More on institutions and growth

There a large belief in the development community that institutions matter. This has emerging from a large number of cross-country regressions, regressions that one should always take with a grain of salt because of methodological issues and data quality. However, this result has emerged so frequently that it must indeed matter. But the precise mechanism through which institutions matter of the course of development is still rather unexplored.

Ines Lindner and Holger Strulik come up with an interesting theory. When the economy is fragmented into small regions, entrepreneurial behavior is governed by local and informal enforcement. But as economies become more integrated, through specialization and/or the reduction in transportation costs, "connectivities" go from local to global, and informal enforcement is not sufficient. Formal institutions need to arise, and if they are weak, entrepreneurship will be weak. I wonder, though, how such a theory of networks could be tested in the data.

Progesa: a success story thanks to academics

I have written a few times about the frustration when policy makers ignore the advice of economists. Yet, there are a few cases where economists were given free reign over the design of policy interventions, which not only allowed to obtain positive outcomes but also useful information for further study.

Nora Lustig reports about Progresa, the Mexican cash transfers program designed to elicit parents to send their kids to school and make sure necessary health check-ups were attended. From the start, the program was designed and administrated by people with an academic background. Progresa has worked remarkably well, to the point that it was not only not scrapped, as is usual, with presidential changes, its coverage also kept increasing. The only setback was a name change to Oportunidades. The critical ingredient to this success was the scholarly involvement, that not only designed it for success, but also provided the tools to measure this. And along with that a wealth of data that has allowed to understand even better what makes good intervention in practice.

Penis size and growth

Understanding why some countries are poor and why some grow than others is probably one of the most important questions in Economics. The traditional tool to tackle this challenge has been growth regressions: use cross-country data and regress the GDP growth rate on various indicators that could be relevant in order to find which matter most. These regressions have been abused over the years, especially as there are obvious endogeneity and collinearity issues. Also, the results are driven by a multitude of (poor) countries where data quality is quite horrendous. The worst is probably all the data mining that is going on in this literature, which culminated with Xavier Sala-i-Martin's two million regressions.



Tatu Westling uses a variable the previous literature completely ignored: the average length of the erect human penis. Adding this variable to the regression shows a U-shaped relationship for the GDP level, explaining 15% of its variation. The optimal penile length is 13.5 cm, and 16cm is disastrous. For GDP growth, the relationship is negative, explaining 20% of the dispersion. This is not negligible, and more than institutional variables that are thought to be the key to growth and convergence.



I wonder how many people will take these results seriously and try to get policy recommendations from it. Westling hypothesize about the impact of self-confidence. The paper is very well written, taking the 'male organ hypothesis' very seriously, but in truth tongue-in-cheek. Very different from this study on flag colors I wrote about previously.

Land titling and access to credit

It is widely believe that a key ingredient of economic development is the accessibility of credit. Indeed, entrepreneurs typically need credit to develop their business plans, and much of capital accumulation is performed through credit. But no one is going to grant credit on a promise, some collateral is needed. And that is a problem in many developing economies, as people hold little property and even land is communal or without clear property rights. Hence the idea that distribution of untitled land, with well-established property rights, should provide collateral to a large fraction of the population and make credit possible. How does this work in practice?



Caio Piza and Maurico Moura study the case of a major land titling initiative in Brazil. They use an interesting natural experiment. Two neighboring and very similar communities of the city of Corosco (correction: Osasco) were to get property titles for every inhabitant, but five year apart (2007 and 2012). This leads to a nice control group, which allows to overcome the problem of the endogeneity of ownership rights of a typical study by using a difference-in-difference approach. Indeed, the authors conducted a survey in 2007 before the titling, and another one in 2008. In addition, the context here is urban, which is unusual for a titling study. It appears access to credit increases by 22 percentage points, or about a half, within 18 months of titling. This is major. I do not think such large estimates have been found in rural studies. And given that developing countries become increasingly urbanized, this is very interesting.

Aid and remittances as hedges against food price shocks

Food is a substantial part of household expenses in developing economies, and in many of the latter foreign aid and remittances from emigrants provide a substantial part of national income. As world food prices have been subject to large fluctuations lately, causing much grief and even riots, it is natural to ask whether aid and remittances can provide some smoothing against the effects of these fluctuations.

Jean-Louis Combes, Christian Ebeke, Mireille Ntsama Etoundi and Thierry Yogo use a cross-country panel data set to study this question. First, they confirm that food fluctuations have a notable impact on aggregate consumption, especially in the poorest economies. Second they find that aid and remittances do help, and remittances seem to be more efficient at hedging. Indeed, an aid-to-GDP ratio of 29% is theoretically necessary to absorb food price fluctuations, while 9% is sufficient is for remittances. Only Mozambique and Nicaragua satisfy the first, while a few more countries satisfy the second.

Kuznets in a post-industrial world

The Kuznets curve traces the evolution of inequality as an economy develops. It is based on Kuznets observation that income and wealth inequality increased and then subsided as economies get richer. While this was established on a cross-section of countries, it has been proven right in the time dimension in some cases, like England and Wales through the Industrial Revolution. But what happens thereafter, when an economy further develops into one where the service sector dominates or globalization becomes most relevant?

Jordi Guilera asks this question noting that most developed economies have recently experienced a sharp increase in inequality. Is thus Kuznets' inverted-U becoming a N? Beyond simply observing this, one would also need a theory with predictions about other correlations to make some progress. The theory here is that skill-biased technological change generates increasingly large education premia, and evidence from long-term wage inequality in Portugal seems to corroborate this hypothesis. In particular it shows that inequality between sectors was the leading determinant of inequality until the 1980s, while inequality within sectors has taken over now.

Trade constraints of developing countries

With all the current posturing in the US and Europe, while addressing doubtlessly important problems, it is easy to forget that there are much bigger issues that need to be solved: how to get the poor and especially the poorest economies to a decent standard of living. We have been blessed to be born in the right families and in the right countries, and we should share this luck with those who were no so fortunate. This does not necessarily mean to give to the poor, just giving them a fair chance may be enough.

Jean-Jacques Hallaert, Ricardo Cavazos Cepeda and Gimin Kang consider the consequences of trade barriers on developing economies. The latter should be able to benefit greatly from selling on world markets goods produced with the factor they are relatively rich of, unskilled labor and to some extend land, while importing the complementary goods, likely capital-intensive investment goods. This OECD study finds that developed economies cannot do much more in terms of reducing import tariffs. Where there is more potential is with home-grown issues: unreliability of electricity, high transportation costs, poor education, bad governance, and instability. These results have been obtained by regressing exports, imports or their sum on a number of indicator for a panel of data. I am not particularly keen on these exercises due to poor data quality, gigantic endogeneity and especially the fact that proxies for essentially unquantifiable variables are used, like property rights and governance. But I suppose this is the best one can do, and the results appear to be rather stark. Now as to how to solve these economic problems, that is a gigantic task that we should be really talking about these days, instead of posturing for political gain.

The child quality/quantity trade-off in the Industrial Revolution

Non-economists cringe when they hear us talking about investment in children and the quantity/quality trade-off in this regard. Yet, this is a very real aspect of child rearing pointed out by Gary Becker that is at the core of many models, and has been found wild in nature. This trade-off is though to be an integral part of the demographic transition, where fertility suddenly drops massively in the course of development.

Marc Klemp and Jacob Weisdorf look at data from Anglican parish registers from the 18th century that contain all sort of demographic data to look at the child quality/quantity trade-off during the Industrial Revolution. Theory tells us that if the returns to education and/or the cost of time (wages) get larger, parents switch from having many children with no education to few of them with better education. Klemp and Weisdorf's data indicates clearly that this trade-off is present: each additional sibling reduces by 8% the probability of a child eventually becoming literate. That is a strong effect, in particular considering the larger number of children at the time, and its rather large standard deviation during this time of transition.

Venezuela's downfall

Venezuela was once the poster child in Latin America on how to do well (the opposite being Argentina), growing richer than European economies in the 1950's from quite modest means in less than two generations. And then all went downhill, and the country continues to slide into poverty. While many like to put blame on Chavez and his "revolution," the trend started long before he came to power.

Omar Bello, Juan Blyde and Diego Restuccia, instead of going through the usual case study that just rehashes anecdotal evidence, perform a growth accounting exercise to give the start of an answer. They find that the exceptional growth episode was due to a combination of plain old capital accumulation along with total factor productivity growth originating in the booming oil industry and its foreign direct investment transferring know-how to locals. The following collapse shows the undoing of this but with a very different origin. A severe misallocation of resources lead to a drop in total factor productivity, which then triggered capital loss. And how did the government manage ti create the mess? First, it steered the economy away from oil, which may be a good idea for diversification. But the second error was to favor heavy industries, a common development mistake. And third, general government meddling in affairs it should not be looking at. Chavez has just continued a long tradition in this regard.

Mission drift in microfinance?

Microfinance is based on a very simple principle. The poorest can only improve if they invest, and very small loans may be sufficient to get them started. But conventional banks do not bother with such loans, and informal money-lenders charge horrendous rates. Microfinance step in and lend small amounts, often without collateral in a community-based scheme where one's reputation is sufficient to obtain somewhat reasonable repayment rates. I am not totally convinced this scheme would work without subsidies, but it obviously serves a useful purpose, as long as it does not crowd out the regular financial system.

Beatriz Armendáriz and Ariane Szafarz point out that the latter can become a problem because of mission drift: as microfinance institutions grow, they gradually target larger loans, neglecting their original mission and becoming more like regular banks. This is like car models that grow in size through the years to follow the life-cycle of their drivers. But Armendáriz and Szafarz think that what looks like mission drift could very well be cross-subsidization, and larger and more profitable loans are made to help continue giving small and less profitable ones. The distinction is important, as donors could be put off by mission drift.

Entrepreneurs need an educated workforce

Entrepreneurship is the driver of growth and wealth, or at least an important driver. This is why so many initiatives are geared towards making life easier for entrepreneurs. And the champion in the US, with relatively little red tape, low taxes and especially very developed financial markets. One aspect that is much discussed right now is how low these taxes should be, especially as lowering them implies reducing some public benefits such as education. Is there a trade-off?

José María Millán, Emilio Congregado, Concepción Román, Mirjam van Praag and André van Stel use a panel dataset from several European countries to show that education matters for entrepreneurial performance, and it is not only the entrepreneur's own education, but also that of the workforce. An entrepreneur who cannot find appropriate workers or clients who are sophisticated enough for her products is not as successful. While the results are strong, I am a bit wary of using a short annual sample to tease anything out of education measures, but this is worth further investigation.

Charter cities and colonialism

Growth is very unequal across the world. In some areas, the experience has been very frustrating, foremost in Africa, others have been booming, foremost dense areas like Singapore, Hong Kong, or Taiwan. From there, growth has spilled over to neighboring areas, the best example being Guangzhou next to Hong Kong. These areas all have in common that they are autonomous from the surrounding areas, either by history or by design. This has lead Paul Romer to push for charter cities as a new development concept in other areas: give a preferably coastal city autonomy from the rest of the state in its management, allow it to trade freely in goods with the rest of the world, and allow free movement of people. As these charter cities grow, they will eventually help the backcountry to grow as well.

This idea is met by some resistance, though. One is that this is once more the people from the North trying to impose a radical change in the way business is done. This sounds like colonialism all over again, but as Voxi Heinrich Amavilah points out, the concept of charter cities is precisely about imposing anything, letting the locals run the show as they wish. Also, the rents from trade remain local, as the locals are free to trade, whereas under colonization foreigners took the rents. I think the idea has merit, especially for areas where a failed state is a major impediment to progress.

How to kill growth: corruption and large military

While it is not a slam dunk, there is pretty good empirical evidence that corruption and government expenses that are not tied to public infrastructure are not good for economic growth. This evidence comes largely from linear cross-country regressions of the kind that anybody with a little sense of theory or econometrics shudder. But sometimes this is done a little bit better.

Giorgio d'Agostino, John Dunne and Luca Pieroni take a simple growth model where government expenses are divided in public infrastructure, public consumption and military expense. Along with private capital, all three enter the production function for reasons that are not entirely clear, but we can let the data speak here. In addition, each expense is adorned with a multiplier that identifies how much is lost through corruption. The result is an equation for the growth rate that can be brought to the data, specifically a set of 53 African countries over 5 years. This is were things become iffy, as it is by now well-known that using panel data in growth regressions leads to very spurious results, especially when African data is considered. Using instruments and GMM will not help you much when data is of poor quality, especially from one year to the next. And taking lags of growth rates will make things even worse.

Results show coefficients "of the right signs" and a particularly strong interaction between corruption and military expenses. I am not sure I can believe these results given the above problems, but they make sense. And if one can extrapolate this African result to other countries, I would be especially worried for the US, where military expenses are always high and bribery of politicians is common and legal.

Towards better growth accounting

There are some literatures that I find very frustrating, and the empirical growth literature is among them. The initial idea to take a production function to see the contribution of labor and capital to the average growth rate of an economy and then also to compare this way differences in income levels was initially very instructive, in particular because it highlighted how total factor productivity was important. It went all downhill from there, as people started wildly regressing whatever they could get their hands on across countries, mostly with poor data. TFP can be influenced by many things, and there is no way one can identify anything without applying some structure, even with good data.

Gino Gancia, Andreas Müller and Fabrizio Zilibotti use a model to distinguish the contributions of factors (labor, human capital and physical capital), barriers to technology adoptions and technology inadequate for local conditions. The results are interesting, too. Removing these barriers would increase per capita income by 24% in the OECD and 36% elsewhere. And given that a model was estimated, it can be used for various scenario analyses. For example, they find that globalization increases skill premia and thus world income disparities, but this can be reversed by coupling trade liberalization with a reinforcement of intellectual property rights. These latter results are somewhat counterintuitive, but are justified by the fact that with stronger IP rights, there can be a transfer of technology to the South.

Time for an agricultural revolution in Africa?

When you think about income differences across the world, Africa is really depressing. It seems nothing is making a lasting impact in terms of policy for it to catch up with the others, and seeing how Asia managed to transform itself makes you wonder what is fundamentally wrong. While one may think this has to do with misguided policies, so much has been tried that something ought to have stuck. But no. One thing that helped Asia is that evolution in rice brought an agricultural revolution that freed human resources for manufacturing, so could such a revolution also happen in Africa?

Donald Larson, Keijiro Otsuka, Kei Kajisa, Jonna Estudillo and Aliou Diagne claim that several areas in Africa are suitable for rice, but local diets and tastes are too diverse for rice to have the success it had in Asia. The productivity of other crops needs to improve as well. So it does not look like there is a ready-made solution that will kick-start the agricultural revolution soon, despite some very localized successes.

That said, why insist of improving agriculture on a continent that is visibly not appropriate for this? Much like telecommunications in Africa jumped over landlines directly to mobile telephony, why not bypass agricultural development straight to manufacturing? One argument against this is the large transportation costs that make local agriculture essential and manufacturing away from the ports unprofitable. But why insist on keeping the population on the countryside? Why not develop coastal cities and take advantage from returns to scale there, like Singapore and Hong Kong did, and