There is More to Life than Manufacturing

NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.

One of my continuing questions about research in economic growth is why it insists on remaining so focused on manufacturing to the exclusion of the other 70-95% of economic activity in most economies.

I’ll pick on two particular papers here, mainly because they are widely known. The first is Chad Syverson’s “What Determines Productivity?“, a survey piece that reviews the literature on firm-level productivity measurement. The main theme of the survey is that productivity varies widely across firms. Which firms? Syverson cites his own work showing that within disaggregated manufacturing industries, productivity varies by a factor or roughly 2-to-1 between the 90th and 10th percentiles. The rest of the survey contains citation after citation of papers studying manufacturing sector productivity differences.

Hsieh and Klenow, in their paper looking at the aggregate impacts of these kinds of productivity gaps, look at manufacturing plants in India, China, and the U.S. They find that the productivity differences, if eliminated, would raise manufacturing productivity by 40-50% in China and India. What goes unsaid in Hsieh and Klenow is that a 40-50% increase in productivity in manufacturing would be something like a 10% increase in aggregate GDP in India, and a 15% increase in China. Both still impressive numbers, but much smaller than the headline result because the manufacturing sector is *not* the dominant source of value-added for any country.

Why do we persist in focusing on this particular subset of industries, sectors, and firms? I think one of the main reasons is that our data collection is skewed towards manufacturing, and we end up with a “lamppost” problem. We look for our lost keys underneath the lamppost because that’s where the light is, even though the keys are out in the dark somewhere.

Our system of classifying economic activity is part of the problem. It was designed to track manufacturing originally, and then other sectors were sort of stapled on as an afterthought. To see what I mean, consider the main means of classifying value-added by sector (ISIC codes) and the main means of classifying occupations (ISCO codes).

ISIC stands for International Standard Industrial Classification. It was designed to distinguish one goods-producing industry from another, not to provide any nuance with respect to services. The original ISIC system had 10 industries, and 2 of them were manufacturing. Those 2 manufacturing industries were divided into 20 total sub-industries. *All* of the other economic activity in the economy was assigned a total of 25 sub-categories. So we’ve got “manufacture of wood and cork, except for furniture” and “manufacture of rubber products” under manufacturing in general. But we’ve got “wholesale and retail trade” as a sub-category under commerce.

From ISIC’s perspective, separately tracking the manufacture of wood of cork products (but not furniture, that’s different) was important, but it was sufficient to just lump all wholesale and retail activity in the economy together. Even in 1960, all manufacturing value-added in the U.S. was only slightly larger than all wholesale and retail trade value-added. But the former is subdivided into 20 sub-categories, while the latter is simply a sub-category of its own. Our methods of categorizing value-added are a relic of an economy now 60-70 years old, and even back then this was un-related to the relative importance of different sectors.

And no, ISIC has not kept up with the times. Yes, the current ISIC revision 4 now breaks out wholesale and retail trade into its own sub-categories (2-digit) and sub-sub-categories (3-digit). Wholesale and retail trade now has 20 3-digit categories. Retail sale of automotive fuel, for example. Manufacturing has 71 3-digit categories. Manufacture of irradiation, electromedical, and electrotherapeutic equipment, for example.

In the current ISIC version, “Education” is a top-level sector, similar to “Manufacturing”. But while manufacturing still has 24 sub-sectors at the 2-digit level, and 71 at the 3-digit, education has 1 sub-sector at the 2-digit level, and 5 at the 3-digit level. “Human health and social work” is a top-level sector, and it has 3 2-digit sub-sectors, and 9 3-digit sub-sectors. We have “hospital activities” and “medical and dental practice activities” as 2 of the 9, so you can at least separate out your optometrist appointment from your emergency appendectomy.

Think of how ridiculous this is. We are careful to distinguish that your dining room table was produced by a different sub-sector than the one the produced the wooden salad bowl you use on that table. But we do not bother to distinguish my last tooth cleaning from my grandma’s last orthopedic appointment.

The calcification of our view of the sources of economic activity continues if we look at occupation codes. These are from ISCO, and the last revision to the codes was in 2008. ISCO uses a similar multi-digit system as ISIC. The one-digit code of 2 means “Professionals”, and below that is the two-digit code of 25, for “Information and communications technology professionals”. That two-digit code has the following lower-level breakdown:

  • 251 Software and applications developers and analysts

    • 2511 Systems analysts
    • 2512 Software developers
    • 2513 Web and multimedia developers
    • 2514 Applications programmers
    • 2519 Software and applications developers and analysts not elsewhere classified
  • 252 Database and network professionals
    • 2521 Database designers and administrators
    • 2522 Systems administrators
    • 2523 Computer network professionals
    • 2529 Database and network professionals not elsewhere classified

These are incredibly high level designations in the tech world. Imagine that you are building a new web site for your retail business, and you need someone to do user interface. Do you ask for someone who does “web and multimedia development”, or someone who does “software development”? No. Those are far too general. You’d post an ad for someone who does UI/UX design, with a knowledge of html, css, and perhaps javascript. You might also require them to know Photoshop. And this person is completely different than the person you’d hire to build your iPhone app, who needs to know Xcode at a minimum, and is different from the guy who builds the Android app.

On the other hand, we have the one-digit code of 7 that means “Craft and related trade workers”. Below that is code 71, for “Building and related trades workers, excluding electricians”. That category is broken down further as follows:

  • 711 Building frame and related trades workers

    • 7111 House builders
    • 7112 Bricklayers and related workers
    • 7113 Stonemasons, stone cutters, splitters and carvers
    • 7114 Concrete placers, concrete finishers and related workers
    • 7115 Carpenters and joiners
    • 7119 Building frame and related trades workers not elsewhere classified
  • 712 Building finishers and related trades workers
    • 7121 Roofers
    • 7122 Floor layers and tile setters
    • 7123 Plasterers
    • 7124 Insulation workers
    • 7125 Glaziers
    • 7126 Plumbers and pipe fitters
    • 7127 Air conditioning and refrigeration mechanics
  • 713 Painters, building structure cleaners and related trades workers
    • 7131 Painters and related workers
    • 7132 Spray painters and varnishers
    • 7133 Building structure cleaners

The separate occupations involved in building a house are pretty clearly delineated here: framers, plumbers, painters, etc.. Heck, ISCO makes sure to distinguish “spray painters” from regular old “painters”, and those are all different from people who clean building structures (I’m guessing these people have power washers?).

While all the individual occupations of building are house are broken down, all the individual occupations of building a successful web-site are lumped into one, maybe two occupations? “Software developers” is not the same level of disaggregation as “plumbers”, despite ISCO having them both coded to a 4-digit level.

If you go back to the ISIC codes, you can get an idea of how our conception of economic activity atrophied somewhere around 1960. What follows are some current descriptions of 3-digit sectors from ISIC.

This is for the “Manufacture of Furniture”:

This division includes the manufacture of furniture and related products of any material except stone, concrete and ceramic. The processes used in the manufacture of furniture are standard methods of forming materials and assembling components, including cutting, moulding and laminating. The design of the article, for both aesthetic and functional qualities, is an important aspect of the production process.

Some of the processes used in furniture manufacturing are similar to processes that are used in other segments of manufacturing. For example, cutting and assembly occurs in the production of wood trusses that are classified in division 16 (Manufacture of wood and wood products). However, the multiple processes distinguish wood furniture manufacturing from wood product manufacturing. Similarly, metal furniture manufacturing uses techniques that are also employed in the manufacturing of roll-formed products classified in division 25 (Manufacture of fabricated metal products). The molding process for plastics furniture is similar to the molding of other plastics products. However, the manufacture of plastics furniture tends to be a specialized activity.

Note the detailed differences accounted for in the definition of furniture manufacture. ISIC is careful to distinguish that wood furniture is distinct from just processing wood, because of some aesthetic element. And yes, the techniques for metal and plastic furniture are similar to other 3-digit industries, but there is something particular about furniture that sets it apart from these.

Now here’s the description of the “Computer Programming, Consultancy, and Related Activities” code:

This division includes the following activities of providing expertise in the field of information technologies: writing, modifying, testing and supporting software; planning and designing computer systems that integrate computer hardware, software and communication technologies; on-site management and operation of clients’ computer systems and/or data processing facilities; and other professional and technical computer-related activities.

On the other hand, anyone who does anything even remotely connected with IT gets lumped into one gigantic category. Write code in Ruby on Rails for web sites? Convert legacy systems at a major corporation from COBOL over to C? Do tech support for a bank? Manage a server farm? Create mobile apps in Xcode? All that shit’s basically the same, right? Computer stuff.

This concentrated focus on manufacturing is problematic because it means we cannot undertake detailed studies similar to Syverson’s or Hsieh and Klenow’s about the sectors that are actually growing rapidly. Is there a lot of productivity dispersion in software? How about in retail, or home health care? These industries actually account for large and growing shares of economic activity, so productivity losses in them are relatively important compared to manufacturing.

The classification system also helps sustain the myth that this sector is somehow inherently more valuable than other types of economic activity. It plays into this idea that a country is failing if its manufacturing sector is declining as a share of GDP. But that decline in manufacturing is simply evidence that we have gotten very, very adept at it, and that there is an upper limit on the marginal utility of having more manufactured goods. All that effort that goes into tracking individual types of manufacturing activity would be far better spent tracking more service-sector sub-categories and occupations, because those are actually going to expand in size in the future.

And yes, I just wrote 2000 words about ISIC and ISCO codes. What has happened to me?

All Institutions, All the Time?

NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.

Wolfgang Keller and Carol Shiue just released a working paper on “Market Integration as a Mechanism for Growth“. They are looking at growth in Germany during the 19th century, and proxy for growth by using city population growth, on the presumption that people only flood into cities that are booming economically. They examine the explanatory power of both market integration and institutions for city population growth, and hence for economic growth.

To measure market integration KS use the spread in wheat prices between pairs of cities. The smaller the spread, the more integrated the cities are. Larger price spreads indicate either high transportation costs and/or some kind of other barrier to transactions that keeps trade from reducing this spread. Why wheat? Because it is widely traded, homogenous, and they have good data on it.

For institutions, KS use three different measures, all binary indicators: abolition of guilds, equality before the law, and the ability to redeem feudal lands. The very good part about their measures are that they are binary, and this conforms to the historical situation. As Napoleon conquered German territories, he imposed some very specific institutional change in these places. So one can reasonably code a 0/1 variable for whether a specific city had abolished guilds, or had imposed equality before the law (that is, adopted the Napoleonic code), or allowed redemption of feudal lands. There is natural variation across German cities in when (or if) these institutional changes took place, based on Napoleon’s activity. (This empirical set-up is drawn from Acemoglu, Cantoni, and Robinson).

The binary indicators are fine as they are. But KS then do a bad thing, and average these measures. Regular readers of this blog know how I feel about arbitrary indexes of institutions, and averaging creates an arbitrary index. Their main specification averages the first two (guilds and legal equality). This effectively presumes that abolishing guilds and legal equality have precisely the same effect. A city that abolished guilds but did not adopt legal equality has an institutional level exactly equal to one that did not abolish guilds but did adopt legal equality. Why should this be identical in effect? These are clearly not institutional substitutes. They potentially have wildly different effects on economic activity. If you want to use different measures of institutions in this kind of study, then you should incorporate these measures separately in your regressions.

That gripe aside, what do KS do? First, they realize that if they just regress city population growth on their institutional measure and their measure of price gaps, then this is subject to all sorts of objections regarding endogeneity and omitted variables. So KS come up with instruments. They use a dummy for French rule to instrument for institutions, as only those places conquered by Napoleon necessarily adopted the institutional reforms (this is also the Acemoglu et al strategy). They then use a geographic measure of the slope of terrain surrounding a city as an instrument for market integration. This is because the cost of shipping by rail increases with the slope of the terrain (gravity is a bitch). They make an argument that both French rule and the slope characteristics are exogenous to city population growth, and serve as valid instruments.

They’re using IV, so you could also chuck rocks at the instruments and claim they don’t work. If you’re going to do that, you need to have some plausible story for why the IV’s aren’t exogenous. I don’t have a good story like that, so I’m going to take their IV strategy as solid.

What do they find? They find that city population is significantly and negatively related to market integration (price gaps) and insignificantly (but positively) related to institutions. Cities that had smaller price gaps with other cities, and so were more integrated into the wider economy, experienced more rapid city population growth over the 19th century. Cities with better institutions may have had higher city population growth, but the evidence is too noisy to know for sure. For future reference, their 2nd-stage regression has an R-squared of 68%, which includes the impact of city and year fixed effects. The regression also predicts 73% of the actual city growth in the mean city. So they have what I would consider a lot of explanatory power (although a bunch could just be due to fixed effects).

Here is where I start to get confused by the paper. I look at this and think, “Looks like institutions – at least the abolition of guilds and the Napoleonic code – didn’t have a big impact on city growth. Holding those institutions constant, more integrated cities grew faster.” But KS seem determined to find an interpretation of these results that preserves the primacy of institutions as an explanation for growth. They take this result and say it does not tell us about the relative importance of institutions, meaning those two or three very specific institutions of guild abolition, legal equality, and feudal redemption.

They argue that what you should really be doing is not looking at the lack of significance on institutions in this regression, but do some different counter-factuals. So they do two different regressions. They regress city population growth on market integration only, with market integration instrumented by only the geography instruments. This is their “mechanisms” model, and it is intended to capture just the pure effect of market integration. That specification yields an R-squared of 49%, and predicts 44% of actual city growth in the mean city. Again, these numbers include any influence of the city and time fixed effects, so this isn’t all due to market integration.

They then do the mirror image of this. They regress city population growth on institutions, instrumented with only the French rule instrument. This is their “institutions” model, and is intended to capture the pure effect of institutions. That gives them an R-squared of 15%, and predicts 13% of actual city growth in the mean city. Again, these numbers reflect the explanatory power of institutions and the city and time fixed effects.

Unsurprisingly, both of these separate regressions have less explanatory power than the combined specification. But it sure seems as if market integration is far more important that institutions, doesn’t it? The R-squared is 49% versus 15%, and remember that those both include the explanatory power of the city and time fixed effects. So it could well be that the explanatory power of institutions was zero, and the explanatory power of market integration is like 34%. (This is knowable, by the way, and I’d suggest they report the partial R-squared’s in the paper.)

KS press on, though, to keep institutions a central part of the story. They argue that we should view institutions as fundamental, and that institutions led to market integration, which led to further growth. In support of this, they use their first-stage results from the main specification. This shows that market integration is significantly related to both the French rule dummy and the geographic variables affecting rail costs. On the other hand, the institutions measure is only significantly related to the French rule dummy. From this, they conclude that “Institutional change led to gains in the integration of markets, but market integration did not, at least in the short run, affect institutions.” Institutions are more fundamental, so to speak.

I don’t think this follows from those first stages. Market integration is related to the French rule dummy, which is not a measure of institutions. It is a measure of whether the French ever ruled that particular city. It captures everything about French rule, not just those three particular institutional reforms. It captures, in part, whether Napoleon thought the city was worth taking over, and I would venture to guess this depended a lot on whether the city was well-connected with the rest of Germany. He needed to move troops around, so cities that were already well-integrated to other areas via roads would be particularly attractive. The French rule dummy does not tell me that institutions matter for market integration. They tell me that places conquered by Napoleon were better connected to other cities.

I’m not sure why it is so crucial to establish that these particular institutions in this time frame were important for growth. KS have a really cool paper here, with an impressive collection of data, an interesting time period to analyze, and a lot of results that stand up by themselves as interesting facts. Why shove it through the pin-hole of institutions?

I think KS could have easily written this paper as evidence that market integration matters more than the three institutions they study. And that would be okay. It doesn’t mean INSTITUTIONS don’t matter for growth, it means that guild abolition, legal equality, and feudal redemption were not important for growth. That leaves approximately an infinity of other institutions that could be important for growth. Given the ambiguous definition of institution, market integration is an institution itself, even if it depends on (gasp!) geography. Eliminating some institutions as relevant would be helpful at this stage, as the literature has to this point (miraculously?) found that every single institutional structure studied really matters for growth. Have we reached the point where publication requires finding each and every single institution relevant for growth?

Trust and the Benefit of the Doubt

NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.

This is going to go off the rails quickly, so hang on. First, read this classic Douglas Adams story, and pay attention to what you think this tells you about English culture:

This actually did happen to a real person, and the real person was me. I had gone to catch a train. This was April 1976, in Cambridge, U.K. I was a bit early for the train. I’d gotten the time of the train wrong. I went to get myself a newspaper to do the crossword, and a cup of coffee and a packet of cookies. I went and sat at a table.

I want you to picture the scene. It’s very important that you get this very clear in your mind. Here’s the table, newspaper, cup of coffee, packet of cookies. There’s a guy sitting opposite me, perfectly ordinary-looking guy wearing a business suit, carrying a briefcase. It didn’t look like he was going to do anything weird. What he did was this: he suddenly leaned across, picked up the packet of cookies, tore it open, took one out, and ate it.

Now this, I have to say, is the sort of thing the British are very bad at dealing with. There’s nothing in our background, upbringing, or education that teaches you how to deal with someone who in broad daylight has just stolen your cookies.

You know what would happen if this had been South Central Los Angeles. There would have very quickly been gunfire, helicopters coming in, CNN, you know. . . But in the end, I did what any red-blooded Englishman would do: I ignored it. And I stared at the newspaper, took a sip of coffee, tried to do a clue in the newspaper, couldn’t do anything, and thought, what am I going to do?

In the end I thought, Nothing for it, I’ll just have to go for it, and I tried very hard not to notice the fact that the packet was already mysteriously opened. I took out a cookie for myself. I thought, That settled him. But it hadn’t because a moment or two later he did it again. He took another cookie. Having not mentioned it the first time, it was somehow even harder to raise the subject the second time around. “Excuse me, I couldn’t help but notice . . .” I mean, it doesn’t really work.

We went through the whole packet like this. When I say the whole packet, I mean there were only about eight cookies, but it felt like a lifetime. He took one, I took one, he took one, I took one. Finally, when we got to the end, he stood up and walked away. Well, we exchanged meaningful looks, then he walked away, and I breathed a sigh of relief and sat back.

A moment or two later the train was coming in, so I tossed back the rest of my coffee, stood up, picked up the newspaper, and underneath the newspaper were my cookies.

The thing I like particularly about this story is the sensation that somewhere in England there has been wandering around for the last quarter-century a perfectly ordinary guy who’s had the same exact story, only he doesn’t have the punch line.

You’re welcome for funny story and lack of math. Now, is there something to make out of this story regarding cultural explanations for economic growth? (If you answered no, let me remind you that this is the internet, so yes, of course every anecdote has deep meaning.)

Think about Adams and the other man bumbling around England on a day to day basis, taking advantage of a culture in which trust is high. They make anonymous transaction after anonymous transaction with strangers every day: buying the cookies, buying the newspaper, getting a train ticket, etc.. They never really question that the other party will come through with the cookies, the newspaper, or the train ride. It saves them all the time and effort of either providing these things themselves, or of spending their time and effort enforcing their implicit contracts (perhaps through physical coercion). Trust also implies that property rights will be respected. People will not arbitrarily steal my things, and I will not arbitrarily steal theirs. So I am willing to undertake transactions, because I know I can retain the profits/goods/utility from that transaction.

But in the story, *both* Adams and the stranger think the other has deviated from that norm. He stole the cookies!

And what do they do about it? Nothing! Nothing happens. This violation of the culture of trust does not cause Adams or the other man to play “deviate” and assault the other, or demand the cookies, or even so much as mention it. So this got me to think about what exactly is the important element of the norm of trust.

Perhaps it is really just the benefit of the doubt. Adams says nothing because he trusts that the other man wouldn’t deliberately violate the norm. As it turns out, this is correct; the man did not. So does trust mean that even if there is a deviation from the norm, you act as if there was not? You allow for the possibility or likelihood that it was accidental. This allows you to avoid confrontation, cost, and a breakdown of trust. Does trust matter because it makes you wait a minute, a day, or whatever before acting to punish someone who deviates? And in so doing ensures that you only punish those who actually deviate? Which means you can expect the same consideration, and so are willing to undertake transactions, because you know you won’t be falsely accused if you are acting in good faith? Let’s call this “Type II trust” in that you want to avoid falsely rejecting the null of cooperation by the other person. I think Adams and the other man display Type II trust: they is incredibly unwilling to reject the null. So unwilling that one of them even walks away having literally been cheated out of his cookies (and Adams walks away with a great story).

This is differentiated from “Type I trust”, where you want to avoid falsely accepting the null of cooperation when in fact you are being cheated. Type I trust is pretty naive: assume that everyone will cooperate with you, and occasionally you’ll be wrong. Type I trust would be like the other man pushing the box of cookies over to Adams and offering him one explicitly, perhaps on the assumption that Adams would return the favor. But that is clearly not what Adams is describing.

Perhaps the cultural advantage of the Western economies in economic transactions is that they have a particularly large amount of Type II trust, but not necessarily more Type I trust. That is, Western economies are just as suspicious of new transactions with strangers, and usually need some third-party reference to undertake them in the first place. However, once convinced to transact with a stranger, they have a higher tolerance for apparent deviation, willing to wait it out to see if in fact they were cheated. More transactions take place successfully, and more people are able to acquire trustworthy reputations, because there is no rush to judgement. More trustworthy reputations means more transactions, and so forth.

Yes, I know that’s a lot to suck out of a Douglas Adams anecdote. And I’m certain that somewhere, someone has written something about these varying shades of trust before. So feel free to school me up in the comments.

Growth Effects, Level Effects, and Transitional Growth

NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.

This post is about a metaphor for explaining growth dynamics to people. It might be useful if you are either trying to learn growth theory, or teach growth theory. I think the metaphor works nicely for explaining what we mean when we talk about level and growth differences by putting into a context that students can understand. Comments are welcome, I’d like to know if it is something I should try out with a live class next year.

Imagine that every country is a car, and those cars are traveling along a two-lane highway. The farther you go along the highway, the richer you are. Instead of mile markers you have GDP per capita markers, $1,000 per person, $2,000 per person, etc. etc. Your growth rate is your speed, as it measures how fast you go from one GDP p.c. marker to the next. Doing 70 MPH? You’re growing really fast. Doing 30 MPH? You’re growing slowly. But your speed does not tell me where you are along the highway. The car going 70 MPH could be way behind the car going 30 MPH, or it could be way ahead, or it could be in the process of passing the 30 MPH car. So we need another piece of information, which is your location. In terms of growth theory, I would call your location along the highway your level. A country could be much poorer than another (way behind on the highway), much richer (way ahead), or equally rich (at the same spot on the highway). Now the level, or location along the highway, is constantly changing. So it is more accurate to think of level as “how far behind the leading car are you?”

Using this metaphor, how do we think about explaining differences in observed GDP per capita across time or across countries?

First, a “level difference” is the distance between two cars traveling along the highway at the same speed. If they are both going 55 MPH, then this distance will remain constant over time, even though both of them will continue to drive forever on the highway. Level differences are about your position on the highway relative to other cars or trucks. Level differences in GDP per capita are about one country’s position relative to another, but holding the growth rate constant.

Second, a “growth difference” is a difference in the speed of the two cars. If one is going 70 MPH and the other 55 MPH, then even if the faster car starts out behind (poorer), it will pass the slower car, and then continue to expand its lead along the highway. The faster car will always end up richer, and the gap will grow over time. Growth differences would generate massive divergence in GDP per capita, just as persistent speed differences would generate massive divergence in your location along the highway relative to a slower car.

Finally, “transitional growth” is like a car accelerating temporarily to pass a truck doing 55 MPH in the right lane. Transitional growth changes your level difference with respect to the truck. You were behind, and now you are ahead. The only way to make that happen is 70 MPH temporarily. Your measured growth rate (the speed at which the GDP pc markers fly by) is higher than 55 MPH for a minute or two, but after you pass the truck you go back to 55 MPH (there is another truck in the way). But you do not have a permanent growth difference with the truck you just passed. You fundamentally are both doing 55 MPH. Transitional growth just means you jumped ahead of the truck. Transitional growth and level differences go hand in hand. Transitional growth is how you change level differences, just like temporary acceleration to 70 MPH changes your position with respect to the truck.

When we look at the advanced economies of the world (US, Japan, W. Europe, etc..), they seem have small level differences, and little to no growth differences. They are all driving at 55 MPH, roughly. The US is ahead of Japan, Germany, and France by a few car lengths, but nothing too major. Maybe Singapore is a little ahead of the US. But they all are driving at 55 MPH.

Why doesn’t the US just accelerate, and get faster economic growth? Here we need to imagine that there is a sheriff driving along in the right lane at exactly 55 MPH. Passing the sheriff is a bad idea – he’ll arrest you if you try. The sheriff dictates the long-run growth rate at the frontier of economic growth. Whatever happens, you cannot pass the sheriff. Now, within the growth literature there is some debate on whether the sheriff himself can speed up. Chad Jones’ semi-endogenous growth theory comes to the conclusion that the sheriff could perhaps temporarily accelerate, allowing all the countries stacked up behind him to accelerate temporarily as well. But the sheriff cannot really change the fundamental speed limit of 55 MPH. Others will argue that yes, the proper set of incentives or policies could permanently allow the sheriff to speed up to 56 or 57 MPH or more. Regardless of the exact nature of the sheriff, he represents some kind of limit to how fast you can move along the highway once you are the front.

How about countries like China, which seems to have been driving at 90 MPH for a few decades? We think of this as transitional growth, not a growth difference. In other words, China will eventually slow back down to 55 MPH like all the leading countries. China was able to grow so fast because it started out miles behind the leaders on the highway. Once it accelerated up to 90 MPH, it was able to keep that speed for a long time as it zipped down the left lane past a bunch of countries. But as it approaches the sheriff, its speed will slow down, and we are already seeing a little evidence that this is happening. Where exactly it ends up relative to the US or Europe is not clear. It could end up a mile behind, a few car lengths behind, a few car lengths ahead. But its rapid growth is probably transitional growth, not a fundamental growth difference. If China really did have a faster fundamental growth rate – if it could drive 65 MPH forever – then it would pass the sheriff. We’ve never seen anyone pass the sheriff yet, so I’m inclined to think you can’t do it. But maybe China knows a guy, or has diplomatic plates or something.

When we talk about particularly poor countries – Somalia, for example – then we perhaps are looking at both growth and level differences. In level terms, they are far, far behind the leaders, miles back. And their speed appears to be even slower than the leaders, maybe only 25 MPH. So not only are these countries poor, but they are falling further and further back from the leaders. Their economic growth is not sufficient for them to catch up to the leaders.

Do You Have to Choose Growth or Development? Part Deux

NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.

In my last post I talked about Lant Pritchett’s recent article which questioned the focus of the World Bank on only the extreme poor. He wondered whether the Bank was the right partner for developing countries hoping to grow to middle- or high-income living standards. I agreed with Pritchett that poverty alleviation efforts are not capable of generating what we might consider transformative growth, meaning significant convergence towards rich countries.

I got a lot of very thoughtful responses to that post (and one or two unhinged ones). One response came from Emre Ozaltin, who had written an earlier reply to Pritchett. Emre pointed out on Twitter some research showing that health improvements had accounted for 11% of growth in a set of developing countries, suggesting that this means poverty alleviation efforts do lead to growth.

Twitter just isn’t sufficient to make a coherent reply, so here we go. Even if health interventions really were responsible for 11% of growth in developing countries, that is not the same thing as saying that health interventions can create fundamental economic development.

Comparative Growth
Consider the figure, which shows the time path of GDP per capita in the U.S., South Korea, and Tanzania from 1950 to 2010. In 1960, South Korea and Tanzania are roughly equivalent in living standards. They are both far poorer than the U.S., by a factor of about 10 to 1. In the subsequent decades, though, South Korea and Tanzania have entirely different experiences. South Korea has transformative growth, and the U.S. is ahead of South Korea now by a factor of 1.5 to 1. In contrast, Tanzania doesn’t experience much overall growth at all, and the U.S. is ahead by a factor of 42 to 1.

When I talk about and study economic development, I mean the study of what caused South Korea to make that dramatic leap to rich-country status. What will promote that transformation in poor countries? There is no evidence that health or education interventions could be the answer to that question.

When Emre is talking about health generating growth, he is talking about the contribution of health to that mild growth seen in the last twenty years or so in Tanzania. Yes, there was growth. Yes, health interventions were (maybe) responsible for 11% of that growth. But that growth has not been sufficient to do anything to transform Tanzania into the next South Korea.

It doesn’t mean that these efforts were a waste, or should be stopped. There is no binary choice between poverty alleviation and promoting transformative growth. I believe firmly that from a humanitarian perspective, we should act to alleviate the conditions of poverty in these countries as much as possible. At the same time, we should also be doing what we can to promote the transformation of these economies, so that they take off in the way South Korea did.

I think Pritchett is worried that the Bank is ignoring transformative growth in favor of focusing only on poverty alleviation. And I agree with him in general that one should not abandon promoting transformative growth. But I don’t know that we should worry specifically if the World Bank changes its focus.

From the World Bank perspective, if they do want to focus on poverty alleviation, mazel tov. But do not claim that this is because it is a more robust way to generate fundamental economic development, or because you have somehow “seen the light”. You are making a distinct choice to focus on the humanitarian aspect of development, and ignore the promotion of transformative growth.

Do You Have to Choose Growth or Development?

NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.

A number of posts/comments have been floating around the last few days that deal with the goals or the World Bank. Lant Pritchett published a piece that asks whether rich countries are in fact good partners for poor countries looking to develop. Pritchett is worried that rich-country development agencies (including the World Bank) have altered their focus from promoting overall economic development, and “defined development down” to be only about alleviating the conditions for the extremely poor – those earning less than $1 per day.

Pritchett suggests that the reason for this is a “post-materialist” attitude within rich countries. More crudely, you could say that this is another example of rich countries attempting to impose their goals/values/hopes onto developing countries. We in rich countries in general – and most likely highly paid development agency workers specifically – have the luxury of saying that material economic growth is not that important. Pritchett argues that this is to ignore the goals/values/hopes of actual people in those developing countries, who very much would like some material economic growth, please.

I’m very much on Pritchett’s side on this, with a caveat I’ll get to later in the post. I wrote a post back when I started this blog on defining development economics. I contrasted “development economics” with the “economics of poverty”. Development economics, to me, is the study of what allows countries to shift from poor, agricultural, rural economies to rich, industrial, urban economies. It is “development economics” in a classic sense, but today you’d probably call it “growth economics” or “macroeconomic development”.

The economics of poverty is about the constraints facing poor people in un-developed economies, how they cope with those constraints organically, and what kind of interventions will alleviate these constraints. The problem is that what I call the economics of poverty is what everyone else calls “development economics” – field studies and surveys in poor countries, running randomized control trials of interventions, and the like.

Pritchett is arguing, in my mind, for the World Bank to return to thinking about growth economics, or about development in the classic sense. Looking for projects like ports, roads, energy generation, and the like. Scale-intensive activities that need someone to coordinate the investment, and investments that will not take place organically because they are essentially public goods. Things that might allow or push economies into sustained growth.

Pritchett’s article generated a response in defense of the World Bank’s focus on poverty alleviation. The main example I know of is here, by Emre Ozaltin. He argues that Pritchett has a “growth fetish”, and that we have evidence that this does not lead to development. That’s debatable, but Ozaltin is correct that this is not an either/or decision. One does not have forgo poverty alleviation to focus on growth, or vice versa.

But Ozaltin also overstates the case for focusing on poverty alleviation. He says, “The sum of the activities in which we are engaged are not incidental to the challenge of development. They are development. For example targeting, investing in health and education, and doing so in multisectoral and coordinated ways, are all critical to growth.”

No, they are not. We have no convincing evidence that improving on those dimensions leads to growth. Yes, we have hundreds of well-designed studies showing how specific interventions improve health or education outcomes, but that does not mean they lead to economic growth. Acting to alleviate poverty is a noble, useful, moral activity. But you do not get sustained growth as a freebie on top of it. What Pritchett is arguing (I think. I’m putting words in his mouth here.) is that the Bank has presumed that their poverty alleviation efforts will generate growth as a byproduct. They haven’t, and most likely won’t. Growth is a distinct dimension of development different from poverty alleviation.

Now, here is my caveat to supporting Pritchett’s position. Who cares if it is specifically the World Bank that provides that infrastructure investment supporting economic growth? If the aims and goals of the World Bank have changed to poverty alleviation, fine. Let that be their focus, and the business of promoting growth can be left in the hands of other entities.

This has essentially already happened, and it isn’t clear why one should try to stop it. Tim Taylor had a nice post on the World Bank. In it, he links to research showing that the World Bank is rapidly running out of countries that qualify for its help. Further, official development assistance (ODA) is being dwarfed by foreign direct investment, remittances, and sovereign bonds as a source of investment funds for developing countries. Development banks such as the Inter-American Development Bank, the African Development Bank, the Asian Development Bank, and the new bank proposed by China are all in the business of lending for large infrastructure projects. Let them.

I think Pritchett is wasting his time here, trying to turn the World Bank to a new (actually, old) heading. The Bank is a gargantuan organization, and has reached the point where self-perpetuation is as important as the actual mission. This isn’t to trash the World Bank, it’s no worse than any other large organization on this front. But if the nature of the interventions that the Bank wants to undertake has changed, so be it. Argue instead for increased funding to the existing development banks. Argue for the US to drop its opposition to the Chinese-led development bank. It may be useful or best to separate the poverty alleviation and growth-promotion, anyway. But you need both. Poverty alleviation alone is not a robust path to long-run sustained economic development.