New growth perspectives on New growth perspectives on spillovers and povertyspillovers and poverty

January 1999January 1999

by William Easterlyby William Easterly

Over very long run, poor countries stay trapped in povertyGrowth Rates Diverge between Rich

and Poor: 1820-1992

1820 1992

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A puzzle: even if national policy incentives explain

national growth differences,

Why do we observe persistently poor Why do we observe persistently poor areas within a given country?areas within a given country?

If “people respond to incentives” why don’t the poor

respond to the same incentives as the rich?

Proposed thesis: poor people stay poor Proposed thesis: poor people stay poor because their incentives to grow are because their incentives to grow are

poor; their incentives are poor poor; their incentives are poor because of spillovers from other because of spillovers from other

poor people.poor people.

Outline Direct evidence of poverty traps and Direct evidence of poverty traps and

spillovers between peoplespillovers between people

Theory of Increasing Returns (poverty Theory of Increasing Returns (poverty traps) versus Diminishing Returns (no traps) versus Diminishing Returns (no poverty traps)poverty traps)

More Testing predictions of increasing More Testing predictions of increasing versus diminishing returns modelsversus diminishing returns models

Testing predictions of diminishing versus increasing returns models

Diminishing returns:Diminishing returns:

Wealth and poverty Wealth and poverty depend on individual depend on individual characteristics; there is characteristics; there is no reason to expect no reason to expect concentrations of concentrations of wealth and povertywealth and poverty

Increasing returns:Increasing returns:

Wealth and poverty Wealth and poverty are concentrated in are concentrated in particular areasparticular areas

Direct evidence for spillovers

Rauch 1991 found that identical workers Rauch 1991 found that identical workers have higher wages in US cities with high have higher wages in US cities with high average human capital than in cities with average human capital than in cities with low average human capital.low average human capital.

Borjas 1994 found that identical workers Borjas 1994 found that identical workers have different wages if they belong to have different wages if they belong to different immigrant groups (average human different immigrant groups (average human capital of ethnic group = “ethnic capital”)capital of ethnic group = “ethnic capital”)

Direct evidence for spillovers

Households in the Households in the Tangail/Jamalpur Tangail/Jamalpur district of district of Bangladesh have Bangladesh have 47 percent lower 47 percent lower real consumption real consumption than identical than identical households in households in Dhaka.Dhaka.

Anecdotes of poverty concentrations

Where are the poorest all-white counties in Where are the poorest all-white counties in the US? the US?

18 of the 20 all-white counties with the 18 of the 20 all-white counties with the worst poverty rates are in Southeastern worst poverty rates are in Southeastern Kentucky.Kentucky.

The poorest county, Owsley, has 52 percent The poorest county, Owsley, has 52 percent of the population under the poverty line and of the population under the poverty line and only 35 percent are high school graduates.only 35 percent are high school graduates.

The poor in Southeastern Kentucky remain poor because they are surrounded by other poor people

SoutheasternKentucky

Anecdotes of poverty concentrations

Indigenous Indigenous Mexicans have Mexicans have a poverty rate a poverty rate of 81 percent;of 81 percent;

non- non-indigenous indigenous Mexicans 18 Mexicans 18 percentpercent

Anecdotes of poverty concentrations

In China, 5 percent of the population are In China, 5 percent of the population are below thebelow the poverty line in Guangdong while poverty line in Guangdong while Guangxi has 37 percent below the poverty Guangxi has 37 percent below the poverty line.line.

Anecdotes of poverty concentrations

In Malaysia, non-Bumiputras (Indians/ In Malaysia, non-Bumiputras (Indians/ Chinese) earn 68 percent more than Chinese) earn 68 percent more than BumiputrasBumiputras

Poor remain poor because they associate Poor remain poor because they associate mainly with other poor people.mainly with other poor people.

High income is also concentrated in space

The most economically dense 10 percent of The most economically dense 10 percent of global land area produces 54 percent of global land area produces 54 percent of global GDP; the least dense 50 percent of global GDP; the least dense 50 percent of land area produces 11 percent of global GDPland area produces 11 percent of global GDP

The most economically dense 2 percent of The most economically dense 2 percent of US land area produces 50 percent of US US land area produces 50 percent of US GDP; the least dense 50 percent of the land GDP; the least dense 50 percent of the land produces 2 percent of GDPproduces 2 percent of GDP

High income is concentrated in space

US metropolitan counties US metropolitan counties are $3300 richer per capita are $3300 richer per capita than rural counties.than rural counties.

Metropolitan counties in Metropolitan counties in the BosWash corridor are the BosWash corridor are $5874 richer per capita $5874 richer per capita than other metropolitan than other metropolitan areas (2.4 standard areas (2.4 standard deviations).deviations).

Boston-Washington corridor

High income is concentrated in space

Even within the Washington DC Even within the Washington DC metropolitan area there are huge differences metropolitan area there are huge differences across space.across space.

Wealth concentrations are reinforced Wealth concentrations are reinforced because rich associate with each otherbecause rich associate with each other

Poverty concentrations are reinforced Poverty concentrations are reinforced because poor associate with each otherbecause poor associate with each other

A journey through the DC area

Andrews AFB

Potomac

High income is concentrated in space

A journey through the Washington DC area

10000

20000

30000

40000

50000

60000

70000

80000

90000

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Northwest DC

Anacostia DC

Andrews Air Force

Median household income by zipcode 1989

White House

Capitol Hill

Still see mild divergence with more recent data:

Growth and initial per capita incomes, 1960-94, decade averages

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0.025

lowest quintile fourth quintile third quintile second quintile highest quintile

Incomes per capita by quintile

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Theory of Increasing versus Diminishing Returns

Diminishing Returns Diminishing Returns Production Function: Production Function: y=Aky=Akaa

k is individual’s own k is individual’s own physical capital, y is physical capital, y is individual’s own individual’s own outputoutput

a<1a<1

Increasing Returns Increasing Returns Production Function: Production Function: y=Aky=Akaahhbb

k is individual’s own k is individual’s own broadly defined capital, broadly defined capital, h is average level of h is average level of broad capital in societybroad capital in society

in equilibrium, k=hin equilibrium, k=h

a + b > 1a + b > 1

Incentives with Diminishing vs Increasing Returns

Diminishing Returns (no poverty trap)

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Poverty trap region

Increasing Returns (poverty trap)

Ingredients of Increasing Returns

Knowledge Knowledge spills over spills over between people between people (Desh Garments (Desh Garments story)story)

Ingredients of Increasing Returns

Technology Technology is only as is only as strong as its strong as its weakest weakest link link (Kremer’s (Kremer’s O-ring O-ring theory)theory)

Ingredients of Increasing Returns

““Weakest link” theory implies strong Weakest link” theory implies strong complementarity between peoplecomplementarity between people

Your productivity is higher if you work with Your productivity is higher if you work with other high productivity peopleother high productivity people

High human capital people tend to segregate High human capital people tend to segregate themselves into an exclusive group, leaving themselves into an exclusive group, leaving low human capital people to associate with low human capital people to associate with other low human capital peopleother low human capital people

Incentives with Diminishing vs Increasing Returns

Diminishing Returns (no poverty trap)

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Poverty trap region

Increasing Returns (poverty trap)

Testing predictions of diminishing versus increasing returns models

Diminishing returns:Diminishing returns:

Poor catch up to richPoor catch up to rich

Increasing returns:Increasing returns:

Country poverty trapsCountry poverty traps

Incentives with Diminishing vs Increasing Returns

Diminishing Returns (no poverty trap)

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Poverty trap region

Increasing Returns (poverty trap)

Testing predictions of diminishing versus increasing returns models

Diminishing returns:Diminishing returns:

Initial conditions don’t Initial conditions don’t mattermatter

Increasing returns:Increasing returns:

Initial conditions Initial conditions mattermatter

Incentives with Diminishing vs Increasing Returns

Diminishing Returns (no poverty trap)

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Poverty trap region

Increasing Returns (poverty trap)

Over very long run, poor countries stay trapped in povertyGrowth Rates Diverge between Rich

and Poor: 1820-1992

1820 1992

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The rank correlation across 36 countries of income per capita in 1820 and income per capita

in 1992 is .85

The poor nations stay poor because The poor nations stay poor because individual incentives are poor; individual incentives are poor; individuals’ incentives are poor individuals’ incentives are poor

because they associate with other because they associate with other poor individuals.poor individuals.

Testing predictions of diminishing versus increasing returns models

Diminishing returns:Diminishing returns:

Capital flows to poor Capital flows to poor areasareas

Increasing returns:Increasing returns:

Capital flows to rich Capital flows to rich areasareas

Incentives with Diminishing vs Increasing Returns

Diminishing Returns (no poverty trap)

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Poverty trap region

Increasing Returns (poverty trap)

Portfolio capital gross inflows per person, annual average 1970-94

Annual inflow to Annual inflow to poorest quintile of poorest quintile of countries: six cents per countries: six cents per personperson

Annual inflow to Annual inflow to richest quintile of richest quintile of countries: $189 per countries: $189 per personperson

Total gross capital inflows, 1990

The richest 20 percent The richest 20 percent of world population of world population received 88 percent of received 88 percent of gross capital inflowsgross capital inflows

The poorest 20 percent The poorest 20 percent of world population of world population received 1 percent of received 1 percent of gross capital inflowsgross capital inflows

Testing predictions of diminishing versus increasing returns models

Diminishing returns:Diminishing returns:

National policies have National policies have weak effectweak effect

Increasing returns:Increasing returns:

National policies have National policies have strong effectstrong effect

Incentives with Diminishing vs Increasing Returns

Diminishing Returns (no poverty trap)

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Poverty trap region

Increasing Returns (poverty trap)

How strong are policy effects?

They are strong, as we have seen in They are strong, as we have seen in previous presentationsprevious presentations

Caveats ““Conditional convergence” seems to Conditional convergence” seems to

contradict increasing returns, although the contradict increasing returns, although the two can be made consistenttwo can be made consistent

Causality is an open question about strength Causality is an open question about strength of policy effectsof policy effects

Failure to find spillovers from FDI in firm-Failure to find spillovers from FDI in firm-level studieslevel studies

Growth rates can’t increase without boundGrowth rates can’t increase without bound

Conclusions Most of the evidence supports the existence Most of the evidence supports the existence

of spillovers between people and increasing of spillovers between people and increasing returns.returns.

Poverty itself creates poor incentives for the Poverty itself creates poor incentives for the poor with increasing returns: the poor are poor with increasing returns: the poor are poor because they get spillovers only from poor because they get spillovers only from other poor people.other poor people.

Policy implications

Need to subsidize return to physical capital, Need to subsidize return to physical capital, human capital, and technology adaptation in human capital, and technology adaptation in poor areas.poor areas.

Have subsidy increase as poor raise their Have subsidy increase as poor raise their incomes, not decrease.incomes, not decrease.

Market-friendly government policies matter Market-friendly government policies matter even more under increasing returns than even more under increasing returns than under diminishing returns.under diminishing returns.