Mind of an Economist (10)

The rights of a state

Friday, 12/16/2011, at 3:38 PM
What gives the right to a nation to tell its citizens how to behave? Is it to promote peace and prosperity? Is it to maintain its control over the masses? States were formed to protect against outside invasion. When outside invasion is less likely, why does the state persist in its rights over the masses? These rights can be individual-oriented. For example, individuals are punished if they attempt to end their life or in some countries, take away the right to abort. In theocratic countries, individuals have to follow a particular religion and the state takes away the right to convert to another. What gives a national government the right to acknowledge birth, marriage and death thereby giving them legitimacy? Possible rationalist explanations –

Inertia resulting from history of protection. This is a behavioural explanation because it implies that individuals are used to respecting the state because it has been in existence for a long time and individuals can be brainwashed into nationalism either by the school curriculum or by their brainwashed parents.

Externalities arising on other population members – come up with an institution that is on average concerned with the average person and will exercise control in order to promote the well-being of the average person. Why will an individual not expect a back-lash and thereby not conform to the right behaviour on his/her own? Why do we need gun laws for instance? 

Bundling of the state with religion. Religion is propagated by the state in order to enforce its legitimacy of rights over the individual. It is easier to question the state but not easy to question religion. Can stateand religion together prevent individuals from taking their own decisions? 

If individuals are ignorant of the right actions to take such that they may harm others unintentionally, then the state may have a rationale for having a monopoly over individual rights. This is a very strong assumption as it means that government is somehow made of special people who are less ignorant compared to the masses. Even if individuals are ignorant, why not allow their relatives and friends to make them enlightened. 

Legitimacy of government’s monopoly over individual rights may be a bi-product of the necessity of a government to collect national statistics so that it can exercise dominance in other areas – for instance, collection of taxes.

It may incentivize the masses to try to achieve power and may drive them towards gaining authority. If the government did not have control of our rights, there would be no incentive to join the government except the low fixed wages.

It may act as a co-ordination device for everyone to believe that there is a unitary right and there cannot be heterogeneity of rights.

One of the most enthusiastic students in Econ 111, Andrew Edelman, adds the following to this category:"Multicultural co-unity: These rules allow for a mix of cultures to exist together when they would otherwise conflict.  If you look at countries that were formed through European colonialism, there have both weak governments and, in many cases, tribal conflicts.  In countries such as the United States, England, and even Russia, people with many different nationalities live together under a set of rules separate from their own cultural identities which minimizes conflict."

A related point is that a multiplicity of identities (national, regional, religious) dilutes original identities increasing the possibility of inter-ethnic complementarities.

Government acknowledgements may be a way to signal high-types from low-types. This is dependent on a common belief in the system that the government can exercise credible and effective control over our rights.

If a lack of control over one’s behaviour can affect other state institutions, for example, the quality of state education or health-care, then there may be an argument for the government to monopolize rights.

David Beron, another excellent student of mine states that this could be related to Michel Foucault’s ideas on Humans in terms of numbers: there is a maximum population at which society can efficiently function (considering diminishing marginal product). If the ideology of people fails to control such matters (religion might be an incentive to procreate), the government needs to intervene. Because no invisible hand exists to match people’s non-capital desires with their nation’s “carrying capacity”, the government has to set limits to the "number of slices" in order for "the cake" to grow as a whole. China can be used as an example: people's behavior is restricted by the one child policy and, perhaps a coincidence, the country is currently going through an economic boom.
The above explanations are not mutually exclusive. These reasons are likely to exist in some combination and it would be difficult to differentiate the relative importance of each mechanism.

Institutional successes of the modern world

Tuesday, 9/27/2011, at 10:05 PM

What are the great institutional successes of the modern world? Democracy, rule of law, fiscal policy and monetary policy. How do we know these have been successes? Rules or constraints at the level of the state have been followed by individuals to co-ordinate on an equilibrium such that there is little uncertainty and more opportunities for growth. There is greater power for the individual in a constrained political framework where the executive has constraints on the power and repression. Where the individuals can compete to become leaders and have information about the political parties which compete in an open and transparent manner. These measures are hallmarks of a state that does not have to tinker with exogenous rules to maintain growth. The changes to rules come from within. However, these are examples of political institutions. There can be institutions that work to promote law and order, to collect taxes and to affect the efficiency and equity of the banking system. What I would like to talk more about are the institutions governing the expenditure of taxes. These can in the extreme case go to the leader’s pocket if there are no restrictions – either constitutional (in terms of getting re-elected) or de facto power that the leader exerts by virtue of the weakness of other institutions – such as that of independence of judiciary or media. This is the case in many African countries (like Zimbabwe). How do these institutions change to bring about better targeting of expenditures. To reduce poverty, to improve the quality of life and to bring peace and prosperity into the lives of the national population. Does change come from external sources like conditional aid? Does it come from within – through revolutions and coups? Does it come with time naturally?
Now take a developing country with fairly strong democratic traditions (like India). Here, how should expenditures be targeted. Of course, health and education would take precedence. Within health, how should health workers be compensated? How much to spend on new equipment? How much should be spent on building more hospitals and improving access? These are institutions that are again linked to other political and economic institutions (for example, democracy and how effective the tax system is or if law and order is a problem). There can be failures at this level of institutions if the targeting of expenditures does not have a desired impact. These failures can be sustained if there is a lack of knowledge on the demand side (for example, the population) or even if there is no lack of knowledge – there could be problems of collective action. On the other hand, there could be a supply-side problem too. Here, the workers may not be motivated enough by what the government is paying them and they end up demotivated and reduce their quantity and quality of effort. Successful fixing of such institutions can then mean making workers motivated and improving knowledge among the beneficiaries or by solving collective action through community-based interventions. An example of solving both demand-side and supply-side problems is the microfinance model a la Grameen Bank. Here supply-side problems of adverse selection and moral hazard that lead to high non-performing assets are solved by group credit (social capital is the collateral) and also promising more credit if the loan is repaid. The demand-side problem of inadequate information (about saving, financial instruments, investment opportunities) as well as self-control issues are addressed through regular meetings with stakeholders. Another example could be paying performance pay to child health workers and at the same time educating mothers about health and nutrition. If only performance pay is offered to workers and they improve their inputs, there could be an endogenous feedback such that mothers may reduce their feeding to the children. Similarly, workers may reduce their efforts if mothers increase the inputs at home. Incentivizing workers and mothers to improve their inputs would fix both types of market failures simultaneously and help sustain an institutional equilibrium that improves lives of both health workers and beneficiaries without any negative spillover effects on political and economic institutions.

Link between Agri-growth and malnutrition?

Tuesday, 9/27/2011, at 9:58 PM

In their Economic Times article, ‘Agri-growth and malnutrition’, Gulati, Kumar and Shreedhar put forth an interesting hypothesis: agricultural growth is necessary for a decline in child malnutrition in India. The authors proxy agricultural growth (which is quite volatile) with land productivity and estimate a strong negative correlation between agri-growth and malnutrition. They argue that this implies agri-growth is a necessary condition for combating malnutrition. However, their reasoning is notoriously flawed. First, it is highly contentious if land productivity can be taken as a good proxy for agri-growth. Agri-growth may depend on a state’s institutions – for instance, trading opportunities, law and order, the banking system, quality of governance, access to technological innovation and so on. A state’s institutions are very likely to be correlated with land productivity. Richer countries also tend to have more favourable climates and more fertile lands. This may be driven historically, by higher population growth in fertile areas which fuels more innovation or by the government having better fiscal capacity. In any case, better geographic and soil conditions do seem to lead to a more “developed” state on average. This means that some states are born “lucky” and others are not. If this is the case, it is no surprise we find a negative correlation between land productivity and malnutrition. The real result may be that some states that have better soil conditions tend to have better institutions and also lower malnutrition. It is quite another question, then, to ask what makes better institutions apart from luck.
It is not easy to find determinants of malnutrition. However, the only way to try to unbundle the causes is not to take a state-level approach but a micro-level study. At the level of a city or a village, it may be possible to see what is truly correlated with malnutrition, given the same access to technology, trading and credit opportunities, etc. I study malnutrition among five thousand children (aged 3-6) enrolled in Anganwadis in slums and find that diet, family income, mother’s expenditure on food, mother’s nutritional knowledge, education and other fixed local environmental factors (like prices of products, local water quality, quality of Anganwadi, etc.) all together contribute in explaining only 8% of the variation in child malnutrition this year. This means that child malnutrition among 3-6 year olds may be difficult to predict even given detailed information about their local environment let alone land productivities at the state-level.
There are at least two possibilities: it could be driven through genetic factors – underweight mothers on average have underweight babies and so on. It could also be the knowledge of the mother at the time of child-birth. Several medical studies point to moderate and severe malnutrition being linked to malnutrition within the first two years of birth. It could be dietary habits or the history of immunization and disease during the formative years. If this is the case, it would be futile to improve agricultural growth as it is likely to fail to lead to better outcomes for health. In order to make policy implications, one must make statements that are micro-founded at the level of the family and not the state. It is a common blunder to adhere to state-correlations without digging deeper. Child malnutrition is a complex and difficult problem. It demands a more rigorous solution.        

Do CCTV's deter terrorists?

Tuesday, 9/27/2011, at 9:27 PM
There has been a surge in the amount of low-intensity warfare as a tool to propagate terror. The obvious question to ask is: why has there been a spate of low-intensity bombings in local densely populated areas as opposed to say, the high-intensity bombing of a strategic location?
First, the cost of planning a low-intensity operation is much lower. Second, the cost of executing it by placing ammonium nitrate inside a tiffin box atop a cycle is also very small. Third, the benefit gained by the terrorists through media coverage of the destruction and accompanying terror is relatively significant and contributes to creating distrust between communities. Fourth, the extremely low risk of getting caught makes engaging in terrorism more lucrative for a few local people and organisations funding such activities.
This means that there are broadly only three ways in which we can reduce bombings in low-intensity attacks and not compromise the security of strategic locations:
  • To raise the costs for terrorists of planning and executing low-intensity attacks.
  • To reduce the “benefit” the terrorists obtain from such attacks.
  • To increase their risk of getting caught.
Figure 1 illustrates the equilibrium number of bombings terrorists execute. The two black diagonal lines represent marginal cost and marginal benefit curves, i.e., the planned cost or benefit of bombing one more location in a single terrorist attack. Equilibrium is reached where these two curves intersect. Here, implementing (a) would mean a parallel upward shift of the marginal cost curve and implementing (b) would lead to a shift of the marginal benefit curve leftward. These have not been shown on the diagram. Acting on (a) and (b) by interfering with efficient market mechanisms like putting controls on use of fertilizers or on free media is not advisable as it can have negative spillovers and inefficiency losses.
The only convincing way of dealing with terrorism of this nature is to increase a terrorist’s risk of getting caught on camera in at least one of the locations. This not only raises the costs of planning an attack (making the curve move upward), but also makes the marginal cost curve steeper than before as chances of getting caught increase like an ad valorem tax. The marginal cost curve now becomes the red line and the equilibrium number of bombings carried out in one attack comes down dramatically. By exponentially raising the costs of carrying out one extra bombing, two effects may take place. First, there would be a decline in the number of bombings per terrorist incident (as shown in the graph). Second, there would be a greater incentive to go in for one high-intensity blast at a strategic location. This would work like a substitution effect, whereby a worker tends to reduce the amount of work if marginal tax rate increases. However, it would be a preferable situation for India if we consider this a zero-sum game, whereby raising the costs for terrorists works in the same manner as increasing benefits for India.
Installing Closed Circuit Television (CCTV) cameras in susceptible places like markets, shrines, hospitals and colleges would help garner information on terrorists, should they decide to attack. These cameras may be visible or hidden. These can also be used to detect traffic violations, violence, drug abuse, shoplifting and property theft. Britain had started using CCTV cameras to combat IRA terrorism during the 1970’s and today has the highest amount of camera surveillance in the world. In London, there is a good chance that one will be captured by over 300 cameras in a single day. The only dilemma facing the authorities should be whether to install fixed cameras or Wi-fi enabled cameras. The latter are more expensive, but give the option of higher mobility and thus may indeed be the better option since terrorism seems to be a long-run issue. There are also costs of maintenance and staff to monitor the pictures that must be taken into account in any cost-benefit analysis.
Although studies show a decline in vandalism in London buses and reduced robberies in London Underground stations when they are equipped with CCTV cameras, there is very little quality evidence to suggest the extent of their achievement. This is mainly because of the problem of lack of randomisation when the cameras are installed.
For instance, in order to quantify the degree of success of a drug, a pharmaceutical company will undertake randomised trials, in which a random sample of people is given the drug and others are not. Everything else remains the same for these two groups. This is helpful in finding the true extent of potency of a drug. Similarly, to find out if smaller class groups increase learning ability, a randomised solution has been carried out by economists in Israel. In another experiment, a bank in South Africa lent money at different rates to randomly selected individuals, in order to find its effect on non-performing assets.
Therefore, in order to judge the efficacy of cameras, the police would need to install these cameras at pre-planned locations in randomly selected cities (“treated” cities). The difference in terrorism and crime between the treated and the control cities would be monitored. If the difference changes significantly after the introduction of cameras, it would imply that surveillance is having an effect and, more importantly, the quantitative effect can be found. Furthermore, dummy cameras (which are readily available online) can be used in half the cities and real cameras in others to distinguish the effect of deterrence from just the perception of being under-watch and deterrence from actual catching and punishment.
The problem lies in implementing such an experiment on a large enough scale. In order to give policy recommendations, it is of great importance to delineate causal impacts of policies. Carrying out randomised social experiments will give a fillip to finding out “clean” effects of surveillance on terrorist activities.
Generally the police would like to set these cameras in cities where crime is expected to be high, but this would rule out a way to find the causal impact of CCTV on crime as there would be a selection bias. Moreover, it would be a multi-pronged approach (increased policing, hiring more personnel, etc.) to tackling crime and terrorism, and thus to isolate the impact of CCTV on crime would be impossible.
CCTV is also likely to change the behaviour of people who are not potential offenders. In a survey carried out in Germany to assess perceptions of people to CCTV, it was found that a majority of people like to have cameras installed in malls, banks, railway platforms, and along motorways. However, there is displeasure at placing them at the entrance of residential buildings, in public toilets and in changing or dressing rooms. There is a general concern that being constantly under inspection will adversely affect civil liberties.
Between 1996 and 1998, more than three quarters of the UK government spending on crime prevention went towards CCTV installation and monitoring. It has been shown that effects of CCTV on deterrence are short-lived and not persistent. For instance, the underlying patterns of car thefts in British cities re-emerged after three quarters of low-crime.
The Indian police are waking up to the yawning gap in their surveillance infrastructure. In a recent news article, it was predicted that by 2010, all NCR towns of Haryana would come under hi-tech CCTV surveillance through Wi-fi, hi-band and fiber based surveillance systems covering all major sensitive locations such as the expressway, malls and MNC offices, bus stands and railway stations. Even though there are no randomised studies on the benefits of installing these and several concerns on their use remain, there seems to be a consensus emerging on advantages of having “someone watching over us”.

Framing of a title

Tuesday, 9/27/2011, at 9:21 PM
Think of answers to the following questions:

1. Would you rather have:
a) 99% pure drinking water or
b) Drinking water with 1% impurities

2. Would you rather have?
a) A bird-flu vaccine that is able to save 90% of the lives or
b) 10% of the population will die despite the bird-flu vaccine

3. Would you rather have:
a) Buy 1 + Get 1 free or
b) Buy 2 + Get 50 % off

In all these cases, most people would choose a) even though both options are equivalent. This psychological phenomenon is called “Framing Effect” whereby altering the structures of sentences can lead us to prefer one to another. Neuro-scientists think that there are sections in the brain responsible that help emotions overrule rational decisions leading to framing effects. This has lead many researchers to believe that some people may be more susceptible to framing effects than others. MRI scans on the brain reveal that these may be caused by a section of almond-shaped neurons called amygdalae.

Framing biases affect investing, lending, borrowing decisions and are used by advertisements to capture the attention of a potential consumer. They are used by politicians and economists to mask a snail-slow economy in seemingly robust terms. They are used by students to show off their achievements on the curriculum vitae. By Sainsburys to sell Orange juice and the 'Orange juice' to (mis-)communicate the amount of calories or sugar it has. You may call it a play on the numbers or the words, but it is a combination of amygdalae doing their work and firms maximizing profits.

Prospect theory in economics explains the framing effect by saying that people weigh losses more heavily than equivalent gains and this leads to a bias in favour of the 'positively-framed' statements. In our case, this would correspond to choices a on all the three questions. This revelation puts framing effects on the forefront of Behavioral Economics.

So next time you see John F. Kennedy's famous quote: “Ask not what your country can do for you, but ask, what you can do for your country,” think of framing effects!

For you I have the following question: On a sunny Sunday afternoon, you want to play cricket. So you go to Lillywhites and ask them for a bat and a ball. The salesman says, “The bat costs £1 more than the ball and they together cost £1.10.” Can you guess the price of the ball?

Role of London School of Economics in Indian History

Tuesday, 9/27/2011, at 9:18 PM
The London School of Economics is not merely a congested cluster of buildings in the heart of London. It has also produced leaders who have gone on to shape the lives of millions of people.

When India became independent, the LSE-educated Bhimrao Ambedkar wrote India’s constitution and later went on to champion the rights of untouchables. His bronze bust stands at the entrance of Clement House at LSE. Another figure from LSE who made a deep impact on post-partitioned India was Sardar Tarlok Singh. He was the Director General of Rehabilitation in the Punjab responsible for the resettlement of over ten million refugees. Making two key innovations, he made the biggest refugee resettlement operation a resounding success.

India’s first Prime Minister, Jawaharlal Nehru chose Krishna Menon (from LSE) as a key advisor and India’s defence minister. Menon, who had earlier been India’s first Ambassador to the UK, helped shape the mindset of India that was suspicious of Pakistan but a supporter of socialism. In 1962, China’s victory in a war against an ill-prepared India forced Menon to resign.

Stepping into her father’s shoes in 1966, Indira Gandhi chose P.N. Haksar (also from the LSE) as her Chief Advisor. Haksar had earlier interned with Menon in London.

In an obituary to Menon, P.N. Haksar described how he met Krishna Menon:

I can recall in all its detail the day I met him. I recall the year. It was 1937. The month was November. It was lunch time. I was stepping out of LondonSchool of Economics. Next door to it, in the
Houghton Street
where the School was situated, was a small cafe run by a cheerful Italian. As I was turning towards it. I met Feroze Gandhi (also at the LSE who went on to marry Indira Gandhi). Feroze and I walked into Aldwych past a group of buildings called the Bush House, then on to the Strand, up a flight of dark stairs, we entered a room. There for the first time I saw Krishna Menon.

Under Haksar's strategy, Indira moved sharply to the left. She became the icon of hundreds of millions of India's poor, by adopting socialist economic policies. She eliminated the allocations to India's ex-royalty and nationalized the banking system. Haksar also sought to boost India’s military forces, which helped India win the war against Pakistan in 1971. Her landslide victory soon after was accredited to Haksar’s political and military strategy.

In recent years, India has had KR Narayanan as President in the 1990’s, who happened to study to LSE. IG Patel, ex-Governor of India’s Central Bank served as the Director of LSE from 1984-90. The IG Patel Chair was established in his honour at the LSE last year. In 1998, Amartya Sen was awarded the Nobel Prize in Economics for his work in Development economics, much of which was done as a teacher at the LSE. The influence does not stop here. Many of the world's leading economists working on India are here at LSE, notably, Maitreesh Ghatak, Tim Besley, Robin Burgess, Lords Stern and Desai

and several graduate students.

If a country’s history is decided by the institutions its policy makers went to, LSE can rightfully claim to have had the biggest hand in shaping modern India

Why did Punjab breed terror? A rationalist perspective

Tuesday, 9/27/2011, at 9:13 PM
In many ways the story of Punjab is anomalous to the stylized facts of civil war literature. Empirical literature on civil wars points to a negative correlation between income and likelihood of conflict. There is also cross-country evidence to suggest that rough terrain contributes to greater possibility of violence. Both these facts did not hold in the case of Punjab. However, recent research on terrorism supports the view that terrorism is not correlated with poverty and lower education levels. This is consistent with terrorism in Punjab, where terrorists on average were moderately educated and came from families owning small and medium sized farms.

Having a rural base in Punjab was essential to the terrorist movement as this helped them remain hidden from the police forces. This was despite not having forest cover or rugged terrain. The key to inducing the local population not to denounce the rebels is local knowledge or information about who is doing what at the village level. Local knowledge allows the rebels to credibly threaten retribution for informing the police. Evidence from Algeria by Kalyvas (1999) suggests that ethnic insurgents use this informational advantage to a great extent, often threatening and inflicting harsh sanctions on their own people. In Punjab, kidnapping was an efficient technology used by terrorists to extract their rents and terrorism was informationally extremely localized, especially in villages. This suggests that farmers were deeply affected by terrorism and were acutely aware of the attacks due to a high degree of social capital locally.

The year 1984 saw the Indian Army being deployed in the state because of several incidents of terrorism. A separatist group, Khalistan Commando Force proclaimed the independence of Punjab (calling it "Khalistan") and they along with Bhindranwale took refuge in the Golden Temple, the holy shrine for the Sikhs. In April, extremists simultaneously attacked thirty nine local railway stations located in twelve different districts. On 2nd June, the army sealed off Punjab from the rest of India and seven tanks rolled into the Golden Temple. As has been observed elsewhere, specific events suddenly mobilize large numbers through grievance and coordination and this seems to have been the case after Operation Bluestar. A couple of months later, Indira Gandhi was shot dead by two of her Sikh bodyguards.

In 1985, President’s rule was lifted with the Rajiv Gandhi-Longowal Peace Accord, which referred all contentious issues to several commissions. But the accord was never fully implemented by the central government. In May 1987, due to political instability, President’s rule was imposed again. It has been shown through a theoretical argument that a peace pact may increase conflict in later years because the extremist faction of the separatists would want to grab power from the moderates who signed the accord. This appears to have happened in Punjab.

The death toll due to terrorist violence rose from 1,333 in 1987 to 5,265 in 1991 and tapered to 871 in 1993. By 1994, the police under the leadership of K.P.S. Gill declared that terrorism had been defeated and that normalcy had returned. Along with an increase in police personnel, changes in foreign support due to sealing of borders with Pakistan and the curtailing of ISI funding by Benazir Bhutto contributed to usher in peace. This eventually resulted in both internally generated terrorism and external abetment being wiped out.

In the rationalist strand of explanations for civil conflict, the theory of commitment problems seems to fit the scenario of Punjab. Despite a series of negotiations, there was no breakthrough between the Centre and the separatists. This may have been because of two reasons. First, there were commitment problems, i.e. no credible commitment mechanism for the separatists to believe in the centre’s offers. This would mean that once the extremists handed over their weapons, there would be an incentive for the government to renege on its promises. This commitment problem is prevalent in many civil conflicts and usually can be solved through a credible third-party commitment agency or if the movement is crushed completely as was done in Punjab. Second, issue indivisibilities namely, river water sharing and Chandigarh being made capital of Punjab were issues that did not seem to have a bargaining equilibrium as there may have not been enough alternatives for the groups to choose from. This problem was accentuated by the divisions among the militant groups themselves despite trying to forge alliances through committees. Which of these reasons was more important is an open question, but I think that issue indivisibilities could have been resolved using monetary transfers, but trustworthiness of the government would have always been suspect (which is rational for the terrorists).

During 1987 to 1992, the agricultural growth rate plummeted from 6% to 2%. To analyze how terrorism impacted Punjab’s economy, it is critical to understand how violence affected investment decisions of firms and farmers. A likely mechanism through which terrorism affects investment is through firms facing the threat of extortion of their employees (human capital losses) or loss of property (physical capital losses). The threat of extortion may increase especially if the investment is visible to outsiders, for instance if the farmer has a tractor or a firm has a huge plant. Another mechanism could be through the risk of migration. Due to deterioration of such property rights, investment is likely to decrease. Also, as conflict increases, land would be more difficult to collateralize (and interest rates set higher). This would lead to a reduction in land investment. Terrorism may increase the risk of a regime change and the accompanying redistribution of land would make long-term investment unprofitable. An increase in the probability of dying would also make investment less attractive. Finally, an increased risk of migration would negatively impact investment.

Which of these factors was responsible for a decline in agricultural investment and shutting down of several factories can only be found out by ruling out the others. As of now, because of data availability issues, it is difficult to say which channel was the most important. However, regression analysis shows that violence leading to an increase in the probability of kidnapping (proxying for threat of extortion) turns out to be a significant channel. Such a channel has been ignored earlier in the empirical literature on conflict. It reinforces the anthropological stylized fact that individuals were well informed about terrorist activities. And this knowledge helped them better predict future kidnappings and reduce their investment accordingly.

Corruption Economics 101

Saturday, 10/1/2011, at 5:13 PM

In the 1980’s, the prevailing view was that corruption can be good for growth. Huntington said, “In terms of economic growth, the only thing worse than a society with a rigid, over-centralized, dishonest bureaucracy is one with a rigid, over-centralized, honest bureaucracy.”

In other words, it acted as the lubricant between the rusty wheels of bureaucracy.

But, now, several studies later, the consensus is that corruption is actually bad for growth. Many people compare taking bribes to taxes. However, it is worse than taxes, because taxes distort incentives but corruption goes one step further. It distorts incentives but the outcome is uncertain too. The only incentive to provide a good after taking a bribe for it is, if there is reputation cost involved. It may be better for growth if bribes were fixed and the outcomes certain. Then, corruption would simply be an additional tax.

Corruption is the misuse of public office for private gain. During Suharto’s regime in Indonesia, there was rumored to be widespread corruption and nepotism. Nevertheless, Indonesia recorded high growth during his tenure. This may have been because bribes were reportedly fixed at a constant proportion and the outcomes were generally certain. Suharto’s son, meanwhile, was running the biggest media conglomerate in the country. Of course, Suharto said that it was due to his son’s hard work and talent that he had reached where he had. Edward Miguel, a bright young economist, decided to investigate. What was the effect of being Suharto’s son on the firm’s value? He looked at the firm’s stock market price before and after Suharto fell ill (which happened on a number of occasions and was taken to mean that he may not be President) and compared the fall in the price of the son’s firm with a control portfolio of similar looking firms. What he found astonished him. There was a huge impact on the son’s firm but the control portfolio suffered only a blip. The difference between the two portfolio prices before and after Suharto's illnesses gave us a measure of the value of political connection or nepotism.

It is important to distinguish the different types of corrupt activities. There are two types: with theft and without it. With theft, the government official just pockets all the money and provides, say a driver’s license. Without theft, he gives the government the official price paid by the consumer, but takes an additional fee which he hides. In corruption with theft, corruption can propagate as price charged is usually lower than the official price. Interest of buyers and sellers are aligned, making corruption more persistent. An accounting system that limits theft may reduce corruption.

Banerjee argues that corruption is caused by bureaucrats wanting to make money and governments making laws to prevent them from doing so. Economists try to model corruption as a way to get a product with a certain probability of getting caught. It is the marginal benefit and marginal cost (which depends on law enforcement) of doing so that determines the equilibrium level of corruption.

However, sociological evidence suggests that corruption may also be a cultural phenomenon. In order to test if the sociological explanation holds water, Raymond Fisman and Edward Miguel had a look at the data for New York Parking tickets. Due to diplomatic immunity, foreign diplomats were not required to pay their fines until recently (until when the paper was published!). This meant that effectively the fear of punishment was zero for diplomats of all countries. So the only explanation of systematic patterns of unpaid parking tickets could be due to cultural norms. They found that countries that were more likely to be perceived as corrupt (there are many indices that measure this including a World Bank index and a Transparency International index), were also more likely to have more "corrupt" diplomats.

Apart from trying to change the culture of corruption, there are two ways of reducing it. First, a bottom-up approach in which the locals are given the authority to supervise on projects. Second, the top-down approach, where the authority sends central representatives for monitoring. In a randomized experiment by Ben Olken in Indonesia that focused on road infrastructure, the top-down approach was found to be more effective in reducing over-reporting of use of funds. The grass-root level channel was subject to elite capture as has been found elsewhere in studies on aid and decentralization.

The Big G-School Puzzles

Tuesday, 9/27/2011, at 9:04 PM
1. Why do poor students in government schools undertake extra tuitions costing 12 times more than the government school fees?
• Bad teaching: Teaching in government schools is only to the level required for answering questions in the exam, and not catered to applying concepts.
• Peer pressure: Children see other students doing better than them (who take tuitions) and make the causal inference that tuitions = better marks.
• Parental conscience: “If Sharma ji’s son is taking tuitions, we should also send our son. We can compromise on our living expenses but not our son’s education. Even though we are not educated, we cannot deprive our son of a good education.” [Note: the gender preference in the above statement is intentional.]
• Tuition teachers work harder: As they are paid on an hour basis, they have a greater incentive to put in more effort. The market is competitive as there are a large number of teachers who can provide tuitions.
• Job prospect theory: If a child goes for tuitions, he will get better marks, which will get him to a good college, which will get him a good job.

2. Why do government colleges have a better environment than government schools?
• Motivated students: As there is a cutoff for entry even in government colleges, above average students self-select themselves into government colleges.
• Better teachers: The teachers are paid more and thus better skilled teachers are chosen for college teaching.
• Higher fees: Colleges are not as subsidized as primary schools, so there is a greater incentive to provide better quality because it is charging the students.
• Age: As children mature, they become more subdued (and have a better understanding of complex concepts).
• The good trap: If students understand better, teachers are more effective and this increases the students’ level of understanding leading to a self-reinforcing mechanism.

3. Why do we have “bad teaching” in government schools?
• Self-selection: Bad (under-skilled, under-motivated and over-weight) teachers self-select themselves into positions that require less effort per hour and there is less chance of them getting fired.
• No explicit goals: There are no set goals and often teaching is only to cater to the exams rather than making students better at applying concepts or exploring creative answers.
• Tuition disadvantage: Teachers know that students are going to take tuitions, so why bother? This in turn, leads to more tuition.
• No feedback: Students hardly ever give feedback. They are often shy or instead, they fear retribution if the feedback is not kept anonymous. They are required to uphold teachers as gods and listen to every word without ever questioning them. This leads to moral-hazard (hidden action) for teachers.
• No top-down sticks: The principals of the schools do not care about the quality of teaching as they too have no incentive to monitor classes. There are no explicit goals (except in some cases, marks obtained) which can be addressed to by the teachers by awarding marks copiously.

4. Why do religious schools tend to do “better” than government schools?
• Discipline: Religious schools enforce discipline in code of conduct which regulates the students and makes them fulfill their daily commitments.
• Intrinsic motivation: These schools are often run by people who do not have a monetary goal in mind, but are driven by their passion to instill a value-based education in students (the value being correlated with the religion they represent).
• Self-selection: These students are often brought up in a religious environment at home too. Religious environments at home are arguably correlated with less deviance, less domestic violence, more discipline and less junk food and less idiot box watching (which reinforces their faith).
• Similar preferences: Peers are more often than not of the same religion and the same sex. This leads to a greater social capital and trust and more productivity or greater retribution if one is deviant.
• External support: These schools get a great deal of funding from religious organizations that have a stake in the system and are driven by their zeal to instill their values in the youth.

5. Why do students in government schools lack fluency in English or knowledge about current affairs?
• Teachers’ ability: The government school teachers are on average worse in spoken English and general knowledge.
• Family income: As I observed in our interviews with children who had applied for scholarship, family income is a strong predictor of English fluency of the child. On the other hand, parents may have lower earning potential because they are not good at English. This also leads to a “Bad English trap”.
• Exposure to people who speak better: Low exposure to English-speaking students, teachers, and parents’ social network lowers the bar and makes children end up like those whom they have coffee with (in this case mid-day meals).
• No exam: There are no exams on verbal ability and current affairs in government schools and so no immediate incentive for students.
• Infrastructure and technology utilization: Libraries have locked shelves. Librarians are bored individuals who only care about books not being stolen. The perceived marginal benefit from reading an Enid Blyton or a J.K. Rowling is cipher. There is hardly any hands-on experience to prepare students for the ever innovating tech-world (internet, email, google, video chat, Powerpoints, Windows, etc.).

Is Aid good for growth?

Tuesday, 9/27/2011, at 9:01 PM
Live 8 was a series of benefit concerts in 2005 organized by Bono and Bob Geldof that made the right music for getting aid to Africa. Jeffrey Sachs, a prominent economist at Columbia University, has argued that the developed countries should give more aid to the poorer countries. Leaders of African countries are asking for more. After African colonies gained independence, most got a lot of aid from their ex-colonizers. Yet, after close to $600 billion of assistance, most of Africa is at the same income level as it was in 1970. Why has it lagged behind other developing countries? Why has aid not helped Africa grow as fast as other countries?
One way to check whether aid had an effect on growth is to run instrumented regressions. Instrumented regressions allow us to get a better picture after controlling for the effect that growth would have on the likelihood of getting aid and other factors that may be affecting growth and are correlated with aid. If we run such a regression, we find that aid seems to have no effect on growth. Even more startling is the result that this ineffectiveness remains even if the government follows good policies such as low inflation, more trade and low fiscal deficits.
After 1990, UK declared that it would only give aid to countries who make their political systems more open, tighten constraints on the executive and have regular (and fair) elections. Even after repressive dictatorships turned into repressive pseudo-democracies, conditional aid increased but growth remained elusive.
William Easterly, an economist at New York University, believes that aid should not be given to the governments directly because there is no accountability. Most of this money ends up in the pockets of politicians and developed countries are led to believe that they are uplifting poverty. He says that aid should only be given to countries conditional on them giving the money to an independent institution that supervises and reports how it is being used. Moreover, aid should be project-specific so that we can assess the exact quantitative effect of aid. This may not result in growth (in the short term at least) but would result in human capital development. For example, in Mexico aid was transferred to an independent health research institution that gave cash grants to mothers in return for them sending their kids to school, bringing them for health check ups and giving them nutritional supplements. Comparing attendance and health results showed significant gains. A similar programme was carried out for deworming in Kenya and that too showed an increase in class attendance though not an increase in the marks obtained.
Thus, aid should only be given where its effects can be evaluated against a control group. If it is found to be effective, it could be implemented at a larger scale.
Another view on aid (that is still very much in the minority) is that simple giving aid to the governments might actually be bad for growth. This may be because it may generate incentives for coup attempts and civil wars as there is a bigger pie at stake. A prolonged civil war results in poverty, which means more aid, and this trap between conflict, poverty and aid might just be the reason why we see these three recurring states in Africa.