Transcript The Indomitable in Pursuit of the Inexplicable

How to get rich without
knowing how:
the paradox of development economics
NYU College of Arts and Sciences Scholars’ Lecture
October 6, 2009
William Easterly (Economics)
The paradox of development
economics
• Development does NOT require any one
person (Expert, Leader, or Aid Official) to
have a comprehensive understanding of
how to achieve Development…
• (sort of like how evolution happened on its
own before Darwin)
• …we development economists must
accept this paradox to say useful
BOTTOM-UP things; refusal to accept it
leads to wrong TOP-DOWN advice.
Growth Ignorance
The Paradox meets the Political
• THE PARADOX: 2 decades of growth
research has failed to identify robust
determinants of growth
• The POLITICAL: Yet we economists are
required to advise leaders how to achieve
increases in growth for all countries.
• Out of this contradiction comes the tragedy
of misguided development economics.
.15
Temporary high or low growth,
moves back towards world average
LVA
.1
MDA
EST
AGO
.05
CMR
ALB
TTO MMR
NIC
SLE RWA TCD
SVK
HUN
ZMBROM
DZA
HTI
MOZ
JOR IRN
COG
SUR
WSM
ARE
GRC
BGR
ETH
MEX
ISL
SEN MNG
BEN
FINTUN
ZAF
PAN
NAM
MLI DOM
TGO
PER
MDG
MAR
SDN
GMB
CIV
SAUBFA
VNM
MWI
BGD
NER
SWE
CAN
NZL
COM
CPV
PHL
CAFGAB ECU
LAO INDIRLBWA
EGY
NGA
GHA
BHR
AUS
LKA
USA
HND
CHE
BOL
UGA
TUR
KEN
GBR
DNK
BDI
MRT
NOR
BRA
FRA
ESP MAC BTN
TON
AUT
KIR
BEL
NLD
ARG
GTM
CRI
VCT LUX
NPL
PAK
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DEU
GUY
LSO
ITA
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ISR
JPN
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PRY SLV
COL
SYC
URY
BLZ
HKG
CHL
MYS
SGP
PNGSWZ
ZWE
JAM MLT
GNB
IDN
0
ZAR
-.05
Change
in
growth
from
198695 to
19962005
MHL
SLB
-.1
-.05
0
g8695
dg9605
CHN
KOR
THA
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Fitted values
Previous growth rate (1986-95)
.1
Why so ignorant about growth?
• Temporary spurts of growth are bad news
when most explanations of growth involve
permanent factors.
• 145 different variables found to “determine
growth” (with approx. 100 observations).
None were robust to sensitivity testing or
new data.
Failure of specific attempts to raise
growth
• The “Big Push” of foreign aid to raise
growth rates (50s through 70s)
• Structural adjustment to raise growth (80s
and 90s)
• Shock therapy to reach high growth in exCommunist economies (90s)
Actual growth in quarter of countries
with highest foreign aid compared to
predicted growth by "Big Push" model
6000
5000
4000
Predicted
3000
2000
1000
0
19
60
19
65
19
70
19
75
19
80
19
85
19
90
19
95
20
00
Per capita income
Predicted path
of income of
intensive-aid
countries
under topdown planning
approach
Actual growth in quarter of countries
with highest foreign aid compared to
predicted growth by "Big Push" model
6000
4000
Actual
Predicted
3000
2000
1000
0
19
60
19
65
19
70
19
75
19
80
19
85
19
90
19
95
20
00
Per capita income
Actual
outcome of
top down
planning in
aid-intensive
countries
5000
Everyone confesses ignorance
• Barcelona Development Agenda (2004) -Blanchard, Fischer, Krugman, Rodrik,
Sachs, Stiglitz : “there is no single set of
policies … to ignite sustained growth.”
• “experience …frustrated the expectations
…{that} we had a good fix on the policies
that promote growth.” (Rodrik 2007)
• “in real life it is very hard to move the
permanent growth rate; and when it
happens… the source can be a bit
mysterious even after the fact.” (Robert
Solow, 2007)
Spence Growth Commission
(World Bank) 2008
• Had $4 million budget. And the answer is:
• “It is hard to know how the economy will
respond to a policy, and the right answer
in the present moment may not apply in
the future.”
Why so unable to explain
growth?
Some predicted the unpredictability
of growth
• Friedrich Hayek: “The growth of reason is based
on existence of differences. . . .{between}
individuals, possessing different knowledge and
different views. [I]ts results cannot be predicted .
. . . [W]e cannot know which views will assist this
growth and which will not.”
• Development is BOTTOM-UP outcome of lots of
unpredictable individual successes and failures.
Growth is innovation!
• Cannot predict innovations or they wouldn’t be
innovations!
• Innovations behave a lot like random shocks,
like coin flips!
• Unpredictability of growth is a testable
hypothesis just like unpredictability of the stock
market. We have already seen from nearly
100% mean reversion that we cannot predict
future growth from past growth.
Growth as innovation: it is surprising
where growth will come from
• Who would have predicted cut flowers in Kenya
(40% of European market),
• or women’s cotton suits in Fiji (42% of the US
market)?
• Or that Egypt gets 30 percent of its
manufacturing exports from bathroom ceramics,
of which 93% goes to Italy?
• Public goods (health) also draw on individual
innovation, like (accidental) invention of penicillin
• Social entrepreneurs in aid: discovery of oral
rehydration therapy to prevent infant deaths from
diarrhea; microcredit.
If innovations are unpredictable,
why do we think we know more
than we do?
•
•
•
•
•
Biases about randomness:
Explanations bias
Leader bias
Success bias
All of these biases favor TOP DOWN rather
than BOTTOM UP
Kahneman-Tversky biases about
how we treat randomness
• The myth of the “hot hand”
– interpret hot streaks as
better performance
even when they are
really random
– “growth miracles”
defined by a hot streak
– We spuriously
EXPLAIN them with
“great leadership” or
some policy
Related Kahneman-Tversky bias
• “Law of small numbers”
– Making too much of too few years for “secret
to success”, when a small sample will have a
HUGE random component.
• Example: After one good harvest, Malawi
confirms wisdom of fertilizer subsidies!
• Example: a few years of high growth:
Mozambique miracle – Great President
Chissano
• It’s too easy to find “small numbers” cases to
“prove” or “disprove” a case for your favorite
policy X, or for a leader.
Do Rats understand Growth better
than Economists?
• Experiment: rats and humans shown a
light that randomly flashed either red
or green, red twice as often; asked to
guess what will flash next
• Rats followed optimal strategy of
always guessing red.
• Humans thought they saw “hot
streaks” of green so sometimes
guessed green.
• “Our desire to see patterns in
randomness allows us to be
outsmarted by a rat.” Mlodinow
Attributing intentional skill to random
outcomes
• Experimental subjects watched two people who
were rigged to perform the same.
• The subjects know one of the two gets a
payment, which one is determined by coin flip.
• After payment, despite the subjects’ knowledge
that the payment was random, they gave better
grade to the one who received the payment.
• We do the same with Leaders and growth rates.
The leadership bias in growth
analysis
• The Spence Commission after all the
studies were done: “Growth at such a
quick pace… requires strong political
leadership.”
• “Framework” prepared before the Studies
said: “Economic growth requires:
Leadership.”
The “success” bias
• Drivers of Lamborghinis
at 150 miles an hour on
I-95 from NY to DC
arrive in DC from NY in
less than 2 hours
• In DC, observing only
these “successes”
leaves out the majority
of Lamborghinis who
crashed in flames along
the way.
• performance of hockey
moms driving minivans
from NY to DC is better.
Example: Dani Rodrik on industrial
policy
• Dani Rodrik:“the countries that have
produced steady, long-term growth during
the last six decades are those that
promoted diversification into manufactured
… goods”
• So Dani concludes, developing countries
should have “real industrial policies.”
The problem is mixing up our
probabilities (very common bias)
• Dani is calculating wrong probability (If successful/Then
you have industrial policy)!
• Correct Probability (If have industrial policy/Then
successful). Low with failures in Africa, Latin America,
Middle East, $6 billion Nigerian Ajaokuta steel mill that
never produced a bar of steel.
• Analogous to : Probability(If you win big in Vegas/You
Bet Large Sums at Long Odds) is HIGH – casino
owners want you to focus on this probability.
• Correct Probability (If You Bet Large Sums at Long
Odds/ you win big) is LOW, so don’t bet your life savings!
• Industrial policy may be disastrous on average but a few
successes at long odds
How explaining growth despite
growth ignorance led us to wrong
approach to development
The question that always comes
up in discussions of world
poverty:
What must we do to end world
poverty?
Answer: that question only makes
sense in an approach to poverty that
will not end poverty
• First, who is “we”? “We” must have power to
implement “the answer”, so “we” must be
authoritarian leaders (AUTHORITARIANISM)
• Second, “we” could not allow poor people to choose
their own paths, because “we” already know the
“right answer” for THEM. (PATERNALISM)
• So this question only makes sense in authoritarian
paternalism approach to development, which we
have seen didn’t work
The myth of the “man in charge”
• We act in our “growth advice” like there is
somebody all-powerful in charge
(reinforced by leader bias)
• But there is nobody in charge of a
complex economy, leaders have only a
limited, partial, often unintentional effect.
• The only effect of our “man in charge”
myth is to improve the reputation of
dictators.
Legacy of the Depression: Development
Economics refused to accept Bottom-Up,
preached Top-Down
• Depression led to view: “economic development
not spontaneous, as in the classical capitalist
pattern, but consciously achieved through state
planning.” (UN History)
• Nobel Laureate Gunnar Myrdal (1956): “the
alternative to making the heroic attempt is
acquiescence in economic stagnation which is
politically impossible …this is why [planning] is
unanimously endorsed by experts in the
advanced countries.”
Reliance on “invisible hand” a small
minority viewpoint in birth of
development economics
• South African economist Herbert Frankel (1951):
“development depends NOT on the goals and
enforced decisions of planners, but on the
piecemeal adaptation of individuals to goals
which emerge but slowly … as they themselves
become aware, in the process of doing, of what
can and ought to be done next.”
• TOP DOWN Myrdal got the Nobel Prize,
BOTTOM UP Frankel was completely forgotten.
Planning Approach continues today
in development aid
• the World Bank today requires 70 poor
country governments to submit “Poverty
Reduction Strategy Papers” -- PRSPs.
• “define medium- and long-term goals
…capture disparities by social group, gender,
and region. …. … take into account … the
expected contribution of policy actions to the
attainment of long-term goals and
intermediate indicators. ….” (Sourcebook on
World Bank PRSP web site today)
The expert alternative today in
academic development
• “We formulate … “growth diagnostics”:
how can we discover the binding
constraints on economic growth in a
specific setting, and then how do we come
up with policy solutions that are cognizant
of local second-best interactions and
political constraints.” (Dani Rodrik 2008)
Government in Bottom-Up View
• Of course, governments are necessary to
provide public goods like health and
infrastructure.
• But democracy means holding
governments accountable from the Bottom
Up for providing quality public goods
But don’t we need experts to design
democracy & other institutions?
• “The value of freedom consists mainly in the
opportunity for the growth of the un-designed …
freely grown institutions.” (Hayek)
• Changes in institutions also emanate from the
Bottom Up, e.g. William Lloyd Garrison,
Frederick Douglass, Susan B. Anthony, Alice
Paul, Martin Luther King Jr., all campaigning for
more individual equality and rights.
• One thing those who understand BOTTOM UP
can do is campaign for IDEALS and PRACTICE
of individual equality and rights.
Why economists can say
something useful after all
Optimal response to “law of small
numbers”
• Get more numbers!
• Research has shifted to explaining per
capita income levels rather than growth
rates
• Log of per capita income is the sum of all
previous percent growth rates – that takes
us away from misleading “law of small
numbers” to the true power of “law of large
numbers.”
SGP HKG
CHL
GBR
AUS
USA
1
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-2
Regulation
hostile to Free
Market
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2
Free market institutions from
values/norms
Regulation
0
Collectivist norms
20
40
60
INDIVIDUALISM
REGQUAL2007
80
100
Fitted values
Value individual rights
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0
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2
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40
60
INDIVIDUALISM
VOICE2007
Collectivist norms
GBR
AUS
80
100
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Value individual rights
11
Development and values/norms
NOR
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DNK NLD
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7
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Less
development
0
20
Collectivist norms
40
60
INDIVIDUALISM
lpcy2005
80
100
Fitted values
Value individual rights
What about China?
• Economics is not exact science – ONE counter-example
does not disprove a hypothesis
• Relative lack of individual freedoms in China correctly
predicts low level of income today in China (less than
1/10th of US)—
• --Because growth is so volatile, we cannot be confident
that high Chinese growth will persist so as to overtake
US under current Chinese system—
• China may possibly show the effect of a positive
CHANGE in individual freedoms on BIG CHANGE in per
capita income (but it’s only one observation so this is
really untestable)
Intuition for BOTTOM UP
• If “growth experts” at the TOP don’t how to raise
growth…
• …then best system is BOTTOM UP where problems
solved by INDIVIDUALS with local feedback and
incentives to fix problems.
• Individual rights…where any individual can seize any
opportunity
• Free markets … problems are profit opportunities that
entrepreneurs will fix
• Free, competitive politics … problems are opportunities
for political advancement, which political entrepreneurs
will fix.
Friedrich Hayek saying more
poetically what I just said:
• “It is because every individual knows so
little and… because we rarely know which
of us knows best that we trust the
independent and competitive efforts of
many to induce the emergence of what we
shall want when we see it."
Everything you need to know you
learned in kindergarten
• Economics common sense stood the test of time:
• “Invisible hand,” individual rights, comparative
advantage, gains from trade, democratic
accountability
• These all lead to common sense recommendations:
don’t interfere with markets or trade too much!
Don’t expropriate private property! Find out what
public good voters want and give it to them!
• Also advice for all of you: find your own
comparative advantage, exploit gains from
specialization, fix very specific problems, let other
individuals worry about other specific problems.
Bottom Up Hope!
• Bottom Up Development is hopeful
because instead of all depending on a few
at the TOP, we all at the BOTTOM can
contribute..
• …you could discover penicillin, or oral
rehydration therapy, or microcredit …or the
iPhone.
• the up side can be (and has been) so large
for entrepreneurs from the Bottom Up