New ideas about overseas aid may offer lessons for Eurozone debt.

It is a brave person who dares to question the appropriateness of developed countries donating billions of dollars a year to nations deemed to be poor. Hence the fact that Britain’s Coalition Government, while imposing “austerity policies” at home, has protected the country’s aid budget in a move that will see it rise to £11.5bn by 2013. Some politicians have questioned the scale, but the idea that a country such as the UK should give substantial sums away to others is pretty much beyond challenge. And yet questions are being asked about whether the money is well-spent or at least about whether it is being spent in the right ways.

POOR ECONOMICS

One of the most prominent of the doubters is Dambisa Moyo, an economist who has worked at Goldman Sachs and the World Bank and who argues in the book “Dead Aid” that such assistance does more harm than good through, among other things, creating a dependency culture. Although she has the backing of William Easterly, a prominent academic and author of various critiques of aid, hers is still a relatively lonely voice. There seems to be a tendency – on the part of the media, non-governmental organisations and others to back the approach of Jeffery Sachs, a United Nations adviser, academic and author who believes that some countries are caught in a “poverty trap” created by a combination of such factors as disease and infertile land. Such countries, he maintains, can only escape with the help of massive amounts of foreign aid designed to kick-start the sort of activities that can make them more productive.

Into this debate enter two Massachusetts Institute of Technology economists – Abhijit V, Banerjee and Esther Duflo – who have made it their lives’ work to understand the realities of the poor – those living on less than 99 US cents a day. The pair run the Abdul Latif Jameel Poverty Action Lab, which has as its mission to reduce poverty by ensuring that policy is based on scientific evidence. That sounds reasonable until Banerjee and Duflo describe how most decisions about international aid appear to be based on assumptions rather than on hard fact. It is rather as if business leaders devoted their resources to areas based on what they had read in the newspapers rather than on any real research or insights of their own. There is also a tendency to look at the “big issue” rather than breaking it down into little parcels that might respond to intervention.

As they write in “Poor Economics” (PublicAffairs, US; Perseus Books, UK), the fascinating book that has just been named the FT/Goldman Sachs Book of the Year for 2011, “Talking about the problems of the world without talking about some accessible solutions is the way to paralysis rather than progress.” The book is not the result of some sudden blinding flash of inspiration. It is instead the product of extensive research and observations on the ground that have been described in many academic papers. And it is this rare combination of economic analysis and empirical evidence that makes it so compelling and attracted the attention of no less a figure than Bill Gates. The founder of Microsoft-turned-philanthropist, on his blog last month praised the book as being “both empirically rigorous and insightful about the realities that the data doesn’t always capture”.

THE THREE ‘I’s

The book is packed with examples of how what the authors call “the three Is” – ideology, ignorance and inertia – on the part of experts, aid workers or local policy makers often explain why policies fail and why aid does not have the effect it should have. Arguing against “lazy thinking”, Banerjee and Duflo call for “a patient, step-by-step approach”.

Bed nets prevent malaria

One of their examples concerns the much-talked about issue of using bed nets to halt the spread of malaria, the deadly disease that has such an overwhelming impact in many poor countries. The issue divides Sachs on one side from Moyo and Easterly.

The former advocates free net distribution on the grounds that it is a worthwhile investment in reducing disease, while the others object on the grounds that, first, people do not value and therefore probably do not use things that are free and, second, that it could wreck the economics of bed net production in the countries concerned.

Banerjee and Duflo point out that answering this question involves breaking it down into three separate questions. First, if people have to pay something like full price for a net will they prefer to go without? Second, if they receive them for nothing or at a substantial discount will they not be used and so wasted? Third, if they get a net at a subsidised price once will they then be less willing to pay for the next one if subsidies are reduced or removed?

To obtain effective answers, researchers had to observe the behaviour of comparable groups with different levels of subsidy. The emphasis was on “comparable”. Such groups are not necessarily alike. The cleanest way to find the answers was through the sort of randomised trials conducted by drugs companies. They cite an experiment of this type and show how its findings moved the debate on in this area and so influenced policy.

That in itself is helpful. But the real gain is in the information that is gleaned about how poor people behave and make decisions along the way. If you apply this approach not just to poor people in developing countries but to those in developed ones, say, or to other social groups whose behaviour you are trying to change, or “nudge” in the terminology of the currently in-vogue “behavioural economics”, all kinds of decisions about government’s actions and allocations of resources might change. As the economist Diane Coyle notes on her blog, The Enlightened Economist, “the evident applicability of its [the book’s] approach to economic policy anywhere” is what makes it really interesting.

There are doubtless lessons here for any country that is currently wrestling with problems posed by its own citizens living on benefits and trying to decipher how much state aid is part of the problem rather than a proper solution. And of course there are all sorts of extrapolations that could be made about the current Eurozone debt crisis. Does a bail out (read overseas aid) really help a country whose politicians have splurged state largesse instead of using low interest rates and the efficiencies of the world’s largest single market as a mechanism to drive economic modernisation? Whilst most commentators still see the prospect of Greece leaving the Eurozone as an economic catastrophe in the making, many also doubt the wisdom of allowing countries to operate outside the constraints of those that fund them.  In its recent leader on the Greek crisis the Economist newspaper also said “the euro zone’s emphasis on austerity rather than structural reform has aggravated Greece’s political woes. Instead it should favour medium-term fiscal consolidation. The creditor nations could boost domestic demand, to provide a bigger market for debtor’s exports.”

In effect it’s not only the same argument as Bannerjee and Duflo make – that help is best directed towards those that help themselves – it also springs from the same sentiment, that only by doing due diligence on the data do you reach conclusions that will stand the test of time. Anything else is simply poor economics.  

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