It’s NBER Summer Institute season, when every bar and restaurant in East Cambridge, from Helmand to Lord Hobo, is filled with our tribe. The air hums with discussions of Lagrangians and HANKs and robust estimators. And the number of great papers presented, discussed, or otherwise floating around inspires.
The paper we’re discussing today, by Wyatt Brooks at Notre Dame and Kevin Donovan at Yale SOM, uses a great combination of dynamic general equilibrium theory and a totally insane quasi-randomized experiment to help answer an old question: how beneficial is it for villages to be connected to the broader economy? The fundamental insight requires two ideas that are second nature for economists, but are incredibly controversial outside our profession.
First, going back to Nobel winner Arthur Lewis if not much earlier, economists have argued that “structural transformation”, the shift out of low-productivity agriculture to urban areas and non-ag sectors, is fundamental to economic growth. Recent work by Hicks et al is a bit more measured – the individuals who benefit from leaving agriculture generally already have, so Lenin-type forced industrialization is a bad idea! – but nonetheless barriers to that movement are still harmful to growth, even when those barriers are largely cultural as in the forthcoming JPE by Melanie Morton and the well-named Gharad Bryan. What’s so bad about the ag sector? In the developing world, it tends to be small-plot, quite-inefficient, staple-crop production, unlike the growth-generating positive-externality-filled, increasing-returns-type sectors (on this point, Romer 1990). There are zero examples of countries becoming rich without their labor force shifting dramatically out of agriculture. The intuition of many in the public, that Gandhi was right about the village economy and that structural transformation just means dreadful slums, is the intuition of people who lack respect for individual agency. The slums may be bad, but look how they fill up everywhere they exist! Ergo, how bad must the alternative be?
The second related misunderstanding of the public is that credit is unimportant. For folks near subsistence, the danger of economic shocks pushing you near that dangerous cutpoint is so fundamental that it leads to all sorts of otherwise odd behavior. Consider the response of my ancestors (and presumably the author of today’s paper’s ancestors, given that he is a Prof. Donovan) when potato blight hit. Potatoes are an input to growing more potatoes tomorrow, but near subsistence, you have no choice but to eat your “savings” away after bad shocks. This obviously causes problems in the future, prolonging the famine. But even worse, to avoid getting in a situation where you eat all your savings, you save more and invest less than you otherwise would. Empirically, Karlan et al QJE 2014 show large demand for savings instruments in Ghana, and Cynthia Kinnan shows why insurance markets in the developing world are incomplete despite large welfare gains. Indeed, many countries, including India, make it illegal to insure oneself against certain types of negative shocks, as Mobarak and Rosenzweig show. The need to save for low probability, really negative, shocks may even lead people to invest in assets with highly negative annual returns; on this, see the wonderfully-titled Continued Existence of Cows Disproves Central Tenets of Capitalism? This is all to say: the rise of credit and insurance markets unlocks much more productive activity, especially in the developing world, and it is not merely the den of exploitative lenders.
Ok, so insurance against bad shocks matters, and getting out of low-productivity agriculture may matter as well. Let’s imagine you live in a tiny village which is often separated from bigger towns, geographically. What would happen if you somehow lowered the cost of reaching those towns? Well, we’d expect goods-trade to radically change – see the earlier post on Dave Donaldson’s work, or the nice paper on Brazilian roads by Morten and Oliveria. But the benefits of reducing isolation go well beyond just getting better prices for goods.
Why? In the developing world, most people have multiple jobs. They farm during the season, work in the market on occasion, do construction, work as a migrant, and so on. Imagine that in the village, most jobs are just farmwork, and outside, there is always the change for day work at a fixed wage. In autarky, I just work on the farm, perhaps my own. I need to keep a bunch of savings because sometimes farms get a bunch of bad shocks: a fire burns my crops, or an elephant stomps on them. Running out of savings risks death, and there is no crop insurance, so I save precautionarily. Saving means I don’t have as much to spend on fertilizer or pesticide, so my yields are lower.
If I can access the outside world, then when my farm gets bad shocks and my savings runs low, I leave the village and take day work to build them back up. Since I know I will have that option, I don’t need to save as much, and hence I can buy more fertilizer. Now, the wage for farmers in the village (including the implicit wage that would keep me on my own farm) needs to be higher since some of these ex-farmers will go work in town, shifting village labor supply left. This higher wage pushes the amount of fertilizer I will buy down, since high wages reduce the marginal productivity of farm improvements. Whether fertilizer use goes up or down is therefore an empirical question, but at least we can say that those who use more fertilizer, those who react more to bad shocks by working outside the village, and those whose savings drops the most should be the same farmers. Either way, the village winds up richer both for the direct reason of having an outside option, and for the indirect reason of being able to reduce precautionary savings. That is, the harm is coming both from the first moment, the average shock to agricultural productivity, but also the second moment, its variance.
How much does this matter is practice? Brooks and Donovan worked with a NGO that physically builds bridges in remote areas. In Nicaragua, floods during the harvest season are common, isolating villages for days at a time when the riverbed along the path to market turns into a raging torrent. In this area, bridges are unnecessary when the riverbed is dry: the land is fairly flat, and the bridge barely reduces travel time when the riverbed isn’t flooded. These floods generally occur exactly during the growing season, after fertilizer is bought, but before crops are harvested, so the goods market in both inputs and outputs is essentially unaffected. And there is nice quasirandom variation: of 15 villages which the NGO selected as needing a bridge, 9 were ruled out after a visit by a technical advisor found the soil and topography unsuitable for the NGO’s relatively inexpensive bridge.
The authors survey villages the year before and the two years after the bridges are built, as well as surveying a subset of villagers with cell phones every two weeks in a particular year. Although N=15 seems worrying for power, the within-village differences in labor market behavior are sufficient that properly bootstrapped estimates can still infer interesting effects. And what do you find? Villages with bridges have many men shift from working in the village to outside in a given week, the percentage of women working outside nearly doubles with most of the women entering the labor force in order to work, the wages inside the village rise while wages outside the village do not, the use of fertilizer rises, village farm profits rise 76%, and the effect of all this is most pronounced on poorer households physically close to the bridge.
All this is exactly in line with the dynamic general equilibrium model sketched out above. If you assumed that bridges were just about market access for goods, you would have missed all of this. If you assumed the only benefit was additional wages outside the village, you would miss a full 1/3 of the benefit: the general equilibrium effect of shifting out workers who are particularly capable working outside the village causes wages to rise for the farm workers who remain at home. These particular bridges show an internal rate of return of nearly 20% even though they do nothing to improve market access for either inputs and outputs! And there are, of course, further utility benefits from reducing risk, even when that risk reduction does not show up in income through the channel of increased investment.
November 2017 working paper, currently R&R at Econometrica (RePEc IDEAS version. Both authors have a number of other really interesting drafts, of which I’ll mention two. Brooks, in a working paper with Joseph Kaposki and Yao Li, identify a really interesting harm of industrial clusters, but one that Adam Smith would have surely identified: they make collusion easier. Put all the firms in an industry in the same place, and establish regular opportunities for their managers to meet, and you wind up getting much less variance in markups than firms which are induced to locate in these clusters! Donovan, in a recent RED with my friend Chris Herrington, calibrates a model to explain why both college attendance and the relative cognitive ability of college grads rose during the 20th century. It’s not as simple as you might think: a decrease in costs, through student loans of otherwise, only affects marginal students, who are cognitively worse than the average existing college student. It turns out you also need a rising college premium and more precise signals of high schoolers’ academic abilities to get both patterns. Models doing work to extract insight from data – as always, this is the fundamental reason why economics is the queen of the social sciences.
A Fine Theorem 