Summary slides development economics

Macro part

Week 1

Lecture 1 – Growth theory and emprirics

Measurement
• How to measure development?
• Most common standard: levels and growth of income/production per capita
• Development ≠ income per capita growth
• Health improvements (nutrition, clean water, sanitation, health services), education (access
schooling, literacy), material well-being, political rights and freedoms, environmental improvements
• Last few decades focus on income criticized too narrow
• Per capita growth not automatically leads to development  sometimes no connection
• Still per capita GDP fairly good proxy
• Ultimately rising income levels will lead to development (growth is good for the poor)
x-axis: average annual growth in per capita income
y-axis: average annual growth in per capita income, poorest quantile
 positive slope, poor is also very vulnerable for declines in income.

Important development index constructed by UNDP for all countries: Human Development Index
(HDI)
• 3 elements HDI:
– life expectancy at birth (reflecting i.a. infant and child mortality)
– educational attainment (weighted index of adult literacy 2/3 and enrollment rates 1/3)
– per capita income
• HDI takes simple average, weights arbitrary  Nevertheless HDI often used
• High correlation GDP per capita and HDI (logical because GDP per capita income is a component of
HDI)
• High correlation individual indicators and HDI (like life expectancy, infant mortality, literacy)
• Income and life satisfaction  high (positive) correlation

 So, GDP per capita not perfect, but good proxy for development
• additional measurement issues:
• GDP measures both total output and income
• Total value of final goods and services produced in a country during a given year
• With trends over time, real GDP, income adjusted for domestic price inflation
• To compare per capita income across countries, we may use exchange rate method
• Convert income in local currencies into common currency (US$?) and then divide by population
(per capita)
• But cross-country comparisons of per capita income using exchange rate method can be biased for
three reasons:
1. Underreporting of income in developing countries (tax evasion, subsistence production for
own consumption)Example India 18-21% of income unrecorded. Cambodia 1/3 of labor force
unpaid family worker
 May overestimate growth
 Correct through imputations.
2. More serious bias, non-tradable goods not reflected in exchange rates, reflect prices tradable
goods (tradable goods prices equalized through arbitrage). Non-tradable goods lower prices
in poor countries, therefore conversion to US$ using exchange rates underestimates real
incomes in poor countries.
  Correct for by using PPP dollars (expresses all non-tradable goods (use average price of
haircuts in all countries instead of4$ in India and 45$ in US)

 Summers-Heston dataset PPP-based country incomes since 1950, also called Penn World
Tables
3. Other subtle measurement problems:
a. Distorted pricing: GNP measurement uses market prices, assumed to reflect people’s
preferences. But, not all markets perfect competition, neither fully flexible prices, price
information sometimes absent or not nationally representative.
b. Externalities: Prices may not reflect true cost, e.g environmental damage, resource
depletion
 Correct by using shadow prices

Trends Economic Development

• Long-term development
• Angus Maddison, economic historian, estimated income levels and rates economic growth world
economy from 1BCE
• estimates populations, GDP, price index PPP
• He finds annual per capita world income growth:
Doubling time
– Period 1BC– 1000: 0%
– 1000 – 1820: 0.05% 1400 years
– 1820 – 2010: 1.3% 55 years
• Doubling time income implicit in growth rate:
• If income (or e.g. population) were to grow at r%, how long would it take to double?
• Therefore have a look at how long it would take for 1 dollar to turn into 2 dollars if growth
(interest) is r%.
• Solve [1+(r/100)] T = 2
↔(taking logs on both sides) ln [1+(r/100)] T = ln2
↔ T ln [1+(r/100)] = ln 2 ≈ 0.7
using that for small values of x , ln (1+x) ≈ x
↔ T (r/100) ≈ 0.7 ↔ T ≈ 70/r.
• So, 70 divided by the annual % rate of growth gives the doubling time
• Nowadays 2% growth appears not impressive
• But, throughout most human history growth in per capita GDP was exception
• Modern economic growth born after industrial revolution, accelerated

• Where has growth taken place?

• 1BC – 1000 uniformity in per capita incomes (China/India slightly ahead)
• 1000 – 1820 bit growth West Europe and offshoots
• 1820 – 2010 see graph next slide, wide divergence incomes

• Western offshoots: US, Canada, Australia, New-Zealand

• Growth rates accelerated since 1820, especially after 1880, and again since 1950
• Striking, richest regions recorded highest growth rates, poorest regions slowest, at least until 1950
• 1950-2001 patterns of economic growth changed:
– Asia, then poorest region recorded fastest growth, narrowing gap with richest
– Widened gap W. Europe-W. offshoots narrowed
– LA and Africa growth stagnated in 80s and 90s, resumed mid-1990s
– Eastern Europe collapsed after fall Berlin Wall 1989, resumed mid1990s
– Since 1950: end of WWII and end of colonial era
• Although we see clear regional differences, within regions different country experiences
 negative growth, slow growth, moderate growth, rapid growth (see table)

Economic growth across countries

• Reduction global number of poor (people living in extreme poverty) mostly in Asia
• Income gap between the world ‘s richest and poorest region now 20:1, historically large
• Many developing countries are way behind in per capita income relative to developed countries
• Therefore, larger rates of per capita income growth high on agenda for these countries
• Percentage point added to per capita growth can make difference between stagnation and
prosperity over the period of one generation, search for economic growth is compelling
• Now-developed world increased its per capita income almost 7-fold within a century

Harrod-Domar
• Harrod- Domar model emphasizes the role of saving for economic growth
• Firms produce goods which creates household income
• both consumption and capital goods produced
• Part household income used to buy consumption goods, part of it is saved (for future consumption)
• Firms use these savings to buy capital goods, investment
• Cycle of production, consumption, saving, and investment
• Macroeconomic balance if saving = investment

• The modeI:

(1) Yt = Ct + St (Income divided between C and S)

(2) Yt = Ct+ It (Production consists of C and I)
(3) St = It (Macroeconomic balance)
(4) Kt+1=(1- )Kt + It (Capital stock over time)
(5) s = St /Yt (Savings rate)
(6) θ = Kt /Yt (Capital-Output ratio)
Combining (3) to (6) gives:
(7) s/θ = g +  (Harrod-Domar equation)
(7) Links growth rate to ability to save and capital-output ratio
 θ* Yt+1 = (1-) θ*Yt + s*Yt
(θ = Kt+1 /Yt+1  θ*Yt+1= Kt+1  fill in Kt+1 = (1-)Kt + It  fill in Kt = θ*Yt and It = St = s*Yt)
θ* Yt+1 = [(1-) θ + s]Yt
Y t +1
θ* = (1-) θ + s
Yt
Y t +1 s
=¿(1-) +
Yt θ
Y t +1 s
−1=¿= - +
Yt θ
Y t +1−Y t s
g= = -
Yt θ
s/θ = g +   links growth to ability to save and the capital-output ratio

(7) s/θ = g +  (Harrod-Domar equation)

(7) refers to the growth rate of total GDP. We want this in per capita terms, so introduce population
growth n:
(8) Pt+1=Pt (1+n)
and combining (7) and (8) then gives:
(9) s/θ = (1+g* )(1+n) - (1-) where g * is per cap. growth
Expand right-hand side and get (10), simpler form of (9)
(10) s/θ = g *+n+ (ignoring g *n very small number)
Features underlying per capita growth: ability to save/invest (s), ability to convert capital into output
(inverse θ), depreciation (), and population growth (n)
Compare (7) and (10) and note that g * = g-n

 θ* Yt+1 = (1-) θ*Yt + s*Yt

θ∗Y t+1 s∗Y t
= ¿¿¿ +
Pt Pt
Y
y t = t Multiply on left-hand side both numerator and denominator by Pt +1to get:
Pt

θ∗Y t+1 P t +1 Y t +1 P t +1
* = (1-) θ*yt + s*yt  = yt+1 and = 1+n
Pt +1 Pt P t +1 Pt

θ *yt+1 * (n+1) = (1-) θ*yt + s*yt

devide al by yt

θ∗ y t+1
* (1+n) = (1-) θ + s
yt
y t +1
= (1+g*)
yt
 θ(1+g*)(1+n) = (1-) θ + s
Devide by θ
s
(1+g*)(1+n) = (1-) +
θ
s
(1+ n + g* + g*n) = (1-) +
θ
Ignore g*n
s
1+ n + g* -1 +  =
θ
s
n + g* +  =
θ
• Per capita Harrod-Domar equation (10) gives per capita growth rate for given values of saving rate,
capital-output ratio, population growth and depreciation rate
• Shortcoming: many of these parameters are endogenous, determined by growth as well
• For instance savings can be endogenous, influenced by the level of per capita income in a country
• As incomes change, s that enters into the Harrod-Domar equation will change
• This feedback mechanism is missing
• Important, because can cause development trap: low s <-> low y

• Also population growth may be endogenous, vary with per capita income
• Demographic transition
• May cause development trap For low-income countries:
Increasing per cap. income -> higher population growth
Higher population growth -> lowers per cap. income (for given g)  divided by more n

Avoid the trap:

- Shift g upward
- reduce n

• Harrod-Domar model emphasizes the role of saving (and investment and capital accumulation) and
implies saving is sufficient for sustained growth s/θ = g * +n+ (higher s -> higher g and g *)
• The model doesn’t address endogeneity of s and n
• The model doesn’t address changes in technology/productivity (are important for g)
• Also model assumes fixed capital-output ratio θ while marginal product of capital declines as more
capital is accumulated -> capital-output ratio endogenous

Lecture 2 – Growth theory and empirics continued

Solow model
• Solow model makes the capital-output ratio θ endogenous.
• Endogenous capital-output ratio θ :
• This ratio is low for poor countries (labor abundant and capital scarce), because MPC is high if little
capital is used.
• As countries accumulate more capital and income per capita grows, MPC declines (each additional
unit of K produces less additional Y, so Y/K ↓), so the capital-output ratio θ = K/Y ↑.
• => K/Y (= θ) determines growth, but is in turn also affected by growth
• Endogeneity of capital-output ratio is incorporated in Solow model through production function
with diminishing returns to capital (diminishing marginal product of K).
• We will see this results in long-run equilibrium (steady state) where growth in per capita capital
and per capita output/income is zero

• Two main equations in the Solow model

 1. Production function with 2 inputs:
Yt = F(Kt , Lt )
❖ F(.) has 3 properties:
▪ Constant returns to scale
F(λKt , λLt )= λF(Kt , Lt )
▪ Positive marginal products of K and L
F’K (Kt , Lt ) > 0, F’L (Kt , Lt ) > 0
▪ Marginal product decreases (diminishing returns to K, L)
F’’K < 0, F’’L < 0
2. Capital accumulation equation

1. The production function

• A production function that satisfies the above criteria is the Cobb-Douglas production function
F(Kt, Lt) = AKtα Lt1-α , A >0, 0<α<1
Where A is total factor productivity (TFP)
• Here, we use the production function in per capita terms.
• The Cobb-Douglas production function in per capita terms would be as follows:
Divide Y = AKtα Lt1-α by L and get Y/L = AKtα Lt1-α / L
K α
 Y/L = AKtα Lt-α  Y/L = A( )
L
• Define y=Y/L and k=K/L and express above equation as
y = Akα
• Note that y and k move together
• Typical production function with diminishing returns to capital, expressed in per capita terms,
concave. Note Y/K

Y K Y
Slope / =
L L K

Θ = K
Y

• So, as capital per capita increases output-capital ratio Y/K ↓ (or θ = K/Y↑) because relative
shortage labor
• As noted above, production function with diminishing returns to capital is combined with second
key equation of the Solow model, the capital accumulation equation

2. Capital accumulation equation

• (Capital accumulation equation is the equation that relates kt+1 to kt )
• First, we combine three equations we also used in the HarrodDomar model
(1) St = It (Macroeconomic balance)
(2) Kt+1=(1- )Kt + It (Capital stock over time)
(3) s = St /Yt (Savings rate)
• To get:
(4) Kt+1=(1- )Kt + sYt

• We then write (4) Kt+1=(1- )Kt + sYt in per capita terms first by dividing through population Pt and
then assume that population grows at rate n: Pt+1= (1+n)Pt next, substituting Pt+1/ Pt by (1+n) gives per
capita form of (4):
K t +1 P t +1 Kt Yt
= (1 – 𝛿) +s <=>
P t +1 Pt Pt Pt

(5) (1+n)kt+1=(1- )kt + syt

where k=K/P (per cap capital) and y= Y/P (per cap production/income)
 equation 5 is the transition equation
1
 kt+1= [(1- )kt + syt ]
(1+n)
• This capital accumulation equation in per capita terms indicates how we get from k t to kt+1. It
shows: depreciated per capita capital plus per capita investment in year t give per capita capital in
year t+1, but we have to correct for population growth which reduces per capita capital.
• Combine this capital accumulation equation (5) with production function with diminishing returns
in per capita terms (e.g. the Cobb-Douglas one: y= Akα) to get following graph illustrating dynamics of
kt and thus of yt in the Solow model.

y = Akα
y* is constant  Y/L
k* is constant in the steady state  L is growing at
rate n, and K is also growing at rate n

• In the graph, starting from any value for kt , you can find kt+1 on the concave curve. Then moving
horizontally to the 45-degree line, you can find the position of kt+1on the horizontal axis, which you
can then use to find the level of kt+2 on the concave curve. Keep repeating to find the dynamics of k
and thus of y (remember k and y move together).
• Graph shows if per capita capital is low, per capita capital grows fast, because output-capital ratio is
high (high marginal product of capital). Relatively high additional output per capita means relatively
high additional saving and investment per capita (large enough to more than compensate for n and
), thus increase in k is large.
• If k grows fast, y grows fast
• Starting on the right side of k* , the marginal product of capital has become so small that not
enough to compensate for n and , so per capita capital stock k declines until you end up in k * .
• Economy thus converges to the equilibrium, the steady state, where k is constant at k*
• Also income per capita y is then thus constant!  No long-run per capita income growth due to
saving
• Implies that K and Y grow at population growth rate n in steady state (so total K and Y do grow)
• So, to the left of k* , capital is accumulated faster than labor, which is why you get diminishing
returns to capital and the growth process slows down.
• Income per capita y is constant in the long run in Solow model  savings cannot sustain per capita
income growth. Contrast with Harrod-Domar model, where savings affected the per capita income
growth rate.
• Difference is exactly due to diminishing returns to capital (and thus increasing capital-output ratio)
in Solow, and constant capital-output ratio in Harrod-Domar.

• Savings rate in Solow doesn’t influence long-run per capita growth rate (which is zero in this
model), but it does affect the long-run level of per capita income.
• Illustrate increase in s, level-effect in steady state (and growth effect only during transition to new
steady state).
• Also illustrate increase in n or , increase in either implies you need higher s to keep k* constant.
• Distinguish:
– Per capita growth of capital and income in steady state
– Per capita growth of capital and income in transition towards steady state
• Solving for the steady state:
• Use per capita capital accumulation equation
(5) (1+n)kt+1=(1- )kt + syt
• Plug in k* for kt and kt+1 to obtain equation describing steady state:
• k * /y* = s/(n+ )
• s↑, n ↓, and  ↓ increase capital-output ratio and thus also k* must be higher (and y* )

Solow model-with technical growth

• In basic Solow model no long-run growth by s
• Technological growth in Solow model can however sustain per capita income growth
• 2 ways to see impact of technological growth in Solow:
– Increase A in Cobb-Douglas production function
– Express the model not in per capita terms (so not per unit of labor), but per unit of effective
labor, where labor is augmented with efficiency term

• Increase in A shifts production function upwards and increases per capita income in steady state,
so continuous increase in A (=continuous technological growth) can sustain per capita income growth
 curve shifts upwards (see notes)
• Introducing units of effective labor
L’(t)=E(t)*P(t) and expressing the model in these L’(t) instead of P(t), you find that in steady state
growth of capital per unit of effective labor L’(t) is also zero, but because efficiency E(t) grows with
rate 𝜋, also capital per capita has to grow with rate 𝜋. Story is rather similar to basic model. Use
K
^k = instead of capital
E∗P
K
per person k=
L
L’= E*P
𝜋 growth rate of the
efficiency term

Et+1 = (1+ 𝜋) Et

E grows with rate 𝜋

K/ P  grows with rate 𝜋
• In Solow technological growth 𝜋 is exogenous, where does it come from? The model doesn’t say
anything about that. Manna from heaven
•  Endogenous growth models
Endogenize technological growth through:
1. Accumulation of human capital
2. Technical progress through R&D investment or spillovers

• Illustration of Solow model with China and US. What does the model predict about their steady
states and thus about their long-run per capita income?
• Look at difference in savings rate and level of technology

• So, theories of economic growth take us quite far in understanding the development process, at
least at some aggregate level
• Both the Solow and the Harrod-Domar model put saving (and investment and capital
accumulation) at core of growth process.
• In Harrod-Domar this is sufficient to sustain growth in per capita income, in Solow not
• Extended Solow model emphasizes technological growth for sustained growth of per capita
income
• Both models include exogenous variables (s, n) that may be endogenous and cause development
traps

Week 2

Lecture 3 – Population and economic growth

Global population growth

• 1 C.E. world population estimated 230 million (Indonesia)
• Population growth recent and unprecedented event
• From beginning human settlements took > 10K years 1 billion
• Last five decades 1 billion added every 12 to 15 years
• Introduction settled agriculture, reliable and increased food supply, death rates fell.
• Industrial revolution, innovations agriculture increased productivity and transport allowed supplies
to food-deficit areas.
• Modern medicine, improved sanitation reduced death rates
• After WWII techniques introduced in developed countries spread throughout globe
• All contributed to worldwide population explosion
 So, driving force behind population increase last 100 years was demographic transition.
• Death rates fell quickly, while birth rates took longer to fall and in the interim period the population
growth rate increased to unprecedented levels.
• Demographic transition describes effect from economic development to population growth
• First increase then decrease in population growth
• First in developed countries, then in developing countries.

• Developed countries started demographic transition in earlier centuries

• In Europe and North America 1650-1933 (almost 300 years), relative population growth
Europe and North America increase from 1650  decreased from 1933 (while others increased)
• Now worldwide pop growth declining, but rates bit higher in developing countries, decline started
later

• Illustration of demographic transition: countries from poor to rich
• Pop growth rates developing countries higher, becoming negative in advanced countries.
 developing countries: larger share is having children (larger share of young people compared to
advanced economies)
 poor countries: both birth rates and death rates are high
• Sharply increasing share of population will live in now developing countries.
• In 1950: 65 % of world pop lived in developing countries, in 2000: 80 % and 2050: >86%
 Asia: highest pop. (increased from 1950 till now, after will decrease)
 Africa: increasing sharp pop. From 2020 till 2100
 Europe & America: stable pop. growth
• Population by continent in billions 1950-2100
• Population of nine now largest countries (millions) excl. China (1.4 billion), India (1.3 billion), 1950-
2100

• Overall global population will increase strongly. UN forecasts of future pop growth. All scenarios
similar assumptions declining mortality, different assumptions fertility declines (due to economic
improvements, better education, family planning programs).
• Higher population growth in developing countries, low in developed countries also implications for
age distributions and again for population growth.

• Relatively high population growth in developing countries is partly result of very sudden and
widespread decline in death rates
• Medical innovations (antibiotics, use of pesticides to reduce malaria), elementary methods of
sanitation and hygiene etc. did not have to be reinvented, widespread application
• Decline in death rates took about 300 years Europe and North America, while in developing
countries only several decades

how quickly will birth rate follow death rate in downward course?
• Adjustment birth rates: various factors keep birth rate high:
• At macro-level, large share population in reproductive age keeps birth rates high even if fertility
rates are reduced
• At household level, children are substitutes for missing markets (mostly social security in old age,
but also insurance: medical care, life insurance, loss of employment, disability)
• Number of children is chosen with intention of receiving support at old age, which may not be
forthcoming because (1) child may die, (2) child may not earn enough income, (3) child may
deliberately not support its parents. More children increases probability of support.
• Falling death rate reduces (1), but not (2) and (3), which may well increase
• Gender bias may further increase fertility (when a daughter is born, they want a son  get more
children)

1-(1-p)n > q
p = prob. that a given child will support you
1 – p = prob. That a given child will not support you
(1-p)n = none of you children will support you
1- (1-p)n = prob. that at least one of your children will support you
q = threshold prob. of receiving support of at least one child that is found acceptable by a couple
f.e. if (1) reduces  p↑  n↓

More factors that may keep birth rates high:

• So far, we haven’t taken costs of raising children into account
• Becker (1960) introduced cost-benefit approach to fertility choice
• Costs of having children take 2 forms: direct costs (food, clothes, education etc.) and indirect or
opportunity costs (time not spent earning income * wage rate)
• Low wages  low opportunity costs  high fertility
• Increase wage-income (economic growth) reduces fertility

• Goods preferences represented by indifference curves

• Point A is total potential income with no children
• Slope of budget line AB measure of unit cost of having children
• Consider 2 scenarios:
(a) Non-wage income increase to CD (e.g.
rent), demand children and other goods
increases
(b) Wage-income increase to BE (opp costs
for children increases), demand children
reduces

• Fertility may be socially sub-optimally high while privately optimal

– Externalities: fertility decisions may have implications for others. E.g. Subsidized public education at
little or no cost to users. Not possible for users to value at true social cost, because private cost is
lower than social cost, not be properly internalized. Number of children will exceed social optimum.
• Fertility may also be sub-optimally high due to:
– Incomplete information on fallen death rates (example of Mr. Singh, India)
– Social norms are often strength as provide social stability (celebrating birth many children,
especially sons; polygyny; not using contraceptives etc.) change slowly and may become
weakness when environment changes (e.g death rates decline and old-age security becomes
available)
• With respect to social norms: family-planning experiment in Matlab 1977, Bangladesh, providing
contraceptives and informing about them. In 3 years fertility rate in treatment villages declined to
two-thirds of that in control villages. Signalling new social norm. (Also role of media in changing
norms.)

• From above, effect economic growth on population growth:

– Greater provision of organized old-age security reduces fertility rates
– Economic progress may shift societies from extended family system to nuclear family
system. Less externalities in costs of child rearing, costs are more internalized  reduces
fertility
– Increase in female wages increases opportunity costs  reduces fertility
– Reductions in infant mortality  reduces fertility

Population and economic growth

• Effects population growth on economic growth, negative:
1. Using Harrod-Domar model: increase in n has negative effect on g*. But, since capital-
output ratio is fixed, doesn’t account for increased population raising output.
2. In Solow, increase in n has no effect on long-run per capita income growth, but negative
effect on level.
no effect in LR per capita income growth bc 2 effects cancel each other out:
- output needs to be divided among more people (negative)
- pop. Growth leads to more labor  more production  more output (positive)
3. Faster population growth lowers savings rate as it shifts age distribution towards the very
young, increasing the child dependency ratio. As children consume more than they produce,
there is dissaving.
• Positive effects population growth on economic growth:
1. As birth rates start to decline, the latter (3) may turn into positive effect on economic
growth, as share of working age population starts to increase. This is demographic dividend.
2. Population growth creates economic necessity, which forces creation/adoption of
innovation and technical growth (demand-driven).
3. Population growth fosters development simply because probability of innovation increases
as many heads better than one (supply-driven).

Ad 1. Demographic dividend:
• The temporary increased population growth produces a boom of children that will move through
the age distribution.
• First, boom concerns children, then 15 to 20 years later they become the economically active
population (age 15- 65) and finally they are the elderly.
• So first increasing youth-dependency, then declining youth-dependency and then increasing
elderly-dependency.
• First, the effect on economic growth is negative (more children), then it becomes positive (more of
working-age), and finally it may become negative again (more elderly).
• Middle phase is called the demographic dividend.
 demographic dividend is not automatic
 Depends on the implementation of effective policies (improving health and education of working-
age population to improve their productivity, employment creation).

Historical evidence:
• Industrial countries as a group received a dividend of 1 percentage points.
• Cross country growth regression by Bloom and Williamson (1998) finds that 1/3 of the ‘economic
miracle’ in East Asia attributed to demographic dividend
• Relates to growth accounting exercise by Young (1995) for Asian tigers (1965-1990), also included
correction for increasing participation rates.

• Recent IMF study suggest developing countries in total as result of rising share working age pop will
enjoy “demographic dividend” resulting in stronger economic growth next 20 to 30 years
• Especially SSA, potentially largest demographic dividend
• In Africa, since 1985 dependency ratio falling, mirrors Asia, 20 years earlier dependency ratio falling
(in Asian tiger countries)
• Dependency ratio = ratio of young plus elderly to those in the labor force

Lecture 4 – Aid and Growth

• Foreign aid consists of financial flows, technical assistance, and commodities:
– for development purposes
– provided as grants or subsidized loans
• Subsidized loan is aid if grant element of 25% or more
• Aid provided as cash, goods, services, or debt relief
• Official development assistance (ODA) by governments vs. private assistance (NGOs, foundations,
companies)
• Foreign aid always controversial, effectiveness debated

• Arguments aid proponents:

– Aid instrument to fight poverty, accelerate economic growth
– Aid promotes growth by financing new investment, especially public goods contributing to capital
accumulation
– Poor countries unable generate sufficient savings, finance investment, accumulate capital, generate
growth
– In strongest version, poorest countries may be stuck in a poverty trap, where income too low, and
total saving too small to compensate for depreciation capital stock, no capital accumulation and thus
no growth
– Aid can also support growth by building knowledge and transfer technology from one country to
another. E.g. aid-funded agricultural research in 1960s and 1970s (new varieties of seeds, fertilizers,
pesticides), became known as green revolution. Similarly, aid as technical assistance aimed at
increasing productivity
– Achieve other development objectives in LICs, e.g. health and education programs

 Aid can also help to push the economy beyond the threshold to prevent poverty trap
• Although aid not always worked well, overall record positive, critical for poverty reduction and
growth many countries, helped prevent worse performance in others
• Argue many weaknesses aid more to do with donors than recipients, substantial aid for political
reasons, so not surprising not always effective fostering growth
• Point to successful recipients Botswana, Indonesia, Korea, Taiwan and more recently Ghana,
Mozambique, Uganda
• Several successful aid-financed initiatives: green revolution, campaign against river blindness
Main proponents: Jeffrey Sachs, Joseph Stiglitz
• Arguments opponents: Aid no effect on growth, may undermine:
– Aid invites corruption (ends bank accounts, cars)
– Entrenches corrupt dictators (supports political regimes that impoverish the poor)
– Aid is wasted, large bureaucracies, TA reports, new projects, no maintenance
– Undermines incentives for private sector activity, e.g. Dutch Disease, real appreciation exchange
rate undermining export, drawing workers and investment from productive activities
– Aid may reduce government investment, aid is fungible, effectively finances activities not intended,
e.g. aid used for investments government would have made without aid, resources freed up for other
purposes

• Cite widespread poverty Africa and South Asia despite decades aid
• Call for aid programs reformed, curtailed, or eliminated altogether
• Point to countries high amounts aid, disastrous growth: DRC, Haiti, Sudan
Main opponents: Dambisa Moyo, William Eaterly

Who gives aids?

• More than 40 governments provide aid
• Below ranking according to aid % of GDP
• Measured in US $, different ranking, US by far largest donor (34 bln. US$, 2017)

How much aid?

• In real $:
• ↑ till end cold war
• Then ↓ to 2000
• ↑ due to:
– Iraq/Afghanistan
– Increased commitment
• In % GNI:
• ↓until 2000
• ↑ thereafter
ODA  official development assistance
FDI  foreign direct investment
Workers’ remittances: financial flows
send back home from migrants

Since 1997: workers’ remittances >ODA

Aid recipients:

• 150 countries receive aid

• Some countries, trivial amounts (0.5 % GDP or less), others aid flows substantial (20%, 40 + % GDP )
• Important capital flow LICs (low income countries):
• South Asia < 1% GNI
• 2003 per cap. aid LICs $14
• India since then MIC
 • Raised per cap. aid to LICs

Motivations for aid

• Foreign policy and political relationships, e.g.
– US and Soviet Union during Cold War used aid to gain crucial votes in UN (Cuba, N-Korea, E-
Europe)
– Now significant aid provided to former colonies to retain political influence
– US aid largest recipients countries key national security interests (Iraq, Afghanistan)
• Humanitarian: poverty (main rationale for many people in rich countries and for some donors
(Nordics), above aid flows most important for poorest countries. As their income rises private capital
flows increase, aid declines)
• Country size (donors provide more aid to smaller countries, as impact more noticeable. For political
reasons donors want to influence as many countries as possible, tends to lead to disproportionate
amount to small countries. Vote in UN General Assembly same from small or large country)
• Commercial ties (bilateral aid often designed at least partially to help support economic interests
of firms or sectors. Many donors tie part of their aid to purchases within donor country. Helps
increase political support, but adds to cost of aid programs (15 to 20% according to one study).
• Democracy(since end cold war donors tended to increase their aid to countries that have become
democracies. Alberto Alesina and David Dollar found typical country to receive 50% increase after
switch)

Impact of foreign aid

• Empirical evidence aid effectiveness mixed
• Findings vary from no to conditional to positive impact
• On balance, evidence suggests on average modest positive impact development outcomes, but
wide variation.
• Aid supported growth and development in some countries and contributed to improvements
certain areas, health, agricultural technology
• Other countries little effect, not spur growth
• In some countries it probably held back development, particularly when given to political allies with
corrupt or inefficient governments with little interest economic development
• Economic growth always been main yardstick to judge aid effectiveness, more aid expected to lead
to faster growth
• But, no apparent simple relationship between aid and growth, see figure
• Some countries much aid, high growth, others much aid, negative growth
• Also, some countries receiving little aid did very well, others didn’t

• For some this is evidence of failure aid

• Too simple conclusion, because endogeneity:
– Omitted variable bias: other factors affecting both aid and growth (endemic disease, long-
standing conflict, poor geography may lead to high aid and poor growth)
– Or reverse causality: from growth to aid, countries with low growth receive more aid
• Controlling for these factors (including control variables and instrumenting for aid), aid could have
a positive effect on growth
• Debate continues on overall general trends, but general agreement on some broad issues:
• Most aid pessimists agree that aid has been successful in some countries (Botswana, Indonesia,
Mozambique, Tanzania)
• That aid has helped improve health and that aid has been important in providing emergency relief
• Similarly, aid optimists concede much aid wasted or stolen (Marcos regime Philippines, Duvalier
regime Haiti) and that even under best circumstances, aid can have adverse incentives on economic
activity
• Empirical evidence mixed, conclusions i.a. depending on time frame, countries involved, methods
used. 3 views:
• View 1. Although not always successful, on average aid has had a positive impact on economic
growth
• View 2. Aid has had little effect on growth
• View 3. Aid has a conditional relation with growth, stimulating growth only under certain
circumstances

View 1
Although not always successful, on average aid has had a positive impact on economic growth
• Majority of studies find positive relationship aid and growth, after controlling for the impact of
other factors on growth
• Since mid 1990s, aid-growth studies began investigate whether aid spurs growth with diminishing
returns. Small amounts of aid, large impact, each additional dollar less effect. Standard assumption in
growth theory, but earlier research only tested linear relation
• Aid can also have a positive effect on other development objectives that affect growth only
indirectly, such as better health and education. Large share of aid is allocated to health and
education . Impact on growth can take long to materialize.
• Micro studies find strong impact, especially on health & education

View 1

View 2

View 3

View 2
aid has had little effect on growth
• Especially early studies, not controlling endogeneity, finding simple negative correlations
• Also early studies testing only linear relation
• Health and education effects not yet apparent in old studies
• But also some more recent studies no effect

View 3
Aid has a conditional relation with growth, stimulating growth only under certain circumstances
• Tries to explain why aid effective in some cases, not in others
• Three conditional explanations emerged:
– Characteristics of recipient country (quality of institutions)
– Types of aid (emergency and humanitarian aid, negatively associated with growth, aid
affecting growth after very long time (health, education), aid directly aimed at affecting
growth, strong positive aid-growth relation)
 – Donor practices (e.g. bilateral vs multilateral aid, tied vs. untied aid, donors that coordinate
with others vs acting on their own, donors with effective monitoring/ evaluation)

• Nowadays: increased use of RCTs (Randomized Controlled Trials) to evaluate direct impact aid
intervention, rather than impact on economic growth.
• Impact of micro-interventions (especially health and education) tested with treatment and control
group

Improving aid effectiveness

• Since late 1990s, with rising aid flows, increased discussion on how to increase aid effectiveness
• “Paris Declaration on Aid Effectiveness and Accra Agenda for Action” best articulates consensus on
best practices in aid delivery
• In recent years, donors began to put some of these ideas in practice
• These ideas:
1. Country selectivity (good policies and institutions, with more aid going to countries with
higher poverty levels)
2. Recipient participation (less donor domination in setting priorities, design, monitoring and
evaluation. More active role groups in recipient)
3. Donor harmonization and coordination (typically 30 or more aid agencies, hosting 3+ aid
missions per week)
4. Results-based management (aid programs aim to achieve specific quantitative targets, and
decisions to renew aid based on these results)

• Ad 4. Nowadays: increased use of RCTs (Randomized Controlled Trials) to evaluate results/impact

aid.
• Much learned, especially on health /education

Week 3

Lecture 5 – Growth: Empirical Findings

Convergence
• Prediction one could make from Solow model under certain assumptions about poor and rich
countries’ predicted growth rates
• Two types:
– Unconditional convergence
– Conditional convergence

Unconditional convergence
• Implies per capita incomes of countries move ever closer, converging to same steady-state • Initial
conditions k0 and y0 don’t matter in the long run given steady-state k* /y* = s/(n+ + 𝜋)
• kt k* from any k0
• due to diminishing returns to capital…
• … and the equality of s, n, 𝜋 across countries
•  Assertion is poor countries will grow faster
• Assertion poor countries will grow faster implies negative relation initial per capita income and per
capita income growth
• Does this assertion fit the data?
▪ Option 1. Small number of countries, long horizon
▪ Option 2. large number of countries, short horizon

Option 1. Small number of countries, long horizon

• Baumol (AER 1986): 16 countries, among richest in the world today
• In order of poorest to richest in 1870: Japan, Finland, Sweden, Norway, Germany, Italy, Austria,
France, Canada, Denmark, the United States, Netherlands, Switzerland, Belgium, the United
Kingdom, and Australia.
• Data Angus Maddison: per capita incomes for 1870
• Idea: regress 1870-1979 growth rate on 1870
incomes
Ln yi1979 – ln yi1870 = A + b ln yi1870 + εi
• Baumol’s finding supports the unconditional
convergence hypothesis quite strongly
• Finds strong negative relationship, see graph

• De Long critique (AER 1988):

• Selection bias by including only successful countries
in terms of current (1979) per capita income (only
including rich and poor)
• Add 7 more countries to Baumol’s 16
• In 1870, they had as much potential for membership
in “convergence club” as any included in 16:
Argentina, Chile, East Germany, Ireland, New Zealand,
Portugal, and Spain  had equal chances of becoming
rich in 1979
• All had per capita GDP higher than Finland in 1870
 slope still negative but loses significance
 correct for measurement error, game  no evidence of unconditional convergence

Option 2 large number of countries, short horizon

• Barro (QJE 1991): 100+ countries over 1960-1985

• Unconditional convergence clearly rejected by

the data  no clear decline (poorer countries don’t
grow faster)
• Unconditional convergence assumes all
parameters are the same across countries
• Obvious weak link: s, A, ∆A (or 𝜋), n, and  differ
• Allowing this means that countries can now
converge to their own steady state

Conditional convergence
• If countries have own steady state, then not necessarily that poorer countries grow faster
• Suppose e.g. similar technological progress 𝜋 across countries, but different s, n, and 
• So, growth rate of k and y in steady state is similar (𝜋), but
levels different, due to s, n, and 
• Then initially wealthier countries may grow faster, see
graph
Convergence condition on and conditional on openness, savings, and
population growth population growth

• How do we control for effect of s, n, A, 𝜋, 𝛿 on position steady state?  need relation between per
capita income and these parameters
• Based on Solow model and using a Cobb-Douglas production function, following relationship
emerges between per capita income and parameters (3.15)
α α
𝑙𝑛𝑦(𝑡) ≈ 𝐴 + ln 𝑠 − 𝛼 ln(𝑛 + 𝜋 + 𝛿)
1−α 1−α
• This relationship can be tested with data
• 𝛼 ≈1/3 such that 𝛼/(1-𝛼)≈ 0.5 𝛼 = share of capital income in total national income
• Mankiw, Romer and Weil (QJE 1992) did this using 𝜋 + 𝛿 ≈ 0.05
• More than half of world variation in 1985 per capita GDP can be explained by variation in s and n 
strong result
• They do find positive coefficient for ln(𝑠) and negative coefficient for ln(𝑛 + 𝜋 + 𝛿), but too large,
not close to 0.5
• Observed variations in per capita income are thus too large relative to those predicted by theory,
too little convergence (so maybe less diminishing returns to capital? But constant returns to capital
simply not true)
• So, once we drop assumption that all parameters are same across countries, Solow model does
make some sense of the data, some evidence of conditional convergence, but still too little
convergence

Growth Accounting
• In growth models, output/income can grow for three reasons:
– Growth in capital input (by saving/investment)
– Growth in labor input
– Technological progress
• So far, we have identified these as core determinants of growth
• How important are each of these in explaining growth?
• Solow pioneered early efforts to quantify contribution of each of these proximate causes
• This approach is more of an accounting framework based on actual data than economic model 
growth accounting
• Seeks to find proportions of economic growth we can attribute to growth capital stock, growth
labor force and TFP growth
• 𝑌 = 𝐴𝐾𝛼𝐿1−𝛼  𝑔𝑦 = 𝑔𝐴 + 𝛼𝑔𝐾 + (1 − 𝛼)𝑔𝐿
• Economic growth, growth capital stock and growth labor force can be measured, TFP growth
measured as residual (Solow residual)

• Limits to this analysis: TFP is measured as residual, will include combination of influences that
analysis cannot disentangle
• TFP growth due to faster computers, new seed varieties agricultural crops, other technology?
• Or efficiency gains from improved trade policies, reduced corruption, less red tape?
• Growth accounting cannot answer these questions, part of growth that is not explained by the data
on accumulation K and L  measure of ignorance
• Residual also includes measurement error
• Sources of growth analyses have been carried out for many countries
• Solow’s initial study on US attributed 88% of growth to TFP growth, only 12% to increased capital
per worker
• Subsequent studies included better measures of inputs (including skill categories, quality of capital)
• For industrialized countries, particularly rapid growers, increases in capital per worker frequently
account for less than half increase in output, while TFP growth for bit more than half.
• Was surprise, as most basic models put capital formation at heart of growth
• Similar studies for many developing countries; generally these attribute a larger role to capital
formation (main source of growth)
• This is consistent with Solow model, as developing countries have lower levels of capital per worker
and can increase incomes (converge) through investment
• TFP growth tends to become more important as income rises

• Example: economic growth East Asia 1965-90 higher than any other region in world history
• East Asian Tigers: Japan, Hong Kong, Korea, Taiwan, Singapore, Indonesia, Thailand, Malaysia
• Clues to explain their success? Policy implications
• Countries had high accumulation of physical (s↑) and human capital (especially secondary
enrollment ↑)
• TFP growth according to World Bank publication very high (explaining 1/3 growth, high relative to
other developing countries), thus productivity-based catching up due to openness
• But, Young (1995, QJE) did more proper growth accounting exercise, accounting for all changes in
inputs
• Since 1960s, several developments have contributed to high growth rates
– Participation rates have risen
– Labor moved from agriculture to manufacturing
– Education levels improved
– Capital has been accumulated faster (I/GDP investment ratio)
• Is there a role left for TFP-growth, residual?
• For Singapore, all growth can basically be attributed to accumulation of capital and (to lesser
extent) labor
• For other East Asian Tigers, similar story holds
• Conclusion: although there has been productivity growth in East Asia, this has not been
exceptionally high. Factor accumulation has played most important role.

Cross-country growth regressions

• Growth accounting identifies proximate sources of growth, factor accumulation and productivity
growth.
• But what underlying factors explain a country’s ability to attract investment and accumulate capital
per worker, increase efficiency and obtain new technologies?
• Large body of research tried to answer this by searching for broad characteristics common to
rapidly growing economies
• Most recent studies modeled on research by Robert Barro in early 1990s, try explain variance in
growth rates across countries (country growth rates as dependent variable, controlling for countries’
initial income level)
 This type of research has been controversial, far from consensus on exact group of variables that
affects growth.
• For one thing, although this type research based on Solow model, for many variables tested, no
theoretical link between variable and either growth or factor accumulation or productivity growth
Problem:
• Existing growth theories just not explicit enough about exactly what variables determine shape
production function, rate of investment, rate of technical change etc.
• Some characteristics appear significant in one research including certain variables, unimportant in
another including different var.
• Second issue involves interpretation of results
• High savings rates can lead to rapid growth, but also vice versa. Direction of causality? (statistical
challenge to disentangle)
• Despite these issues, empirical growth research helped better understand broad characteristics
rapid growth, though imperfect
• Debate still ongoing about which variables influence long-run growth, how they do so, and
magnitude effect

• Broad clues from this empirical research about why some countries grow faster
• Most rapidly growing developing countries tend to share 6 characteristics (e.g. Sala-i-Martin, AER
1997):
1. Macroeconomic and political stability
2. Investment in health and education
3. Effective governance and institutions
4. Favorable environment for private enterprise
5. Trade, openness, and growth
6. Favorable geography

1. Macroeconomic and political stability

• Economic and political instability undermine investment and growth through increased risk
• Macroeconomic stability: low budget deficit (high public s), sound monetary policy, appropriate
exchange rates, sustainable foreign debt, etc.
• DRC (democratic republic of Congo), annual inflation rate 1990-2002 of 2,800%, wars involving
troops from 5 other countries, -7.2% growth per year
• Paul Collier points out negative cycle of civil war: poverty increases risk of conflict, conflict
undermines growth and entrenches poverty
 political stability (on average 28% decline in average income after civil war)
 2. Investment in health and education
• Healthier and more productive labor force
• Also, firms more likely to invest where workers healthy and productive
• People more likely to invest in education if longer life expectancy
• Basic healthcare facilities, clean water, sanitation, disease control programs, reproductive and
maternal and child health programs help increase life expectancy
• Micro-level studies show high rates of return to education, macro-level relation is modest
(consistent measurement)
• Better health and education <-> higher income growth (endogeneity)

3. Effective governance and institutions

• Attention to this factor since early 1990s, Nobel prize-winning economist D. North
• Strength rule of law, extent corruption, property rights, quality government etc.
• Strong institutions reduce risk and increase return
• Governance in most rapid growers varied from very effective (Singapore, Botswana) to more mixed
(Indonesia, Thailand), but generally better than in slower-growing countries
4. Favorable environment for private enterprise
• No heavy business regulation and strong property rights
• Good infrastructure (electricity, water, roads)
• For many countries: good agricultural policies:
• no low controlled prices, access to fertilizers, seeds, and good rural roads. Not necessarily
absolutely free markets: subsidized fertilizer, buffer stocks)
• Also small-scale businesses and manufacturing no unnecessarily high costs through licensing,
permits etc.

5. Trade, openness, and growth

• Trade volume: Higher trade to GDP increases per capita income
• Trade facilitates transfers of capital and technology, increases competition, brings economies of
scale
• Trade policy: Outward-orientation is believed to contribute to growth (e.g. East Asia) although
debate on evidence is ongoing (Rodrik).

6. Favorable geography
• Poorest countries are almost all in tropics, richest countries in more temperate zones
• Even within temperate zones, regions closer to tropics tend to be less well off
• Strong relation location and growth
• Tropical countries greater burden diseases, erratic climate, some areas poor quality soil
• Landlocked countries and small-island states isolated from major markets (overland transport costs
can be three times higher)
• Being landlocked doesn’t mean growth is impossible, but adds to production costs (-> improve
infrastructure)

In sum
• Growth accounting indicates capital accumulation contributes substantially to growth in low-
income countries, while increase in size and quality of labor force also important contribution
• Productivity growth tends to account for a larger share of growth in high-income countries
• Our understanding of precisely how these and other factors affect the growth process is far from
complete.

Lecture 6 – Inequality and Poverty

Inequality
• 1820-1970-2000: first global income divergence, then convergence
• 1820: 85 to 95% of world in absolute poverty
• 1970: bimodal world income distribution, world divided in rich and
poor
• 2000: unimodal, more equal and much richer
• Incomes measured in international dollars (PPP)
• Now per region 1800-1975-2015 (including poverty line extreme
poverty 1.9 I$ per day)
• 1975-2015: Rapid growth in the poorer regions, particularly Asia 
global inequality declined

Graph: on a logarithmic x-axis

Graph:
Linear axis: emphasizing high global income
inequality (distribution stretches out far to the
right, much further than cutoff at 14,000
intern.$)
• But inequality declining, Gini coefficient from
68.7 (2003) to 64.9 (2013)
• Also rise of global median income from
1,090 int.$ (2003) to 2,010 int.$ (2013), almost
doubling

• Changes in total global income inequality driven by changes in inequality between countries and in
inequality within countries.
• Inequality between countries declining since 1980s
• Inequality within countries increasing since 1970s ‘
• Trend in global inequality now driven mostly by changes inequality between countries, because this
inequality higher than within-country inequality.

• Within-country inequality (Gini) over last three decades increased in many countries, especially in
advanced countries and Asia and Pacific.
• In Latin America and Sub-Saharan Africa decline, but high levels
• Also, rising share of top income earners in several countries.

Poverty
• Share of population in poverty declined since 1820.
• World population living in extreme poverty fallen from around 90% in the 19th century, to 9.6% in
2015.
• Extreme poverty: < 1.90 $ per day (in 2011 intern. $)
• This continuous decreasing share of people in extreme poverty over last two centuries one of most
remarkable achievements of humankind.
• Especially the last 4 decades very steep declining share.
• Number of extreme poor until 1970 did increase (despite declining population share), but since
then also number of extremely poor decreased (despite strong
population growth).
• Also using higher poverty lines (more dollars a day), the
number of poor has been declining in recent decades. (see
graph distribution of popultaion between different poverty
thresholds)
• Decline, yet still large share of world population below 10 int.
$ per day (from 75% to 66%).

• Striking that perception especially in rich countries (graph UK) is share of poor increased.
 only 12% decreased
 55% increased

• Concentration of world’s poorest shifted from East Asia in 1990s to South Asia in the 2000s to
SubSaharan Africa now.
• Steep decline poverty during last generation because the poorest people lived in countries with
strong economic growth, large part in Asia, but also in countries like Ethiopia and Ghana.
• This is now different. Many of world’s poorest now live in countries with low economic growth in
past. Half a billion face the prospect to remain stuck in extreme poverty.
• Goal number one of Sustainable Development Goals (SDGs), agreed on by all nations, is
“eradication of extreme poverty for all people everywhere” in 2030.
• Although projections show a further decline in extreme poverty, world not on track to end extreme
poverty by 2030.
• Number of people in extreme poverty will likely stagnate at almost 500 million in 2030, mostly in
SSA.
• Big lesson from history of extreme poverty is that it is ec. growth of an entire economy that lifts
individuals out of poverty. Micro-level interventions (short-term support households with productive
asset grant, consumption support, skills training, health education etc.) also help.

• In 2013 (2015) still 746 (705) million people (10.7%) in extreme poverty.
• Africa is now region with largest number people in extreme poverty (in 1990 this was Asia).
• India (in 2013) the country with the largest number of people living in extreme poverty (218 million
people). Nigeria and the Congo (DRC) follow with 86 and 55 million people.
 • Breakdown by (region &) country:

Micro part (focus on people instead of countries)

Week 5 – Poverty: measurement, theory and evidence

• There are very large differences in income per capita across countries today
• Growth China/India: millions moved above $1/day
• Other countries have seen their poverty rate increase over time

The growth gap

• Some countries are much richer than others because they have grown steadily over an extended
period of time
• Understanding causes of economic growth = understanding causes of persistent poverty.

Proximate vs fundamental causes of economic growth

•Income is a function of capital, human capital and technology
Y = γF (K, L)
• Explain log(per capita GDP) with investment rate, population growth, and education
R2= 0.78
• Good fit, but does it help to explain the causes of differences in wealth?

• Why do some countries fail to improve their technologies, invest more in physical capital, and
accumulate more human capital?
• Capital, human capital and technology are only proximate causes of economic growth and
economic success  they are endogenous variables in the model (and not exogenous variables)

• Fundamental causes of economic growth:

• Bad endowments
 Poor land quality, climate: low land/agricultural productivity
 Tropical disease burden (malaria, dengue, tse-tse fly): low productivity
• 93% of Sub Sahara Africa is tropical
• For most products, yields per hectare as substantially lower in the tropics compared to the rest of
the world
 Cold night are important for yields
 Little, and insecure rains
 Bad quality of solid and low use of fertilizer
 Tropical illnesses (people and animals)
• High cost of doing business
 Without government subsidies farmers in Africa pay 2 to 3 times as much for fertilizer as
compared to farmers in Thailand/India or Brazil.
 Access to trade routes: Ratio coast over landmass is low in Africa 1.15 in SSA, 2.54 in South
Asia, and 15.7 in West Europa
• Bad institutions (preventing investments in physical/human capital)
 Institutions are the rules of the game in a society or, more formally, are the humanly devised
constraints that shape human interaction
• institutions are humanly devised
• Formal and informal rules
• they set constraints , thus are enforced
• they shape incentives
• Bad institutions can reduce economic productivity. For example, women should not work
• Even though they set constraints, they can augment economic productivity!

Institutions:
• Economic institutions: economic rules of the game (property rights, contracting institutions)
• Political institutions: political rules of the game (democracy vs dictatorship, electoral laws,
constraints)
• Socials institutions: religion, social norms, culture
 Exogenous in the short run, endogenous in the long run
• Do Institutions change slow enough so that they can be considered exogenous, and thus an
explanation of growth differences?
• Possible mechanisms:
 Property rights land  Less worry about losing land  More investments in land  higher
productivity
 Democracy  Rulers worry about re-election  less corruption  allocation of capital
towards production
• Cross country regressions: Positive relation between institutions and GDP  but is it causal?

Causal evidence
• “Causal effect” refers to the answer to the following counterfactual thought experiment: if, all else
being equal, a particular characteristic of the country were changed (“exogenously”), what would be
the effect on its growth rate?
• Answering such causal questions is extremely difficult because:
 I it is difficult to observe changes in country characteristics that are not driven by something
that will also affect growth directly
 so difficult to isolate the impact of a given characteristic
• There is no definitive answer  context matters!

Example: aid and development in Africa

• Money has been spent, but GDP did not increase  But what would have happened without the
aid? (Jeff Sachs, “Breaking the Poverty Trap.”, Bill Easterly, “Africa’s Poverty Trap.”)  we don’t know

• Any statement we make must have theoretical foundations and is grounded in rigorous evidence
 Rigorous evidence = no anecdotes, because that is not representative  we are all subject to
“confirmation bias” (we tend to notice/remember things that match our prior and discount
stories hat does not agree with us)
• Not just look at correlations  because of reverse causality, omitted variable
• Empirical setting in which one variable changes, ceteris paribus

Poverty: Measurement
Definition of poverty: people experiencing well-being below some minimal acceptable level

How to measure well-being:

• Household income/consumption per capita:
  Consumption more suitable than income in developing countries
 Measure assumes no inequality within households
 Measure does not consider differential cost of children

How to draw the line defining unacceptably little?

• World Bank Poverty line
 Set in 2009 at $1.25 per person per day in 2005 PPP (based on poverty line of 15 poorest
countries)
 Later updated to $1.90 a day in 2011 PPP
 Only adjusting for inflation, same real value
 10 perc in world are poor worldwide (2015)
 41 perc in sub Saharan Africa

How to aggregate information for many people?

q
• Head count ratio: HCR =  q= number of poor people, N= population
N
 Does not take account of how poor people are
q
1 z−Y i
• Poverty Gap Ratio: PGR=
N ∑ z
 z = poverty line, Y i = per capita consumption of indiv i
i=1

Vulnerability to poverty
• Many households are not poor, but vulnerable to falling into poverty
• vulnerability: risk that household will fall into poverty at least once in the next few years
• Indonesia: 20 percent of people below poverty line
• close to 60% of total Indonesian population have a ≥ 50% chance of falling into the bottom 20%
• The percentage of being sometimes poor is much higher than the percentage of being always poor

Poverty is not only a lack of income, but also:

• Poor health: 8 million children every year die under the age of 5, mainly of preventable disease
• Poor education: 40% of adults in low income countries cannot read
• Poor quality of life: hours collecting water instead of playing, working, learning
• Difficulty to realize your ambition: Difficulty to get a loan for a business, be insured for the risk of
your farm

Amartya Sen’s capabilities approach

• Amartya Sen (1999) Development as Freedom
• Poverty = absence of one or more of the basic capabilities that are needed to achieve minimal
functioning (“freedom”)
 enough income to be fed and clothed and sheltered and healthy
 education
 political voice/participation

Main point: no matter how you measure is, world poverty is massive and a very serious challenge
• And lack of income is a very good proxy for lack of development

Poverty traps
• Poverty trap = the poor are poor because ... they are are poor.
• Initial conditions play a crucial role in determining where an individual or country ends up
 a self-perpetuating condition where a household (economy), caught in a vicious cycle, suffers
from persistent poverty (underdevelopment).
Many possible traps:
• Low schooling trap: Poor children can’t afford school  once adults, they are stuck in low-wage
occupations such as farming  they remain poor and cannot send their kids to school
• Low asset trap (with fixed cost in production): Suppose you need 100 dollars to start a profitable
business, otherwise stuck in subsistence farming: if there is no credit market, only those with enough
wealth to start with can invest and grow richer
• Infant industry trap due to Learning-By-Doing Externalities: Young firms are inexperienced and
less productive, so they cannot offer wages high enough to attract/keep experienced workers 
Remain inexperienced and unproductive.
• Demographic Trap: the economy may be caught in the vicious cycle of high fertility/low human
capital and child labor traps
• Scarcity trap: Extreme scarcity may cause the poor to be worse decision-makers than the non-poor
 the non-poor. I Financial stress results in lower mental resources (cognition, attention span, self-
control, etc.). Because mental resources are important for economic outcomes, this creates a
poverty trap.
 I Each model of poverty trap is designed to highlight one particular feedback mechanism behind
the vicious cycle  In reality, of course, many sources of poverty trap are likely to co-exist

Health-based poverty traps

The nutrition poverty trap:
• Is it possible that these nutritional deficiencies “trap” people into poverty?
• Chronic malnutrition still prevalent:
 UNICEF: 40-60% of children in developing countries are iron deficient
 Recent Lancet study: 61 million stunted children in India, which is over half (51%) of all Indian
children under the age of five years
 Also in India: 70% of women and kids have serious nutritional deficiencies such as anemia
(Save the Children Nutrition barometer 2012)

Theory
The capacity curve: relates income and work capacity (productivity)
• Higher income  better nutrition  higher work capacity / productivity
 But the relationship is not quite linear  Calories you ingest: first 1700 of them used by the
body for basic (resting) metabolism, only then does it translate into higher capacity, up to a
certain point

Capacity curve
• Use the capacity curve to introduce a relationship between
income from work today and income you can generate tomorrow
• Inter-generational version: can also think of it as relationship
between income inherited from parents and income once adults.
 Inherited income = income today: determines health status
 Income from work = income tomorrow: determined by
health status

Multiple Equilibria and the Povery trap

Concave capacity curve: no trap Everyone gets rich: no trap, unique equilibrium

If the capacity curve is above the 45 degree

line, there is no poverty trap either

Everyone gets poor: no trap, unique equilibrium When does a poverty trap emerge?

• Poverty traps are closely linked to the presence

of multiple equilibria.
• They require that the S-Shaped curve intersects
the 45 degree line from below:
 For poor people, income grows slowly, so
slowly that income tomorrow is below income
today: the poor become poorer (up to a point)
 There is a threshold at which the rate of
growth of income becomes positive: income
yesterday becomes larger than income today: the
middle class and the rich become richer (up to a
point)

If the capacity curve is about the 45 degree line, everybody ends up poor

• Note that a double feedback loop (e.g. poor nutrition lowers your income, and low income means
you cannot buy a lot of food) does not always mean there is a poverty trap: the relationship has to be
sufficiently strong
 In mathematical terms: the product of the two elasticities has to be greater than 1

The math
• Income is a function of health:
yt+1 = f (ht), f’ > 0  investment in health today raises income tomorrow
• But at the same time health is a function of income:
ht+1 = g(yt+1), g’ > 0  higher income today means higher health investment
• Combining the two functions defined above gives us a dynamic map:
yt+1 = f (g(yt)) = ϕ(yt)
• Necessary (but not sufficient) condition for there to be a trap: The capacity curve needs to intersect
the 45◦ line from below. This means that there must be a range where for a dollar in extra income,
capacity increases by more than 1. That will be the case only if there exists a fixed point where ϕ’ (.)
> 1.
• In terms of elasticities, this would mean that the elasticity of capacity wrt income must be > 1,
which means that the product of the elasticity of capacity wrt nutrition and the elasticity of nutrition
wrt income must be > 1 (at least somewhere)
f ’ (h) g’( y)
ϕ' (y ) = f’ (g(y )) × g’ (y ) = h× y = εfh × εgy
f (h) g( y)
 εfh is the elasticity of capacity w.r.t health (nutrition)
 εgy is the elasticity of health (nutrition) w.r.t income

Empirical evidence
• To test whether the conditions are such that there could be a trap, need to look for evidence on:
1. Effect of income on nutrition
2. Effect of nutrition on work capacity
• And the product of the two elasticities has to be at least 1 somewhere

Relationship #!: from Income to Health/Nutrition

• today, in developing countries, do people eat more when they earn more?  little agreement
• Why?
 It is complicated to measure caloric intake
 You cannot easily approximate caloric intake with food expenditure since relationship not
linear  e.g. Albert Heijn tomatoes and Ekoplaza tomatoes have the same caloric content
but not the same pricetag, more importantly substitution across food groups as income goes
up (the rich get more of their calories from fruits than from cereals, and the fruit calories are
more expensive)
• Jensen-Miller (REStat, 2011): randomized subsidy experiment in China
 no evidence that food subsidy to very poor households improved nutrition (in fact, negative
effect on caloric intake in one province!)
 it’s because subsidy for staple food (on which people spend a large share of their meager
budget) creates a wealth effect, which itself leads to substitution towards less nutritious but
possibly better tasting foods
• Surprisingly, calorie consumption is falling down in India, at the same time as income and overall
expenditure increase  suggested explanation: Calory requirements are going down over time
(better health infrastructure/more sedentary work); people do need to get enough calories to do
their work, but they try to get the tastiest one possible within this constraint
• Problem with that explanation: nutritional status is still really poor in India
 2004, 33% of men and 36% of women were undernourished (BMI below 18.5)
 D&D’s explanation assumes that people are satisfied with a nutritional status that most of us
would consider quite poor

Relationship #2: From Health/ Nutrition to Income

• do people earn more when they eat more?  very low levels of nutrition are very bad for
productivity (Minnesota starvation experiment during WWII)
• Less extreme cases  little micro literature, often not well identified
• John Strauss (1986): “Does Better Nutrition Raise Farm Productivity?”
  Uses consumption and farm productivity data from Sierra Leone (1974-1975), estimates fairly
strong relationship between nutrition and productivity  estimated elasticity: 0.33
• Problems with Strauss study:
 Not individual-specific nutritional intake data, needs to make assumption about how
consumption allocated across household members based on age
 Reverse causality story a concern (those who produce less can eat less)
• One more recent experimental study finds that workers getting more nutrients are more
productive at physical tasks
 Experiment in Indonesia provided iron supplement to randomly selected households.
Compared to other men, those in treated households they were stronger, less likely to be
anemic, less likely to be sick, worked longer hours, and earned more
 Important finding – since iron deficiency anemia is believed to affect up to 1 billion of people
worldwide

• The evidence overall suggests that:

 There is a link from income to nutrition, and from nutrition to income
 Rough estimate of elasticity of nutrition to income: very small
 Rough estimate of elasticity of income to nutrition ∼ 0.33
 Product clearly below 1
 So the two-way relationship between income and nutrition is not steep enough to generate a
poverty trap by itself

Conclusion
• Empirical evidence does not really suggest there is a nutrition based poverty trap
• But the poverty trap model is not a literal description of the reality. The model is there to force us
to think about how the nexus between human capital and income can lead to a vicious circle
• This circle may be found across generations, rather than within
• Effect of parental income on children nutritional status:
 In rural Cote d’Ivoire, children are more likely to suffer from malnutrition when rainfall in
abnormally low (Jensen, 2000)
 In South Africa, old-age pensions have a large positive impact on the anthropometric status
(weight for height and height for age) of grandchildren (Duflo, 2003)
• Effect of children nutritional status on future adult income:
 Barker hypothesis (1992): poor nutrition in utero leads to irreversible losses (IQ, physical
fitness)
 Evidence: iodine deficiency in first trimester of pregnancy leads to permanent irreversible
brain damage. Study estimating impact of Iodine Supplementation campaign among
pregnant women in Tanzania find very large impacts on educational attainment (Field, Robles
and Torero, AEJ Applied 2007)
Policy implications
• Poverty traps can exist outside the health context (school, business etc)
• Sachs “Big Push” idea: Give money for basic health, education, productive investment  get
people out of trap  people can start getting richer and richer on their own
• If there is no trap, basic income may reach humanitarian goals but not promote growth

Week 6 – Disease and Development

• Tropical regions tend to be poor  most poor countries are between the two tropics
• tropical diseases
 malaria, yellow fever, dengue, helminths, sleeping sickness, lymphatic filariasis,
schistosomiasis, …
• Is there a causal relationship from a high disease burden to poor development?
Theoretical mechanisms
Direct effect of disease on productivity
• Disease burden  Poor nutrition  Lower productivity
• Disease burden  Many illness spells  Fewer days worked (because sick oneself or caring for sick
relative)
• Disease burden  Exposure in utero or childhood  Reduced endowments (physical, IQ)  Lower
productivity

Indirect effect of disease on productivity (via lower levels of investments in education)

• Disease burden  High health care costs  Reduces income available for investments in
education, production, etc.
• Disease burden  Shorter life expectancy  Reduced returns to investing in education
• Disease burden  High infant mortality  Higher fertility  quality-quantity tradeoff
• Disease burden  Orphanhood / sick parents  Need to work as child to compensate  no time
for school

• Disease burden reduces returns to business and infrastructure investments

 Disease burden  Less foreign direct investment  Fewer resources in-country (e.g.
Panama Canal)
• Other potential effects:
 Disease burden  Outmigration of those who can afford to leave  Fewer resources in-
country
 Disease burden  Less income from tourism
• Recent research emphasizes the interconnection between geography and institutions

Indirect effects of disease burden through institutions

• Acemoglu, Johnson, Robinson (AER, 2001): “The Colonial Origins of Comparative Development: An
Empirical Investigation.”
 Disease burden at the time of colonization determined where Europeans settled en masse
and where they only sent a few people
 Where they settled en masse (Australia, New Zealand, Canada, US)  settlers demanded
“inclusive institutions”
 Where they did not settle because disease burden too high (e.g. Central Africa), colonizers
set-up or reinforced “extractive” institutions (slavery)
 Persistent effect of institutional legacy of colonizers
• Alsan (2012): argues that presence of tse-tse fly had long-term effects on development through its
impact on pre-colonial institutions
 Tse-Tse fly is unique to the African continent
 Transmits a parasite harmful to humans and lethal to livestock
 Limits the use of domesticated animals in transport and agriculture and inhibits the adoption
of animal-powered technologies
 Favors use of indigenous slavery instead of animal-powered technologies
 Such extractive institutions prevent investments in human capital

Reverse causality problem

How to quantify the impact of disease burden?
• At the macro-level, some have argued extremely high impact of health on GDP per capita (Sachs,
Commission on macroeconomics and health)
 E.g. Sachs (2003): yearly GDP growth rate 1.3pp lower in malaria-endemic countries
compared to non-malarious countries
• Problem: Tropical disease is a consequence of poverty as well, so reverse causality. Hard to isolate
effect of health on growth.

Historical data on health

• In fact, if you look at timing with 1000-yr perspective, health patterns very similar to economic
growth patterns
• Prior to the Industrial Revolution:
 there was little long-term change in average health, though with considerable short-run
variation (e.g. Black Plague)
 cross-sectional differences (across countries) in health were also small.
• In the 19th century, there was a takeoff of health in Europe and its offshoots, with little change
elsewhere
• Starting in the middle of the 20th century, health improvements in trailing countries began to
exceed those in leaders
 Health convergence in last 50 years much stronger than income convergence.
• Timing above suggests important effect from income to health for developed countries
• for developing countries, often health improved first
• Historically, improvements in health resulted from three sources:
1. Improved standard of living, especially nutrition
2. Public health investments (which rise with income) – clean water, sanitation
 Cutler and Miller (2005): 43% of decline in mortality in 13 big US cities 1900-1936 due to
water quality improvements
3. Medical innovations (antibiotics, other drugs, surgery, etc.)

How to solve the reverse causality problem?

• Both micro and macro studies have tried to solve the reverse causality problem
• Typical approach: Look at large-scale, targeted campaigns

Empirical evidence: micro studies

Malaria Eradication in the Americas (Bleakly, 2010)
• Set-up: Historical Efforts to combat malaria
 US, circa 1920, result of new public-health knowledge
 Latin America, circa 1955, DDT-based international eradication campaign
• Three key elements of rigorous research:
 Intervention is exogenous: Start of effort determined by exogenous technological advances
 There is variation in the intensity of the intervention: Areas with more malaria benefited
more from the treatment
 Intervention has no direct effect on growth: Spraying or better sanitation does not make you
rich
• Difference-in-difference estimation strategy:
 First difference: Before / After, across birth cohorts
 Second diffence: Control / treatment, across regions

Fast eradication campaigns

First
difference:
across
cohorts
The right
graph
displays
the
fraction of childhood that is exposed to a hypothetical (instantaneous) campaign as a function of the
year of birth minus the start year of the campaign
• In paper, definition of “treated” cohorts
 US: 1920 or later // Latin America: 1957 or later

Second difference: across regions

• Figure B-1: Ratio of malaria mortality to total mortality by state circa 1890. Darker colors indicate
more malaria.
• Figure B – 2: Malaria Intensity by State in Brazil Notes: Displays a map of an index of malaria
ecology as constructed by Mellinger et al. (2004). Darker colors indicate climatic and geographic
conditions more conducive to the transmission of malaria..

• Notes: the y-axis displays the estimated decrease in malaria

mortality post-intervention. The x-axis is the pre-campaign malaria
mortality rate. The 45 degree line represents complete eradication,
Both variables are expressed per 1000,000 population

 In both countries, highly infected areas saw greater declines in

malaria

Basic idea of diff-in-diff strategy

• Table shows (hypothetical) income by

cohort and region
• Diff-in-diff effect of malaria eradication
in this hypothetical case: +2
Data and Outcomes
• Census data – limited number of outcomes
• US: Occupational income score (proxy for labor productivity)
• Brazil, Mexico: census has data on literacy, years of education, and income (both total and earned)
• Note: analysis on males only since not all females participate in the labor force.

Results: US

• Each dot corresponds to a cohort

• Each dot displays the coefficient on state-of-birth 1890
malaria mortality for each year of birth.
• line shows childhood exposure to malaria eradication
campaign
• Vertical axis: regression coefficient

• For those born before 1900, more pre-eradication malaria in one’s state of birth predicts lower
adult income on average (coefficient is just below -.1)
 that’s because they were exposed in utero/childhood
• For those born after 1920, more pre-eradication malaria in one’s state of birth has no effect on
adult income on average (coefficient is around 0)

Results: Latin-America

Robustness
• Can perform “placebo” tests:
 Old versus very Old
• Test if the assumption on parallel trends is likely to hold:
 OK (no diverging pre-trend)  not OK – diverging pre-trend across two sets of

areas (high and low)

• If diverging pre-trends: then diff-in-diff doesn’t pick up effect of malaria eradication campaign but
some other thing
• Bleakley performs such placebo tests, results pass the test!

What about exposure to malaria in adulthood, does that affect productivity?

 Surprisingly, no direct study of this
 But historical accounts suggest yes: Panama canal story
 Also household surveys show many days of work lost to illness (see discussion in Malaney,
Spielman and Sachs 2004)
• Other diseases matter for productivity:
 Iron deficiency (remember the WISE study in Indonesia by Duncan Thomas and coauthors) –
found productivity impacts of iron supplementation
 HIV – clear drop in productivity when CD4 count is low
• Habyarimana et al. (2010). The Impact of HIV/AIDS and ARV Treatment on Worker Absenteeism:
Implications for African Firms.  Study introduction of ARV program for
workers by Debswana Diamond Company in Botswana
• ARV treatment starts once CD4 relatively low (line at 0 on the graph)
• Clear increase in absenteeism of workers as their CD4 count decreases

From Micro estimates to Macro implications

• Bleakley estimate: childhood infection decreases adult income by 50%
• So if malarious countries have childhood infection rates about 60%, and assuming no general
equilibrium effect, implies a GDP effect of 0.6*(50%)=30%
• Lower than cross-country estimate in Sachs (2003) of 1.3 in log points per year (which amount to
30% of GDP after just 25 years – but the gap in malaria exposure has been there for at least that
long)
• Reasons why Bleakley’s estimate smaller than cross-country estimates?
 cross-country estimates are not well identified – omitted variable and reverse causality
 P. vivax was the predominant strain of malaria in the Americas at the time of the studied
campaigns. But P. falciparum is worse and the dominant strain in countries still fighting
malari
 Issues when going from micro-estimates to macro-estimates: competing risks and general
equilibrium effects

Competing risks
• e.g. consider a population in which 50% of children are healthy, 20% have TB, 20% have malaria
and 10% have both diseases.
• If having Malaria and TB makes you more sick than having Malaria or TB added up, adding up the
disease specific effects overestimates the true impact of eliminating both diseases

General equilibrium effects

• Maybe the older cohorts are affected indirectly by the anti malaria campaign, through the effect on
the younger cohorts.
• Depends on nature of externalities
 Negative: younger cohorts displaced older cohorts on the labor market
 Positive: younger cohorts generated technological progress benefiting older cohorts

• So ideally we would want to look at macro-estimate (that takes into account effects across
generations and diseases)
• But what’s hard there is to find plausible source of variation (identification)
 if countries that eradicate malaria are those with better institutions, then comparing them
with countries not eradicating malaria would not be very helpful in estimating impacts of
malaria eradication

Empirical evidence: macro studies

Daron Acemoglu and Simon Johnson. (2007). “Disease and Development: The Effect of Life
Expectancy on Economic Growth”
• Use the same identification strategy as Bleakley, but in a cross-country setting, for the diseases
against which significant progress were made in the post-war period (mainly turberculosis,
pneumonia, malaria)
• Pre- and after- campaign morbidity from turberculosis, pneumonia, malaria  use that to “predict”
the change in mortality generated by the eradication campaigns (filtering our disease, country and
time effects)
• Find clear correlation between predicted change in mortality and realized change in life expectancy
and change in morbidity from diseases
 so as in Bleakley, treatment intensity is a function of pre-campaign morbidity
• considerable gains in life expectancy
• considerable gains in population
• But no gains in Total GDP
 so on balance a loss in GDP per capita!
• Their interpretation of their finding: Big reductions in mortality triggered rapid population growth,
which reduced income per capita via Malthusian channel
• Note: This does not mean that epidemiological transition was a bad thing! Big welfare gain from
lives saved, lots of suffering avoided.
• Very controversial paper (also Africa not in their sample)
• Recent critic published in the JPE by Bloom, Canning and Fink (“Disease and Development
Revisited”)
 Argue that malaria mortality in 1940 was endogenous, with richer countries in 1940 being
better able to afford vector control of mosquitoes, such as swamp clearance.
 so countries that got a big “treatment” were systematically different from those that didn’t
• Another critic by Cervellati and Sunde (2011)
 Argue that the negative overall effect of AJ 2007 masks substantial heterogeneity in the
effect across two sub-samples – countries that had not entered the fertility transition by
1940 (‘pre-transitional’ countries) and countries where fertility had already begun to drop
(‘post-transitional countries’)
Conclusion
• Macro evidence really difficult to interpret since not well identified
• At least the micro-studies we have reviewed suggest that tropical diseases indeed have important
economic effects
 Clear benefits from controlling diseases
• Though these benefits don’t immediately translate in higher growth
 A main channel through which diseases affect the economy is the human capital of children
 Disease controls will not result in a much more productive labor force (and thus higher
output) until the current adult population is replaced

Week 6 – Improving Health in Developing Countries

• Good health is a critical economic asset, particularly for poor people
• 3 of the 8 Millenium Development Goals called for specific health improvements
 Reducing child deaths
 Reducing maternal mortality
 Slowing the spread of HIV/AIDS, malaria and tuberculosis

Demand for health

Potential causes of underinvestment in preventive health
• About 2/3 of under-5 deaths could be averted if parents used simple, relatively cheap preventative
technologies (e.g., anti-malarial bednets, bleach for water purification, ORS kits to avoid dehydration
during diarrhea episode)
• Why don’t the poor invest in high-return technologies?
1. They don’t care about health?
• Yes they do
• Exhibit 1: they spend a lot of money (relative to their income) on treating illnesses
 Kenya, 70% of households have at least one presumed malaria episode per month; spend
$1.70 on medicines on average (more than a day’s wage)
 Often households go into serious debt to deal with health emergencies
 Or they sell assets, work more, take on risky jobs, etc.
• Exhibit 2: they report being stressed about health issues
 Own health or health of relatives is the primary source of stress or anxiety among the poor
 actually, they care very much about their health
 But they spend inefficient: Too much on curative care and too little on preventive measures
2. They don’t know the returns to these technologies?
• Indeed. They lack information on both the causes of their poor health and what to do about it
• Evidence: Information campaigns can have large impacts
 Bangladesh: people told that their well was contaminated with arsenic  switched water
source
 India: people told that their water source was contaminated with E Coli  started using
bleach to purify
 Nigeria: people told that bednets are more effective against malaria when treated with
insecticide more likely to treat their bednet
 Egypt: ORS kit usage became extremely widespread after mass government education
campaign
• They lack information about their own health status
 For example, they lack access to proper diagnosis and as a result often treat themselves for
the wrong illness (e.g. malaria)
 they often don’t know the returns to these technologies
3. They don’t have the money to invest in preventative technologies?
• The poor are liquidity constrained
1. They often don’t have access to credit. When they get access to credit, investments increase
considerably
 Morocco. Credit for home water connection: demand increases from 10% to 62%
 India. selling bednets on credit increases take-up from 10% to 55%
2. But why can’t they slowly save for these technologies?
 Lack of access to savings tools? Commitment problem?
 Also heath emergencies can easily wipe out savings: vicious cycle of poor health
 the poor often lack access to credit

Solutions: what can be done?

1. Make sure people have information
• Providing information (all of it)
• A cautionary tale:
 Bangladesh Arsenic information campaign: led people to switch water source
 Problem: wells with less arsenic actually had more E Coli (because less deep), but no
information was provided about that, since wells not tested for E Coli at the time
 So households that reacted to arsenic information ended up drinking water that was unsafe
 Result: 27% higher child mortality rate
2. Subsidize preventative technologies in the short-run, to put people over the hump
• Can short-term subsidies do the trick?
 Mass free distribution of bednets, mass free immunization campaigns, etc.
• Arguments for subsidizing health products
 Many diseases are communicable  externality of one’s health behavior onto others.
Rationale for permanent subsidy
 People need to experiment with the product to learn its effectiveness. Subsidizing products
initially can enable this experimentation and learning. Rationale for large temporary subsidy.
 People are too poor to pay and don’t have access to credit
• Arguments against too much subsidization
 Subsidized products might not be used properly
o Selection: people who are not willing to pay much for a product might not be willing
to spend time using it, maintaining it
o Psychological effect: we feel more compelled to follow through with the appropriate
behavior, the more we had to pay for the product (“sunk cost fallacy”)
 Even if people use technology while free, they may not invest in it once subsidy is lifted if
take first price as “reference point”  can make things worse in the long-run
• unless people spend money on something they will be unlikely to value it – or use it. Give things
away and they will be taken for granted, it’s thought.
• Do people use appropriately health products that are given to them for free?
• Dupas (AER P&P, 2009), Cohen and Dupas (QJE 2010): Kenya, LLIN:
 Compare usage across different levels of subsidies (RCT)
 People who received bednets for free or very cheap are as likely to use them as the others.
• Ashraf et al. (AER 2010): Zambia, Water purification product:
 No evidence of sunk cost fallacy
 Some evidence of a selection effect of prices
 Very short-run outcomes, however (i.e., did people use product within 1 month) it is possible
that people who cannot afford the product keep it for emergency situations
• Are people willing to pay more once the subsidy goes away?
 Depends on what they learnt while using the product
• For bednets, they do
  In a follow-up experiment, Dupas (2013) shows that people who received a bednet for free
or very cheap are more likely to buy another bednet at full price in the medium run than the
others.
 Free/cheap access to long-lasting ITN help people learn private returns to ITN use; this
boosts WTP in the long-run
• For deworming, they don’t.
 Kremer and Miguel (2007) study “The Illusion of Sustainability”
 Once deworming program at school goes from free to not-free (20 cents), demand drops to
very low level
 That’s because free-riding is optimal: private costs to deworming (side effects) and equally
high returns from neighbors deworming their kids.
Free Distribution or cost-sharing? Taking stock
• Free or highly subsidized distribution can help achieve widespread coverage quickly for a number
of health products
• Since those products are quite cheap, the cost of the subsidy is low and typically lower than the
cost of any potential information campaign or education campaign (e.g. PSI, a leading health
organization, would spend $10 in marketing costs to convince people to pay $1 for a bednet
subsidized at 85%)
 not a bad idea to subsidize preventative technologies in the short-run
3. Provide credit
• Yes, though microfinance studies haven’t looked at health impacts/ability to cope with health
shocks. Need more work on this

How far can we go if we focus on individual behavior?

• We can inform people or give them subsidies, but is it cost-effective?
• Is it more effect than the poor supply?
 Shouldn’t we rather focus on
 Finding vaccines/cures for more tropical diseases?
 Make sure everyone has access to clean water, and to well-equiped hospitals?
 Make sure health professionals do their job?

Supply of health
Failures in service delivery
• Services fail poor people often
(a) in access
(b) in quality

Lack in access
• The nearest school or health center can be quite far
• More public spending for the rich than for the poor
• This does not mean that poor people visit health providers less often
 In rural Rajasthan, people visit a doctor about six times a year.
 In the US, people visit doctor about 3.4 times a year.
• But they pay much less, and receive lower quality
 Many visits to private professionals without formal license or pharmacies.
 Surveys indicate informal sector accounts for 65−77% of care seeking in Bangladesh, 36−49%
in Nigeria, 33% in Kenya, and 55−77% in Thailand.

Poor Service Quality in Public Health Facilities

• High rates of absenteism among health workers: always above 20%
• Example: Udaipur district, rural Rajasthan, India
  Public health facilities were surveyed weekly for over a year (on average 49 observations per
facility)
 Subcenters (staffed with just one nurse) were on average closed 56% of the time
 In only 12% of the cases was this because the nurse was on duty somewhere else around the
center; the rest of the time she was simply absent

• Implications:
 Households get discouraged
 Don’t bother to bring child to center for immunization since with more than 50% chance
center will be closed when they show up
• Fascinating work by Das and Hammer:
 “Which doctor? Combining vignettes and item response to measure clinical competence,”
 “Money for nothing: The dire straits of medical practice in Delhi, India,” J
• Setting: Delhi. Both public and private physicians interviewed
• Majority of the private physicians don’t have any medical training
• Vignettes to measure health providers’ depth of knowledge:
 Providers know the correct treatment only about 40 percent of the time
• Fake patients sent to measure health providers’ practice:
 In the average interaction, physician sees the patient for 3.8 minutes, asks 3.2 questions and
performs less than one examination procedure
 So not only they don’t know much, they don’t even use all of their knowledge! (there is a
“know-do” gap)
 Median provider is ranked as “harmful”
• It is not just India
• “A recent study in Benin found that one in four sick children received unnecessary or dangerous
drugs from health workers”
• The World Bank started measuring the competence of providers in several countries in Sub-
Saharan Africa through its Service Delivery Indicators initiative:
 diagnostic accuracy was 34 percent in Senegal, 57 percent in Tanzania and 72.2 percent in
Kenya
 So high provider absenteism may be a blessing in this context

The Know-Do Gap

Solutions: What works in improving services for the poor?

1. Contracting out to increase access  privatizing
• Galiani, Gertler, & Schargrodsky (JPE 2005)
 In the 1990s Argentina embarked on one of the largest privatization campaigns in the world
as part of a structural reform plan
 The program included local water companies covering approximately 30 percent of the
country’s municipalities
• Difference-in-difference strategy:
  Child mortality fell by 5–7 percent in areas that privatized their water services
 Largest gains in the poorest municipalities
• How did that happen?
 Private companies expanded access considerably
When is privatization a good idea?
• Definitely not always! Cf. problem set
• When monitoring quality is easy and cheap
 For water, privatization can work because water quality can be easily checked so it’s possible
to contract over quality/performance
• When efficiency is key to reduce costs, itself necessary to expand coverage
 Assumption: for-profit motives makes private firm more efficient, compared to bureaucrat
who is not residual claimant on gains from efficiency
• In practice, privatization requires public regulation
 May be as challenging as public provision!
 Not only in developing countries
 Flint, Michigan, USA: ongoing crisis of water contamination
Is it a good idea for health services?
• Difficult to write terms of contract Two solutions:
 Contract to party with social objectives. Cambodia contracted out health services to NGOs
 Or limit yourself to predictable services for which it is easy to write a contract. Most
experiences in contracting out maternal and child health services
2. Bottom-up monitoring of quantity/quality: Community empowerment / beneficiary control
• The users have the biggest stake in quality of public services
• So why can’t we harness the end users’ interest in order to monitor providers?
• Main problem: performance of providers can be hard to measure
 How do you know if your doctor gives you the wrong remedy?
• In 2004, the World Bank strongly advocated for beneficiary control
• Evidence to back this recommendation:
Martina Björkman and Jakob Svensson (2009) “Power to the People: Evidence from a Randomized
Field Experiment on Community-Based Monitoring in Uganda” The Quarterly Journal of Economics
• Looks at improvement in health care services through grassroot mobilization in Uganda
 Problems in Uganda similar to those seen in Udaipur by Banerjee et al. (e.g., absence rate in
health center: 47%)
• Intervention started with a household survey to collect data on experience with public health
facilities
• Then, community organizations facilitated meetings, in which people discussed how to improve the
situation, and how the community members would monitor the facilities
• Positive impact on immunization, mortality rates and weight-for-age z-scores
Does beneficiary control always work? Replication
• Recent working paper replicating Power to the People (Raffler, Posner, Parkerson, 2019)
 Same country, same intervention, same outcomes.
 10 years later, larger scale (376 health centers and 14,600 hh vs. 50 and 5,000)
• Found NO significant impact on health outcomes, including child mortality
• Potential explanations:
 Different baselines: Initial health outcomes were better in 2015 than in 2005 so there was
less room for progress
 Different samples: Lucky draw?
 Different program implementation: Organizers were well-known by communities only in the
original study.
• Raises issues of generalizability: how much should we trust small-scale trials? how to scale-up a
seemingly effective intervention?
• Evidence of failures in education services in India (Banerjee et al., 2010)
• Looks at empowerment of parents in monitoring performance of school/teachers
• On paper, India has a system of school committees (“Village Education Committee”, VEC) and
parent control over the school resources
• In practice, at least in Uttar Pradesh, it seemed largely ignored
 Less than 8% of parents are aware that there is a VEC
 Less than 3% of parents can name a VEC member
• Given all this, Pratham (an NGO in India) started a mobilization campaign involving providing
information to parents on school quality, teacher absenteeism
• Found NO impact whatsoever on parents’ involvement or the quality of public schools
 Free riding problem?
 Parents have no idea what to do?
3. Top-down monitoring of quantity/quality: Financial incentives
• Another way to improve performance of service providers is to reward good performance and
punish bad performance
• Two key questions in implementation of such incentives program:
1. What to tie the rewards to? behavior or output?
 Outcomes also influenced by other factors, for example, whether the student studies.
Difficult to hold the teacher accountable.
 For behavior, if the provider’s job includes multiple tasks, but the performance measures of
these tasks are not equally good, then it may not be efficient to give explicit incentives
2. Who is in charge of monitoring the performance? does the monitor need to be incentivized
too?

Option 1: Indexing pay on presence

• Banerjee, Duflo and Glennerster (JEEA 2007)
• Udaipur, India: project to solve high absenteism (cf. above)
• Sanctions set by the government: wage cuts + suspension if recidivism  to solve high absenteeism
• Results:
 Early on, large impact: Nurses are sensitive to incentives
 However, as time goes on, attendance declined in monitored group
 At the end, attendance was higher in the non-monitored group! What happened?
 Answer can be found in the nurse register indicating reason for absences... Absence became
"exempted days"
 Local health system was not committed to implementing the monitoring of nurses, despite
commitment at the top.
o Did not implement sanctions... So nurses quickly learned that the commitment to
presence was not a real priority
Option 2: Indexing pay on performance
• Gertler and Vermeersch (WP May 2013): “Using Performance Incentives to Improve Medical Care
Productivity and Health Outcomes”
• RCT of performance pay for medical care providers in Rwanda
• Formula based on quantity (number of patients) and quality (content of care)
• Find large effects on child health
• Pathways?
 Increased preventative care utilization + improved clinical quality of care
 Decrease in know-do gap
• But evidence of strong complementarity between performance incentives and baseline provider
skill
 So incentivizing low-quality providers does not help

Recap
• Contracting out
 Works if and only if well-regulated
 For services which are well defined
 The private sector in itself is not the solution to government failures
• Bottom-up monitoring
 Relying on communities to ensure that they receive health services is tricky; on their own,
they often do not have the resources / information necessary
• Top-down monitoring
 Ensuring better selection or providing incentive schemes (publicly provided or publicly
regulated) are essential to increase performance
• Overall, good quality health care must be a politically salient issue to guarantee the quality of the
public sector
 Otherwise government doesn’t implement own rules / doesn’t monitor / doesn’t audit

Conclusion
• A lot of “low-hanging fruits” as Banerjee and Duflo call them in Poor Economics
 We know bed nets prevent malaria, water filters or water purification prevent diarrheal
diseases, etc
• But poor governance prevents these low-hanging fruits from being picked
• Ultimately, having to constantly use a bed net, filter one’s water, etc. is not the solution
 None of us have to do that
 We have a malaria-free environment, clean water
 In developed countries, most improvements in health came through big pushes, e.g. clean
water infrastructure in cities
• Issue of incentives / accountability of public providers not specific to health
• Crucial topic on the development agenda!