Gambling on Development

Stefan Dercon

• Publisher: Hurst Publishers
• Year: 2022
• Print ISBN: 9781787385627
• eBook ISBN: 9781787388581
• Topic: Economics
• Subtopic: Sustainable Development
• Index: Economics

In the last thirty years, the developing world has undergone tremendous changes. Overall, poverty has fallen, people live longer and healthier lives, and economies have been transformed. And yet many countries have simply missed the boat. Why have some countries prospered, while others have failed?

Stefan Dercon argues that the answer lies not in a specific set of policies, but rather in a key ‘development bargain’, whereby a country’s elites shift from protecting their own positions to gambling on a growth-based future. Despite the imperfections of such bargains, China is among the most striking recent success stories, along with Indonesia and more unlikely places, such as Bangladesh, Ghana and Ethiopia. Gambling on Development is about these winning efforts, in contrast to countries stuck in elite bargains leading nowhere.

Building on three decades’ experience across forty-odd countries, Dercon winds his narrative through Ebola in Sierra Leone, scandals in Malawi, beer factories in the DRC, mobile phone licences in Mozambique, and relief programmes behind enemy lines in South Sudan. Weaving together conversations with prime ministers, civil servants and ordinary people, this is a probing look at how development has been achieved across the world, and how to assist such successes.

PART I

1

DEVELOPMENT THINKERS AND THEIR THOUGHTS

It was 8 September 2012, and the evening newspaper in London milked the leak for all it was worth. Reportedly, the new UK secretary of state for international development had said when appointed, ‘I didn’t come into politics to distribute money to people in the Third World!’¹ Moreover, she admitted to never visiting any of the countries receiving aid from the UK. Even though she always denied her protest, it was enough to put the entire UK Department for International Development (DFID) on full alert for her arrival. The question was what do with a new boss in charge of spending £11.5 billion a year on international development who clearly did not know much about it. An email then went around asking for ideas on what the new secretary of state should read.

Meeting her for the first time was memorable. Her facial expression spoke volumes when the policy director handed her a pile of books on development, saying that perhaps she should read them over the weekend. Without thinking, I said, ‘I could also give you a tutorial on all these books.’ And I did the next week. Over the course of about two hours, we discussed the books, and how they were different or alike, as well as the effects of the views in them on developing country governments, aid agencies, and international organisations.

This was an important assignment: I could shape her thinking and decision-making. In the UK, just as across the world, politicians and senior public servants can hardly be expected to be on top of the latest research on and happenings in economic growth and development worldwide or even in their own country. And yet they must be able to make good, consistent decisions on what policies to promote and how to spend their department’s budget. In the UK ministers do not have the luxury of bringing in an army of trusted personal advisors. Instead they must rely on the UK civil service, a strongly independent body but one that is bound through a strict civil service code to give the best possible advice. And that day she had to rely on me, an academic who had stumbled into the civil service less than a year earlier, to induct her into international development thinking.

Not only in politics but also in most of life’s choices, people need frameworks to help them make decisions. In psychology, these frameworks are called mental models—the concepts, stories, and views that reveal how the world works.² Politicians are no doubt shaped by their own worldviews and ideology, but in making decisions they also need a clear causal model of what is and is not possible. Because this minister’s mental model of how the world of development works was somewhat empty, I was asked to help shape it, keeping in mind that in the UK civil servants advise, ministers decide.³ I was, however, determined at least to make the new appointee aware of the grand and exciting opportunity she now had as the secretary of state for international development.⁴

The pile of books presented to the minister had been chosen because of their broad appeal—all were best-sellers—and because of their influence on the development and aid community. They were not chosen because someone, let alone me, had decided the views they espoused were right or in line with official UK views. Hence, the authors included best-selling academics and thinkers such as Amartya Sen, Jeffrey Sachs, Bill Easterly, Paul Collier, Jim Robinson and Daron Acemoglu, Esther Duflo and Abhijit Banerjee, Joseph Stiglitz, Dambisa Moyo, Angus Deaton, Ha-Joon Chang, and Dani Rodrik.⁵ Yes, plenty of white males (although not all), and all were economists. By now, five have a Nobel Prize,⁶ and I suspect one more is to come. Women, key authors from development studies or political science and other high-quality thinkers were surely missing, but the list was intended to reflect those who appeared to have had the most influence over the debates on economic development, including those that took place in political circles in Whitehall. As for this author, in the next chapter I offer my own understanding of how development comes about—that is, my own mental model of development.

The rest of this chapter gives a sense of the dominant thinking on why countries and poor people lag behind and what to do about it, based on what I told the minister. Later in this chapter, I will come back to these authors because each offers a different framework, both for the main problems surrounding international development, and also for how to overcome them. But first what follows is a brief introduction from the perspective of development economics on why countries or people may be poor.

A quick guide to the economics of poverty and development

Recent decades have seen much research and thinking on what holds countries and people back. But even mainstream development thinking, as reflected in the best-selling books, offers a range of answers. At the risk of not giving credit to the nuances of all this work, a few diagnostic statements allow me to differentiate between quite a lot of it, not least its implications for what can be done, if anything, to boost poor countries and people. Here, then, I offer in the form of four propositions competing diagnoses of what the core problems are.

Proposition 1: ‘Countries and people are poor because they are poorly endowed’. All economists agree that markets matter. Since well before Adam Smith, they have understood that prices, set through the market mechanism, are key to achieving functioning economies. There are limits to how much a government can tinker with all this. Still, few economists have ever subscribed to the view that markets should just be left to get on with it and all will be well in society.

In fact, this point touches on what is likely a big misunderstanding about economists, not least those working with developing countries. Some people claim that economists don’t care about fairness. This misunderstanding comes from a misreading, or at least an incomplete reading, of the most basic economic theories. What economists call the first welfare theorem says that if markets are perfectly competitive so that anyone can enter a market, no one can hide what they do, and no one hinders this free market, the result will be the most efficient possible allocation of all resources—labour, capital, land, and technology. However, the fine print, wilfully ignored by some, says that those in such a system will be rewarded in line with what they had to start with: their labour, their endowments, the opportunities they were given, the power they had. So, because this is a world with rather big differences in the birth lottery—such as where you were born, who your parents are, and other factors determining your starting position—the market allocation can hardly be called fair. Markets really matter for efficiency, but it doesn’t mean countries shouldn’t do anything to seek fairness in outcomes or opportunities.

All this leads to a straightforward, almost tautological explanation of poverty: people or countries are poor because they were poor to start with. Much justification for large-scale social spending by governments as well as for development aid depends on this explanation. When resources are spent on boosting poor countries’ or poor people’s endowments—by building infrastructure, improving health, upgrading education, providing finance for small business—those countries and their populations will be able to reap bigger rewards from their efforts. A poor person may not have much to start with, but once receiving a good education and enjoying better health, or accessing some capital to buy a cow or the stock needed for a small shop, he or she can begin to make a bit more money and take a step towards making a decent living.

This simplest expression of why people or countries are poor—they were poor to start with—is not as innocent as it may seem. It appears to let markets off the hook: they just reward what anyone has to offer in view of what they have. After all, there is inequality to start with, and the economy just reproduces this inequality. If anyone doesn’t have enough, don’t blame the economy. Instead blame whatever process in history or society caused some to have a lot and others to have little. There’s no need to interfere with the market; just set the past right.

Proposition 2: ‘Market failures are costly for poor people and may trap them in poverty’. Market ‘failures’—imperfections in the functioning of the market system—are an essential feature of any economy, and no simple set of instruments exists to avoid them, especially not the practice of laissez-faire.

What are examples of market failures? Perfect markets assume no oligopolies or monopolies: no firm is powerful enough to set the prices, and scale of operations does not offer any advantages. Perfect markets also assume no moral hazard: for example, a bank can easily be assured that anyone taking a loan will use it for the intended purpose. And perfect markets assume no negative externalities: a deal between two firms does not affect anyone not included in the deal, such as the households who must contend with any pollution generated as a result of the deal. Market power, entry constraints, and the presence of scale economies, moral hazard, and negative externalities such as pollution are common examples of market failure. Many economists view these imperfections as substantial enough to be highly costly to the economy and society itself. They open the door for interventions by the state to correct market outcomes, assuming this can be done.

Many authors, such as Joseph Stiglitz and Abhijit Banerjee, have linked market failures to poverty, claiming that some market failures especially hurt the poor and exacerbate their lack of initial wealth and endowments.⁷ So the markets are not off the hook. Instead, their ingrained imperfections are a central cause of the plight of the poor and may end up trapping the poor in poverty. The differences between the rich and poor in access to capital in the credit market are a good example. A smart woman from a poor family will find it far harder than a not very smart woman from a better-off family to get a bank loan to pay for her education or to raise the capital for setting up a business. Banks will ask for collateral that neither she nor her family will have. But this will not be as much of a problem for someone from a better-off family. Without this constraint on raising capital, she will be able to get a better job through a college education or succeed as an entrepreneur.

Two people alike in ability will therefore end up with different earnings because banks don’t hand out loans based on future income. Instead, faced with the deeply rooted problems of imperfect information or enforcement in the market system, banks ask for collateral. In this way, the market exacerbates the poverty of the woman from the poor family, who ends up earning less throughout her life because she was unable to go to college or start her own business.

The cost of market failures to the economy and society is huge. Poor people end up being trapped in low-return activities, with little chance of growing rich and leaving their poverty behind: they are in fact trapped in poverty.⁸ And this would be true even if they were just as smart and entrepreneurial as a richer person, who was able to pursue an education or start a business and so earn more throughout life. In short, there are inequalities to start with, but markets reward people differently.

Proposition 3: ‘Growth traps stem from market failures that are costly for poor countries’. This proposition offers a big-picture version of essentially the same ideas. The first two propositions offer explanations for why in a society one person may not be able to do as well as another. Likewise, countries may lag behind because they’re unable to build up infrastructure or the educational levels of their population due to a low international credit score arising from market failures. Or they may not be able to compete against large international companies because of the way international markets work.

Long-standing conditions at work in a country, such as poor human or physical capital, are exacerbated by market failures. The result is long-term divergence between most developing countries and the world’s richer economies. Two market failures feature prominently. The first one is externalities, particularly from human capital. For example, Paul Romer has suggested that education doesn’t just boost the incomes of the educated; the externalities from higher levels of human capital also boost productivity across the economy through ideas and innovation.⁹ The other market failure is economies of scale across the economy. For example, Paul Krugman and others have pointed out the importance of agglomeration effects—that is, the increasing returns from setting up firms in the same locality.¹⁰ Firms can then take advantage of proximity through better-functioning product and input markets: it is easier to make sales, bring down transport costs, and hire or buy inputs.

Both kinds of market failures may explain why poor countries would find it hard to catch up because they are latecomers in these growth processes, leading to a growth trap. Countries with low education levels may find it hard to have the same growth and innovation dynamic as those with highly functioning education systems to start with. Countries that came late to manufacturing will find it hard to attract firms because firms tend to take advantage of the agglomeration effects in other locations with established firms. For example, sixty years ago, when the port areas of Singapore and Mombasa were likely almost similar, it was Singapore that first attracted new firms, while Mombasa missed the boat. As increasing returns benefit the early starter, Mombasa and other African ports have faced ever higher hurdles to catch up and so have persistently experienced lower economic growth, diverging ever more from Singapore’s growth.

Proposition 4: ‘Growth traps stem from failures in states and their governance’. Other authors have linked persistence in differences in growth performance to features of states and societies, both theoretically and empirically. In particular, instead of focusing on different levels of financial or human capital, they highlight a very different kind of capital—the fabric of society and institutions as they have evolved through history, such as the nature of the rule of law and the political system.¹¹

Research has emphasised a whole slew of features.¹² Some investigators have focused on the failure of the preconditions for a market economy, required for proposition 1 to be valid. Such preconditions are well-defined property rights and contract enforcement through a functioning court system, among other features of the rule of law. Others have looked at the political system per s...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• Acknowledgements
• Preface
• Introduction
• Part I
• Part II
• 4. The Dragon, the Tiger Cub, and the Peacock: China, Indonesia, and India
• 5. Hippos in the Lake: Development on Hold in 117 Sierra Leone and Malawi
• 6. Kenya, Uganda, and Ghana: Ready for Take-off?
• 7. Nigeria and the Democratic Republic of Congo: Not Enough Oil and Diamonds?
• 8. Taming Clans of Hyenas: Peace and Economic Deals 189 in South Sudan, Afghanistan, Nepal, Lebanon, and Somaliland
• 9. Bangladesh: The Bengal Tiger Cub
• 10. Ethiopia and Rwanda: African Lions?
• Part III
• Notes
• Index
• Back Cover