Euphoric End-of-Poverty Declarations May Be Based on Wrong Premises

Click to read the 2013 Development Cooperation Report - Ending Poverty
Click to read the 2013 Development Cooperation Report – Ending Poverty

Today’s post is by Helmut Reisen, former Head of Research at the OECD Development Centre and author of the Shifting Wealth blog. Erik Solheim, Chair of the OECD Development Assistance Committee will reply tomorrow.

Mostly thanks to China’s supercharged 2000s growth and the related global development impact, extreme poverty (in its 1.25$ PPP/day/person variety) has dropped as a percentage of a growing world population – from 40 to 20% over the past two decades.  Consider this back-of-the-envelope calculation: One percent of GDP growth in China has been associated with 0.34% of GDP growth in countries with an annual Gross National Income (GNI, Atlas method) below 1,035$/year per person that are classified by the World Bank as Low-Income Country (LIC); estimates of poverty elasticity for LICs to growth vary between 1.2 and 3.1 for the 2000s (they are higher than the estimates for the 1990s). Assume a poverty elasticity of 2; then, a percentage point of Chinese growth would lower the LIC poverty headcount by .68%. With roughly 1.1 billion people still in extreme poverty outside China, one percent of China´s growth has translated into 7.7 million poor people less year by year. However, note that while the bottom third of the global income distribution have also made significant income gains, real incomes of the poorest 5% of the world population have remained the same even in the past Golden Age of emerging-country growth.

Millennium Development Goal #1 – to halve extreme poverty by 2015 – was thus reached fairly easily with China as the global poverty reduction machine (and not because leaders signed the Millennium declaration!). A close corollary to developing-country growth performance has been LICs’ eligibility for and graduation from concessional finance. Several countries have graduated from IDA borrowing since 1999, including populous countries such as China, Egypt and Indonesia, with India expected to graduate soon. There are today only 36 LIC countries eligible for concessional finance – grants and soft loans – by the International Development Association (IDA) and the soft windows of the regional development banks. (The Inter-American Development Bank and its soft window, the Fund of Special Operations (FSO), considerably reduced in size). The graduation threshold itself is controversial, however: an outdated LIC/MIC threshold explains that the share of the poor (and, indeed, of the whole population) in LICs has declined over time. With China and India having crossed the threshold, the reduced demand for concessional finance (CF) may partly reflect a statistical artifact.

What arguably accounts better than income levels for CF demand is a country’s domestic capacity of resource mobilization, especially through taxation. Availability of public and private resources for development, coupled with the fall in global poverty, are said to imply that dramatically more funding is potentially available for each poor person. And domestic resources, especially tax receipts, may be mobilized better as result of high raw material income and better tax administrations.

Looking beyond 2015, the target year defined by the Millennium Goals, international organizations and their leaders have increasingly joined a chorus of euphoric We-Can-End-Poverty declarations. OECD boss Angel Gurria proclaimed when the last DAC Report Ending Poverty was presented late 2013 in London: “Ending Poverty Completely and Forever”, seconded by DAC chair Eric Solheim “Eradicating Extreme Poverty Completely – ‘Yes We Can’”.  There are today numerous websites devoted to the goal to end extreme poverty, such as,,, or, which translates a strong belief in the feasibility of poverty eradication. While macroeconomic observers are now abuzz with secular stagnation, China´s forthcoming crash, or emerging market taperitis, this is not the stuff that most of the ODA crowd is familiar with on a professional level. So the End-of-Poverty banner waving seems quite detached now from what can be expected from future growth and seems to extrapolate a trend of global poverty reduction that may have been special to the past decade.

The End-of-Poverty banner waving seems to be based on two influential studies, from the Center for Global Development (CGD) and Overseas Development Institute (ODI), which projected total population in IDA-eligible countries to decline from 3 bn (2012) to 1 bn by 2025 and the global poverty pool to shrink dramatically by 2025 as a result of high per capita income growth. According to these studies, soft CF windows such as the African Development Fund (AfDF), the Asian Development Fund (ADF), the International Development Association (IDA) and also some International Monetary Fund (IMF) facilities would likely face a wave of country graduations by 2025. These studies also foresee a reduced number of selected low-income, post-conflict and fragile countries, mostly in Africa, re-established as the main location for CF-eligibility. A drastically altered client base will have significant implications for the strategic options as well as operational and financial models of IFIs. The strategic choices facing the IFI shareholders are at the heart of the future of the global concessional finance architecture.

Both studies are penetrated by emerging market optimism that underpins their view that “we” can successfully eliminate poverty without continued access to concessional finance. However, there are important shortcomings to both studies on a closer look at technical detail:

  • Both the CGD and ODI studies cited above are start from GDP projections provided by the IMF in its World Economic Outlook (WEO). However, the accuracy of IMF-WEO forecasts is dismal as they have been overly optimistic in the past. Highly optimistic assumptions on the growth of total factor productivity in emerging countries, derived from observations of converging countries in the past decade, have been deployed for projections to 2025. Projecting growth rates over long horizons is hazardous, especially if rates are held constant and do not build in major occasional disruptions to growth, such as from natural disasters and financial crises.
  • Mind the gap: GDP is not the appropriate income concept but GNI, especially in poor countries due to inflows of remittances (that could be used to reduce poverty at home). Disruptions to remittances (e.g. when resource-rich countries send immigrant workers home, as happened recently in Saudi Arabia) can lead to important differences in the growth projections in the two national-account concepts.
  • The two studies also understate the Balassa-Samuelson effect (or Penn effect) of growth convergence in poor countries: the increase in price levels that have accompanied the last decade of high growth in emerging countries may have given rise to estimates for CF demand that are excessively low (The Economist’s brilliant post “Appreciating the BRICs”shows how actual and projected GDP is lowered by holding prices and currencies constant, by correcting for the Penn effect.). Higher prices for services (such as real estate rents, transport cost, schooling) lower the purchasing power of nominal incomes and may lock in the poor below poverty thresholds. The CGD study, e.g., holds all calculations in constant 2009 dollars with the hidden assumption that price levels stay the same. Over a decade-long projection, this leads to massive distortions.
Click to see the original
Click to see the original
  • As poor-country growth over the last decade has been based on expansive monetary policy in OECD countries and on unsustainably high growth in China, a return to normalized rates of global money supply and to sustainable growth in China must receive special attention in growth projections to 2025. (Large emerging countries with high external deficits – Brazil, India, Indonesia, South Africa and Turkey – are supposed to suffer once monetary stimulus is scaled back). Both studies were carried out at a time that many observers  consider now the peak of emerging-country euphoria. Emerging-country optimism has rapidly ebbed with two major sources – ultralight monetary policy in the US notably and unsustainable growth in China – running dry.
  • Finally, there seems to be excessive optimism around about poor countries’ capacity to mobilize their own resources rather than to depend on aid dollars, via redistribution from the “rich” to the “poor” within developing countries. Evaluating poverty levels using expenditures from the national account data helps downplay the problem of rising inequality in many middle-income countries. Whether middle-income countries will, as projected, manage to solve their enormous distributional challenges is yet to be seen.
Click to see original
Click to see original

Ravaillon shows that there is a positive correlation between domestic capacity for redistribution (as indicated by a low required marginal tax rate to close the poverty gap) and a country’s average per capita income. His measure – marginal tax rates on the “non-poor by US standards” required to cover the poverty gap – finds that for most (but not all) countries with annual consumption per capita under $2,000 the required tax burdens are prohibitive—often calling for marginal tax rates of 100 percent or more. By contrast, the required tax rates are very low (1% on average) among all countries with consumption per capita over $4,000, as well as some poorer countries. The tax ratio calculations thus demonstrate that LICs (and even UMICs) have little or no prospect for increasing domestic resources in the medium term to meet these needs.

So there a mismatch between the loudness of the End-of-Poverty chorus and the empirical solidity of the projections on which the official declarations are pegged.

A fascinating survey just released by Gallup cautions also against excessive post-2015 optimism. Gallup’s self-reported household income data across 131 countries indicate that more than one in five residents (22%) live on $1.25 per day or less.  About one in three (34%) live on no more than $2 per day. The World Bank Group recently set a new goal of reducing the worldwide rate of extreme poverty to no more than 3% by 2030, but Gallup’s data suggest meeting that goal will require substantial growth and job creation in many countries. In 86 countries, more than 3% of the population lives on $1.25 per day or less.

extreme poverty percentage population
Click to see original

Even in the OECD, “Ending Poverty Completely and Forever” has not been achieved, as the Gallup global poverty map makes clear. To be sure, OECD leaders have no core competence in eliminating poverty. They would benefit from more modesty. Despite more extended tax, welfare and transfer systems and per capita income levels much higher than in developing countries, most OECD countries have witnessed a remarkable rise in poverty rates during the past fifteen years. In most OECD member countries, relative poverty – defined as the share of people living in households with less than 50% of median disposable income in their country – affected 11% of OECD population in 2010, after taxes and transfers. This was a marked increase of poverty rates compared to 1995. Source? OECD!

Useful links

Can we really end poverty?  Brian Keeley’s report from a debate in London in December 2013 to launch the Development Cooperation Report

Can we really end poverty? The debate

poverty debate
Click to find out more about the debate

What’s it like to be poor? The question might sound dumb, even patronising, but it’s increasingly important to how the development community thinks about poverty. At its heart is the idea that no two people, no two communities, experience poverty in exactly the same way. Causes differ, experiences differ, and so can solutions.

This realisation has deepened greatly over the past 15 years or so, a period covered by the first set of Millennium Development Goals. It’s also a period that has also seen an enormous improvement in how we understand poverty, mainly through the availability of better information. This includes both internationally comparable household surveys and qualitative research like the World Bank’s Voices of the Poor survey.

“Putting these together … we are able to try to understand the different depravations that people experience,” according to Sabina Alkire of the Oxford Poverty and Human Development Initiative, “and the different things that trap people in depravation in different ways. This kind of information … could feed a more adequate response to poverty.”

Dr. Alkire was one of the speakers at last week’s “Can we really end poverty?” debate in London, which we previewed recently. The debate coincided with the publication of this year’s OECD Development Co-operation Report , which examines the prospects and challenges of eradicating $1.25-a-day, or extreme, poverty by, perhaps, 2030. Many advocates believe this target should be included in the next round of Millennium Development Goals, building on the world’s success in halving extreme poverty over the course of the first set of MDGs.

If the international community is to achieve the goal of eradicating extreme poverty, a number of the panelists argued that it will need to do more to move closer to the lives of poor communities and beyond the big global and national averages that can conceal those who are being left behind.

“It’s great that averages improve, but if some individuals don’t meet those, then those averages don’t count for much,” said Homi Kharas of the Brookings Institution, who has been heavily involved with the UN High Level Panel drawing up the post-MDGs development agenda. “We need to be much more fine-grained,” he said, adding that the necessary political will and resources depended on development delivering benefits to all: “We need to be thinking about developing programmes where almost everyone feels they have a stake in the progress of the country.”

Better data and the freer flow of information can help in achieving that, several of the contributors said. It can also go a long way to empowering both local and international communities to press for change. Speaking about the situation in neighbouring India, Priyanthi Fernando of the Centre for Poverty Analysis in Sri Lanka said the country’s freedom of information law had made “a huge difference. Indian bureaucrats don’t like it because they have to be much more accountable, but it has made a difference.”

And referring to the idea of “smart growth,” Jamie Drummond of the ONE advocacy group, pointed to the power that could come from the amount of data that people now have access to. “The exciting thing is when data gets into people’s hands. That’s empowerment, that’s the ‘killer app’ – it’s transformational,” he said, adding that it was “opening up a world of possibilities” to hold leaders and businesses accountable.

Inevitably, any discussion based on the premise of “ending poverty” couldn’t avoid one key question: Can it be done?

“Confident, no,” said Dr. Kharas, “hopeful, yes.” Erik Solheim, chair of the OECD Development Assistance Committee, was more upbeat. “There’s absolutely no doubt that we can eradicate absolute poverty by 2030,” he said, but then touched on another of the recurring “big picture” themes of the evening – the politics of poverty: “The issue that could stop us is that we’re not able to mobilise the political will.” Climate change was also a threat, he warned, but pointed to the success of Brazil in simultaneously tackling deforestation and reducing poverty. And he finished with an exhortation: “To me we should adopt the slogan of Nike: Just do it!”

Useful links

DAC Chair Erik Solheim says we can eradicate extreme poverty

OECD work on development

Can we really end poverty?

poverty debate
Click to find out more about the debate

Development issues are often shrouded in a fog of jargon – “institutional capacity building”, “accountability”, “concessional lending”. The list goes on (and on and on …). But, occasionally, an idea emerges that is strikingly clear. The latest is this: End extreme poverty by the year 2030.

OK, so there’s one word in there that might need explaining – extreme. To explain, extreme poverty is usually defined as people living on less than $1.25 a day, although it also carries a sense of people lacking the most basic resources in terms of food, shelter, access to healthcare and so on. Understand that, and the fact that perhaps around 1.3 billion people worldwide live on less than $1.25 a day, and the ambition of the goal of eradicating such poverty becomes clear.

Can it be done? Growing numbers of people believe it can, including no less than President Barack Obama who, in his 2013 State of the Union speech, declared that the U.S. would join the effort to end “extreme poverty in the next two decades”.

The idea is also at the core of the latest edition of the OECD’s Development Co-operation Report, which carries the simple subtitle “Ending Poverty”. And it’s the topic of a special debate in London next week, organized by the OECD and Intelligence Squared, where speakers like Homi Kharas of the Brookings Institution and Priyanthi Fernando of Sri Lanka’s Centre for Poverty Analysis will discuss the prospects for, and challenges of, ending extreme poverty (more details below).

Despite the ambitiousness of this goal, the prospects for achieving it look reasonably encouraging. As we’ve noted before on the blog, the long-term trend of extreme poverty is downwards. In 1820, it’s estimated that around 84% of people on the planet were living in extreme poverty. In other words, only around three in 20 people weren’t poor. More recently, it’s now generally believed that the Millennium Development Goal of halving extreme poverty has already been met, ahead of the 2015 deadline (although much of this fall is attributable to large-scale poverty reduction in China).

So what’s to stop us going all the way and finally eradicating extreme poverty, possibly as part of the next round of Millennium Development Goals?

Writing in the upcoming Development Co-operation Report, Andy Sumner of King’s College, London says it’s “entirely feasible” to meet this goal, or come very close, by 2030, but only under the right conditions. One of those conditions is strong economic growth; the other is a fall in income inequality within countries.

That last point is interesting: As we’ve noted before, Andy Sumner has done some fascinating work to explain where exactly the poor live. In the 1990s, this wasn’t an issue: The poor lived in poor countries. Today, the picture is less clear-cut. Around half of the world’s poor live in China and India, both of which are now classed as middle-income countries. What happens in these countries – especially in terms of income distribution – will go a long way to determining the world’s success in eliminating poverty.

But as Andy Sumner also points out, eradicating extreme poverty won’t mean the end of poverty. The $1.25-a-day figure is just one of several poverty indicators, and a very low one at that. “Poverty does not end above one or two dollars a day,” he writes, “the risk of falling into poverty may only diminish when people reach about $10 a day.”

That point is echoed by another contributor to the Development Co-operation Report, Andrew Shepherd of the UK’s Overseas Development Institute, who focuses on the poor living in fragile states. He argues that it’s important not just to help people out of long-term poverty, but to ensure they stay out of it. Doing that, he says, requires bold action, including “unthinkable” steps like providing families with conditional cash transfers and rethinking approaches to agriculture, education, energy and employment. Policy makers, he writes, “must be prepared to borrow ideas and experiences from other societies, and to take some risks on behalf of the poorest.”

Can We Really End Poverty?, an OECD/Intelligence Squared debate, takes place on Thursday 5 December, 2013, at the Royal Institute of British Architects in London. The event is sold out, but you can join the waiting list for tickets by contacting [email protected]. The event will be streamed live starting at 7pm London time (that’s 1900 GMT, 2pm in New York, 8pm in Paris and 4am in Tokyo). You can also follow the run up to the debate on Twitter using the hashtag #PovertyDebate.

Useful links

Development Co-operation Report

OECD Insights: From Aid to Development

Rich Man, Poor Man: Poverty, then and now

They don't look very industrious to me
They don’t look very industrious to me

In the first of three postings on wealth distribution, we look at changing attitudes to poverty.

Should we should try to end poverty? “Yes,” you reply, and wonder why we’d even ask.

People in earlier times would have been surprised, too. And for them, the answer would have been equally obvious – “no.” Well into the 19th century, poverty was widely seen as inevitable: Economists estimate that in 1820 around 84% of the earth’s population lived in absolute poverty, or on the equivalent what we now call “a dollar a day” (it’s actually $1.25). Poverty was also seen as useful: “Everyone but an idiot knows that the lower classes must be kept poor or they will never be industrious,” the English writer and traveller Arthur Young wrote in 1771.

That quote comes from a fascinating paper by Martin Ravallion, which traces – from an economist’s perspective – the great shift in attitudes towards poverty over the past three centuries. For much of that time, poverty was regarded as necessary: “True, it was miserable for the poor,” as The Economist commented recently. “But it also kept the economic engine humming by ensuring the availability of plentiful cheap labour.” Not just cheap, but uneducated: “To make the Society happy and People easy under the meanest Circumstances, it is requisite that great Numbers of them should be Ignorant as well as Poor,” the 18th century economist Bernard de Mandeville wrote.

That’s not to say that the poor didn’t have their defenders. But, as Ravallion points out, efforts to help them were focused on easing suffering, not eradicating poverty. Workhouses began to appear in Europe in the early 17th century: “Welfare recipients were incarcerated, where their ‘bad behaviours’ could be controlled, and obliged to work for their upkeep.”

When did attitudes change? Ravallion traces the beginnings of the First Poverty Enlightenment to the late 18th century, and the coming together of several key ideas, such as the French Revolution’s “liberty, equality, fraternity,” which established a moral case for regarding the poor as equal human beings. Later, industrialisation would help make the case for mass education, which raised individuals’ economic prospects. Over time, acceptance also grew for the construction of social safety nets and at least some income distribution.

Today, it’s hard not to feel a bit smug when confronted with the attitudes of the past. In two centuries, we’ve gone from a world where “all countries were sick and poor and life expectancy was below 40,” in the words of Hans Rosling, to one where a significant number of countries are rich and where the Millennium Development Goal of halving absolute poverty was met “five years ahead of the 2015 deadline”. Few now would argue against poverty eradication.

But as the work of Amartya Sen has shown, narrow measures only tell part of the story: Poverty is not simply a lack of wealth but can also represent a lack of access to things like healthcare, decent education and economic opportunity.

We associate these problems mostly with developing countries, but they are also issues in the wealthy world, where there are concerns about signs of a gradual rise in relative poverty. Relative poverty is typically calculated as the number of people living below a “poverty line”. For developed countries, the OECD places the line at 50% of median income. Median income is the point in the income range  (after taxes are paid and state transfers received) that separates the top 50% of earners from the bottom 50%.

Between the mid-1980s and the late 2000s, relative poverty rose in 16 of 19 OECD countries for which data are available, and there has also been an uptick in child poverty. As a recent Unicef report said (and as we noted here on the blog), children living in relative poverty are “to some significant extent excluded from the advantages and opportunities which most children in that particular society would consider normal”.

Those disadvantages are especially clear in education, where the OECD’s PISA assessments have shown a clear link between family background and how well students do in high school. And they continue in tertiary education: If your parents went to university, the odds rise substantially that you’ll go too.

Many experts argue that these patterns of educational disadvantage are set very early in a child’s life, and that more needs to be done tackle them by investing heavily in pre-school and early education. But rallying support can be difficult: The benefits can take decades to appear and, as The Economist noted recently, some critics argue that such early interventions represent overreach by the state.

More than two centuries on from the era of Arthur Young, it’s clear we no longer believe that people should be kept poor or deprived of educational opportunities. But, it seems, we’re still figuring out how best to ensure that these opportunities reach everyone.

Useful links

OECD work on poverty reduction, income inequality and inclusive growth
Divided We Stand: Why Inequality Keeps Rising (OECD, 2011)

Will the bottom billion always be with us?

Click to go to the Forum website
Click to go to the Forum website

I know a photographer who worked in the Egyptian oases at the time when the people living there became poor. Their wealth and number of possessions didn’t change, but with the arrival of television and other modern media, they suddenly learned that they were living in a backward, disadvantaged area. Until then, they’d believed that they had everything you needed for a good life – food, water, animals, plants, friends, feuds… But they didn’t have fridges, schools, and most of the other goods and services to be found in the city. At the same period, people who lived in a metropolitan slum would not have considered themselves rich just because they had a TV, electricity and most of the other things the Bedouin lacked.

Poverty then isn’t just a question of income. The newly-published 2013 UN Human Development Report looks at two measures: poverty defined in strictly monetary terms as living on less than $1.25 a day, and the Oxford Poverty and Human Development Initiative’s Multidimensional Poverty Index (MPI). The MPI has three dimensions and ten indicators, all equally weighted, which reflect some Millennium Development Goals and international standards of poverty. The three dimensions are health, education and living standards; while the indicators are nutrition, child mortality, years of schooling, school attendance, cooking fuel, sanitation, water, electricity, type of floor of the dwelling, and assets.

The data support the optimism of the UN report’s title “The Rise of the South: Human Progress in a Diverse World”. More than 40 countries in the developing world have done better than expected in human development terms in recent decades, with their progress accelerating markedly over the past ten years. Of 22 countries having data on MPI poverty over time, 18 reduced MPI significantly, and most of them reduced multidimensional poverty faster than income poverty.

On current trends, half the 22 countries would eradicate MPI within 20 years and 18 within 41 years, but it would take 95 years for all 22 to eradicate multidimensional poverty.

What about the “bottom billion”, the poorest of the poor? In this article in 2010, Brian Keeley discussed Andy Sumner’s argument that if we focus on the poorest countries, we’ll actually miss most of the world’s poor. The new figures suggest that where the bottom billion live depends on whether you look at national averages, the subnational  level or the intensity of poverty experienced by each poor person.

At national level, the bottom billion are concentrated in the 30 poorest countries. But the situation can vary significantly from one region to another within a given country. For instance in Tanzania, 32.4% of the people in the Kilimanjaro region were poor in 2010, but the figure rises to 87.4% in the Dodoma region just 250 miles (400 km) away. Looking at 265 subnational regions, the bottom billion are spread across 44 countries.

The bottom billion by individual poverty profiles more than doubles the number of countries to 100. This is calculated by starting with people who are deprived in all 10 indicators. This gives 17 million in all, with India and Ethiopia having 4 million each. You then add people who are deprived in 95% of the indicators and so on until you reach 1 billion.

Surprisingly, 9.5% of the bottom billion live in upper Middle Income Countries, and 41,000 of the poorest bottom billion live in five High Income Countries. Unsurprisingly, 51.6% reside in South Asia, 32.7% reside in Sub-Saharan Africa, and 12.3% reside in East Asia and Pacific. Nearly 40% of the bottom billion poor reside in India.

But to get back to the optimism. Bangladesh was the original international “basket case” (a term used by the Henry Kissinger-led State Department in 1971). The image persists, but in reality Bangladesh is one of the three top performers in reducing MPI, along with Nepal and Rwanda. The Economist argues that it got out of the basket thanks to four factors: it improved the status of women; the Green Revolution and remittances boosted incomes; the government maintained social spending; and non-government organisations managed to scale up their programmes to work nationwide.

You may have noticed that The Economist doesn’t cite economic growth. The Human Development Report says something similar: “Economic growth alone does not automatically translate into human development progress. Pro-poor policies and significant investments in people’s capabilities  – through a focus on education, nutrition and health, and employment skills – can expand access to decent work and provide for sustained progress. The 2013 Report identifies four specific focuses for sustaining development momentum: enhancing equity; enabling participation of citizens, including youth; confronting environmental pressures; and managing demographic change.

These themes will also be discussed at the OECD Global Forum on Development on 4-5 April. The Forum will be looking at how the global economic landscape has changed, and with it, the understanding of what development and poverty are all about. For example the session on the multidimensional nature of poverty will highlight the links between poverty reduction, natural resource management and growth as issues that are central to social protection and pro-poor growth.

Useful links

The OECD Global Forum would like to hear your opinions on the major themes.

Click here to discuss: Post 2015: Effective partnerships for development in a changing world

Click here to discuss: Beyond Poverty reduction: The challenge of social cohesion in developing countries

Click here to discuss: Measuring poverty, well-being and progress: Innovative approaches and their implications for statistical capacity development

Click here to discuss: The global-national nexus and country-level policy actions

The 2010 edition of the OECD Development Centre’s Perspectives on Global Development: Shifting Wealth pioneered the topic of shifting wealth and the impact of emerging economies on the development of Low Income Countries, taken up in this year’s Human Development Report. The 2012 edition of Perspectives looking at the impact of shifting wealth on social cohesion has an extensive analysis of poverty trends and measures.

Getting Globalization Right: China Marches to its Own Beat

Foreigners are welcome if they foster domestic capabilities

Today in collaboration with Americas Quarterly, we’re publishing the last of a series of three articles on globalisation and the fight against poverty by Dani Rodrik, Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University.  You can read a print version in AQ’s Spring 2012 edition on social inclusion (online version here) and the first article in the series here

China’s experience offers compelling evidence that globalization can be a great boon for poor nations. Yet it also presents the strongest argument against the reigning orthodoxy in globalization, which emphasizes financial globalization and deep integration through the World Trade Organization (WTO). China’s ability to shield itself from the global economy proved critical to its efforts to build a modern industrial base, which would in turn be leveraged through world markets.

Since 1978, income per capita in China has grown at an average rate of 8.3 percent per annum—a rate that implies a doubling of incomes every nine years. Thanks to this rapid economic growth, between 1981 and 2008 the poverty rate in China (the percent of the population below the $1.25-a-day poverty line) fell from 84 percent to 13 percent, much of it from reducing rural poverty. This meant a whopping 662 million fewer Chinese in extreme poverty, a number that accounts for virtually the entire drop in global poverty over the same period.

During the same period, China transformed itself from near autarky to the most feared competitor on world markets. That this happened in a country with a complete lack of private property rights (until recently) and run by the Communist Party only deepens the mystery.

China’s big break came when Deng Xiaoping and other post-Mao leaders decided to trust markets instead of central planning. But their real genius lay in their recognition that the market-supporting institutions they built, most of which were sorely lacking at the time, would have to possess distinctly Chinese characteristics.

China’s economy was predominantly rural in 1978. A Western-trained economist would have recommended abolishing central planning and removing all price controls. Yet without a central plan urban workers would have been deprived of their cheap rations and the government of an important source of revenue, resulting in masses of disgruntled workers in the cities and the risk of hyperinflation.

The Chinese solution to this conundrum was to graft a market system on top of the plan.

Communes were abolished and family farming restored, but land remained state property. Obligatory grain deliveries at controlled prices were kept in place, but once farmers had fulfilled their state quota they were now free to sell their surplus at market-determined prices. This dual-track regime gave farmers market-based incentives and yet did not deprive the state of revenue nor deprive urban workers of cheap food.  Agricultural productivity rose sharply, setting off the first phase of China’s post-1978 growth.

Another challenge was how to provide a semblance of property rights when the state remained the ultimate owner of all property. Privatization would have been the conventional route, but it was ruled out by the Chinese Communist Party’s ideology.

Once again, an innovation came to the rescue. Township and village enterprises (TVEs) proved remarkably adept at stimulating domestic private investment. They were owned not by private entities or the central government, but by local governments (townships or villages). TVEs produced virtually the full gamut of products, everything from consumer goods to capital goods, and spearheaded Chinese economic growth from the mid-1980s until the mid-1990s. The key to the success of TVEs was the self-interest of local governments, which would reap substantial income from their equity stake in the enterprises.

China’s strategy to open its economy to the world also diverged from received theory. The Chinese leadership resisted the conventional advice to remove trade barriers. Such an action would have forced many state enterprises to close without doing much to stimulate new investments in industrial activities. Employment and economic growth would have suffered, threatening social stability.

The Chinese decided to experiment with alternative mechanisms that would not create too much pressure on existing industrial structures. While state trading monopolies were dismantled relatively early (starting in the late 1970s), what took their place was a complex and highly restrictive set of tariffs, nontariff barriers and licenses restricting imports. These were not substantially relaxed until the early 1990s.

In particular, China relied on Special Economic Zones (SEZs) to generate exports and attract foreign investment. Enterprises in these zones operated under different rules than those that applied in the rest of the country; they had access to better infrastructure and could import inputs duty free. The SEZs generated incentives for export-oriented investments without pulling the rug out from under state enterprises.

What fueled China’s growth, along with these institutional innovations, was a dramatic productive transformation.

The Chinese economy latched on to advanced, high-productivity products that no one would expect a poor, labor-abundant country to produce, let alone export. By the end of the 1990s, China’s export portfolio resembled that of a country with an income-per-capita level at least three times higher than China’s.

Foreign investors played a key role in the evolution of China’s industries. They created the most productive firms, introduced new technology to the economy, and became the drivers of the export boom. The SEZs, where foreign producers could operate with good infrastructure and with a minimum of hassles, deserve considerable credit.

But if China welcomed foreign companies, it always did so with the objective of fostering domestic capabilities. It used a number of policies to ensure that technology transfer would take place and that strong domestic players would emerge. Early on, they relied predominantly on state-owned national champions. Later, the government used a variety of incentives and disincentives to foster joint ventures with domestic firms (as in mobile phones and computers) and expand local content (as in autos). Cities and provinces were given substantial freedoms to fashion their own policies of stimulation and support, which led to the creation of industrial clusters in Shanghai, Shenzhen, Hangzhou, and elsewhere.

Many of these early policies would have run afoul of WTO rules that ban export subsidies and prohibit discrimination in favor of domestic firms—if China had been a member of the organization. Chinese policy makers were not constrained by any external rules in their conduct of trade and industrial policies and could act freely to promote industrialization.

By the time China did join the WTO, in 2001, it had created a strong industrial base, much of which did not need protection or nurturing. China substantially reduced its tariffs in preparation for WTO membership, bringing them down from the high levels of the early 1990s (averaging around 40 percent) to single digits in 2001. Many other industrial policies were also phased out.

However, China was not yet ready to let the push and pull of global markets determine the fate of its industries. It began to rely increasingly on a competitive exchange rate to effectively subsidize these industries. By intervening in currency markets and keeping short-term capital flows out, the government prevented its currency (renminbi) from appreciating, which would have been the natural consequence of China’s rapid economic growth.

Explicit industrial policies gave way to an implicit industrial policy conducted by way of currency policy.

Asia’s economic experience violates stereotypes and yet offers something for everyone. In effect, it acts as a reflecting pool for the biases of the observer. If you think unleashing markets is the best way to foster economic development, you will find plenty of evidence for that. If you think markets need the firm, commanding hand of the government, well, there is much evidence for that too.

Globalization as an engine for growth? East Asian countries are a case in point. Globalization needs to be tamed? Ditto. However, if you leave aside these stale arguments and listen to the real message that emanates from the success of the region, you find that what works is a combination of states and markets. Globalization is a tremendously positive force, but only if you are able to domesticate it to work for you rather than against you.

You become what you produce. That is the inevitable fate of nations. Specialize in commodities and raw materials, and you will get stuck in the periphery of the world economy. You will remain hostage to fluctuations in world prices and suffer under the rule of a small group of domestic elites.

If you can push your way into manufactured and other modern tradable products, you may pave a path toward convergence with the world’s rich countries. You will have greater ability to withstand swings in world markets, and you will acquire the broad based, representative institutions that a growing middle class demands, instead of the repressive ones that elites need to hide behind.

Globalization accentuates the dilemma because it makes it easier for countries to fall into the commodities trap.

The international division of labor makes it possible for you to produce little else besides commodities, if that is what you choose to do. At the same time, globalization greatly increases the rewards of the alternative strategy, as the experiences of Japan, South Korea, Taiwan, and China amply show.

Sustained poverty reduction requires economic growth. A government committed to economic diversification and capable of energizing its private sector can spur growth rates that would have been unthinkable in a world untouched by globalization. The trick is to leverage globalization through a domestic process of productive transformation and capacity-building.

Useful links

This series is adapted from Dani Rodrik’s The Globalization Paradox: Democracy and the Future of the World Economy published by Norton

Americas Society – Council of the Americas

OECD work on China

Perspectives on global development (publications from the OECD Development Centre)

Natural Resources and Pro-Poor Growth: The Economics and Politics

OECD work on poverty reduction and social development

OECD work on the benefits of trade liberalisation

Getting Globalization Right: The Japanese Exception

明治大帝,before Westernisation

Today, in collaboration with Americas Quarterly, we’re publishing the first of a series of three articles on globalisation and the fight against poverty by Dani Rodrik, Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University.  You can read a print version in AQ’s Spring 2012 edition on social inclusion (AQ’s own version of the article is here).

The proximate cause of poverty is low productivity. Poor people are poor because their labor produces too little to adequately feed and house them, let alone provide adequately for other needs such as health care and education.

Low productivity, in turn, has diverse and multiple causes. It may be the result of lack of credit, lack of access to new and better technologies, or lack of skills, knowledge or job opportunities. It may be the consequence of small market size, or exploitative elites, in cahoots with the government, who block any improvement in economic conditions that would threaten their power.

Globalization promises to give everyone access to markets, capital and technology, and to foster good governance. In other words, globalization has the potential to remove all of the deficiencies that create and sustain poverty. As such, globalization ought to be a powerful engine for economic catch-up in the lagging regions of the world.

And yet, the past two centuries of globalization have witnessed massive economic divergence on a global scale. How is that possible? This question has preoccupied economists and policy makers for a long time. The answers they have produced coalesce around two opposing narratives.

One says the problem is “too little globalization,” while the other blames “too much globalization.” The debate on globalization and development ultimately always comes back to the conundrum framed by these competing narratives: if we want to increase our economic growth in order to lift people out of poverty, should we throw ourselves open to the world economy or protect ourselves from it?

Unfortunately, neither narrative offers much help in explaining why some countries have done better than others, and therefore neither is a very good guide for policy. The truth lies in an uncomfortable place: the middle. It’s a point best illustrated by the country that has contributed the most—given its overall size—to the reduction of poverty globally: China. China, in turn, learned from Japan’s example, as did other successful Asian countries.

In the aftermath of the Industrial Revolution, globalization enabled new technologies to disseminate in areas with the right preconditions, but also entrenched and accentuated a long-term division between the core and the periphery. Once the lines were drawn between industrializing and commodity-producing countries, strong economic dynamics reinforced the division. Commodity-based economies faced little incentive or opportunity to diversify. As Jeffrey G. Williamson shows, this was very good for the small number of people who reaped the windfall from the mines and plantations that produced commodities, but not very good for manufacturing industries that were squeezed as a result. The countries of the periphery not only failed to industrialize; they actually lost whatever industry they had. They deindustrialized.

Geography and natural endowments largely determined nations’ economic fates under the first era of globalization, until 1914. One major exception to this rule would ultimately become an inspiration to all commodity-dependent countries intent on breaking the “curse.” The exception was Japan, the only non-Western society to industrialize prior to 1914. Japan had many of the features of the economies of the periphery. It exported primarily raw materials – raw silk, yarn, tea, fish – in exchange for manufactures, and this trade had boomed in the aftermath of the opening to free trade imposed by Commodore Matthew Perry in 1854. Left to its own devices, the economy would have likely followed the same path as so many others in the periphery.

But Japan had a local group of well-educated, patriotic businessmen and merchants, and even more important, following the Meiji Restoration of 1868 a government that was single-mindedly focused on economic (and political) modernization. That government was little moved by the laissez-faire ideas prevailing among Western policy elites at the time. Japanese officials made clear that the state had a significant role to play in developing the economy, even though its actions “might interfere with individual freedom and with the gains of speculators.”

Many of the reforms introduced by the Meiji bureaucrats were aimed at creating the infrastructure of a modern national economy: a unified currency, railroads, public education, banking laws, and other legislation. Considerable effort also went into what today would be called industrial policy – state initiatives targeted at promoting new industries. The Japanese government built and ran state-owned plants in a wide range of industries, including cotton textiles and shipbuilding. Even though many of these enterprises failed, they produced important demonstration effects. They also trained many skilled artisans and managers who would subsequently ply their trade in private establishments.

Eventually privatized, these enterprises enabled the private sector to build on the foundations established by the state. The government also paid to employ foreign technicians and technology in manufacturing industries and financed training abroad for Japanese students. In addition, as Japan regained tariff autonomy from international treaties, the government raised import tariffs on many industrial products to encourage domestic production.

These efforts paid off most remarkably in cotton textiles. By 1914, Japan had established a world-class textile industry that was able to displace British exports not just from the Japanese markets, but from neighboring Asian markets as well. (For varying accounts of the role played by the state and private industry in the take-off of cotton spinning in Japan, see W. Miles Fletcher and Gary Saxonhouse)

While Japan’s militarist and expansionist policies in the run up to the Second World War tarred these accomplishments, its achievements on the economic front demonstrated it was possible to steer an economy away from its natural specialization in raw materials. Economic growth was achievable, even if a country started at the wrong end of the international division of labor, if you combined the efforts of a determined government with the energies of a vibrant private sector.

In the next article, I’ll look at how the experience of Asian tigers after the Second World War (South Korea, Taiwan, Hong Kong, Singapore, Malaysia, Thailand, and Indonesia) reinforced the lesson.

Useful links

This series is adapted from Dani Rodrik’s The Globalization Paradox: Democracy and the Future of the World Economy published by Norton

Americas Society – Council of the Americas

Perspectives on global development (publications from the OECD Development Centre)

Natural Resources and Pro-Poor Growth: The Economics and Politics

OECD work on poverty reduction and social development

OECD work on the benefits of trade liberalisation

Comparative advantage: Doing what you do best (from the Insights blog)