Gambling on Development Review

How the politics of countries matters for development

TL;DR

1. Economic development is dependent on the deal between elites of a country. In most poor countries, elites choose to extract resources from the economy because the policies that lead to development can endanger their political position.

2. When elites decide to have pro-growth policies, they’re taking a risk that it will work out and benefit them personally. Most elites do not want to take this risk, and would rather enjoy the spoils of corruption instead.

3. Some circumstances like the possibility of losing legitimacy (e.g. China after the Cultural Revolution) can force elites to focus on economic growth. But this doesn’t guarantee it. Elites also have to ration state capacity wisely and be open to correcting course for countries to escape extreme poverty.

Mandatory meme:

If you ask economists to predict which countries will escape extreme poverty, they'll tell you that it depends on the economic policies they have. Some economic policies like stable monetary policy, private property rights, enforcing the rule of law, attracting foreign investment and investing in health and education are likely to aid in increasing growth and reducing poverty. 

Stefan Dercon, the author of Gambling on Development agrees with this, but goes one step further. He asks the question: what makes some governments more likely to pursue these policies than others? 

Most answers to this are vague like “be a democracy” or “have good institutions a thousand years ago”, but I think Dercon’s explanation is special because he provides a detailed explanation of why some elites focus on development and others don’t. 

It's not that they don't know what to do, governments get that from economists in their own country and could always ask foreign development institutions for it. Dercon’s answer to the question is that it depends entirely on the political deal the government has within itself and other elites in their society. 

Good Deal, Bad Deal

The elite bargain in a country is an agreement on how political power and economic resources are allocated among the elite. For example, in Egypt, Thailand and Pakistan, their militaries have coerced the government into giving them large amounts of power and economic resources. The ensuing elite bargain is that the country's economic resources are used to further the interests of the military, while civilian leaders do not have much power. This doesn't lead to much economic development because policy is usually skewed to help the military, large amounts of tax money is used on military spending and so, the economy's resources are used primarily for the military's ends. 

In some countries the political elites loot whatever resources exist in a competitive free-for-all between them. Economic policy is shaped such that it helps individual leaders and their cronies, government spending is focused on helping specific interest groups and as a consequence of this, very little productive activity happens. The elites have no incentive to change because they're stuck in a bad equilibrium. If one person stops stealing, they'll lose out to another who continues to steal. The ensuing arrangement optimises for extracting as much money as possible for personal gain. 

But there are times when the political elite of a country can coordinate to have growth seeking policies. If there's higher growth, there will be more resources for them to tax. There will be more to be gained from controlling a larger economy. They're more likely to win wars with a stronger economy. The country as a whole becomes more powerful. And you might be forgiven for thinking that elites would be in favour of policies to increase growth. 

But you'd be wrong. 

Usually, elites take a dim view of economic growth. They might be fans of the idea that they control a more powerful country, but they usually don't like the means it takes to get there. The problem from the elites' perspective is that the policies which are required for development are damaging to their interests. Typically, they have to give up their control over markets and open them up to competition. This reduces the amount of money they can extract in the short run and give to their supporters. They also have to allow new technology which might provide means for organising against the government. Both of these hurt elite power, and if they do adopt these measures, they’re taking a huge risk. 

But in some countries they do take the risk. They remove controls on the economy and give up the possibility of making more money for themselves and their cronies. If the new economic reforms lead to higher economic growth and they stay in power, it pays off. Otherwise, from the elites’ perspective, it is a failure. 

According to the book, the reason why the political elite don’t make the reforms necessary for growth is because they’re too comfortable extracting money from the rest of the country. They wouldn’t want to take the risk of losing their power in exchange for the possibility of more power in the future. 

The book says this about Sierra Leone and Malawi which fits the theory: 

Their elite bargains are based on an apparent political bargain for short-term gains by those in the elite who control the state. It is an economic deal with far less interest in creating economic growth and development than in redistributing the gains from controlling the state to the groups that happen to be in control or support those in control. The state structures in both countries are built to serve this purpose through patronage and clientelism. Leadership transitions are possible through electoral processes, but, as described in this chapter, those processes appear to function mainly as a way of simply passing control of the patronage structures from one group to another.

Dercon, Stefan. Gambling on Development (p. 151). Hurst Publishers. Kindle Edition. 

But we know from history that this isn't true for every country. In some countries, elites do choose to focus on development instead of zero sum activities. The deal they have amongst themselves is quite different from what's described above. 

The next obvious question is that if elite bargains are so important, what makes them likely?

Sometimes, we attribute economic success to individual leaders. We say Lee Kuan Yew is responsible for Singapore’s economic miracle, Deng Xiaoping for China’s or Paul Kagame for Rwanda’s. It is true that individual leaders are extremely important in keeping the politics of the country committed towards development, managing their political coalitions and providing direction to policy. But having a good leader is hardly sufficient for economic growth. The point the book makes is that these leaders would still need the support of other elites to make and maintain their elite bargain. Individual personalities are important, but not sufficient.

Dercon does suggest a few things. In many cases, the elite bargains came after a period of instability in the country where there are fewer vested interests. In Ethiopia, after a bloody civil war that ended in 1991, the government requested assistance from the IMF and later the World Bank in 1992. The new agricultural policy they developed was seen as a fresh start where previous players didn’t exist and there was a place to build a new deal. But another part was that the new government needed political legitimacy among the public and they saw economic growth as the best way to do that. 

Another example is China where the Communist Party saw the possibility of their support falling after the Cultural Revolution and wanted to regain legitimacy by focusing on economic growth.

Bangladesh too was shaped by a desire for growth and legitimacy after the democratic government took over 1991. The government pursued growth friendly policies and had a laissez-faire approach to the emerging garments industry. 

The Means of Development

If and when a country’s elite is interested in development, what comes next? There are two other parts to Dercon’s story. The first is that the capabilities of the state are used to achieve the goals of development. And the second is that the government has the capacity to course correct mistakes. 

Work with the state you have, not the one you wish you had

The book is very insistent that the best way for the state to develop is to utilise existing levels of state capacity, and not to overextend the state. In countries where the state already has a tradition of strong administration and centralisation, it makes sense to have a state led economic development model. But on the other hand if you don’t have a state with such a tradition, it makes more sense for them to be hands off and to let the private sector or NGOs take over parts of government action.

Ethiopia has a tradition of a strong centralised state with an administrative system built over a century, and which (for reasons that are not explained in the book) didn’t serve itself but whoever pulled strings at the top. This helped with getting a bureaucracy that was highly educated (Tedros Adhanom Ghebreyesus, the director general of the WHO is from Ethiopia as is Ato Newai Gebre-Ab, an accomplished economist and former adviser to the Ethiopian President). The book’s thesis goes that a centralised state made it much easier for Ethiopia to implement its growth plans. This connection isn’t made very clear in the book but is implied. 

A counterfoil to this is Bangladesh where the state recognized that it didn’t have much state capacity, and NGOs like Grameen bank and BRAC which get extensive financial support from donors abroad. This isn’t perfect but it is better than the state overextending itself, crowding out private enterprise and failing to run social services. In many countries the government might stop the NGOs but in Bangladesh they’re fine with it and to some extent they condone it as long as they stay away from high level politics. 

Course Correction

A fundamental problem in economic policy is that people make mistakes. It’s sort of inevitable that they will happen. The question is if elites have both the humility and the political capital to be able to accept their mistakes. A good example is in China where they tried reforms at a local level, reviewed the results and then applied them to the national level. For example, the first de-colllectivisation of Chinese farms came because of the experience of local officials in Anhui, and the elites up the chain of command considered that it was a worthwhile endeavour. They changed their minds about old Maoist policies. Experiments like these were repeated across China, with policies starting small scale and deciding to scale up depending on their success. 

But you also need it for very large policies. In Ethiopia the government had a policy of expanding credit to farmers to buy fertiliser. The problem was that the state owned banking system couldn’t risk its assets on such a large expansion. So they lent the money but used regional government budgets as collateral. In the case of farmers not paying money back, it would be taken from the budgets of regional governments. This was a bad idea, and the Ethiopian government quickly reversed its course when it saw the costs. Instead they focused their attention to setting favourable prices and building better infrastructure. 

Dercon’s argument is that this ability to course correct is essential for development, or else governments would get stuck in poor policies. This sounds obvious, but it is in his opinion a strong predictor of how well a country is going to develop. It makes them less likely to have large policy blunders. 

Success and Failures

One of the less well known successes that Dercon explains in the book is Ethiopia. From 2004 to 2018, Ethiopian incomes grew 138% from $771 to $1838 per capita. The country is probably the best example of Dercon’s theory. Ethiopia’s elite bargain was forged after the EPRDF (Ethiopian People's Revolutionary Democratic Front) defeated the Soviet supported Derg in a civil war. Growth was initially very slow from 1992 to 2003 with per capita incomes increasing only 7%. But after 2002, when the government saw a threat to their legitimacy due to a food crisis, they started focusing more on economic growth.

In the first few years attention was devoted towards reversing its poor performance in agriculture. And then they used the success from this to work on industrialisation. The key here, Dercon notes, was that the government itself was involved in it and had a strong commitment towards working on development. They drafted the plans themselves, took help from international agencies when required, and all ends of government were committed to achieving them. This is what other countries would miss as the elite would find it less risky to stick to their existing model of extracting whatever comes from a stagnating economy. 

The Prime Minister, Meles Zenawi, was very important in this but as was his trusted team of technocrats which was able to draft and implement their economic development plans. Ethiopia also had the ability to course correct its mistakes. Even after Zenawi’s death it seemed as if the strong performance would continue, but a civil war in 2021 has brought much of that to a standstill. Regardless, the facts in Ethiopia (and China, India and Indonesia) fit Dercon’s theory. 

One of the failures he talks about is Sierra Leone. The main problem in Sierra Leone is that their political elite really just didn’t care. When the central bank governor in Sierra Leone was attending an aid talk here’s how he responded:

 ‘I don’t understand why you aid donors care so much about the poor,’ said the smartly dressed governor of the Central Bank of Sierra Leone.

Dercon, Stefan. Gambling on Development (p. 152). Hurst Publishers. Kindle Edition. 

Aid to Sierra Leone was used for vanity projects. In all likelihood it was likely that it helped 

He would sign on to an aid package only if he was allowed to also sign a deal to build a $318-million shiny new airport with a loan from China (adding almost 20 per cent to the country’s external debt), despite serious concerns by the International Monetary Fund (IMF).11 It is true that accessing the country was not easy, but that was largely due to geography, and the newly planned airport was not going to change that—Freetown would still be accessible only by boat from the airport. The president nevertheless had set his heart on it, and probably boosting someone else’s bank balance was on offer as well.

Dercon, Stefan. Gambling on Development (pp. 156-157). Hurst Publishers. Kindle Edition. 

It is really important to understand that an extractive elite is the default. It is very rational for them to take the trade of extracting money from the public, because they don’t want to take the risk. They’re too comfortable, and nothing has forced them to come out of their comfort zone. And so you see them continuing to be corrupt, and use money for personal ends. Take another example here

Maybe even more shocking, when fighting Ebola with huge international support, the respectable Office of the Auditor General documented in January 2015 that about 30 per cent of the $9.5 million mobilised locally by Koroma’s government through donations could not be accounted for. Moreover, whenever he could, the president had awarded all Ebola-related contracts to a small network of businessmen, each owning several companies and allegedly with close connections to the president’s All People’s Congress (APC) government.

Dercon, Stefan. Gambling on Development (p. 158). Hurst Publishers. Kindle Edition. 

And it's unlikely that it will change apart from some serious event that forces them to worry about their legitimacy or if new innovative leadership enters. 

My review

I find his work on elite dynamics to be new and innovative. It is true that “have a good elite” is trivial. But it is also not one of our leading theories of economic development! And it is a useful tool in trying to understand why some countries have better economic policy than others. 

The book is also a good complement to theories that focus on historical effects like Why Nations Fail. But it focuses more on catchup growth which makes it different from WNF. 

There is one place where I have a serious disagreement with Dercon and that is the value of democracy. Dercon is correct that being a democracy or an autocracy doesn’t make much of a difference conditional on having an elite bargain. But democracies have substantially *less* variance in economic growth than autocracies do. So, he should be at least mildly in favour of them, as compared to autocracies. Democracy offers a safety valve against the worst types of leaders, which is why it's important for very poor countries.

I think Dercon should have written more about identifying development bargains before they are clear. It is true that after elites have taken the required steps to align their interests with development, we can recognize a development bargain. But for most countries this isn’t very clear until the very end. But the value of recognizing them when they’re in their infancy is very high to people in the private sector like frontier market investors, and to donors who can target their aid better. More detail on this process, either theoretically or case studies would have helped quite a bit. 

Second, there is a lot left out on how to increase economic growth after they hit middle income. How does the elite bargain have to change then? Which countries hit the middle income trap and which don’t? This is an important unanswered question in the book. For example in Taiwan and South Korea, as incomes went up the population demanded more political rights and democracy. This did change their elite bargain quite a bit, what were the effects of that? 

Finally, elite bargains might work for increasing very low incomes to middle income, but after a certain point, governments can’t rely on factor accumulation (like building more infrastructure and increasing population and physical capital) and would have to focus on increasing productivity instead. What do the elite bargains of this economy look like?

Despite these minor omissions, I highly reading the book!

I’ll be writing another post about practical actions to take to increase economic growth. Stay tuned