William Easterly's The Elusive Quest for Growth -

Chapter

Easterly’s primary thesis is that the numerous efforts to remedy

extreme poverty in the Third World have failed because they have
neglected that individuals, businesses, governments, and donors
respond to incentives. Thus, he argues, the failure of economic
development in poor tropical nations is not the failure of economics, but
the failure to apply economic principles to practical policy work.
Inspired by the moral imperative to improve the lives of the poor, his
recommendation is not to abandon the quest, but to improve the
institutions of governments and international actors to create incentives
that promote growth

The post WWII era brought about an economic model that was misused for
decades and is now considered defunct. Evsey Domar and Roy Harrod
independently developed economic models that explained how aid could
increase development in poor countries. Their combined work is known as
the Harrod-Domar model. A summary of the theory states that to achieve a
desired growth rate, a country must have a particular level of investment.
But most poor countries have a low savings rate and can’t provide internal
investment high enough to achieve desired growth. Thus, aid is given to fill
this so-called financing gap. So countries get proper investment levels, enjoy
growth and leave poverty in the dust. Or so it goes.
Easterly opens with the example of Ghana in its years of independence and
explains the sense of hope that economists and Ghanians had in the 50s. He
writes that President Kwame Nkrumah had a plan, banking on the idea that
investment leads to growth, “to build a large hydroelectric dam on the Volta
River, which would provide enough electricity to build an aluminum
smelter” (26). In turn, alumina would be processed in a new refinery, which
would be supplied by a new bauxite mine. The dam was also going to provide
a fishing industry and irrigation capability. Our author points out that
aluminum production did grow 1.5% per annum for 23 years, but all other
aspects of the project were a failure and the people of Ghana are just as poor
today as they were fifty years ago.
Easterly describes the failure of Ghana because he wants readers to
understand that increased investment is not a lone predictor of growth. He
notes the foolishness of economists for using the H-D model for nearly 40
years after the author of the model renounced it, saying that it isn’t meant to
describe growth, but being based on situations involving unlimited labor
supply, that it shows an increase in machines in the short run will provide
growth.
He continues to argue that the H-D model is used in a flawed manner
because economists assume countries receiving aid will increase savings to
ensure their ability to repay loans. However, as Easterly points out, most aid
recipients saved less after receiving aid. He attributes this to the idea that aid
recipients are provided with no incentive to save, they just want to spend.
Finally, Easterly argues that there are two tests that must be passed before a
country provides aid to another. “First, there should be a positive statistical
association between aid and investment. Second, aid should pass into
investment at least one for one: an additional 1 percent of GDP in aid should
cause an increase of 1 percent of GDP in investment” (37). He shows that this
doesn’t necessarily happen in many aid transactions. In the end this model
fails to accurately predict which recipients will sustain growth. Thus, the idea
should be scrapped and economists should begin building up incentives to
invest in poor countries

-The first section of the book is dedicated to the various Post-WWII

efforts to promote economic growth among impoverished tropical
nations. Early efforts to promote investment and capital accumulation
were based on the Harrod-Domar Model, the Lewis Model, and
Rostow's stages of growth, which proposed that GDP growth would
always be proportional to the share of investment in GDP, and that
capital accumulation was the critical factor for growth.

Easterly, however, demonstrates that most aid did not go into

investment in the years 1965-1995, and finds no statistical association
between investment and growth. As Robert Solow discovered in the
late 1950s, it is not just investment in machines but investment in ever-
improving machinery—technological progress—that improves worker
productivity in the long-run.

-----Easterly also discusses the failed efforts of states to use education,

family planning, and debt forgiveness as means to grow out of poverty.
He notes that there is little incentive for a student in a poor country to
value and invest in her own education if there is no future return for
that investment.

For education to provide a return on the investment, the society must

have well-functioning institutions and markets that foster a demand for
skilled individuals.

The second section of the book outlines how the poor often do see
incentives to invest in their futures. Bad luck, poverty traps, and corrupt
governments plague individual efforts to overcome poverty. Easterly
argues that "getting incentives right is not itself another new panacea
for development. It is a principle that has to be implemented bit by bit,
stripping away the encrusted layers of vested interests with the wrong
incentives, giving entry to new people with the right incentives." [3]

According to Easterly, "the prime suspect for mucking up incentives is

government." [4] High inflation, negative interest rates, black market
premiums, high government budget deficits, restrictions on free trade,
poor public services, corruption, and arbitrary enforcement of property
rights lower the return on private investment and create poor incentives
for growth. However, good government can promote broad and deep
growth when it holds itself accountable and "energetically takes up the
task of investing in collective goods like health, education, and the rule
of law." Transparent institutions that promote these and other
economic freedoms ultimately foster a productive society. [5]