Karthik Tadepalli in Asterisk: To many people, “development economics” is synonymous with the randomized controlled trial: randomly assigning some group of people to an intervention, like cash transfers or malaria protection nets, in order to tell if it really makes the recipients better off. RCTs have revolutionized development economics and international aid policy. The RCT pioneers Esther Duflo, Abhijit Banerjee, and Michael Kremer won the Nobel Prize in Economics in 2019, and the chief economist of USAID, Dean Karlan, is a prominent RCT advocate. RCTs are influential because they are a powerful tool to cut through uncertainty and preconceptions. For example, international development practitioners long believed that providing textbooks in underfunded schools would help students learn more: but an RCT in Kenya showed that most students did not benefit from getting textbooks, primarily because they were already learning very little in school. RCTs can help us identify what works. Yet nearly everyone who thinks about development has, at some point, had a crisis of faith.
Skeptics argue that RCTs distort the focus of policymakers toward technocratic questions that lend themselves to studies of limited scope, and away from the hard problems that are ultimately more important. After all, aren’t RCT-driven solutions just Band-Aids over the fundamental reality that poor countries are poor? Shouldn’t we spend our time and money focusing on how to bring economic growth and prosperity to countries, rather than tinkering with partial solutions for a tiny number of people?
This argument is appealing, but it faces difficulties when the rubber meets the road. What would it look like to adopt a “growth strategy” for doing good?
One policy commonly proposed by international agencies like the World Bank or the International Monetary Fund is trade integration between developing countries and global markets. Trade almost certainly increases growth, so reducing trade barriers could be a huge win. Thus, a candidate growth-first intervention might be funding a think tank that advocates for reducing trade barriers in a large, relatively protectionist country like Nigeria.
But are we certain that a large-scale increase in trade integration is the right goal? It does likely increase growth, but it may have increased rural poverty in India, caused lasting unemployment in Brazil, and led to political polarization in the U.S. These costs eat away at the benefits. Even if trade integration is the right goal, how would we pick which sectors to focus on? And how likely would our think tank be to succeed in its advocacy for lower tariffs when other political interest groups benefit from high tariffs? As the costs and uncertainties stack up, our growth-first policy starts to look less appealing. The intervention could still be the best way to promote economic growth, but you can start to understand why this approach isn’t so appealing to many people.
The modern, RCT-driven style in development economics arose in part as a response to challenges like these. Macroeconomic policy is hard. Every country has different needs and constraints — and the poorest countries in the world are usually the ones that struggle the most to design and implement good policy.
But the right response to this difficulty is not to abandon growth as a goal and go back to narrow household interventions. Instead, we should search for a “missing middle.” Are there interventions that are likely to impact growth, but which have a much stronger evidence base, and are narrow enough in scope to be easily implementable? There are different ways to conceptualize what this middle ground looks like, but I’ve chosen to focus on one approach that is naturally relevant to international aid spending: interventions for firms.
The missing middle: firms in developing countries
The founding question of development economics was “How do we make poor countries rich?” It was a powerful motivation, but it was too abstract to generate credible prescriptions. Instead, it led to a lot of dubious cross-country correlations presented as causal evidence, and broad statements about the causes of growth (“institutions,” “ideas,” “human capital”) that might be correct, but didn’t translate into sharp policy recommendations.
But you can make a remarkable amount of progress with a simple observation: A country’s economic growth can be understood as the aggregate of the growth of its individual firms. 1 Specifically, a country’s growth rate is mechanically determined by three factors:
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