This article originally appeared in [https://blogs.worldbank.org/impactevaluations/banerjee-and-duflo-s-poor-economics-micro-steps-towards-a-quiet-revolution] and belongs to the creators.
Hot on the heels of More than good Intentions comes an outstanding new book by two of the most prominent leaders of the recent push for more rigorous evaluation – Abhijit Banerjee and Esther Duflo’s Poor Economics: A Radical Rethinking of the way to Fight Global Poverty. They summarize their approach to fighting poverty as
It is possible to make very significant progress against the biggest problem in the world through the accumulation of a set of small steps, each well thought out, carefully tested, and judiciously implemented…The political constraints are real, and they make it difficult to find big solutions to big problems. But there is considerable slack to improve institutions and policy at the margin…These changes will be incremental, but they will sustain and build on themselves. They can be the start of a quiet revolution.
What follows is not a randomista’s manifesto, but their attempt to piece together a coherent story of how poor people live their lives, of the constraints that keep them poor, and of the policies that can alleviate this poverty. The book is an excellent refresher course on the micro side of development economics – a typical chapter pieces together evidence from around 20 studies, including both experimental and non-experimental evaluations as well as descriptive and analytical pieces. It does not try and provide an exhaustive overview of recent literature and as is natural, is heavy on their own work and that of their students and collaborators. Nevertheless, it summarizes a lot of information (e.g. I did not previously know about Deaton and Dreze’s finding that over the past 25 years, as India has gotten richer, people are actually eating less). If you are a development economist, you definitely need to know what is in this book.
The book provides the latest (and I mean latest! – probably half the studies cited are dated 2009 to 2011, with coverage of some recent research that hasn’t even appeared as working papers yet) evidence on what are mostly quite traditional topics. Indeed the topics are generally very similar to those covered in the development economics class I took with Chris Udry at Yale in 1998: health, education, intra-household decision-making, risk and insurance, and microcredit – with much new evidence on each of course. So let me focus on a few of the newer ideas and overarching themes.
The book views a lot of the evidence through the lens of poverty traps. This is an area where there has been much recent progress – indeed a 2006 book that I reviewed on the topic had very little to say about micro evidence. Banerjee and Duflo discuss whether income dynamics are S-shaped (start too low and you are trapped) or L-shaped (everyone converges eventually to high levels) and examine the evidence for a hunger trap, a health trap, a family-size trap, and educational expectations trap, and a entrepreneurial technology trap.
One of the key ideas of the book is that a combination of lack of information and incorrect expectations can trap the poor. To take one example, if the poor believe the returns to education are low at low levels and only high at higher levels, and that it is unlikely they will ever get to the higher levels, they may not want to make the effort to invest in the lower levels. If this is the case, interventions which change information and beliefs can have powerful effects, as seen in Robert Jensen’s work in the Dominican Republic.
One area where I disagree somewhat with the authors’ reading of the evidence on poverty traps comes from their discussion of microenterprise growth. Like them, I believe that available evidence suggests that many self-employed will never grow to the point of hiring workers, and that a good number of them would rather have a stable wage job (Indeed in Sri Lanka when we use “species classification” to classify the self-employed as either potential wage workers or potential SME owners, 2/3rds to 3/4ths of the self-employed seem more like wage-workers). But Abhijit and Esther argue that part of the reason is that the poor face two production technologies: one with low capital requirements and high returns that taper off fast, and a second which requires a minimum level of investment before any returns can be generated, and then generates high returns thereafter. Combining the two technologies yields an overall non-convex production function – and to their conclusion that “the reason the poor don’t grow their businesses is that, for most of them, it is too hard – they can’t borrow to cross the hump, and saving up to get there will take too long…and this knowledge means that the poor are not motivated to make smaller efforts”.
Why do I disagree? It seems unlikely to be that there are just two potential technologies facing a given entrepreneur – many microenterprises innovate by adding new products or processes, and they face a choice between more than just two scales. So the small-scale vendor can make incremental steps and decide whether to sell more of the same type of products, start selling some additional products, maybe add a street-cart to sell in a new location, invest in some advertising to get more customers, etc. rather than having to make an all-or-nothing decision of whether or not to make a lumpy investment and start in a new location at a larger scale. Then if we think of the overall production technology as the combination of 100 or 1000 potential technologies that the poor can possibly be choosing among, things convexify pretty fast. Chris Woodruff and I tested this idea in Mexico, finding no evidence for non-convexities in production. We do however find returns to start high and decrease as more capital is invested – consistent with the L-shaped production technology that does not lead to poverty traps. In such a world the poor can still be left running very small businesses if their entrepreneurial skills are low and they are better suited as wage workers, but there is nothing technological to stop them slowly reinvesting their profits and growing until they reach their optimal scale.
The authors motivate in part their belief in the dual technologies by referencing an experiment I carried out with Suresh de Mel and Chris Woodruff in Sri Lanka, in which we gave grants of 10,000 Rs and 20,000 Rs (approximately $100 and $200) to microenterprise owners. They note that the larger grant did not lead to a larger increase in profits than was found for the smaller grant, which they speculate may be because the owners did not think their businesses could absorb it. However, we can’t reject (p=0.39) that the 20,000 Rs grant had twice the impact of the 10,000 Rs grant either – basically our experiment lacked power to distinguish between these grant levels. This is a general issue I believe arises with several of the studies and discussion in this book – potentially over-interpreting results where power is low. Much of the recent work on microfinance and firms suffers from this problem, given the enormous heterogeneity and low correlation in firm profits and sales, as discussed in my recent post.
A second major theme that didn’t appear in my graduate economics classes (and one that also runs through More than Good Intentions) is the role of behavioral economics. Banerjee and Duflo make a compelling case that the poor bear responsibility for too many aspects of their lives – unlike us, they are responsible for making sure their water is clean, they lack automated ways to save and stable income flows, they can’t afford ready-made fortified breakfast cereals and so have to work harder to make sure their children get the right nutrients, etc. As a result default options and small nudges can make large differences.
Readers of the recent discussion on our blog on whether there is an unmet need for birth control will very much appreciate Chapter 5 of the book, which discusses the Ashraf, Field and Lee paper and Pritchett papers that appeared in that discussion, along with other related evidence. The discussion relates to a third underlying theme in the book – whether demand-side or supply-side interventions are needed or what the authors determine the debate between “supply-wallahs” (a.k.a. Field of Dreams policy – build it and they will come) and “demand-wallahs” (the problem is getting people to want the stuff, then demand will generate its own supply). There is much careful discussion of this debate in various domains, with the authors emphasizing that it is not an either/or debate.