Notesale: Turn your study into money

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ECON 7010: Economics of Development
Introduction to Economics Development
Why poor countries consume less? Because they produce less
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Lack of physical capital (no tools and machinery)
Lack of necessary education (low productivity)
Not healthy enough (low productivity)
High population growth, high fertility rates, have too many children (high dependency ratio)
Lack of access to credit, women who are main brokers of health and education cannot gain
access to credit for income generating activities (require microfinance)
Cultures, institutions and governments

Poverty traps require a simultaneous and coordinated large scale investments in capital, education and
technology
About 80% of the countries have GDP per capita below the average income per head
Poverty proxied by relative income per capita is indeed multi-dimensional
...

Proximate determinants of poverty are causes that directly affect the variable of interest (low income
per capita) ex
...
Ex
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Countries near the equator have lower levels of income per capita because people in these countries
have higher tendency to be malaria-striken
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Gross Domestic Product (GDP) = total value of all goods and services produced in a country in a year
Per Capita Gross Domestic Product (GDP) = Total value of goods and services/total population
Take into account inflation by using same units over time ex
...

If we use market exchange rate, India’s GDP will be underestimated

Alternative is to use Purchasing Power Parity (PPP)
Purchasing power parity exchange rate is based on a basket of traded and non traded goods
Best income measure: PPP adjusted real per capita GDP
Richest 20% of the world population receive 62% of world income
Countries are richer today because they experience faster rates of economic growth in the past
therefore it is important to understand determinants of real income per capita growth
Yt+n = Yt(1+g)n
Asian tigers: Singapore, Taiwan, Hong Kong and South Korea experienced high rates of income growth
annually with about 7%
South Korea experienced rapid growth within a generation
...
Between 1965 to 1990, South Korea’s income per capita grew by
7% annually
...

Of the world’s population, 13% has not enough to eat, 16% has no access to safe drinkable water and 38%
do not have access to sanitation
HDI (Human Development Index)
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Life expectancy

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Educational attainment (adult literacy, school enrollment)
Per capita GDP

Traditional Theories of Economic Development

1
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Production is assumed to use capital only
b
...
Production can have other inputs like labour, skills,
infrastructure
d
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The rich has higher income so they save more and they
experience more growth
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Gap between needed investment and actual savings is the financing
gap that can be achieved by foreign aid or soft loans
...


Rostow’s Stages of Growth

1
...
Medieval Europe)
2
...
Early 18th
century Western Europe)
3
...
Britain after 1780s or US after 1860
4
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Age of mass consumption
-shift to production of consumer durables, services and other hightech and skill intensive products
-development of welfare state
-benefit from the investment in capital
Ex
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Developing countries are either in Stage 1 or Stage 2
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Predicts that development is inevitable but this is not true
...
There are
other factors affecting development such as governments,
infrastructure and education
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Easterly’s Tests

Easterly’s First Test shows that only 17 out of 88 countries have a
positive and statistically significant relationship between aid and
investment
Foreign aid may not be used for investment if people do not have
the incentives to invest so they will use foreign aid for consumption
goods
...
Giving more money does not change the
incentives to invest
...

Easterly’s Third Test:
Maybe investment is a necessary but not a sufficient condition for
growth
...

Investment is not the main constraint for growth because in
countries with abundant cheap labour like China, labour can be used
to substitute machinery if capital is scarce
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Incentives to invest cause investment in machines, education and
efficient institutions, infrastructure, quality of public provision etc

4
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Lewis Two Sector Model
-developed by Arthur Lewis
-dominant model of
Economic development in
1960s and 1970s
-highlights urbanization
and industrialization

Two sectors
1
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Modern Sector
-Labour is productive
-MPL > 0
Sustained growth comes from two sources
a
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Investment where capitalists profits are reinvested in capital
and modern sector expands further
This process continues until all surplus labour is used up
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Potential problems:
a
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BUT profits may not be
reinvested and they can be reinvested in new forms of
labour savings capital (employment process stops)
b
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BUT there may not be surplus
labour in rural areas
...
Fast rate of capital accumulation fast rate of growth in

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modern sector  fast rate of job creation may not occur
d
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Modern sector wages are not set in a competitive labour
market
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f
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In Ethiopia, with a population growth of 2
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Unemployment
rate in urban areas is about 20
...
Lewis two sector model not very
applicable in Ethiopia
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-labour migrates on the basis of expected wages in cities
-Some people ended up in informal employment in cities such as
flower sellers and little food hawkers
6
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The Solow model is not realistic enough because the difference in
income between countries is too huge to be explained by differences
in savings/investment only
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Only growth in the model is transitional
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The Famous Baumol
Convergence Study

Studies the relationship between initial income and subsequent
income growth of 16 countries from 1870-1979
Problems:
a
...
Biased sample due to sample selection
c
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In the early 1950s, more than a hundred countries lost more than 1/5 of their
children before their first birthday (all of sub-Saharan Africa, South Asia and
Southeast Asia)
Introduction of penicillin after the war and the use of vector control (chemical
assault on disease-carrying pests) led to rapid increases in life expectancy in
countries like Malaysia and Sri Lanka
UNICEF vaccinated children in Europe against tuberculosis after the war and
extended its reach in worldwide campaigns against tuberculosis, malaria,
leprosy
...
They thought they are fine even though they suffer from many
preventable diseases
...
Lack of government capacity is the core problem to deliver
healthcare and provide licensing
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9 years to 26
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Haiti
 No relation between decline in infant mortality and population growth
 Poverty is not the only reason why economic growth is not eliminating infant
mortality automatically
 Lack of government accountability and people do not see the potential in
effective health interventions
 Health concerns not as high as job security or poverty reduction in developing
countries
 Lack of spending and expectation from the health systems mean lack of
effectiveness and quality
 Lack of regulation of the private sector (lack of qualified doctors and overprescription of medicine)
 Need collective efforts such as public health systems, water and sanitation
systems
Deaton says that to improve health standards as proxied by infant mortality rates
1
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Improvement in public health care (currently clinics are poorly endowed and
there is high absenteeism among medical workers)
3
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When it is free, everyone took a bed net home but no one paid for a bed net
at PSI price
...
Incorrect dosage and poor patient
compliance
Steriod use also lead to premature ageing and lower life expectancy
Government is to blame? Preventive care not delivered due to high
absenteeism and low motivation among government health providers
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Government medical workers don’t treat the patient well: they interact with
patients for 3 minutes, provider ask 3 questions and provide 3 medication
...

People avoid the public health system because they don’t work well
People are more likely to make use of something they have paid for,
psychological sunk cost effect
People may judge quality by price and things may be judged valueless
precisely because they are cheap
Faith, a combination of beliefs and theories, is important how we navigate in
the health system
People make choices based on what makes sense to them and to the poor,
they believe that it is important medicine is delivered directly to the blood
through injectables
People do not have sufficient education to understand that injectables are not
the only way of medication
Immunization do not solve existing problem, it prevents future problems so
hard to convince people
Immunization only prevents some diseases so when a child is sick after being
immunized, the parents feel cheated
Hope becomes essential
...
The poor are much
less likely to see a doctor with chronic illness
At least the poor feel that they are doing something about their illness
Immunisation has no place in their belief system
...
Difficult to convince villages to go for immunization
...
Even if people were convinced of value
of immunization, children may not be immunized
But incentives not enough for people to complete the 5 shots of
immunization because benefits of immunization are in the future but costs
are accrued today and people tend to postpone it

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Fines or incentives can push individuals to take some action that they
themselves consider desirable but perpetually postpone taking
Government or NGO should make the option that it thinks is best for the
people the default option
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Piped water comes chlorinated, people don’t
need to remember to buy chlorine and put correct number of drops into
water
Key challenge is to design ‘nudges’ tailored to the environment of developing
countries
The poor procrastinate and underestimate the benefits of immunization
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Psychological sunk cost (The low hanging fruits are cheap so people think that
they are of poor quality
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Wrong beliefs that medicine has to be delivered directly to the blood (a lot of
imperfect and incorrect information)
3
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Procrastination and time consistency (incomplete vaccination cycles as benefits
are accrued in the future)
5
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People who got the free
mosquito nets are willing to buy them the next time, showing learning
...

Just that people in developed countries have a lot of default options and clean
water gets piped in so they don’t have to remember to add chlorine
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Gertler – Boyce

 Invest in educating mothers
 Invest in clean water, sanitation and reduce costs for the poor
 Well designed incentives
 Make full cycle immunizations compulsory
Incentive based welfare: Progresa is a unique anti-poverty program in Mexico that
combines a traditional cash transfer program with financial incentives for families

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to invest in human capital in children (health, education, nutrition)
 Significantly increase utilization of public health clinics for preventive care and
improved health of children and adults
 Health and nutrition in formative years significantly improve physical and
cognitive development
 Healthier children receive more education and earn more wages as adults
 Cash transfers are given if every family member accepts preventive health
services and they obtain health supplements and health education
 Cash transfers given to the mother of the family to keep the funds within
household to improve children’s education and nutrition
 PROGRESA covered 2
...

 So, PROGRESA combines the two strategies
 Micronutrient deficiency is also a major concern among young children
 PROGRESA tries to minimize low birth weight (LBW) and subsequent child
health and nutrition problems
 Children and pregnant women attend growth monitoring programs where
they receive supplements
 During checkups, special attention given to family planning, detection and
prevention of parasites, education on health habits, first aid treatment
 Households need not apply, they are informed of their eligibility using doorto-door methods
 To minimize corruption and improve transparency of cash transfers,
PROGRESA established offices outside normal govt bureaucracy
 Conditional Cash Transfer (CCT) program is effective
 Significant increase in health of PROGRESA adults and children
 Utilisation of public health clinics increased
 Nutrition monitoring system increased
 Utilisation of public hospitals fell as people fell sick less often
 No reduction in the utilization of private providers
 Lower incidence of children falling sick and better nutrition
 Adults health also improved
 Reduction in number of days of difficulty with daily activities due to illness,
17% less days incapacitated, 22% fewer days in bed
Drawbacks of the program

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1
...
People do not want to give up their benefits easily so they underreport their
income
3
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If they see
no future, there is no growth
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Mortality and poverty relationship is bidirectional
In a poor country unable to afford sanitation and medical care, people die
young
People with a short time horizon expect to die young so they have less reason
to save and economy fails to grow
Poverty leads to high mortality which in turn inhibits economic growth
Spread of health knowledge to less developed countries have led to a faster
convergence in mortality rates than income levels
40 countries with the highest mortality rates, only 3 are out of Africa
(Afghanistan, Laos and Cambodia)
Adult mortality effect on economic growth acts primarily through the
channels of physical capital investment and fertility
Effects of adult mortality, the probability of a young adult living long enough
to reap the gains of long term investments
Premature death of an adult means total loss of any human capital
investments and inability of that adult to personally enjoy the fruits of other
investments
Prospect of early death brings shortsighted behaviour
People who expect to die young fail to take decisions that have short term
costs but long term benefits
People who are likely to die of other causes will be more prone to engage in
risky behaviour yielding short term benefits at longer term costs
A high incidence of adult mortality reduce incentives to obtain an education
or accumulate other skills (human capital investment)

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Decisions about physical and human capital accumulation are made primarily
on the basis of returns they will yield in adulthood
In an environment of high uncertainty, parents will bear more children than
they would prefer to minimize risk of having too few descendants
This results in higher net fertility, higher population growth, reduce capitallabour ratio and hence reduce growth rate
Variation in adult mortality has the potential to account quantitatively for all
the growth shortfall experienced in Sub-Saharan Africa between 1960 to 2000
Results across Indian states mirror the results of the world’s cross section:
Economic magnitude of growth differences associated with difference in adult
mortality is very large
Level of income is clearly a strong determinant of mortality: rich countries
have typically completed their demographic transitions and devote
substantial resources to healthcare thus are characterized by lower mortality
rates
Use instrumental variables to remove endogeneity problems: malaria ecology,
climatic variables, geographical features of the countries
Neither interstate or intrastate war has any significant impact on growth
Little evidence that adult mortality captures effect of institutions on growth
A high rate of adult mortality is associated with a reduction in investment rate
but infant mortality does not
Magnitude of the relationship between adult mortality and fertility is large:
supports the idea that fertility decisions are affected by a more sophisticated
set of preferences affected by the risks the child will face throughout life
Even after accounting for endogeneity, the overall effect of adult mortality on
growth comes out negative and statistically significant
Adult mortality affects growth through investment, human capital
accumulation and fertility
Investment and fertility are the strongest channels
Adult mortality rate = probability that a 15 year old will die before age sixty,
given current age-specific mortality rates
When adult mortality rate is high, annual growth of per capita income is low
Fertility: Quantity-Quality tradeoff, with more children, resources are more
spread out so less investment per child
Fertility: Having large number of children increases the number of children
that will survive adulthood and become the breadwinner of the family
(substitute of pension funds)
Positive correlation between high adult mortality rates and high fertility rates
The higher the adult mortality rate, the lower the investment share of GDP
(shorter time horizon cause people to underinvest since expected costs are

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higher and benefits may not be reaped)
*Short horizons are a first order problem of development
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This in turn lowers economic growth
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At a minimum, high adult mortality hinders developing countries’ economic
growth
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OLS estimates may be biased because of a third factor that affects adult mortality
and economics growth therefore use Instrumental Variable
...
7 to 2% increase in
population over a 40-60 year horizon
BUT no statistically significant effect on total GDP
In fact, GDP per capita and GDP per working age population show relative
declines in countries experiencing large increases in life expectancy
No convergence in income per capita between initially poor, middle income
and rich countries
Though there seem to be a convergence for life expectancy
Increased life expectancy raises population which reduces capital to labour
ratio and depress income per capita
However, this initial decline can be compensated by higher output if more
people join the labour force and more capital is accumulated
Compensation can be complete if there are significant productivity benefits
Yet, compensation can be incomplete if benefits are limited and there are
other factors of production that are supplied inelastically
Assume that life expectancy may increase output per capita through more
rapid human capital accumulation or direct positive effects on total factor
productivity (TFP)
Assume labour and land are supplied inelastically
Assume life expectancy increases population
Tuberculosis is the largest single cause of death around the world in 1940 and
it is stopped by streptomycin
Pneumonia, resulting from viral and bacterial pathogens, can be cured by
penicillin

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DDT was an effective insecticide against the mosquito that transmits Malaria
through bites
Results: There is a large precise and robust effect of life expectancy on
population
Effect of life expectancy at birth on working age population is very similar to
its effect on total population
2SLS estimates show NO evidence that large increase in life expectancy in
many parts of the world starting in 1940s led to a significant increase in GDP
per capita
Instead, increase in life expectancy was associated with a significant increase
in population and a considerably smaller increase in total GDP
There are other factors not captured by the neoclassical growth model that
are important for understanding the effects of life expectancy on income per
capita
There is a consensus that differences in disease environments and health
conditions lie at the root of large income differences across countries today
but this paper found no evidence that increase in life expectancy led to faster
growth in income per capita

International epidemiological transition is the exogenous source of variation in
health
...
Approach exploits the international epidemiological transition around 1940s
and may not apply to the world today since it is a unique event
2
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HIV/AIDS
3
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of years the children stay in school
adds very little learning
 Pumping more books, more teachers or more training into existing systems is just a
palliative measure
 Teachers often don’t show up and if they do, they are not bothered to engage in teaching
 No child-friendly practices at all in almost 40% of schools
 Children with a contract teacher learned twice as much a year than children with a
regular teacher though civil service teachers are paid 3 to 5 times more
 Spider uses its web to expand its reach but all info created by the vibration of the web
has to be processed by one spider brain in the centre of the web
 Spider organisations are centralized
 Starfish has no brain and it is a radically decentralized organism with only a loosely
connected nervous system
 Starfish organisations are decentralized
 In many countries, legacy system of schooling is a government owned spider
 Top-down bureaucracies that attempt to control the entire system from a central
location
 Spider systems that attempt to force round-peg tasks that require local judgement and
control such as teaching a child, can fail
 Organisations need legitimacy and may resort to simply looking like other successful
organisations
 In many schooling systems today, things seem to get better because there is little
measurement of actual learning
 Quality of public school in Uttar Pradesh is so low even very poor parents will turn down
a government school in favour of paying full cost of a private school

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Many forms a school can take in a starfish ecosystem: community-controlled schools,
private providers, schools under small govt jurisdictions, charter schools
Open, locally autonomous, performance pressured, professionally networked, technically
supported and flexibly financed starfish system builds on the legacy systems that
successfully provided access to schooling, to give children the education they need for
their century
Price of better education is allowing freedom, giving choices and hence ceding power
Success of schooling: vast majority of countries will meet the Millennium Development
Goal target for universal primary school completion
Population of labour force age in developing world has now completed three times more
years of schooling than 1950
Focusing solely on measures of schooling assumes that achieving schooling meets the
goal of education but this is not true
If learning trajectories of students are flatter than it was assumed they would be, kids
come out of school knowing less than expected and a schooling goal no longer meets an
education goal
Andhra Pradesh Randomised Evaluation Studies: Flat Grade Learning profiles in the Basics
It is carried out on a massive scale with hundreds of schools across different districts, it
examines a whole variety of interventions, uses randomization to assign schools to

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treatment and uses a sophisticated test to assess students’ rote learning and their deeper
conceptual understanding
Progress in the conceptual skill of recognizing formal definitions is slow
ASER uses a simple instrument to assess basic reading and arithmetic skills on massive
scale (only 30% of children in grade 4 could read a simple passage)
Educational Initiatives: Studying Flat learning profiles in concepts
LEAPS study is longitudinal, tracking around 6000 Pakistani children from grades two to
six: results similar to those from India
There is some amount of learning and forgetting
Flat learning profiles mean children progress little in conceptual mastery and capability as
they move through school
Main international comparative assessments: PISA coordinated by OECD and Third
International Math and Science Study (TIMSS)
A flat learning profile results in low capabilities and low capabilities means that learning
profile is flat
TIMSS assess mastery of the mathematics curriculum in grade eight: more than 50% of
developing country students are below the ‘low’ international benchmark of 400
compared to developed country Australia’s 11%
Even in upper middle-income countries like Mexico and Brazil, there is low average
performance on PISA and TIMSS tests
They also have very small fractions of students in the two top global distribution
categories
Proportion of students tested who are in global top 10%: in most developing countries it
is significantly less than 1%
Very few students at the top levels of performance means that the problems with
educational system do not only affect poor children
...
In poor
countries, the richest are still getting a mediocre education and the poor cannot be said
to be getting any education at all
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A genuine learning goal should reflect the skill set of an entire cohort including those who
never enrolled or dropped out
In the push for schooling, education got pushed aside
Schooling goals were based on the belief that schooling leads to education and that
children who completed the required schooling would be equipped for life
...

More schooling alone won’t necessarily give an education
Drive to enroll the remaining poor and disadvantaged groups lead to targeted policy
instruments such as conditional cash transfers, targeted scholarships or innovation
intended to ameliorate specific issues that limit enrolment

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Expansion of schooling alone, without an improvement in the pace of learning, the
steepness of the grade learning profile, can result in only very limited progress towards
educating developing-country youths
When little learning happens per grade, completing more and more grades just don’t help
that much in achieving universal capabilities
At average rate of progress on EI questions in India, it would take 16 years of schooling to
get 90% of students producing correct responses on rudimentary reading and arithmetic
skills
Flat learning profiles mean that expanding schooling is no guarantee of reaching or
making substantial progress forward, a learning goal
Grade attainment profile look at 15 to 19 years old and give a picture of a cohort’s
attainment history – whether students enroll, how they progress across grades, when
they finish schooling
This reveals proximate contributions to lack of universal grade completion: Mali is due to
access problem, many didn’t enroll in schools
...

Grade attainment profiles are taken from household surveys so they can show grade
completion differences by socioeconomic conditions
Continuing the momentum for universal primary education is a necessary condition for
learning but expansion in schooling in itself without improvement in learning, will not
adequately equip children for their future
Flat learning profiles mean that reaching proficiency takes too long
In Tanzania, by end of grade 7, only 41% of the students are proficient in the 3
fundamental areas
...
Achieving universal secondary schooling will not produce universal grade 2
education
...

This is double the gain in learning from increased enrollments
Shallow learning profile students make little progress in learning per year expanding
years of schooling doesn’t move them far ahead to meeting a learning goal
Countries with higher initial performance get more out of expanding grade nine
attainment
In many countries, not that many children already make it to grade nine so potential gains
from enrollment alone are limited
Only in already quite high performance countries like Turkey would enrolment expansion
alone get the country significantly more than halfway to a learning goal

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Combination of higher grade attainment and raising learning profile is the most effective
in helping students meet a learning goal
Schooling has to do with something other than sitting in school
If relationship between school learning objectives and time in school is weak, expanding
time in school doesn’t help with education goal
Education systems need to measure and work to achieve their education goals –
whatever they are
Both quantity and quality are essential
Attainment deficits around the world are increasingly the result of students dropping out
Strategies to meet attainment goals should be focused on keeping kids in school and
progressing through grades
Enrolment is not the major challenge to universal grade nine attainment in most
countries
In developing countries, going to school may not be a pleasant experience
...

Single biggest factor associated with test scores was whether students found school
‘boring and not useful’ or ‘fun and useful’
Factors that pull children out of school include poverty, need to work, marriage
Push factors include the fact that children did not like school
Improve learning will keep more kids in school longer
Eliminating charges for school and conditional cash transfers programmes have been
successful in expanding enrolment but not shown to improve learning
Kenya adopted a free primary education policy and abolish all fees in governmentcontrolled schools but nearly all the net increase in enrolment is in private schools
Parents think that quality had gone down since many of the fees were locally controlled
and used for school inputs so there is weak demand for govt controlled schools
Conditional cash transfers (CCTs) induce children to go to school by conditioning
household’s receipt of targeted transfers on enrolment or attendance ex
...
k
...
Oportunidades
CCTs have no impact on learning at all
More is not enough
...
No one expects any additional impact on learning from
each student having one textbook to each student having two of the same textbook
Practical considerations like cost
No developing country has any evidence-based plan for accomplishing any significant
learning objectives through expanding EMIS visible outputs
Very few countries have any articulated and measurable goals
No country has a plan that links the input expansion to learning objectives based on
evidence on effect sizes (magnitude not quantified)
According to a study in Jamaica, a massive and costly input expansion program would
only have a small predicted impact on student standard deviation
Available scope for expanding input is modest
...
Situation may be so bad
that teachers are less productive at helping students learn when trapped in this spider
bureaucracy
Performance of students in government-run schools are worse than those in private
schools
Government schools are substantially more expensive as total cost per student is higher
Lower learning at higher costs implies even lower efficiency
Inequality of school quality is higher among government-run schools
In Uttar Pradesh, students taught by contract teachers learn twice as much per year of
schooling
System does not enforce compliance on even fundamentals: high levels of teacher
absence, abuse of children in government schools discriminated against the poor
Low quality learning experience in government school resulted in nearly half of Uttar
Pradesh rural children enrolling in private schools
Educational systems lack evidence based decision making encourage camouflage or
isomorphic mimicry
Organisations often adopt reforms that give themselves legitimacy and have no
connection with organization goals
Whatever challenged the ‘more the better’ belief system had a difficult time penetrating
the closed space for public funding
In political systems driven by patronage, politicians are rewarded for giving teaching posts
to supporters
Problem lies with governance of schooling
Need a coherent system of accountability in politics and voice, compact and management
(finance, delegation, information and enforceability)
‘best practice’ can make things worse if form and function have diverged

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

Robert
Jensen

Once there is more help, the civil service teachers did not utilize the additional help to
improve performance but rather used it to do less work
 Formal training was valued over local judgement in hiring, civil service protection vs
accountability for performance and higher salaries over market-based wages
 In-service teaching training in Indonesia focus on rent extraction or excessive
reimbursement of training costs to teachers rather than the training itself
 Appeal of high salary attracts people with no interest in teaching to join civil service
teaching jobs by using bribery or political connections to do so (high salary and low
accountability)
 Alternative modes of teacher employment, remedial instruction and technology are
disruptive innovations that have proven to work
 Allow communities to hire local, often less qualified teachers since they teach better but
quality is defined by degree and not performance
 No consistent, reliable system of reporting on basic schooling learning quality so no one
to say contract teachers improve officially measured performance
 Remedial teaching is useful as teachers shape lessons to students rather than stick to a
curriculum too difficult for students to follow
 Innovation have to be adopted and scaled based on impacts on learning
 The very same organizational survival strategies that worked to expand infrastructural
conditions for universal schooling is now counterproductive
The (Perceived) returns to education and the demand for schooling
 It is the perceived returns of students or their parents that affect schooling decisions and
these perceptions may be inaccurate
 Survey data on 8th grade boys in Dominican Republic
 Perceived returns to sec school are extremely low though there are high measured
returns
 When students at randomly selected schools are given info on the higher measured
returns complete on average 0
...
35 more years of school over the next 4 years than
those who were not
 Typical students make their schooling decisions based on limited or imperfect information
 In developing countries, educational attainment remained low despite high measured
returns
 Though 80 to 90% of youths complete compulsory primary schooling, only 20 to 30%
complete secondary education despite mean earnings of workers who complete
secondary school are over 40% greater
 There can be other factors like poverty, credit restraints, high discount rates,
measurement error
 However, if underestimates of the returns and thus a low demand for schooling is a
limiting factor then simply providing information on the returns may be the most costeffective strategy to increase education
 In low income countries, people are not well informed about the returns and there is little
information available about the earnings
 Youths in rural communities where few adults have any education will have little

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information to infer about returns in urban sector
Residential segregation by income could lead to underestimate returns of schooling
Providing parents in Madagascar with information on returns to schooling improves their
children’s school performance and attendance
Perceptions of returns to secondary schooling are extremely low for most students,
especially relative to returns measured with earnings data
Students of a randomly selected subset of schools were provided info and these students
reported dramatically improved perceived returns when re-interviewed 6 months later
and on average completed 0
...
Question deal with hypothetical situations and are lengthy and complicated
...
37
May have omitted variable bias or reverse causality
Of course information alone would not lead to high school completion, other factors
involved
Students overestimate earnings with primary schooling and underestimate earnings with
secondary schooling
Perceived mean difference in earnings for other workers (not influenced by beliefs about
personal characteristics but reflects general knowledge of labour market conditions) by
education is much lower
Students do not have accurate info on earnings and seem to underestimate returns to
schooling
View provision of information as an intervention for specific group of students for whom
low perceived returns and correspondingly low demand for schooling are the only limiting
factor
In follow up survey, treatment group reported on average greater expected earnings
associated with sec school completion and lower expected earnings with only primary
school
Difference in difference calculation

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William
Easterly:
The
Elusive
Quest for
Growth

Intervention on average raised own perceived returns by a statistically significant RD$366
Use treatment indicator as instrument for perceptions, IV estimation
Intervention increased expected future wage gap and lowered opportunity cost of
schooling since there is a decline in expected earnings with only primary schooling
For the poorest households, effect of treatment is extremely small and not statistically
significant
Youths from wealthier households show larger and statistically significant effects
Treatment being limited in impact for poor households
Both the poor and the least poor households had updated expectations after the
treatment but only the least poor households had significantly increase their years of
schooling, finished school or returned to school the next year
Information could be potentially provided at low cost but only expect it to have an impact
on students who are misinformed and have no other constraints preventing them from
schooling
If relative skill composition demanded by labour market not transmitted to youths in the
form of perceived returns, it results in undersupply of skilled labour which in turn inhibits
the development of domestic skill intensive industries or ability to attract FDI
Intervention that provided information on measured returns increased both perceived
returns and schooling
Information based programs may result in students more committed in school (treatment
increased time spent on homework by 11min on average)
However, this is limited in scope and applicability
Optimal strategy: Provide info and financial support and lower barriers to attendance
Study only focused on boys, no info on girls
Can only provide best available current estimate of returns and caveats for uncertainty
but difficult to provide absolute value of returns the students face

Educated for what?
 Many other well educated experts have a natural bias to think that education is important
 UNESCO Commission on Education for the 21st Century published Learning: The Treasure
Within
...

From 1960 to 1990, median college enrollment rate of countries increased more than 7
times, from 1% to 7
...

However, there is a lack of association between growth in schooling and GDP growth
No positive association between growth in education and growth of output per worker
African countries with rapid growth in human capital over 1960 to 1987 period such as
Angola, Zambia and Sudan were growth disasters
Countries like Japan, with modest growth in human capital, were growth miracles
East Asian miracles like Singapore, Korea and China have rapid growth in human capital
that equal or less than the African countries
Zambia had slightly faster expansion in human capital than Korea but its growth rate is 7%
lower
Eastern Europe and Soviet Union compare favourably with Western Europe and North
America in years of schooling attained but their GDP per worker is only a small fraction of
Western European and North American levels
...
06% is attributed to
human capital growth being faster on average
...
91%
...
03%
...
This means that younger workers have considerably more
human capital and this factor gives younger workers higher wages than old workers
But everywhere we see wages rising with years of experience, older workers earn more
than the younger ones even in rapidly growing economies
Even if years of experience count for something, we would have expected fast-growing
countries to have less of a wage increase with experience because of the human capital
advantage of the young but we do not find this
Growth of human capital cannot be that rapid in a fast-growing economy and cannot
account for its rapid growth
Causality between initial schooling and subsequent growth could be reverse
Higher growth in the future raise the rate of return to today’s education
Education is worth more where the skilled wage is growing rapidly than where skilled
wage is stagnant
Therefore, the relationship between initial schooling and subsequent growth is more
consistent with the story that growth cause schooling
Physical and human capital cannot explain variations in growth but can explain the large
international variations in income
Income in the long run in the Solow model is determined by saving in the form of human
and physical capital
Gregory Mankiw of Harvard used % of children enrolled in secondary school as measure
of human capital saving
Strong association between income levels and secondary enrollment ratios
The measure of savings in physical capital and human capital explains as much as 78% of
the per capita income differences among nations
Physical capital accumulation could not be a source of growth in Solow model as it has
severe diminishing marginal returns and low share in output
By adding human capital, share of all types of capital in output increased to 80% and
diminishing returns of human and physical capital together is less severe
Countries with the same technology could have very different incomes because of human
and physical capital accumulation
Supporting Mankiw’s explanation, high rates of physical and human capital accumulation
explained most of East Asia’s growth
Mankiw finds that once capital accumulation and education are controlled for, poor
countries did tend to grow faster
Countries with different rates of capital accumulation and education are headed to
different destinations
But being poor relative to your own final destination mean you move faster towards that

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destination
Mankiw tied up loose end of the lack of capital flows to poor countries
...
If poor country’s
poverty is explained by low human capital then international investors will not want to
invest in these countries as skilled labour is necessary to get a good return on machines
...

But there are 3 problems with Mankiw’s relationship between secondary enrollment and
income
Secondary education is a very narrow measure of educational accumulation
...

By concentrating on secondary education alone, Mankiw exaggerated the variation in
education in general
2nd problem is human capital earnings under Mankiw’s assumptions
Mankiw assumed capital flows would equalize rates of return to physical capital
Only human capital have different rates of return across countries
Explaining income differences with human capital alone is explaining big differences in
income with a minor ingredient
Mankiw’s assumptions implied wage for skilled labour in India should be 3 times larger in
India than US as unskilled labour is abundant in India but skilled labour is scarce
Such wage differentials should induce skilled labour to try to move from US to India but
we see skilled Indians coming to US (brain drain phenomemon)
If Mankiw’s approach is true, unskilled Indians would want to move to US and skilled
Indians will want to stay in India but this is not true
...
4 times more
likely to move to US
...
Skilled wages are 24 times higher in US than India
...

Mankiw’s framework also implies a nonsensically high ratio of skilled to unskilled wages in
India
If people respond to incentives then there should a massive movement into education in
India to acquire skills to earn the skilled wage but no such mammoth skill differential
exists in India
Returns to education in poor countries range no higher than twice that of rich countries –
not 42 times higher (rate of education is only higher because cost of investment or
foregone earnings is lower)
3rd problem: causality
...

Unappealing to say that poor nations are poor because they are not naturally thrifty
More importantly is what the educated do with their skills
In an economy with extensive government intervention, activity with highest returns to
skills might be lobbying the government for favours
Government creates profit opportunities by its intervention
Skilled people may opt for activities that redistribute income rather than activities that
create growth
Economies with a high black market premium on foreign exchange have low growth
regardless of whether they have high or low schooling
Schooling pays off only when the government actions create incentives for growth rather
than redistribution
Administrative targets for universal primary education (free schooling) do not in
themselves create incentives for investing in the future that matter for growth
Quality of education is different for an economy with incentives to invest in the future
Students will apply themselves to study, parents will monitor the progress and teacher
are pressured to teach
Corruption, low salaries for teachers, inadequate spending on textbooks are all problems
that wreck the incentive for quality education
In Brazil, state school is falling apart with weeks without a teacher, no safety, no hygiene
Sheer malpractice on school’s management and teachers are not dedicated to their duty
In Pakistan, politicians dispense teaching positions as patronage
There is large scale cheating in examinations supervised by unscrupulous teachers and
there are more guns than textbooks in schools
Sometimes much more is spent on teachers’ salaries as political patronage and school
materials are very scarce relative to teachers
High skills are only productive if they go together with high tech machinery and other
investments that happen in an economy with incentive to grow
Without incentive to grow, there is no high tech machinery so there is a supply of skills
but no demand for skills
Creation of skills itself can lead to incentives to invest in high tech machinery provided
government policy does not destroy the incentive

In conclusion,
 Easterly argues that education is linked to incentives
 Returns to education explosion is disappointing
 No causal relationship between education and growth
 Incentives to go to school come from future payoffs or higher future returns
 Institutional environment such as the labour market, existence of high value technology
and amount of government intervention determines the existing potential returns of
skilled labour
 Administrative targets for enrollment rates do not create incentive to grow
 Corruption, low salaries, poor infrastructure, textbooks that complement skill acquisition
are obstacles to people having incentive to acquire education
 The creation of skills in people will respond to the incentives to invest in the future

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 Enrollment in formal schooling may be a poor measure of creation of skills
 Without adequate skill acquisition, there are no incentives to invest in complementary
physical capital to increase productivity growth
 Brain drain: skilled labour migration flows from poor countries to rich countries
exacerbate income disparities across countries leaving poor countries trapped in poverty
 International community may turn to controlling population growth to economize on
machines and schools
David
Weil’s
chapter
6
...
7%
There has been large increase in the number of years of schooling over the period for
which data is available
...
Both
require investment to create and both have economic value
...

The opening up of economies to international trade make educated workers scarcer as
the world as a whole has a lower percentage of educated workers
...
Educated workers are more productive
...
If we include
both human and physical capital in our definition, share of national income earned by
capital is indeed 2/3 in developing world and even higher in advanced countries
...

When we used data on the average number of years of schooling in each country, we
implicitly assumed that quality of schooling does not vary among countries but this is not
true
There is clear evidence that richer countries can supply more of inputs into education
such as teachers and textbooks
Student/teacher ratio in high income countries is lower
Teachers in developing countries not as well trained ex
...

Students in rich countries tend to do better in a series of standardized math and science
tests
All evidence suggests that richer countries have not only more schooling than poor
countries but also better schooling
Differences in number of years of education will understate the true difference in level of
human capital of workers in those countries
Human capital differs from physical capital in terms of externalities
...
Giving one person more education raises not only her
own output but output of those around her
Educated farmers adopt new technologies ex
...
In poor countries, 4 years of schooling may deliver a lot
less education than in rich countries (flat learning profiles as stated by Pritchett)
 Output per worker might be much lower for poor countries as it is not linked to education
and resulting productivity that well
 Education has great positive externalities and peer effects are more positive in rich
nations
 Decisions to invest in human capital through education are economic but only partly so
 Value education as both a means towards higher income and as a way to enrich their
intellectual and spiritual lives
 With respect to education, rate of at which human capital is accumulated in the richest
countries will slow down in the future
 Decline in growth of human capital will mean a decline in overall growth rate

Population and Economic growth
David
Weil

Impact of population on economic growth
 Changes in population affect both the consumption needs of the economy and the productive
capacity of the economy
 Interaction of population with a fixed natural resource then size of population matters
...

 Country can have slow population growth but large population relative to their resources
(Japan)
 Country can have rapid population growth but small population relative to their resources
(Kenya)
 There is a strong negative correlation between income per capita and growth rate of
population
 Only in the last 200 years, growth rate of population has taken off
 Persistent population growth rate at a rate beyond glacial crawl is a relatively new
phenomenon
Malthusian model
 Thomas Malthus Essay on the Principle of Population
 Given the right circumstances, humans can breed at a prodigious rate (power of population)

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Force limiting human population in the face of this potential fertility was the limited quantity
of available resources in particular land
The smaller the population relative to the available land, the better off people will be
The better off people are, the faster the population grows
As population grows however, amount of land available for each person falls and people
become poorer
This poverty in turn limits population growth
Eventually, society would reach a level of income commensurate with constant population
...

Better technology or more land will not lead to higher yss or healthier and happier people, just
more of them
Implication of Malthusian model that countries with higher productivity will not have higher
living standards but more people accords well with economic history
...
It predicts standards of living will
remain constant over time even with technological progress but not true for the past 2
centuries when living standards improved dramatically

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Malthusian model predicts that higher income raises population growth rate but this
relationship became negative
...
Higher population
leads to shortage of resources is still an important factor historically though not the dominant
one now
...


Population growth in Solow model
 Effect of population on capital, the factor of production
 Focus on growth rate of population
 If quantity of capital did not change in a country with population growing rapidly, population
growth results in less capital being available for each worker
 Capital dilution: negative effect of population growth on capital per worker
 This results in decline of output per worker
 If there is no investment in the face of growth in labour force, capital per worker would
decline
 Δk = γf(k) – δk – nk = γf(k) – (n+δ)k
 Condition for steady state is Δk = 0, γf(k) = (n+δ)k
 Increase in population growth rate will rotate curve (n+δ)k anti-clockwise, leading to lower
steady state level of output
 Solow model shows that higher population growth dilutes capital per worker more quickly
and lowers steady state level of output per worker
 F(k) = AKα
 If we compare 2 countries which are the same in all dimensions except population growth,
the predicted ratio of incomes is still not as large as the differences between high and low
population-growth countries
 Solow model can only partly account for the negative correlation between income per capita
and population growth (channel of capital dilution)
 Malthusian model treats income and population as endogenous variables but Solow model
treats population growth as exogenous
 Malthusian focuses on interaction of population with natural resource ex
...
In India, life expectancy increased from 26
...
6 years
between 1930 to 1980 with income per capita of only $1239
Reduced mortality is due to 3 forces
...

Better fed population now is more resistant to diseases
...

2nd, improvement in public health measures such as securing clean water and food and
draining of mosquito-infested swamps
3rd, role of medical treatments in curing diseases
Rapid declines in mortality in developing world is due to these 3 forces arriving in developing
world almost all at once instead of accumulating slowly in the rich countries in the past
Govt and NGO rapidly imported public health techniques and modern medicine
Fertility is measured by Total Fertility Rate (TFR), number of children a woman would have if
she lived through all of her childbearing years and experience the current age-specific fertility
rates at each age
Fertility has fallen dramatically over the last 140 years in US, from more than 5 children to 2
However, there is a baby boom of 1946 to 1964
...

Change in fertility in developing world has been compressed into much less time than fertility
transition in most developed countries
Net rate of reproduction (NRR) = number of daughters that each girl who is born can be
expected to give birth to, assuming she goes through her life with mortality and fertility of
current population
Consider NRR as the factor by which no
...
NRR =2 means no
...
Condoms were
improved and fell in price with invention of vulcanized rubber
...
In the past, anti-contraception laws are constitutional and laws are hostile
towards birth control
...
Rest
of the decline is explained by changes in desired fertility – number of children that families
want to have
Effective example of fertility reduction program with significant restrictions on human rights =
China’s one-child policy implemented in 1979
Couples who agree to have one child only received higher wages and preferential treatment
in housing
Those with too many children need to pay a social obligation fee to offset the burden they
imposed on society
Duty of couples to enforce family planning was incorporated into Chinese constitution
TFR fell from 5
...
76 in 1995
By 2000 when the policy is relaxed, it is estimated to have resulted in the birth of 70 million
children only
In India, government used drastic measures for a short time in 1970s
...

However, policy is highly unpopular
...
In
Mexico, govt incessantly broadcast the jingle Small Families live better on TV
India’s campaign to encourage families to have 2 children with slogan ‘We Two and our Two’
which later became ‘We are One and our One’
Indonesia distributed free contraceptives and educational materials and govt backed birth
control relentlessly
...
Family planning jingle is played at
train stations and sirens to remind women to take their pills
...
Points above signify that actual
fertility is higher than desired fertility but difference is small
Evidence that differences in fertility among countries are not due to availability of
contraceptives come from surveys that ask women directly about their desires
Only 17% of women in developing countries reported an unmet need for contraception so
providing contraception to all women who wanted it only reduce fertility by 17% at most
Economic growth changes environment family faces in such a way they want less children
(desired fertility falls)
Development is the best contraceptive
Decline in mortality perhaps cause decline in fertility
Families care about number of children surviving to adult hood and often about whether they
produce a surviving son
As mortality falls, it becomes possible for families to produce same no
...
When mortality is high, parents want
more children than necessary to produce no
...
Extra children are a form
of insurance against riskiness of survival
...
Rise in women’s wages increases
opportunity cost of women’s time faster than household income hence fertility falls with
economic growth
...
As women spend more time working,
incentive to provide girls with education increases
...
Educated women more
likely to know the benefit and how to control fertility
...
Cost of
education can continue well into the child’s life
...
Incentives for a family to produce children are reduced
...

Not complete explanation: parents don’t value children solely on economic terms (If they did,
people in developing countries won’t have children) and cost of children have to be explained
themselves (parents today spend more on children and to a large extent, this is voluntary)
Quality and Quantity tradeoff: Parents hope that resources they devote to rearing and
educating the children will have payoffs in the general well being of the child
...
When survival to adulthood is assured, parents will be
secured to concentrate their resources on a few children instead of having many children to
spread out the risk
Economic growth increases benefits that the quality of children produces
Growth is associated with increase value of education, giving parents an increased incentive
to educate their children
Children who receive more education become more productive workers as adults which
contribute to economic growth

Future population trends
 If we think of population and natural resources of the world as a whole, trade cannot ease
constraints on resources
 Forecasts of future population and assumptions underlying them
 Future of fertility: fertility is very low in developed countries and very high in developing
countries now
 Economic effects of population changes: In more developed countries, fraction of nonworking elderly will rise significantly, imposing economic burden
...
28 billion
 Tools used to make long range population forecast: Age-specific survivorship function
(probability that a person of a given age will not die over the next year) and age-specific
fertility function (probability that a women of a given age will bear a child over the next year)
 To forecast population in the next year, we begin by ‘ageing’ the population and make an
adjustment for mortality
 Difficulty with forecasting is to predict how mortality and fertility will change in the future
 Worldwide AIDS epidemic: more than 90% of the people infected with HIV live in developing
countries and life expectancy is lower than it would in absence of AIDS
 Epidemic is destroying scarce human capital and reducing productivity
...
AIDS also reduce life expectancy which reduces NRR
 Current medical therapies are too expensive to significantly affect AIDS mortality in
developing world
 Overall economic effect of HIV is indeterminate

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Improvements in mortality has significantly raised net rate of reproduction but in future
forecasts, mortality changes have less effect since nearly all the girls live through their childbearing years
...
0
Replacement rate of fertility is roughly 2
...
1 by year 2050
Such an outcome means: fall in fertility in developing countries and rise in fertility in
developing countries
In year 2005, TFR for most developed group of nations is 1
...
1 children
People’s preferences change and government can increase incentives to have children
(subsidized day care and schooling)
Furthermore, there is the tempo effect
...

A delay of x% of a year of childbearing will reduce TFR by x% of its original level
Age of childbearing is indeed rising in developing countries but tempo effect can only account
for small part of fertility reduction
Future course of population in developing countries will depend on how quickly fertility
declines continue in these countries
For developing world as a whole, TFR has fallen from 5
...
9 but uneven decline in regions
(China’s decline was large but Sub-Saharan only a little)
A country with NRR = 1 will not necessarily have a zero population growth straight away
There is demographic momentum
...
of women in their reproductive years rises, number
of babies born will rise even if rate at which women have babies remain constant
...
If TFR is high to
begin with, even if there is fall in TFR, the demographic momentum will keep population
growth high
Useful measure of demographic momentum is the fraction of population aged under 15
Countries with a large fraction of population under age 15 are guaranteed to have rising
population for next decades due to increase in no
...
2
years over the next 50 years
Ageing results from declining mortality and declining fertility
In more developed countries, there will be 1
...

In less or least developed countries, children will still outnumber the elderly
GDP per capita = GDP per worker x (no
...
In 1900, Europe’s population is 3 times than of Africa
But by year 2000, the 2 continents are of equal size due to fall in fertility in Europe and rising
life expectancy in Africa
By 2050, Africa is projected to be 3 times as populous as Europe
Asia’s share of world population is roughly constant at about 67%
Developed countries: shrinking population
...
4 billion by year 2050
 Growth rate of world population will slow down
 Balance of world population will shift away from currently developed countries
 Population of developed world will age significantly
 Not certain whether fertility in developing countries will fall to replacement rate and whether
fertility in developed countries will rise to replacement rate
 Slower population growth is good for economic growth due to less capital dilution
 However, ageing population will lead to increase in fraction of elderly people and consequent

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reduction in fraction of working age people will slow down growth rate of income per capita
 In some countries, reduction in fraction of children and rise in fraction of working population
is economically beneficial (population is maturing)
 Among poorest countries, demographic momentum will ensure population to continue to
grow rapidly for next decades so it will still affect growth

TodaroSmith
Chapter
8

Urbanisation and Rural-Urban migration: Theory and Policy
 Phenomenon of massive and historically unprecedented movement of people from rural
countryside to burgeoning cities of Africa, Asia and Latin America
 Potential role of cities and urban informal sector to foster economic development
 Generally, the more developed the country measured in per capita income, the greater the
share of population living in urban areas
 Highest income countries like Denmark are the most urbanized
...

 LDCs are urbanizing at a faster rate
 Urbanisation is occurring everywhere, at high/low levels of income and whether growth is
positive/negative
 Rapid growth of cities in developing countries – UN predicts that in 2025, over 80% of the
urban dwellers of the world will reside in less developed countries
 Africa cities are growing at about 6% per annum, Asian and Latin American cities are also
growing at about 5% whereas large cities like New York is growing at 1%
 Of the 15 largest cities in year 2015, only 2 cities Tokyo and New York are from developed
countries
 Megacities are cities with at least 10 million people
...
4
more giant cities will join the ranks: Istanbul in Turkey, Hyderabad in Pakistan, Bangkok in
Thailand and Tianjin in China
 World’s urban population is as large as its rural population for the 1st time
 Almost all of the increments to world population is accounted for by growth in urban areas as
migrants stream into cities
...
Cairo is
copying with 10 million people with a water and sanitation system built for 2 million
 Explosion of shantytowns: population growth, accelerated rural-to-urban migration
 LDC governments misguided policies regarding urban planning and outmoded building codes

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

often mean that 80% of the new urban housing is illegal
In Manila, 88% of population is too poor to buy or rent an officially legal house
Almost all developing countries are dissatisfied with size and growth of their urban population
and they believe internal rural-urban migration is the most prominent factor contributing to
city growth
The pursuit of industrial modernization, technological sophistication and metropolitan growth
has led to a geographical imbalance in economic opportunities and the accelerating influx of
rural migrants into urban areas

Role of cities
 Cities are formed because they provide cost advantages to producers and consumers through
agglomeration economies
 Urbanisation economies are effects associated with general growth of a concentrated
geographic region
 Localization economies are effects captured by particular sectors of economy such as finance
or automobiles as they grow within an area
 When transportation costs are significant, users of output of industry may benefit from
nearby location to save on these costs (forward linkage)
 Firms of same/related industries benefit from locating within the same city so they draw from
the same large pool of workers with specific skills for that sector/specialized infrastructure
(backward linkage)
 Firms located in industrial districts can learn from other firms through joint ventures and
benefit from opportunities to contract work out easily when an unusually large order
materialises
 There is flexible specialization and firms don’t need to turn down large orders due to lack of
capacity
 Firms also operate at well known districts for marketing advantages of locating that
consumers know to shop to get best selection
 Silicon Valley in California: innovative computer firms
 Sinos Valley in Brazil: shoe suppliers
 Industrial clusters are common in developing countries but range from cottage industry to
advanced manufacturing
 Groundwork clusters prepare the way, industrializing clusters begin process of specialization,
differentiation and technological development, complex industrial clusters produce
competitively for wider markets
 Role of govt policy to encourage upgrading of clusters
 If govt enforces irrational and stifling regulations, there is cluster stagnation
 Successful clusters in developing countries: software in Bangalore area in India, footwear in
Sinos Valley in Brazil
 Collective efficiency advantages can be realized through such passive location and joint
investments and promotional activities of the firms
 Social capital is critical ex
...

A developing country that overwhelmingly specializes in agriculture might have one or two
large cities serving national industries like finance and govt and many smaller towns serving
local agricultural areas
...
of transportation routes linking the industries within
an economy is a key role
Model predicts urban concentration where scarce transportation routes cross (internal
nodes)
Primary processing industries usually locate near source of primary resource
Main transportation routes are usually a legacy of colonialism
Hub-and-spoke system
In US, developers usually create a new edge city within a metropolitan area with inducements
like tax breaks
In Europe, public sector plays a much larger role in coordinating new towns and large
developments
In developing countries, govt may be ineffective
...
Sec school education will find formal-sector
jobs quickly but they are a small proportion
 In deciding to migrate, individual must balance the probabilities and risks of being
unemployed or underemployed for a considerable amount of time against the positive urbanrural real income differential

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If probability of success and therefore expected urban income is still higher than rural income,
it is perfectly rational for the migrant to try his luck in the urban area even if urban
unemployment may be extremely high
Considering many migrants are between age 15 to 24, decision to migrate depends on basis
of longer term, more permanent income calculation
Longer time horizon: If migrant anticipates low probability of finding regular wage
employment in initial period and expects this probability to increase over time as he expands
his urban contacts, it is still rational for him to migrate
As long as present value of net stream of expected urban income over migrants’ planning
horizon exceeds that of expected rural income, decision to migrate is justifiable
Instead of equalizing urban and rural wage rates, Todaro model’s rural-urban migration acts
as a force to equate rural and urban expected incomes
Expected incomes are determined in terms of both wages and employment probabilities so it
is possible for migration to continue despite sizeable rates of urban unemployment
Unemployment equilibrium between urban expected wages and average rural income
Although it is privately rational from a cost-benefit perspective for an individual to migrate to
the city despite high unemployment, it can be socially costly
If we incorporate different levels of human capital, we can see why a higher proportion of
rural educated migrate than uneducated since they have a better chance of earning even
higher urban wages than unskilled migrants
Migrants from same rural region tend to settle in common cities
Earlier migrants create positive externalities for later potential migrants by lowering cost of
moving and provide them with info on available jobs (probability of unemployment lower)
Search for employment, selection into migration decision and forward looking behaviour can
be incorporated into this equilibrium migration model

Todaro migration model
 Assume wages in agricultural sector reflect marginal productivity and wages in urban sector
are institutionally set
 Migration is stipulated primarily by rational economic considerations of the relative benefits
and costs, mostly financial and also psychological
 Decision to migrate depends on expected rather than actual urban-rural real wage
differentials
 Expected differential is determined by actual urban-rural wage differential and probability of
successfully obtaining employment in urban sector
 Probability of finding an urban job is directly related to urban employment and inversely
related to urban unemployment rate
 Expected wage in urban sector = ratio of labour employed in urban sector to job seekers
multiplied by the wage institutionally set in urban sector
 Migration rates in excess of urban job opportunity growth rates are not only possible but
rational and even likely in face of wide urban-rural expected income differentials
 High rates of urban unemployment are inevitable outcomes of serious imbalance of economic
opportunities between urban and rural areas in most underdeveloped countries
 Ex
...

Group lending
 Microfinance institutions inspired by Grameen Bank
 Loan officer visits villagers and record individual transactions in his ledger, noting weekly instalments on
loans outstanding, savings deposits and fees
 Loan officer dispense advice and make arrangements for customers to obtain new loans from branch
office
 Process is done in public to make it transparent
 Group lending is synonymous with micro finance
 Group lending refers to arrangements by individuals without collateral who get together and form
groups to obtain loans from a lender
 Loans are made individually to group members but all in the group face consequences if any member
runs into serious repayment difficulties
 Fundamental idea of group responsibility or joint liability with regular group meetings
 Other microfinance institutions such as BRAC in Bangladesh, BancoSol in Bolivia
 Weekly group meetings offer convenience to the villagers, the bank comes to them and any problems
can be resolved on the spot
 Bank offers the same convenience as local moneylender
 Transaction costs are greatly reduced for loan officer since multiple savings and loan transactions of 40
people can take place in a short block of time
 Joint liability mitigate moral hazard, adverse selection and enforcement problems
 Disadvantages: groups collude to not repay, problems with peer monitoring, local information is
difficult to obtain if borrowers are dispersed, borrowers cannot observe each other’s efforts or reluctant
to punish shirkers, free riding
 Grameen style group lending
 2:2:1 staggering where 2 members of the 5person grp get their loans first and if all instalments are paid
on time, initial loans are followed 4 to 6 weeks later by loans to 2 other members then by the loan to

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the group chairperson
The group is a source of solidarity, offering mutual assistance in times of need
If serious repayment problems emerge, all group members will be cut off from future borrowing
In practice, a borrower who does not want to lose access to microcredit loans accepts the possibility of
having to bail out her fellow group members in times of need
When all goes well with repayments, borrowers are offered a larger loan repayable in the next loan
cycle
If relationship between Grameen and borrowers continue, loan sizes grow over the years and eventually
loan is large enough to repair a house
Adverse selection problem occurs when lenders cannot distinguish between inherently risky borrowers
from safer borrowers
If lenders can distinguish by type, they can charge different rates to different types of borrowers
Group lending with joint responsibility mitigate adverse selection as customers inform the bank about
reliability of potential joiners, allowing the bank to adjust terms accordingly
When banks charge the same rate, safer borrowers are implicitly subsidizing the riskier borrowers
If this implicit subsidy is so large, interest rates too high, safe borrowers leave the market
Groups are encouraged to form on their own: potential borrowers use their information to find best
partners
So given the choice, safe types stick together and safe borrowers no longer have to shoulder burden of
default by risky types
Safe types pay lower interest rates than risky types as they do not need to cross subsidize them
anymore
Now that banks are better insured against defaults, average interest rates are lower while banks break
even so it further encourages safe types to reenter the market
All borrowers face the same contract but thanks to assertive matching, risky types pay more on average
However, not all microfinance programs start with close knit borrowers with rich information: FINCA’s
process means a few people know each other before joining the village bank
If populations are highly mobile and have little information about each other, group lending cannot lead
to assortative matching
Limited liability will then help to protect safe borrowers
Once loans are granted, Banks may face moral hazard problems due to difficulty in monitoring
borrowers’ actions
Possibilities that group members who often live and work closely together can impose social and
economic sanctions on each other
Group lending contract circumvents ex ante moral hazard by inducing borrowers to monitor each
other’s choice of project and inflict penalties upon borrowers who have chosen excessively risky
projects
They will take steps to punish anyone who puts in little effort and thus burdens the group with
excessive risk
In principle, the threat of sanctions if both members shirk
Another concern is that borrowers may be tempted to pocket revenues without repaying the lender
Banks cannot tell which borrowers truthfully cannot repay vs borrowers who are seeking to run away
with their earnings
Group lending with joint responsibility makes lending sustainable by inducing peer monitoring and
overcoming enforcement problems
Each member incurs a monitoring cost and partner can force the peer to repay

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Evidence shows that individual lenders who charge higher interest rates face greater levels of default
and lenders that use group based methods do not
This suggest that group contracts mitigate incentive problems
However, group lending can create peer pressure that works against the poorest and most vulnerable
members of community
Loan officers put sharp pressure on borrowers to repay, even if they face difficulties beyond their
control
Forced acquisition of utensils and livestock of defaulting members
In reality, it is also the larger village-level group that ensures repayment discipline (meeting day joint
liability)
Village banking model used by FINCA, Freedom from Hunger, Pro Mujer encompasses a single villagelevel group of 30 members
However, some lab experiment show that social ties per se have little impact on repayment rates,
friends do not make more reliable group members than others
Participants are sometimes softer on their friends, worsening repayment rates
Framed field experiment shows that under full information, joint liability does not encourage greater
risk taking
Social capital proxies: cultural similarity based on language, dressing, geographical proximity
Larger scores on measures of geographic proximity and cultural similarity predict lower default rates
Cannot pin down whether group contracts are better because of greater trust or the fact that people
who live more closely have an easier time to monitor each other
Too much social capital can be a bad thing too if it fosters collusion against the bank
Some studies find that risk averse borrowers are more likely to form groups together only under the
condition that access to future loans is conditioned on repayment of current loan
There is dynamic incentive
Greater diversity may aid repayments by diminishing chance of collusion
...
Small Farmer Credit Program (PCPA) in Bolivia, it was difficult to find potential borrowers to
volunteer to lead their groups and group leaders need to spend a great deal of time persuading
borrowers to accept group lending contract
In China, attending group meetings and monitoring group members is costly esp if houses are not close
together
28% of dropouts of such programs in Bangladesh left in part because of the frequency of meetings
Group lending brings added risks to borrowers as borrower now faces risk that her partner will default
also
Loan sizes are limited by what the group can jointly guarantee so clients with growing businesses who
are ahead of others may find that group contract bogs everyone down
At a certain size of business, individual lending is preferred by customers
...
25 acres in Bangladesh
Wealthier clients tend to seek individual loans as they move forward and at the same time, some clients
simply prefer not having to be obligated to others
Scope for collusion increases when borrowers share knowledge and social ties
Ultimately, having more information leads to contracts that improve on standard individual-lending
contracts
System of cross reports allow punishments not to be levied so bluntly as the defaulter may run into a

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crisis that has nth got to do with peer monitoring
Usually group contracts are seldom enforced exactly and loan officers spend a great deal of time to
investigate problem cases and if defaulter’s peers are blameless, the defaulter is dropped from the
group
Loan officers can address problems of defaulter without invoking punishments for entire group
Under Grameen Bank II, borrowers are offered Basic Loan with weekly repayments and if borrower gets
into trouble, she is offered Flexible Loan with sharp drop in loan size limit but easier terms spread over
longer period
Only when customers fail to repay Flexible loan then they are expelled

Summary of group lending
 A microfinance institution request borrowers apply individual loans in groups
 Groups are made jointly responsible for their loans: If one borrower does not repay, the rest have to
repay for her or else everyone is excluded from future refinancing
 Incentivise borrowers to screen, monitor and enforce repayments on peers
 Way to transfer onto customers the responsibility for jobs usually undertaken by lenders
 Screening potential customers, monitoring their efforts, enforcing contracts
 In return, customers without collateral can get loans that would otherwise be inaccessible or at least
not available at such low interest rates (MFI wanting to break even can now offer lower rates than
moneylenders) and expect repayment from poor individuals
 Group lending contract achieve efficient outcomes even when lender remain ignorant
 Prevent moral hazard and adverse selection issues and promote social capital which enhances efficiency
(investment)
 Peer groups in close knit society can impose social sanctions and reduce agency costs
 If borrowers lack good info on each other such as mobile urban neighbourhoods and sparsely populated
areas, bank is worse off
 Microfinance is good for efficiency and good for equity
 Repayment rate bank can charge under joint responsibility is higher than the repayment rate bank can
charge under normal bilateral contracts: lending become possible
 Widespread methodology with village banks in Latin America and solidarity groups in Asia
 Mixed results from empirical work
 Emerging tensions: borrowers frustrated at cost of attending regular meetings, loan officer refused to
sanction good borrowers who happen to be in bad groups and constraints imposed by diverging
ambitions of group members
Beyond Group Lending
 Progressive lending: practice of promising larger and larger loans for groups and individuals in good
standing
 Repayment schedules with weekly and monthly instalments, public repayments and targeting of women
 More flexible attitudes towards collateral
 Bangladesh ASA and Grameen Bank II has eliminated joint liability and BancoSol in Bolivia has moved a
large share of its portfolio out of solidarity contracts into individual contracts
 Individual contracts are for established clients and solidarity group contracts are for small loans
 Microlenders focusing on individuals serve better off clients and are more self reliant
...
Acceso FFP vs
the original BancoSol
...

Helps to address overindebtedness and make borrowers face consequences of strategic defaults
Difficult to set up credit bureaus in Bangladesh where there is no system of social security numbers or
national ID numbers
Guatemalan lender started using credit bureau and it resulted in significant number of clients ejected,
improvement in portfolio quality and efficiency measures improved
From borrowers point of view, those with good repayment histories seek out more loans
Presence of an adequate regulatory framework ex BancoSol is required by law to report names and
National ID numbers of defaulters
Informal arrangement to share info
Lenders have to fend for themselves in dealing with such overlapping customers

Frequent repayment instalments
 Lenders expect loans to be repaid in small instalments, starting soon after disbursement
 Weekly repayment schedules were demanded on smaller sized loans while larger loans carried biweekly
or monthly instalments
 This creates early warning system as meeting weekly allows credit officers to know their clients by
seeing them face to face on a regular basis
 Personalised relationships and regular opportunities for monitoring are established
 Correlation between repayment troubles and frequency of required installments: Lower repayment
troubles when instalments are required weekly as compared to lump sum repayment
 Frequency repayment schedules reduces bank’s risk by selecting borrowers that are more likely to be
able to repay loans even if their investments fail
 Households have some other stream of income to repay early instalments before investment take fruit
 Repayment schedule is easiest way for microlender to capture other household income and guarantee
that they are put towards paying off the bank loan
 For borrowers with difficulty saving, frequent repayment schedules increase quality of service received
from microlenders
 If weekly instalments are too costly in low population density areas, then monthly instalments
 Seasonality is one of the main challenges of microfinance
 Rain fed agriculture and risk that a bad drought or pest infestation devastate the region
 Grameen Bank II allows loan officers to vary size of weekly instalments according to season
...
Land without certification or title
Collateral requirements discourage borrowers from defaulting
With collateral requirements, banks can charge higher interest rates without fear of default
Many microlenders require borrowers to show they can save regularly for a period before they are
eligible to borrow
Discipline and money management skills
Safesave in Dhaka slums: the first loan product developed require borrowers to hold savings acc for at
least 3 months before borrowing is allowed
While loans are withdrawn, savings withdrawals are limited
At Grameen bank, borrowers holding loans need to have obligatory personal savings acc
If borrowers get into repayment trouble, microlender can hold on to deposits to minimize exposure to
full extent of default

Making repayments public
 Customers still meet in groups and make public repayments
 Lenders can use the avoidance of social stigma as an inducement for individual borrowers to repay loans
 Public repayments heightened threat of stigma
 Meeting as a cluster of borrowers reduce transactions of bank staff
 Staff can directly elicit info from the whole group about errant borrowers and create pressure when
needed
 Group meetings facilitate education and training of the borrowers to aid in financial performance
 Keeping transactions open reduce opportunities of fraud and enhance internal control for banks
 Comfort of clients enhanced as they approach bank with neighbours
Targeting women
 Garmeen Bank has bound microfinance to create opportunities for poor women
 There are growing repayment problems in male centres so by 2002, 95% of clients are women
 Women seem to be more reliable than men in repaying their loans
 Profit maximizing for banks to lend to women, independent of other concerns like gender equality
 Women are more cautious than men and they are more sensitive to verbal hostility of fellow members
and bank employees
 Men are more argumentative and noncompliant
 Women tend to stay close to home and easier to find when troubles arise and give them little way to
escape pressure
 Women have fewer alternative sources of credit so they are more likely to repay
Information gathering by bank staff
 Incorporating neighbours in credit decisions can improve bank performance

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Many microlenders spend considerable time talking to prospective borrowers’ neighbours and friends
when making lending decisions
Staff visits to borrower’s business and homes
Some microfinance institutions reintroduce outside guarantors
Assessment of applicant’s character and creditworthiness is more important than business assessment
Views of people in the communities
Not to refinance defaulters is a strong penalty
Cross reporting: statements made by one borrower about another
Cross reporting provides important input on reasons of one party’s default
In order for it to work, need a system of reward for truthful reports and banks itself have to check on
borrower’s monitoring activities

Summary
 Group lending with joint responsibility
 Create dynamic incentives through attractive long term relationships
 Help customers manage cash flows
 Weekly/monthly repayment schedules are critical to allow customers to repay loans in manageable bits
 Allow repaying of loans from household funds other than profits from investment
 Flexible approach to collateral (value that customer attach to losing the item is more important)
 Public repayment
 More innovations needed
Asharf et al savings (microsavings)
Evidence from a commitment savings product in Philippines
 Commitment savings product for a Philippine Bank intended for individuals who want to commit now to
restrict access to their savings and who were sophisticated enough to engage in such a mechanism
 Natural field experiment to test whether individuals would open a savings acc with a commitment
feature that restricts their access to their funds but has no further benefits
 Examine whether individuals who exhibit hyperbolic preferences (preference for commitment) are
more likely to open the acc
 Test whether such individuals save more as a result of opening these acc
 Randomized control experiment to evaluate impact of SEED on saving levels of clients
 Green Bank of Caraga, a rural bank in Mindanao in Philippines
 Sample of field experiment consists of 4001 adult Green Bank clients who have savings acc and
randomly assign them into 3 groups
 Commitment treatment (T), marketing treatment (M) and control (C)
 Then second randomization to select clients to interview for baseline household survey
 Baseline household survey on existing or former clients of bank
 Baseline survey includes hypothetical time discounting questions to identify individuals with hyperbolic
preferences
 1 month later, commitment product is offered to a randomly chosen subset of clients out of which
28
...
Known amount needed for new roof
Most chose a date-based goal
Amount based goal actually is a stronger device with incentive to continue depositing after initial
deposit otherwise amount deposited cannot be accessed
Date based goal has no explicit incentive to continue depositing
All clients were encouraged to set a specific savings goal as purpose of SEED acc
This goal is written on the bank form and their commitment savings certificate
47% want to save for celebration, 20% save for tuition and education expenses and 20% save for
business or home investments
2 deposit design features
Locked box (ganansiya box) offered to client for a small fee which is similar to a piggy bank with small
opening for deposits and the bank has the key to the lock to open it
Box is easy to break so it is only a mental acc with a small physical barrier
Box provides a small physical mechanism that provides individuals with a way to save for a particular
purpose
Most of the clients chose this locked box
The other option is to automate transfers from a primary checking acc into the SEED acc
Goal orientation of the acc might inspire higher savings due to mental accounting
Other half of surveyed individuals were assigned to control group that received no further contact or a
marketing group that received a special visit to encourage savings using existing saving products only
Randomised control experiment to account for unobserved determinants of participation in savings
program
Women who exhibit hyperbolic preferences more likely to take up offer
Similar but insignificant effect on men
Women who exhibited a lower discount rate for future relative to current trade offs and have
preference for commitment were significantly more likely to open the commitment savings acc
After a year, average saving balances increased by 81% for those assigned to treatment group relative
to those assigned to control group
After 12 months, 110 of the date based SEED acc reached maturity and nearly all clients chose to roll
over their savings
After 12 months, 6 out of the 62 amount based SEED acc reached their savings goal and chose to roll
over their savings into a new SEED acc
Effect of treatment indeed came from the product itself, rather than simply being offered the product
as those who were offered the product but did not take up have increased savings in line with clients in
control and marketing treatment group

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Heterogeneous treatment effect: SEED treatment worked on getting inactive savers to save but did not
work on clients who were already active savers
Savings response represents a lasting change in savings not merely a short term response to a new
product
Individuals who voluntarily engage in commitment devices ex ante may improve their welfare
Policy implications: product design influence both savings level as well as selection of clients that take
up product
Such commitment products are not in market possibly because it is not profitable for banks if they
believe a large proportion of consumers are naiive about their self control problems

Empirical strategy
 2 main outcome variables of interest: take up rate of commitment savings product (D) and savings at
financial institution (S)
 Financial savings refer to both savings in SEED acc and savings in normal deposit acc
 Measure accounts for crowd out to other savings vehicles at bank
 Characteristic of interest: reversal of time preference question
 For each category of money, rice, icecream, individuals are coded as hyperbolic if they wanted
immediate rewards in short term but willing to wait for higher amount in the long term
 Individuals are coded as impatient if smaller rewards are consistently taken over larger delayed rewards
 We can get an estimate of the differential impact of a savings product with a commitment mechanism
relative to being encouraged to save more in their normal noncommitment savings acc
 According to survey data, married women are more impatient than unmarried women, education is
uncorrelated with impatience, unemployed individuals are more impatient, higher income households
are more patient
 Those who are time inconsistent are in fact more likely to take up SEED product
 Hyperbolic preference strongly predicts take up of SEED product for women
 Education, income and being female also predict take up of SEED
...
Belgium colonization of Congo
...
State
intervention and compulsory cultivation of cash crops in colonies to be sold and distributed by the
state at controlled prices
...
Spanish and Portuguese colonization was to obtain gold and other valuables from America and

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the Spanish crown set up monopolies to extract resources from colonies or Gold coast and Ivory
coast in West Africa
In non settler colonies, colonial powers set up authoritarian states to solidify their control and
facilitate extraction of resources
The other type is settler colonies where many Europeans migrated and settled in the colonies
creating Neo-Europes
...
Australia, US, New Zealand, Canada
When establishment of European-like institutions did not arise naturally, settlers were ready to fight
for them
...
Most of the early settlers in Australia were ex-convicts and they fought for institutions
and political rights like those prevailing in England
Colonisation strategy was influenced by feasibility of settlements
...

Little doubt that institutions of law and order and private property established in early states of
colonization in Australia, NZ and Singapore have formed basis of the current day institutions of
these countries
In Latin America, the full panoply of monopolies and regulations which had been created by Spain
remained intact after independence
...

Setting up institutions that place restrictions on government power and enforce property rights is
costly so institutions are usually inherited and not changed even after colonial powers left
In many cases where European powers set up authoritarian institutions, they left the running of the
state to a small domestic elite who controlled the state after independence and favoured extractive
institutions since the ruling elite gain larger share of revenue
Agents made irreversible investments that are complementary to a particular set of institutions so
they are more willing to support them and these institutions persist
Mortality rates expected by the first European settlers in the colonies are used as instrument for
current institutions in these countries
Potential settler mortality  settlements  early institutions  current institutions  current
performance
Data on mortality rates of soldiers, bishops and sailors stationed in colonies between 17th and 19th
centuries are used
This give a good indication of the mortality rates faced by settlers and Europeans are well informed
about these mortality rates at the time (British and French press informed the public about
mortality rates in colonies)
Strong negative relationship between log GDP per capita today and log of settler mortality rates per
thousand for a sample of 75 countries
Colonies where Europeans faced higher mortality rates are today substantially poorer than colonies
that were healthy for Europeans

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Regress current performance on current institutions and use settler mortality rates as an IV on
current institutions
Focus is on property rights and checks against government power
Protection against risk of expropriation index from Political Risk Services as a proxy for institutions
(value of 0 to 10 with 0 corresponding to lowest protection against expropriation)
Expect notion of extractive state to correspond to low value on this index and tradition of rule of law
and well enforced property rights to correspond to high value
Before using IV, authors use OLS regressions of log per capita income on the protection against
expropriation variable in a variety of samples
OLS shows that in the whole world sample, there is strong correlation between our measure of
institutions and income per capita
...
Implies that Nigeria’s institutions improve to level of
Chile could in the long run lead to as much as 7fold increase in Nigeria’s income
...

There can be reverse causality effect since rich countries can afford and therefore prefer better
institutions
Many omitted determinants of income differences that may naturally correlate with institutional
differences
Institutions variable can be measured with considerable error
Therefore, we need an instrument for institutions that is an important factor in accounting for
institutional variation but does not have a direct effect on performance: settler mortality during
time of colonization
Strong first stage relationship between settler mortality rates and current institutions
...
Furthermore, people in malaria plagued areas
are more likely to have genetic immunity against malaria (sickle cell anaemia)

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Yellow fever leaves surviving victims with lifelong immunity and most Africans had a light case
earlier in life
These diseases affected European settlement patterns and type of institutions set up but little effect
on health and economy of indigenous people
Furthermore, modern medicine was at its infancy and militaries didn’t know how to control malaria
and yellow fever
Mortality rates used is the annualized deaths per thousand mean strength of European soldiers
Spanish and Portuguese militaries did not keep good records so mortality rates of bishops in Latin
America are used (Vatican records)
Almost linear relationship between log settler mortality and measure of institutions
...
94
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16
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Climate, geography, identity of main colonizer, latitude, fraction of
population in different religions, fraction of population from European descent, natural resources
etc, protection against expropriation still have a statistically significant comparable effect on income
per capita
Some argues that malaria reduces output through high mortality but after controlling for malaria,
coefficient of institutions is still significant
Overidentification tests also show that settler mortality is a valid IV instrument
Results indicate that reduction of expropriation risk will lead to significant gains in income per capita
Ultimately, set of institutions that matter for economic performance is very complex and difficult to
just use a single measure of institutions
Institutional features like expropriation risk are outcomes of more fundamental institutions like
presidential or parliamentary system so effect of more fundamental institutions on expropriation
risk has to be looked into

Foreign Aid

Joven Liew Jia Wen
12001778
Burnside-Dollar: Aid, Policies and Growth
 Paper uses new database from World Bank on foreign aid to examine relationships among foreign aid,
economic policies and growth of per capita GDP
 Panel of 56 countries with 6 time periods
 Model of growth with a range of institutional and policy distortions
...
Most significant variables in
the regression are institutional quality, dummy for sub-Saharan Africa, inflation rate and openness
...

 This policy index weights the different policy variables according to their correlation with growth
 Other exogenous variables: measure of institutional quality that captures security of property rights and
efficiency of govt bureaucracy, ethnolinguistic fractionalization variable, assassination variable to capture
civil unrest, level of broad money (M2) over GDP to proxy for development of financial system and
regional dummy variables for sub-Saharan Africa and East Asia
 Used both OLS and 2SLS (error terms may correlate since aid may be given to serve strategic interest of
donors so country with commodity boom may receive special favour from donors)
 Fixed time effects are included to capture impact of world business cycles
 In both OLS and 2SLS, there is no significant relationship between aid and growth
 Hence, in the OLS equation, the authors added 2 interactive terms
...
4) than in a poor policy environment
 Result is statistically significant in all regressions except 2SLS regressions that include outliers
 Derivative of growth wrt aid is significantly higher in good policy environment
 Policy seems to be more important for aid effectiveness in lower income countries

Joven Liew Jia Wen
12001778
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Good policies are the ones that are themselves important for growth
To find out determinants of aid and turning to allocation issues, authors estimate an equation to explain
aid receipts as a share of GDP
Regress aid on log of initial income, log of population, group of variables that capture donor’s strategic
interest (dummy variables for Sub Saharan Africa where most European aid is directed, Franc zone which
gets special treatment from France, Egypt and Central American countries who get aid from US), measure
of arms imports relative to total imports and policy variables
Estimate separate equations for bilateral, multilateral and World Bank aid
Dummy variable for Egypt, ally of US, is highly significant
Measure of arms imports relative to total imports lagged one period explains allocation of aid to middle
income countries
Donors direct aid to low income countries and are influenced by population (small countries get more)and
variables that reflect their strategic interest
Quality of policy has a small impact on allocation of aid, no tendency to allocate more aid to countries with
good policy since coefficient of policy on aid is insignificant
Bilateral aid is influenced by donor interests and multilateral aid is influenced by income level, population
and policy
The authors also estimated an equation for government consumption and found that aid associated with
donor interests, primarily bilateral aid, increases govt consumption
Bilateral aid in particular has a strong positive impact on government consumption though government
consumption as a share of GDP has no robust association with growth
...

Results suggest Aid is more effective if it were more systematically conditioned on good policy and
allocated towards good policy environments
Authors believe that aid does affect growth but impact is conditional on same policies that affect growth
Poor countries with sound economic policies benefit directly from policies and in this environment aid
accelerates growth
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4
 However there have been cutbacks in financing of foreign aid
 Thus, climate for effective aid is improving while amount of aid diminishes

Joven Liew Jia Wen
12001778
Easterly: Was Development Assistance a mistake?
 Development assistance is the combination of money, advice and conditions provided by rich nations and
international financial institutions such as World Bank and IMF which is designed to achieve economic
development in poor nations
 In 1950s to 1970s, economic growth was simply a matter of raising rate of investment to GDP which
includes public investment for roads, schools and private investment
 However, debts accumulated to finance these investments turned out not to be repayable
 2 debt crises during 1980s and middle income and low income countries entered a long process of
rescheduling and writing off debt
 This was a sign of unproductive investment esp in Latin America and Africa hence development wisdom
moved away from mobilizing and guiding capital accumulation
 Attention shifted to success of East Asian Tigers (South Korea, Taiwan, Hong Kong and Singapore) which
combined export orientation and macroeconomic stability
 Adjustment with growth: removing price distortions, opening up to trade, correcting macroeconomic
imbalances (mainly budget deficits)
 Couldn’t replicate the East Asian miracle elsewhere in the world since loans to finance structural
adjustment also didn’t bring about growth in low income countries and loans couldn’t be repaid
 Then conventional wisdom shifted to stress the importance of institutions such as property rights, contract
enforcement, democratic accountability and freedom from corruption
 There is no single set of policies that can guarantee to ignite sustained growth
 Different policies can yield same result and same policy can yield different results, depending on country
institutional contexts and underlying growth strategies
 Economists know about development and are reasonably confident that some combination of free
markets and good institutions has a good historical track of achieving development
 It is just that they don’t know what specific actions contribute to free markets and good institutions and
how all the small pieces fit together
 They don’t know how to achieve development and development assistance have failed to achieve
development
 Over the past 42 years, $568 billion has flowed into Africa yet per capita growth of the median African
nation has been close to zero
 Top quarter of aid recipients received 17% of their GDP in aid over those 42 years yet they also have nearzero per capita growth
 South Korea only took off after aid is reduced and they disregarded the advice of aid donors
 Ghana, Uganda and Mozambique were cases of recovery after steep collapse and depend on rapid growth
episodes that usually prove to be temporary
 Currently most celebrated cases of rapid growth (India, China, Vietnam) receive little aid as % of GDP
 A lump sum transfer does not change the incentives at the margin to invest in the economy
 Any poor country where incentives to invest are attractive does not need aid
 A poor country without incentives to invest will not have aid going into investment
 The international capital market imperfections and alleged low savings rates in poor countries used to
justify aid in the past did not hold up well
...
To reduce malaria deaths, provide more clean water, build and maintain roads, provide
scholarships for talented but poor students
 Seek to create more opportunities for the poor rather than seek to transform poor societies
 Rmb principles of division of labour and gains from specialization
 Focus on problems such as inflation stablisation, financial regulation and elimination of red tap
encountered by business
 Contribute to allow for spontaneous bottom up process to work
 Economic growth without influence from experts is happening in China, India, Vietnam, Chile which
involves homegrown gradual movement to freer markets



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