Our Word is Our Weapon

I’ve previously posted here and here about the serious problems with the kind of ‘general equilibrium’ models so often used to predict the amazing gains that would be made from trade liberalisation.

Now, in their paper A Development Round of Trade Negotiations?, Joseph Stiglitz and Andrew Charlton raise some more issues. They’re arguing for a proper ‘impact assessment’ to be carried out on any potential changes to the mulitlateral trade regime, but offer a few caveats on the reliability of general equilibrium models:

The interpretation of general equilibrium analysis must recognize that models are
sensitive to their assumptions. Much of the analysis of the impacts relies on a
particular model of the economy, the neo-classical model, which assumes full
employment of resources, perfect competition, perfect information, and well
functioning markets. These assumptions are of questionable validity for any country,
and are particularly problematic for developing countries. Under full employment
general equilibrium models often predict significant welfare gains from trade
liberalization because it enables resources to be redirected from low productivity
protected sectors to more productive sectors as the economy specializes in its areas of
comparative advantage. However if there is unemployment, trade liberalization may
simply move workers from low productivity protected sectors into unemployment.
This lowers the country’s national income and increases poverty.

A complete incidence analysis must also include adjustment costs. Most of the tools
used to analyze general equilibrium effects of trade liberalization are static models.
They describe the movement from one ‘steady state’ to another but do not incorporate
the costs associated with transition or the consequences for economies which are
initially out of steady state. Even if trade liberalization had no impact on the
equilibrium level of unemployment, it may take the economy considerable time to
adjust, and the costs of adjustments—lost income and increased poverty—may be
considerable. The fact that implementation and adjustment costs are likely to be
larger in developing countries, unemployment rates are likely to be higher, safety nets
weaker, and risk markets poor are all facts that have to be taken into account in
conducting a relative incidence analysis.

It’s also instructive to note that different general equilibrium analyses have produced huge varying estimates of gains from trade. Annex B of this document published today by the Treasury shows just how wide the range is. The logical conclusion is that the models are extremely sensitive to the assumptions made and should be taken with a pinch of salt.

In their paper A Development Round of Trade Negotiations?, Joseph Stiglitz and Andrew Charlton identify a wide range of problems with the current international trade regime, and explore some potential solutions. One interesting point they make is that the ‘dispute resolution’ mechanism in the World Trade Organisation priveleges richer countries:

The sanction for violating a WTO agreement is the imposition of duties. If Ecuador, say, were to impose duties on goods that it imports from the
United States, it would have a negligible effect on the American producer; while if
the United States were to impose a duty on goods produced by Ecuador, the economic
impact is more likely to be devastating. In practice, the WTO system has no effective
way of enforcing an unfair trade action, the main impact of which is on small
developing countries.

One solution to this asymmetry would be to require non-compliance with WTO
rulings to be punished by all WTO members. However there has been considerable
resistance to this kind of proposal. Of course a classic problem with enforcement
through retaliatory protectionism is that it is not in the interests of the enforcing
country. Thus an alternative proposal would be to require that trade losses be
compensated with financial payments, either as reparations from the responsible
country, or from the proceeds of an international auction of the right to retaliate.

For more ways in which rich countries have more clout in the WTO, try my dissertation on the subject.

In response to a recent post of mine bemoaning the tendency in economics to base theories on an abstracted idea of purely rational individuals, a reader mentioned a study reavealing obviously irrational behaviour among New York taxi drivers. I know, it shouldn’t take a team of economists to identify irrational behaviour among New York taxi drivers, but bear with me here.

It turns out there’s a growing field of economic theory devoted to studying the many and diverse ways in which people are not the rational droids of orthodox theory. For an excellent and readable summary of some of this research, try From Homo Economicus to Homo Sapiens, by Richard Thaler.

Sendhil Mullainathan applies some of these insights to development in Development Economics through the Lens of Psychology (MS Word document). Here’s an excerpt from the summary:

Individuals have self-control and time inconsistency problems. They can give into short-run temptations and later regret it. They can have strong feelings about others that drive them to commit both generous acts and spiteful ones. They often passively accept defaults, rather than making active choices. They let the institutions around them make their choices for them. They may misread new data in a way that fits what they believe in. In short, the rational maximization model may not be a very good approximation to human behavior.

Debt relief, say some campaigning NGOs, is better for poor countries than equivalent amounts of direct aid from rich countries. Here’s why:

——————

A growing body of literature suggests that debt relief is the most efficient and effective form of
resource transfer with many indirect benefits for the macro economy, growth prospects, the
prudential management of public resources, and development policy as a whole.

•Debt relief minimises the unpredictability of aid flows. Many bilateral aid programmes
are still bedeviled by problems of low stability and low predictability and high pro-cyclicality.
Moreover the granting or withholding of aid tends to aggravate economic
cycles. Empirical analyses by the IMF 11 shows that aid flows tend to be more volatile
than fiscal revenue or output, and highly unpredictable. In one in five African countries
there is a divergence of at least 30% between budgeted and actual spending – and this is
exacerbated by fickle aid flows. Debt relief on the other hand is highly predictable,
stable and, therefore, can act as a counter-cyclical source of finance. As a result, debt
relief helps low-income governments to strike a balance between meeting poverty
reduction expenditure commitments, while striving to maintain fiscal stability.

•Debt relief is anti-inflationary. A recent IMF paper points to a strong correlation
between higher levels of indebtedness and increased inflationary pressures.

•Debt relief spurs economic growth. There is a positive correlation between debt relief
and domestic private savings and investment, as well as FDI. Some African finance
ministries and regional analysts suggest that high levels of indebtedness lead to HIPC
governments increasing their borrowing from domestic credit sources resulting in higher
interest rates and the crowding out of local investors to affordable credit. Debt write-offs
can relieve the pressure on domestic borrowing, increasing the availability, and reducing
the cost, of domestic credit thereby acting as a spur to economic growth. On the other
hand, there is little if any evidence of a positive interaction between aid flows and
domestic investment and savings.

•Debt relief acts as de facto budget support. By enhancing central government spending
capacity, debt relief supports the development of locally owned government expenditure
priorities and monitoring systems. In line with donors’ emphasis on Medium Term
Expenditure Frameworks, debt relief acts as an important boost for (some) donors’ efforts
to increase the predictability of flows and enhance coordination and common pool
approaches. Where debt relief results in increases in national budgets, it facilitates a
closer integration of budget management systems and an improved coordination between
capital and recurrent expenditures. Aid, however, can distort the relationship between
recurrent and capital spending. Some donors prefer to spend on tangible capital projects as opposed to meeting recurrent budgetary costs. Aid, unlike debt relief, can leave
recipient governments cash poor and project rich.

•Debt relief cuts down on transaction costs. Aid can tie up recipient governments’
meagre administrative staff in endless negotiations, report writing and separate auditing
procedures with an array of official donors. Some estimates suggest that officials can
spend half their time on donor-related activities rather than on improving the delivery of
public sector services and administration.

•Debt relief improves local accountability and good governance. Debt relief within the
context of locally developed and owned Poverty Reduction Strategies has the added
benefit of increasing, and sometimes even kick-starting, political participation in
decision-making over the management and distribution of public resources. As
development agencies, we have heard many of our partners in recipient countries express
their frustration with national governments, and particularly with the official donor
community, regarding their unwillingness to take seriously the inputs of a wider group of
stakeholders in the design and implementation of national Poverty Reduction Strategies.
Nevertheless, some have reported improved access to key decision-making processes and
a rise in public accountability regarding the management of public finances.

To sum up, the continued reliance on ear-marking and the detailed conditionality and institutional
controls by donors undermines the accountability of recipient governments to their own public
and civil society agents, and weakens incentives and their capacity to improve public resource
allocation for the intended beneficiaries – poor people.

————

Comments: this all seems reasonable enough to me. I wonder if debt relief would also be more attractive to rich-country governments than aid?

The ITDG says that indoor air pollution - basically, smoke from kitchen stoves - kills 1.6 million people a year, making it the fourth biggest cause of death and disease in poor countries behind being underweight, unsafe sex, unsafe water, sanitation and hygiene. Fewer people die from malaria, yet malaria is rightly a major global health priority.

From the summary:

More than a third of humanity, 2.4 billion people, burn biomass (wood, crop residues, charcoal and dung) for cooking and heating. When coal is included a total of 3 billion people – half the world’s population – cook with solid fuel.

The smoke from burning these fuels turns kitchens in the world’s poorest countries into death traps. Indoor air pollution from the burning of solid fuels kills over 1.6 million people, predominately women and children, each year. This is more than three people per minute. It is a death toll almost as great as that caused by unsafe water and sanitation, and greater than that caused by malaria. Smoke in the home is one of the world’s leading child killers, claiming nearly one million children’s lives each year.

Indoor air pollution is not an indiscriminate killer. It is the poor who rely on the lower grades of fuel and have least access to cleaner technologies. Specifically, indoor air pollution affects women and small children far more than any other sector of society. Women typically spend three to seven hours per day by the fire, exposed to smoke, often with young children nearby.

Interestingly, the report doesn’t just point out the problem but also goes into detail on the best solutions - for now, more fuel efficient stoves seem the best way forward.

Hat-tip for the link to The Agreeable World of Tom Allen.

I’ve been studying some economicsrecently, and I’ve mostly found it interesting. But I’ve occasionally found it depressing, too, and I’ve had to spend some time trying to work out why.

At least part of the reason is the rather clinical and limited view in much economic theory of human nature. In some economics people don’t feature much except as bundles of rational and predictable behaviour patterns - ‘agents’ ruled by the interaction of their simple natures with the simple world of more or less utility. Utility itself is a limited thing akin to narrow material self interest.

Insofar as economics sticks to this conception of human nature, it sticks to the ground and lacks interest beyond the fairly routine interplay of some thuddingly dull principles. Insofar as the model of how people work is expanded upon and made more uncertain and unpredictable, economics turns into a relatively bright subject to look into. Agents start to look familiar - we empathise with their flaws, their confusion and their affection.

The main reason why economics has depressed me is that so many people who lay claim to expertise or authority in the area, or who make themselves influential through an economic angle, stick rigidly to the first conception. They choose to prefer the economics of six billion robots who have somehow learned to climb stairs.

I think we need to reject this model. It’s dangerous to try to cut out all but one dimension of human nature with a flick of the analytical knife. I don’t think it’s even a useful abstraction. I reject the idea, and so, as it happens, did Adam Smith, who wrote in The Theory of Moral Sentiments:

“How selfish man be supposed, there are evidently some principles in his nature which interest him in the fortunes of others and render their happiness necessary to him though he derives nothing from it except the pleasure of seeing it”.

EU trade chiefs say they want to eliminate export subsidies. This is good. But only if other WTO members do the same. This is fair enough. And only if they get the result they want in other parts of the talks. This is typical EU - we’ll only do something everyone agrees is for the general good if there’s something in it for us! Peter Gallagher has a series of good posts explaining why the EU offer is not much to get excited about. But it is a step forward, which makes a change for the WTO.

Speaking yesterday at the launch of the Commission for Africa, Gordon Brown said “We hope to have a major breakthrough in debt relief at the next G8 meeting [in the US next month].”

That would be great, because right now debt relief simply hasn’t been delivered. For an in-depth look at how inadequate the G8’s efforts have been so far, see here.

Here are some recommendations on tackling world poverty made by a high-level international commission:

�Increase the development of renewable forms of energy to aid an orderly transition from non-renewables.
�An international tax on arms.
�Restrain exports of arms to areas of conflict or tension.
�Stabilisation of commodity prices at a remunerative level.
�Greater support for International Commodity Agreements.
�Compensation for shortfalls in real commodity export earnings.
�Trade barriers by industrialised countries against exports of developing countries should be rolled-back.
�Fair labour standards should be agreed internationally.
�An international investment regime should be established which creates reciprocal obligations on the part of host and home countries in respect of areas such as technology transfer and repatriation of profits.
�The IMF should not excessively regulate developing economies.
�The IMF should not impose deflationary measures as standard policy.

Some people might be shocked by how radical these suggestions are. They can rest easy; these are some of the recommendations of the Brandt Commission in its report ‘North-South’, published almost a quarter of a century ago in 1980.

The recommendations are reproduced by the World Development Movement in a new briefing pre-empting the first meeting today of the Blair-led ‘Commission for Africa’. The WDM seem a little frustrated by the attention being focused on yet another high-powered survey of Africa’s problems, when we already have several perfectly good analyses with some perfectly good recommendations. They are also pessimistic about the potential for actual action after the Blair commission eventually reports its ‘findings’ : note that none of the Brandt Commission points listed above has been implemented to any great extent.

The WDM lists fifteen policies that the British Government could implement (pretty much immediately), and which are backed up by sound evidence and common sense, which would help Africa greatly. Why, they seem to be asking, is Blair bothering with this commission if it is not to avoid taking some of these necessary but tricky steps?

I can see their point, but I’d speculate that Blair hopes to generate some real new political momentum behind what he would probably call a ’step-change’ in attitudes towards Africa. Maybe that’s what will happen. But I simply don’t believe that the Blair commission will make the kind of radical recommendations that could actually justify, capture and channel that political energy into real change - I think they’ll come out with a lot of noble aspirations, give a bit of a boost to aid flows and debt cancellation, and that will be mostly that. Africa will unsurprisingly remain mostly as it is, and the political momentum will dissipate to be replaced by an even greater sense of despair. See, we did our best and it made no difference!

The point is that such a limited result would not be ‘doing our best’. For an indication of how narrow the political space for change in Africa has become, compare WDM’s recommended policies to the Brandt Commission’s. Today even activist campaigners seem to be aiming lower than the establishment did 25 years ago. The Blair commission needs to go further: they could start by picking up every one of WDM’s recommendations, and every one of the Brandt Commission’s. Of course they won’t all get implemented, but that’s the idea - aim high or there’s no point playing the game at all.

Unfortunately, as I said, I don’t think they will aim high. They may recommend some greater transfer of resources to Africa, and that’s good. But what Africa needs even more is a transfer of power. Put simply, as long as the rich hold all the power the poor will stay that way.

There was an interesting article in the Guardian last month about the profits being reaped by Europe’s fixed market in sugar, and the struggle in Brussels over reform of the industry. I found a paragraph towards the end particularly interesting:

last month, the group representing the 49 least developed countries (LDCs) asked the EU to consider returning to fixed quotas for imports from poor countries. They fear if they flood Europe with unrestricted exports of cheap sugar, prices will plummet, allowing Brazil, the world’s cheapest producer, to capture the market.

This suggests at least three possible kinds of outcomes:

• Something like the present system, fixed in favour of EU farmers;

• Something like a completely free market, favouring the lowest cost producer whoever that is (in this case Brazil);
• A system fixed (by quotas, for example) in favour of countries who produce at a higher cost than Brazil but who are poorer.

It’s an interesting issue, and highlights the fact that liberalisation of agricultural markets in the North will not necessarily benefit the areas where poverty is greatest. I lean towards the third system at the moment, since I believe policies should be targeted at producing the greatest possible reduction in poverty. In this way poverty reduction becomes a positive ‘externality’ that needs to be factored in to the price of the transaction.

It’s possible, of course, that sugar farmers in Brazil are much poorer than other Brazilians and possibly even poorer than farmers in the LDCs, so allowing them to capture the market would actually produce a greater reduction in poverty. It’s possible, but intuitively I’d say it’s not likely.

Recent research has revealed the growth of household overcrowding in London, and the links with poor health (especially a heightened risk of TB infection) and reduced educational attainment. I’ve found some research from Finland which includes this chart comparing European countries using almost the same measure (persons per room, excluding kitchens) which it calls ‘normative overcrowding’, alongside a measure of ’subjective overcrowding’ (in the survey, people were asked whether they felt they had enough space at home or not).

The results are pretty interesting. Probably the most surprising thing is the extremes of overcrowding across Europe - while fewer than 1% of households in the Netherlands are normatively overcrowded (i.e. have more than 1 person per room), an incredible 27% of households in Greece are apparently above the threshold. To be honest, disparities of this size make me wonder how consistent and reliable the results are.

Secondly, there’s the old North/South split: the four countries with the most normative overcrowding are all Mediterraenean. The fifth, Ireland, is on this as on many other social indicators an ‘honourary’ Southern Europe country.

Thirdly, I thought I’d investigate the link with TB. There’s some evidence of a link with a few countries significantly bucking the trend. According to data from the EuroTB project, the two countries with the highest rates of TB notifications in 1996 were Portugal and Spain, both countries with very high overcrowding. But the link breaks down with Greece (very high overcrowding, low TB) and the Netherlands (very low overcrowding, middling-to-low TB).