Leontief Prize 2010 Winners

Bina Agarwal

 

Daniel Hahnemann

How to target the poor in Indonesia?

In developing countries, identifying the poor for redistribution or social insurance is challenging because the government lacks information about people’s incomes. This paper reports the results of a field experiment conducted in 640 Indonesian villages that investigated two main approaches to solving this problem: proxy-means tests, where a census of hard-to-hide assets is used to predict consumption, and community-based targeting, where villagers rank everyone on a scale from richest to poorest. When poverty is defined using per-capita expenditure and the common PPP$2 per day threshold, we find that community-based targeting performs worse in identifying the poor than proxy-means tests, particularly near the threshold. This worse performance does not appear to be due to elite capture. Instead, communities appear to be using a different concept of poverty: the results of community-based methods are more correlated with how individual community members rank each other and with villagers’ self-assessments of their own status than per-capita expenditure. Consistent with this, the community-based methods result in higher satisfaction with beneficiary lists and the targeting process.

Thats from Targeting the Poor: Evidence from a Field Experiment in Indonesia by Abhijit Banerjee et al. This result is surprising. With a standard indicator there are more poor people than with perception-based poverty measure.

Book review: The Social Atom

Book review published in The Kathmandu Post

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Bricks in the wall

There is a pattern to everything

Have you ever wondered why hundreds of thousands of people join protests and participate in riots? Or, why ordinary people plunge headlong into collective madness (ethnic cleansing, ethnocentric violence, and vandalism)? Also, why do some societies achieve results that others envy of (such as in 1991 Kerala became the world’s only 100 percent literate state)? Why human beings act in the way they do, i.e. they cooperate but at the same time fight with each other; they assume rationality but act based on pure instincts; and they adapt to different situations and imitate others.

To comprehend this range of confounding issues Mark Buchanan uses tools and insights from physics, economics and other social sciences in his book The Social Atom: Why the Rich Get Richer, Cheaters Get Caught, And Your Neighbor Usually Looks Like You. It is about what Buchanan calls “social physics”, which basically is social science along the lines of physics, i.e. trying to find mathematical regularities in social life. One of the core themes of the book is that there is a pattern to everything that happens in nature.

By viewing humans as “social atom”, Buchanan, a theoretical physicist and former editor of Nature and New Scientist, offers an enriching and stimulating discussion of events ranging from literacy campaigns in Kerala to sudden riots in the most unexpected regions of the world to natural segregation of societies along racial and ethnic lines to genocide in Rwanda.

The message directed at social scientists is simple: Understanding human behaviour might seem a daunting, complex task but, like in physics, if we go to the most simplest unit—treating each human being as atom, thus social atom—then it might not be as complex as it sounds. Complexity is rooted in simplicity.

He argues that by looking at patterns behind the origin and functioning of both usual and unusual events, social scientists can discover mathematical laws like the ones we find in physics. No wonder, the failure to look at patterns might have resulted in a lack of laws in economics and social sciences. This is not the case in pure sciences such as physics, chemistry and biology. By flatly assuming that people are self-interested and that they make rational decisions, the mainstream economists ignore the fact the human beings are a part of the nature and there is a pattern on how they learn, act and behave. In fact, human beings are not rational calculating machines, but biological pattern recognisers who are able learn from their mistakes.

He advises the mainstream economists to think of people as if they were atoms or molecules following simple rules in society. Failure to do this is clearly visible in economics: even the most sophisticated economic theory lacks the kind of understanding found in pure sciences. Humans are not rational calculators, but crafty gamblers. They are skilled at recognising patterns and adapting to changing world. Sadly, most of the economists have failed to recognise this simple behavioural pattern.

Interestingly, our collective behaviour follows mathematical patters of surprising precision. He argues that the most common one of them is power law. It emerges “naturally in systems that are decidedly not in equilibrium.”

The book is filled with enriching discussion about the occurrence of power law in the distribution of wealth and inequality, power and politics, class hatred, racial segregation, fads, fashion, riots, spontaneous outbreaks of goodwill and hatred within communities and financial markets.

There are three kinds of social atoms: (i) adaptive atom, (ii) imitating atom, and (iii) cooperative atom. Human beings are adaptive rule followers, not rational automations. The rationality assumption incorrectly presupposes that people do not learn, form hypotheses and tests, and change their decisions frequently.

People are fundamentally adaptive and their decision accords with reality, even if their choice might look irrational to economists. People have to make decisions in an uncertain and ever-changing setting of markets. Their decision, however irrational it may look like, comes from adaptive behaviour, i.e. they make mistakes, rectify their actions, and adapt to changing environment. It is not unusual that large movements in the market seem to take place in the absence of any big event, he argues.

In addition to being adaptive, we are also born imitators. Imitation does not generate any new information but it amplifies the consequences that a little bit of information can have. Coming back to the point of public protesting and rioting, it is by constant interaction and imitation that hundreds and thousands of protesters and rioters take on to the streets, irrespective of their awareness of the main causes of riots and strikes. This behaviour of social atoms is usually ignored by economists. Buchanan argues that what gets a riot going at the outset isn’t necessarily the same as what keeps it going or determines how big it eventually gets.

The decision of the first person to join riot might be his own but after 50 people start smashing things up, the decision for 51st to join the riot is completely different. It is not “nearly so hard to join in when everyone you know is doing it.” The imitative behaviour of Kerala resident in achieving high levels of education has made it one of the most literate states in the world.

Next comes the cooperative atom, who is an altruist defying the assumption of self-interested agents. Humans are not as self-interested and greedy as economic theorists assume. This has been well documented by game theorists and behavioural economists. The assumption of self-interested agents fails to account for selfless actions that millions of people undertake every day without any strategic hope of future reward. Many of us are “biologically predisposed to such altruistic acts.”

With a combination of adaptive, imitative and cooperative behaviours, human beings are equally skilled at making peace for the same reasons that they are skilled at making war. Even blind prejudice helps people to cooperate and participate in things that are usually not expected of them. This is why ethnocentric movements have large number of participants cooperating with each other even in the face of incomplete or manipulated information.

Repeated interactions between people of opposing ideals and values, and the imposition of effective social norms help to keep ethnocentrism at bay. May be this is what we need to defuse the tense crisis in Nepal right now!

The crux of the book is that social scientists need to view human beings as atoms and molecules following fairly simple rules, that there is a pattern to everything, and that even oversimplified models can go a long way “if social scientists can get right the few details that really matter.”

Perhaps economists need to pay more attention to realistic assumptions, simplify their models to reflect reality rather than to fit elegant mathematical models, and view human interactions as complex but having some pattern to it.

[Published in The Kathmandu Post, May 15, 2010, pp.7]

Industrial Policy of Nepal 2010 - II

So, the Nepalese government finally decided to endorse a new industrial policy, which replaces the old one of 1992.

Check out this blog post for details.

The new industrial policy would mean little if there is no political stability and policy consistency. Political stability has been the most binding constraint on economic growth and industrial activity in Nepal. Also, the sad truth is that policies are formulated but hardly implemented. We have to see how far the policies will be implemented in reality in the days ahead. But, for now, formulating a new, updated industrial policy is a good progress in an economy where pretty much everything variable seems to be in doldrums.

Notes on SAFTA

This is just a summary/note of the status of South Asian Free Trade Agreement (SAFTA). It is heavily extracted from Weerakon’s chapter in this book published by the WB. I will post updated analysis and figures later. It walks through the events leading to SAFTA (from the establishment of SAARC and the passage of SAPTA). The one thing that stands out is that the role of India in stimulating trade in the SAARC region.

Most of the SAARC nations heavily depend on the Indian market for trade. Meanwhile, in terms of trade volume, India trades the least with SAARC nations. So, SAARC nations need India to liberalize its trade regime further, not the other way round! It is time for other SAARC nations to reciprocate India. I still need to get hold of a good paper that weighs the gains and losses to each SAARC nation from SAFTA.

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In 1977, Sri Lanka initiated the process of policy liberalization and other countries followed in the 1980s. A regional bloc named South Asian Association for Regional Cooperation (SAARC) was established in 1985.

India liberalized in early 1990s, leading to a wave of economic liberalization in South Asia. To be fair, without India’s initiation, no trade agreement under SAARC would be possible. SAARC countries rely heavily in the Indian market for both exports and imports. However, this is not the case with India, which trades more with ASEAN, the EU and the US.

A proposal to initiate SAPTA was agreed upon by SAARC members in December 1995. The next year, they agreed to start SAFTA by 2000 (but not later than 2005). With good progress in SAPTA by 1998, the SAARC nations proponed the initiation date of SAFTA to 2000.

Unfortunately, the initiative dealt a blow due to rising political tension between India and Pakistan. The SAFTA framework was only adopted in 2004 after political tension cooled between the two countries. To be fair, progress in the SAARC blog has been a victim of bitter animosity and untrustworthy environment between India and Pakistan.

Outstanding issues liked to rules of origin (ROO), sensitive lists and other concerns were sorted out in January 2006. Under the proposed Tariff Liberalization Program (TLP), SAFTA will become fully effective for LDCs (Nepal and Afghanistan) by 2016 and for non-LDCs by 2013.

There are legitimate concerns about the usefulness of SAFTA because of the number of goods in sensitive list, ROO conditions, and other preferential access through bilateral FTAs that will offer more generous tariff cuts and market access than SAFTA does. Moreover, there are arguments that regional integration would not be that effective because there is hardly any potential for comparative advantage-driven trade because most of the countries share similar socio-economic fundamentals such as low income, abundant labor, language in general, etc. Others echo the view that countries are better off if they liberalize trade unilaterally (this works only if India leads and it benefits other SAARC nations). Some (here and here) argue that regional trade integration will in fact yield a net welfare loss and slow unilateral liberalization. However, new studies have identified benefits not only in trade in goods but also in services and investment.

SAPTA did not move far enough because of various self-imposed trade constraints.The most limiting factor of SAPTA was the scope of goods protected under special lists. For instance, products imported from under SAPTA concessions translated to only 15 percent of total imports between SAARC nations. Intra-SAARC trade was just 5 percent of total trade with the rest of the world.

Meanwhile, SAFTA adopted a negative list and sensitive list rather than goods covered under preferential concessions. Under SAFTA, non-LDC members are required to reduce existing tariff to 20 percent within two years of implementation of the agreement. Then, in the next five years, they are required to reduce tariffs to a range of 0-5 percent. For LDCs, in the first two years, tariffs should come down to 30 percent and to 0-5 percent in the next eight years. The LDCs are in a better position in terms of reducing tariff. Note that the tariffs reduction under SAFTA still fall short of the concessions under some of the bilateral trade agreements among SAARC nations, mainly with India.

With regards to rules of origin (ROO)- which generally includes provisions to prevent trade deflection, facilitate value addition, and augment the volume of intraregional trade- SAFTA ROO is similar to that under the bilateral FTAs in the region.

Regarding sensitive list, which is used to shield sensitive industries from increased competition, there are a lot of items that do not face competition, i.e. tariffs are not brought down. In general, countries retain a negative list of 20 percent of tariff lines for non-LDC nations. Nepal maintains the highest number of items under sensitive list. There is no formal and binding provision in the framework agreement requiring that negative lists are pruned down over time. This is in contrast to other FTAs, which require explicitly that negative lists be phased out with time.

Almost 53 percent of total import trade among South Asian nations by value is excluded from the liberalization of tariffs proposed under the SAFTA treaty. India is taking an unilateral move to prune its sensitive list by removing an additional 264 items applicable to LDCs. There is also no explicit commitment to deal with nontariff barriers.

SAFTA is confined to trade in goods, leaving trade in services, investment and other areas of economic cooperation. Moreover, the required initial tariff liberalization of 20 percent threshold is not that encouraging because most of the nations have been unilaterally lowering Most Favored Nations (MFN) tariffs quite substantially over time.

More than 90 percent of regional trade for Nepal, Bangladesh, Sri Lanka is confined to a bilateral relationship with India. Basically, the process of creating SAFTA involves market access between India and other South Asian economies. India is the biggest consumer of other SAARC nations’ exports. If India gives generous concessions, then the trading partner benefits tremendously. For instance, Nepal and Sri Lanka benefit from trading with India. Nepal’s share of trade with India in total intra-SAARC trade is almost 100 percent, while in total world trade, Nepal’s trade with India is close to 70 percent.

The SAARC nations need India to open up its markets and give more concessions, not the other way round. In fact, India’s share of imports from SAARC nations is close to one percent, which is less than its imports from ASEAN+3 nations (27 percent).

Nepal’s trade with India is increasing rapidly while its trade share with ASEAN+3 is decreasing. India is becoming the most valued market for Nepali exports. The more concessions India gives, the more will be Nepal’s trade with India.

At present, most South Asian nations are restricting 55-65 percent of their imports from India under SAFTA sensitive lists.

Almost all the countries have signed either bilateral or regional (or both) trade agreements involving India.

Green industrial policy in Brazil

Tarun Khanna and Santiago Mingo argue that the green industrial policy of Brazil worked.

What did they do?

Brazil’s experience at promoting renewable fuels, beginning in the 1970’s, is directly relevant to today’s polarized views of industrial policy. A 10-year industrial policy program called Pro-álcool was crucial in the development of the industry. Today, Brazil is the world’s most competitive producer of renewable fuels, based primarily on bioethanol. Ethanol accounts for more than 50% of current light-vehicle fuel demand in the country, and Petrobras – Brazil’s energy giant and one of the largest companies in Latin America – expects this share to increase to more than 80% by 2020.

Our research shows that industrial policy was successful in promoting a competitive bioethanol industry in Brazil. A massive stimulus package, prompted by the 1970’s rise in oil prices, gave rise to an entirely new industry. But it would not have worked without the crucial role played by competition.

How did they do?

As world energy prices collapsed, Brazil fortuitously turned off its subsidy tap, whereupon a

brutal Darwinian free-for-all ensued. This competitive rationalization was the key to the policy’s success.

The Brazilian state offered low-interest loans and credit guarantees for the construction of distilleries, as well as tax incentives for the purchase of ethanol-powered vehicles. Ethanol prices were manipulated to make it an attractive alternative to gasoline. In addition, the government induced Petrobras to distribute the renewable fuel. Gas stations installed ethanol pumps. The government signed agreements with the major automobile companies to provide incentives to make vehicles that could run on 100% ethanol.

By the 1990’s, the major subsidies and policies were abolished, and the industry was deregulated. Our statistical analysis of the entry and exit patterns of entrepreneurs in the Brazilian ethanol industry shows that the more efficient acquired the less efficient. Most underperforming ethanol companies went bankrupt or were taken over by entrepreneurs who had successful track records in running efficient operations.

The government did not bail out the underperformers, allowing market forces to restructure the industry during the post-subsidy phase. Certainly, the beneficiaries of Pro-álcool’s subsidies lobbied the state to continue the protective policies even after their usefulness – inducing the development of the industry – had expired. Fortunately, the government was not persuaded.

Lessons from Brazilian IP exercise:

Brazil’s experience offers three important lessons for nations implementing renewable energy initiatives: (1) government policies must be consistent, simple, and long-lasting, providing assurance to would-be entrepreneurs that they can invest for the long haul; (2) picking winners, the familiar weakness of overenthusiastic bureaucrats, must be kept to a minimum; and (3) the state must have the discipline to dismantle subsidies when the need for them has passed.

The poverty of poverty professionals

Ravi Kanbur echoes what a lot of development professionals working on the ground in developing countries have been saying for a long time.

Each poverty professional should engage in an “exposure” to poverty (also known as “immersions”) every 12 to 18 months. I do not mean by this rural sector missions for aid agency officials, nor the running of training workshops by NGO staff. What I mean is well captured by Eyben (2004); these are exercises that “are designed for visitors to stay for a period of several days, living with their hosts as participants, as well as observers, in their daily lives. They are distinct from project monitoring or highly structured ‘red carpet’ trips when officials make brief visits to a village or an urban slum….

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What is striking about the class of poverty professionals (of whom I am one) is that the good living (granted, not at the billionaire or millionaire level, but pretty good nevertheless) is made through the very process of analyzing, writing, recommending on poverty. To me, at least, this is discomforting and disconcerting

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I recall many years ago, when I was in my twenties, telling the anthropologist Mary Douglas about how I was starting to do consulting for the World Bank on poverty issues, and how important it was to do this work. “And it’s not too bad for one’s own poverty either, is it?” came her worldly, knowing, reply. The seeds of discomfort sown by that comment have germinated and taken root, and now won’t let go.

Perception of poverty matter. What is troubling is that researchers who have never lived a life of a poor person (for simplicity, discount the opportunity cost of what Collier says "hope") brand people living in developing country as "poor" when the "poor" don't feel that s/he is really "poor".