Economic development policy: Backgrounder and update on research trends, 2013

Rwanda (Millennium Villages)
Rwanda (Millennium Villages)

In October 2013, the World Bank announced that although economic growth in Sub-Saharan Africa was continuing to rise, the level of poverty on the continent remains strikingly high. The Bank’s most recent data notes that 48.5% of the population in the region still lives on $1.25 or less a day. It has become clear that even when certain industries are booming, this does not automatically translate into increased access to a sustainable income, health care, or education for impoverished populations. But what kinds of interventions most quickly and cost-effectively lead to better outcomes for those in need? Experts continue to engage in a lively debate over the best way forward; at the general level, the major current intellectual positions are represented by some key individuals and institutions.

Jeffrey Sachs, Director of Columbia University’s Earth Institute, argues that ending poverty requires an ambitious, integrated approach and foreign aid — if properly administered — can do the job. This view is manifested by the Millennium Villages project, an initiative Sachs directs that pours significant resources into selected African villages to address a range of challenges in agriculture, education, health, infrastructure, gender inequality and business development. Sachs’s latest research paper, “Development, Structure, and Transformation: Some Evidence on Comparative Economic Growth,” co-authored with Gordon C. McCord of U.C. San Diego, draws some new conclusions about the importance of biophysical and geophysical factors in limiting or enhancing development.

The Millennium Villages project has, in any case, received some criticism, notably from economists Michael A. Clemens of the Center for Global Development and Gabriel Demombynes of the World Bank. Clemens and Demombynes argue that the expensive program has not been subjected to the level of evaluation required to determine its true effects. Sachs has since answered these accusations.

In contrast, economists like William Easterly, co-director of New York University’s Development Research Institute and author of The White Man’s Burden, contend that undertaking large-scale aid plans in poor countries often only exacerbates the problems. Easterly believes that truly sustainable development solutions are more likely to be homegrown and more specifically targeted.

Holding yet another view, Esther Duflo and Abhijit Banerjee — co-founders of the Abdul Latif Jameel Poverty Action Lab (J-PAL) at MIT — hesitate to make any generalizations about development policy without undertaking rigorous randomized control trials in the field to understand the root causes of various specific poverty problems.

With all these different theories, what recent evidence do we have on the advantages and disadvantages of various development strategies? The following review, while not comprehensive, can provide a useful starting point:

The end of the microfinance revolution?

Microfinance is often associated with Muhammad Yunus, the Bangladeshi economist who founded Grameen Bank in 1983 to provide small loans to impoverished communities, particularly targeting women. Yunus received much acclaim, including the Nobel Peace Prize, and inspired what some have labeled a “microfinance revolution,” which spawned many other microfinance institutions (MFIs) operating around the world. According to the Microcredit Summit Campaign, as of December 2011, a total of 3,703 MFIs reported reaching 195,014,970 clients.

Uganda_WikipediaHowever, more recently these institutions have come under scrutiny, particularly after a string of people unable to repay their loans committed suicide in the Indian state of Andhra Pradesh in 2010. In a 2013 update to their 2010 paper, economists Abhijit Banerjee, Esther Duflo, and Rachel Glennerster (J-PAL) along with Cynthia Kinnan (Northwestern University) shed some light on the supposed “miracle of microfinance.” The researchers conducted a randomized evaluation of poor neighborhoods in Hyderabad, India, some of which were selected for the opening of an MFI branch and others not. The researchers compared the outcomes of the two groups and found some discouraging results for champions of microfinance: “For those who choose to borrow, while microcredit ‘succeeds’ in leading some of them to expanding their businesses (or choose to start a female-owned business), it does not fuel an escape from poverty based on those small businesses. Monthly consumption, a good indicator of overall welfare, does not increase for those who had early access to microfinance, neither in the short run (when we may have foreseen that it would not increase, or perhaps even expected it to decrease, as borrowers finance the acquisition of household or business durable goods), nor, more tellingly, in the longer run, after this crop of households have access to microcredit for a while, and those in the former control group should be the ones tightening their belts.”

Banarjee et al. also find that access to microcredit appears to have no discernible effect on women’s empowerment in the short or long run, even though this is one of the key goals of many MFIs.

A 2013 paper, “Microfinance and the Challenge of Financial Inclusion for Development,” published in the Cambridge Journal of Economics, provides an overview of recent literature on microfinance. The work also highlights some of the problems with microfinance, insofar as it is seen as a primary solution to poverty alleviation. Author Jayati Ghosh of Jawaharlal Nehru University notes that the “processes and impacts of microfinance cannot be separated from the broader local and macroeconomic dynamics of livelihood and employment, consumption, investment and financial development in general.”

For ongoing updates to the microfinance debate, follow the Center for Global Development’s Microfinance Open Book Blog.

Conditional cash transfers

Another popular way of achieving development goals for poor communities is to grant needy groups money, provided they fulfill certain requirements. The intention behind these conditional cash transfers (CCT) is to incentivize increased spending in targeted areas, such as health or education. One of the most influential CCT programs is Oportunidades, an initiative in Mexico that provides cash transfers to poor households if they can prove their children are regularly attending school, visiting health clinics, and being given nutritional support. Evaluations of the program have found it to be successful in achieving better education and health outcomes for children, both in the short and long term, and it has served as the inspiration for many subsequent CCT programs.

Uganda_WikipediaRecently, some researchers have advocated for improvements to the original Oportunidades-style model. The authors of a 2011 paper in the American Economic Journal: Applied Economics, “Improving the Design of Conditional Transfer Programs: Evidence from a Randomized Education Experiment in Colombia,” experimented with the CCT design, concluding that thinking more deliberately about the transfer goals can have even greater impact. For instance, they find that “simply postponing some of the cash transfers to a large lump-sum, paid at the time when the re-enrollment decision is made (and re-enrollment expenses incurred), increases enrollment in both secondary and tertiary institutions without reducing daily attendance.” They also note that providing financial incentives for graduation rather than mere school attendance leads to even higher levels of daily attendance and higher levels of enrollment at the secondary and tertiary schooling levels.

Unconditional cash transfers

More recently, economists have also been questioning what happens when you remove the conditional aspect of cash transfers. A 2011 study published in the Quarterly Journal of Economics attempted to answer this question by performing an experiment in Malawi in which cash transfers were provided to households with school-age girls. One group received cash transfers conditional on regular school attendance (CCT), while the other group received unconditional cash transfers (UCT). The results of the randomized control trial indicated that although the CCTs increased school enrollment rates and improved regular attendance, the UCTs seemed to reduce teenage pregnancy and marriage rates; the likelihood of being pregnant as a teenager was 27% lower in the UCT arm than in the control group. This leads the authors to conclude: “UCTs to such households can improve important outcomes even though they are not as successful in improving schooling outcomes as CCTs.”

Going even further, the economists behind the non-profit GiveDirectly argue that the best way to help people out of poverty is exactly as the organization’s title suggests: Just give unconditional cash transfers to people in need, no strings attached. But does this work? In June 2013, Jeremy Shapiro (Princeton University) and Johannes Haushofer (J-PAL) announced a plan to evaluate GiveDirectly’s program in western Kenya and released some initial results of the randomized control trial in October 2013. Some of their key findings included:

  • GiveDirectly’s transfers led to a 20% increase in food consumption, which led to a decline in hunger and food insecurity. There was a 30% reduction in the likelihood of the respondent having gone to bed hungry in the preceding week, and a 42% reduction in the number of days children went without eating.
  • The transfers have not appeared to increase spending on temptation goods, such as alcohol and tobacco; instead, the researchers observed particularly strong increases in spending on food and medicine.
  • Transfers increase investment in and revenue from livestock and small businesses; earnings from animal husbandry increased by 48% and total revenue from self-employment increased by 38%.
  • Transfers improve psychological well-being of recipients and their families; they lead to a 0.18 standard deviation (SD) increase in happiness, a 0.15 SD increase in life satisfaction, and a 0.14 SD reduction in stress, as measured by psychological questionnaires and levels of the stress hormone cortisol.

Private sector development

While there is less empirical evidence on the effects of corporate social responsibility, or what Bill Gates calls “creative capitalism,” there has been some recent research on the importance of improving private sector practices in developing countries. In a 2012 paper, Alejandro Drexler (University of Texas – Austin), Greg Fischer (London School of Economics) and Antoinette Schoar (MIT) argue that teaching basic financial literacy in ways that people genuinely understand can play a positive role in improving business practices. Based on results from an experiment in the Dominican Republic, the researchers find that while traditional finance classes have no measurable effect on changing business practices, training programs based on simple “rules of thumb” led to significant improvements in the way businesses managed their finances relative to the control group. They note significant improvements in the likelihood that businesses would keep accounting records, calculate monthly revenues, and separate their business and home financial records.

In addition, in a 2013 paper in the Quarterly Journal of Economics“Does Management Matter? Evidence from India” — researchers ran a field experiment on several Indian textile firms, providing free consulting on management practices and comparing their performance to those that had not received the training. For those firms that received the training, they found: “Adopting these management practices raised productivity by 17% in the first year through improved quality and efficiency and reduced inventory, and within three years led to the opening of more production plants.”

Keywords: Asia, Africa

    Writer: | Last updated: November 7, 2013


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