Nobel Laureate Angus Deaton on Human Progress, Poverty, and Aid

Princeton University economist Angus Deaton was awarded the Nobel prize in economics today. His work on carefully measuring consumption and other measures of well-being led him to understand development as a complex process not susceptible to improvement by technical or top-down interventions. For Deaton, knowledge is a key to development—even more so than income—and helps explain the tremendous progress humanity has experienced in the last 250 years when parts of the world we now call rich began their “great escape” from poverty and destitution.

In his book, The Great Escape: Health, Wealth, And the Origins of Inequality, Deaton documents how that progress is now spreading around the globe and is the reason we are living longer, wealthier and healthier lives than at any time in history. (You can see him presenting the book at this Cato forum, and see a summary of that talk here.) Even countries with relatively low incomes have seen tremendous advances, largely as a result of the spread of scientific, medical and other kinds of knowledge. Though he is not deterministic, Deaton paints a largely hopeful picture of humanity reminiscent of the views of Julian Simon, whom he cites. He is also concerned with inequality, but recognizes that “Inequality is often a consequence of progress,” and distinguishes between inequality that helps humanity and the kinds that harm it (e.g., inequality that can lead to political inequality).

As his career progressed, Deaton joined the growing number of development experts who have become skeptical of foreign aid and consider that numerous other factors play a critical role in development. Citing pioneer development economist Peter Bauer, Deaton notes a foreign aid dilemma: “When the ‘conditions for development’ are present, aid is not required. When local conditions are hostile to development, aid is not useful, and it will do harm if it perpetuates those conditions.” In The Great Escape, Deaton goes on to document the myriad practical problems with foreign aid including corruption, the failure of loans conditioned on policy changes, the institutional incentives to lend, the divergence of donor country interests from recipient country needs, etc. Even when aid projects do good, he concludes:

The negative forces are always present; even in good environments, aid compromises institutions, it contaminates local politics, and it undermines democracy. If poverty and underdevelopment are primarily consequences of poor institutions, then by weakening those institutions or stunting their development, large aid flows do exactly the opposite of what they are intended to do. It is hardly surprising then that, in spite of the direct effects of aid that are often positive, the record of aid shows no evidence of any overall beneficial effect.

When thinking about aid, the developed world would do well by heeding Deaton’s advice and by not asking what we should do. “Who put us in charge?” Deaton rightly asks. “We often have such a poor understanding of what they need or want, or of how their societies work, that our clumsy attempts to help on our terms do more harm than good…And when we fail, we continue on because our interests are now at stake…”

Deaton provides a far better way of thinking about development:

What surely ought to happen is what happened in the now-rich world, where countries developed in their own way, in their own time, under their own political and economic structures. No one gave them aid or tried to bribe them to adopt policies for their own good. What we need to do now is to make sure that we are not standing in the way of the now-poor countries doing what we have already done. We need to let poor people help themselves and get out of the way—or, more positively, stop doing things that are obstructing them.

Governments Subsidize Disaster—and the Wealthy

The Wall Street Journal takes a look at hurricane threats to cities along the seacoasts. It’s an odd article because the author, Greg Ip, does not discuss the central role that governments play in encouraging people to live in hurricane-prone areas.

Ip does mention the “levee effect” of misguided development taking place in low-lying areas because people feel safer behind large sea walls. In the United States, federal spending by the Army Corps of Engineers has encouraged people to live in unsafe coastal areas, as I discuss in this essay. After Hurricane Betsy struck New Orleans in 1965, for example, the Corps extended levees to additional low-lying areas around the city, thus encouraging further development and exacerbating damage in subsequent storms.

Ip does not discuss federal and state flood and wind insurance subsidies, which also encourage people to live in harm’s way. I discuss federal flood insurance subsidies in this essay, and a new essay in Cato’s Regulation examines state wind insurance subsidies.

I note,

rather than reducing the nation’s flooding problems, the National Flood Insurance Program (NFIP) has likely made flood damage worse by encouraging more development in hazardous areas. Since 1970, the estimated number of Americans living in coastal areas designated as Special Flood Hazard Areas by FEMA has increased from 10 million to more than 16 million. Subsidized flood insurance has backfired by helping to draw more people and development into flood zones.

And the Regulation article notes, “Insurance, if priced accurately, provides an important service of signaling to people the risk cost of living near water. [But] subsidized insurance rates destroy the information value of full-risk premiums, thus suppressing the true cost of living in severe weather zones and creating an excessive incentive to populate attractive but dangerous locations.” The federal government subsidizes flood insurance, and the article notes that Florida subsidizes wind insurance. Partly as a result of these subsidies, the coastal population of Florida has soared in recent decades.

An interesting fact about flood and wind insurance subsidies is that they are welfare for the well-to-do. Politicians often talk about helping the poor, but many of their policies disproportionally benefit the well-off.

A 2010 study, for example, looked at flood insurance claims data over a 10-year period and concluded, “the benefits of the NFIP appear to accrue largely to wealthy households concentrated in a few highly-exposed states.”

Similarly, the Regulation article examines Florida wind insurance data and finds that the benefits “accrue disproportionately to affluent households and the magnitude of this regressive redistribution is substantial.”

Montana Bureaucrats: Religious Families Need Not Apply

Montana’s scholarship tax credit (STC) law was already crippled and now bureaucrats are attempting to issue the coup de grâce

Montana’s STC law offers individuals and corporations tax credits in return for donations to nonprofit scholarship organizations that help families send their children to the school of their choice. All Montana students are eligible to apply for a tax-credit scholarship and the value of the scholarships is capped at half the statewide average per-pupil expenditure at the district schools (just over $5,300).

The only catch is that donations are capped at $150 per donor, far lower than in any other state. That means it would take at least 34 donors to fund a single $5,000 scholarship–a monumental task for scholarship organizations seeking to fund thousands of students.

But even if the scholarship organizations manage to raise the requisite funds, families may not be allowed to use the scholarships at their preferred school due to Montana Department of Revenue’s proposed rule barring the use of tax-credit scholarships at religious schools

The proposed regulations would bar schools from participating in the program if they’re “owned or controlled in whole or in part by any church, religious sect, or denomination.”

The proposed regulations also note schools are barred if their accreditation comes from a faith-based organization. […]

Republican state Sen. Kristin Hansen, who supported the bill, said the department was out of bounds.

“It’s the opposite of the intent of the legislation,” she said. “When we drafted the bill, we intentionally drafted a substantial definition of who qualified, so there wouldn’t be any questions about who would be eligible. I think the department has exceeded its authority by adding its own interpretation … when the Legislature was very clear. Absolutely, I think this proposed rule exceeds the department’s authority on more than one level.”

The bureaucrats claim they’re just following the state constitution’s historically anti-Catholic Blaine Amendment, which prohibits the appropriation of “any public fund or monies” to churches, religious schools, and other religious institutions. However, as the U.S. Supreme Court and several state supreme courts have held, tax-credit scholarships constitute private funding, not public funding, because the funds never enter the state treasury. Constitutionally, tax credits are no different than tax deductions or tax exemptions. Has the Montana Department of Revenue prohibited donors to churches from receiving charitable tax deductions? Has it prohibited the churches themselves from taking property tax exemptions? If not, why is it treating the tax credit law differently?

The department will hold a hearing on its proposed rules on November 5th. Hopefully the bureaucrats will see the error of their ways and change course. If not, they are inviting a lawsuit–one they are likely to lose.  

The Common Core Is in Retreat

A Politico article today declares that the Common Core has “quietly” won the school standards war. It is a headline that would have been accurate several years ago, but today’s headline should be somewhat different:  “Common Core in major – but quiet – retreat.”

The one thing the article gets right is that the Core did, indeed, achieve almost complete domination very quietly. But that was around six years ago, when the Obama administration, at the behest of Core strategizers, slipped the de facto requirement that states adopt the Core into the $4.35 billion Race to the Top program, a pot of “stimulus” money the large majority of states grabbed for while the country panicked about the Great Recession. It was also used to pay for national tests to go with the Core. It was, for all intents and purposes, a silent coup.

But then something happened. Around 2011 the public suddenly became cognizant that they’d lost a war they weren’t even aware they were in. After the states had done their part in conforming to the new standards overlords, districts and schools were told, “implement this new set of standards you’ve never heard of.” That’s when the resistance began, and it quickly grew fierce. Indeed, the Core has been on the defensive ever since.

Polling, though subject to lots of variation thanks to wording and other issues, shows the losses the Core has suffered. As I noted a few months ago, more-neutral poll questions tend to show very low support for the Core, but it is a question that is biased in favor of the Core that captures the direction in which the Core has been going: backwards. Defining the Core as standards states simply choose to adopt that “will be used to hold public schools accountable,” the annual Education Next poll found support dropping from 65 percent in 2013 to 49 percent in 2015. Among teachers, the Core freefell from 76 percent support to 40 percent, with 50 percent now opposing.

Capturing how bad things are for the Core, a question in a brand new poll that blatantly spins for the Core, describing it as a “set of high-quality [italics added] academic standards,” elicited only 44 percent support, with only 9 percent saying the standards “are working in their current form and should not be changed.”

Sure doesn’t seem like the Core is triumphant, at least not on the battlefield of public opinion.

Setting the REAL ID Record Straight in Minnesota

A few weeks ago, unsatisfied with a report on REAL ID in the Minneapolis Star Tribune, I submitted an op-ed that the paper was kind enough to print. Unfortunately, they followed it up with an editorial favoring state compliance with REAL ID. And last week, the Star Tribune published an op-ed from a pro-national-ID advocacy group arguing that Minnesota should join the national ID system. The paper’s recent coverage of a meeting between state officials and the DHS reported uncritically on federal bureaucrats’ misrepresentations to Minnesota’s lawmakers. The REAL ID record in Minnesota should be set straight.

According to the Star Tribune’s report, Ted Sobel, director of DHS’s Office of State-Issued Identification Support, told Minnesota officials: “We are not asking Minnesota to turn over the keys to your information to anybody else. REAL ID does not affect one way or another how Minnesota protects the information of its residents.”

That is not accurate. REAL ID compliance would require Minnesota to make its drivers’ information available to all other States. The law is unequivocal on that (you can get it right from DHS’s web site):

To meet the requirements of this section, a State shall adopt the following practices in the issuance of drivers’ licenses and identification cards: …
(12) Provide electronic access to all other States to information contained in the motor vehicle database of the State.
(13) Maintain a State motor vehicle database that contains, at a minimum–
(A) all data fields printed on drivers’ licenses and identification cards issued by the State; and
(B) motor vehicle drivers’ histories, including motor vehicle violations, suspensions, and points on licenses.

That seems like turning over the keys to me, and it absolutely affects the security of Minnesotans’ personal information.

Urbanization Is Good for the Environment

Urbanization is on the rise around the world. By 2050, some 70 percent of humanity will live in the cities and that is good news for the environment.

Many of the environmental advantages are derived from living spaces being condensed. For example, electricity use per person in cities is lower than electricity use per person in the suburbs and rural areas. Condensed living space that creates reduction in energy use also allows for more of the natural environment to be preserved. In a suburban or rural environment, private properties are spread out, because land values are relatively low. So, more of the natural environment is destroyed. In cities, property values are higher and space is used more efficiently. That means that more people live in the same square mile of land than in the rural areas.

Another environmental advantage of cities compared to rural areas is a decrease in carbon emissions per person. In a rural or suburban area people normally use their own vehicles to drive to work or anywhere else. Due to congestion, the use of personal cars in the city is much less attractive. More people use public transportation instead and that means that less carbon dioxide gets released into the atmosphere.

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The Courage to Act in 2008

Ben Bernanke’s memoir is now out and is unapologetically pro-Fed. It is titled The Courage to Act. Here is the cover quote:

bernanke, courage to act, 2008 crisis

The main point of Bernanke’s book is that absent the Fed’s interventions over the past seven years the U.S. economy would have undergone another Great Depression. Thanks to him and his colleagues at the Fed the world is a much better place.

There has already been some push back on this Bernanke triumphalism. George Selgin, for example, notes that the recovery under Bernanke’s watch was anemic. Inflation consistently undershot the Fed’s target and the real recovery was weak. We may not have experienced another Great Depression, but we sure did get a long slump. Ryan Avent makes a similar point by observing that Bernanke had a chance in late 2011 to do something bold by endorsing a NGDP target, an action that could have jolted the economy from its doldrums. But alas, Bernanke failed to muster up the courage to have what Christina Romer called his “Volker Moment”.

Expect more push back along these lines from a book with such a bold title. One strand of criticism that many observers miss, but I hope will be considered in future reviews of Bernanke’s book is the role the Fed played in allowing the crisis to emerge in the first place. Could the Fed have done more to prevent the recession from becoming as severe as it did? Maybe a recession was inevitable, but was a Great Recession inevitable? These are the questions first raised by Scott Sumner and echoed by others including me. Our answer is no, the Great Recession was not inevitable. It was the result of the Fed failing to act aggressively enough in 2008.

This understanding draws upon the fact that the housing recession had been going on for about two years before a wider slowdown in economic activity occurred. As seen in the two figures below, sectors of the economy tied to housing began contracting in April 2006 while elsewhere employment growth and nominal income continued to grow. This all changed in the second half of 2008.

So what went wrong in the second half of 2008? Why did a seemingly ordinary recession get turned into a Great Recession? We believe the Fed became so focused on shoring up the financial system and worrying about rising inflation, that it lost sight of stabilizing aggregate demand. Based on theses concerns, especially the latter, the FOMC decided to do abstain from any policy rate changes during the August and September 2008 FOMC meetings. But by doing nothing at these meetings the FOMC was doing something: it was signaling the Fed would not respond to the weakening economic outlook. The FOMC, in other words, signaled it would allow a passive tightening of monetary policy in the second half of 2008.

A passive tightening of monetary policy occurs whenever the Fed allows total current dollar spending to fall, either through a endogenous fall in the money supply or through an unchecked decrease in money velocity. The decline in the money supply and velocity are the result of firms and households responding to a bleaker economic outlook. The Fed could have responded to and offset such expectation-driven developments by properly adjusting the expected path of monetary policy.

The figures below document this monumental failure by the FOMC. The first one shows the 5-year ‘breakeven’ or expected inflation rate. This is the difference between the 5-year nominal treasury yield and the 5-year TIPs yield and is suppose to reflect treasury market’s forecast for the average annual inflation rate over the next five years. The figure shows that prior to the September 16 FOMC meeting this spread declined from a high of 2.72 percent in early July to 1.23 percent on September 15. That is a decline of 1.23 percent over the two and half months leading up to the September FOMC meeting. This forward looking measure was screaming trouble ahead, but the FOMC ignored it.

One way to interpret this figure is that the Treasury market was expecting weaker aggregate demand growth in the future and consequently lower inflation. Even if part of this decline was driven by a heightened liquidity premium the implication is the same: it indicates an increased demand for highly liquid and safe assets which, in turn, implies less aggregate nominal spending. Either way, the spread was blaring red alert, red alert!

The FOMC allowed these declining expectations to form by failing to signal an offsetting change in the expected path of monetary policy in its August and September FOMC meetings. The next figure shows where these two meetings fell chronologically during this sharp decline in expectations.

As noted above, this passive tightening in monetary policy implies there would be a decline in the money supply and money velocity occurring during this time. The Macroeconomic Advisers’ monthly nominal GDP data indicates this is the case:

The Fed could have cut its policy rate in both meetings and signaled it was committed to a cycle of easing. The key was to change the expected path of monetary policy. That means far more than just the change in the federal funds rate. It means committing to keeping the federal funds rate target low for a considerable time and signaling this change clearly and loudly. With this approach, the Fed would have provided a check against the market pessimism that developed at this time. Instead, the Fed did the opposite: it signaled it was worried about inflation and that the expected policy path could tighten.

Recall that Gary Gorton provides evidence that many of the CDOs and MBS were not subprime, but when the market panicked a liquidity crisis became a solvency crisis. This is especially true in late 2008. Had the Fed responded to the falling market sentiment in the second half of 2008 the financial panic in late 2008 may have been far less severe and the resulting bankruptcies fewer. Again, the worst part of the financial crisis took place after the period of passive Fed tightening. This is very similar to the Great Depression when the Fed allowed the aggregate demand to collapse first and then the banking system followed.

So had Fed had the courage to act in 2008 the economy would be in a very different place today. Future reviewers of Bernanke’s book should keep that in mind.

P.S. For a more thorough development of this view see the book by Robert Hetzel of the Richmond Fed.

[Cross-posted from]