Economics
Demystifying Poverty
by Cindy Wagner
Breaking the poverty trap will require long-term thinking.
Democracy is often touted as a panacea for poverty: It promotes economic
development, encourages innovation, and facilitates long-term investment. But there's more
to economic development than democracy and free trade.
Since more than a billion of the world's people live in extreme poverty,
economists and policy makers need to look more deeply at the factors contributing to
wealth and poverty, argues political economist Romain Wacziarg of the Stanford Graduate
School of Business.
Economic growth happens when there is an accumulation of resources, such
as capital, labor, and technologies. Without these resources, an economy cannot grow.
Poverty happens when a nation cannot accumulate these resources, so it is crucial to
understand the reasons underlying this inability, Wacziarg explains. The suggestion that
"democracy" or "free trade" can somehow solve poverty is overly
simplistic, and not entirely accurate, he argues.
"Conventional wisdom is that democracy creates wealth, but this is
hard to detect in the data because many autocracies such as Singapore and Chile have done
quite well," Wacziarg notes. Despite being a dictatorship, Chile thrived during the
1970s while other countries faltered, largely due to its economic protections and
incentives for business. "Democracy certainly does not hurt economic growth, but
neither is it a panacea."
Free trade, on the other hand, does appear to be good for economic growth,
as has been the case in India, where the annual growth rate increased by 1.5% after
external reforms were applied in the 1990s. But growth (and prosperity) can still be
thwarted in free markets. The key to unlocking the mysteries of poverty, Wacziarg
believes, may be the factors producing a short-term vs. a long-term outlook throughout the
society. And these factors may be more social and demographic than economic, political, or
technological.
Impoverished countries tend to be those with high mortality rates (as well
as high population growth). When people tend to die young, there may be little incentive
to invest in business—individuals won't have the opportunity to reap the benefits of
the investment, and businesses won't have the labor needed to fuel long-term growth. In
Sierra Leone, for instance, a 15-year-old has a 57% chance of dying by age 60, so
investment for a nonexistent long term doesn't seem to make sense, Wacziarg and co-authors
note in a recent research paper.
And this lack of long-term investment suppresses economic growth,
perpetuating the "poverty trap." Population growth continues to accelerate in
these impoverished nations because children are viewed as insurance against high mortality
rates, but this causes further economic strain on poor countries. "High adult
mortality reduces economic growth by shortening time horizons," write Wacziarg and
co-authors in the paper, "Death and Development."
"Higher adult mortality is associated with increased levels of risky
behavior, higher fertility, and lower investment in physical and human capital.
Furthermore, the feedback effect from economic prosperity to better health care implies
that mortality could be the source of a poverty-trap."
Breaking out of that poverty trap requires a nation's institutions to
adopt longer-term perspectives. For instance, Wacziarg's research suggests that protecting
people's right to own land, machines, factories, and other resources creates incentives
for investment and innovation. Such investment, in turn, creates the resources to provide
health services that could lower mortality rates.
One byproduct of breaking out of the poverty trap could be freer
societies, as "wealth seems to promote the proper conditions for democracy to
develop," Wacziarg concludes.
Source: Stanford Graduate School of Business, News Service, 518
Memorial Way, Stanford University, Stanford, California 94305. Web site
www.gsb.stanford.edu/news. See also "Death and Development" by Peter Lorentzen,
John McMillan, and Romain Wacziarg (January 2005), available from www.stanford.edu/~wacziarg/downloads/death.pdf.
