Eight ways the world should be spending its money

The MIT Poverty Action Lab has a fantastically simple, compelling list of seven ways to help achieve the Millennium Development Goals. I'm going to print these and put them in my wallet.

My favourite finding is still that deworming kids in Kenya at 50 cents each adds a year to their schooling. It's widely known in the academic community, but not enough outside it (and are there any case studies outside Kenya?).

My nomination for an eighth high-impact way to spend money is REDD: Reducing Deforestation and Forest Degradation. If done properly this could make a big contribution to carbon emissions cuts and help improve the productivity of smallholder agriculture at the same time. I have high hopes that this will form part of whatever deal emerges at Copenhagen; paradoxically, it may be easier to get it through if the rest of the summit is a flop, because the world will be desperate for some good news (though beware countries who think they can buy their way out of climate change on the cheap. We still has to replace those coal fired power stations with something better) . See here for a new Economist article about it.

What doesn't make the list? Stimulus packages, the war in Afghanistan and bank bail-outs. Personally, I think all three of the above are necessary to avert worse disasters (after all a global economic collapse would also cut the amount we can spend on development) but the ease with which we shovel vast amounts of money down the banks' throats is still staggering.

Measuring economic growth from outer space

I love the satellite picture of the world at night - the one where Europe and America are seas of light, North Korea is invisible and the only lights visible in much of Africa are in South Africa and the oil flares in the Gulf of Guinea. Obviously, there is a strong correlation with economic development, or at least people having stuff to do at night.
J. Vernon Henderson, Adam Storeygard and Vernon N. Weil at Brown University take this insight a step further: why not use lighting levels to measure changes in development over time? This turns out to be a particularly useful method for countries where statistics are erroneous or missing, for example because of civil war. Governments can manipulate figures, but lighting never lies. Here are the two main findings (also summed up by the Wall Street Journal and Marginal Revolution):

1. Lighting is indeed a proxy for economic development and it goes down as well as up: there are some great pictures of changes in lighting levels in Eastern Europe in the 1990s. Whereas Poland experienced economic growth of 56% and an increase in lighting of 80%, neighbouring Ukraine saw its economic activity decline by 35% and lighting fall by 47%.

2. Increases in agricultural productivity (from high rainfall years)raise economic activity and hence lighting in nearby cities. Are these farmers rushing to sell their goods at the market, buy TVs with the earnings or simply celebrating their good fortune at the bar?

I'd love to see some further work on this data set. One question I have is whether the data might be distorted by certain high-light activities: mining, for example, or oil refining. This might matter for, say, DR Congo, where light levels seemed to increase in the 1990s, in the middle of a devastating civil war. I'd also like to see the impact of power cuts, such as California experienced a few years ago or South Africa in 2008. Most power cuts don't last long enough to show up in GDP figures, but their short-run effect might be severe: think of what happened in Europe this January when Gazprom turned the heating off. Next time that happens, we might be able to measure its effect from outer space.

Deaton on the randomistas

Last night, Angus Deaton gave the British Academy’s annual Keynes lecture on ‘Instruments of Development?’. I expected it to be enlightening; it turned out to be witty as well.

Some questions recur in economic research again and again, without ever seeming to get closer to a resolution. “Does aid work?” is one. “Do children learn better in small classes?” is another. Frustrated by years of trying to identify ever smaller effects in ever more complicated regressions, we have resorted to two clever techniques: instrumental variables (in macro) and randomized controlled trials (in micro). Angus Deaton suggested that these apparently different techniques are closely linked and similarly flawed.

Economics, like any social science, has a problem with experiments. You can’t work out the effect of aid on development by randomly selecting one country to receive aid and another not to: even if it were moral, it wouldn’t be practical because there’s so much else going on. Instrumental variables are a clever technique to overcome this (see ‘Freakonomics’): basically, you have to find a factor that could contribute to the effect you care about (latitude helps determine prosperity) without any possibility of reverse causation (because the prosperity of a country has no effect on its latitude). Deaton argued, in short, that instrumental variables are no panacea, because they are not statistically exogenous and in any case countries differ in ways we cannot control. If economists set instrumental variables up as a gold standard, we doom ourselves to eternal methodological debates amongst ourselves and ridicule from everyone else.

Randomized controlled trials are even more popular in the micro development world. Want to know by how much a vaccination programme improves public health? Easy: just pick the counties you vaccinate at random and compare the outcomes. Leaving aside the ethical difficulties with this (who deserves to come first?), the technique only tells us the mean treatment effect; it doesn’t tell us whether the effect was distributed widely or limited to a few very special cases. Moreover, some of the randomizations are less random than they seem. Supposed you picked schoolchildren with surnames starting with A to take part in an experiment: would they really do better because of the experiment, or because they have always sat in the front row and got more attention from their teachers? Maybe, maybe not: we don’t know.

Deaton poked fun at the ‘randomistas’ (Banerjee, Duflo, Kremer and others) but was sympathetic to their quest for identification, as long as it has a theoretical foundation. He also argued we should avoid randomization to test very obvious propositions (“Do parachutes help keep people who fall out of planes alive?”) or those that pose grave ethical problems (“do HIV-positive people receiving anti-retroviral drugs live longer than those who don’t?”). Rather as with evidence-based medicine, the statistical evidence is only as good as its interpretation by the doctor, or the economist, who applies it to the patient’s condition. Randomized controlled trials, in this view, should take their place in the economist’s toolkit, as one useful tool among many rather than as the knockout argument.

I agreed with all of his points as far as economists are concerned. My worry is what the non-economists (and that’s most of us) are supposed to do. Are we really supposed to wade through umpteen regression models and meta-analysis papers? Are we supposed to get excited about some tiny coefficient that is significant at the 95% level? I fear that policymakers and donors, who might understand the finding of a random evaluation, will turn off as soon as regressions rear their head. Surely it’s better for decision-makers to have some scientific evidence than none at all. Let the economists work out the 95% answer; meanwhile the rest of us will make do with 80%.

With or without the US

I've been enjoying reading Bono and Jeff Sachs' FT column from New York. Bono's ramblings might work better as rock lyrics, but he comes across as well-informed and genuine at least. Sachs, meanwhile, is passionate and provocative as ever:

"The UN meetings were abuzz that the US could find $700 billion for a bailout of its corrupt and errant banks but couldn’t find a small fraction of that for the world’s poor and dying. It didn’t make sense to the world community. The puzzlement was all the greater since the very banks being bailed out so generously had awarded themselves more than $30 billion in bonuses early this year, roughly the world’s entire aid budget for 800 million people in sub-Saharan Africa."

Amen. I wouldn't blame the financial crisis, entirely on the banks, but that's not the point. What is sad is how serious development issues drop off the news agenda as soon as there is a recession or 'crisis'. The same happened at the Gleneagles summit in 2005, when a terrorist attack send the TV crews scurrying to London. If we want to advance the development agenda at an international level, we need to work out a way of doing so even when the world's attention is elsewhere.

For the time being, a global financial crash is bad for emerging markets, as interest rates shoot up and 'risky' loans are called in. In the longer term, I wonder if it might be a good thing, for three reasons.

First, the USA and Europe no longer look like safe havens (OK, maybe Switzerland). A Brazilian, Russian or Chinese investor might therefore be keener to invest at home in the future.

Second, US banks and the US government are coming to depend increasingly on sovereign wealth funds, Japanese pensioners and so on for their capital. The result: the US will no longer be able to dictate terms to everyone else. The Washington consensus becomes the Dubai discussion.

Third, the reduction in US influence means we are no longer entirely dependent on US leadership in international economic matters. Not a bad thing when the world's largest economy is distracted by the election, bank bailouts and the like.

Indeed, Sachs praises Gordon Brown for continuing to push the MDG agenda at the United Nations. Brown doesn't have Bono's talent for PR, but if all world leaders took development as seriously as he does, we might make some progress - with or without the US.

The market versus the mall

Whenever I travel out of Accra towards Ghana's central or west coast, I pass through Kaneshie station - which is really a large market with a bus station attached. It looks chaotic, but is actually very well structured: if you can bear the noise and the smell, you will be on a minibus to almost anywhere within a minute or two. The market sellers are organized too: all the plastic-sandal-merchants are in one corner, all the beef-and-goat-meat-choppers in another.

A few miles away is the Accra Mall: a new, air-conditioned shopping emporium as clean and bland as any other in the world. Between the stressed-out SUV drivers and lost-looking backpackers, upper-class local kids 'hang out' in the food court, because that's what kids do in malls.

Where is the future of African retail? For now, my money is on Kaneshie market. Their local produce is cheaper and better (never mind the cold chain: it was picked this morning) and their imported Chinese crap is as cheap and as crap as anyone else's. The problem is, there are no economies of scale and virtually no product differentiation. 500 people selling the same pile of onions equals 500 tiny profit margins. Fine if you are content for people to just survive. Not fine if you want some of these businesses to grow, employ others, maybe move into a proper shop so I don't have to trip over goat heads on my way to the beach.

So far, so much anecdotal speculation. Fortunately, when I got back from the beach I found this new paper by Rafael La Porta and Andrei Shleifer. (Thank you Dani Rodrik for pointing it out). Their question is: does a large informal economy help or hinder economic development? Their answer is: neither.

According to La Porta and Shleifer, there are three ways of viewing the informal economy. The first is the 'romantic view', associated with Hernando de Soto and a thousand microfinance outfits. According to this view, the sellers at Kaneshie market are all budding entrepreneurs. Give them secure property rights and some microloans and presto, within a few years we'll have a Kaneshie Mall with a plastic sandal supermarket and value-added goat head products.

Not much evidence for that, unfortunately: it turns out that almost all small businesses stay small even when you pump them up with microloans. So how about the 'parasite view', exemplified by this article from the McKinsey Global Institute? These guys say informal firms have a cost advantage in spite of their low productivity, because they pay lower taxes and rent than the formal ones. This prevents more productive formal-sector firms from getting off the ground. The solution: cut taxes on the formal sector and enforce them in the informal one. Then watch the Accra Mall outcompete the street markets, just like Wal-Mart does in Mexico.

This is a controversial view: who likes Wal-Mart? There's not much evidence for it either. Many city governments have cracked down on street vendors and markets, only to find them creep back months or years later. Zimbabwe's Operation Murambatsvina ('Drive Out the Rubbish') in 2005 destroyed the informal economy in Harare, but did nothing to alleviate food shortages. Rather than the informal entrepreneurs rushing to register their businesses, most just stop trading and are forced to find another livelihood.

The most interesting finding of the paper is that the formal sector does not grow out the informal sector, it replaces it. Most formal firms started off that way: they registered and paid tax from the beginning, using seed capital from friends, family or foreign investment (rarely banks). That lends credence to the third view of the informal economy, the 'duality view'. This view explains the productivity differences between formal and informal firms in the skills of their owners and managers. Skilled managers (usually those with a college education) go to work in the formal sector, where their productivity is rewarded with high wages. Less educated managers stay in the informal sector, whose meagre returns are commensurate with their skills. The formal and informal sector are different people selling different things in different markets. The South African running the Nike store in the Accra Mall would no more think of competing with the Hausa shoe trader at Kaneshie than she would of buying her biltong from him.

A good friend recently came to Accra to research the same topic and he described the informal sector as facing a 'mesh ceiling': there is no insurmountable obstacle to small businesses growing large, it just almost never happens. He found that even when market-traders and shopkeepers were selling the same product, their perceptions of the challenges and opportunities of the business were completely different. In particular, the shopkeepers, who usually have some access to credit, complained bitterly about high interest rates and stingy banks; the market traders, who have none at all, didn't even mention it.

The informal economy doesn't formalize when an economy develops, therefore: it just gradually becomes less important. In the USA, 95% of food is sold in supermarkets; in Latin America it's close to 50-50 and in China their share is growing fast. Shoprite won't put my local fruit seller out of business. But her grandson might get a job there.

Limits to aid: yes please, but not a cap

Earlier this week I wondered about how to engineer a 'negotiated withdrawn' of aid to avoid fast-growing countries getting trapped in aid dependency.

Then I came across an interesting article in the Financial Times by Adrian Wood, Chief Economist of DFID. Wood argues that we should limit aid to a certain proportion of a country's budget - say 50%, or maybe 10% of GDP. Bill Easterly and Robert Wade provide trenchant commentary. (Nothing new here, says Easterly, but it won't work - the incentives for donors are to continue putting out aid come what may).

The debate continues at the Center for Global Development, with contributions from Nancy Birdsall, Jeff Sachs and Michael Lipton, amongst others. (Surely the problem is not too much aid, but too little? says Sachs - particularly when we have promised it and then not delivered, as is happening now).

I'm all for setting a limit to aid: but please let's make it a time limit, not a quantity limit. As Jeff Sachs points out, 10% of GDP for a country with a GDP per capita of $200 is $20 per person per year. That might be the upper limit of what a capacity-strapped or corrupt government can spend, but in post-war or desperately poor countries, much more will have to be directed at (re)building infrastructure, if necessary bypassing the government. To give an example off the top of my head, Liberia's annual budget is about $200m (itself the highest for 15 years), rebuilding their old hydropower station would cost at least $200m. I'd be curious to know what proportion of German or Japanese GDP was spent on rebuilding in the period 1945-50.

Rather than limiting expenditure per year, I'd like to see an aid agenda that says "We will work with you to achieve these targets and build capacity - but after 2015 we will begin cutting aid - and by 2025 we will have shut up shop, sold our Land Cruisers and our country economists will be out of a job. Over to you." Call it a surge, then a staged withdrawal.

The Great Illusion: Part One

Paul Krugman has a thought-provoking piece in the New York Times. He compares the international situation now with 1914, when the last great wave of globalization ended and the world turned in on itself for more than a generation.

I am substantially less well informed to comment than Krugman or many others, but it seems to me he is right to highlight the end of Pax Americana (but didn't that end in 2001, if it ever existed?). He is also right to point out how quickly national selfishness and protectionism reared their heads in the food price crisis - with export bans and the like.

There are three crucial differences between 2008 and 1914, however, which make me hopeful that we are not about to see an end to globalization.

The first is that international institutions are enormously stronger now than in 1914. The UN Security Council may have been powerless to do much about Russia and Georgia fighting, but that's because Russia is a member of it. The League of Nations would have issued a nice condemnation, but that institution was useless precisely because the USA, USSR, Germany and Japan were not a partof it. Besides the powerful military and economic bodies, there are countless talking shops where even sworn enemies without diplomatic ties can talk to each other in private, with a mediator if necessary. Europe depends on Russian gas; but Russia depends on Europe's continuing custom: you can't re-route a pipeline.

Second, unlike the Great Depression, the food price crisis contains the seeds of its resolution. 'Crisis' is often taken to mean a disaster, when really it means a turning point: this crisis is also an opportunity, by giving farmers in food-importing countries the incentive they need to grow more food. Here in West Africa, the price of imported rice and cooking oil has gone through the roof; but local food and oil production are starting to rise. Behind the crisis talk on the World Bank's website, a press release celebrates the halving of rice imports in countries as diverse as Guinea, Nigeria and Uganda, thanks to high-yielding rice varieties!

Third, there are large areas of the world that are as stable now as they ever have been. Krugman reminds us that war is now unthinkable in Western Europe; I would argue this extends to all 27 EU member states. The Americas and most of Asia are not islands of stability, they are oceans.

Rather than the end of globalization, I am much more concerned about another great illusion: the idea that we can deal with climate change by burying our heads in the sand. More uninformed ramblings on that to follow . . .

Doha and Firestone

Two pieces caught my eye yesterday:

First, my old Professor Dani Rodrik's offers a characteristically acerbic critique of the Doha Round. A waste of time, he says; most of the benefits would go to rich country taxpayers. And why is it published in an English-language Egyptian newspaper? Maybe Egyptian cotton farmers were hoping to benefit from Doha?

Second, the Firestone Company has signed an agreement with workers in Liberia. For the first time in the 82-year history of the world's rubber plantation, the company has done a deal with elected workers' representatives. (The ILRF has a self-congratulatory press release, but I would give more credit to the workers' union, Liberian government and media for keeping up the pressure). I wouldn't expect the miserable working conditions in the plantation to change immediately, but higher wages, more schools and buses to take tappers to work and their children to school are certainly steps in the right direction. As ever, the difficulty will be in implementing the deal: after all, workers are already supposed to be limited to an 8-hour working day when in fact it takes more like 12 hours to reach the daily quota (see picture).

At first glance, these two items are entirely unrelated. But I began to wonder why we never hear about rubber in the global trade talks? Or, for that matter, cocoa, coffee or oil palm?

Probably because none of the commodities above are grown in the USA or Europe. The most egregious trade restrictions, the ones that protect a few rich-country farmers at the expense of millions of Africans, are in cotton and sugar. Even Rodrik agrees that farmers in West Africa would benefit from a more liberal trade regime in cotton - but the US blocks it because of a few thousand swing voters in Florida. Meanwhile, in Europe we still make sugar out of beet. Maybe we're afraid that pirates will cut off our supplies of cane from the Caribbean.

I certainly hope that global trade negotiators will find a way to salvage some useful parts from the wreckage of Doha. But let's not pretend that selling a bit more cotton or sugar will end poverty in Benin or Burkina Faso. Low productivity means poverty, whether your crop is freely traded or not.

Microfinance for the armchair investor

I have been a big fan of Kiva since I stumbled across their website nearly two years ago (just before a NY Times article got them widely noticed). Late-night visitors to the Kennedy School of Government's computer lab found me perched on the edge of my stool, pondering the relative merits of investing in chickens in Kenya, a bookstore in Bulgaria and cassava-grinding in Colombia. It's strangely addictive, or would be if I could remember my PayPal password.

Lately, though, I've begun to wish there were more Kivas out there, for two reasons. One, Kiva doesn't pay interest. That's fine if you only have $100 invested, but put $1,000 in and you start to notice. Two, a lot of the businesses I lend to are very small, doing very similar things. I'm all in favour of food retailers, but there is a limit to the number of them a street or market can support. I have at least 5 vegetable sellers within a 5-minute walk of my house in Accra. (That's 5 times more than I did in Cambridge, unless you count WholeFoods). Any new one would probably compress the margins of the others.

So I was excited to discover MyC4 yesterday, Denmark's answer to Kiva (with loans in euros!). MyC4 is set up for bigger loans: they pay interest, usually around 10%. This cost is passed onto borrowers, but if the loans are bigger, the operating costs fall to compensate. Best of all, the interest rate is set by auction, so the borrower gets to borrow from whichever lender offers the lowest interest rate. It's a slightly different model - more wealth creation than poverty reduction perhaps - but a welcome one, in my opinion.

I bought €100 of credit and jumped straight in. So far, MyC4 only has partners in three countries, but one of them is Côte d'Ivoire, which is exciting because they don't get a lot of microfinance. Right now I am invested in 2 Ivoirien businesses and am waiting to hear if my bid to invest in one in Uganda has been accepted.

Even with the prospect of larger loan sizes, though, the most common business model on MyC4 is "X buys Y wholesale and sells it retail. The loan will enable her/him to buy more stock." Sure, but food and clothing retail is highly competitive in most developing world cities I know, so the potential for additional profit is small.

What am I looking for, then? Three things. One, rural lending. Microfinance seems to be as scarce in rural areas as it is common in the cities (how many Ugandan microfinanciers operate outside Kampala? maybe this Kiva fellow can tell me). Small loans for fertiliser and seeds would make a huge difference to many farmers. Two, product differentiation. Three, businesses that add value to commodity items. I can get delicious mangoes and pineapples all over Ghana, but no fresh mango juice. I'll bet if you wheeled a juicer around Accra you could make some good money and undercut Coca-Cola at the same time. Good for you, good for Ghana and great for my teeth.

A really cool way to reduce fuel prices

I'm generally in favour of letting the price mechanism operate. Fuel prices are rising because demand exceeds supply, so the rising prices are a necessary signal to help us adjust to using less fuel. Subsidising fuel will just lead to shortages and postpone the inevitable; it's generally a waste of taxpayers' money.

Still, when governments jack up fuel prices by 40% over the weekend, it blows a hole in commuters' budgets (and hurts anyone who needs kerosene for cooking or heating). This happened in Côte d'Ivoire two weeks ago and I saw how bus and taxi fares immediately jumped to reflect the higher costs. Still, transport operators staged a strike: they claimed the government wasn't letting them raise fares by enough to cover the cost of fuel.

The government's response was to cut ministers' salaries in half and curtail foreign travel for government officials. The money saved will pay for a reduction in fuel tax. Fuel will still cost more than before, but only by 30%, not 40%.

Cynics might call this an election-time gimmick, but I think it's fantastic. I doubt the ministers will be thrown into poverty by the cut and it probably won't last long, but it sets a great precedent.

Who should be next? Maybe Kenya, where the government had to raise taxes to pay for their hair-raising 40 ministers (that's power sharing for you). But I would start with the European Parliament, whose members receive probably the most ludicrous travel allowances of any organization in the world. They can fly to Brussels on Ryanair for €99 but charge the round-trip business fare on, say, Air France (€500? €1,000?) and pocket the difference. The EU has already imposed a travel ban on President Mugabe and his entourage; wouldn't it be nice if we imposed it on EU parliamentarians too?

Why cocoa-growing countries shouldn't make chocolate

It's an obvious economic development strategy: add value to your natural resources. After all, why should coffee growers only get a few cents when a cup of coffee sells for $3? Why should Liberians export their rubber raw to Ohio when they could earn more by making tyres? And why should Ghana and Côte d'Ivoire send most of their cocoa to Europe for processing? Isn't this just the legacy of colonial exploitation and underdevelopment?

Of course, adding value in the source country doesn't pay for multinationals, otherwise they'd be doing it. Now a team at the Center for International Development at Harvard show that it doesn't pay for the country either.

West African countries have lots of rain, cheap labour and an ideal soil for growing tree crops: in other words, a comparative advantage in growing cocoa. Processing cocoa requires entirely different factors: cheap power, semi-skilled labour, a stable environment for big capital projects and cheap transport links. Making chocolate out of cocoa butter is a different business again, calling for more specialized equipment and skills. There is one company making chocolate in Ghana, but it doesn't sell well even here. In fact it's highly unlikely that any country could have comparative advantage in such completely different activities. We shouldn't expect Ghana to specialize in chocolate any more than we would expect Belgian or Swiss chocolatiers to source their cocoa from European greenhouses.

Hausmann, Klinger and Lawrence conclude their paper as follows: "Policies to promote greater downstream processing as an export promotion policy are misguided. Structural transformation favors sectors with similar technological requirements, factor intensities, and other requisite capabilities, not products connected in production chains." (Policy brief here)

Now if only I could figure out what that actually meant in Ghana . . .

The impact of food price rises on trade balances

As world leaders, UN officials and thousands of hangers-on gather in Rome to talk about food, the US Department of Agriculture has released a fascinating map showing how food price increases affect trade balances.

On the face of it, this looks like bad news for developing countries, especially in Africa. A few traditional food exporters, mostly temperate-zone countries like the USA and Argentina, stand to improve their trade position, while densely populated Asia and Africa will see their trade balances move towards deficit.

However, we should beware the mercantilist fallacy that a trade surplus is somehow a sign of virtue: in fact, it could be a sign of excess saving (Japan, after all, ran a trade surplus throughout the recession years of the 1990s). So maybe a slide towards deficit in countries like Nigeria or Peru, where high commodity prices have created trade surpluses and risks of 'Dutch disease', isn't such a bad thing.

The problem with this graph is that it doesn't tell us anything about the terms of trade between countries. Trade in food, like anything else, is determined by relative prices: so the real question is which countries stand to improve their terms of trade as a result of food price changes. After all, if your terms of trade improve, you can afford more imports for the same quantity of exports. You could conceivably increase your import volume while the value of your imports falls. That's a real welfare gain. A trade surplus is nothing of the sort.

Robert Zoellick visits the Kennedy School

Last week, the World Bank's President Zoellick made a brief stop at the Kennedy School to address the Harvard International Development Conference. A few of us were also lucky enough to attend a small group meeting with him beforehand.

Zoellick is probably the most impressive Republican official I have ever encountered: smart, engaging and thoughtful. He spent an hour and a half asking each of us where we came from and what we were working on. In the picture above, he is quizzing my friend Carlos on the effects of the Colombia Free Trade Agreement (which Zoellick helped negotiate) on Carlos' native Ecuador.

It was left to Professor Dani Rodrik, sitting opposite Zoellick in the picture, to point out the inconsistency in the World Bank's attitude towards trade. (He did so in a different meeting, as we didn't let the professors say anything in the first one!). Essentially, Zoellick wants to conclude the Doha Round at the same time as increasing the supply of basic foods. But the Doha Round entails reducing the subsidies the USA and EU pay to farmers to grow these foods, which will raise their price in the short run, just when the world is facing record shortages of rice and other staples.

Is this a real contradiction, or will it disappear over time? I'm inclined to think that the supply response of farmers in Africa and Asia will ultimately outweigh the decline in US and European production. After all, the subsidies are most distorting in crops like cotton, which is not a food crop and not in short supply. The Bank's own research suggests that eliminating subsidies will increase global rice prices by 4.2% and wheat by 5%. That's much less than the current spike in prices. So what is the elasticity of rice supply over 3-5 years?

Driving up food prices

The BBC reports that Cote d'Ivoire's president has reduced taxes and customs duties on food in response to rioting. As the prices of wheat, rice and other staples continue to rise, I wonder if we are seeing a new kind of 'beggar-thy-neighbour' trade policy emerging?

In the last few months, export taxes have been imposed in Argentina and export restrictions imposed in Thailand and Vietnam. A few months ago, I noticed the same thing in Ecuador. These measures may work to contain the price rise in food exporting countries, for a while; but they will drive prices even higher for everyone else. This hasn't had much effect in Cambridge, Massachusetts, where food makes up maybe 10% of our expenditure, but most of the poorest countries in the world are food importers and poor people spend over two-thirds of their income on food.

I teach a course on globalization and the parallel with the 1930s is alarming: at that time, the Smoot-Hawley tariff provoked retaliatory tariff increases by Europeans, South Americans and others. A tariff may be optimal for one country is detrimental to the world. Only this time, we are talking about restrictions on exports, not imports.

What are the options for dealing with this? Maybe the World Food Programme or FAO should convene an emergency food summit to try to persuade food exporters not to starve everyone else.

Rice in Ecuador: price control or export ban?

A few weeks ago, The Economist reported on the ever-rising price of agricultural commodities, including rice. What's good news for farmers is bad news for urban consumers and since cash crop farmers need to eat, they get hurt by higher food prices as well.

I've been spending some time in beautiful Ecuador visiting friends and picked up a copy of the local paper. Rising food prices are a major topic here as well, but the government's response is a little unusual: they simply banned rice exports.

Now, I could understand that if there were a real risk of people going hungry: Ireland famously continued exporting potatoes to England during the 'Potato Famine' of 1847. But since most of the poorest people in Ecuador are farmers, stopping them from selling their rice at the best price they can get seems like a bad idea.

On the other hand, banning rice exports will not lead to rice shortages in the short term, whereas price controls would, because any sensible farmer would just sell them abroad. So maybe it's the lesser of two evils?

Maybe, but beware the unintended consequences: Colombia, which used to import rice from Ecuador, has now imposed a ban on imports of other agricultural commodities! The same newspaper showed a farmer throwing lovely ripe mangos in a ditch, because Ecuador now has a mango glut. Simultaneous food shortages and other kinds of food going to waste? That's precisely what happens if you stop farmers from trading.

Testing the Growth Diagnostics approach

Bolivia is the poorest country in South America - its income per capita is not much above Ghana. A revolution, radical land reform, decades of foreign aid and structural adjustment have not changed this basic fact. The only dynamic parts of the economy are the natural gas and soy beans produced in the eastern plains, far from where most Bolivians live.


Bolivia is therefore a prime candidate for a Growth Diagnostic as proposed by Ricardo Hausmann, Dani Rodrik and Andres Velasco. Growth Diagnostics are appealing to policymakers for two reasons. One, they are empirically grounded, without sacrificing theoretical rigour. Two, they combine hard data with case studies - which makes life more interesting for the grad students as well!

I joined David Elmaleh, Naomi Krieger and Molly Kinder to read dozens of reports, run regressions and crank out charts. We soon became dissatisfied with the standard explanations for Bolivia's poor growth. If low foreign investment was the problem, why didn't Bolivia boom in the 1990s? If the people of the highlands were poor because they were excluded from power, why didn't the Bolivian revolution of 1952 or the election of President Evo Morales change that? If the IMF and World Bank were the problem, why didn't the massive debt cancellation of 2002-03 help?

The key to Growth Diagnostics is that you can't do everything at once. The key is to identify the binding constraint to growth - the market or government failure that is the most important cause of the many problems you observe. Our very tentative conclusion, based on the best data we could find, was that Bolivia is stuck in an informality trap. Small businesses can't get credit to grow or increase their productivity, because they are in the informal sector. But when they try to join the formal sector, they find the taxes, regulations and red tape they have to endure put them at a competitive disadvantage.

Meanwhile, gas and agricultural exports are booming, but those sectors don't employ many people and the profits are captured by multinationals and large landowners. The government of President Morales is trying to tax them to fund welfare and pensions, but the (relatively) productive eastern provinces have responded by declaring autonomy and threatening to dissolve the state.

In this tense environment, what could the Bolivian government do to promote growth and poverty reduction? Nothing, say the eastern provinces - we know what to do, let us get on with it! We humbly suggest another approach: by tackling bank monopolies, cutting red tape and reducing the legal burden on small businesses, the government will be helping its core constituency, the indigenous people of the highlands, to break out of poverty. Neighbouring countries like Chile, Peru and Brazil have realized that being pro-poor doesn't mean you have to be anti-business.

We hope that the government and provinces will be able to resolve the constitutional crisis and give growth a chance. The prospects are good: after all, everyone from Argentina to Venezuela wants to help Bolivia. Why not get the World Bank to build roads and Hugo Chavez supply free heating oil to the (freezing) altiplano?

Institutions matter. Especially in football

My favourite economic cliche is any paper entitled "xxx matters". Governance, institutions, latitude, size - you name it, it's statistically significant in someone's regression.

Last weekend I watched Harvard thrash Yale in New Haven. I was surprised at our victory, but even more surprised at the good humour and complete absence of violence in the crowd before, during or after the game. If you have ever been to, or near to, a football (soccer) match in Europe, you will know what I mean. Any politician who laments the culture of violence in modern society should try putting on a Harvard shirt and walking through New Haven an hour after defeating the local team. We didn't get so much as a whistle from the locals.

So why are otherwise peaceful people like the Brits or Italians so eager to start a fight when it comes to football, while it's a family day out in New England? It can't be a greater police presence: they have them in Europe to. It can't be lack of alcohol: that was freely available at the pre-match tailgate. It can't be weapons: the US in general, and New Haven in particular, has lots of them. Maybe the huge geographic mobility of US society holds back the local pride and partisanship you find elsewhere. But when the Red Sox won the World Series a few weeks ago, I detected a fair bit of local pride at their victory parade.

I think there is a cultural norm at work here: football is a game for the family, so crowd violence is unacceptable. How this norm evolved is anyone's guess, but once it's there it's very hard to change. British police trying to deal with hooliganism in the 1980s had the same problem in reverse: the culture of violence had become an institution, an informally accepted way of doing things.

Social norms underpin economic behaviour wherever you look. Consider fare evasion on the subway. In London or New York, you have to pass through a fare barrier to get to the platform. In Paris, the barriers are as large and heavy as doors, to stop people from vaulting them. In law-abiding Vienna, there are ticket-stamping machines but no barriers. The city transport authority decided it would be cheaper to employ roving inspectors levying on-the-spot fines than build fare barriers in every station. Why do buses travel faster in Berlin than in Boston? Because passengers can use any of the doors to get on the bus, not just one - the driver takes it on trust that they have a ticket.

On a more serious level, business and government is a lot cheaper in high-trust societies. Imagine how much it would cost to send all your business mail by DHL or FedEx because the postal service is insecure. Try keeping a stash of $5 top-up cards in the petty cash box and giving them to your staff one at a time to make phone calls, because you can't get a telephone credit account. Or if you're a retailer, how about counting the inventory in your store at the end of every day to make sure nobody is stealing it?

Institutions matter, in sport as in everything else - we're just a little late to realize it.

Will your exports make you rich?

Rich countries make rich-country things. Poor countries make poor-country things. According to the theorem of comparative advantage, you should specialize in whatever you have relatively low costs - but we also know that over time, countries grow rich by changing and upgrading what they produce.

But why have some developing countries grown into diversified, mature economies whereas much of Africa is still stuck growing or mining a few basic commodities?

This answer comes from Cesar Hidalgo, Bailey Klinger, Laszlo Barabasi and Ricardo Hausmann, who just got it published in Science (or see here for the full version):This diagram shows the 'product space'. Imagine international trade as a forest, with individual products making up the trees. Firms are like monkeys swinging through the trees. The closer the trees are together, the easier it is for firms to move from one tree to another. Thus firms and countries specializing in products in ‘denser’ areas of the forest can diversify more easily. Countries tend to move into the centre over the time - but the denser the part of the forest where they start, the quicker they will get there.

Where does Liberia fit within this product space? It turns out that most of Liberia’s exports are within the sparsest part of the forest: rubber, cocoa, iron ore and palm oil all have extremely poor links to other products. See where tropical agriculture is in the diagram above . . . and compare it with garments, say, or vehicles and machinery.

The implication of this is that export diversification will not be easy in Liberia, because the economy has specialized in products that are very remote from other products. It takes 7 years for a rubber or cocoa tree to become economically useful. Rubber or cocoa plantations are therefore a huge ‘sunk cost’ and difficult to change. On the other hand, neighbouring countries like Ghana and Nigeria show the perils of trying to develop industries in which you don't have a comparative advantage. Maybe fruit, vegetables and low-tech food processing (canning, juicing) are a way forward.

If you go to the authors' website, you can download the map and the data for your country. A blinding insight or another example of economists restating the obvious in a more complicated way?