Read Online Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram G. Rajan - Free Book Online
Authors: Raghuram G. Rajan
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in use than in poor countries. Physical capital increases income because it makes everyone more productive. A single construction worker with a backhoe can shift far more mud than several workers with shovels and wheelbarrows.
If, however, the only difference between the rich and the poor countries is physical capital, the obvious question, posed by the University of Chicago Nobel laureate Robert Lucas in a seminal paper in 1990, is, Why does more money not flow from rich countries to poor countries so as to enable the poor countries to buy the physical capital they need? 2 After all, poor countries would gain enormously from a little more capital investment: in some parts of Africa, it is easier to get to a city a few hundred miles away by taking a flight to London or Paris and taking another flight back to the African destination than to try to go there directly. Commerce would be vastly increased in Africa if good roads were built between cities, whereas an additional road would not make an iota of difference in already overconnected Japan. Indeed, Lucas calculated that a dollar’s worth of physical capital in India would produce 58 times the returns available in the United States. Global financial markets, he argued, could not be so blind as to ignore these enormous differences in returns, even taking into account the greater risk of investing in India.
Perhaps, Lucas concluded, the explanation is that the returns in poor countries are lower than suggested by these simple calculations because these countries lack other factors necessary to produce returns: perhaps education or, more broadly, human capital. It may seem that an Egyptian farmer, using the ox and plow that his ancestors used five thousand years ago, could increase his efficiency enormously by using a tractor. By comparison, it would seem likely that a farmer in Iowa who already owns an array of agricultural machinery would improve his yield only marginally by buying an additional tractor. But the Egyptian farmer is likely to be far less educated than the farmer in Iowa and to know less about the kinds of fertilizers and pesticides that are needed or when they should be applied to maximize crop yields. As a result, the additional income the Egyptian farmer could generate with a single tractor might be far less than what the Iowa farmer could generate by buying one more machine to add to the many he already has.
However, even accounting for differences in human capital between rich and poor countries, Lucas surmised that capital should still be far more productive in the latter. Moreover, evidence suggests that the enormous investments in education around the world in recent years have not made a great difference to growth. 3 Something else seems to be missing in poor countries that keeps machines and educated people from maximizing productivity and the countries from growing rich—something that dollops of foreign aid cannot readily supply.
Organizational Capital
The real problem, in my view, is that developing countries, certainly in the early stages of growth, do not have the organizational structure to deploy large quantities of physical capital effectively. 4 You cannot simply buy a complicated, high-speed machine tool and hire a smart operator to run it: you need a whole organization surrounding that operator if the machine is to be put to productive use. You need reliable suppliers to provide the raw materials, buyers to take the output from the tool and use it in their production lines, managers to decide the mix of products that will be made, a maintenance team to take care of repairs, a purchasing team to deal with suppliers, a marketing team to deal with buyers, a security outfit to guard the facility at night, and so on. The organizational differences between a small car repair shop and Toyota, or between a medical dispensary housed in a shed and the Mayo Clinic, are enormous, and determine their ability to use large modern sophisticated
If, however, the only difference between the rich and the poor countries is physical capital, the obvious question, posed by the University of Chicago Nobel laureate Robert Lucas in a seminal paper in 1990, is, Why does more money not flow from rich countries to poor countries so as to enable the poor countries to buy the physical capital they need? 2 After all, poor countries would gain enormously from a little more capital investment: in some parts of Africa, it is easier to get to a city a few hundred miles away by taking a flight to London or Paris and taking another flight back to the African destination than to try to go there directly. Commerce would be vastly increased in Africa if good roads were built between cities, whereas an additional road would not make an iota of difference in already overconnected Japan. Indeed, Lucas calculated that a dollar’s worth of physical capital in India would produce 58 times the returns available in the United States. Global financial markets, he argued, could not be so blind as to ignore these enormous differences in returns, even taking into account the greater risk of investing in India.
Perhaps, Lucas concluded, the explanation is that the returns in poor countries are lower than suggested by these simple calculations because these countries lack other factors necessary to produce returns: perhaps education or, more broadly, human capital. It may seem that an Egyptian farmer, using the ox and plow that his ancestors used five thousand years ago, could increase his efficiency enormously by using a tractor. By comparison, it would seem likely that a farmer in Iowa who already owns an array of agricultural machinery would improve his yield only marginally by buying an additional tractor. But the Egyptian farmer is likely to be far less educated than the farmer in Iowa and to know less about the kinds of fertilizers and pesticides that are needed or when they should be applied to maximize crop yields. As a result, the additional income the Egyptian farmer could generate with a single tractor might be far less than what the Iowa farmer could generate by buying one more machine to add to the many he already has.
However, even accounting for differences in human capital between rich and poor countries, Lucas surmised that capital should still be far more productive in the latter. Moreover, evidence suggests that the enormous investments in education around the world in recent years have not made a great difference to growth. 3 Something else seems to be missing in poor countries that keeps machines and educated people from maximizing productivity and the countries from growing rich—something that dollops of foreign aid cannot readily supply.
Organizational Capital
The real problem, in my view, is that developing countries, certainly in the early stages of growth, do not have the organizational structure to deploy large quantities of physical capital effectively. 4 You cannot simply buy a complicated, high-speed machine tool and hire a smart operator to run it: you need a whole organization surrounding that operator if the machine is to be put to productive use. You need reliable suppliers to provide the raw materials, buyers to take the output from the tool and use it in their production lines, managers to decide the mix of products that will be made, a maintenance team to take care of repairs, a purchasing team to deal with suppliers, a marketing team to deal with buyers, a security outfit to guard the facility at night, and so on. The organizational differences between a small car repair shop and Toyota, or between a medical dispensary housed in a shed and the Mayo Clinic, are enormous, and determine their ability to use large modern sophisticated
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