Goyal and Sitharaman must read book by Nobel Laureates Banerjee and Duflo 

The book, ‘Good Economics for Hard Times’ by Nobel Prize winners Abhijit Vinayak Banerjee and Esther Duflo, to be released in India next month, show how policies affect the poor. A book extract:

File photo (Courtesy: Social media)
File photo (Courtesy: Social media)
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Abhijit V. Banerjee & Esther Duflo

In 2015, only 23 percent of Americans thought they could trust the government “always” or “most of the time.” Fifty-nine percent had a negative opinion of the government. Twenty percent thought the government had no tools to improve equality of opportunities between the rich and the poor, and 32 percent thought lowering taxes on wealthy people and corporations to encourage investment would be a better way to improve equality of opportunities than increasing taxes to finance more programs for the poor.

This radical skepticism about government action may be the single biggest constraint on helping those who need it most, paradoxically because many of those people themselves hold precisely these views.

Manpreet Singh Badal, a bright young minister in the Indian state of Punjab, saw his political career stumble over just this issue. Farmers in Punjab get free electricity, and groundwater is free, with the result that everyone over-irrigates their land with the consequence that the water table is falling so fast that in a few years there will be no water to pump out. It is in everybody’s interest to reduce water consumption now.

Badal’s solution was to give everyone a fixed sum of money to compensate them, and then charge them for the electricity so they would not pump any more water than they needed, because the cost would act as a deterrent against excess pumping.

From the point of view of economic logic, this is a no-brainer. But it was political suicide. The measure, introduced in January 2010, had to be removed ten months later, and Badal lost his job as finance minister and eventually had to leave his political party. Farmers simply did not trust they would get any money, and the powerful farmers’ associations radically opposed the measures.

Remarkably, in 2018 Badal, back in government, decided to try again. This time the plan was to first give a direct transfer of Rs 48,000 to all farmers directly into their bank accounts, before charging them for electricity by deducting from this same account.

The subsidy has been calculated such that at the going rate, a farmer consuming less than 9,000 units of power would come out ahead (the state estimates the average consumption is between 8,000 and 9,000 units). The idea was to make it absolutely clear that this is not a tax in disguise, a sly way to raise money from the farmers.

And this time the government moved slowly. They began with a small pilot program, and are now planning a larger RCT to evaluate the impact of this scheme on water consumption and farmers’ welfare. Still, farmers remain suspicious. The farmers’ union continues to claim that “their real agenda is to discontinue the power subsidy for agriculture.” Why are people so suspicious of the government?

A central tenet of all the growth theories is that resources are smoothly delivered to their most productive use. This is a natural hypothesis as long as markets work perfectly. The best companies should attract the best workers. The most fertile plots of land should be farmed most intensively, while the least productive will be used for industry. People who have money to lend should lend to the best entrepreneurs.

But this is often not true. Some firms have more employees than they need while others are unable to hire. Some entrepreneurs with great ideas may not be able to finance them, while others who are not particularly good at what they are doing continue operating: this is what macroeconomists call misallocation.

A vivid instance of misallocation comes from the impact of the introduction of cell phones on fishing in the state of Kerala in India. Fishermen in Kerala would go out to fish early in the morning and return to shore midmorning to sell their catch. Before the cell phone, they would land at the nearest beach, where their customers would meet them.

The market would run until there were no customers left or the fish ran out. Since the catch varied quite a bit from day to day, there were a lot of wasted fish at some beaches, while at the same time there were often disappointed customers at others.

This is a stark example of misallocation. When cell phone connectivity became available, fishermen started to call ahead to decide where to land; they would go where there were lots of customers waiting and not a lot of boats. As a result, waste essentially vanished, prices stabilised, and both customers and sellers were better off.

Abhijit once asked migrant respondents in Delhi slums what they liked about living in the city. They liked many things; there were more options to give their children a good education, health care was better, finding a job was easier.

The one thing they did not like was the environment. This is no surprise. Delhi has some of the vilest air in the world. When asked about which problems in their living environment they wanted fixed first, 69 percent mentioned drains and sewers, and 54 percent complained about garbage removal.

The combination of choked drains, absent sewers, and piled-up garbage are often what gives the slums in India (and elsewhere) their distinctive odor, somewhere between acrid and putrescent.

For obvious reasons, many slum dwellers hesitate to bring their families with them. Instead, when it all becomes unbearable, as it must fairly quickly, they go home. But why do they need to live in slums, or worse? Why don’t they rent themselves something a bit better? Often, even if they can afford it, the option doesn’t exist.

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. There is a reason for this. Most third-world cities lack the infrastructure they need to serve their population.

According to a recent report, India alone needs 4.5 trillion US dollars in infrastructure investment between 2016 and 2040, while Kenya needs 223 billion and Mexico 1.1 trillion. This means the relatively small parts of most cities with decent-quality infrastructure are always hugely in demand and have astronomically high land prices.

Some of the most expensive real estate in the world, for example, is in India. Starved of investment, the rest of the city develops in haphazard ways, with the poor often squatting on whatever land happens to be unoccupied, whether or not it has sewer connections or water pipes.

Desperate for a place to live but worried they can be evicted any day because it’s not their land, they build makeshift housing that sticks out like scars on the urban landscape. These are the famous third-world slums.

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.”

India, for example, imposes draconian limits on how high buildings can be, much stricter than what is found in Paris, New York, or Singapore. These restrictions result in massive urban sprawl and long commutes in most Indian cities. The same problem also shows up in China and many other countries, albeit in a less extreme form.

For the would-be low-income migrant, this set of bad policy choices creates an unenviable trade-off. He can crowd into a slum (if he is lucky), commute many hours a day, or resign himself to the daily misery of sleeping under a bridge, on the floor of the building where he works, in his rickshaw or under his truck, or on the pavement, protected perhaps by the awning of a shop.

If that is not discouraging enough, for reasons already discussed, low-skilled immigrants know that, at least to start out, the jobs they can get are the jobs nobody else wants. 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 is only the migrants with the ability to think past the immediate obstacles and pain, and contemplate a steady climb from busboy to restaurant chain owner, who typically take it on.

The attraction of home goes beyond creature comforts. Poor people often live very vulnerable lives. Their incomes tend to be volatile and their health precarious, making it very useful to be able to call on others for help when needed. The more connected you are, the less exposed you will be if something bad happens.

You might have a network where you are going, but your network is probably deeper and stronger where you grew up. You (and your family) may lose access to that network if you leave. As a result, only the most desperate or the very well off who can afford the risk will leave.

(Extracted from Good Economics for Hard Times, authored by Abhijit V. Banerjee and Esther Duflo, with permission of the publisher, Juggernaut)

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Published: 19 Oct 2019, 6:45 PM