Good Economics for Hard Times: Better Answers to Our Biggest Problems

by Abhijit V. Banerjee

split-ticket voting is at its lowest on record.

The world is a sufficiently complicated and uncertain place that the most valuable thing economists have to share is often not their conclusion, but the path they took to reach it—the facts they knew, the way they interpreted those facts, the deductive steps they took, the remaining sources of their uncertainty.

Economists are more like plumbers; we solve problems with a combination of intuition grounded in science, some guesswork aided by experience, and a bunch of pure trial and error.

Good economics starts with troubling facts, makes some guesses based on what we already know about human behavior and theories elsewhere shown to work, uses data to test those guesses, refines (or radically alters) its line of attack based on the new set of facts, and eventually, with some luck, gets to a solution.

Truth did not sway their opinions. Simply thinking about migration makes people more parochial. The facts aren’t allowed to get in the way.

This is much more than the bottom 30 percent in those two states, who live on less than $1 a day at PPP. Yet the rest of the very poor people (of whom there are about a hundred million) have not opted to move to Delhi and more than double their earnings.

Indian software professionals who got to work in the United States because they won the visa lottery made six times more money than their peers who stayed in India.14

The problem with these numbers is also what makes them easy to interpret: they rely on comparisons among those who applied for visa lotteries.

Using this data, researchers found that for anybody who was under twenty-five at the time of the eruption, losing a house led to large economic gains.16 By 2014, those whose parental houses were destroyed earned over $3,000 per year more than those whose parental houses were not destroyed, even though not all of them moved.

That it takes a disaster scenario or a war to motivate people to gravitate to a location with the highest wages shows economic incentives on their own are often not sufficient to get people to move.

The immigrants may not produce growth for their new communities unless they spend their earnings there; if the money is repatriated, the economic benefits of immigration are lost to the host community.

A second reason why low-skilled migration might push up the demand for labor is that it slows down the process of mechanization. The promise of a reliable supply of low-wage workers makes it less attractive to adopt labor-saving technologies.

Given there are nearly twenty million people in the greater Delhi area, one might imagine every street corner would have such an assemblage. In fact, one has to look around to find them.

First, established workers are much more secure from competition from newcomers than a pure supply-demand model would have us believe.

This logic says that the wage the firm must pay to get workers to work typically has to be high enough that being fired actually hurts. This is what economists call the efficiency wage.

This makes the incentive to employ a prospective migrant even weaker. Moreover, employers are also reluctant to have large differences in wages within their establishments, for fear of lowering morale.

This contributes to why native workers are not quickly replaced by cheaper immigrants.

there is paradoxically more scope for a skilled migrant to undercut the wages of the natives.

It helps low-skilled natives, who benefit from cheaper services (most doctors who serve the poorest corners of the United States are migrants from the developing world) at the cost of worsening the labor market prospects of the domestic population with similar skills (nurses, doctors, engineers, and college teachers).

Connections are supposed to help people, but the fact that some have access to them and others do not may actually shut down a market that would function just fine if no one had connections.

Only one out of ten migration episodes lasts more than three months. This means migrants tend to stay close to their home village, which probably limits the kinds of jobs they can get and the kinds of skills they acquire.

In many developing countries, there are often several missing rungs in the quality ladder of housing. The next thing to a slum might be the nice little flat entirely out of reach.

Making matters worse, as Ed Glaeser has argued in his wonderful book Triumph of the City, are city planners who resist building dense neighborhoods of high-rises for the middle class, aiming instead for a “garden city.”

If you happen to be dropped somewhere without a choice you may take them on, but it is hard to get excited about abandoning friends and family and going to the end of the world to sleep under a bridge, clean floors, or bus tables.

It turns out, for example, that parents who worry about being abandoned in old age may strategically underinvest in the education of their children to make sure they do not have the option of moving to the city.

Therefore, on average, contrary to what the Nepalese government believed, misinformation was keeping the migrants home.

The fear of failure is a substantial disincentive for embarking on a risky adventure.

A would-be migrant who stays home can always maintain the fiction he would have succeeded had he gone.

This is perhaps why migrants, at least those not pushed out by desperation, tend to be not the richest or the most educated, but those who have some special drive, which is why we find so many successful entrepreneurs among them.

This has contributed to the divergence in earnings, lifestyles, and voting patterns in the country and a sense of dislocation, with some regions left behind as others pull ahead.

therefore even workers in the United States can be made better off if society taxes the winners from free trade and distributes that money to the losers.

It is clear that the kind of extreme state control these economies operated under before liberalization was very effective at keeping inequality down, but at a high cost in terms of growth.

In other words, was it growth (or the potential for growth) that caused trade liberalization, and not the other way around?

it is very hard to have a lot of faith in the results. There are always going to be a million ways to do cross-country comparisons, depending on exactly which brave assumption one is willing to swallow.

However, as we saw with migration, labor markets tend to be sticky. People do not move even when labor market conditions would suggest they ought to, and as a result wages are not automatically equalized across the economy. There are in effect many economies inside the same country and it is possible to learn a lot by comparing them, as long as the changes in trade policy affecting these subeconomies are not all the same. One

Contrary to what the Stolper-Samuelson theory would tell us, the more exposed a particular district was to trade, the slower poverty reduction was in that district. In a subsequent study, Topalova found that the incidence of child labor dropped less in districts more exposed to trade than in the rest of the country.

And her work does not imply that inequality increased in India as a whole, just that it went up more in the more trade affected districts. In fact, because the places most touched by liberalization tended to be somewhat richer to start with, the fact that they did not fare particularly well after liberalization, paradoxically, reduced countrywide inequality.

The very fact that Topalova finds any difference between more exposed and less exposed districts tells us resources (workers, but also capital) do not move easily, as we noted earlier.

In India, Topalova found the negative effect of trade liberalization on poverty was exacerbated in states where strict labor laws made it very difficult to fire workers and shrink unprofitable firms, allowing profitable ones to take their place.

Topalova’s research found very little “creative destruction.” Firms never seem to discontinue a product line that has become obsolete.

Of course, it took more than money. In these two cases there was also someone with vision and talent. But clearly money helped.

Having a name also helps. It is no accident that Gucci, originally a high-end leather goods producer, now sells everything from car seats to perfume, and that Ferrari, which started with sports cars, now sells eyeglasses and laptops.

A substantial part of the business model of two of the world’s most successful companies, Amazon and Alibaba, is to insert themselves in place of these intermediaries by allowing individual producers to build their own reputations on their sites, for a price of course, thereby not requiring certification from the intermediary.

it is essentially impossible for an isolated producer in the third world to start competing on the international market, however good its product is and however low its prices are.

and India today is actually more open than China or the United States.43

The sheer fragility of the process of acquiring a reputation, the critical importance of the right connections, and all the breaks needed to succeed also make us question whether trying to break into international trade is the way forward for the average poor country.

The total number of jobs lost was often larger than merely the number of jobs lost in the industries that were hit, and rarely less. This is presumably a consequence of the clustering effect we talked about.

For him, channeling public funds into regions doing poorly is throwing good money after bad. Blighted towns are meant to shrink while others take their place. It is the way of history. What public policy needs to do is to help people move to the places of the future.56

US import share (8 percent) is one of the lowest in the world.

Poor transportation, both for inputs and for the final products, erode the cost advantages of a cheap labor force.