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POVERTY Economic Possibilities for Our Time

JEFFREY D. SACHS

THE PENGUIN PRESS

NEW YORK

2OO5

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First published in 2005 by The Penguin Press, a member of Penguin Group (USA) Inc.

Copyright ©Jeffrey D. Sachs, 2005 All rights reserved

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Sachs, Jeffrey. The end of poverty / Jeff rey Sachs.

p. cm. Includes bibliographical references and index.

ISBN 1-59420-045-9 1, Poverty Developing countries. 2. Developing countries—Economic policy.

8. Developing countries—Economic conditions. 4. Economic assistance—Developing countries. I. title.

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Introduction

This book is about ending poverty in our time. It is not a forecast. I am not predicting what will happen, only explaining what can happen. Cur­ rently, more than eight million people around the world die each year because they are too poor to stay alive. Our generation can choose to end that extreme poverty by the year 2025.

Every morning our newspapers could report, “More than 20,000 people perished yesterday of extreme poverty.” The stories would put the stark numbers in context—up to 8,000 children dead of malaria, 5,000 mothers and fathers dead of tuberculosis, 7,500 young adults dead of AIDS, and thousands more dead of diarrhea, respiratory infec­ tion, and other killer diseases that prey on bodies weakened by chronic hunger. The poor die in hospital wards that lack drugs, in villages that lack antimalarial bed nets, in houses that lack safe drinking water. They die namelessly, without public comment. Sadly, such stories rarely get written. Most people are unaware of the daily struggles for survival, and of the vast numbers of impoverished people around the world who lose that struggle.

Since September 11, 2001, the United States has launched a war on terror, but it has neglected the deeper causes of global instability. The $450 billion that the United States will spend this year on the military will never buy peace if it continues to spend around one thirtieth of that, just $15 billion, to address the plight of the world’s poorest of the poor, whose societies are destabilized by extreme poverty and thereby become havens of unrest, violence, and even global terrorism.

That $15 billion represents a tiny percentage of U.S. income, just 15 cents on every $100 of U.S. gross national product, or GNP. The share of U.S. GNP devoted to helping the poor has declined for decades, and is a tiny fraction of what the United States has repeatedly promised, and failed, to give. It is also much less than the United States should give, both to solve the crisis of extreme poverty and thereby to provide for U.S. national security. This book, then, is about making the right

2 THE END OF POVERTY

choices—choices that can lead to a much safer world based on a true reverence and respect for human life.

I have spent the past twenty years working with heads of state, fi­ nance and health ministers, and villagers in dozens of countries in all parts of the world. I have visited and worked in more than a hundred countries with around 90 percent of the world’s population. The cumu­ lative experience of seeing the world from many vantage points has helped me to appreciate the real circumstances on our planet—the causes of poverty, the role of rich-country policies, and the possibilities for the future. Gaining a proper perspective on these issues has been my struggle and challenge for two decades. Nothing else in my intellectual life and political engagement has been as rewarding.

I have been fortunate to have observed, and contributed to, some real successes—the end of hyperinflations, the introduction of new sta­ ble national currencies, the cancellation of unpayable debts, the con­ version of moribund communist economies to dynamic market-based economies, the start-up of the Global Fund to Fight AIDS, TB, and Malaria, and modem drug treatment for impoverished HIV-infected people. I have increasingly understood the yawning gap between what the rich world claims to be doing to help the poor and what it is actually doing. I have also gradually come to understand through my scientific research and on-the-ground advisory work the awesome power in our generation’s hands to end the massive suffering of the extreme poor, and thereby to make our lives safer in the process.

In the following pages, I will explain what I have witnessed and learned in societies as varied as Bolivia, Poland, Russia, China, India, and Kenya. You will see that all parts of the world have the chance to join an age of unprecedented prosperity building on global science, technology, and markets. But you will also see that certain parts of the world are caught in a downward spiral of impoverishment, hunger, and disease. It is no good to lecture the dying that they should have done better with their lot in life. Rather, it is our task to help them onto the ladder of development, at least to gain a foothold on the bottom rung, from which they can then proceed to climb on their own.

Am I an optimist? Optimism and pessimism are beside the point. The key is not to predict what will happen, but to help shape the future. This task is a collective one—for you as well as for me. Although intro­ ductory economics textbooks preach individualism and decentralized

INTRODUCTION 3

markets, our safety and prosperity depend at least as much on collective decisions to fight disease, promote good science and widespread educa­ tion, provide critical infrastructure, and act in unison to help the poor­ est of the poor. When the preconditions of basic infrastructure (roads, power, and ports) and human capital (health and education) are in place, markets are powerful engines of development Without those preconditions, markets can cruelly bypass large parts of the world, leav­ ing them impoverished and suffering without respite. Collective action, through effective government provision of health, education, infra­ structure, as well as foreign assistance when needed, underpins eco­ nomic success.

Eighty-five years ago the great British economist John Maynard Keynes pondered the dire circumstances of the Great Depression. From the depths of despair around him, he wrote in 1930 of the Economic Possibilities for Our Grandchildren. At a time of duress and suffering, he envisioned the end of poverty in Great Britain and other industrial countries in his grand­ children’s day, toward the end of the twentieth century. Keynes empha sized the dramatic march of science and technology and the ability of advances in technology to underpin continued economic growth at com­ pound interest, enough growth indeed to end the age-old “economic problem” of having enough to eat and enough income to meet other basic needs. Keynes got it just right, of course: extreme poverty no longer exists in today’s rich countries, and is disappearing in most of the world’s middle­ income countries.

Today we can invoke the same logic to declare that extreme poverty can be ended not in the time of our grandchildren, but in our time. The wealth of the rich world, the power of today’s vast storehouses of knowl­ edge, and the declining fraction of the world that needs help to escape from poverty all make the end of poverty a realistic possibility by the year 2025. Keynes wondered how the society of his grandchildren would use its wealth and its unprecedented freedom from the age-old struggle for daily survival. This very question has become our own. Will we have the good judgment to use our wealth wisely, to heal a divided planet, to end the suffering of those still trapped by poverty, and to forge a com­ mon bond of humanity, security, and shared purpose across cultures and regions?

This book will not answer this question. Instead, it will help to show the way toward the path of peace and prosperity, based on a detailed un-

4 THE END OF POVERTY

derstanding of how the world economy has gotten to where it is today, and how our generation could mobilize our capacities in the coming twenty years to eliminate the extreme poverty that remains. I hope that by showing the contours of that promising path, we will be more likely to choose it. For now, I am grateful for the chance to share what I have seen of the world and of the economic possibilities for our time.

18 THE END OF POVERTY

creased China’s exports from around $20 billion in 1980 to around $400 billion in 2004.

ASCENDING THE LADDER OF ECONOMIC DEVELOPMENT

What do these four widely divergent images of the globe show us? We see an almost unimaginable divide between the richest and poorest parts of the world, with all the gradations in between. We glimpse the pivotal roles that science and technology play in the development process. And we sense a progression of development that moves from subsistence agriculture toward light manufacturing and urbanization, and on to high-tech services. In Malawi, 84 percent of the population lives in rural areas; in Bangladesh, 76 percent; in India, 72 percent; and in China, 61 percent. In the United States, at the other upper end of the development spectrum, it is just 20 percent. Services account for under 25 percent of employment in Malawi, whereas in the United States, they account for 75.

If economic development is a ladder with higher rungs representing steps up the path to economic well-being, there are roughly one billion people around the world, one sixth of humanity, who live as the Mala­ wians do: too ill, hungry, or destitute even to get a foot on the first rung of the development ladder. These people are the “poorest of the poor,” or the “extreme poor” of the planet. They all live in developing countries (poverty does exist in rich countries, but it is not extreme poverty). Of course, not all of these one billion people are dying today, but they are all fighting for survival each day. If they are the victims of a serious drought or flood, or an episode of serious illness, or a collapse of the world mar­ ket price of their cash crop, the result is likely to be extreme suffering and perhaps even death. Cash earnings are pennies a day.

A few rungs up the development ladder is the upper end of the low- income world, where roughly another 1.5 billion people face problems like those of the young women in Bangladesh. These people are “the poor.” They live above mere subsistence. Although daily survival is pretty much assured, they struggle in the cities and countryside to make ends meet. Death is not at their door, but chronic financial hardship and a lack of basic amenities such as safe drinking water and function­ ing latrines are part of their daily lives. All told, the extreme poor (at

A GLOBAL FAMILY PORTRAIT >9

around 1 billion) and the poor (another 1.5 billion) make up around 40 percent of humanity.

Another 2.5 billion people, including the Indian IT workers, are up yet another few rungs, in the middle-income world. These are middle­ income households, but they would certainly not be recognized as mid­ dle class by the standards of rich countries. Their incomes may be a few thousand dollars per year. Most of them live in cities. They are able to se­ cure some comfort in their housing, perhaps even indoor plumbing. They can purchase a scooter and someday even an automobile. They have adequate clothing, and their children go to school. Their nutrition is adequate, and some are even falling into the rich-world syndrome of unhealthy fast food.

Still higher up the ladder are the remaining one billion people, roughly a sixth of the world, in the high-income world. These affluent households include the billion or so people in the rich countries, but also the increasing number of affluent people living in middle-income countries—the tens of millions of high-income individuals in such cities as Shanghai, São Paolo, or Mexico City. The young professionals of Bei­ jing are among the fortunate one sixth of the world enjoying twenty first-century affluence.

The good news is that well more than half of the world, from the Bangladesh garment worker onward, broadly speaking, is experiencing economic progress. Not only do they have a foothold on the develop­ ment ladder, but they are also actually climbing it. Their climb is evident in rising personal incomes and the acquisition of goods such as cell phones, television sets, and scooters. Progress is also evident in such crucial determinants of economic well-being as rising life expectancy, falling infant mortality rates, rising educational attainment, increasing access to water and sanitation, and the like.

The greatest tragedy of our time is that one sixth of humanity is not even on the development ladder. A large number of the extreme poor are caught in a poverty trap, unable on their own to escape from ex­ treme material deprivation. They are trapped by disease, physical isola­ tion, climate stress, environmental degradation, and by extreme poverty itself. Even though life-saving solutions exist to increase their chances for survival—whether in the form of new farming techniques, or essen­ tial medicines, or bed nets that can limit the transmission of malaria— these families and their governments simply lack the financial means to make these crucial investments. The world’s poor know about the

THE END OF POVERTY20

development ladder: they are tantalized by images of affluence from halfway around the world. But they are not able to get a first foothold on the ladder, and so cannot even begin the climb out of poverty.

WHO AND WHERE ARE THE POOR?

There are many definitions, as well as intense debates, about the exact numbers of the poor, where they live, and how their numbers and eco­ nomic conditions are changing over time. It is useful to start with what is agreed, and then to mention some of the areas of debate. As a matter of definition, it is useful to distinguish between three degrees of poverty, extreme (or absolute) poverty, moderate poverty, and relative pov­ erty. Extreme poverty means that households cannot meet basic needs for survival. They are chronically hungry, unable to access health care, lack the amenities of safe drinking water and sanitation, cannot af­ ford education for some or all of the children, and perhaps lack rudi­ mentary shelter—a roof to keep the rain out of the hut, a chimney to remove the smoke from the cook stove—and basic articles of cloth­ ing, such as shoes. Unlike moderate and relative poverty, extreme poverty occurs only in developing countries. Moderate poverty gener­ ally refers to conditions of life in which basic needs are met, but just barely. Relative poverty is generally construed as a household income level below a given proportion of average national income. The rela­ tively poor, in high-income countries, lack access to cultural goods, entertainment, recreation, and to quality health care, education, and other perquisites for upward social mobility.

The World Bank has long used a complicated statistical standard— income of $1 per day per person, measured at purchasing power parity— to determine the numbers of extreme poor around the world. Another World Bank category, income between $1 per day and $2 per day, can be used to measure moderate poverty. These measures feature promi­ nently in public policy circles, and most recently were estimated by World Bank economists Shaohua Chen and Martin Ravallion. They esti­ mated that roughly 1.1 billion people were living in extreme poverty in 2001, down from 1.5 billion in 1981. Figure la shows the distribution of the world’s extreme poor by region. Each bar signifies the number of poor in the region, with the first bar indicating the number in 1981, the

A GLOBAL FAMILY PORTRAIT

Figure la: Numbers of Extreme Poor

second bar, in 2001. The overwhelming share of the world’s extreme poor, 93 percent in 2001, live in three regions: East Asia, South Asia, and sub-Saharan Africa. Since 1981, the numbers of extreme poor have risen in sub-Saharan Africa, but have fallen in East Asia and South Asia.

Figure lb repeats the same measurement, but now shows the pro­ portion of the region’s population in extreme poverty, rather than the absolute number. Almost half of Africa’s population is deemed to live in extreme poverty, and that proportion has risen slighdy over the period. The proportion of the extreme poor in East Asia has plummeted, from 58 percent in 1981 to 15 percent in 2001; in South Asia the progress has also been marked, although slightly less dramatically, from 52 percent to 31 percent. Latin America’s extreme poverty rate is around 10 per­ cent, and relatively stuck; Eastern Europe’s rose from a negligible level in 1981 to around 4 percent in 2001, the result of the upheavals of com­ munist collapse and economic transition to a market economy.

Figures 2a and 2b show the calculations for the moderate poor, those living between $1 and $2 per day. East Asia, South Asia, and sub- Saharan Africa continue to dominate the picture, with 87 percent of the world’s 1.6 billion moderately poor. The numbers of moderate poor in East Asia and South Asia have actually risen as the poorest households

THE END OF POVERTY22

East Asia □ 1981 □ 2001

Sounr Data fwm Chai and Ruvalhon (2004).

Eastern Europe and Central Asia

Latin America and

Caribbean

Middle East South Asia Sub-Saharan and North Africa

Africa

Figure lb: Proportion Living in Extreme Poverty

have improved their circumstances from extreme poverty to moderate poverty. Some 15 percent of Latin Americans live in moderate poverty, a rate that has been fairly constant since 1981.

Map 1 gives us yet another perspective on these data, on a country- by-country basis. Each country is shaded according to the proportion of the population living in extreme poverty and moderate poverty. A country as a whole is deemed to suffer from extreme poverty if the pro­ portion of the population in extreme poverty is at least 25 percent of the total. A country is categorized as suffering from moderate poverty if it is not in extreme poverty, but at least 25 percent of the households are extremely poor or moderately poor, that is, living under $2 per day. Most of the countries of sub-Saharan Africa are in extreme poverty (and even more would be in this category but for lack of reliable data), as are the countries of South Asia. East Asia and Latin America include many countries in moderate poverty, but also many that have risen beyond moderate poverty in recent decades.

The precision of the World Bank figures have been questioned in heated debates. The World Bank has relied on household surveys, while other researchers have relied on national income accounts, which tend to show somewhat faster progress in the reduction of Asian poverty. The details need not detain us here, except to say that the general picture re­ mains true in either case: extreme poverty is concentrated in East Asia,

«3A GLOBAL FAMILY PORTRAIT

Figure 2a: Numbers of Moderate Poor

Saunt. Dala frum Chai and Rauallion (2004).

24 THE END OF POVERTY

South Asia, and sub-Saharan Africa. It is rising in Africa in absolute num­ bers and as a share of the population, while it is falling in both absolute numbers and as a proportion of the population in the Asian regions.

We will have many occasions to discuss the specific circumstances of the poorest of the poor. They are mainly in rural areas, though with a growing proportion in the cities. They face challenges almost unknown in the rich world today—malaria, massive droughts, lack of roads and motor vehicles, great distances to regional and world markets, lack of electricity and modem cooking fuels—challenges that are at first har­ rowing to contemplate, but on second thought encouraging, precisely because they also lend themselves to practical solutions.

OUR generation’s challenge

The very hardest part of economic development is getting the first foothold on the ladder. Households and countries at the very bottom of the world’s income distribution, in extreme poverty, tend to be stuck. Countries already on the ladder of development, such as Bangladesh and India, are generally making progress, even if it is uneven and some­ times painfully slow. Our generation’s challenge is to help the poorest of the poor to escape the misery of extreme poverty so that they may be­ gin their own ascent up the ladder of economic development. The end of poverty, in this sense, is not only the end of extreme suffering but also the beginning of economic progress and of the hope and security that accompany economic development.

When I speak of the “end of poverty,” therefore, I will be speaking of two closely related objectives. The first is to end the plight of one sixth of humanity that lives in extreme poverty and struggles daily for survival. Everybody on Earth can and should enjoy basic standards of nutrition, health, water and sanitation, shelter, and other minimum needs for sur­ vival, well-being, and participation in society. The second is to ensure that all of the world’s poor, including those in moderate poverty, have a chance to climb the ladder of development. As a global society, we should ensure that the international rules of the game in economic man­ agement do not advertendy or inadvertently set snares along the lower rungs of the ladder in the form of inadequate development assistance, protectionist trade barriers, destabilizing global financial practices,

A GLOBAL FAMILY PORTRAIT 25

poorly designed rules for intellectual property, and the like, that prevent the low-income world from climbing up the rungs of development.

The end of extreme poverty is at hand—within our generation— but only if we grasp the historic opportunity in front of us. There al­ ready exists a bold set of commitments that is halfway to that target: the Millennium Development Goals (MDGs), the eight goals that all 191 UN member states unanimously agreed to in 2002 by signing the United Nations Millennium Declaration. These goals are important tar­ gets for cutting poverty in half by the year 2015, compared with a base­ line of 1990. They are bold but achievable, even if dozens of countries are not yet on track to achieve them. They represent a crucial midsta­ tion on the path to ending extreme poverty by the year 2025. And the rich countries have repeatedly promised to help the poor countries to achieve them through increased development assistance and improved global rules of the game.

These, then, are the economic possibilities of our time:

• To meet the Millennium Development Goals by 2015

• To end extreme poverty by 2025

• To ensure well before 2025 that all of world’s poor countries can make reliable progress up the ladder of economic development

• To accomplish all of this with modest financial help from the rich countries, more than is now provided, but within the bounds of what they have long promised.

To meet these challenges, we first have to understand how we got to where we are, for in that understanding we will also find the way forward.

56 THE END OF POVERTY

stand which of these various processes is working and which is not. Knowing that an economy is in decline is not enough. We must know why the economy is failing to achieve economic growth if we are to take steps to establish or reestablish it.

WHY COUNTRIES FAIL TO ACHIEVE ECONOMIC GROWTH

The most common explanation for why countries fail to achieve eco­ nomic growth often focuses on the faults of the poor: poverty is a result of corrupt leadership and retrograde cultures that impede modem de­ velopment. However, something as complex as a society’s economic sys­ tem has too many moving parts to presume that only one thing can go wrong. Problems can occur in different parts of the economic machine and can sometimes cascade, bringing the machine to a near halt.

In economic growth, eight major categories of problems can cause an economy to stagnate or decline. I have witnessed these kinds of disas­ ters in many parts of the world. Each has its own different appropriate course of treatment; therefore, a good diagnosis is crucial.

The Poverty Trap: Poverty Itself as a Cause of Economic Stagnation

The key problem for the poorest countries is that poverty itself can be a trap. When poverty is very extreme, the poor do not have the ability—by themselves—to get out of the mess. Here is why: Consider the kind of poverty caused by a lack of capital per person. Poor rural villages lack trucks, paved roads, power generators, irrigation channels. Human cap­ ital is very low, with hungry, disease-ridden, and illiterate villagers strug­ gling for survival. Natural capital is depleted: the trees have been cut down and the soil nutrients exhausted. In these conditions the need is for more capital—physical, human, natural—but that requires more saving. When people are poor, but not utterly destitute, they may be able to save. When they are utterly destitute, they need their entire in­ come, or more, just to survive. There is no margin of income above sur­ vival that can be invested for the future.

This is the main reason why the poorest of the poor are most prone to becoming trapped with low or negative economic growth rates. They are too poor to save for the future and thereby accumulate the capital

WHY SOME COUNTRIES FAIL TO THRIVE 57

per person that could pull them out of their current misery. Table 1 shows the rate of gross domestic saving as a share of GDP for countries at different income levels. Clearly, the poorest of the poor have the low­ est saving rate because they are using their income merely to stay alive.

Sourct' World Bank (2004).

Table 1: Saving Rates in Developing Countries by Income Level in 2002, in % of GDP

Upper-Middle-Income Countries 25% Lower-Middle-Income Countries 28% Low-Income Countries 19% Least-Developed Countries 10%

In fact, the standard measures of domestic saving, based on the offi­ cial national accounts, overstate the saving of the poor because these data do not account for the fact that the poor are depleting their natu­ ral capital by cutting down trees, exhausting soils of their nutrients, mining their mineral, energy, and metal deposits, and overfishing. These forms of natural capital are not monitored in the official national ac­ counts data and, as a result, their “depreciation” or depletion is not rec­ ognized as a form of negative saving. When a tree is cut down and sold for fuelwood, and not replanted, the earnings to the logger are counted as income, but instead should be counted as a conversion of one capital asset (the tree) into a financial asset (money).

Physical Geography

Even if the poverty trap is the right diagnosis, it still poses the question of why some impoverished countries are trapped and others are not. The answer often lies in the frequently overlooked problems of physical geography. Americans, for example, believe that they earned their wealth all by themselves. They forget that they inherited a vast continent rich in natural resources, with great soils and ample rainfall, immense navigable rivers, and thousands of miles of coastline with dozens of nat­ ural ports that provide a wonderful foundation for sea-based trade.

Other countries are not quite so favored. Many of the world’s poor­ est countries are severely hindered by high transport costs because they are landlocked; situated in high mountain ranges; or lack navigable rivers, long coastlines, or good natural harbors. Culture does not ex­

5® THE END OF POVERTY

plain the persistence of poverty in Bolivia, Ethiopia, Kyrgyzstan, or Ti­ bet. Look instead to the mountain geography of a landlocked region facing crushing transport costs and economic isolation that stifle almost all forms of modern economic activity. Adam Smith was acutely aware of the role of high transport costs in hindering economic development. He stressed, in particular, the advantages of proximity to low-cost, sea­ based trade as critical, noting that remote economies would be the last regions to achieve economic development:

As by means of water-carriage a more extensive market is opened to every sort of industry than what land-carnage alone can afford it, so it is upon the sea-coast, and along the banks of navigable rivers, that industry of every kind naturally begins to subdivide and improve it­ self, and it is frequendy not till a long time after that those improve­ ments extend themselves to the inland part of the country.

Other kinds of geographical distress are also at play Many countries are trapped in arid conditions with low agricultural productivity or vulnera­ bility to prolonged droughts. Most of the tropics have ecological condi­ tions that favor killer diseases like malaria, schistosomiasis, dengue fever, and dozens of others. Sub-Saharan Africa, in particular, has an ideal rainfall, temperature, and mosquito type that make it the global epicenter of malaria, perhaps the greatest factor in slowing Africa’s eco­ nomic development throughout history. Jared Diamond, in his wonder­ ful book Guns, Germs, and Steel, gives a magnificent account of how geography helped shape the early stages of human civilization. He of­ fers scintillating insights into how the Americas, Africa, Europe, and Asia differed in terms of indigenous crop species, animals for domesti­ cation, ease of transport, possibilities for the spread of technology, dis­ ease ecology, and other geographically related factors in economic development. Some of these factors, of course, became much less or not at all important with the advent of modern transportation and commu­ nications and the resulting transfer of crops and animal species across different regions of the world.

Fortunately, none of these conditions is fatal to economic devel­ opment. It is time to banish the bogeyman of geographical determin­ ism, the false accusation that claims about geographical disadvantage are also claims that geography single-handedly and irrevocably deter­ mines the economic outcome of nations. The point is only that these

WHY SOME COUNTRIES 1A1I TO THRIVE 59

adversities require countries to undertake additional investments that other, more fortunate, countries did not have to make. Roads can be built from a landlocked country to a port in another country. Tropical diseases can be controlled. Arid climates can be overcome with irriga­ tion. Adverse geography poses problems that can be solved, typically through physical investments and good conservation management. But adverse geography raises the costs of solving the problems of farming, transport, and health, and thereby makes it much more likely that a country will be caught in a poverty trap.

Fiscal Trap

Even when the private economy is not impoverished, the government may lack the resources to pay for the infrastructure on which economic growth depends. Governments are critical to investing in public goods and services like primary health care, roads, power grids, ports, and the like. The government may lack the financial means to provide these public goods, however, for at least three reasons. First, the population it­ self may be impoverished, so taxation of the population is not feasible. Second, the government may be inept, corrupt, or incapacitated, and thereby unable to collect tax revenues. Third, the government may al­ ready be carrying a tremendous load of debt (for example, debt carried forward from an earlier decade), and must use its limited tax revenue to service the debt rather than to finance new investments. This third case is often called a debt overhang. Debt from the past crushes the prospects for growth in the future. In such circumstances, debt cancellation may be the only way to give the country a fresh start on a path of economic de­ velopment.

Governance Failures

Economic development requires a government oriented toward devel­ opment. The government has many roles to play. It must identify and fi­ nance the high-priority infrastructure projects, and make the needed infrastructure and social services available to the whole population, not just a select few. The government must create an environment con­ ducive to investments by private businesses. Those investors must be­ lieve that they will be allowed to operate their business and to keep their future profits. Government must exercise self-restraint in demanding

6o THE END OF POVERTY

bribes or side payments. Governments must also maintain internal peace and safety so the safety of persons and property is not unduly threatened, maintain judicial systems that can define property rights and honestly enforce contracts, and defend the national territory to keep it safe from invasion.

When governments fail in any of these tasks—leaving huge gaps in infrastructure, or raising corruption to levels that impair economic ac­ tivity, or failing to ensure domestic peace—the economy is sure to fail, and often to fail badly. Indeed, in extreme cases, when governments are unable to perform their most basic functions, we talk about “state fail­ ures,” which are characterized by wars, revolutions, coups, anarchy, and the like. We will see later on that state failures are often not only the cause of economic disaster, but also the last stage of it. State failure and economic failure can chase each other in a dizzying and terrifying spiral of instability.

Cultural Barriers

Even when governments are trying to advance their countries, the cul­ tural environment may be an obstacle to development. Cultural or reli­ gious norms in the society may block the role of women, for example, leaving half of the population without economic or political rights and without education, thereby undermining half of the population in its contribution to overall development. Denying women their rights and education results in cascading problems. Most important, perhaps, the demographic transition from high fertility to low fertility is delayed or blocked altogether. Poor households continue to have six or seven chil­ dren because the woman’s role is seen mainly as child rearing, and her lack of education means that she has few options in the labor force. In these settings women often lack basic economic security and legal rights; when they are widowed, their social circumstances turn even more dreadful, and they are left completely impoverished without hope for improvement.

Similar cultural barriers may apply to religious or ethnic minorities. Social norms may prevent certain groups from gaining access to public services (such as schooling, health facilities, or job training). These mi­ norities may be blocked from entering universities or public sector jobs. They may face harassment in the community, including boycotts of their businesses and physical destruction of property. In extreme cir­

WHY SOME COUNTRIES FAIL TO THRIVE 61

cumstances, as occurred in East Africa with the Indian community, wholesale “ethnic cleansing” may ensue, with many fleeing for their lives.

Geopolitics

It takes two to trade. Trade barriers erected by foreign countries can im­ pede a poor country’s economic development. These barriers are some­ times political, as when a powerful country imposes trade sanctions on a regime that it does not like. These sanctions may aim to weaken or top­ ple a despicable regime, but often they simply impoverish the popula­ tion of the targeted country without toppling the regime. Many factors in addition to trade that may affect a country’s development can be ma­ nipulated from abroad for geopolitical reasons.

Lack of Innovation

Consider the plight of inventors in an impoverished country. Even if these inventors are able to develop new scientific approaches to meet local eco­ nomic needs, the chances of recouping investments in research and de­ velopment through later sales in the local market are very low. The local purchasing power to buy a new product is tiny, and will not provide for sufficient profits if an invention is successfully brought to market, even if the impoverished country has state-of-the-art patent legislation. The prob­ lem is not the property rights to the invention, but the size of the market.

There is, therefore, a huge difference between rich and poor coun­ tries in their tendency to innovate. Rich countries have a big market, which increases the incentive for innovation, brings new technologies to market, further raises productivity and expands the size of the mar­ ket, and creates new incentives for innovation. This momentum creates, in effect, a chain reaction, which economists call endogenous growth. Innovation raises the size of the market; a larger market raises the in­ centives for innovation. Therefore, economic growth and innovation proceed in a mutually reinforcing process.

In the rich countries of North America, Western Europe, and East Asia, the process of massive investment in research and development, leading to sales of patent-protected products to a large market, stands at the core of economic growth. Advanced countries are typically investing 2 percent or more of their gross national product directly into the re­ search and development process, and sometimes more than 3 percent

62 THK END OF POVERTY

of GDP. That investment is very sizable, with hundreds of billions of dol­ lars invested each year in research and development activities. More­ over, these investments are not simply left to the market. Governments invest heavily, especially in the early stages of R and D (more in R, re­ search, than in D, development, although government finance is pres­ ent at both stages).

In most poor countries, especially smaller ones, the innovation pro­ cess usually never gets started. Inventors do not invent because they know that they will not be able to recoup those large, fixed costs of devel­ oping a new product. Impoverished governments cannot afford to back the basic sciences in government labs and in universities. And the scien­ tists do not stay. The result is an inequality of innovative activity that mag­ nifies the inequality of global incomes. Although today’s low-income countries have 37 percent of the world’s population and 11 percent of the world’s GDP (adjusted for differences in purchasing power), these countries accounted for less than 1 percent of all of the U.S.-registered patents taken out by inventors in the year 2000. The top twenty coun­ tries in patenting, all high-income countries, account for 98 percent of all patents.

Over the span of two centuries, the innovation gap is certainly one of the most fundamental reasons why the richest and the poorest coun­ tries have diverged, and why the poorest of the poor have not been able to get a foothold on growth. The rich move from innovation to greater wealth to further innovation; the poor do not. Fortunately, there are a few opportunities for innovation, although these are not as robust as we would hope.

The first is the diffusion of technology. Even when countries are not inventors of technology, they can still be beneficiaries through the im­ portation of technology. All countries today, without exception, are us­ ing personal computers, and cell phones are reaching most parts of the world as well, even very poor places. Innovations can be imported through consumer goods, capital imports by business (in the form of machinery, for example), foreign direct investment (in which a high- tech firm sets up a factory in a poor country), or textbooks, word of mouth, and reverse engineering. History is replete with examples in which new capital goods and blueprints were simply pilfered and brought to a new location.

However, the importation of technology can be frustrated in the poorest of the poor countries. These countries may be too poor to pur­

WHY SOME COUNTRIES FAIL TO THRIVE 63

chase the capital goods, and they may be unattractive as places for for­ eign investment, given their lack of infrastructure. But there is often a much deeper problem. Many of the key breakthroughs in technology developed in the rich countries are relevant for the particular ecologi­ cal conditions of the rich countries, and are not especially useful in the tropical, or arid, or mountain environments where so many of the ex­ treme poor live today. The massive investments in biomedical research in the rich countries, more than $70 billion, largely overlook the chal­ lenges of tropical diseases such as malaria. Rich-country funding is, not surprisingly, aimed at rich-country diseases.

Many poor East Asian countries were initially successful in raising technology not so much through home-grown innovation as through their success in attracting foreign investors who brought the technolo­ gies with them. As early as the late 1960s, Texas Instruments, National Semiconductor, and Hewlett Packard, among others, set up operations in Singapore, Penang Island (Malaysia), and other parts of East Asia. They saved a lot of money but also introduced what were otherwise very poor economies to sophisticated scientific technology and advanced management processes. If a poor country can become an attractive place for high-technology enterprises to conduct part of their production activi­ ties, then they can become a home, even at a low level of development, to quite sophisticated production and management techniques. Under the right circumstances, hosting such activities on the home turf can then lead to a diffusion of knowledge, and participation in modem produc­ tion, so that those benefits can then be transferred to domestic firms.

The process even works in technologically humbler sectors like ap­ parel. When foreign investors such as Wal-Mart, J. C. Penney, Yves Saint Laurent, and others outsource their production to Dhaka, they bring in the latest fashion designs and integrate the local production unit into a global supply chain. The local production units do the cutting, stitch­ ing, labeling, and packaging of the merchandise, which is designed and ultimately destined for the United States and Europe. These factories become important training grounds for climbing the technology lad­ der, moving from basic technology up to the next steps. A cutting and stitching company may take 100 percent of the fashion design orders from abroad at the beginning, but later on, once it gets the hang of it, it may start hiring its own designers, and start selling not only the labor of the assembly operation, but also the designs. That progression has hap­ pened over and over again throughout the world.

64 THE END OF POVERTY

What prevents this process from taking hold everywhere in the world? Eventually it can, but in the early stages the process almost always starts right at a port. The accompanying maps, 3 and 4, show the locations of multinational companies in the electronics sector and in textiles and gar­ ment manufacturing, illustrating the coastal location of these firms, espe­ cially in their operation in the poor countries. Hinterlands have lagged far behind in their ability to attract these kinds of industries.

It is no coincidence that booming sites for foreign investment— such as Penang Island (Malaysia), Singapore, Taiwan, Hong Kong, and Mauritius—are all islands on the Asia-Europe trade route. It is no coin­ cidence that China’s leading economic city, Shanghai, sits right on the coast at the mouth of the Yangtze River. It is no coincidence that Mex­ ico’s assembly sector is right along the Rio Grande River, since Mexico’s economically relevant “coast” is its border with the United States. The same geographical advantages are seen in many other places that have received substantial foreign investments in recent years. Wroclaw, Poland, and Bratislava, Slovakia, and Lada Bolislav, Czech Republic, and Lubljiana, Slovenia, have all reaped an extra bonus of jobs and technol­ ogy transfer by virtue of their proximity to Western European markets.

The Demographic Trap

Most countries have experienced a significant decline in fertility rates in recent decades. Half the world, including all of the rich world, is at or near the so-called replacement rate of fertility, in which each mother is raising one daughter on average to “replace” her in the next genera­ tion. The replacement rate is two children, one of whom, on average, is a girl. (In fact, the replacement rate is a little bit above two, to take into account the possibility that the daughter will not survive to reproductive age.) The poorest of the poor countries, by contrast, are stuck with fer­ tility rates of five or more. On average, a mother is raising at least two girls, and in some cases three girls or more. In those circumstances, na­ tional populations double each generation.

However, the demographic transition has occurred in most parts of the world. Moreover, although Western Europe’s demographic transi­ tion took a century or more, the transition among developing countries in the twentieth century has occurred over decades or just a few years. In Bangladesh, the total fertility rate fell from 6.6 in 1975 to just 3.1 in 2000, as we saw plainly with the BRAC microfinance group in the village

WHY SOME COUNTRIES FAIL TO THRIVE 65

Note. X axis isona logarithmic scale.

Sotine. Calculated using data firm World Bank (2004).

outside of Dhaka. In Iran following the 1979 Islamic revolution, the transformation was even fester, from 6.7 in 1980 to just 2.6 in 2000. The Iranian revolution, it seems, brought a generation of young girls into the schools, and this boom in girls’ literacy has translated rapidly and dramatically into the desire for fewer children.

One reason for a poverty trap is a demographic trap, when impover­ ished families choose to have lots of children. These choices are under­ standable, yet the results can be disastrous. When impoverished families have large numbers of children, the families cannot afford to invest in the nutrition, health, and education of each child. They might only afford the education of one child, and may send only one son to school. High fertility rates in one generation, therefore, tend to lead to impoverish­ ment of the children and to high fertility rates in the following generation as well. Rapid population growth also puts enormous stresses on farm sizes and environmental resources, thereby exacerbating the poverty.

As with the other obstacles to economic growth, the demographic trap is avoidable. Girls’ education would allow women to more easily join the labor force, increasing their earning power and the “cost” of staying home to bear children. Education, law, and social action can empower women to more easily make fertility choices (instead of having those

66 THE END Of POVERTY

choices made solely by husbands or others in the family). Children can be treated for disease to better ensure their survival, meaning that parents can have fewer children, feeling secure that they will survive to take care of their parents in old age. Family planning and reproductive health services can be provided even in very poor communities. All of this re­ quires money, however, and money is lacking in the poorest economies.

Figure 1 shows how the total fertility rate in the year 2001 compares with the country’s national income per person. The total fertility rate, and hence the population growth rate is stunningly high especially in the poorest parts of the world. Here is the demographic trap in vivid perspective: the poorest places, many with the greatest obstacles to modem economic growth, are also the places where families have the most numbers of children, and where the populations continue to soar. High population growth leads to deeper poverty, and deeper poverty contributes to high fertility rates.

WHERE GROWTH HAS FAILED

Map 5 shows all of the countries in the world where per capita GDP de­ clined during the twenty-year period between 1980 and 2000. Notice that not one single rich country in North America, Western Europe, or East Asia failed to achieve economic growth! All of the problems lie in the developing world. Forty-five countries had negative growth in GDP per capita. (Only countries with a population of at least two million people in 1980 were examined in order to avoid the idiosyncrasies of some very small countries.)

It is illuminating to divide the world’s economies into the following six categories, depending on their per capita income in 1980:

• All low-income countries

• Middle-income oil exporters

• Middle-income postcommunist countries

• Other middle-income countries

• High-income oil exporters

• All other high-income countries

Thirteen

MAKING THE

INVESTMENTS NEEDED

TO END POVERTY

At the most basic level, the key to ending extreme poverty is to en­able the poorest of the poor to get their foot on the ladder of de­ velopment. The development ladder hovers overhead, and the poorest

of the poor are stuck beneath it. They lack the minimum amount of cap­ ital necessary to get a foothold, and therefore need a boost up to the first rung. The extreme poor lack six major kinds of capital:

• Human capital: health, nutrition, and skills needed for each person to be economically productive

• Business capital: the machinery, facilities, motorized transport used in agriculture, industry, and services

• Infrastructure: roads, power, water and sanitation, airports and seaports, and telecommunications systems, that are critical in­ puts into business productivity

• Natural capital: arable land, healthy soils, biodiversity, and well­ functioning ecosystems that provide the environmental services needed by human society

• Public institutional capital: the commercial law, judicial systems, government services and policing that underpin the peaceful and prosperous division of labor

MAKING THE INVESTMENTS NEEDED TO END POVERTY 245

• Knowledge capital: the scientific and technological know-how that raises productivity in business output and the promotion of physical and natural capital

How to overcome a poverty trap? The poor start with a very low level of capital per person, and then find themselves trapped in poverty because the ratio of capital per person actually falls from generation to genera­ tion. The amount of capital per person declines when the population is growing faster than capital is being accumulated. Capital is accumu­ lated, in turn, in a balance of two forces, one positive and one negative. On the positive side is the capital accumulated when households save a part of their current income, or have a part of their income taxed to fi­ nance investments by the government. Household savings are either lent to businesses (often through financial intermediaries such as banks) or invested directly in family businesses or equities traded in the market. Capital is diminished, or depreciated, as the result of the pas­ sage of time, or wear and tear, or the death of skilled workers, for exam­ ple, because of AIDS. If savings exceed depreciation, there is positive net capital accumulation. If savings are less than depreciation, the capi­ tal stock declines. Even if there is positive net capital accumulation, the question for growth in per capita income is whether the net capital ac­ cumulation is large enough to keep up with population growth.

HOW THE POVERTY TRAP WORKS AND HOW FOREIGN AID HELPS OVERCOME IT

Figure 1 shows the basic mechanics of saving, capital accumulation, and growth, and figure 2 shows how a poverty trap works. In figure 1, we start on the left-hand side with a typical household. The household di­ vides its income into consumption, taxation, and household savings. The government, in turn, divides its tax revenues into current spending and government investment. The economy’s capital stock is raised by both household savings and by government investment. A higher capi­ tal stock leads to economic growth, which in turn raises household in­ come through the feedback arrow from growth to income. We show in the figure that population growth and depreciation also negatively affect the accumulation of capital. In a “normal” economy, things pro­ ceed smoothly toward rising incomes, as household savings and govern-

246 THE END OF POVERTY

ment investments are able to keep ahead of depreciation and popula­ tion growth.

In figure 2, the process breaks down into a poverty trap. We start again on the left-hand side, but now with a household that is impover­ ished. All of its income goes to consumption, just to stay alive. There are no taxes and no personal savings. Nonetheless, depreciation and popu­ lation growth continue relentlessly. The result is a fall in capital per per­ son and a negative growth rate of per capita income. That leads to still further impoverishment of the household in the future. The figure de­ picts a vicious circle of falling incomes, zero savings and public invest­ ment, and falling capital per person as a result.

The solution is shown in figure 3, where foreign help, in the form of official development assistance (ODA), helps to jump-start the process of capital accumulation, economic growth, and rising house­ hold incomes. The foreign aid feeds into three channels. A little bit goes directly to households, mainly for humanitarian emergencies such as food aid in the midst of a drought. Much more goes directly to the budget to finance public investments, and some is also directed toward private businesses (for example, farmers) through microfinance pro­ grams and other schemes in which external assistance directly finances private small businesses and farm improvements. If the foreign assis­ tance is substantial enough, and lasts long enough, the capital stock rises sufficiently to lift households above subsistence. At that point, the poverty trap is broken, and figure 1 comes into its own. Growth becomes self-sustaining through household savings and public investments sup­ ported by taxation of households. In this sense, foreign assistance is not a welfare handout, but is actually an investment that breaks the poverty trap once and for all.

A Numerical Illustration

Economists like to use numerical models because it helps them to cali­ brate more specifically how much it will cost to accomplish a particular goal, in this case the goal of breaking a poverty trap. Here’s a numerical illustration of how the poverty trap works, and though a bit tedious, it shows how financial planning can be used to identify the overall magni­ tude of official development assistance that will be needed to end poverty. To keep things simple, I use an illustration based entirely on

MAKING THE INVESTMENTS NEEDED TO END POVERTY 247

household savings and investment, without worrying about taxation and public investment.

Figure 1: The Basic Mechanics of Capital Accumulation

Suppose that an economy requires $3 of capital for every $1 of an­ nual production. Suppose also that the capital stock depreciates at a rate of 2 percent per year. For each $1 million of capital this year, about $835,000 will remain at the end of a decade, after ten years of depre­ ciation. We’ll suppose that the economy currently has 1 million poor people, each with capital of $900. This results in annual income of $300 per person ($900 capital divided by three). The total GNP is therefore $300 million ($300 per person times 1 million people). The population is growing at 2 percent per year, so at the end of the decade there will be about 1.2 million people.

Suppose now that the society is too poor to save. Each year the pop­ ulation lives hand to mouth, consuming whatever meager amount is produced. The starting income of $300 is just barely enough to meet ba sic needs. At the end of a decade, the capital stock will have partly worn out. Instead of $900 million in capital, there will be only $750 million in capital. In the meantime, the population will have grown from 1 million

248 THE END OF POVERTY

Figure 2î The Poverty Trap

to 1.2 million. Instead of $900 of capital per person, there is now only $628 of capital per person ($750 million in capital divided by 1.2 mil­ lion population). Instead of each person being able to produce $300, each person will now produce only $209 ($628 of capital divided by three). Households will be sinking into extreme poverty, without the in­ come to meet basic needs.

In another illustration, suppose now that for whatever reason, the economy begins with the same population, but with a capital stock that is twice as large, equal to $1.8 billion. Per capita income is also twice as large, $600 per capita. As before, households need $300 per person per year to meet their basic needs, and do not save anything out of incomes of $300 or below. On all income above $300 per person, they save 30 per­ cent. Thus a household earning $600 per capita saves 30 percent of $300 ($600 income minus $300 basic needs), or $90 in annual saving. Economywide saving is therefore $90 million.

This year, the capital stock is $1.8 billion, or $1,800 per capita. What about next year? I have assumed that 2 percent of this year’s capital stock, or $36 million, will depreciate by next year. But there is also new savings of $90 million. The net change of the capital stock is a rise of $54 million ($90 million minus $36 million). Next year’s capital stock is therefore

MAKING THE INVESTMENTS NEEDED TO END POVERTY 249

Figure 3: The Role of ODA in Breaking the Poverty Trap

$1.854 billion ($1.8 billion plus $54 million). This amount of capital pro­ duces a GNP of $618 million ($1.854 billion divided by 3). The popula­ tion also grows by 2 percent, and so stands at 1.02 million. Per capita income is equal to $606 ($618 million divided by 1.02 million). Per capita income has increased by 1 percent (in comparison with $600), and will increase each year through the decade. Actually, the growth rate will rise gradually over time, reaching more than 2 percent per annum toward the end of the decade as household incomes rise further above the $300 threshold of basic needs. If you use a spreadsheet to repeat the calculations for ten years rather than one year, the GNP per person at the end of the decade is $687, up 15 percent during the decade.

Voilà. With the same economic structure as the first economy, but starting with twice the capital stock, the economy grows rather than de­ clines. The reason is that at an income of $600 per person, the economy is wealthy enough to save for the future; at $300 per person, it is not. Therefore, starting at $600 per capita, the economy finds its way onto a sustainable growth path, whereas starting at $300 per capita, the econ­ omy sinks into further misery.

This is not all. As capital accumulates from the income base of $600 per person, and the ratio of capital per person increases, not only does the economy grow, but the economy is likely to get an extra boost from

•2 50 THE F N O OI P O V E R I Y

increasing returns to scale of capital. An economy with twice the capital stock per person means an economy with roads that work the year-round, rather than roads that are washed out each rainy season; electrical power that is reliable twenty-four hours each day, rather than electrical power that is sporadic and unpredictable; workers who are healthy and at their jobs, rather than workers who are chronically absent with dis­ ease The likelihood is that doubling the human and physical capital stock will actually more than double the income level, at least at very low levels of capital per person.

A graphic illustration of increasing returns to capital is the case of roads like the one that connects the port at Mombasa, Kenya, with the landlocked countries Uganda, Rwanda, and Burundi. The transport costs on this road are extremely high because the road is in very poor condition on various stretches. From time to time, transport is dis­ rupted entirely when the rains wash away bridges and sections of the road. Suppose that, at some point, around half the road is paved and us­ able, and the rest is unpaved and impassable, with alternating sections of paved and unpaved roadway. Repairing the missing sections would amount to doubling the kilometers of paved road, but would much more than double the economic benefits of the road, since it would be­ come usable along its entire length. This is an example of a threshold effect, in which the capital stock becomes useful only when it meets a minimum standard.

Thus targeted investments backed by donor aid lie at the heart of breaking the poverty trap. Donor-backed investments are needed to raise the level of capital per person. When the capital stock per person is high enough, the economy becomes productive enough to meet basic needs. Households can thus save for the future, putting the economy on a path of sustained economic growth. In my illustration, foreign aid (over several years) that raises the capital stock from $900 per person to $1,800 per person would enable the economy to break out of the poverty trap and begin growing on its own. It would also enable the economy to benefit from increasing returns to capital.

Without donor funding, alas, the necessary investments simply can­ not be financed. No matter how hard a government might try—through taxes, user fees, or privatization—the poor households at $300 per per­ son simply do not have enough income to meet their basic needs and at the same time finance the accumulation of capital. They need the $300 just to eat and provide clothing, shelter, and other basics.

MAKING THE INVESTMENTS NEEDED TO END POVERTY ’5'

Differential Diagnosis and Capital Accumulation

In a simple illustration, or model, as economists call it, it is easy enough to talk about capital as a single item, something that can be doubled or halved fairly straightforwardly. Much of the complexity of real eco­ nomic strategy, however, is.that capital comes in numerous, almost un­ limited, forms. Suppose that an economy successfully negotiates an extra $1 billion in foreign aid. Should that go to building roads, or schools, or power plants, or clinics, or to pay doctors, or teachers, or agricultural extension officers? The answer, in general, is yes to all of the above. The mix will differ markedly country by country. At the core of an effective investment strategy is a rigorous differential diagnosis. The differential diagnosis should build on the appropriate division of labor between the public sector and the private sector, as shown in figure 4.

The public sector should be mainly focused on five kinds of invest­ ments: human capital (health, education, nutrition), infrastructure (roads, power, water and sanitation, environmental conservation), natu­ ral capital (conservation of biodiversity and ecosystems), public institu-

Figure 4: Private and Public Investments in Capital

252 THE END OF POVERTY

tional capital (a well-run public administration, judicial system, police force), and parts of knowledge capital (scientific research for health, energy, agriculture, climate, ecology).

The private sector (funded largely through private savings) should be mainly responsible for investments in businesses, whether in agricul­ ture, industry, or services and in knowledge capital (new products and technologies building on scientific advances), as well as for household contributions to health, education, and nutrition that complement the public investments in human capital. Occasionally the public sector will want to provide direct financing for some private-sector activities, for example, to help fanners adopt new technologies, or to help impover­ ished rural families to start small businesses or buy critical inputs for the farm, or to encourage the start-up of new urban industries. The general lesson of successful economies is that governments are wise to stick mainly to general kinds of investments—schools, clinics, roads, basic re­ search—and to leave highly specialized business investments to the pri­ vate sector.

Why should government finance schools, clinics, and roads, rather than leave those to the private sector? There are five kinds of reasons, all compelling in the proper context. First, there are many kinds of infra­ structure, especially networks like power grids, roads, and other transport facilities—airports and seaports—which are characterized by increasing returns to scale. If left to private markets, these sectors would tend to be monopolized, so they are called natural monopolies. If such capital in­ vestments are left to the private sector, the privately owned monopolies would overcharge for their use, and the result would be too little utiliza­ tion of this kind of capital. Potential users would be rationed out of the market. It is more efficient, therefore, for a public monopoly to provide network infrastructure and set an efficient price below the one that would be set by a private monopolist.

A second category of publicly provided capital goods includes those that are nonrival, when the use of the capital by one citizen does not di­ minish its availability for use by others. A scientific discovery is a classic nonrival good. Once the structure of DNA has been discovered, the use of that wonderful knowledge by any individual in society does not limit the use of the same knowledge by others in society. Economic efficiency requires that the knowledge should be available for all, to maximize the social benefits of the knowledge. There should not be a fee for scien­ tists, businesses, households, researchers, and others who want to utilize

MAKING THE INVESTMENTS NEEDED TO END POVERTY 253

the scientific knowledge of the structure of DNA! But if there is no fee, who will invest in the discoveries in the first place? The best answer is the public, through publicly financed institutions like the National Institutes of Health (NIH) in the United States. Even the free-market United States invests $27 billion in publicly financed knowledge capital through the NIH.

Third, many social sectors exhibit strong spillovers (or externali­ ties) in their effects. I want you to sleep under an antimalarial bed net so that a mosquito does not bite you and then transmit the disease to me\ For a similar reason, I want you to be well educated so that you do not easily fall under the sway of a demagogue who would be harmful for me as well as you. When such spillovers exist, private markets tend to undersupply the goods and services in question. For just this reason, Adam Smith called for the public provision of education: “An instructed and intelligent people ... are more disposed to examine, and more ca­ pable of seeing through, the interested complaints of faction and sedi­ tion. ...” Smith argued, therefore, that the whole society is at risk when any segment of society is poorly educated. Natural capital is an­ other area where externalities loom large. Private actions—pollution, logging, overfishing, and the like—can lead to species extinction, defor­ estation, or other kinds of environmental degradation with serious adverse consequence for the whole society, or even the whole world. Governments therefore have a crucial role to play in conserving natural capital.

Fourth, societies around the world want to ensure that everybody has an adequate level of access to key goods and services (health care, education, safe drinking water) as a matter of right and justice. Goods that should be available to everybody because of their vital importance to human well-being are called merit goods. The rights to these merit goods are not only an informal commitment of the world’s govern­ ments, they are also enshrined in international law, most importantly in the Universal Declaration of Human Rights, as follows:

• Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing and medical care and necessary social services, and the right to security in the event of unemployment, sickness, disability, widow­ hood, old age or other lack of livelihood in circumstances beyond his control.

»54 THE END OF POVERTY

• Everyone has the right to education. Education shall be free, at least in the elementary and fundamental stages. Elementary education shall be compulsory. Technical and professional education shall be made generally available and higher education shall be equally acces­ sible to all on the basis of merit.

Moreover, according to Article 28 of the Universal Declaration, “Every­ one is entitled to a social and international order in which the rights and freedoms set forth in this Declaration can be fully realized.” A follow-through on commitments to the Millennium Development Goals would mark a major practical application of that article.

Fifth, government will want to help the poorest of the poor not only by providing infrastructure and social investments, but also by provid­ ing productive inputs into private businesses if that, too, is required to help impoverished households get started in market-based activities. Thus government might want to provide subsidized fertilizers to subsis­ tence farmers so that they can produce enough to eat or microcredits to rural women so that they can start microbusinesses. Once these house­ holds successfully raise their incomes above subsistence, and begin to accumulate savings on their own, the government subsidies can be grad­ ually withdrawn.

At the same time, except in the case of the poorest households, gov­ ernments generally should not provide the capital for private businesses. Experience has shown that private entrepreneurs do a much better job of running businesses than governments. When governments run busi­ nesses, they tend to do so for political rather than economic reasons. State enterprises tend to overstaff their operations, since jobs equal votes for politicians, and layoffs can cost a politician the next election. State-owned banks tend to make loans for political reasons, rather than on the basis of expected returns. Factories are likely to be built in the dis­ tricts of powerful politicians, not where they can best serve the broader population. Moreover, governments rarely have the in-house expertise to manage complex technologies, and they shouldn’t, aside from sec­ tors where the government’s role is central, such as in defense, infra­ structure, health, and education.

It is one thing to identify the general checklists of public invest­ ments and another to apply the checklist to specific contexts. In Sauri, Kenya, and thousands of villages like it, the priorities include the Big Five: agriculture, health, education, infrastructure (power, transport,

MAKING THE INVESTMENTS NEEDED TO END POVERTY' »55

and communications), and water and sanitation. Natural capital needs bolstering, especially land reclamation, pollution control, and limits on overfishing, logging, and deforestation generally. Support should come both as direct public provision of services and as public support for pri­ vate capital accumulation via microfinance and provision of critical farm inputs for smallholder farmers.

A distinct package of public investments will be needed in the urban areas. The higher urban population density makes it feasible, and in­ deed necessary for public health and economic reasons, to reach house­ holds through infrastructure grids for water, sewerage, and power. It is often claimed that in urban areas, private markets can provide these in­ frastructure services on the basis of market prices. This claim typically overlooks the fact that a sizable proportion of low-income households will be unable to purchase their basic needs at market prices, and will therefore require significant subsidies. One successful model for com­ bining a market approach with subsidies is through lifeline-tariff pric­ ing. In this approach, all households (or all poor households, if they are easy to identify) are guaranteed a given supply of free infrastructure ser­ vices, for example six thousand liters of water per household per month in South Africa’s program. Above that amount, the household pays by the meter.

Urban areas are also vulnerable to intense environmental damage, though in ways quite different from rural areas. Urban environmental hazards include outdoor air pollution (especially from fossil fuel com­ bustion) , the release of toxic chemicals into the environment from fac­ tories, excessive mining of water aquifers, urban garbage, coastal erosion and destruction of fragile marine ecosystems close to urban centers, and the transmission of airborne infectious diseases (such as tuberculo­ sis) in the crowded living conditions of urban slums. These conditions need to be ameliorated by targeted environmental investments, though impoverished cities rarely have the financial means to undertake these investments on their own.

Why Good Investments Come in Packages

One of the weaknesses of development thinking is the relentless drive for a magic bullet, the one -decisive investment that will turn the tide. Alas, it does not exist. Each one of the six identified types of capital is needed for an effective, well-functioning economy. Each one is needed

Seventeen

WHY WE SHOULD DO IT

Will the rich world act to help save the poor? The cynics say no.Why should we? Poverty is not our problem; it is theirs. What can the poor do to us, or for us? When has any country done anything out of altruism for others? How can we fight poverty when we have to fight ter­ rorism? How can politicians ask the public to give more for Africa when the public is already feeling squeezed economically? These are ques­ tions I hear daily.

They are also particularly American questions these days. Many Americans do not see economic assistance as having much to do with their national security. For that they have put their faith in the military. The United States is spending thirty times more on the military than on foreign assistance in 2004, $450 billion compared with $15 billion. Only Greece comes anywhere close to that lopsided ratio, as figure 1 shows using the most recent available data for the year 2002 (before much of the current U.S. military buildup).

The American investment decision to back military rather than other approaches to international relations reflects several mistaken ideas. The first is that we are already doing all that we can do to help the poor. Public opinion research conducted over the past decade illus­ trates, time and again, that the American public greatly overestimates the amount of federal funds spent on foreign aid. In a 2001 survey, the Program on International Policy Attitudes (PIPA) at the University of Maryland reported that Americans, on average, believed that foreign aid accounts for 20 percent of the federal budget, roughly twenty-four times the actual figure. PIPA found essentially the same result in surveys in the mid-1990s.

THF END OF POVERTYS3«

Figure 1: Ratio of Military Expenditure to Official Development Assistant (2002)

President Bush seems to make the same error. In a press conference in April 2004, he said that as “the greatest power on the face of the Earth, we have an obligation to help the spread of freedom. We have an obligation to help feed the hungry.” Yet how does the United States ful­ fill its obligation? U.S. aid to farmers in poor countries to help them grow more food runs at less than $1 billion per year, perhaps $1 per sub­ sistence farmer in the world. Mind you, $1 billion comes to one penny of every hundred dollars of U.S. national income. The United States gives another $800 million in food itself, which helps to feed individuals in a crisis, but does nothing by itself to solve the more fundamental problem of unstable and insufficient food production.

The second fallacy is a widespread view that the U.S. military can achieve security for Americans even in the absence of a stable world. It is the same mistake that led Americans to believe that the United States would be greeted as liberators in Baghdad, that the capture of Saddam Hussein would stop the Iraqi violence, or that one more assault against al Qaeda will end the terror. Whether terrorists are rich or poor or mid­ dle class, their staging areas—their bases of operadon—are unstable so­ cieties beset by poverty, unemployment, rapid population growth,

WHY WF SHOUID DO IT 33>

hunger, and lack of hope. Without addressing the root causes of4hat in­ stability, little will be accomplished in stanching terror.

The third fallacy is the “clash of civilizations,” the belief that the world is entering a war of cultures. For many in America this is a literal war, the war of Armageddon. Millions of Americans, though just how many is unclear, believe that we are approaching the “end days” of bibli­ cal prophecy. This millennial belief has returned in waves in American history, but never before with the United States as a nuclear and global superpower. It is terrifying for those of us who would rather use rational­ ity than scriptural prophecy to determine U.S. foreign policy.

Hard evidence has established strong linkages between extreme poverty abroad and the threats to national security. Poverty abroad can in­ deed hurt us at home, and has repeatedly done so. To answer the earlier question, yes, countries do occasionally act altruistically, helping other countries to address their basic economic and social challenges. Indeed, they have done so for generations, as with the magnificent U.S. Marshall Plan. Foreign policy strategists have long recognized that acts of altru­ ism—ending the slave trade, supporting countries in their independence from empire, extending assistance for reconstruction and development, providing humanitarian relief after natural disasters—are also acts of en­ lightened self-interest. That self-interest does not diminish such generous acts. Moral precepts, after all, are rules of behavior that establish a basis for cooperation and reciprocity on which civilization depends.

It is also wrong to suppose that politicians are punished for support­ ing such actions. There is plenty of experience to show that the broad public will accept such measures, especially if they see that the rich within their own societies are asked to meet their fair share of the bur­ den. The problem in the United States has not been public opposition to increased foreign assistance, but a lack of political leadership even to inform the public about its importance, and to ask the public for greater efforts. Americans have shown an overwhelming willingness to “share at least a small portion of its wealth with those in the world who are in great need,” reaffirming the American public’s strong support for giving foreign aid in principle. The PIPA survey also found that 54 percent rejected the idea that foreign aid “should be strictly a private matter taken care of by individuals giving donations through private or­ ganizations.” Americans understand what must be done and why it is a public duty. What they do not appreciate is how little the United States is in fact following through.

33« THE END Ok POVERTY

U.S. SECURITY AND GLOBAL POVERTY

As a general proposition, economic failure—an economy stuck in a poverty trap, banking crisis, debt default, or hyperinflation—often leads to state failure as well. The most comprehensive study of state failure, carried out by the State Failure Task Force established by the Central In­ telligence Agency in 1994, confirms the importance of the economic roots of state failure. The task force defines state failure as a case of revo­ lutionary war, ethnic war, genocide, politicide, or adverse or disruptive regime change. Failed states, in turn, are likely to create problems not only for themselves, but also for the rest of the world. Throughout history they have been seedbeds of violence, terrorism, international criminality, mass migration, refugee movements, drug trafficking, and disease. If the United States, Europe, Japan, and other high-income countries want to spend less time responding to failed states, they will have to reduce decisively the number of failed economies.

Americans would dearly love to believe that the United States can be an island of stability and prosperity in a global sea of poverty and eco­ nomic failure. History, however, proves otherwise. The examples are le­ gion. The rise of the Bolsheviks to power in 1917 took place in the wake of the economic collapse of wartime czarist Russia. The rise of Hitler in 1933 occurred in the midst of the Great Depression that affected Ger­ many especially hard because of its large foreign debt. More recently, Yugoslavia disintegrated into regional war not only because of intereth­ nic conflicts, but also because of an economic collapse and the descent of the former federal state into hyperinflation in the late 1980s. Slobo­ dan Milosevic used the economic collapse to grab power. Iraq’s declin­ ing economic fortunes and rising debt burdens following the Iran-Iraq war of the 1980s prompted, at least in part, Saddam Hussein’s invasion of Kuwait in 1990.

I certainly do not want to commit the simplistic fallacy of attributing all political failures to economic crises. The shah of Iran was knocked from power in 1979 in the midst of an oil boom. Tracing the rise of Lenin or Hitler to power on the basis of economics alone would be fatu­ ous. And 9/11 and al Qaeda’s existence weren’t caused by poverty per se, although state collapse in Afghanistan and economic crises through­ out South Asia and the Middle East certainly played their roles. Yet in practice, economic failure abroad undoubtedly matters greatly and can translate into very large costs for the United States in many spheres.

WHY WE SHOULD DO IT 333

The findings of the CIA task force are compelling: it counted all cases of state failure between 1957 and 1994 in countries of half a mil­ lion people or more, and identified 113 cases of state failure. Of all the explanatory variables examined, three were most significant:

• Infant mortality rates, suggesting that overall low levels of mate­ rial well-being are a significant contributor to state failure

• Openness of the economy, in that more economic linkages with the rest of the world diminish the chances of state failure

• Democracy, with democratic countries showing less propensity to state failure than authoritarian regimes

The linkage to democracy has a strong economic dimension, however, because research has shown repeatedly that the probability of a coun­ try’s being democratic rises significantly with its per capita income level. In refinements of the basic study, the task force found that in sub- Saharan Africa, where many societies live on the edge of subsistence, temporary economic setbacks (measured as a decline in gross domestic product per capita) were significant predictors of state failure. They also found that partial democracies, usually in transition from authori­ tarian to fully democratic institutions, were particularly vulnerable to collapse. Similar conclusions have been reached in studies on African conflict, which find that poverty and slow economic growth raise the probability of conflict.

State failures abroad are important to U.S. security, since they often lead to U.S. military engagements abroad. State failures have repeatedly dragged the United States into foreign imbroglios. If we compare the dates of U.S. military engagement with the timing of state failures ac­ cording to the task force, as in table 1, virtually every case of U.S. mili­ tary intervention abroad since 1960 has taken place in a developing country that had recently experienced a state failure. (For the purposes of the table, “military intervention” includes any use of U.S. troops abroad, whether for direct combat, peacekeeping, evacuation of civilians, or protection of U.S. property.) In many or most of these cases, the link­ ages from economic collapse to state failure to U.S. military engage­ ments are vividly clear.

334 THF END OF POVERTY

Table 1: State Failures and Subsequent U.S. Military Involvement

(First date refers to U.S. military involvement, second refers to state failure; in chronological order by military intervention date) Cuba (1962,1956-1961)_______________________________________________________ Thailand (1962,1957)_________________________________________________________ Laos (1962-1975,1960-1979)___________________________________________________ Congo (1964, 1960-1965)______________________________________________________ Vietnam (1964-1973,1958-1975)________________________________________________ Dominican Republic (1965,1961-1966) Congo (1967,1960-1965)______________________________________________________ Cambodia (1970, 1970-1979)___________________________________________________ Cyprus (1974,1963-1968,1974)_________________________________________________ Vietnam (1975,1958-1975)____________________________________________________ Lebanon (1976,1965-1992)____________________________________________________ Korea (1976, not applicable) Zaire (1978,1977-1979)_______________________________________________________ Iran (1980, 1977)____________________________________________________________ El Salvador (1981, 1977-1992) Libya (1981, not applicable) Lebanon (1982,1965-1992)____________________________________________________ Honduras (1983-1989,1978-1990 state failure in Nicaragua) Chad (1983, 1965-1996)_______________________________________________________ Liberia (1990,1989-1997)_____________________________________________________ Zaire (1991,1991) Sierra Leone (1992,1991 onward) Somalia (1992,1988 onward) Bosnia-Herzegovina (1993,1992-1996) Somalia (1993,1988 onward) Sourer: The dales far slatefailurr are takenfrm Ute State Failure Task Fane dala set; the dates of U.S. militan intervention art taken firm

Eilen G Colher. ‘Instanm of Useof United States Forces Abroad, 179S-1993'"(U.S. Congressional Research Servite, October 7, 1993), located al htip://www.histury. navy, mil/wan/foabroad htm

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