997). Horowitz (1985), a book that takes a historical - rather than statistical - approach to this issue, suggests that broad cleavages, not fractionalization, matter. Civil war is more likely to happen when we see, in a given country, two large distinct groups rather than a large number of different groups. But how can we conceptualize this notion of "broad cleavages"?

Professor Ray, along with Joan Esteban, already made this happen in 1994 (see Esteban and Ray 1994). He created a measure of polarization. This measure captures two ideas: identity and alienation. Identity refers to how many people you are identified with - what can be called "local equality". Alienation refers to how far other people are from you - something called "global inequality". As civil war is not something you can do individually, you need to capture something social. That's what "fractionalization index" fails to do. But Esteban-Ray's polarization measure does.

Now a forthcoming paper in American Economic Review - "Ethnic polarization, potential conflict and civil wars" by Jose G. Montalvo and Marta Reynal-Querol - utilises this concept of polarization and does the same empirical analysis as Fearon and Laitin (2003) (see above). Guatemala, Sierra Leone, Nigeria, and Bosnia, countries well-known for civil war, turn out to be countries with high polarization index but low fractionalization index. Even after controlling for a bunch of other variables - income per capita, population, geography, etc. - it is shown that the index of polarization does have a direct impact on the probability of civil war.

The lecture closes with a remaining issue: Do economic differences across groups matter for conflict? Empirically, this question is hard to answer due to lack of data. But it's beginning to be collected. Theoretically, there are two types of civil war: vertical war (poor vs. rich ethnic groups as in Rwanda and Burundi) and horizontal war (economically similar groups fighting each other as in Nigeria). Research is now going on to figure out how economic differences across groups affect the occurrence of civil war.

Robert Townsend's lecture at UCL

Robert Townsend came over to University College of London and gave a two-day lecture titled "Evaluation of Financial Systems in Developing economies".

Professor Townsend is one of the leading development economists though his research strategy is quite different from the others in the sense that he tries to understand macroeconomy by looking at microeconomic datasets. I think this is cool. Usually, economists are either looking at macroeconomic datasets to talk about macroeconomy or looking at microeconomic datasets to talk about microeconomy.

What's also cool about him is, though this is a bit gossipy, he has been doing research on how the economy has grown in a country where his partner comes from (see the overview of Townsend Thai Project). I think this is beautiful.

Anyway, his main argument in the lecture is that Thailand's economic growth in the past few decades has been mainly driven by financial deepening; more and more people become able to borrow money, thanks to a variety of financial policy measures undertaken by the government, and set up their own small businesses.

On the first day, he mainly talked about hard facts on the Thai economy. Based on not only national account data (GDP etc.) but also household survey datasets collected by the Thai government as well as by Townsend's research team, he gave us the following revealing facts:

1. In Thailand, households, usually seen as labor suppliers and goods consumers in macroeconomics (look at the circular flow diagram in your macroeconomics textbook), play a huge role in production. The share of income earned by small household businesses is larger than that of big corporate businesses in Thailand.

2. Looking at tambon-level data ("tambon" is a Thai word for dictricts, smaller than provinces but larger than villages), income distribution is more equal in high-income tambons than in low-income ones, contradicting the usual argument that economic growth brings about inequality at the initial stage of development (Kuznet's inverse U-curve theory).

3. Around 20% of change in per capita income is explained by population movements from low-income occupations to high-income ones.

4. 97% of fimrs in Thailand is small-sized, with many being rice-mills run by one person.

5. The more assets you initially have, the more likely you start a business later and keep your children at school.

6. The BAAC (Thailand's government bank for farmers) serves as an insurance provider for farmers, by rescheduling loan repayments conditional upon verified unexpected shocks such as rainfall failure, with delayed repayments compensated by government subsidies. Looking at who each household borrows money from, the BAAC serves for poor people while other sources of credit (commercial banks, moneylenders, etc.) are mainly for rich people.

On the second day, his lecture began to be more formal. First, he explained his recent article published in Journal of Development Economics, where a simple occupational choice model (see Ghatak and Jiang 2002 for the simplest exposition on what the occupational choice model is like) with the non-intermediate sector where people cannot borrow and the intermediate one where people can borrow is constructed, parameters in the model are estimated based on the Thai household survey data (the amount of wealth they own and whether or not they are self-employed), and macroeconomic variables (growth rates, gini coefficients, etc.) are calibrated. He stressed that this model explains the huge surge in Thailand's economic growth rate in the early 1990s.

An interesting point is that this analysis treats the relative size of the intermediate sector (ie. the fraction of people with access to credit) as exogenous. If they build a model where the fraction of people with access to credit is endogenous and calibrate macroeconomic variables (see Townsend and Ueda 2003), the model fails to explain the upturn in Thailand's growth rate in the early 1990s! That's why Professor Townsend believes that the expansion of finaical markets in Thailand is largely exogenous, induced by the financial liberalization undertaken by the government.

This style of argument is very different from what I'm used to at LSE, or in other words, the way the majority of leading development economists adopt. They say, "At the end of the day, most economic variables are endogenous. So let's find an instrument. If that's very difficult, let's do randomly assigned policy interventions by persuading NGOs (e.g. Kremer and Miguel 2003), the World Bank (Olken 2004), or even the national governments (Shultz 2004)."

I believe it's not about which approach is superior to the other, though Townsend's approach may not be a good strategy for those who want to get more and more papers published in top academic journals...

The above model is, of course, not perfect. Some model predictions are not compatible with reality. But, Professor Townsend said, the model insufficiency tells you what kind of modification in theory is needed and what kind of data is needed. "That's how research makes progress," he said.

He went on to introduce other pieces of research done by him and his students. Interesting results are as follows:

1. Even for those with access to credit, the wealth matters for starting a business. The world is not neoclassical even for them. (A very intriguing statement for an economist at University of Chicago.)

2. Thai firms in a business group share risk; individual firm characteristics do not matter for cash flow within each group.

3. Rubber producers in south Thailand do not smooth consumption in response to rubber price in the world market, a result in contrast with Paxson (1992) on Thai rice farmers.

4. The impact evaluation of the Million Baht Village Fund program - the Thai government gives one million bahts (about US$25,000) to each village, irrespective of the number of households in a village - suggests that the less the number of households in a village (which means more access to credit), the more villagers borrow from other sources of credit, the higher their consumption, and the higher their agricultural investment. (Kaboski and Townsend 2005)

5. The source of credit market imperfection is moral hazard, not limited libability. (See Paulson and Townsend 2003.)

Let me conclude by mentiong this: Professor Townsend said he is increasingly interested in political economy. By doing the whole macro and micro economic research as described above, he came to a conclusion that different financial sectors in Thailand are regulated quite differently. Financial markets are segmented with the BAAC targetting the poor and commercial banks targeting the rich. He seems to want to know why this is the case, a question that requires political economy research.

See? It's political economy that matters in the end when you do research on economic development!

Macondo on Hoxton Square

Had brunch with Sean at Macondo (Unit B2, 8 & 9 Hoxton Square, N1, phone: 020 7729 1119).

Along with dishes, we engaged in a little FAKE cultural exchange: I ordered a soft drink called Agua de Jamaica; Sean from Jamaica ordered a cocktail called Kamikaze. Neighther originates from each country. :)

The second time to come to this nice little cafe/bar/restaurant on trendy (and dodgy at night) Hoxton Square. Although the service is a bit too relaxed, food is good and value for money (three dishes of your choice for 6.50 pounds). The decor is quite relaxing with comfortable sofas and chairs. I like this relaxed atmospher.