Robert Townsend on Development, Poverty, and Financial Institutions
Mar 14 2011

Robert Townsend of MIT and the Consortium on Financial Systems and Poverty talks with EconTalk host Russ Roberts about development and the role of financial institutions in growth. Drawing on his research, particularly his surveys of households in Thailand, Townsend argues that both informal networks and arrangements and formal financial institutions play important roles in dealing with risk. Along the way, he discusses the role of microfinance in poor countries and the potential for better financial arrangements to lead to higher growth and the accumulation of wealth.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Pedro P Romero
Mar 14 2011 at 7:44pm

It is not that the financial systems of the US and Europe were too unregulated, but rather too regulated, e.g. there was not a competitive supply of money. I enjoy the podcast, greatly.

Mar 15 2011 at 7:47am

Judging by the lack of comments, this podcast doesn’t seem to be controversial.

Great discussion and very informative. Thank you.

Alfred Differ
Mar 16 2011 at 2:25pm

I didn’t realize that a provincial state government in India could issue a moratorium on loan repayment like that. Yet another example of why we have to have local experts on the ground where we intend to do foreign business. System boundary costs. Sigh.

Thanks for the info. 8)

john thurow
Mar 17 2011 at 3:35am

Unfortunately, the interpretation of profits being bad is based on marxist propaganda and the idea that they are exploitative is nonsense. Long term profits indicate how well a business is doing at serving their customers. Profits are directly proportional to customer satisfaction and the quality of the service being rendered. Without them there is no way to measure business success. That there was long term profits in micro loans indicate that the program was successful and serving the poor well. That it was destroyed by marxist propaganda is a shame.

As far as the US is concerned, there is nothing that ails the US that can’t be cured by allowing people to be more free. That we are going in the opposite direction can only predict that economically we will continue our decline.

john berg
Mar 17 2011 at 12:16pm

A transcription snafu at the point just 10 lines before 1:04:24 where Hayek is quoted. I think I heard the opposite of what is written.
At 64: a mention is made of that point in development when a change is made from farm to industrial. It reminded me that only once in the US history that redistricting did NOT follow a census: 1920. Apparently the change from farm to industry is also a very political time and one or the other side resists losing power.

John Berg

[Thanks, John. I’ve fixed the Highlights.–Econlib Ed.]

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Podcast Episode Highlights
0:36Intro. [Recording date: March 8, 2011.] In recent years, there's been tremendous economic changes in the world at large, particularly in Asia--and by recent years I mean the last 2 or 3 decades. What are some of the stylized facts of that experience? What do we know about what's happened about growth and development, and particularly in Asia? The most remarkable thing now is the growing presence of India and especially China, with very high rates of growth. Even if you think they are exaggerated a bit or the statistics are unreliable, there's clear they are growing by leaps and bounds. That's the sequel to very high growth rates we saw in Japan and Korea and Singapore and so on. Why do we think Asia is growing so dramatically relative to other poor areas of the world? Latin America and Africa in particular have not matched that pace. Africa has been relatively stagnant compared to the other two. What do we know about what's going on there? These are the big mysteries. Actually, Latin America, if you go back in its history to before, say, the early 1980s, they also had similarly high growth rates. But, they didn't persist. Mexico and other countries basically stagnated a bit. Mexico would grow and then have a financial crisis and take almost one step forward, two steps back. There are a lot of people trying to figure out the causes of this. Many people have prior beliefs about its financial system, its politics, its education. Unfortunately, these pieces don't come together really well. People don't consider a variety of hypotheses, unlike say some of the work we may chat about in a few minutes. Is it a fool's game? In particular, most of us have those prior beliefs. Confirmation bias is a big problem. What role do you think statistical analysis is ultimately going to play in trying to answer those questions? Obviously people try to answer the questions, try to hold things constant in terms of one variable or another. But I wouldn't say any consensus has emerged. Any hope of that happening? I think it's correct on both counts. There is no consensus, but I am confident we can get to the bottom of it. What's the evidence for that confidence? Well, it's a bit self-serving, but myself and some other people have been basically combining some fields together, both micro and macro, to try to get all the pieces. My own view is one has to dig pretty deep down and get existing data or even do one's own surveys and really look at households and really medium sized firms and distinguish among them which are successful, which are less successful, try to get at the constraints. Once we are at constraints or obstacles, then also, how some households and firms overcome those obstacles, then one can extrapolate. So you in my view start with the micro data--obviously not ignoring the environment and the macro data.
5:21There's a big debate in the literature. One issue we've just been talking about is the causes of growth, the causes of stagnation. There's another big debate going on about inequality and its relationship to growth. What's our knowledge there? I think there's a bit more of a consensus. There are controversies about Kuznets's curves, whether it's inevitable the way income will go up and then go down, the way Kuznets had described. I think there is pretty much agreement that we don't have to experience Kuznets's curves and rising inequality or not inevitable. People have been doing decompositions of the sources of inequality into, say, occupation transitions or education or access to the financial system. We are much more able to quantify now what's big or what's small in those numbers. It's not a proof but it kind of tells you where to start looking in terms of the sort of changes in inequality. One of the challenges in this kind of work is the quality of data and challenges to even the best efforts. A lot of the transition we are talking about is going from an agricultural society to a more manufacturing based or ultimately information based economy. We don't have very good data on income in agricultural economies, I assume. Depends on the country. Some countries have been fielding socioeconomic surveys, fairly large cross-sectional surveys. They are not panels; they don't necessarily survey the same households or the same firms year after year. But the sample size is large; and if you are lucky, depending on the country, those data go way back. This is true for example of Mexico. Mexico, from various ministries--quite a few data sources you can use. But yes, obviously in other countries these surveys are not necessarily of high quality, and not nearly so comprehensive. For example, the irony--South Korea, that we know is quite successful for decades, doesn't have detailed household surveys until relatively recently. So, we can't go back deep into that history and really understand how the markets, institutions were evolving. We don't have firm documentation, household by household, of the transition from poor agriculture to this 10th largest manufacturing country. Just echoing the point: sometimes you do have data and sometimes you don't. I was thinking more of the fact that household production in a rural, agricultural setting--stuff isn't brought to market, it's going to be hard to measure; and therefore it might be hard to get a feeling for what growth really is. Institutions such as the World Bank began these living standard measurement surveys, both internally within the bank and advised by some very good academic advisers, and they have pretty extensive questions directed at household production. It is quite true, what you are saying, that the conception of households in the National Income Accounts would be as suppliers of labor and savings, suppliers of factors of production, and in turn the demanders of consumer goods. That's definitely inappropriate for developing economies, where so much of the production is done by the households themselves. Could things be better? Yes, for sure. Ideally one would be collecting the survey data sort of aware not only that households are producers but also in a way consistent with national income statistics so we could get a better measure of what's going on in the household and the extent to which the household contributes to national income. It's a tricky problem even in a developed country. When you have, say, in the United States in the last half of the 20th century, revolutionary increases in women's labor force participation, particularly women with children; and you also have changes going the other direction with men's labor force participation going down--not as dramatically. We take someone who is not working and call them a zero--we don't put them in the sample--and then they get a job so we put them in the sample; quite tricky to analyze what happens to the median in those data sets. We feel like the median is better than the mean because the median isn't distorted by outliers, but the median has its own problems when there are big changes in the size of the pool and there are people artificially classified as zero before. Absolutely. I think of that in my mind as sort of transitions on the extents of margin. You just gave a good example of individuals engaged in home production or at least working at home who then go and make a transition to the market. Kuznets--I find it a bit surprising, but the original conception of national income accounts was to measure market activity, not all production. But we often refer to National Income and National Product as if it were inclusive. I think the National Income Accounts are a bit treacherous, depending on the data you are using. But I think if we have panel data and we can track what's going on in the household over time, then we can actually measure these transitions. Not to mention that it's not necessarily in the house--house work mixed in with some leisure. This is production on the farm or in the household business done in the village. Depending on how much they are eating of their own product, it may not show up as I think it ought to if it were done correctly in household income and national product.
13:14Recent podcast program with Tyler Cowen and his book, The Great Stagnation,--I pushed the claim that when people are talking about the United States and income inequality or stagnation or slow growth, one of the challenges of interpreting that data correctly is there have been a lot of changes demographically in the United States in the last 4 decades--huge increase in divorce rate, big increase in the number of households as a result, so when we are looking at changes in mobility or quintiles, snapshots give a very different picture compared to panel data. Panel data extremely important. We don't have very much of it here in the United States; we have some. By panel data we mean you go to the same household year after year after year and you ask them the same, at least ideally, some of the same questions--you are watching their progress, not comparing medians across time. The United States has the Panel Study of Income Dynamics (PSID), and for many purposes it's almost the only data set around. Even within it--funded by the National Science Foundation--hopefully will continue to go on. But depending on the year, they ask relatively few questions about consumption, for example. So you don't really have the measures you would like to have. You have to get creative and combine, say, the PSID with the Consumer Expenditure Survey, which is largely a cross section--well, not quite because households rotate in and stay there for two or three quarters and then they are rotated out again. But people have been splicing or interpolating those two data sets together to be able to impute or more accurately assess something like consumption, which is well-measured in the Consumer Expenditure Survey, into the PSID so we can exploit the panel. Important work. The PSID gives a very different picture of the last 30-40 years compared to the economy as a whole measured by the median. They don't have the sampling issues. The good thing about the PSID is they try to track spin-off households as they kids leave. And divorce. One might want to periodically reassess the sample and make sure we are sampling adequately to pick up changing situations and trends in the economy. It would be really great if the United States were doing more of this. I've been contacted by the Federal Reserve: What would it take to field a panel in the United States motivated by the recent financial crisis we've had. Hindsight is great; you never know for sure if we would have seen it coming. If we had been tracking some of those households and their mortgages we might have done it a little better. Personally, I'd like to see the Federal Reserve get less involved in the systemic risk, but I know that's not the trend. I'm not taking a policy stand. No, I know; I just find it kind of interesting that they are interested in that kind of research, which I view as a further example of mission creep on their part.
17:33Financial system generally in developing countries. Why is it important? When is it a serious barrier to development? What do we understand about that? Snapshot pictures of existing financial institutions in a developing country provide at best a distorted picture. If you look at a country like Thailand, or other countries by number of branches or balance sheets or funds mobilized, it will look like commercial banks are large and a big part of the picture. But if you go into rural areas, and actually in cities as well depending on who you are sampling, commercial banks are often nowhere in sight. Then, on the other hand, you would see some specialty institutions, government banks, that still exist in many of these countries that are devoted to savings mobilization or to agriculture--they start to become the large players, formal institutions. And then they are actually rivaled by this massive informal market that exists out there, with not just stereotypical money-lenders, but also family, friends, borrowing and lending or giving gifts and sending remittances, those financial transactions are just huge. Typically small, wouldn't think it would amount to much, but as big or bigger when measured by financial transactions as the formal sector. You think about the challenges a little bit if you think about the United States, which most people would argue has a highly developed financial system. On the surface. But there are parts of the United States where there is no commercial bank in sight, or where payday loans are common; very high rates of interest, informal networks. How do we assess, if we can at all, how developed a nation's financial system is? Is that the wrong question? I look at outcomes. I look directly at the consequences of the financial system, not taking a stand on whether it's good or bad. Let's look at consumption again and see what happens to households when they have adverse shocks and income is quite low through unemployment, sickness, or any number of unfortunate events. If consumption drops as income drops, then indeed we've documented that they are vulnerable. On the other hand it could well be they have ways of stabilizing consumption, and consumption is largely immune to these large idiosyncratic income fluctuations. Positive or negative. So if you got a bonus, an unexpected bonus. Yes, you want to smooth off the peaks and the valleys. Milton Friedman, in his Theory of the Consumption Function made that argument, largely born out by data, at least in the United States. Comes up in policy discussions because temporary tax rebates tend to get saved rather than spent. When Friedman won the Nobel Prize someone asked him about how an unexpected windfall like this would affect his consumption, given his own theoretical and empirical work on it; and, ever the wit, he replied: Well, who said it was unexpected? He was being facetious in part. But also, if you do expect a gain in the future you might start to spend it along the way. You wouldn't necessarily go wild when you received the money--you'd add it to your wealth. Friedman's argument: you'd smooth your consumption. But how much of that is just a theory, versus what people actually do, versus what's desirable? How much is cultural? When you are in a place like Thailand, on the ground, what do we learn about how people feel about those kind of changes? Let me agree and yet draw a distinction. Friedman was talking about smoothing over time, thinking about the permanent income hypothesis. Yes, that does assume there is a way to smooth off the peaks and fill in the valleys through, say, borrowing and lending. I'm actually adding to that insurance across people at a point in time. If you had Friedman's world there would be a lot of smoothing going on, but there wouldn't be a wavelike picture where consumption is moving up and down together. Smoothed, yes, but not coincident across the households. What insurance adds is the capability of basically through remittances, gifts, and so on providing money to the unlucky poor at that moment, away from the lucky rich. I want to say lucky and unlucky in the sense that I'm not arguing for equality--not taking a stand that efficiency means an egalitarian system. You can have long-run, persistent differences across households in terms of their levels. I'm sort of renormalizing against the long run average, and then on top of that we can have these insurance-like systems. To get to the answer to your question: I did this in India, in an article in Econometrica called "Risk Insurance in Village India," which showed that for the most part, with some exceptions, households in the village were doing remarkably well at achieving this efficiency standard. Raised a controversy because there were presumptions by policy makers and others that these households that were near or below poverty would not be able to help themselves and organize among themselves in a way that I seemed to be finding. And there is an exception, and I should say it right away: The relatively poor, the poorest among the poor and those say with wage earnings as opposed to those engaged in agriculture actually were somewhat vulnerable, but not anywhere near $.70 on the dollar--converted into rupees--but rather on the order of maybe $.20 on the dollar. Every dollar of income fluctuation making its way into 20 cents worth of fluctuations in consumption. Pretty remarkable. Different economic system than the developed world. What was the typical source of income for the people who were poor? Quite diversified, typically. Some earning wages by working in the village or outside of it. Some tapping palm trees and making toddy liquor; some rearing livestock, bullocks used for plowing, or even running stores and small businesses. That's pretty typical. Not one homogeneous world out there. Plenty of differences both in average levels of income and in the sources of income. Yet somehow they are pooling all of that together as if they were in an implicit mutual fund and sort of eating the dividends.
27:03I derailed you from your starting point--that you don't look at particular institutions but at the outcomes, and you are talking about the potential to smooth through organized financial transactions or these informal methods of assistance from families and friends, or some formal agreements they might have--private agreements that we don't normally think of as financial institutions. Those are outcomes that make life more pleasant. So, your shop loses business, you get hurt and lose your job, you are fired, bullocks get sick and you can't get any income from them. Bad luck, and having some kind of financial system is important. That's what I would think of as your wellbeing over time for a given level of activity. What role does the financial system play in getting you out of the rut you are in if you are very poor? What outcome measures would you want to look at to determine whether those systems were working well for growth--not just dealing with a particular level of average income? One of the big findings, and puzzles, is that the system doesn't work nearly so well for these longer-run investment possibilities. To some degree it does. If we come back to the idea of transient shocks and smoothing, you would like a system where households are not sensitive to cash flow in terms of the timing and magnitude of investment. Just by consumption, some of these households in some of these villages can do quite well pooling resources. But if you draw back from that and look at the big picture: How are they doing over the longer term? One measure would be what financial analysts use: the return on assets, which is simply income or net profits divided by productive assets. There's a tremendous variation over households in that number. On the high end, the rates of return are so large as to raise doubts, at least among people who have not studied developing economies. You can have real rates of return that are on the order of 40-50% per year; which begs the question you were raising: if such rates exist out there, surely there would be investors giving them the money. But the answer seems to be no, it's not happening much. And the other end of it is there are households who are running businesses and farms with relatively low rates of return. So, again, if things were working better you would expect these households to exit what they were doing and do something with better returns to their labor and their resources. But by and large that happens slowly, if at all. This is symptomatic of a poorly functioning financial system. Interesting that in that context you will see by accident or design some financial innovations. In Thailand, for example, the previous government established a local savings and loan for every single village in the country by seeding it with a grant from which, like rotating credit essentially, or other financial institutions, capitalized by government sources as a gift, but then those become the village resources and they set up a committee to lend and they recover loans and so on. Ironically, the same amount of money was put in every village, but village vary quite a lot by the number of households that live there, so the per person or per household treatment varied quite a lot. We exploit that to be able to back out the impact of this financial innovation. And investment actually does go up. Investment in agricultural activities, in repair of vehicles used by traders; other things happened as well. Consumption goes up, arguably because they now have a reliable source of borrowing and they don't need to have as many buffer stocks around to squirrel away for the rainy day--really the drought day. There's an instance where something like microcredit could be assessed without all the politics that comes with it. It looks on net as if it was helpful. That said, there are alternative ways to give away money other than establishing a financial institution. The real winners in this were households who were constrained in the amount of investment they could do; other households would have preferred to take a lump sum grant. It would have had the same consequences for the government budget. Of course, nowhere in what I said do we refer to the losses of the people who pay the taxes to fund this government program. But at least it does allow us to answer your question about the impact of microcredit.
34:07I want to go back to the example you mentioned earlier of the households that had very high rates of return on their assets, in the 40-50% range. I've read there are for-profit financial institutions in poor countries that can charge rates higher than that even and generate profit from those who are credit constrained and who have opportunities to pay that high and are willing to borrow the money at high rates. Is it not that a better financial system would lead to big increases, not modest increases, in wellbeing? Yes, quite true. So what do we think is stopping people, in the good sense of the word, either on the borrowing or the lending side? You've got somebody who has got an asset that's returning 50% a year; they'd like to have twice as much of it. Maybe the rate would fall to 40% if they had twice as much, but somebody could lend them money and make 20%, 30%--huge returns lending them the money--and the people borrowing that money to make farm equipment, whatever we are talking about, would thrive. There appears to be a very large, unexploited gains from trade there. Do we have any insight into the mystery? Some. Let me throw in one comment, which is it's not as if the households necessarily just sit there doing nothing about the possibility of doing better. In fact, the strongest evidence that we are getting the numbers right is that these households with very high rates of return do take the money they earn and put it back in the business. Their savings rates are higher. They will even drop consumption in order to try to get more resources to put in the business. Using yourself as a bank. You don't see this catch-up happening very quickly because they have a long way to go. One wonders how quickly the gains would fall off; in, say, a Solow model, eventually with diminishing returns you get to a steady state. These households seem very far away from a steady state, even though some of them have been investing in their own business. To come back to your question, I think part of the problem is these things are not well understood and that people have priors one way or another. Microfinance in India is in big trouble right now. Why? My take on it is that ironically, some of the microfinance institutions, as you were suggesting, were making a lot of money. They start as not-for-profits. In Mexico, some of them start as religious organizations. But eventually, the more successful ones privatize. They have IPOs and the owners make tons of money. In Mexico there is an investigation from the Congress, and in India this hit the press. It fed into this preconception that people are making money off the backs of the poor, and this is evil. And microfinance is supposed to be helpful, not profit-oriented. It gave a rebirth to the concept at the beginning. Ironically, at the very beginning people questioned whether microfinance institutions could actually make profits. Setting aside whether they ought to. The claim being, I guess, that the lenders wouldn't pay the money back, would just take advantage of it; and then the nest egg would be gone; would just have to start over. That was the original worry. Or that these households didn't understand what they were doing and they were going to be over-indebted and their life would be miserable. That's not the picture I'm painting, which is households with fairly low debt and insufficient funds for some of them to take advantage of profitable opportunities. So, in India, about a month or so after the banner headlines about how one of these microfinance institutions had made so much money, there was another series of articles that over-indebted households had no place to go and had committed suicide. This was quickly picked up and spread and the provincial state government issued a moratorium on repayment of loans, which basically destroys the culture of repayment. It happened a couple of years ago in a small way; and in November in a big way. That affects the flow of funds, in India and to microfinance institutions. Outside investors are going to be leery of getting their money back. So, venture capital has been drying up. The Royal Bank of India now realizes the problem and is trying to set up some kind of insurance pool to keep things going, but in many respects a lot of damage has been done. Not all countries are like India, of course; but these sort of conceptions and misconceptions mixed in with politics have often been a barrier to innovation.
40:49Coming back to my earlier question about growth and the role of finance. Has the earlier success of microfinance in India been important in India's growth? Or is it only smoothing, an insurance scheme? I don't know, for India. I know there's a potential there. There had been evaluations of some microfinance lending. My colleagues, Banerjee and Duflo, have done this in Hyderabad. Again, it's not a resounding success for all the borrowers. Many people don't borrow at all. Those that do sometimes use it for consumption--which in my mind is fine. But you can find this sort of subset of the population of entrepreneurs who either set up a business or expand their business. Important to repeat--that's like my Thai data. It's not all these households; it's just a subset. For India, I don't know what the impact is for this spread. For Thailand, we've actually built economic models based on these data and have simulated the experience over the last 30 years, with the spread of financial institutions. Not so much microfinance institutions. Thailand actually doesn't have very many of those apart from these village funds. The spread of a government bank for agriculture, for example, and we can explain about 75% of the movement in macro- total factor productivity (TFP) with this deepening of the financial sector. What does it mean to deepen the financial system? It means that there are more branches of banks, more borrowers as well as savers. Like that extensive margin we referred to earlier, where some households don't work and then do, going into the wage-labor market. Well, in this case, some households don't engage with formal financial institutions, at least not at first, but eventually many of them make that transition. So, if you go to a cross-sectional data set the Thai government has been collecting since 1976, they fortunately asked a question--noisy but useful--Did you have a transaction with this bank for agriculture or with a commercial bank in the previous month? Back in 1976, only 7-8% of the households answered the question affirmatively. But over the years, between 1976 and, say, 1996, a period of very high growth for Thailand, that number rises by three-fold. That's what I mean by financial deepening on the extensive margins. I guess TFP is better understood, but to review it: it's the amount of output that you can produce both taking into account land, labor, capital, but also productivity term in the aggregated production function; and that productivity term, holding resources constant, moves around quite a bit. In advanced industrialized economies, a lot of the growth is associated with productivity growth and not with changes of the factors. But that's likewise true for an emerging country like Thailand. TFP is high but moving around, and we've been able to determine that the movements in it are very highly correlated with this financial deepening. It makes sense because it's not creating more factors of production. It's reallocating them. It's taking money, through lending and interest-bearing deposits from those households who shouldn't be running their own farm and business and channeling it through credit to those that should. Nothing's changed about land, labor, or capital. What's really changed is intermediation. And then the lenders get to share some of those gains. That's right, in principle can benefit from this. Side-route to the United States. My claim is that through policy errors and some stupidity, our highly vaunted and developed financial system managed to channel trillions of dollars into housing over the last 10-15 years. We think of the financial system key for allocating capital--the story you just told--Wall Street will constantly tell you they play a crucial role in productivity because the allocating of capital is crucial, important issue. But I would suggest in recent years we've misallocated capital in the United States rather remarkably. Do you think that's true? Yes, I do. I agree with the example of housing. I think, through well-intended reasons perhaps, both through Democratic and Republican administrations, housing has been thought to be not exactly a right but it would be a good thing if many more people and low-income people could own their own home. I think that creates incentives for local and national, at the federal level, to create institutions to try to make that dream come true. Clearly, to speak to the obvious, in the latest round, there were many people who weren't qualified to borrow money who had mortgages and got into homes. The construction that went along with it mushroomed, sprouting all over these suburban complexes or rural areas with fields basically getting filled in with these housing developments. Amazing that people didn't put two and two together, but that's hindsight. I'm not arguing that financial systems always do well. They can certainly go off track. It's important to be clear about how they function, to rate financial institutions in terms of the services they are providing--using these very same benchmarks I was referring to earlier. Takes data and the political will to do it. I mention the United States because so often people measure some intervention or other as what it costs the taxpayers; in our case, I think it's going to cost us hundreds of billions of dollars, maybe trillions, but the unseen cost, that's transfer mostly, is the misallocation of what we don't have because we built so many and so much bigger houses.
49:43Let's turn to Thailand. Thailand has been growing dramatically for three decades, interrupted by the Asian financial crisis in the late 1990s. But now they are doing well, I think. Is that correct? The growth rate never got up to the 5-6% on average that it was, so there is kind of like a shift in terms of long run averages, but they are still the envy of many countries in the world. For them, it's a bad year when the growth rate is below 4%, and that's still the case; their growth rate is typically higher than that. They've had other problems, too--the [December 2005] tsunami. They have a political crisis ongoing. But somehow they weather these storms and manage to continue to produce high rates of growth. In the United States there's a claim out there--that I don't agree with--that average income in the United States has grown dramatically in the last three to four decades, but supposedly most of that has gone to the top 25%; sometimes you hear top 20%, top 10%. And I argue that some of that's a distortion of the data--it's not the same people, there have been demographic changes, etc. In your case, you've got household data of a substantial size to look at people's lives, so in Thailand, during this period when growth is 4-plus percent year in, year out, which doubles by the rule of 72: every 18 years you are going to double income--and when you get 6% you double every 12 years, which is unbelievable. They had some 10% years in there. You double every 10 years. It's actually the rule of 70. You divide the growth rate into 72 and that's basically how many periods it takes for the number to double. Has the rising tide in Thailand lifted most boats, some boats? What does your panel data tell us? At first, inequality was increasing. The wage rates were kind of staying low, pinned down by the return of subsistence agriculture without a whole lot of technological progress, while the country was industrializing. This was a source of great profits for business, which got reinvested. But eventually, you see this increasing level of capital increasing the productivity of labor, which around 1992, 1994 made its way into wages. And then the picture reversed itself rather dramatically: inequality started to drop, and dropped substantially. A bit like the tides raising boats. These are households that are benefiting indirectly from the industrialization through higher wages. There was a bit of a backstep in the financial crisis. Inequality went up again pretty sharply for a year or two, but then relatively quickly it fell back down and is now lower than it was, I think, prior to 1997. Is this a rural-urban transition, a case where people are leaving farming and coming to factories? Somewhat, yes. The number of people earning wages is going up; it's becoming the single largest category of people. Whereas if you go back to 1960, say, it's farm and non-farm self-employment. Surprising to many people, corporate profits still are not the biggest source of income in the national accounts. Profits are maybe 22% of all household income, whereas some of these other numbers are 40-50%. But I would dispel the image of lots of poor farmers migrating to Bangkok. That has happened to a large degree; it is part of the story. But it's not the only story. There's a lot of development going on in the regions. Collection of villages grow to the point they become towns. In our data we gather soil moisture in the fields; those fields got paved over with highways and we lost our ability to measure. Startling indicator of the urbanization that's going on not just in Bangkok but in the regions. Small business plays a big part. It's still the case that a large chunk of national income is coming from these small household businesses, often without hired labor, that make money and when added up contribute a substantial chunk. Not everywhere, not uniformly, but there are hotspots. Give me some examples. A lot of it is truck, barter, and exchange. You'll buy a pickup truck, which is not a small expense--could easily spend $30-40,000 U.S. dollars on a vehicle. Tribute to their previous savings. And then they'll haul stuff around, buy and sell. Being a middleman, helping others make transactions more cheaply. I'm thinking about Adam Smith--not the truck, barter, and exchange, which is Adam Smith's reference--but about the pin factory and specialization in general. So, you have a population that maybe in 1960 was relatively self-sufficient, people on farms; now they are integrating themselves into an economy that has more specialization, more division of labor, more trade. Is that an accurate picture? Yes. Part of it is not that you are learning to create pins better. It's that as transportation costs fall, as the economy improves, you get these predictions that people for interregional trade, that people are used to thinking about as inter-country trade, like Portugal and England with wine and wool. So these rural areas were relatively labor abundant and had low wages; and near and around Bangkok labor was relatively scarce and capital was abundant. So you see divergence in interest rates and wages depending on the most common thing around. But over time as the country opens up, you get these predictions that the wage starts to rise in the rural area. Effectively they are exporting labor-intensive goods to Bangkok and to the rest of the country. So, you are getting the gains to trade happening. But not all at once, because the infrastructure doesn't improve all of a sudden.
59:01Have we learned anything from Thailand in particular? And also, your bird's eye view: the fact that you are looking at households per se rather than aggregate data only? What might we learn from those two phenomena that might help other countries get close to that 4-plus growth rate? Facilitate transitions into the financial system; changing occupation; getting the kids educated. But not necessarily doing it by giving money away. Doing it by improving the institutions that are there. That's layered on top of a country where households are very entrepreneurial. They are very successful, some of them. So, they don't sit around unemployed, rarely, even in the financial crisis households set up businesses--some of them with low rates of return, but still employed, earning more than they would be if they were just returning to the village to sit around unemployed. This is something we can see in my data, comparing the pre-financial crisis to the post-financial crisis businesses. Perhaps this varies culturally; that's not my relative expertise. I look at look at how cultures create local institutions that can help mitigate these problems. These kinship networks for example are quite lively and robust and have been helpful. Some lessons are we need to understand what's going on on the ground before we jump to conclusions. The notion that somehow moneylending is evil: Thailand unfortunately has taken the route of trying to replace local moneylenders with sources of cheap credit. That in my mind is probably a very big mistake. Not only is cheap credit not sustainable, but they are undercutting these local financial systems. You can kind of think, a bit provocative, to draw some parallels with the United States. These informal financial systems in Thailand are by and large quite helpful. Doesn't work in every village. Whereas in the United States, we seem to be going in the direction of stifling financial innovations. This is a tricky business. We have to get to the bottom of where the distortions were without adopting policies that really deal with the symptoms and not the underlying disease. A policy of thwarting the informal financial market, which in some instances is all the villages have going for them, is arguably a bad policy, at least in Thailand; and gives me pause when I think about over-labeling financial institutions in the sense of drawing on a plan and saying this kind of institution should be doing x and another kind of institution can be doing y. If they cannot then coordinate with each other in some way, you can definitely cause some problems. Or as F. A. Hayek said: The curious task of economics is to illustrate to men how little they really know about what they imagine they can design. I'm having a lot of fun; I enjoy what I do. There is kind of a sense of discovery; when you have the data I have you can look and see what is going on. It's never enough, of course. I really think many countries would be much better off if they not only had these kinds of data but also had the frameworks so they could interpret them and base policy on the conclusions of the analysis.
1:04:24We've gone through a couple of changes in the United States. Response to the crisis, thinking about consumer protection, often attempts to protect consumers and make them worse off if it's done poorly. Tendency to think that policy is always designed with the best of intentions, and when things go wrong, there are unintended consequences; that's part of life. I tend to think there are fewer unintended consequences than people think; a lot of consequences are intended. In the United States, the financial sector is extremely savvy and politically powerful. Not only does it give money, I think it also has access: recent podcast with Daron Acemoglu, this came up. In these developing countries, what are some of the political forces that inhibit or help good policy with respect to financial systems? In many countries the banking system is rather thin. If you count the top 5 banks in Mexico, they pretty much account for all of it. You do kind of a financial access survey and discover--at least you would have discovered five years ago--large sectors of the Mexican population without use of savings and other financial services. I kind of agree with where you are going with this one. You really have to look hard at the barriers. What is it that's preventing innovation in the financial system? You can see it happen with microfinance institutions: all of a sudden, when they are successful, you get these Congressional investigations and so on. Is that well intended, or is that because there are losers? I wouldn't discount the fact that in many of these countries banks are intentionally making money and have very little incentive to innovate. In Thailand, we are working with the government to try to improve the financial system. But often, some of the work involved in doing that is just getting the facts out there, summarizing the data. If banks don't have an incentive to innovate, then if you bring up a case study from an area they don't service, they are inevitably going to regard it as very risky and not do it. The tricky thing here is that we shouldn't be in the business of telling every institution what they ought to do and that they ought to offer a certain array of services. But if there are gains to making pins and specialization in banking, then we have to make sure the rest of the system is open so that somebody else can step in and innovate. It's a very slippery slope. The finance companies in Thailand were relatively unregulated, unlike the commercial banks, and they were the culprits, feeding that housing bubble that broke in Thailand and the rest of Asia, that financial crisis. My heartfelt agenda is to have enough data and enough frameworks to be able to assess the flow of funds and rates of return and call a spade a spade, institution by institution.

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