The trouble with talking all the time in the language of countries growing and countries failing to grow, is that we forget the real actors: People start a business, hire other people, make some people richer by buying from them, drive yet others out of business. This is what capitalism is all about. Growth is just the name we give to the accretion of all that.
What makes someone start a business? There is an influential view that says that being an entrepreneur comes naturally to people: Hernando De Soto tells us that if only the government would stop making it hard for them (by refusing to give them titles to the land they own, for example) the poor (which is most people in the developing world) could transform themselves and the rest of the economy through their entrepreneurship.
A quick look at the data actually makes this look quite plausible: In almost every country for which there is detailed survey data that allows us to answer this question, nearly 50% of the urban population living under two dollars a day and much more than 50% of the rural population is self-employed, which means that they are in effect running their own business. Compare that to the 4-8% who are self-employed in most rich countries and you begin to think that there must be some entrepreneurship bug going around among the poor.
However that view does not really survive a second look at the data: It turns out that the businesses of the poor are also poor businesses: The typical business has zero paid employees and no machines in almost every country where we have data and where we have the information to be able to calculate this, what the household earns from the business is less than what they would earn on the lowest end of the labor market. They are in effect buying a job and not particularly good job at that.
Isn’t this just a reflection of the fact that they do not have enough capital to run a proper business? Yes and no. These businesses are certainly undercapitalized, but the businesses of those who are significantly richer (those who live on $6 to $10 a day, for example) really do not look all that different from these. Moreover the amounts of money invested in these businesses are so tiny that a family living on three or four dollars a day per capita, could easily double or treble their capital stock in a year by simply halving what they spend on tea or cigarettes.
Dean Karlan and Sendhil Mullainathan, in a recent paper, put this point rather starkly. They study fruit vendors in Chennai, India, who make about two to three dollars a day by buying fruit in the morning on credit and paying it back at night. It turns out that the interest rate they pay is 5% per day and at that rate, saving the ten cents they spend on tea for just one day would allow them to pay back their entire loan in six months (the power of compound interest) and add a dollar a day to their earnings. Yet most of them seem to be permanently stuck in their business model.
My point here is not to suggest that there is something egregiously irrational about the poor. Looking at it from their point of view, it seems clear that what they are missing out on is not really an opportunity to transform their lives: we are talking about a few more cups of tea or a few more meat dinners, in return for a few months of discipline. They would remain poor, indeed very poor.
When offered something that would make a significant difference to their lives—say the opportunity to join a ROSCA or a savings club that would help them buy a television—the poor seem to be happy to make the sacrifices. It is more that business-wise they do not see themselves being able to do anything very different. And most of them are probably right.
The problem is that for a business to rise beyond its many competitors—the thousands of fruit vendors in Chennai---it has to have something special about it: The product (P) must be different or the quality (Q) must be especially high, or the firm must have special reputation for reliability (R) or the scale of operations (S) must be large enough to generate significant cost savings. And each of these requires a combination of special skills and substantial amounts of money, both beyond the reach of all but a few poor or even not so poor business owners.
It is these PQRS businesses that generate the good jobs that other aspire to, and the earnings that come out of them lead to other businesses and so on. This, to a first approximation, is my vision of the process of how growth happens. It is what China has managed to do very successfully and Africa will have to find a way of doing.
None of this of course tells us much about how all of this comes about. The problems that all economies (barring those that live entirely off natural resources) have to solve are (a) how to generate those special skills and (b) how to make sure that those who have the skills get matched with the capital needed to take best advantage of them. Many countries do this very badly: the money stays with the moneyed classes, and is forced to work with whatever skills available among the children and the grandchildren of the rich. But all successful economies have found ways to do better, though the mechanics of how that happens varies from country to country, and both governments and foreign capital have had a role to play. But I will keep that story for another day.
In the meanwhile, any reactions?
