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!