With the 2020 Nobel Prize in Economics being revealed today, now seems like the ideal time to look back at last year’s Laureates. This article is an attempt to make economic breakthroughs more accessible to the public and an encouragement to take interest in the many fields of research in economics.

The 2019 Nobel Prize in Economics was awarded jointly to Abhijit Banerjee, Esther Duflo and Michael Kremer, a team of three economists from MIT and Harvard “for their experimental approach to alleviating global poverty”. Three facts make last year’s award a very special one.

Firstly, the prize was awarded to a woman, Esther Duflo. She is the second woman to be awarded this prize and the youngest Laureate ever in the category at only 47 years old. Secondly, the trio does not owe their prize only to their research, but also to the opportunity and capacity they have offered to other researchers to make significant progress in the fight against global poverty. As mentioned by the Swedish Bank “The Laureates’ research findings – and those of the researchers following in their footsteps – have dramatically improved our ability to fight poverty in practice”. Thirdly, the prize was awarded extremely early compared to previous years’ laureates. The Nobel scientific summary does not mention any studies done by the trio before 2003. While 16 years can seem like a lot for an outsider, it is not in the context of a Nobel Prize. A testament of this fact may be Michael Kremer’s “complete surprise” when he learnt he had won via a Skype message.

But what makes the trio’s work worthy of the highest award? To know the answer, a bit of context is needed.

The History of Development Economics

Up until the late 1990s, emphasis was put on structural reforms on a global scale. However, results were unsatisfying. In 2000, 75 out of 1’000 children died before the age of 5[1], mostly due to preventable diseases, more than 28% of the world population lived in extreme poverty[2] and 907 million people were undernourished[3], 14% of the world population at the time.

Two views of international aid and global poverty alleviation were colliding. The “poverty trap” view represented by Jefferey Sachs argued that poor countries are stuck in a vicious cycle: they are poor because they have a harsh climate and suffer from deadly disease that they cannot eradicate because they are poor and lack the necessary funding to help them deal with these issues. The developed world should then step in and massively invest in poor countries to get them out of this poverty trap.

The “freedom” view, led by William Easterly argues that aid does more harm than good by keeping people from looking for their own solution. It is also said to be bureaucratic, wasteful and paternalistic. According to them, aid robs people from their autonomy: if poor people do not use bed nets and if quality of education has not improved in the last 50 years, it is because people do not see its usefulness. Therefore, the West should stop forcing these solutions down their throats and leave to poor countries the freedom to make their own decisions. A view not shared by 1998 Economic Nobel Prize winner Amaryta Sen, pioneer in welfare economics and expert in development economics, who would argue that the freedom to make choices is useless without the capability and the opportunity of making said choices.

Although both these views have strong advocates, they each lack one critical thing: proofs. The discourse on both sides relies more on philosophical and theoretical arguments extrapolated from anecdotes rather than evidence. The field of development economics in general lacked evidence until economists such as Michael Kremer (among others) came up with the idea of using randomized controlled trials (RTCs) in order to find evidence on whether or not a specific policy had positive impacts on poverty.

What are RTCs?

The principle of RTCs is to randomly assign individuals (students) or groups of individuals (villages) to either a treatment group that will experience the effects of the policy or a control group that will not experience the effects but will serve as a comparison once the experimentation period is over. If randomization is correctly done and if the sample is large enough, the difference between both groups should represent the effect of the treatment. This methodology is widely used in the field of medicine to test the effects of new medication. However, the chaotic nature of the real world did not until now allow economists to use methods requiring a high level of control over the subjects. What now allowed researchers to apply this methodology was the rise of high-quality datasets that came with the tech revolution.

It was now clear that the attempts at large scale reforms and with it, the popular technique of “throwing huge amounts of money at stuff and hope it works” (or THAoMaSaHiW as the experts say) had shown its limits. RTCs brought a change in scope by changing the approach to development economics. The question was no longer “How to stimulate growth in the developing world?” but rather “What is the best way to incentivize parents into treating their children with deworming pills?”, a question that sounds irrelevant, but is actually a very cheap investment that provides significant lifetime benefits.

The team’s achievements

In 2003, Esther Duflo and her would-be husband Abhijit Banerjee (respectively 31 and 42 years old at the time) founded the Poverty Action Lab at MIT. The objective was to conduct randomized evaluations in order to find evidence-based answers to questions related to the eradication of poverty. Michael Kremer would join the lab the same year. The lab would later be rebranded as the Abdul Latif Jameel Poverty Action Lab or J-PAL. To this day, the lab is the leading research institution in the field of development economics, having published hundreds of studies and working in collaboration with more than 200 researchers across the world.

In their book “Poor Economics: A Radical Rethinking of the Way of Fighting Global Poverty”, Banerjee and Duflo invite us to rethink our preconceived ideas about people living in poverty and invite policymakers to change their approach of tackling poverty. As one learns when reading the book, poor people are just like us, they are no less rational and not lazier than us westerners. Rather, they share with us the same behavioral flaws that are much more punishing for them because they live in an unforgiving environment.

 

“We [westerners] rarely need to draw upon our limited endowment of self-control and decisiveness, while the poor are constantly being required to do so.”

 

From the book, two main concepts arise: the Poverty Trap mentioned earlier in the Sachs and Easterly comparison and the Three I’s: Ideology, Ignorance, Inertia.

A poverty trap exists when a country’s income is too low to allow one to improve its conditions: there exists an income threshold under which one cannot escape poverty. According to Sachs, developing countries as a whole are trapped in poverty, but it is also possible for individuals to be stuck in poverty.

Banerjee and Duflo nuance this point of view by pointing out that poverty traps are not systematic: “There will be a poverty trap whenever the scope for growing income at a very fast rate is limited for those who have too little to invest, but expands dramatically for those who can invest a bit more”. Research should then focus on uncovering in which scenarios poverty traps do exist, what are the key factors that trap people in poverty and policymakers should focus on the best way to alleviate those key factors.

Graphical illustration of what a poverty trap looks like (left) vs. no poverty trap (right)

The second concept illustrated in the book is the three I’s. A policy is designed by Ideology, fails because of Ignorance of what the reality is like for poor people and is sustained through Inertia. Both concepts will come back later.

Over its 10 chapters, the book offers 5 takeaways on what it is like to live as a poor person and how best to help them live a happier, healthier, more fulfilling life.

Takeaway Number 1: Poor people lack critical information and believe things that are not true.

Poor people underestimate the value of one more year of education and overestimate the value of a full education because they have never been correctly informed. It is obvious for them that education is a path to a better life, but they wrongly think that one more year of education will not help their children. Thus, if they can only afford to pay for one more year of education and if a degree is three years away, they will forego the extra year. This will have dramatic consequences for the child who could have benefitted from the extra education, the perception of a poverty trap where there isn’t one actually creates one. Similarly, since parents overestimate the return on a full education, they will finance their perceived smartest child’s education and sacrifice all of their other children’s, putting all of their eggs in the same basket. As we will see later, this perception is not always true.

Takeaway Number 2: Poor people have it harder because the right decisions are not made for them.

Contrary to rich countries where systems make the right decision for you (such retirement plans directly taken from your income, savings accounts or purified water coming directly from the tap), poor people have to take much more decisions on a day-to-day basis. In addition, the best decision is not always the default option. This is why “nudging” people with the correct incentive may be an extremely powerful tool for policymakers. It sounds paternalistic and it may be, but it actually makes the decision-making process easier for poor people.

 

“But then it is easy, too easy, to sermonize about the dangers of paternalism and the need to take responsibility for our own lives, from the comfort of our couch in our safe and sanitary home. Aren’t we, those who live in the rich world, the constant beneficiaries of a paternalism now so thoroughly embedded into the system that we hardly notice it?”

 

Takeaway Number 3: Poor people have it harder because they do not have access to some critical markets such as insurance or banking.

A common view in the West is that poor people have to take responsibilities for themselves and act more reasonably, by saving a part of their income for example. But this is actually a misguided view: most commercial banks do not offer their services to poor people because it is too costly to manage small accounts. As such, poor people have a hard time saving money to invest in themselves or their children and get out of a potential poverty trap. This is also why most businesses fail to reach a medium size: microfinance offers loans to create or maintain small businesses and banks offer loans to big businesses, but no one will finance a $5000 equivalent loan that a business might require to reach medium size.

This is a case where technology could be a potential solution. Giving poor people access to savings accounts via digital banking (a service much cheaper than regular banking) might help them get out of their own poverty trap, and if a critical market cannot emerge, it may be time for governments to step in and provide the adequate services.

Takeaway Number 4: Poor countries are poor because of bad policies designed by bad institutions.

The last chapter of the book discusses at length why institutions fails in developing countries. The reason are multiples, such as the remanence of colonial institutions maintained by an elite acting in their own self-interest or Ideology, Ignorance and Inertia. Corruption seems to be the most important issue to solve because it undermines the design of potentially good policies: “If truck drivers can pay a small bribe to drive massively overloaded trucks, billions of dollars will be wasted in building road that will be destroyed under their wheels”.

Many theories are mentioned concerning how to address the issue, such as foreign intervention or liberalization, but the authors defend the idea that marginal, bottom up changes can go a long way. Reforming the INSTITUTIONS by reforming the institutions. According to them, a “careful understanding of the motivations and constraints of everyone can lead to policies and institutions that are better designed”, as opposed to Ideology and Ignorance or simplistic thinking.

Simple programs have been put in place in countries such as Brazil or India to hold local official accountable to their voters by publicizing in the newspaper or on TV information about where government money was being spent. Exposed corrupt officials were either voted out or stopped their illegal activities.

Another example of small changes producing big results occurred in Indonesia, where village councils are still held and are being led by mostly local elite. Simply sending a formal letter to every adult in the village increased attendance and participation from everyone, leading to a better representation in decision-making and better social outcomes. Similar results were observed in Indian villages where only women were allowed to run for village head.

Takeaway Number 5: Expectations become self-fulfilling prophecies

We have mentioned in Takeaway Two how perceptions of children’s intelligence are often wrong. Children often internalize adults’ and teachers’ perceptions of them, leading them to confirm said perceptions even though they may not be true. Teachers also exhibit an elitist bias, believing that children from poor families and lower castes will perform worse. As a consequence, they will put less effort in lower caste children and more effort in higher caste children regardless of their objective intelligence. There again, both parents and teacher’s expectations of students’ performance can create a poverty trap where there isn’t one. This is one of the many examples where expectations become self-fulfilling prophecies.

Despite this tragic observation, there seem to be hope. After seeing female village heads, villagers dropped their negative perception of women in power and started empowering their own daughters, raising them to the idea that one day, they could also be political leaders. Changing expectations is hard, but it is not impossible, and it leads to drastic positive changes for the people.

It may seem like the authors advocate for more government whenever an issue arises, but this is not true. In most cases such as education, healthcare or water supply, the government is already in some way involved. According to them: “Governments exist to solve problems that markets cannot solve”. As such, they do not advocate for more government but for better government supported by evidence rather than Ideology, Ignorance and Inertia.

One year after

Since then, the team has continued to run the J-PAL research lab, notably launching programs aimed at fighting the effects of climate change and COVID-19 in poor countries. Together with the MIT, they awarded their first master’s degree in “Data, Economics, and Development Policy program” to 22 young graduates.

Banerjee and Duflo’s 2019 book “Good Economics for Hard times: Better answers to our biggest problems” contrasts their earlier work by talking about Economics with a capital E. In it, they go through the history of climate change policy, immigration policies and adaptation to automatization (among many other topics), highlighting what politicians have been doing wrong for so long and what may be the answers to these problems. They advocate for the creation of a more humane economy and society as a whole and push back against simplistic thinking and common misconceptions of economics : “there are no iron laws of economics keeping us from building a more humane world, but there are many people whose blind faith, self-interest or simple lack of understanding of economics, makes them claim that this is the case”. The book is an essential read for anyone with an interest in modern economics and the many possible futures of our society.

 

Michaël Wegmüller

Sources:

  • Royal Swedish Academy of Science, 2019, Press release: The Prize in Economic Sciences 2019, Royal Academy of Sciences, viewed October 7 2020, https://www.nobelprize.org/prizes/economic-sciences/2019/press-release/
  • data on child mortality: UN Inter-agency Group for Child Mortality Estimation, Under-Five Mortality, UNICEF DATA 2020, viewed October 7 2020, https://data.unicef.org/topic/child-survival/under-five-mortality/
  • data on global poverty: World Bank, 2019, Distribution of population between different poverty thresholds, World, 1981 to 2015, Our World in Data, viewed October 7 2020, https://ourworldindata.org/grapher/distribution-of-population-poverty-thresholds?stackMode=relative
  • data on world hunger: Food and Agriculture Organization of the UN, 2017, Number of people who are undernourished, 2000 to 2017, Our World in Data, viewed October 7 2020, https://ourworldindata.org/hunger-and-undernourishment
  • Banerjee, Duflo, E 2011, Poor Economics, a Radical Rethinking of the way to Fight Global Poverty, Public Affairs, USA
  • Duflo, E 2010, Le développement Humain, Lutter contre la pauvreté (I), Seuil, France
  • Banerjee, Duflo, E 2019, Good Economics for Hard Times : Better Answers to Our Biggest Problems, Public Affairs, USA
  • https://data.unicef.org/topic/child-survival/under-five-mortality/
  • https://ourworldindata.org/grapher/distribution-of-population-poverty-thresholds?stackMode=relative
  • https://ourworldindata.org/hunger-and-undernourishment
  • https://motormouthsite.wordpress.com/2015/12/26/randomized-control-trials-approach-to-poverty-action-poor-economics-and-its-critics/