Future Development Reads: Reconciling the politics with the economics

Editor's note:

At the end of each week, one of the rotating editors for Future DevelopmentShanta DevarajanWolfgang FenglerIndermit Gill, or Homi Kharas—provides recommended literature on a specific development topic.

We live in an era where political debates appear much shriller, and polarized, than economic analysis would predict. A case in point is the effect of trade opening on wage inequality, which, according to economics, could be ambiguous whereas the political rhetoric, especially in rich countries, is that it is always harmful. A recent paper in VoxDev reconciles this difference by showing that the initial effect of trade liberalization is increased wage inequality, but as firms’ input costs fall further, wage inequality begins to decline. In addition to deriving the result theoretically, they empirically corroborate it with data from Brazil.

At a recent lecture at the World Bank, Pinelopi Goldberg from Yale cited a different effect, also in Brazil, that showed that the negative employment effects of trade liberalization tended to be magnified over time, and be reversed only by increased employment in the informal sector. The implication here is that the people protesting trade liberalization may be capturing a longer-term effect than economists’ short-run models.

Another area where the rhetoric outpaces solid economic analysis is automation and the loss of jobs, particularly in developing countries. A recent paper by Karishma Banga and Dirk Wilhelm te Velde from the Overseas Development Institute helps to fill in the gap with careful econometric analysis of the relative effects of robots and 3-D printing and wages in Kenya. They find that Kenyan workers will remain competitive for about 20 years, which gives low-income country governments a window of opportunity to prepare for the technological changes, especially if they focus on the less-automated sectors such as food and beverages, garments, metals, and paper. The messages resonate with an earlier study, entitled “Trouble in the Making,” by my World Bank colleagues, Mary Hallward-Driemeier and Gaurav Nayyar.

Finally, the 2011 Arab Spring revolutions pose a puzzle for economists because most standard economic indicators, such as GDP growth, poverty, inequality, and access to basic services were improving in the first decade of this century. Hassan Hakimian at University of London provides an explanation, drawing on Aristotle’s famous quote, “In order to secure his power, a tyrant must keep the population in poverty, so that the preoccupation with daily bread leaves them no leisure to conspire against the tyrant.” Hassan suggests that the growing prosperity raised expectations, particularly of the middle class, which the current regimes were not able to fulfill. The hypothesis echoes Elena Ianchovichina’s and my paper, “A Broken Social Contract, Not High Inequality, Led to the Arab Spring.”