Book Summary: “Poor Economics” by Banerjee and Duflo

Title: Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty
Author: Abjijit Banerjee and Esther Duflo
Scope: 4 stars
Readability: 4 stars
My personal rating: 4.5 stars
See more on my book rating system.

If you enjoy this summary, please support the author by buying the book.

Topic of Book

The authors find a middle ground between those who claim increased development aid is critical and those who claim development aid hurts poor nations.

If you would like to learn more about the how developing nations can create economic growth, read my book From Poverty to Progress: How Humans Invented Progress, and How We Can Keep It Going.

Key Take-aways

  • Western aid to developing countries is hamstrung by two opposing views:
    • Jeffrey Sachs says: Aid is very effective at overcoming “poverty traps”, so we need to increase giving.
    • William Easterly says: Aid does not work and it only strengthens corruption in authoritarian regimes. Therefore, it should be cut.
  • We can, however, use Randomized Controlled Trials (such as used in medical research) to identify which programs work and which do not.
  • The critical point is to identify “poverty traps” where the poor cannot incrementally ratchet their way up into increasing prosperity through their own effort.
  • We should then focus international aid into identified poverty traps and avoid investing in other areas because the poor can do it themselves.
  • It is not necessary to completely overhaul institutions, nor is it likely possible. Incremental improvement on the edges can make a real difference.

Important Quotes from Book

Our focus is on the world’s poorest. The average poverty line in the fifty countries where most of the poor live is 16 Indian rupees per person per day. People who live on less than that are considered to be poor by the government of their own countries. At the current exchange rate, 16 rupees corresponds to 36 U.S. cents. But because prices are lower in most developing countries, if the poor actually bought the things they do at U.S. prices, they would need to spend more— 99 cents.

What is striking is that even people who are that poor are just like the rest of us in almost every way. We have the same desires and weaknesses; the poor are no less rational than anyone else—quite the contrary. Precisely because they have so little, we often find them putting much careful thought into their choices: They have to be sophisticated economists just to survive. Yet our lives are as different as liquor and liquorice. And this has a lot to do with aspects of our own lives that we take for granted and hardly think about.

Poor Economics is a book about the very rich economics that emerges from understanding the economic lives of the poor. It is a book about the kinds of theories that help us make sense of both what the poor are able to achieve, and where and for what reason they need a push. Each chapter in this book describes a search to discover what these sticking points are, and how they can be overcome.

This book is an invitation to think again, again: to turn away from the feeling that the fight against poverty is too overwhelming, and to start to think of the challenge as a set of concrete problems that, once properly identified and understood, can be solved one at a time.

Unfortunately, this is not how the debates on poverty are usually framed. Instead of discussing how best to fight diarrhea or dengue, many of the most vocal experts tend to be fixated on the “big questions”: What is the ultimate cause of poverty? How much faith should we place in free markets? Is democracy good for the poor? Does foreign aid have a role to play? And so on.

Jeffrey Sachs, adviser to the United Nations, director of the Earth Institute at Columbia University in New York City, and one such expert, has an answer to all these questions: Poor countries are poor because they are hot, infertile, malaria infested, often landlocked; this makes it hard for them to be productive without an initial large investment to help them deal with these endemic problems. But they cannot pay for the investments precisely because they are poor—they are in what economists call a “poverty trap.” Until something is done about these problems, neither free markets nor democracy will do very much for them. This is why foreign aid is key: It can kick-start a virtuous cycle by helping poor countries invest in these critical areas and make them more productive. The

But then there are others, equally vocal, who believe that all of Sachs’s answers are wrong. William Easterly, who battles Sachs from New York University at the other end of Manhattan, has become one of the most influential anti-aid public figures, following the publication of two books, The Elusive Quest for Growth and The White Man’s Burden.5 Dambisa Moyo, an economist who previously worked at Goldman Sachs and at the World Bank, has joined her voice to Easterly’s with her recent book, Dead Aid.6 Both argue that aid does more bad than good: It prevents people from searching for their own solutions, while corrupting and undermining local institutions and creating a self-perpetuating lobby of aid agencies. The best bet for poor countries is to rely on one simple idea: When markets are free and the incentives are right, people can find ways to solve their problems. They do not need handouts, from foreigners or from their own governments. In this sense, the aid pessimists are actually quite optimistic about the way the world works. According to Easterly, there are no such things as poverty traps.

Whom should we believe?

There are in fact answers—indeed, this whole book is in the form of an extended answer—it is just that they are not the kind of sweeping answers that Sachs and Easterly favor. This book will not tell you whether aid is good or bad, but it will say whether particular instances of aid did some good or not.

In any case, it is not clear that answering some of these big questions, like whether foreign aid works, is as important as we are sometimes led to believe. Aid looms large for those in London, Paris, or Washington, DC, who are passionate about helping the poor (and those less passionate, who resent paying for it). But in truth, aid is only a very small part of the money that is spent on the poor every year. Most programs targeted at the world’s poor are funded out of their country’s own resources.

Even in Africa, where foreign aid has a much more important role, it represented only 5.7 percent of total government budgets in 2003 (12 percent if we exclude Nigeria and South Africa, two big countries that receive very little aid).

More important, the endless debates about the rights and wrongs of aid often obscure what really matters: not so much where the money comes from, but where it goes.

The main disagreement shows up when we turn to the question,

“Do we know of effective ways to help the poor?” Implicit in Singer’s argument for helping others is the idea that you know how to do it.

same. The point is simple: Talking about the problems of the world without talking about some accessible solutions is the way to paralysis rather than progress.

This is why it is really helpful to think in terms of concrete problems which can have specific answers, rather than foreign assistance in general: “aid” rather than “Aid.”

These questions can be answered, but the answers are by no means obvious. Yet many “experts” take strong positions on them that have little to do with evidence.

The cleanest way to answer such questions is to mimic the randomized trials that are used in medicine to evaluate the effectiveness of new drugs.

The shift from broad general questions to much narrower ones has another advantage. When we learn about whether poor people are willing to pay money for bed nets, and whether they use them if they get them for free, we learn about much more than the best way to distribute bed nets: We start to understand how poor people make decisions.

It is no accident that Sachs and Easterly have radically opposite views on whether bed nets should be sold or given away. The positions that most rich-country experts take on issues related to development aid or poverty tend to be colored by their specific worldviews even when there seem to be, as with the price of the bed nets, concrete questions that should have precise answers. To caricature ever so slightly, on the left of the political spectrum, Jeff Sachs (along with the UN, the World Health Organization, and a good part of the aid establishment) wants to spend more on aid, and generally believes that things (fertilizer, bed nets, computers in school, and so on) should be given away and that poor people should be enticed to do what we (or Sachs, or the UN) think is good for them: For example, children should be given meals at school to encourage their parents to send them to school regularly. On the right, Easterly, along with Moyo, the American Enterprise Institute, and many others, oppose aid, not only because it corrupts governments but also because at a more basic level, they believe that we should respect people’s freedom—if they don’t want something, there is no point in forcing it upon them: If children do not want to go to school it must be because there is no point in getting educated.

There will be a poverty trap whenever the scope for growing income or wealth at a very fast rate is limited for those who have too little to invest, but expands dramatically for those who can invest a bit more. On the other hand, if the potential for fast growth is high among the poor, and then tapers off as one gets richer, there is no poverty trap.

The lack of a grand universal answer might sound vaguely disappointing, but in fact it is exactly what a policy maker should want to know—not that there are a million ways that the poor are trapped but that there are a few key factors that create the trap, and that alleviating those particular problems could set them free and point them toward a virtuous cycle of increasing wealth and investment.

This radical shift in perspective, away from the universal answers, required us to step out of the office and look more carefully at the world. In doing so, we were following a long tradition of development economists who have emphasized the importance of collecting the right data to be able to say anything useful about the world. However, we had two advantages over the previous generations: First, there are now high-quality data from a number of poor countries that were not available before. Second, we have a new, powerful tool: randomized control trials (RCTs), which give researchers, working with a local partner, a chance to implement large-scale experiments designed to test their theories. In an RCT, as in the studies on bed nets, individuals or communities are randomly assigned to different “treatments”—different programs or different versions of the same program. Since the individuals assigned to different treatments are exactly comparable (because they were chosen at random), any difference between them is the

effect of the treatment.

A single experiment does not provide a final answer on whether a program would universally “work.” But we can conduct a series of experiments, differing in either the kind of location in which they are conducted or the exact intervention being tested (or both). Together, this allows us to both verify the robustness of our conclusions (Does what works in Kenya also work in Madagascar?) and narrow the set of possible theories that can explain the data (What is stopping Kennedy? Is it the price of fertilizer or the difficulty of saving money?).

This might seem self-evident, but as we will argue throughout the book, it is not how policy usually gets made. The practice of development policy, as well as the accompanying debates, seems to be premised on the impossibility of relying on evidence: Verifiable evidence is a chimera, at best a distant fantasy, at worst a distraction.

The studies we use have in common a high level of scientific rigor, openness to accepting the verdict of the data, and a focus on specific, concrete questions of relevance to the lives of the poor.

We will see many instances in the chapters that follow where the wrong policy was chosen, not out of bad intentions or corruption, but simply because the policy makers had the wrong model of the world in mind: They thought there was a poverty trap somewhere and there was none, or they were ignoring another one that was right in front of them.

The message of this book, however, goes well beyond poverty traps.

As we will see, ideology, ignorance, and inertia—the three Is—on the part of the expert, the aid worker, or the local policy maker, often explain why policies fail and why aid does not have the effect it should. It is possible to make the world a better place—probably not tomorrow, but in some future that is within our reach—but we cannot get there with lazy thinking. We hope to persuade you that our patient, step-by-step approach is not only a more effective way to fight poverty, but also one that makes the world a more interesting place.

Our colleague Daron Acemoglu and his long-term coauthor, Harvard’s James Robinson, are two of the most thoughtful exponents of the rather melancholy view, active in economics today, that until political institutions are fixed, countries cannot really develop, but institutions are hard to fix.

Acemoglu and Robinson’s pessimism comes in part from the fact that we rarely see successful drastic regime change from authoritarian and corrupt to well-functioning democracy. The first thing the view from below allows us to see is that it is not always necessary to fundamentally change institutions to improve accountability and reduce corruption.

Although wholesale democratic reforms are few and far between, there are many instances where democracy has been introduced, to a limited extent and at the local level, within an authoritarian regime.

Similarly, fighting corruption appears to be to some extent possible even without fixing the larger institutions.

Although there is scope for improvement in accountability and corruption even within the framework of generally “bad” INSTITUTIONS, there is, conversely, no guarantee that good INSTITUTIONS necessarily work well in practice. Once again, it depends on how they operate on the ground. At some level, this is a rather obvious point, and one that institutional pessimists agree with. What is not recognized as often, however, is how important the effect of seemingly very small modifications in the rules can be.

good for the poor.

Good intentions are probably a necessary ingredient for good policies, but they only go so far. Very bad policies are sometimes born out of the best of intentions, because of a misreading of what the real problem is.

Part of the problem is that even when governments are well intentioned, what they are trying to do is fundamentally difficult. Governments exist to a large extent to solve problems that markets cannot solve.

We agree with both of them: The focus on the broad INSTITUTIONS as a necessary and sufficient condition for anything good to happen is somewhat misplaced. The political constraints are real, and they make it difficult to find big solutions to big problems. But there is considerable slack to improve institutions and policy at the margin.

Careful understanding of the motivations and the constraints of everyone (poor people, civil servants, taxpayers, elected politicians, and so on) can lead to policies and institutions that are better designed, and less likely to be perverted by corruption or dereliction of duty. These changes will be incremental, but they will sustain and build on themselves. They can be the start of a quiet revolution.

As this book has shown, although we have no magic bullets to eradicate poverty, no one-shot cure-all, we do know a number of things about how to improve the lives of the poor. In particular, five key lessons emerge.

First, the poor often lack critical pieces of information and believe things that are not true.

Second, the poor bear responsibility for too many aspects of their lives. The richer you are, the more the “right” decisions are made for you. The poor have no piped water, and therefore do not benefit from the chlorine that the city government puts into the water supply. If they want clean drinking water, they have to purify it themselves. They cannot afford ready-made fortified breakfast cereals and therefore have to make sure that they and their children get enough nutrients. They have no automatic way to save, such as a retirement plan or a contribution to Social Security, so they have to find a way to make sure that they save. These decisions are difficult for everyone because they require some thinking now or some other small cost today, and the benefits are usually reaped in the distant future. As such, procrastination very easily gets in the way. For the poor, this is compounded by the fact that their lives are already much more demanding than ours: Many of them run small businesses in highly competitive industries; most of the rest work as casual laborers and need to constantly worry about where their next job will come from. This means that their lives could be significantly improved by making it as easy as possible to do the right thing—based on everything else we know—using the power of default options and small nudges.

Third, there are good reasons that some markets are missing for the poor, or that the poor face unfavorable prices in them.

In some cases, a technological or an institutional innovation may allow a market to develop where it was missing… But we also have to recognize that in some cases, the conditions for a market to emerge on its own are simply not there. In such cases, governments should step in to support the market to provide the necessary conditions, or failing that, consider providing the service themselves.

Fourth, poor countries are not doomed to failure because they are poor, or because they have had an unfortunate history. It is true that things often do not work in these countries… But many of these failures have less to do with some grand conspiracy of the elites to maintain their hold on the economy and more to do with some avoidable flaw in the detailed design of policies, and the ubiquitous three Is: ignorance, ideology, and inertia.

The good news, if that is the right expression, is that it is possible to improve governance and policy without changing the existing social and political structures. There is tremendous scope for improvement even in “good” institutional environments, and some margin for action even in bad ones.

Finally, expectations about what people are able or unable to do all too often end up turning into self-fulfilling prophecies.

Despite these five lessons, we are very far from knowing everything we can and need to know. This book is, in a sense, just an invitation to look more closely.

If you would like to learn more about the how developing nations can create economic growth, read my book From Poverty to Progress: How Humans Invented Progress, and How We Can Keep It Going.

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