Global Policy Forum

By Williams Easterly*

Book Review by Dennis Whittle**

The Elusive Quest for Growth, by Bill Easterly, a senior advisor in the research department of the World Bank, is a must read for anyone interested in global development. Its appeal lies in its unprecedented reach and candor in surveying the assumptions and theories underlying the development assistance provided by richer countries and international agencies to poorer countries. Easterly's conclusion is that the emperor (the international aid industry) has almost no clothes.

While one can quibble with the specifics of some of his analysis, the overall effect is a compelling, authoritative book that makes it impossible to avoid facing the fact that the current aid framework needs a radical overhaul. The aid industry has spent about 1 trillion dollars over the last forty years, and the returns have been disappointing.

Fortunately, Easterly points the way toward the beginning of a new wardrobe. There's bad news and good news. The bad news is that nearly all of the theories that drive the design of aid programs are not borne out by the experience to date. Most fundamentally, the formal mathematical models underlying the macroeconomic analyses of organizations such as the World Bank and IMF are built on two plausible but wrong assumptions.

The first of these is that investment drives growth. Unfortunately, the record shows that investment only drives growth in those few cases where it is made in conjunction with appropriate technology, know-how, and a sound overall economic policy environment. The second wrong assumption is that aid increases investment. Extensive analysis indicates that most governments simply consume rather than invest the aid they receive.

The striking thing about these two faulty pillars of the development paradigm is that even the best aid organizations continue to use a framework that they know is wrong. Easterly also takes a sober look at fads that have swept through the field of development. The first of these is education. Many people argued that investment in basic education is the key to stimulating growth, and this has led to massive investments and high hopes. Unfortunately, in retrospect the evidence shows little correlation between education investment and growth.

The same holds true with population control, where the link between population dynamics and growth has proven to be far more complex that originally expected. Easterly does not conclude that the evidence shows that education or population planning is unimportant; to the contrary, they can be effective but only in a broader context where other important conditions are also present.

What are some of these broader conditions that must be in place? Fortunately, we have made some progress in understanding what helps counties develop economically and socially. In particular, there is strong evidence that economic growth is the best way of reducing poverty in developing countries. Contrary to what many think, a one percent increase in overall income in a country tends to translate into a one percent increase in the income of the poorest. And we do know that economic growth itself requires countries to maintain policies that avoid certain pitfalls-in particular, high inflation and budget deficits, excessive black market premiums for their local currencies, negative real interest rates, corruption, and restrictive trade policies.

If we know at least the minimum policies required for growth and poverty reduction, then why don't most countries adopt them? Thus began another chapter in the history of development aid. Beginning in the 1980s, the World Bank, IMF, and others launched a large number of 'structural adjustment' programs designed to support countries' adoption of these policies. Twenty years later, it is clear, however, that many of these programs were ineffective. There is little evidence that aid has had any influence on countries' policies. Instead, policies seem to be driven by the self-interest of the policy makers and the interests they represent.

Easterly's refrain in the book is that 'people respond to incentives,' and this is clearly true at the macro-policy level as well as the household level. One leading edge of thinking about development draws on the simple observation that people tend to associate with people like themselves. Well educated people with access to financial resources, technology, and know-how-some of the main ingredients for economic growth-tend to congregate with and learn from each other. This creates a virtuous cycle for them. Unfortunately the same dynamics hold for the poor. The poor, who tend to be less well educated, have less access to financial resources, technology, and know-how, also tend to congregate with each other. Consequently, the opportunities for learning, investment, and growth are lower.

This raises the obvious question of how we can increase interaction between rich and poor, between the more advantaged and less advantaged. This leads us to the current state of affairs, and ironically offers hope for a common ground between traditional policy economists and the critics of aid and globalization. Many of the critics are implicitly or explicitly arguing against corruption and/or policies that are implemented in a way that make the rich richer and the poor poorer-something that the policy economists agree with. Few people nowadays would disagree on the desirability of low inflation and budget deficits, a fairly valued currency, interest rates that encourage savings, and trade policies that don't force consumer to overpay and that give incentives for people to produce and export goods that can generate wealth.

The real issue is how do we get governments to adopt these policies? And how can countries put in place the institutional capacity and governance arrangements that will ensure that good policies are fairly implemented? And how can we increase the direct connections between rich people and poor people? These are as much political and social challenges as they are economic ones. And they require the policy economists and social activists not to butt their heads together, but to put their heads together to find a solution.

* Williams Easterly is a top ranking economist at the World Bank

** Dennis Whittle is formerly head of Corporate Strategy and Innovation at the World Bank. In October 2000 Whittle left the Bank after 14 years and is now CEO and co-founder of DevelopmentSpace, an open-access social capital marketplace for the international development industry.

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