People respond to incentives. This tagline is echoed in every chapter of William Easterly’s book The Elusive Quest for Growth. Easterly goes out on a limb to make sure that he can relate any development problem a country may face to this one idea. Sometimes this idea is right on point; incentives are a powerful source of influence over people. However, in his attempt to give the reader one simple answer, Easterly falls short when it comes to development problems that have more to do with human emotion than hard economics.
Easterly seems to hit the nail on the head when it comes to economic matters. People do respond to incentives in this case. For example, chapter six of the book is titled “The Loans That Were, the Growth That Wasn’t”. It focuses on the efficacy of loans made to developing countries by the World Bank and IMF. Easterly posits that the downfall of such loans came as a result of poor incentives to produce sustainable growth.
In the 1980s, the World Bank had an optimistic view of the future of developing countries. Though growth was measured as being close to zero, the World Bank predicted a growth rate of 3.3%. This lead the World Bank and IMF to start a new practice call adjustment lending. This lending allowed developing countries to borrow money from the organizations under the condition that they institute economic policy reforms.
This practice has been highly scrutinized because of its policy of imposing western ideas of how to develop an economy on countries that are not western and have very different resources, governments, and cultures. Easterly does not mention this as a possible source of why adjustment loans fail to produce growth and whether the IMF and World Bank should make an effort to adjust their policies for each individual country.
In addition, Easterly fails to recognize the importance monitoring the implementation of the conditions on adjustment loans. He sets forth a plan to reform the loaning process by making loans conditional on progress in making reforms and the country’s proposed plan, but he fails to outline if he would monitor progress after the loan is made.
However, he does point out the he believes the root of the adjustment loan problem lies in the fact that the World Bank and IMF do not discriminate when making such loans, creating weak incentives for countries to use the money wisely for sustainable growth. In this regard he is right: people respond to incentives. Adjustment loans provide no incentives to invest in the future because the accessibility of such loans allows debtors to use the money for consumption today. If the World Bank and IMF were to put conditions on the loan such as improving infrastructure with a portion of the money or else the country would receive no further loans, this would provide and incentive to properly use the money.
Such a practice is vital to producing long-term growth in developing countries. When governments simply aim to finance current consumption, they do it at the risk of harming future generations. Not only will the next generation have to pay off the previous one’s debt, but it will inherit a poor infrastructure, over exploited natural resources, and hardly any state enterprises. In this case, if the IMF and World Bank do not create incentives to invest in the future, people will not respond.
A similar theme is found in chapter seven of the book titled “Forgive Us Our Debts.” This chapter concentrates on how debt forgiveness has led to poor incentives for countries to adopt economic policy reforms. Like chapter six, Easterly points out that irresponsible governments have the tendency to use loans to finance current consumption at the expense of future generations. Debt forgiveness only enables such bad policies by wiping the slate clean, only to allow these countries to take out more loans in the hopes that these too will be forgiven in the future.
Allowing countries to do this provides weak incentives for creating actual growth within the country according to Easterly. He proposes a plan of reform for debt forgiveness programs. Under his model, only countries that have proven they are using the money wisely for growth would be able to receive forgiveness. This will enhance the incentives to adopt growth enhancing policies instead of ones that only finance consumption. Additionally, forgiveness would only be issued once. Such a policy would further emphasize the importance of progress.
Easterly has shown once again that people to respond to incentives; or lack there of. However, it is important to remember that the opportunity that debt forgiveness affords under one regime can be squandered, while a future government may have honest intentions of policy reform and growth promotion. Therefore, there should be exceptions to the one-time forgiveness policy if a country has changed regimes.
Easterly also explores the concept of “filling the gap” in this chapter. This is a policy that suggests that the IMF and World Bank should finance the difference between the investment a country needs and that country’s savings. Easterly says that this is unnecessary because FDI should do this and if it does not it is a tell-tale sign of bad government policies. However, this is not true in all situations. There are many factors that contribute to a countries inability to attract FDI and they do not all point to bad governance. Easterly overlooks business’ incentives to go to where they can find the cheapest labor or a natural resource vital to production.
“Filling the gap” is also dealt with in chapter two: “Aid for Investment”. This concept was created largely in part to Evsey Domar’s hypothesis that the amount of machinery an economy is proportional to how much it can produce. This idea set off the “filling the gap” movement because it recommended that countries invest in machines in order to produce growth. Developed countries began to send aid in the amount of billions of dollars.
Yet, they failed to recognize that Domar’s model was based on short-term growth in already developed countries that have far different histories than developing countries today. As a result, growth was not seen even in countries that did properly use the money for investment in machinery. This again shows the dangers of believing that economic practices used in western and/or developed countries will work for all countries. Easterly again had the opportunity to touch upon the importance of this issue but passed it by. Perhaps this is because it does not fit into his “people respond to incentives” model because it allows for inappropriate policies, not people, to be the real cause of the problem.
Another problem with “filling the gap” came as a result of the ideas of W.W. Rostow. He believed that foreign aid would stimulate growth which would in turn stimulate investment and saving so that the country could avoid unsustainable debt. On the contrary, countries simply used this aid to finance their consumption. Like the case of debt forgiveness, countries used the loans for consumption because they knew that developing countries would be willing to give money again. This creates weak incentives for the money to be used to invest in machinery that developed countries believed was vital to developing countries’ growth.
However, investment in machines may not even prove fruitful. Chapter three of the book, “Solow’s Surprise: Investment Is Not the Key to Growth”, explains that long-term growth can not be found by investing in capital. With each additional machine the amount of output decreases, making capital goods more vital to growth only when they are limited. More importantly, eventually the number of workers will not be adequate to operate the number of machines present because labor is a fixed good. This points to technology as the only way to increase productivity according to Robert Solow because it increase s the efficiency of labor and in turn the output per worker.
Easterly argues that investment in capital for countries that have a limit supply of it will produce growth in the short-run but it must be followed by investment in technological advancement. This is often difficult because developing countries have less access to such technologies because they attract less FDI which is the force that pulls technology into developing countries. Perhaps this is exactly why developed countries continue to get richer while poor countries have shown virtually no growth through the years.
The fact that developing countries have less access to technology is a very important point, however Easterly seems to gloss over it. Again, perhaps this is because explaining the failure of an economy to perform on the basis of its inability to attract FDI would not fit into his “people respond to incentives” model. It would place the blame on business instead of the countries themselves.
Easterly would probably agree that the only way for nations to attract FDI and in turn make technological advances is to eliminate the issues that stop companies from investing: instability and war. If people do truly respond to incentives than this money would be well spent seeing as problems such as war are the biggest factors keeping businesses from investing in developing countries where labor is cheap. Still, he neglects to mention this in the chapter.
Easterly does address another factor that can lead to a lack of FDI later on in the book. In chapter twelve, “Corruption and Growth”, Easterly explains how corruption negatively impacts the economic growth of countries. He says that there are two kinds of corruption: centralized and decentralized. Centralized corruption occurs when someone within the government sets up a system by which bribes are taken and the profit is shared among the ranks with the largest cut going to the top officials. Decentralized corruption takes place when corruption is occurring at all levels without any guiding force to say how much can be taken for bribes and by whom.
Easterly contends that decentralized corruption is far more damaging because those who are conducting the act have no regard for how much corruption the economy can withstand. According to Easterly’s “people respond to incentives” model, it is understandable that decentralized corruption provides no incentive for limits. In these countries, economies are hurt far more by corruption.
He then suggests that the only way to lessen corruption and thereby attract FDI is to build strong institutions. But it is hard to understand where the incentives for countries to do this is. Easterly is proposing that dictators and other corrupt leaders will willingly create these institutions to check themselves. This is an impossible request. He also suggests that the government be limited in its power over citizens and business. This too is unlikely to happen for the same reason: there is no incentive.
In chapter four, “Educated for What?”, Easterly argues that education is not the miracle cure for low economic growth that it is thought to be. He points to four different studies that show there is no correlation between education and economic growth. The first study found that there was no increase in output per worker when education increased. Another study showed that the disparity in human capital across countries does not have much to do with the disparity of growth across countries.
One study showed that there was no correlation between GDP growth per capita and growth in the years of schooling of the labor force. However, they did admit that there was a positive correlation between the growth of productivity and the initial education of the labor force. Easterly dismisses this by saying that growth is high when human capital is high because the return on investment in physical capital is heightened and eventually these two will balance out. But will they? Easterly provides no empirical evidence to show that this is the case. For many developing countries, industry has hardly began to flourish and partly because companies seek skilled labor. Therefore, education would not only attract business, it would provide for more rapid growth once industry is established in the country. Not only has Easterly missed the point, he has forgotten what the true incentives are once again.
Moreover, Easterly miscalculates the influence of education beyond the simple attainment of skills. Schooling keeps children from becoming engaging in crime, builds self-esteem, inspires creativity, etc. He spoke in an earlier chapter about the importance of technology in stimulating growth. But if no one is obtaining an education, how can technology be created? Again he has missed where the real incentives are.
Chapter five, “Cash for Condoms?”, explores the argument that overpopulation can hinder economic development. He also rejects the idea that family planning can have any effect on population control and believes that handing out contraceptives in the third world is futile.
Yes. People do respond to incentives when they know what they are. It is doubtful that couples contemplate the cost of a condom as opposed to the cost of a child. Moreover, though Easterly may not want to admit it, thirty-three cents is, for some people, a large portion of their daily income and it is hard to dismiss that as incentive to not use condoms. This is not to mention the fact many people may see another child as another worker to bring income into the household. The increase in income from this additional worker serves as the largest incentive for couples to choose not to use condoms even if they are available and affordable.
Easterly even goes one step further and says that population growth is a good thing. According to him, it raises tax revenue and increases the likelihood that new technology will be created to sustain larger populations because of the strain on natural resources. But none of these things would be needed if it weren’t for a larger population. The government would not need as much money because there would be fewer citizens. New technologies would not be needed because there would not be as much of a strain on natural resources. And still, there is no guarantee that these new technologies will ever come into being and stop the depletion of scarce natural resources.
Next, Easterly argues that population growth trends are cyclical. Families in developed countries have fewer children because they spend more time investing in skills for each child. However, families in developing countries have more children because there are low returns on skill investment in the future generation. Therefore, they do not invest in their children as heavily. It sounds as if Easterly is suggesting that parents need to invest in their children more. But this runs contrary to his position that education does not matter.
It seems to be trend throughout the book that Easterly forgets what the real incentives are. For the most part, he is right. People do respond to incentives above all else when it comes to matters of money. We have seen this through the examples of debt forgiveness, aid for investment, and adjustment loans. However, Easterly assumes that this principle holds true when it comes to areas that go far beyond money. Regimes will not give up corruption in order to promote economic growth. Education will pull on parents’ desire for their child to have a better future. Natural resources must be thought of when thinking about population control.
In Easterly’s effort to simplify things he has created many holes in his argument. Perhaps if we were instinctual creatures, human beings would adhere to one principal value such as responding to incentives. But we are a fickle species that sometimes responds more to emotions such as joy and fear. People do respond to incentives; but which ones is the real question.