Lecture Two
Efficiency-Equity Trade-offs?
My previous lecture dealt with the effects of international economic integration on four types of issues - productive
efficiency, income distribution, collective bargaining institutions and economic security. This lecture deals with the whole
question of efficiency-equity trade-offs.
Globalization is about market competition and efficiency. For social justice, in which we all have an interest, to be
sustainable it has to be based on a reasonably efficient economy. Productivity is extremely important from the point of
view of social justice. As the radical left-wing economist, Emmanuel(Endnote 9) once put it rather bluntly: "if capitalism is hell there
exists a still more frightful hell: that of less developed capitalism". It is therefore important that the economy is more
productive for us to be able to pursue social justice on a sustained basis. Although some people may not be familiar with
the expression "efficiency-equity trade-off", it is in some sense deeply entrenched in public opinion as well as academic
thinking.
Public opinion on the right, or even the middle, of the political spectrum insists that if we are to pursue equity or social
justice, many of the principles of efficiency will be violated; we should therefore not think too much of equity as it is
bound to be very costly. On the left, the idea of a trade-off comes in again - that we want social justice and, yes, that there
are costs in terms of efficiency, but these are secondary, our primary goal is social justice and equity, and if there are
many costs in terms of efficiency we should be prepared to sacrifice those. But both sides agree on the fundamental
proposition that there is a trade-off between efficiency and equity. Some other economists, including myself, are now
challenging this. There need not be a trade-off and that's largely the theme of this second lecture.
In talking of efficiency, I remember reading some time ago about a journalist on a Chicago newspaper in the 1890s who
once wrote a satirical column on the tycoon John D. Rockefeller. He said that Mr Rockefeller behaves as if he belongs to
the Society for the Prevention of Cruelty to Money. When people who belong to the Society for the Prevention of Cruelty
to Animals see abuse of animals, they go and rescue and adopt the animals themselves. As for Mr Rockefeller, when he
saw inefficient use of money he simply collected the money and adopted it himself - in its own way, a take on the
equity-efficiency trade-off. It operates on the principle that if some people are using money inefficiently, one takes the
money away from them, gives it to people who may be very rich, but who will use it efficiently. Of course, this trade-off
is - I would say - one of the foundation stones of mainstream economics. There is hardly any textbook in economics that
does not accept this trade-off. The general idea is that if one wants to redistribute, to provide income support for the poor,
to provide social security and introduce other poverty alleviation policies, of course one has to fund these programmes.
And the way to raise money usually would be through progressive taxation of various kinds on income or other economic
variables, which is going to undermine incentives to work, invest and to innovate.
One American economist, Arthur Okun,(Endnote 10) said that the transfers from the rich to the poor, even when they are desirable,
are like transferring water in a leaky bucket - by the time it reaches the poor, much of the water has leaked out, which is
inefficient. Instead, as many of the liberal economists suggest, let the economy grow, and if it does some of it will trickle
down to poor people. In recent years, one observed a trend of phenomenal growth, until 1997, in East Asia and, in
association with that growth, the very large reduction in poverty - particularly in China. Hundreds of millions of people
were rescued from poverty by growth, and this is the most important example often cited by liberal economists of the case
of growth helping poverty alleviation. I have no doubt that the disincentive effects of some redistributive programmes are
quite significant. But to me it is too one-sided a view of the economic mechanisms at work. I think the trade-off between
equity and efficiency is often false or at least exaggerated.
In fact, inequality itself has a great number of adverse efficiency consequences. Inequality is bad, not only in terms of
social justice, but also of efficiency, and this, as I said earlier, is the focus of this lecture. I am going to give you several
examples of this proposition. Some redistributive projects may actually enhance productive efficiency rather than reduce it
and, on the issue of trickle-down, quite often in many poor countries it is not enough. In fact, the experience of some
countries in Latin America and Africa shows that growth has not always been associated with social justice and significant
trickle-down. The East Asian case shows a positive association between growth and poverty reduction, but statistical
association is not causation; there are other factors that are also important in the case of East Asia, which may not be
operating in some countries in Africa or in Latin America. The traditional debate about equality and redistributive policies
pitted one partial and incomplete viewpoint against another. Egalitarians favoured an idealised conception of government
intervention, downplaying the incentive problems in the public sector. Their opponents, on the other hand, opposed these
interventions in favour of an idealised view of the private economy, overlooking the incentive problems caused by
inequality itself in the process of private exchange.
However, recent developments in economic thinking on the role of information, incentives and institutions, and recent
developments in the political economy of market and government failures now give us a more balanced framework for
analysing the efficiency-equity relationship. Even in some of the by now old branches of economics, the objectives of
equity and of efficiency were reconciled through aggregate demand. Take the case of Keynesian economics, where there
was support for redistribution to the working class, from the point of view of both equity and efficiency. When resources
are redistributed to the working class, they are mainly spent for consumption. This generates higher aggregate demand for
consumer goods and thus alleviates the socially inefficient phenomenon of mass unemployment. So Keynesian economics
also combined efficiency and equity. But the prospects for such a Keynesian demand expansion today in a globalised
economy are highly limited - particularly in economies where there is not a great deal of slack or excess capacity, and
when capital is internationally mobile. This, for example, was quickly realised by the socialist government in France
under President Francois Mitterand in the early 1980s. At first the French government tried to expand in a Keynesian way,
but very soon the French currency was under attack. In fact, some other countries that have also tried demand
expansionary policies have had their national currencies under attack. In trying to solve the efficiency-equity issue from
the demand side in a global economy one thus faces important limitations. It does not mean that one should not try
Keynesian policies in situations of slack, in situations where capital is not that mobile, even though there are some clear
limitations to this path. In this lecture, my emphasis will be more on the equity-efficiency relationship at the micro-level rather than at the aggregate demand level.
By the micro-level, I mean the level of firms, farms, neighbourhoods and local communities. At these levels there is still a
great deal of scope for efficiency-enhancing egalitarian measures, not all of which are precluded by the forces of globalization. I am going to give
some examples of this. The first one is obvious - inequality quite often induces more political instability and, of course,
things like crime and insecurity of property rights may in turn depress investment and productivity growth. Here is a clear
example of inequality hurting productive efficiency. To the extent that employers try to discipline labour with the threat of
job loss, high levels of unemployment may be counted as one of the enforcement costs of inequality, even apart from the
overt cost of hiring security guards in business or supervisors in the workplace. In general, a large fraction of an
economy's productive potential is used up in enforcing the rules of the game that perpetuate inequality. This is the first
point, and a fairly obvious one.
My second point may be even more important. At the micro-level, a pervasive factor is that of inequality obstructing the
evolution of institutions that enhance productivity or correct the market failures that particularly affect the poor. By
market failures I have especially in mind those that constantly face the working poor, revolving around failures in credit
markets and insurance markets.
I would like to spend some time talking about the credit market. If one asks an economist why the credit market does not
work for the poor, the answer from an economic theory point of view is that, even if the poor could come up with a good
project (or what looks like a good project), the lender quite often is worried about the risk of default and therefore is not
willing to lend money. It is quite possible that what looks like a good project at the beginning may not work out as
expected; or the borrower may just be pretending and may just take the money and run. But even if the borrower invests in
the project, the project might be a failure either because the borrower did not assess the risks properly or did not work hard
or had sheer bad luck. But in any of these cases the lender is going to lose money because he or she cannot attach the
borrower's property if the latter is very poor. That stops the lender from lending. This, of course, causes severe problems
for the borrower. Even if this borrower is a hard-working fellow, even if the project is good, there is no easy way for him
or her to convince the lender about that. The lender usually insists on collateral for his loan operation, as a way of what
economists would call ensuring credible commitment of good faith and hard work on the part of the borrower. If I have
my collateral locked up with the lender when I borrow money, then I will put in my best effort so that the project succeeds
and I do not lose my collateral. So both sides then see this as a signal of credible commitment.
Obviously, the problem is that most poor people do not have collaterisable wealth, and as a result many potentially viable
projects are not financed, and the poor remain trapped in poverty. The escape routes out of poverty remain blocked
because of the absence of collaterisable wealth. I think this is a simple, but an extremely important, aspect of why it is
difficult to do much about the working poor - quite often credit is a fundamental constraint. Redistributive policies that
expand access to credit therefore can be of enormous help to the poor, enabling them, for example, to invest in education
as a way of climbing out of poverty. If they are small farmers or artisans, they could be more economically viable with
credit allowing them to enlarge their scale of production, to take up more high-return, high-risk projects or occupational
choices that formerly were out of their reach, and in general to avoid constrained myopic policies that condemn them to
poverty. In this way, redistributive credit policies can increase a society's aggregate potential for productive investment,
innovation and human resource development. Economic theorists are now grappling with the mechanisms through which
this works, with the aim of formalising the idea. But I do think the idea is fairly obvious. What is less obvious is the issue
of policy.
Many developing countries are aware of this problem and governments have tried to subsidise credit. Unfortunately, in
many developing countries these programmes have had only mixed success. Let me give some examples from the Indian
sub-continent. I think the very large policy experiments that have been carried out there have some lessons that apply to
all developing countries trying to do something in terms of credit for the working poor. India, for example, has had
probably the world's largest asset formation policy through subsidised credit for the rural poor. It is called IRDP (the
Integrated Rural Development Programme), in which the government runs a massive programme of giving credit to the
rural poor, for them to buy productive assets, like a draught animal for agriculture or an irrigation pump, and so on. This
system has been in operation now for more than 20 years, and looking back at this experience one sees it only as a mixed
success. There are many cases in which the credit is largely misappropriated by non-target groups - rich and
middle-income people - who divert this credit away from the people who deserve it - the rural poor. Moreover, when the
government agencies try to distribute credit, the whole credit process becomes politicised. In the case of India, once the
credit is given through nationalised banks or other state agencies, the borrowers think that ultimately they can try to
manipulate the political process to get around loan repayment. In fact, Indian politicians are sometimes under tremendous
pressure, especially at election time, to go out and announce that the farmers do not have to repay their loans. In other
words, the political process is hijacked to generate massive exemptions or debt relief. The general point is that when it is
done particularly through a centralised state, credit policy gets enmeshed in issues of political rent seeking, in which the
incentives to repay or even to invest wisely are seriously harmed. This is the reason many people in the last couple of
decades have started thinking about other mechanisms of delivering credit to the poor.
Drawing on another, probably even better known, example from the Indian sub-continent, there is the case of the Grameen
Bank in Bangladesh. Essentially, the idea was not for the state to monitor the debt repayment; that function has been
delegated to small groups of borrowers themselves. The case of Grameen Bank is now well known, and it is now being
reproduced as a blueprint in many other countries (including in poor neighbourhoods of rich countries). It is no longer an
experiment in Bangladesh, where it is now a very large operation improving the lives of millions of people. What is the
essential mechanism? Here, the state or outside agencies are involved in providing finance and a subsidy, but they are
imaginatively utilising a local network. Quite often the bank gives the money to very small groups of women, sometimes
groups of only five or six, the idea being that if one of the borrowers is attempting for whatever reason to default, the
whole group of five or six is then made liable. This is joint liability for loans, inducing peer monitoring. They monitor one
another, ensuring that one is not being slack or misusing the money, and so on, which has worked in the Grameen case.
What neighbours who know one another can do relatively easily would be very difficult to do from a distance through a
centralised bureaucracy. Utilising local information and local networks can thus be a more effective substitute for state
agencies in credit delivery.
A third example, again from the Indian sub-continent, also illustrates a different principle. The Grameen Bank principle is
a case where potential government failure is superseded by a community mechanism. But my third example is one where
one needs the government or some other outside agency to solve a problem that arises at the community level, again in
connection with credit. This example relates to the case of the Self-Employed Women's Association (SEWA) in Gujarat,
India, which is now quite well known for trying to help self-employed women with credit and mobilising their savings,
not in agriculture, but mostly in small non-agricultural activities. After a while, the SEWA organisers found that the borrowing women sometimes could not repay
the loans, despite their best intentions and their hard work - sometimes it was sheer bad luck and all kinds of risks. In
many instances it was found that when either the woman herself or, more often, somebody else in the family falls ill, she
has difficulty in repaying the loan. In other words, health risk is an important factor in their ability to repay. When SEWA
organisers saw this happening quite often, they wanted to insure against the health risks; and it is this link between a credit
market and the insurance market that I want to emphasise at this point.
For insurance purposes, one needs to diversify the risks, which is why SEWA had to go outside its own community, to
the Life Insurance Corporation of India, a nationalised institution run by the state. So here is a case in which a problem
arises in a community, which could not be solved within that community, and so the community organization turned to
the state, and together they worked out an arrangement in which the health risks for the borrowing women were covered
by the state-run corporation.
I have thus cited three examples, all from the Indian sub continent, an area I know a little better than other parts of the
world. Each illustrates a different principle, and essentially shows that we have to go beyond the usual polarities. Each
co-ordinating mechanism of society - the state, the market, the community - fails in some ways, yet each one has some
unique advantages that we can try to combine to co-ordinate our way out of the failures. These three examples also
illustrate many of the issues relating to credit and, as have I said before, credit is a fundamental instrument for escape from
poverty for the working poor.
Another fundamental issue in escape from poverty is education, extremely important in South Africa, also in my own
country, India, and in many other developing countries. As in the case of credit, so in the case of education; the current
education system is in very bad shape for serving the needs of the poor. And here again, there is much to do, and we
cannot use globalization as a convenient scapegoat for why we cannot get on with the important development tasks that lie
ahead. In fact, quite often, the reason that things do not work, as in the case of credit, is because of government failures
and community failures, which are essentially domestic failures. If government and communities can work together on
these issues, there are many things that can be done, even within the very significant global constraints. And if such
collaboration takes place to effectively deliver education to the poor, the latter may have the opportunity to harness the
benefits of globalization after all.
Education (and health) are examples of what economists call positive externalities - the positive effects of doing
something for some people spill over to benefit others: in particular, doing something for the poor helps the rich as well.
Positive externalities also arise in the context of gender-specific poverty alleviation policies. Better education for women,
for example, is often associated with better education, nutrition and health of children, particularly daughters. I understand
that studies show that in the recent expansion of the social pension programme in South Africa, pensions received by
maternal grandmothers had a large impact in improving their granddaughters' health. In Bangladesh and elsewhere, better
opportunities of outside work for young women, particularly in the globalised garment industry, have led to socially more
beneficial fertility behaviour, through, say, raising the age of marriage. Such externalities make gender equity and
productive efficiency go hand-in-hand.
Then there are important dynamic externalities that can arise from community- or neighbourhood-specific characteristics.
These may refer to physical infrastructure (like roads, communication, irrigation and power systems), improving the
productivity of private investment or, in the neighbourhood case, adult human-capital endowments of neighbours
influence the educational investment decisions of the young. In the inner city neighbourhoods of the United States many
sociologists have found that a young male's propensity to drop out of school depends very much on the role models
among the adults in the neighbourhood, not just on his own family background. If there are other adults in the
neighbourhood who have been educated, who value education, quite often this discourages dropouts. So, in a sense, this is
a neighbourhood externality. It is thus important to acknowledge how the neighbourhood can act as a poverty trap, and
poverty alleviation policies and strategies therefore need to address themselves not just to the individual, or to the family,
but also to others in the neighbourhood. Neighbourhood effects are also important in rural areas in many developing
countries. The largest brain drain in the world is not from the poor country to the rich country, it is from the poor rural
areas to the metropolitan cities within developing countries, and in a sense here the rural neighbourhood effects are
extremely important.
Another very important efficiency-enhancing redistributive policy - in this case, asset redistribution, which enhances
efficiency. This is particularly the case where agriculture is a significant part of the economy. What is of key importance
here is land reform. Land reform is an instance where equity and efficiency very often go together. In traditional,
small-scale agriculture, where the use of lumpy inputs (such as farm machinery) is limited, the economies of large-scale
production are not that important, and the small farm can get labour at a lower social cost than the large farm can. It
therefore has a labour cost advantage, but no disadvantage in terms of economies of scale. Quite often, the data show that
the small farms are more productive than large ones. Of course, the large farmer is likely to have better access to
production credit, to information and marketing networks and to the capacity to insure against risks. If these services -
credit, insurance and marketing - are made available to the small farmer, land redistribution can boost agricultural
productivity. Similarly, tenancy reforms where large tracts of the land are given to tenants by re-arranging property rights
in favour of the actual cultivator of the land, or by providing security of tenure (so that the tenant cannot be easily
evicted), can also improve production incentives. Some international agencies are now trying to promote what they call market-assisted land reforms. Here we can link land reform with the credit reform issue
that I talked about earlier. The idea is that in some situations the big farmer may be interested in selling to the more
productive small farmer and moving to other occupations like industry, finance or trade. But the potential buyer, the small
farmer, does not have the money or the credit to buy the land, even if the seller is willing to sell at an appropriate price. In
such situations what has been called market-assisted land reform tries to raise credit from international (and domestic)
agencies to facilitate the process.
My next point is on issues of bargaining. Let me first talk about the economic theory literature and then I'll talk of
practical applications. In economic theory, it is increasingly being recognised that inequality may cause bargaining
failures which are costly to the economy. Fall-back options among bargainers are often widely divergent, and in such
situations theory suggests - and there are practical corroborations of it - that bargaining is more likely to break down as
actors cannot agree on and pre-commit to a division of the gains from co-operation. Inequality may also heighten
information asymmetries between bargainers leading to costly delays or stalemates.
Let me now come to a practical example of bargaining, which involves labour unions. Here, contrary to many
conservative economists, I believe that unions are important for productivity. A labour union to me is an organization that
potentially can combine both efficiency and equity (although it doesn't always happen this way). The equity part is
obvious; unions are the main agent for improving labour's conditions, for ensuring there is decent work, ensuring that
work is humane, being a watchdog for abuse of labour rights, being a watchdog for safety measures and so on - I think
enlightened capitalists do understand this.
Let me give the example of Japan. If one looks at the Japanese work organization, or analyse conditions on the Japanese
shop floor, one will see it is much less hierarchical than in the United States and many developing countries; this more
egalitarian workplace in the Japanese factory system is not merely equitable, it has also been very efficient. A less
hierarchical work organization has led to more solidarity, more loyalty of the workers and less turnover, which is a very
important difference between the Japanese and the American workplace. Studies show, for example, that in the United
States most of the innovations come from the research and development department, and these are then applied in the
factory floor. In Japan, a very large part of the innovations have come from workers' own suggestions; workers find out
that in the old methods of production there are obvious things they could improve on. In a more egalitarian workplace,
there is much more solidarity, much more interchange of information and tacit knowledge between employers and
employees in terms of improving production methods. This is something quite distinct from the American system and many of the American labour economists now notice it. Here is a situation where I think an egalitarian
workplace or an egalitarian way of organising work improves productivity and obviously combines equity and efficiency.
And in developing countries generally one of the major problems is a high labour turnover, which I think unions can
reduce, inducing workers to acquire firm-specific skills that ultimately also help employers and the cause of efficiency.
However, I should also note that in the public sector in some developing countries, to a large extent, unions also shelter
inefficiency and slackness, protecting lazy or inefficient workers. These things, therefore, should not be generalised about
too much. It is useful to point out that in some cases equity and efficiency can go together. It does not mean that we can
let our guard down in cases where unions are sheltering inefficiency, of which I can cite some. I think we have to quite
explicitly point out that we have to distinguish between the good and the bad role unions play. It also means that union
strategies have to change and, as I mentioned in my previous lecture, union strategies have to be much more concerned
about income security than job security. Policies have to be more inclusive, particularly of the informal sector, since many
of the policies that benefit the formal sector may be at the expense of the informal sector. Union strategies have to be very
much concerned about this because most of the workers in developing countries are in the informal sector. In my previous
lecture I also spoke of possible policies of wage subsidies that might create more jobs without necessarily damaging those
in the formal sector. I am also very much in favour of an international co-ordination of labour bargaining as much as
possible in the context of globalization. At the same time, I think it is very important not to gloss over the difficulties.
Unfortunately, contrary to the slogan, workers of the world do not unite. There is a serious divergence of interests among
workers, particularly between those in developed and developing countries, which one should be very aware of, and try to
tackle in regional and international co-ordination of union activities.
On the matter of work organization let me go a step further. I have already spoken about the Japanese work organization,
but generally I support more co-operative forms of work organization, in which workers own firms, share profits or
participate in management. These are clearly not only more equitable, but also more efficient, especially since they reduce
the need for expensive supervision. They can replace a large part of unproductive supervision by peer monitoring. I have
already given an example from a completely different field - the case of the Grameen Bank - where peer monitoring is
taking the place of monitoring by outsiders. Similar benefits apply to the industrial workplace as well. Of course, workers' organizations face problems in the capital market as well as the insurance market, because when workers own a firm they
have to raise the capital, face the risks, and that is where issues of credit and insurance market failures spoken of earlier
come in.
Let me just very briefly mention two or three other points, which again are examples of combining equity and efficiency.
The first is that (and this is an obvious point) inequality may discourage the evolution of efficiency-enhancing behavioural
norms - such as trust, a predisposition to co-operate in conflictual situations and incentive to find low cost solutions to
co-ordination failures. Quite often in economic life, as in social life, we face various kinds of co-ordination failures, and if
there is relative equality people find it easier to get their act together in overcoming these failures. My next point has to do
with something that is related, which has to do with management of what are known as local commons.
In many developing countries, the livelihoods of the rural poor depend crucially on the local commons. Here, examples
relate particularly to common environmental resources - forestry, fishery, irrigation water, grazing lands and so on. Most
of the time when one thinks of the environment, one thinks of larger global issues, like global warming, ozone depletion
and so on. For the poor an immediate, vital and very large-scale issue is the depletion and degradation of local
environmental resources. Quite often we go to one of two extremes in the matter of management of local environmental
resources. Let me give you an example from forestry. In many developing countries the forests are nationalised; the
government owns the forests. The forest bureaucracy runs the forests and does a very bad job of it, and in fact forest
officials are quite often corrupt and essentially serve the interests of timber merchants and other rich people, who exploit
the resources of the forest commercially. This is the one extreme - the case of some kind of centralised bureaucracy
managing environmental resources. The other extreme is to commercialise the whole thing, to privatise it. As a result,
large numbers of poor people have been left out of the commercialisation process, regardless of the fact that for
generations they have been the traditional users of these resources. And now that private ownership has sufficiently
alienated them from access to these resources, poor communities now become irresponsible users - they are forced to steal
and destroy some of the environmental resources.
So I think both extremes of either nationalisation or privatisation have caused enormous damage to local environmental
resources in many poor countries, and here it is very important to think in terms of local community management. But
why am I emphasising this in the context of equity-efficiency trade-off? It is because equity may have an effect on the
tendency to co-operate in the matter of community management or conservation of common resources. I myself have done
some work in South India on how inequality (say, in land distribution) affects farmers' co-operation in the allocation of
irrigation water. A student of mine has done similar work in central Mexico, again in water management.(Endnote 11) The results that
we got essentially suggest that an underlying equality, both social and economic, among the users of the resource helps in
solving problems of commons management, and thus it is an example of equity and productive efficiency going together.
Another example, this time not from the rural local commons, relates to urban residential commons. In the United States (I
am sure this is true in some cities in South Africa too) there are big public housing projects in the inner cities where the
poor, many of whom go without work for lengthy periods, are concentrated. Quite often, these public housing projects
have essentially become dens of crime, drugs and so on. Here again, the neighbourhood effects that I have alluded to
earlier become very important. There now exist some examples of residential neighbourhoods where the poor have been
helped to own either little plots of land or small flats, and once they have been given credit and other help to own them,
they take much better care of the common areas in these neighbourhoods. There are many common facilities and utilities
that require co-operation among the owner-users for maintenance and promotion. Small ownership and equality among
these small owners help in this matter. As in the case of preserving the forest for villagers who use it for subsistence,
similarly in urban residential neighbourhoods where the commons need to be taken care of (and their degradation by
crime and drug dealing jointly prevented) by relative equality among stakeholders.
The same issue of equity and efficiency arises in the decentralisation of government, my last example. In many
developing countries, it is now generally recognised that centralised bureaucracies cannot resolve many issues, and neither
can they deliver many public services. And it is now increasingly realised, by economists, public administrators and
policy makers, that one has to devolve power to local agencies to deliver the local public goods - education, healthcare, water
supply and so on. But here the issue of complementarity between equity and efficiency arises again. In general, it is
observed that in local communities where there is much inequality - social or economic - the local agencies or local
governments are captured by vested interests, by those who essentially divert public resources for their own good. In
contrast, where there is more equality, particularly where there has been more land reform, there are many examples from
developing countries that self-governing institutions perform much better, and democratic decentralisation provides more
effective delivery of public services to the poor.
One beneficial byproduct of land reform, underemphasised in the usual economic analysis, is that such reform, by
changing the local political structure in the village, gives more voice to the poor and induces them to get involved in local
self-governing institutions and management of the local commons. In other words, land reform or similar asset
redistributive reform makes the poor themselves stakeholders in the system, so they take an interest in a system they were
formerly excluded from. They take an interest in the local self-governing institutions, which is good for the delivery of
public services and management of this local commons.
In general, a major lesson of the economics literature looking into the issues of imperfect information (my example of
credit was in the context of imperfect information and various kinds of costs of enforcement), and in general when
information is costly and asymmetrical, is that the usual separability of equity and efficiency assumed by mainstream
economists breaks down. Under these circumstances, the terms and conditions of various economic arrangements that
directly affect the efficiency of resource allocation crucially depend on who owns what and who is empowered to make
which decisions. Generally, redistribution of property rights, if aligned with redistributing control among those who will
be using this property, will improve efficiency. These micro-level redistributions at the level of firms, farms and local
communities do not lead to large-scale capital flights, and are not seriously threatened by globalization.
Endnote 9:
See A. Emmanuel, Inappropriate or underdeveloped technology? John Wiley, New York, 1982.
Endnote 10:
See A. Okun, Equality and efficiency: The big trade-off, Brookings Institution Press, Washington, 1975.
Endnote 11:
See P. Bardhan, "Irrigation and co-operation: An empirical analysis of 48 irrigation communities in South India",
Economic Development and Cultural Change, July 2000; J. Dayton-Johnson, "The determinants of collective action on
the local commons: A model with evidence from Mexico", Journal of Development Economics, June 2000.
Lecture Three
Governance and Policy Issues
My second lecture dealt primarily with efficiency-equity relations. I tried to show that if we are interested in equity and
social justice and, to make it sustainable, a productive economy, there are many things that can be done, and we need not
be constrained by globalization in achieving them. In fact, if on some of those issues raised in that lecture policies have
failed in many developing countries, we have mostly ourselves to blame, and not globalization. In this lecture I'm going to
talk primarily about governance-type issues, and particularly on some international rules.
The main issue of governance in a global economy is the loss of monetary and fiscal options for the nation state and
subservience to rules sometimes made by the international trade and financial interests. One extreme case of severely
constrained monetary and fiscal policies (particularly the former) is that of Argentina, which has voluntarily abdicated its
monetary policy and, as a result, often tolerates a very high rate of unemployment. As you know, Argentina's currency is
anchored to the United States dollar, so in a sense Alan Greenspan, Federal Reserve Chairman in the United States,
effectively determines the monetary policy of Argentina. Similarly, there are other countries, say, the countries in the
European Union, that are voluntarily surrendering some of their monetary and fiscal options to stabilise the currency
through the European Monetary Union. New York Times journalist Tom Friedman, in a recent book, The Lexus and the
Olive Tree, has described this phenomenon as that of countries putting on the "golden straitjacket" for the sake of
participating in the benefits of the global economy. Of course, in such situations the scope for taxing capital is generally
regarded as severely limited by the threat of capital flight. In fact, capital itself doesn't have to flee the country; quite often
accounting practices, through strategic bookkeeping adjustments allow the base for capital taxes to migrate even when
capital itself does not.
While these limitations are serious, one should not exaggerate their effects. Most countries collect only a small part of
their revenues from capital taxation, even when economies are very closed. In any case, there are strong arguments for
funding redistributive policies through progressive consumption taxes rather than taxes on capital and labour. Of course,
there is a need for tax co-ordination across countries, and there is some evidence that capital taxation is declining and also
converging across countries. But again, one should not overstate this; even in the highly integrated European Union
corporate tax rates have substantially converged not to 0 percent, as some people anticipated, but to about 35 percent.
Similarly, despite all the financial integration among OECD (Organization for Economic Co-operation and Development)
countries there are huge differences in capital tax rates between the United States and, say, Germany or France. Even
within the United States, with free mobility of capital and goods across the states, there persists a great deal of variability
in state tax rates; even neighbouring states in the United States have maintained very different levels of social protection. I
think the important thing to realise here is that capital does not necessarily flow to low-tax countries or low-tax regions. If
a country or a region spends the tax money to improve its public infrastructure, it helps private investment. So one can
have a situation in which there is high tax and high public goods provision as well as one where taxes are low, and public
services are low, and capital need not choose the latter over the former.
Thus global constraints, particularly those imposed by capital mobility, should not be exaggerated. Serious obstacles to
redistributive policies are often domestic. In the past, in the 1960s and 1970s, scholars and writers belonging to the
so-called dependency school pointed to the crushing effect of neo-colonialism and how the tentacles of the international
economy blocked escape from underdevelopment. In this way, I believe, they demonised the international forces and
effectively diverted attention away from domestic vested interests, which were powerful enough to block progress even
without international help. This school faded in significance when several countries, some of them ex-colonies, vigorously
participated in the international economy and had phenomenal rates of economic growth, particularly in East Asia. Today,
one again hears about a kind of demonisation of the global economy strangulating our national policies. But this time,
more often than not, the expositors of such arguments belong as much to the right wing of the political spectrum as to the
left. These thinkers, writers and policy makers on the right warn us against adopting redistributive social policies or
labour-friendly policies, pointing to the threat of capital flight or of losing in the international competitiveness game.
Globalization can thus be used as an excuse for inaction on the redistributive front. But, as I have argued in the second
lecture, there are many policies that can, in fact, improve both productive efficiency and social justice and thus help us
enhance our competitiveness in the global economy.
Let me now go beyond monetary and fiscal policy constraints. There are other global constraints, for example, the ones
that take the form of international regulations and standards. Let me discuss in this context the important issue of
international labour standards. In fact, there is presently a big move on the part of some rich countries to link international
labour standards with international trade rules (as part of a "social clause" to be incorporated in the regulations of WTO,
the World Trade Organization). Already this is being adopted in bilateral negotiations. Last May, United States President
Bill Clinton signed the African Growth And Opportunity Act, which offers African countries trade preferences in the
United States, provided those countries conform to certain international labour standards, an approach that I believe is
generally misguided, possibly causing harm to many poor people.
I think there is general agreement by all concerned that we should prohibit forced or slave labour, minimise hazardous or
unsafe working conditions, and adopt freedom of association and the right to bargain collectively. There is a general
consensus on these core labour standards. There is, however, less agreement on prohibiting other kinds of labour - for
example, child labour, which is not slave labour or semi-slave labour, nor are the occupations necessarily unsafe. There is
even less agreement on the adoption of a minimum "living wage" or avoiding "sweatshop" conditions. In fact, the African
Growth And Opportunity Act of the US insists on acceptable conditions of minimum wages, hours and other work
conditions, about which there is quite a bit of disagreement. Well-meaning humanitarians and not-so-well-meaning
protectionists from developed countries want to ban the products of "sweatshops", or those produced with workers paid
less than what they consider to be a "living wage". They call this "unfair trade", but implementation of such a living wage
in the formal sector is sure to drive most workers to crowd the informal sector, and thus depress the wages there even below
their current low levels. It is clear that in many of the poor countries today workers' wages are well below what would be
considered a living wage in OECD countries, and in some sense almost the whole of the economy in a poor country is
really a sweatshop. To deny trade on these grounds would be to push such a country further into poverty.
On the general question of the desirability of actually implementing international labour standards, I believe the proper
answers are much more complex and context-dependent than many of my activist friends recognise. I will give examples
from the case of child labour. Let us all agree that we want to remove or reduce the incidence of child labour in poor
countries. We want the children to be in the schools instead. Let us all agree on this goal. But I believe that taking mainly
a legal or regulatory approach to achieve that goal is wrong. With the exception of some very abusive or callous parents,
most parents, even from the poorest families, would prefer to withdraw their children from work if they could afford it. So
the main approach should be to try to create conditions that enable parents to send their children to school. There are many
ways of creating such conditions - for example, trying to improve the wages and productivity of adult workers so that they
do not have to send the children out to contribute to the family income. Or, for example, one can try to make existing
schools more attractive for the children - to make schools better and more accessible to them through better transport,
provision of meals in schools as well as more scholarships. In Mexico they have a programme - under PROGRESA - of
paying a subsidy to the mother conditional on her child's school attendance.
A study(Endnote 12) of 1 600 households in Côte d'Ivoire shows that in rural areas, instead of suddenly stopping all child labour,
one can smooth the transition by adopting flexible part-time hours for child work before or after school. In other words, as
long as it is not unsafe or hazardous work that should be banned, in the transitional process work need not be a substitute
for going to school. In my own country, India, the number of children working is quite large, but the number of children
who are neither working nor going to school is many times larger than the children who are working. Therefore, one has
to investigate the various reasons for, and constraints against, these children who do not work but still do not attend
school.
Girls quite often do not attend school as they have to take care of their siblings while their mother is working. Sometimes
children attend school, but then drop out since they do not find the schools attractive or what they are taught does not
interest them. The conditions of the school are quite dismal and they drop out, and this is a general problem in many poor
countries. In such situations, one has to think of and devise other ways of inducing these children to go to school. For
example, in the case of girls looking after siblings, an obvious solution would be to think of a good number of day-care
centres. In the other cases that I mentioned, obviously the answer lies in how to make schools more attractive for these
children. It does not lie in banning child labour and forgetting about the rest of it, nor in taking a legal or regulatory
approach. In fact, there are many well-meaning customers in rich countries who are in favour of banning child-produced
products. Once a product is banned its price will go up in the importing country. Obviously, this means the consumers are
prepared to pay more for higher labour standards. If this is the case, could they not be persuaded to raise funds earmarked
for improving schools, for more and better schooling for child workers from poor families? The issue is how to
co-ordinate that kind of activism.
Simply banning child labour and not taking these other kinds of measures is highly irresponsible, and I think immoral, as
it may worsen the conditions of the children, pushing them to starvation or, in some cases, child prostitution. In general,
the arguments for linking international labour standards to threats of trade sanctions are rather weak, contrary to what loud
proponents of introducing the "social clause" in WTO rulings think. Most child labour in poor countries is in the
non-traded sector. For example, in India only about 5 percent of child labour is in the export sector. WTO sanctions,
which are being pressed by many developed countries, will push these children into the non-traded sector where those
sanctions do not apply, and there their conditions may be worse. The same argument applies to the popular consumer
movement in rich countries, for product labelling, so that consumers have the option to look for the "fair trade" label or
"produced without child labour" label on imported goods. It is a very popular movement. In fact, in Britain there is now a
whole NGO movement in the business of "naming and shaming" shops selling products that do not have these labels.
Little do these NGOs know what harm they will be doing to many poor countries by this movement; it will only punish
the victims and push them into worse conditions in the non-traded sector. There is also a serious monitoring problem -
somebody needs to monitor these labels. Stories abound (some in half-jest) of children in some poor countries stitching
labels on garments that say those garments are produced without child labour. But the monitoring problem is just a
secondary one compared to the much larger issue that I have already pointed out.
In general, I think there is need for co-ordinated action, particularly among developing countries. Some people think that
transnational companies are attracted to countries just for their poor labour standards. There is very little systematic
evidence for that. Multinationals go to poor countries not primarily because of poor labour standards. In fact, labour
standards in the multinational companies, by and large, are somewhat better than in the domestically run factories. It does
not mean that the working conditions are good. They are dismal in many factories, domestic or foreign. What is important
is co-ordination in improving the work conditions. Let me give you an example of co-ordination, ie co-ordination between
government, NGOs and business. Let me cite the example of the international companies that produce soccer balls. Many
of the soccer balls are produced in one town in Pakistan, Sialkot, where for many years the stitching of the soccer balls
was done by children, and many NGOs have been active against the use of child labour there. But they have now come up
with an excellent idea, based on innovative co-ordination. What emerged from negotiations between the main sporting
goods companies, NGOs, the ILO, UNICEF, and the local government (in Pakistan) is now known as the Partners'
Agreement to Eliminate Child Labour in the Soccer Ball Industry in Pakistan. Under the agreement, sporting goods
companies are to give scholarships to children who wish to attend school. But the agreement involves all sporting goods
companies concerned, so that no company is undercut by other companies when the soccer ball price increases as a result
of the agreement. One needs co-ordination among all these sporting goods companies as well as government and
international agencies - after all, schooling facilities, and other facilities, will be provided by them, and one needs
co-ordination with the NGO sector, which will be acting as watchdogs. After about three or four years, despite some
problems with this agreement, the idea remains basically sound. I think in general this idea of tripartite agreements
between government, NGOs and business is one way of resolving or mitigating this kind of problem, and the ILO can play
a constructive role in this, providing some leadership in bringing the parties together.
Similar co-ordination problems arise in connection with other international standards. Take the case of international
environmental standards. First of all, there is a general impression that multinational companies tend to go to countries
where the environmental standards are lax. Again, there is not much systematic evidence for that. As in the case of a
labour standard, the primary need is for co-ordinated action, which is essential for halting the possibility of one firm
undercutting another. One particular multinational firm may be willing to accept an environmental standard, which, of
course, is going to raise the price, but they want to make sure that they are not undercut by another company, and hence
the need for more co-ordination among the companies involved. Many of the natural resource products, which may
deplete the environment through overuse, are products with what economists call low price elasticity of demand in the
international markets, meaning that if the price goes up demand is not going to fall by much. That being the case, there is
a good argument in favour of co-ordination among different countries in this matter.
Take a situation in which three or four developing countries basically sell the same natural resource-intensive product and
have to conform to the international environmental standard. Each country's costs will go up on adoption of the standard,
but if they make a general agreement they can solve the undercutting problem. But there is a problem if it is a product for
which a price rise is going to lead to a serious decline in demand in the international market. Based on empirical evidence,
what I am suggesting is that for many of the natural resource-intensive products, demand is price-inelastic and developing
countries should get together to make use of this. Poor countries may co-ordinate the price rises, which may be necessary
for the adoption of higher environmental standards.
Trade liberalisation, without the simultaneous adoption of domestic regulations on the use of environmental resources, can
magnify environmental degradation. What many protesting NGOs have in mind is that if trade is just opened up, without
the necessary domestic regulations, it may well lead to environmental degradation. What I am suggesting is there are ways
out in which one need not close down the open economy, provided one follows the domestic regulations plus the
international co-ordination and tripartite-type agreements I spoke of. The best policies are more often than not domestic.
For example, in India, irrigation water is provided even to the richest farmers at a throw-away price. Thus, in large parts of
the country, the water-tables are going down because there is over-extraction of ground water. This has what economists
call negative externalities (my extracting the water is lowering your water-table). And yet one major problem of domestic
policy (this is not an international problem) is that the government under various political pressures severely under-prices
this very precious environmental resource.
The same thing is happening in Russia in terms of the under-pricing of energy, which leads to over-extraction and
environmental degradation. So these are examples of wrong domestic price policies that have led to environmental
degradation - and not globalization. An example of wrong property rights policies is timber royalty concessions in
Indonesia and the Philippines, which are leading to indiscriminate logging of forests. Of course, this timber may be
internationally traded, but the root problem is domestic because those royalty concessions encourage excessive felling.
The major loophole that has to be plugged is domestic. I could give many other examples of this kind, but the whole point
is that sometimes it is very easy to blame international forces. The international forces are there, the constraints are there,
which I have already spoken about, but there is also much that we can do on the domestic front. There is also much we
can do in terms of co-ordination internationally.
Endnote 12:
See Christiaan Grootaert, "Child labour in Côte d'Ivoire: Incidence and determinants", in C. Grootaert and H. Patrinos
(eds.), The policy analysis of child labour: A comparative study, World Bank, Washington, D.C., 1998.
Conclusion
Let me conclude. Today globalization is not an option but an indisputable fact of life. We cannot say "stop the world, we
want to get off". Some countries have tried that, for example, the Democratic People's Republic of Korea, Myanmar and
Albania, and they made a mess of their economies. Instead, we should try to harness the forces of globalization to benefit
human welfare and try to limit some of their undoubtedly adverse effects. In my first lecture, I analyzed the mixed effects
of international economic integration on productive efficiency, income distribution, collective bargaining institutions and
economic security. This was from the point of view of the working poor, both in the formal and the informal sectors, and I
tried to suggest that there is a need for new thinking. Moreover, I suggested that the rhetoric on both sides of this issue
often ignores the various complexities involved.
In my second lecture, I suggested that since social justice must have an efficient economic base to be sustainable, we
should be concerned about efficiency, even from the perspective of egalitarians. But in that context, I challenged the idea
of an efficiency-equity trade-off, which is a staple of much of public thinking and of mainstream economics. I then went
on to spell out various, mostly domestic, ways of achieving social justice without necessarily giving up on efficiency in a
global economy. In the third lecture, I mainly discussed the question of global constraints on national governance. I
started with monetary and fiscal policies and then examined the feasibility and desirability of international rules relating to
labour standards or environmental standards, and there I stressed the need for co-ordination.
Let me end with a plea for accountability at all levels: local, national and global. At national and local levels, it is
becoming increasingly apparent that centralized bureaucracies cannot solve many of the problems. Social justice has to be
looked at from the ground level, where the poor live. Centralized bureaucracies are often inefficient in delivering local
public goods and services to the poor. Democratic decentralization that utilises local information, initiative, and ingenuity
is thus extremely important for the poor. But I think we should also talk about accountability at global level. In the
supra-national space, developing economies are increasingly at the mercy of unaccountable institutions such as currency
traders, country fund managers, credit rating agencies and so on. To voluntarily submit ourselves to external discipline
may sometimes be important to check domestic profligacy, wastefulness and short-sighted populist policies. But the
acceptance of such discipline, even when necessary, should be the outcome of democratic decision-making in which all
major social groups participate, and not be imposed from above.
International NGOs sometimes profess to act as a countervailing force to international trade and financial interests, and I
applaud their attempt to counteract many of the unaccountable international institutions. But at the same time, I think it is
very important to bear in mind that the international NGOs themselves give rise to a different kind of accountability
problem. They speak in the name of the poor when agitating against sweatshops, child labour and non-payment of a
"living wage". I have already suggested that in some cases this may be well-intentioned but misguided. But, apart from the
substantive issue that their attempts are sometimes counter-productive, actually making their intended beneficiaries
worse-off, there is also a procedural issue that I want to talk about now. That is, if the developing country happens to have
democratic institutions then one has to think twice about bypassing these institutions and taking upon oneself the authority
to speak in the name of the poor.
Of course, in some countries the quality of governance is dismal, even in some democratic developing countries the poor
do not have a voice, and I think the international NGOs serve a valuable function in giving the poor some voice. But at
other times they are effectively undermining representative institutions. For example, suppose there is a developing
country where an irrigation dam is being built. (I am personally against the construction of large dams in many developing
countries but the point I am going to make is procedural, not substantive.) Suppose the democratic government of the country has taken a decision to build the dam. Of course, in any project like this there are costs as well
as benefits. The major cost is that many of the indigenous people may be uprooted; they are poor and often the
government promises to resettle them elsewhere but ultimately these promises are not kept. It is against the reneging on
these promises by governments that we need to act as watchdogs.
But, as I have already said, there are also benefits. Large numbers of farmers who at present do not have irrigation will
benefit and many of them may be poor farmers. However, what happens far too often is this: suppose the dam is being
partly funded by an international organization, say, the World Bank. Many inter
