Poor Choices

Why are some countries rich and others poor? Differing accounts put more or less weight on the role of policies, geography, culture, history, and international interventions. Only by answering this question can one decide how best to reduce poverty in low-income countries. Yet few debates about public policy are more contentious. More than half a century of intensive efforts to improve the lot of the poor in the developing world has had mixed success. Although some countries, such as China, have made enormous progress in reducing poverty, many others have languished. Today, most estimates suggest that more than one billion people live on less than $1.25 per day.

Poverty presents both a moral and an intellectual challenge. No one can fail to be moved by seeing the slums that plague so many parts of the developing world. And the fact that one can travel a few hours by plane and find extremes of wealth and deprivation at either end of the journey is an insult to economists' notions of ­rationality, efficiency, and equity. There is no greater challenge to the discipline.

Yet traditional economics alone is not enough to grasp the problem fully. I learned this at a pivotal moment early in my career when a senior colleague asked me about my research interests. I proudly listed development economics among them -- and was promptly deflated when he told me that he, too, had once been interested in development, until it dawned on him that most of the problems of the developing world were political and so he did not have the necessary expertise to study the issue. Thankfully, the field of economics has changed a lot in the years since, and issues of politics and economics are routinely interwoven when trying to understand persistent poverty.

Economists have been better able to understand poverty thanks to growing access to micro-level data and new decision-making models that incorporate psychological factors. Three engaging new books showcase these microeconomic advances: Poor Economics, by Abhijit Banerjee and Esther Duflo; More Than Good Intentions, by Dean Karlan and Jacob Appel; and Portfolios of the Poor, by Daryl Collins, Jonathan Morduch, Stuart Rutherford, and Orlanda Ruthven. Written in language sure to appeal to a general reader, they all focus on the micro level of poverty and on the human conditions that underlie it. Their authors make extensive use of vignettes -- an unusual move for economists -- ­introducing readers by name to real people whose stories illustrate broader concepts.

Informed by extensive experience in the field, their understanding of poverty is refreshingly bottom-up. Only by figuring out what happens on the ground, their thinking goes, can they unlock the bigger picture. The problem with such focused efforts, however, is that the authors largely set aside the role of politics and in so doing neglect much of the bigger picture. After all, some of the greatest successes in raising living standards have come about not by altering individuals' choices but by altering decisions made by governments.

NEW ECONOMICS

Mainstream economics used to assume unquestioningly that the poor were rational decision-makers, homines economici who spent what little they had in an informed and farsighted way. But over the past 30 or so years, economists have increasingly taken into account the psychology of decision-making. They now acknowledge, for instance, that people frequently lack self-control, valuing future benefits but acting on short-term impulses. And they have begun to appreciate how poverty could create certain pathologies that might further distort thinking. For example, laboratory evidence suggests that choices made under stressful conditions tend to be worse than those made without stress. Such insights have opened up a whole new range of concerns that need to be taken into consideration when studying the behavior of the poor.

Economists have also become more interested in the impact of social constraints on behavior. A profession that was once suspicious of the power of culture and social structures to explain economic phenomena now routinely builds these factors into its models. This development has led to new insights, such as the idea that people do not save in part because they face social pressure to spend or support their relatives. Seemingly irrational expenditures on lavish weddings or funerals, for example, make more sense when one takes such demands into account.

Research methods are changing, too. One of the most important innovations in economists' tool kits has been the use of randomized control trials to evaluate what works -- studies, like those in medicine, that compare the outcomes for a randomly selected treatment group (which receives, for example, subsidized fertilizer) with those for a control group. Such research has become more commonplace thanks to the growth of nongovernmental organizations (NGOs); governments are generally reluctant to leave a control group unaided. This development is also part of a wider movement toward evidence-based policymaking, and such research is now being conducted at organizations such as MIT's Poverty Action Lab and the NGO Innovations for Poverty Action. Three of the authors of the books under review -- Banerjee, Duflo, and Karlan -- played leading roles in establishing these institutions.

As befits their research backgrounds, Banerjee and Duflo and Karlan and Appel explicitly embrace three new developments in the study of poverty: behavioral models of decision-making, an appreciation of social constraints, and randomized experiments. Consider how the authors treat the question of health and nutrition. Sickness reduces productivity and hence exacerbates poverty, so economists have tried to understand why the poor sometimes make puzzlingly unhealthy choices. Banerjee and Duflo recount the story of a man named Oucha Mbarbk, who lives in a remote village in Morocco. When they ask Mbarbk what he would do if he had more money, he replies that he would spend it on food. "We were starting to feel very bad for him and his family," they write, "when we noticed a television, a parabolic antenna, and a DVD player in the room where we were sitting. We asked him why he had bought all these things if he felt the family did not have enough to eat. He laughed, and said, 'Oh, but television is more important than food!' " To dismiss such preferences as simply irrational would be an error. As Banerjee and Duflo point out, alleviating boredom can be a central priority of poor people.

Banerjee and Duflo also show how societal constraints, such as superstitious beliefs and a lack of reliable information, deter poor people from taking advantage of low-cost medical advances with high returns, such as vaccinating their children -- proverbial dollar bills on the sidewalk, waiting to be picked up. Without a proper understanding of the underlying constraints, public health campaigns, such as attempts to raise vaccination rates, are unlikely to work well.

Throughout their book, Banerjee and Duflo examine all facets of the behavior of the poor through this microscopic lens and discuss how certain types of interventions can make things better. They unapologetically propose a solution they acknowledge to be paternalistic: outside interventions by those who know best. But that type of policy makes sense only after detailed investigations of the conditions under which the interventions will occur, and Banerjee and Duflo are careful to tailor their recommendations to the circumstances on the ground.

MANAGING MONEY

Karlan and Appel, in their entertaining and quirky book, take a similar approach to analyzing poverty, emphasizing faulty decision-making and laying out the evidential findings that have guided successful development projects. They boldly offer a list of seven ideas that work and hence, they argue, should be scaled up: micro-savings accounts, which help the poor hold on to their income; reminders to put money away, which boost savings rates; commitment devices, which lock up savings for a specified period; prepaid fertilizer sales, which allow farmers to invest in future improvements in crop yields; deworming treatments, which keep children in school; remedial-education programs, which focus on the lowest-achieving students; and chlorine dispensers, which provide clean water.

Karlan and Appel frequently discuss the specific studies -- many of them randomized control trials -- that support these claims. Consider the problem of securing savings. They recount a randomized experiment in Kenya that found that when women were offered non-interest-bearing savings accounts, a remarkable proportion of them agreed to set one up. It also revealed that the accounts helped women cope better with periods of illness, since having these savings gave the subjects an alternative to pulling capital out of their businesses.

Portfolios of the Poor is more specific. As Collins, Morduch, Rutherford, and Ruthven summarize their argument, "Not having enough money is bad enough. Not being able to manage whatever money you have is worse." Their book is a detailed effort to understand how poor people manage -- and, frequently, mismanage -- the meager resources at their disposal. They draw on more than 250 financial diaries collected in Bangladesh, India, and South Africa that tracked how money was earned and spent, along with interviews with the diarists. The result is a unique window onto what poverty means for these households.

The data reveal a rich web of financial arrangements and document daily decisions about saving and borrowing. Readers meet a married couple from Bangladesh, Hamid and Khadeja, who have accumulated $175 in savings through six different instruments but owe $223 to shopkeepers, their family, their landlord, and Hamid's employer. The complexity of these arrangements turns out to be typical of what the authors find elsewhere. Their subjects must struggle not only with the fact that their incomes are low but with the fact that they are unpredictable and irregular, too; many of the world's poor rely on seasonal earnings from agriculture. Helping the poor, the authors conclude, is thus a matter not only of raising their incomes but also of finding better ways to help them manage the uncertainty they face in their daily lives.

The problem of financial management among the poor comes up in the other two books as well. Development economists have made much of the difficulty of borrowing, but until recently, they paid relatively little attention to the difficulty of saving. Individuals might find the cost of visiting a bank and having to wait in line too burdensome, or give in to demands for cash from friends and relatives, or remain ignorant of the wonder of compound interest, or simply lack the patience for long-term returns. Understanding these deterrents to saving requires a focus on the micro level. To encourage saving among the poor, the three books suggest a reorientation away from microcredit, the original focus of flagship programs such as Muhammad Yunus' Grameen Bank, toward microfinance, which provides easier-to-access saving opportunities with the possibility of regularizing such decisions.

THE DEVELOPMENT-DRIVEN STATE

Over the past 25 years, the greater use of microdata to generate insights into decision-making and societal constraints has transformed development economics. Scholars know far more than ever before about who the poor are, how they behave, and the constraints they face. But another major innovation in development economics gets little attention in these three books: an increasing focus on political factors in shaping development. Only Banerjee and Duflo offer any real discussion of political economy, and this appears only at the end, largely as an afterthought. And even here, when treating broader political questions, their approach is essentially focused on the micro level. In line with their general focus, they argue for progress "at the margin," where incremental change is feasible. They are largely dismissive of institutions at regional and national levels, which they regard as too unwieldy. But there is no getting away from the fact that public action at the higher tiers of government matters when it comes to sound policymaking.

Thus, the authors of these books could be criticized for paying insufficient attention to issues of political economy. One of the central challenges in developing states is getting the government to direct public resources toward public goods rather than toward special interests -- in the form of corruption, white elephants, or narrowly targeted transfers for the benefit of elites. Arguably, this shift in priorities has been the chief achievement of many modern states, and it is one that poorer countries must emulate if their governments are to become servants of the public interest. If governments build tax and legal systems and direct public spending toward the needs of their populuations, then they will be able to foster growth and human and social development -- and, with that, reduce poverty. Although the means by which governments can make this shift are complex, the subject is simply too important for economists to dismiss.

One place to look for lessons is in China. Over the past three decades, the country has grown remarkably quickly -- achieving, in the process, what is probably the largest reduction in mass poverty the world has ever seen. The World Bank estimates that around 600 million fewer Chinese live in chronic poverty today than did in 1980. China managed this by transforming itself into a developmental state, one that is geared toward transforming the economy and the lives of its citizens, funneling significant resources into public goods such as education and infrastructure.

China's experience is reminiscent of the improvements in the provision of public goods made by governments in the industrialized world during the late nineteenth and early twentieth centuries. In city after city, residents saw their lives transformed by access to drinking water, functioning sanitation systems, and electricity. As in China, an increasingly strong and well-organized state drove economic development, with municipal governments cooperating with higher tiers of government. This process created a symbiotic relationship with private-sector development: governments educated the labor force and built roads, railways, and bridges, which, in turn, encouraged the private sector to invest in factories and create new jobs. Although the benefits were sometimes uneven, the impact on the living standards of many citizens was immense.

But there is no magic formula for building a developmental state. Many countries have tried and failed. The trick is getting political and economic structures to work in tandem, as China has managed to do so far. The Chinese government has institutionalized its rule through a one-party system that constrains power with internal checks and balances and that gives policymakers an incentive to take a long-term view. The economic success that this system has delivered has muted citizens' calls for political change, establishing a social contract that hinges on continued growth. But the model is vulnerable to an economic slowdown or demands for change as a larger middle class seeks political liberalization as an end in itself. The result could be either the democratization of the system or an increasingly brutal regime. Only in rare cases have governments been able to keep democratic demands at bay indefinitely by providing ever more public goods. China's best hope is to open the political system gradually while increasing the constraints on executive power. But managing such a feat will not be easy.

For all these reasons, the Chinese model is not an easy or attractive model for other countries to follow as they seek to build effective states and thereby reduce poverty. Yet the western European model is problematic, too, since up until World War II, it emerged largely out of the need to fight countless wars. That said, Europe does demonstrate how institutional constraints on executive power, along with a more or less free press, can prevent strong states' abuse of power. European states have also learned over the past 150 years that their survival as strong states rests on their ability to orient themselves around meeting their citizens' social and economic needs. Even this change, however, may have been linked in part to the need to ensure that their populations were fit enough to fight; in 1906, the British government gave local councils the power to provide free school meals to poor children in part because it had had such a hard time recruiting able-bodied men to fight in the Second Boer War. Although the example does show how the public's sense of common goals can foster a national identity and a stronger state, nobody, of course, would contend that fighting more is a serious prescription for state development in the modern world.

In fact, no one really knows how to get a state to start recognizing and addressing the core needs of its population. This outcome seems more likely to happen in countries where a parliamentary system diffuses power, where built-in institutions oversee public policies, and where a strong civil society keeps the state in check. But the recent history of the developing world suggests that these features are not easily obtainable. The vast majority of postcolonial countries have done their best to dismantle any checks and balances that they inherited, and many have replaced parliamentary systems with presidential ones that concentrate political power. Crippled by weak institutions, developing states have frequently been captured by favored elites rather than ruled by broad-based coalitions. Political violence, in the form of either political repression or civil war, has become endemic.

Outside donors have tried to help such fragile states by lavishing them with foreign aid, but as admirable as the intention behind such largess may be, it often ends up entrenching governments that do little to promote development. And when outsiders try to use their leverage to spur political reform, it raises many difficult questions; for one, the legacy of colonialism ensures that the international community will always be wary of pushing too hard for social or political transformation in developing states.

The alternative is to give up on existing state structures. For example, multilateral donors and aid agencies could try to build independent agencies to deliver public services in the developing world, institutions that would operate on a larger scale than NGOs currently do and adopt the mantra of evidence-based policymaking. But if states are to remain legitimate in the eyes of their populations, then such agencies will eventually have to be absorbed by the government. Or perhaps they could remain quasi-independent and democratically governed, the way that school boards and hospital trusts are. Such a setup, however, has yet to be tried in the developing world on a systematic basis.

SCALING UP

None of these lessons suggests that there is much low-hanging fruit to be had when it comes to eradicating poverty. Still, economists need to at least try to understand what goes into making states better at fostering development. As Torsten Persson and I argued in our book, Pillars of Prosperity, economists have neglected larger questions of politics and taken state effectiveness as a given rather than as something to be explained.

Nonetheless, there is plenty of value in stepping back from the complex politics of macroeconomic policymaking and drilling down into the nitty-gritty of development. The three books reviewed here are attractive for precisely that reason. Their straightforward prescriptions are based on what the authors have seen on the ground, and they deliberately eschew any complex political strategizing. This bottom-up perspective lends the books special credibility, and the authors' work has already made a real difference to the lives of the poor -- and will continue to do so whether or not these economists start wading into big-picture debates.

Moreover, these books' focus on ground-level strategies to tackle poverty contributes to the larger effort of building better states. Demonstrating that certain interventions work on a small scale highlights just how much could be achieved if a more effective state were to try them on a larger scale. Expanding programs that work could trigger a virtuous cycle, with initial successes leading to further ones, as was the case in western Europe. States there first became strong thanks to the exigencies of war. Having entrusted the government with providing security, citizens later came to support directing resources toward health care, education, and social insurance. Thanks to the dem­­onstrated success of the early movers, pretty much every country in western Europe has embraced universal health care. Such success has widened the domain of state intervention and involvement.

There is inherent value, then, in demonstrating what types of poverty-reduction strategies work at a micro level. In order for those strategies to be pursued on a larger scale, however, the people who make things happen, policy wonks and regular citizens alike, must be convinced of their worth. Thus, the authors of these books should be commended for stepping out of their academic warrens to write them. Readers will realize that making the world a better place requires more than good intentions; it takes hard evidence, too. And they will gain a deeper understanding of poverty, one informed by conditions on the ground.