Saturday, July 28, 2012

The Elusive Quest for Growth: Summary

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II Summary

In The Elusive Quest for Growth, William Easterly will attempt to explain why growth matters, those previous attempts to increase growth that have failed, and his personal perspective on what needs to be done to complete the elusive quest. In his prologue, Easterly begins by comparing this quest, the elusive quest for growth, to other famous quests in history. These include the Golden Fleece, the Holy Grail, and the Elixir of Life. Through this comparison, he tries to highlight the importance of economic growth to worldly development. He then goes on to explain the underlying theme of the book, which is that “people respond to incentives,” and gives the reader a look at what angles he will use to accomplish this task. He expresses this through “four notes to the reader” that conclude the prologue. The first is that the ideas expressed in the book are his own, and not those of the World Bank. The second is that he will not attempt to explain the environment and growth’s effect on it, as he tried in an earlier version and found that he “didn’t have anything useful to say” on the topic. Next, he is not trying to do a comprehensive survey; instead, he will just discuss issues directly related to the subject of the book. Lastly, he will use real-life scenarios called “intermezzos” to show the impoverished conditions that third world countries suffer along with stories of joy that inspire him on the quest for growth.

Chapter One of The Elusive Quest for Growth demonstrates Easterly’s reasons for focusing on the quest for economic growth. He begins by telling of his journey to Pakistan and the surprising amount of poverty and unlivable conditions he experienced there. He follows this with statistics on the correlation between low economic growth and infant mortality and disease rates. The title of one of these sections, “Wealthier and Healthier,” demonstrates in three words the entire meaning of this chapter. He continues with examples and reports linking larger economic growth to a better lifestyle until the end of the chapter when he specifies that higher growth rates are statistically related to increased income and reduced poverty.

Easterly uses the following six chapters to show the fallacies in many other proposed remedies, which he repeatedly refers to as “panaceas.” He presents the evolution of economic thought regarding growth and lists the many panaceas that were proposed as new ideas were created and why they did not come to be correct. In Chapter Two, he starts with an example from when the nation of Ghana first came into existence. Economists thought that this new nation’s plans would result in a 7% per annum growth rate, but instead resulted in barely any growth after years of investment. He then leads into the Harrod-Domar Model. Evsey Domar presented this model in 146, but eleven years later stated that it was not a tool for measuring long term growth and was not even effective anyway. Regardless, many other economists continued to use and believe in this model for centuries to follow. Easterly admits that he was a user of this model at some point too. The basis of this theory is the “financing gap,” which is the amount of money a country should be investing in capital minus the amount of money they actually are able to. The “financing gap” should be filled by aid from other countries to start the growth. Through many examples, in this case counter-examples, Easterly is able to show by the end of the chapter that this theory is not correct and the model should be “laid to rest.”

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The following chapter deals with the Solow Model. Easterly discusses the theory of capital-led growth and the belief that poorer countries will grow at a greater rate than more wealthy countries and eventually catch up. This is known as convergence. He points out that while this sounds good in theory, it rarely happens in the real world because growth is affected by many circumstances other than wealth.

The next subject is education. There existed the belief that an increase of human capital would have a direct effect on growth. However, Easterly gives the results of many studies that show that in many situations there actually exists a negative correlation between these two variables. The main objective of this chapter is that while they can go hand-in-hand, it is not due to the causality of education on growth. Another important point in the chapter was the look back at the Solow Model and the belief that while poor nations will converge on wealthier nations, this convergence is conditional. Easterly does not feel that a nation’s capital accumulation and education, its savings, determine its convergence level.

The cleverly titled chapter “Cash for Condoms?” puts to rest the myth that controlling population is a means of increasing growth. Easterly discusses statistics and studies that disprove this theory and follows with the reasoning behind this. The incorrect assumption is that additional people simply reduce the average GDP per person and does not consider that these people can create additional GDP and perhaps increase GDP per person. Easterly instead argues that growth is a means of decreasing population growth.

“The Loans That Were, the Growth That Wasn’t” discusses policy-based aid. The idea is that countries get aid based on their financial reforms. Easterly uses a myriad of statistics to sum up one major point this is a very ineffective way of choosing which countries receive aid. Any country that puts aside the future to appear to comply with today’s requirement for aid, will receive that aid at a sacrifice of future growth. Countries that received the most aid seemed to grow the least and countries which were probably the most deserving, received the least. Easterly proposes that “we should tie aid to past country performance, not promises, giving the country’s government an incentive to pursue growth-creating policies.”

The final “panacea that failed” is debt relief. Debt relief is the forgiveness of debts of those countries with large foreign debts. In short, Easterly’s response is “too bad it’s your own fault and it won’t help anyway.” He devotes the chapter to showing that the debt of these countries was not bad luck and that relieving their debt will simply lead to the incurrence of a new debt as large as the original.

The third part of the book is entitled “People Respond to Incentives.” It begins with Chapters 8 and , which present converse views on backward nations’ ability to gain higher economic growth from the viewpoint of technological progress. The slightly pessimistic Chapter 8 called “Tales of Increasing Returns Leaks, Matches, and Traps” seems to present the argument that it is difficult for poorer countries to get out of this “trap.” Economic leaks provide a country the ability to gain knowledge from a wealthier country; however, it also provides the entrepreneur with less incentive to start a new idea. Economic matching, the concept that a worker’s production is dependent upon the skill of his co-workers, casts a gloomy outlook on production in poorer countries. The better worker will go somewhere where he is surrounded by other works of his high skill level. The economic trap goes back to the book’s theme of “incentives.” As Easterly states it, “individuals in poor nations face weak incentives, while individuals in rich nations face strong incentives.” This leads to the virtuous and vicious circles. A vicious circle means that new technology is not adopted because skills are too low, and conversely, that skills are not improved because technology is too backward. Easterly then moves on to Chapter , which gives accounts of the power of technology. While the previous chapter blamed technology for the economic trap, this chapter shows how technology can also be more advantageous to those nations with weaker beginnings. He begins by showing how quickly technology has evolved in recent decades. One way to view this progress is that new innovations replace the old ones. In this case, poor nations may “jump in” right away with the newest technology and in many cases be ahead of countries who were using older technology and do not wish to change due to the fact that their workers are already trained for the older method. He does point out that this is not always the case, and there are some unlucky technologies that do not pan out; although, he provides an optimistic view for how a poor country is not always stuck in a trap and is able to turn its economic status around. This all depends upon whether the progress is based on complementation or substitution.

Easterly explains that conditions, luck and government, explain whether a poor country will fall into the large category of stagnation or the exception, catching up to the rich countries. Chapter 10 deals with the first of these luck. Easterly begins with the stories of three people who have fallen “into the vicious circle of illiteracy, unskilled work, and poverty.” One sentence summarizes the idea of the entire chapter. “Growth depends on initial conditions.” Initial conditions are in large part based on luck. While he points out that luck is not overall the largest determinant of economic growth, it does play a role worthy of mentioning. He also spends some of his time writing about mean reversion, falling back towards the mean, to predict that the country with the highest growth rate will tend to have a fall in growth rate, and vice versa. He bases this on the assumption that growth is random. He concludes with a remark about how much consideration luck should be given in growth “luck causes fluctuations around a long-run trend determined by more fundamental factors.”

The government’s role on influencing growth is Easterly’s next focus. Chapter 11, titled “Government Can Kill Growth” takes a look at government policies. The following chapter will deal with corruption in the government. He first searches for causality between government policies and the rates of growth and inflation. As it turns out, he is able to prove a causal relationship between these and many other disastrous effects on growth. He relates this back to his basic theme that people respond to incentives. He cites high inflation, high black market premiums, high budget deficits, strongly negative real interest rates, restriction on free trade, excessive red tape, and inadequate public services as actions that create poor incentive for growth. Next, he moves on to corruption in the government and its effects on growth. Once again, he attempts to prove causality, this time between the level of government corruption and economic growth. Using numerous studies, based on ranking systems, of such categories as “rule of law,” “quality of bureaucracy,” “freedom from repudiation of contracts,” “freedom from expropriation” and “perception of corruption” he is able to prove that each of the first four categories causes change in the final category, “corruption.” He also notes that decentralized corruption has a much worse effect on growth than centralized corruption. Finally, he gives his two ways to end corruption and advance growth. One way is to set up quality instructions that create checks and balances and do not provide opportunity for corruption. The other is to establish policies that eliminate incentive for corruption.

Chapter 1, “Polarized Peoples,” gives a look at how interaction affects growth. He uses an example of six people going out to lunch. If they are to split the bill, each person only feels 1/6 of the weight of any additional item they order. Therefore, they are more likely to order a more expensive entr�e or more food. This is a key theme for this chapter. If people do not have incentives to save, they won’t. This lunch analogy is similar to when multiple interest groups are in charge of an economy. Each will act in their own interest and fail to act in a way that is best for the whole nation. The other concept in the chapter is that in regions where there is a diverse population, there is a worse chance for growth. This is due to the fact that people have been shown to only want improvements, such as in education, if only their own people will be affected. Knowing that someone else will also benefit provides them with less incentive to advance education.

In the final chapter, Easterly steps back and gives a final summation and outlook for the future. He admits that although attempts in the past 50 years to stimulate growth have failed, there is still hope for the future. He does not claim to have a solution to this problem, but instead focuses on three main determinants of affecting growth. He considers these to be the “trinity of governments, donors, and individuals.” Providing incentives to each of these groups is a key to economic growth. He finishes by saying that based on previous performances, economists such as himself have nothing to be arrogant about. However, this is no reason to stop the quest for growth because he has been around the world and has seen exactly why this growth is necessary.



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