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Archive for category Economics

Randomized trials are so 1930s

Aug 9

Posted by Matt in Economics, Research | 4 Comments

Jim Manzi, the CEO of Applied Predictive Technologies (a randomized trial software firm), reminds us that we’ve been subjecting public policy to experimental methods for quite some time:

In fact, Peirce and others in the social sciences invented the RFT decades before the technique was widely used for therapeutics. By the 1930s, dozens of American universities offered courses in experimental sociology, and the English-speaking world soon saw a flowering of large-scale randomized social experiments and the widely expressed confidence that these experiments would resolve public policy debates. RFTs from the late 1960s through the early 1980s often attempted to evaluate entirely new programs or large-scale changes to existing ones, considering such topics as the negative income tax, employment programs, housing allowances, and health insurance.

So the randomistas aren’t so much as a “new wave” as the “next wave.” More interesting though, are Manzi’s thoughts on external validity:

By about a quarter-century ago, however, it had become obvious to sophisticated experimentalists that the idea that we could settle a given policy debate with a sufficiently robust experiment was naive. The reason had to do with generalization, which is the Achilles’ heel of any experiment, whether randomized or not. In medicine, for example, what we really know from a given clinical trial is that this particular list of patients who received this exact treatment delivered in these specific clinics on these dates by these doctors had these outcomes, as compared with a specific control group. But when we want to use the trial’s results to guide future action, we must generalize them into a reliable predictive rule for as-yet-unseen situations. Even if the experiment was correctly executed, how do we know that our generalization is correct?

One example he discusses the frequent experimentation used in crime-prevention, and how the (very few) subsequent attempts:

Criminologists at the University of Cambridge have done the yeoman’s work of cataloging all 122 known criminology RFTs with at least 100 test subjects executed between 1957 and 2004. By my count, about 20 percent of these demonstrated positive results—that is, a statistically significant reduction in crime for the test group versus the control group. That may sound reasonably encouraging at first. But only four of the programs that showed encouraging results in the initial RFT were then formally replicated by independent research groups. All failed to show consistent positive results.

My biggest fear about the current trend in social science RCT work is not only the failure to confirm positive results, but the failure to confirm negative results. While there is a small, but real incentive to repeat a ‘proven’ randomized study in a new setting, there isn’t much being done to confirm that a negligible treatment effect doesn’t improve elsewhere. While big RCT research groups do care about external validity, it is the initial findings that get seared into the mind of the policymakers. Flashy graphs which generalize without concern don’t help.

Here’s part of the closing to Manzi’s piece, which is a must-read if you’re interested or involved in this type of work:

It is tempting to argue that we are at the beginning of an experimental revolution in social science that will ultimately lead to unimaginable discoveries. But we should be skeptical of that argument. The experimental revolution is like a huge wave that has lost power as it has moved through topics of increasing complexity. Physics was entirely transformed. Therapeutic biology had higher causal density, but it could often rely on the assumption of uniform biological response to generalize findings reliably from randomized trials. The even higher causal densities in social sciences make generalization from even properly randomized experiments hazardous. It would likely require the reduction of social science to biology to accomplish a true revolution in our understanding of human society—and that remains, as yet, beyond the grasp of science.

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Keeping it in the Family

Aug 7

Posted by Ranil Dissanayake in Development, Economics, History, Political Economy | No Comments

Michael Corleone condemns his brother to death.

'Never take sides with anyone against the Family again. Ever.'

One of the enduring questions of historical debate is why Western Europe and North America so outperformed the rest of the world economically in the 1800s. Though some (notably Andre Gunder Frank) have argued that the ‘advance of the West’ was really an illusion created by the decline of the rest, it is generally agreed that Western Europe and America had or developed a number of advantages that took their growth forward and retarded the growth of other regions – sometimes through luck, sometimes through natural endowment and often through a combination of the two.

One aspect of these advantages has interested me recently: financial services and the organization of business. It’s now widely accepted that better financial services was part of the reason why Western European companies in particular prospered in this period. The Dutch pioneered the Joint Stock Company to mitigate the risks of long mercantile voyages, and the Dutch East India Company was an early example of the separation of ownership and management. In Britain and then in the rest of Western Europe, regional banks came to prominence and provided the means by which firms could raise capital for expansion. This was generally accompanied by a changing of the structure of firm.

Businesses had till this point been, by-and-large, enterprises that were run by families. The emergence of new forms of financing and capital made it easier to raise money and also made it easier to share risk, as the legal code governing how liability should be assigned to the ownership of a firm changed as different forms of financing became available and different types of company evolved to take advantage of financing which enabled them to exploit risky opportunities overseas.

At the time the East India Company was demonstrating the sheer size that could be achieved through the use of these new firm structures and through exploitation of financing (as well as war-like methods that were part of the ‘trading’ world at the time), almost all the successful Chinese companies were still keeping resources within the family. They were unable to access credit and unwilling to experiment with the new firm structures that expanded ownership and dispersed fiduciary risk to individual owners. Many historians now argue that the innovations in financing allowed the West to expand faster, while the changes in the structure of the firm and the accompanying legal code gave their private enterprises a massive advantage in expansion into new markets.

What I find particularly interesting about this is that the family-ownership pattern has persisted in much of Asia and Africa right to the present day, despite the massive expansion in financial services available. I’m not just talking about the small stalls and dukas which are run by families but major businesses, particularly in India, which are often owned by a patriarchal character, with senior posts in management distributed to sons, sons-in-law and other favoured family members. In South Asia and Africa family networks and even more broadly, ethnic or similar networks remain incredibly important for business. Go almost anywhere where there is an Asian business community – more often than not, you’ll find that there is a network of family run firms, and where they have links to each other, it’s common that they are from the same region or area.

Why has this structure of the firm persisted so long, despite legal and financial advances that should be encouraging larger, less risk-averse firms? The standard answer is ‘trust’. When family or strong ethnic ties bind the decision-makers in an enterprise, the argument goes, it is easier to persuade owners to part with new capital for the expansion of the firm, there are less likely to be financial disputes, theft, and liability can be enforced as it falls within a small circle – no shirking of responsibility is possible. Yet this doesn’t convince entirely. As the infrastructure surrounding firms improves, these issues are less and less binding. Financial institutions now provide far more opportunities for those with collateral, while insurance, commercial courts and dispute resolution all mitigate the risks that using family trust as a basis for commercial enterprises is supposed to leaven.

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Counting desires

Jul 27

Posted by Matt in Aid, Economics, Governance, Research | 4 Comments

Preference aggregation can be tricky business

A key assumption behind the Global Burden of Disease project is that it is possible to come up with a “Disability Weight” for each health state.  Diseases conditions that are considered worse than other carry higher disability weights than others.  A very important issue in the development of such weights is the question of who should define these conditions?  Should those who have the conditions be the best judge or are they biased?  Should healthy people who have never experienced these conditions be the judge?  Should doctors decide?  Should policy makers?  Should health economists (gasp!!)?

In the past, the GBD has relied upon “expert opinion” to make such decisions.  Well, it seems for the next update of the GBD, which is currently underway, you can also be an expert.  I came across a link to the following survey earlier today that allows you to have some input in these weights.

That’s Karen Grepin discussing an attempt to aggregate beliefs over disease burdens to better define the weights given to different ailments. This is a very similar exercise to preference aggregation, where we attempt to construct a unified set of beliefs that will govern public policy. The result is something approaching a social welfare function, which allows us to make statements like “Society strictly prefers A to B.” One way of doing this is to get a sample of individuals to compare different states and to try and tease out an overall ordinal ranking of these states. Using Grepin’s example, each person has to make a pairwise comparison:

The first person has swelling and tenderness in the testicles and pain during urination.

The second person has lost part of both legs, leaving pain, tingling, and frequent sores in the stumps. The person has great difficulty moving around and has episodes of depression, anxiety and flashbacks to the injury.

By asking enough people to compare different states with different combinations of symptoms, we can tease out their overall ranking of those symptoms – how this is done can sometimes be contentious and quite technical. That ranking then represents the best approximation of everyone’s relative rankings of disease burden.

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More on Romer’s Great Folly

Jun 14

Posted by Ranil Dissanayake in Development, Economics, Governance, History, Political Economy | 7 Comments

"You too can have this city, if you just purchase a simple, easily applied set of rules. Retails at $49.99"

Reader Adam alerted me to a piece in The Atlantic on Charter Cities. Long-time readers will know I’m profoundly critical of Paul Romer’s ahistorical, acultural thinking on the idea, which reveals a basic lack of understanding about how cities, migration and laws actually arise and work.

The article is full of badly reasoned logic, too. It says that Romer has been criticized for his Charter Cities idea, but then defends him by saying that he came up with New Growth Theory. So what? Clever people have stupid ideas sometimes, and people who are expert in one field might turn out to be ordinary or worse in another.

A lot else in the piece, some of which comes direct from the mouth of Romer worries me. Here are a few quotes, the first of which Adam pointed out in his e-mail:

“In a sense, Britain inadvertently, through its actions in Hong Kong, did more to reduce world poverty than all the aid programs that we’ve undertaken in the last century,” Romer observes drily.

This is the closest that Romer comes out advocating colonialism outright. Never mind that my earlier criticism pointed out some of the hundreds of holes in his story about how Hong Kong came to be so successful, Romer is decided: Britain made Hong Kong successful by importing new rules. The fact that Hong Kong’s legal code took something close to half a century to evolve, and a further 20 years to be enforced correctly, is completely ignored. I know – my family are all lawyers, and some have been key players in the evolution of that legal code and witnesses to the creation of a police force and institutional structure to enforce it.

“Anything that involves land can be manipulated by people who want to rise up against a leader,” [Romer] began. “You have to find a place where there’s a strong enough leader with enough legitimacy to do this knowing that he’s going to get attacked. It narrows the options quite a bit. But we shouldn’t give up without trying a few more places.” In short, a disappointment with one client is no excuse for failing to pitch other ones. Any entrepreneur knows that.

So, in other words, the only kind of places where a Charter City might actually work are where the Government is strong, has a legitimate leader, and able to resist opposition. Sounds like the kind of Government that least needs a foreign power to come in and govern a city for them.

When you listen carefully, you realize that much of what Romer is saying should not be controversial. A few development economists argue that geography is destiny, but most share Romer’s conviction that decent rules are paramount.

Another worrying statement. The problem is not that economists think that rules are important. The problem is that they are not independent entities. They do not exist in a vacuum, apart from the culture, history, geography, and so on they relate to. Romer’s approach is wrong not because he thinks rules are important or that countries should invite rich Governments to enforce them, but because Romer thinks he already knows the rules, and that they can be imported anywhere. That’s not how it works. In a recent post I pointed out how different rich countries are from each other. That’s partly because their rules, evolved over hundreds of years in some cases, are specific to each of their own contexts. Romer doesn’t see this. He just sees the rules of today, and imagines that they can be peeled off a society and pulled over a new one, like a one size fits all t-shirt.

Finally, one of the old clichés:

But when African teenagers do their homework under streetlights, isn’t Romer right to think the unthinkable?

Romer is right to think outside of accepted conventions, of course. But when his ideas are so misshapen, so at odds with the reality of the world, no amount of poverty in the world justifies their continued advancement.

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What Does Development Look Like?

May 28

Posted by Ranil Dissanayake in Development, Economics, History | 7 Comments

Hong Kong

Not everywhere will look like this

Apologies for my long silence. I was at home in Hong Kong on holiday attempting to eat a hole in the restaurant industry and drain the islands of tea. Going between the places where I work and Hong Kong is always an extreme contrast – the physical dissimilarities are jarring enough, an emblem of the extremes of material wealth that Hong Kong and, say, Zanzibar represent; but beyond this, the conceptions of what constitutes a working economy and society are different as well.

But these differences aren’t just between ‘developed’ and ‘not developed’ countries – one gets the same feeling moving between Hong Kong and London. It’s a reminder of the fact that development looks different in different places. Of course, there are characteristics that unite developed countries: higher average incomes, longer life expectancies, better education, less poverty and better prospects for employment. But the way in which these places function are different.

In England, and most of Europe, working hours are relatively short, incomes protected by legislation and unionism and living standards safeguarded by a social safety net provided or supported by the State. In specific enclaves of the economy, there is frenzied activity: the City of London (dominated by financial and legal services) operates on long hours, high volumes of transactions and isn’t the most stable of employers. But for the most part, England seems a more sedate place with a pretty good work/life balance.

Hong Kong is different. That frenzied economic activity that characterizes the City is everywhere, driven by rampant consumerism. People work insane hours, and not just the bankers and lawyers. Many of my friends there own or manage companies – they work long hours, but most of their staff do as well. Many are paid for a standard eight hour working day, but without the inducement of over-time pay or extra leave choose to stay in the office well beyond this most days to push the company’s business just a little bit further. They know their jobs are not well protected, and depend on the strength of that individual company – any edge they can provide helps safeguard their livelihood. This attitude carries over to the retail sector as well: walking down a busy street in Causeway Bay or Wan Chai and you can buy shoes, movies, stationery or handbags at midnight or later.

This isn’t an unreservedly good thing: while it’s great to be in a vibrant place that doesn’t shut down, a common complaint about Hong Kong is the poor work/life balance. People are compelled to work extremely long hours partly because the Government takes a minimalist approach to social protection and the fact that job security isn’t great, responding closely to economic conditions. Life in England isn’t completely different, but it’s at a different point in the scale of uncertainty, work/life balance and commercialism.

These observations matter for development. We take for granted that there is a vision of ‘development’ or ‘developedness’ that poor countries are striving to, but how accurate is this? There are many different paths that can be taken to the same aims of better incomes, life expectancy, health and education. These paths will lead to a different kind of economy and society, with different advantages and drawbacks. Yet, it doesn’t appear that development policy, certainly not from the donor side, takes into account the myriad approaches to development. From the developing country side, the mania for strategies, visions and plans, while well intentioned, seeks to hit specific targets rather than laying out a conception of what kind of society and economy is desired.

If we accept that developed countries have used different methods to get where they are, and that they have created economies, state structures and societies that have different sets of advantages and disadvantages, there is a case to be made that development policy should focus on individual countries. Specifically, perhaps we should be looking at how the population, state, geography etc. might best develop as a functioning economic and social structure, rather than focusing on the outcomes and outputs that these structures are supposed to achieve to merit the tag ‘developed’.

These are just thoughts. There are good reasons why we focus on incomes, health and such – these are the real experiences of people. But perhaps, in keeping with the modern obsession for measurement, we’re focusing on the wrong end of the development process.

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The unkindness of in-kind aid

Apr 30

Posted by Matt in Africa, Aid, Economics | 10 Comments

"Congratulations Charlie, your poverty-stricken family has just won a lifetime's supply of non-transferable chocolate!" "$%@#!"

The biggest story in the development blogosphere this week has been the 1 million t-shirts for Africa campaign and the incredibly strong  reaction of the blogging community. For those new to the discussion, a full list of all the relevant posts is available here. Until now, my brain was too overloaded to manage anything but a few grunts in crayon form.

There have been various, familiar arguments against the prospect of dumping more used t-shirts into markets in poor countries. A lot of people are worried about the effect on those markets themselves, of undercutting local textile producers. I’ve made this argument myself before, but am becoming less convinced by it; I’m beginning to suspect that the damage to local producers has already been firmly done, and that other sources of cheap clothes (such as growing imports from places like China) will continue to dominated markets in the long-run.  Unfortunately there hasn’t been much in terms of rigorous study on the topic, aside from an in-depth report from Oxfam, making it difficult to know what the aggregate effects are.

Let’s move on to the more important argument, which has to do with missed opportunities and meeting the needs of the recipient. This has been covered quite a bit, but I think it’s an important enough argument to be restated in a more precise way, so here we go:

Gifts in-kind are, for most recipients, strictly inferior than cash gifts of an equivalent value.

Imagine a poor person with no income. Now, give her a dollar and she will spend it on the most urgent necessity  (in econospeak, the good that offers her the highest expected gain in utility). Give her a second dollar, and she may continue to spend it on that good, or she may switch to another good. As the her income rises, she will dedicate each marginal dollar to what matters most to her at that moment. If you give her another dollar and she buys a mango, that doesn’t necessarily mean she couldn’t afford the mango before, but that a mango  currently offers her the greatest marginal benefit after spending her other resources on other, possibly more important things.

This is an extremely rational model of expenditure prioritization. Of course, reality is much more complex – some would argue that it’s not very easy for people to identify what they need or may ignore their own best-interests (although I don’t think the latter assumption gets us very far in life). If you can stomach the constraints of my simple model for a moment, consider the following thought experiment:

You have a population of people of different incomes and different priorities. Some of them have shirts, others don’t. You can easily identify these people and you decide to buy/obtain shirts for those lacking them (at a cost to you of $1).

What is the welfare impact of your intervention compared with just handing out dollars? For a select few – those that were poised to spend their next available dollar on a t-shirt, the welfare impact is equivalent. For everyone else that is shirtless, the welfare impact of giving a shirt is strictly less than that handing out a dollar.

Why is this the case? If you hand someone a dollar, they spend it on the good that represents the highest possible welfare benefit. So if they spend it on something other than a t-shirt, it means that the t-shirt wasn’t the best possible purchase for them*. So, if you hand them a t-shirt instead of a dollar, there is an implicit cost to that missed opportunity. The harder it is for the recipient to exchange that t-shirt for what they want, the bigger the missed opportunity.

The resulting rule of thumb is: “if someone doesn’t have a shirt, there are probably a lot of other things that they don’t have, and we have no good reason to give the shirt priority.” The important thing to take away is that the same holds for all in-kind gifts.

Of course, there are lots of other reasons why we may not want to just go around giving cash, but there are lots of alternatives to running around dispensing used goods. On a micro-scale the gold standard of cash-transfers may be impossible to beat with in-kind gifts, but interventions that move beyond the individual, such as investment in public goods or removing kinks in the system that create poverty traps, can result in larger welfare gains.

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*I am, in this simple model, mostly ignoring budget dynamics. If your income was 90 cents a day, you will buy whatever bundle of goods that is best suited for you at the prevailing prices. It could be that you really, really want a shirt, more than anything in the world, but they cost $1, and when your income goes up to $1 a day, you only spend your money on shirts, and would have loved it if someone had given you a shirt when you were still making 90 cents a day. However, these people are no easier to identify, and so giving each person an extra dollar in income is still strictly superior to handing out $1 t-shirts, because those that had always wanted a t-shirt will just go on to buy the t-shirt.

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The fungible and the furious

Apr 16

Posted by Matt in Aid, Development, Economics | 3 Comments

New, unpleasant information requires careful analysis, not knee-jerk reactions

Last week the medical journal Lancet released an article suggesting that, on average, governments that receive more  health aid divert tend to shift domestic resources away from health.

The paper made some headlines and upset aid critics and much of the global health community. A part of this has to do with a misunderstanding of what the findings mean – a confusion which isn’t helped by  those that propagate incorrect and sensationalist interpretations of the study.

However, a lot of the anger over the results comes from those that do understand the implications of the study, but are angered by an apparent divergence in priorities between the global health community and recipient governments. Both Ranil and Owen Barder talk about this in more detail, although I’ll go through some similar arguments.

These are my scattered thoughts on the whole issue.

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We should be Scared, but not of what we’re Scared of

Apr 15

Posted by Ranil Dissanayake in Aid, Development, Economics, Governance, Political Economy | 13 Comments

Be scared of him, not the Governator.

You should be afraid, just not of what you were afraid of at first...

Amidst the brouhaha over the Lancet article on aid fungibility, there’s one underlying question that seems not to have been addressed explicitly: what is the basis on which we expect funding (aid and domestic resources) to be allocated? I work in this field, and this basic problem has only been addressed with any quality in one place.

The comment on this topic is of sharply variable quality. Most of the voices critical of this evident of ‘fungibility’ deserve to be dismissed out of hand. Many suggest that by reducing own-funding to health the Governments concerned are committing a grave sin, based on absolutely no evidence on what the marginal return of the money moved was in the health sector compared to other sectors. These are single issue activists who lack the will or capacity to think more broadly than their specialism, and as Owen Barder has said, we should scorn them. Two contributions raise specific issues about resource allocation that we should explore further.

Not surprisingly, Owen’s is one of them, and his is the only contribution I would class as unreservedly useful, indeed excellent. He makes the most important point that we must hold in mind: the Lancet article actually does not address fungibility of aid. Aid would be fungible if the exact aid dollars that were earmarked for health could be used for education, transport or even private jets. What the Lancet article shows is that aid money in a sector can free up resources that the Government was always able to spend anywhere it wanted in a new area. That money was already fungible – it has simply been moved from one place to another in response to non-fungible funds. This is of crucial importance to this debate, because it means we can dismiss the question of fungibility altogether. What we are really talking about is resource allocation procedures governing the always-fungible Government resources.

Laura Freschi at Aid Watch makes the other contribution we should pay attention to, though I’m not uncritical of it. She says that donors use project support and earmarked funding to try and ‘force’ recipient Governments to use their resources ‘well’ by which she means ‘as the donors think they should’. This assumes that Governments will not change their own fungible resource allocation after the introduction of new, non-fungible resources by donors, so all aid money is purely additional to the sector it appears in. She says that if it doesn’t do this, then the argument for using earmarked funds disappears. This contribution is important, because it now introduces into the discussion the intentions of donor resource allocation and structure decisions, though I argue below this is an incomplete understanding of how it actually works.

So, how should resources for development be allocated, and how does the reality depart from this norm? Ideally, our resource allocation procedure would be entirely rational. Imagine a world in which no distinction is made between aid and local funds, and all money is fungible, the resource allocation procedure of Government should be straightforward. Looking at all the funds the Government has, it allocates a certain amount to core running costs (salaries, electricity bills and such) and then distributes the balance based on an analysis of the key constraints to the development of the country. If they have problems in health, education, infrastructure and private sector development, the rational resource allocation procedure would then address the constraining factors in each area. Given resources are scarce, we allocate them by looking at where the marginal benefit of each dollar is highest. If after we’ve spent $20 in health, we find that the marginal benefit in education is higher, we switch our attention there, and so on.

What we don’t do is just pour money in one sector until all the problems it faces disappear: doing this is counterintuitive, since after a point, each dollar would have a bigger impact in a different sector.

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Waiting for growth

Mar 30

Posted by Matt in Aid, Development, Economics | 3 Comments

godot

Is there nothing to be done?

A few days ago, over a dinner at the AidData conference, a colleague made an interesting comment over how the aid effectiveness debate is framed. While aid critics and proponents constantly argue over the industry’s ability to generate large, transformational changes in recipient countries (such as through economic growth), he suggested that if we assessed aid by a more modest metric – how well it alleviates suffering in societies that are awaiting these big changes – we might be more optimistic about aid’s effectiveness. Because development is partially random (in the sense that we, as outsiders, cannot easily predict or explain it), he argued that we should perhaps just focus on the smaller problem of improving welfare, while we wait for countries to feel their own way to growth.

The idea that foreign assistance might not be very useful for fostering development would be a difficult, troubling thought for many in the aid industry. While (I think) those working in the NGO and charity sector believe more in aid-as-relief than in aid-as-change, there are many top-down practitioners in the official aid business who ultimately see it as being transformational. Projects such as the UN’s Millennium Villages are a natural extension of this belief that recipient countries cannot achieve development without significant external assistance.

I think I would feel more comfortable in a world where aid only exists to avert suffering and death while recipient countries strive for major change. That would drastically simplify the discussion on aid effectiveness: gone would be the grand ambitions of  revamping societies, to be replaced by worrying over tracking resources and evaluating interventions. We would be unconcerned about long term impacts and macro concepts like growth – they would be outside of our mandate.

This is a vision of aid that we should consider, but not one without pitfalls. Those that have spent time working in heavily aid-dependent countries are privy to signs that large amounts of foreign assistance might actually hurt a country’s chances of making the big adjustments needed for development. Several years ago I worked as a civil servant for the Malawian government, which has a budget financed nearly half by foreign donors. Aside from the usual political absurdities which haunt any civil service, I saw a government forever obsessed with aid. This is rational – whether or not you are concerned about delivering public resources or rent-seeking, foreign aid is too tempting to pass up. The result is that governments spend a very, very large amount of time trying to please donors, sometimes more so than their own populations.

We really should be more worried about how much foreign aid might be crowding out domestic accountability process, which itself might be necessary for long-term development. Sometimes this trade-off is obvious: As it was revealed in Michela Wrong’s excellent book, It’s Our Turn to Eat, donors in Kenya were more concerned with protecting their aid projects than supporting John Githongo’s crusade to improve accountability in the Kimbaki’s government.

There are other factors that may also violate the unspoken creed of ‘do no harm’. If aid is to be forever focused on the small picture, should we not be worried when donors and NGOs routinely steal smart, capable people from government and the private sector, those that are the most likely to lead their countries towards big changes? Even when those people remain in government, the foreign aid sector has dominated the policy discourse for so long that many governments have had little experience developing and debating policies on their own. When, after years of being chained to the IMF PRSP framework,  Malawi finally got the chance to write their own national development strategy, the resulting document looked and read like a distillation of every donor strategy ever produced.

Dambisa Moyo’s infamous and poorly-argued Dead Aid revealed a growing dissent in sub-Saharan Africa over decades and decades of foreign aid that hasn’t delivered massive change for the better. Perhaps a major (downward) revision of expectations are in order. However, while we sit around waiting for growth, we should be careful not be the biggest impediment  to it.

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How to Fund an Elephant Hiding in Your Room

Mar 30

Posted by Ranil Dissanayake in Aid, Development, Economics | 4 Comments

More, please.

More, please.

Dan Altman, who has blogged on these pages before, has a great piece in the HuffPo on an innovative new way of funding private sector enterprises in developing countries.

Since I started working in aid effectiveness, one thing that has always struck me was quite how little aid goes towards the development of a viable private sector. In Malawi, the 2008/09 Annual Debt and Aid Report showed that only 1 per cent of all the aid provided to Malawi in that year went towards activities that were classified under Trade, Industry and Private Sector Development. That translated into $8.3 million. It’s a tiny amount of money for what must ultimately become the central driving force of any economy. What’s more, when donors or domestic Governments do get involved, they don’t fund actual private enterprises. Instead they cast themselves as facilitators for a better business environment, as the World Bank do in its series of Business Environment Strengthening Projects, and as USAID does through many much smaller activities.

Yet a functioning private sector and flourishing domestic economy would be the single best way of addressing poverty: it creates jobs, has an internal growth dynamic, and through tax raises the revenues for sustainable Government action in health, education, sanitation and infrastructure development. These are massive positive externalities that arise from a large scale private sector development process – and when large positive externalities exist, conventional markets will not allocate enough resources to maximize social benefits.

This is exacerbated by the high risk of investment in private sector enterprises in developing countries. Though these enterprises often have a very high potential return they find it particularly difficult to attract investment because there are so many risk factors that may jeapordise their returns, with political instability and shocks to the economy at the forefront.

The upshot of this is that funding for private enterprises, particularly large-scale commercial ones with the largest capacity to create jobs, is very thin on the ground: donors do not support them, and private investors are unable to take on the risk involved. This is where Dan’s idea comes in: he suggests that Governments, who have much longer time horizons and greater ability to absorb risk, can establish swaps markets. On such markets, investors would be able to make high-return, high-risk investments in private enterprises in developing countries, then go to the swaps market and exchange this risky investment for a more stable asset. Governments can make this exchange because they are better able to hold risk, and this extra risk can essentially function as a type of aid to the developing country in which the private enterprise is held. The appeal is clear: private entrepreneurs select investments in the private sector without holding all the risks associated with them, the enterprise gets the resources it needs and the economy benefits from higher investment. The Government(s) that contribute to this swap market provide a sort of diffuse aid to the private sector development of poor countries, an area they have traditionally neglected badly due to their dislike of engaging directly with commercial enterprises.

At first sight, the idea really grabs me. There is much to think about still, about how exactly it would work, about how any potential moral hazards must be dealt with if it is to subsidise risk to some extent, and about how much it would be used. But innovative ideas on how to stimulate large scale commercial enterprise and production are extremely thin on the ground, and when we have any we need to give them all the thought and consideration they deserve.

My one major concern is that it does not address what I consider to be one fundamental constraint to private development in Africa: that most countries are not yet capitalist in their relations of production. It’s partly or largely because of the failure to accumulate assets among capitalists and create a true wage-labour force that private economic development hasn’t been strong. The swap market proposed would open investment opportunities to people who already have assets, probably mainly international capitalists, but will not stimulate the creation of a domestic capitalist class. What do readers think of this idea, though?

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