The Pathology of Domestic Aid

Arvind Subramanian, Chief Economic Adviser to the Government of India, and co-authors have a nice summary of the effect of internal domestic aid on governance (the longer version is a chapter in the excellent Indian Economic Survey.) The bottom line is this:

The evidence suggests that all the pathologies associated with foreign aid appear to manifest in the context of intra-country transfers too

In particular, using one measure of aid to states, Redistributive Resource Transfers or RRT the authors find:

rrtHigher RRT seem to be associated with:

  1. Lower per capita consumption
  2. Lower gross state domestic product (GSDP) growth
  3. Lower fiscal effort (defined as the share of own tax revenue in GSDP)
  4. Smaller share of manufacturing in GSDP, and
  5. Weaker governance.

Causality likely goes both ways of course but using an instrumental variable of distance to New Delhi (which correlates with transfers) the authors find suggestive evidence, as shown in the figure, that transfers are a cause of weaker governance.

It’s interesting to read an official government report which discusses instrumental variables!


This year's Indian Economic Survey is only doing something done with greater insight and less deflection from pressing issues by Professor. Kaushik Basu. Any praise for Arvind Subramanian is only merited because of his past fame & position as someone who worked for the Peterson Institute.

As India's Chief Economic Advisor, he mostly spent time, deflecting attention from inconvenient facts about botched governnace by publishing i official reports, such data or floating ideas with no chance of being put into implementation like the Universal Basic Income. He mimiks serious academics like Kaushik Basu, because those like Tylor Cowen who do not want to comment about the "demonetization" disaster he oversaw in the last quarter of 2016, can talk about such shiny objects.

Economists can fool themselves, but there never has been a CEA like Arvind Subramanian who has demeaned his position by admitting his intent to self-censor to keep his job. He is basically trading the credibility of the profession of economists for climbing the greasy pole. He lies so much using weasel language, that he would have fit right into a Trump Cabinet. This is the kind of guy that Tyler Cowen usually celebrates.

Alex Tabarrok, I mean.

What demonetisation monster ? I was in India in December and went to very rural villages .. things were carrying on just fine. The only people complaining besides the chattering classes were CAs and business men.
It looked more or less a non-event !

It's not quite what the central bank says with regard to the effects on the economy, which nationwide could even be in the range of millions of (equivalent) jobs temporarily lost (with whatever downstream effects that might have) considering estimates in the range of a percent or two lost.

So ... if they weren't chattering, perhaps they weren't getting good enough information.

The rollout of new cash provisions in the new year seems to have gone smoothly, considering the lack of press.

Personally I was in Kochi in early December and demonetisation there had hit hard - people unwilling to give change for 2,000 notes, hoarding massive stacks of 100 notes. My homestay family said they'd struggled to get food for a while. But then all I talked to defended the move and said it was a good thing (although I think that was partly because I was a foreigner, just like economists always defend free trade to non-economists and then openly discuss downsides amongst each other!)

Tabarrok: "Causality likely goes both ways of course but using an instrumental variable of distance to new Delhi (which correlates with transfers) the authors find suggestive evidence, as shown in the figure, that transfers are a cause of weaker governance." So are the flyover states in America relatively poor (relative to the richer coastal areas) because they receive more in federal tax dollars than they pay? Or is it because the coastal areas have a transportation advantage? Or a climate advantage? Or is it because people, when given a choice, a choice made possible by having the resources to locate where they prefer, prefer living in coastal areas? Or is it simply historical, coastal areas being settled first and having the historical advantage of transportation? I believe someone is looking for causation in all the wrong places. It reminds me of the comic's one liner that people are poor because they don't have enough money.

The differences in incomes between coastal metro areas and inland metro areas is probably best chalked up to chance, more or less. I would think that the main reason for the difference in incomes is that the Northeast corridor and the West coast have industry agglomerations that are not present in the interior metros (Houston and Detroit being exceptions). Tech, Finance, and Media jobs are disproportionately located on the coasts. Those are the industries with the highest wages, so overall the coastal areas are wealthier. You see the same pattern within inland metros as well, where places like Austin, Minneapolis, Columbus, and Raleigh-Durham have greater shares of STEM jobs and hence higher incomes.

Yes, well said, water is historically a cheaper way to transport goods than land, hence for historical reasons people settled on or near rivers, and for that reason they later become economic powerhouses (initial conditions). I mean you don't expect Phoenix Arizona to become an economic powerhouse, or Las Vegas, NV, unless there's free water (Hoover Dam). I can't figure out Tempe, AZ and how they got relatively advanced, except smart folk liking the desert sunsets there, and settling there for that reason (plus the university for the smarts).

I think this is gobbledygook from AlexT's article: "Devolution is not all “aid” but embodies a strong redistributive element. We isolate this element—“Redistributive Resource Transfers,” (RRT)—as gross devolution adjusted for some benchmark for the normal resources a state can expect to receive, which we define as the state’s share in aggregate gross domestic product (or alternatively as a state’s share in own tax revenues). Thus, RRT are transfers over and above states’ contribution to GDP (or taxes) and serve as a useful, if imperfect, measure of “aid”. "

What B.S.! This is like "potential GDP" or the "GDP gap" that Keynesian models 'predict'. It's rubbish. If you 'adjust' for anything by definition you get zero or any baseline you want, then build from there to show no effect or some negative/positive effect, anything you want. All the study is saying is that for a given baseline, 'aid given to poor regions doesn't really work, they stay poor' which is either intuitively true (Easterly's White Man's Burden) or, even more aid is needed, the Big Push theory, a coefficient of static friction is great argument that Jeffrey Sachs, Angelina Jolie, and a certain "Bono" constantly call for.

Bonus trivia: I once mentioned "Feed The World" (80s rock aid for Africa) to an African and he was insulted. Apparently it's a sensitive subject to imply these Third Worlders cannot do it on their own, and need help. Probably same in India. Actually they can't do it themselves (India is a basket case and I doubt they ever amount to anything, with all their diverse castes) but in polite conversation you don't go there.

What does this tell us about likely outcomes for the Euro? At present, Germany sends "aid" to Greece; and we see weak governance in Greece. But in the not-so-distant past (pre-1990s), Germany sent aid to Ireland; the sums involved were considerable, up to 4% of Ireland's GNP. At the time, Ireland was a poor country with poor governance. Yet within barely half a decade, Ireland was able to clean up its governance, boost its economy, and reinvent itself as the "Celtic Tiger".

So which direction does the causation run? Are states with weak governance more likely to end up as aid recipients, or does the receipt of aid cause them to have weak government? Does it depend on the way the aid money is spent? Or is aid just a correlation, and there is no causation in either direction?

Imagine an scenario where people receiving cash transfers is uncritical (doesn't care) about the regulations applied to banks or telecommunications. It can be argued that a) cash transfers make people uncritical to government policy, or b) they don't care simply because of their ignorance. Option a implies cash transfers cause weak governance, option b implies ignorance/low skills causes poverty which is the reason they get aid. Weak governance may just the effect of people not making the government accountable.......learned helplessness?

Bottom line. You can never determine causation with a point in time study, and it is utterly predictable that all favor factors could be causes of a need for transfer payments and in turn for transfer payments to be made.

Weak governance very likely helps to cause a smaller share of manufacturing in GSDP, lower fiscal effort, and lower state GSDP, and in turn, lower state GSDP no doubt leads to lower per capita consumption, which in turn leads to the need for Higher RRT.

Indeed, if the money flowed from states with lower state GSDP to higher GSDP we would call it something other than RRT, like "investment in critical national infrastructure" or some such. The correlation is almost definitionally true.

Certainly there will be lots of causality of all types going on, but this cannot be expected to make itself clear in aggregated data without a case-study or literature component which explains outliers and more common trends.

...soft budget constraint!!!! :)

"Distance to New Dehli" doesn't strike me as a great instrumental variable. I doubt the exclusion restriction will hold since "distance to New Dehli" should be correlated with loads of factors other than RRTs that influence governance?

I would be most interested to hear Alex's take on what the best approach is to dealing with the wide-scale poverty and inequality in India. The remnants of the caste system still exist and the shanty towns as portrayed in Katherine Boo's fine book, "Beyond the Beautiful Forevers" is widespread.

Ignoring the "no silver bullets" perspective, trying to raise teacher attendance above 2 in 3 days to somewhere in the range of 99% might help. This might require raising wages above $30 a month though ...

Would you all agree this it true of the United States? As I recall, the more rural, Republican-voting states get more aid than they put into the country's coffers. Or is the graph showing the amount of aid regardless of the tax base?

I'm curious about this statistic, because I've also heard it oft-repeated. How much of it is SS payments? That would skew unfairly Florida, home of the retirees, as a net consumer. How much of it is dumb biofuel subsidies? How much of it is road and school support (probably the most significant source of federal welfare)?

Exactly. Add Military bases to the mix. Predominantly in the South where land is cheaper.

I could actually believe that once you control for Social Security and military bases, red states are still net consumers of federal funds because of the difficulty of having highways and schools through lowly populated areas... but I also suspect the claim is meant to be misleading, like the "Wimminz only get 77 cents to a man's dollar" nonsense. If no-one else has more information, I'll look it up, but it'd be nice to have a reminder, because squirrel.

Its central problem is it tries to create hypocrisy by pretending that everyone in a "Red State" votes Republican and everyone in a "Blue State" votes Democrat.

Well, sure. It's really a rural vs urban issue - but Kansas is mostly rural, for example. This is a big part of our budget issues - funding a school district even if there's only 30 kids in it has some economy of scale issues (to say nothing of police, post office, etc). The quiet response means I should probably research it and report back to class in a week.

There's also the matter of the federal deficit. As large as they've been, it's theoretically possible for _every_ state to be getting back more federal dollars than they contribute.

Interesting to highlight the biofuels subsidies paid out to farmers, but with no mention of the numerous other subsidy benefits they receive, which do not contribute to national energy security but which also undermine the competitive posittion of the poorest and most undercapitalized individuals and nations on the planet.

Please let me know what they are. A lot of subsidies are invisible to the local farmer, they only see the price signal. CRP, I'm guessing? If there are price floors it usually gets lost (hidden) in the futures market.

Here's 226,000 results to get you started:

Sugar and corn are two famous ones. But there's really just such a huge number and type ... man, you'd really have to be an expert in precisely that subject and precisely the USA to have a good answer, and even then you'd always be missing a dozen angles.

For general perspective, one might revert to standard explanations for why the Doha round of trade negotiations failed (EU, US and Japan refuals to reduce their huge agricultural subsidies.)

A lot of these practices aren't actually popular with farmers, despite being implemented 'for their own good'. There's a general perception big farms make out better.

I don't think that's accidental, especially considering that most of the policies were put in place at a time when increased mechanization and industrialization of agriculture was very much an explicit objective.

As the relative importance tilts more towards keeping sufficient agricultural labour force on the soil, the views of the smaller farmers may become more relevant as a policy input, even assuming that they are equally less effective (compared to today) at organizing than their more industrialized and organized peers.

I would be interested to see an analysis of U.S. states that explicitly excluded states in the Northeast and the West coast, or that analyzed those states and the rest of the lower 48 as two separate populations. I think that much of the concentration of wealth in California and the Northeast is in a sense due to chance, or at least doesn't have a whole lot to do with the quality of governance in those states. The Northeast was settled first, and so it isn't surprising that the U.S. financial capital is located there, as well as its most prestigious and prolific research universities, and the capital of the nation. Likewise, California has the biggest ports on the West coast, has an awesome climate, and had the fortune to have courts that refuse to enforce non-compete clauses in contracts, which allowed Silicon Valley to flourish. Granted, any state could pass laws invalidating non-compete clauses, but doing so at this stage of the game is unlikely to result in an industry agglomeration like Silicon Valley or Wall Street. Iowa and Alabama will likely never have those sorts of industry agglomerations, even were they to aggressively pursue such an aim.

It's completely fair to count California's coastline and climate towards California's prosperity, or Panama's canal towards its. Venezuela also has a coastline, and cannot use it well. Kansas is landlocked, doesn't have fantastic navigation, and a middling climate for agriculture, and should be populated to reflect all that. Let California prosper for its virtues!

Venezuela has a lot of problems, but in considering the relative value of its coastline from the perspective of international market access (ports, etc.), don't forget that a decent share of the interior is pretty inaccessible and dense jungle. Compare this to coastal regions in the US, whose ports may service companies from hundreds or thousands of miles into the interior without so much as having to show a waybill.

It is a similar issue to natural resource countries, isn't it, that the government can fund its activities without having to go to the people to raise tax money.

LOL, it takes a Libertarian to think that aid causes poverty rather than vice versa.

Seems like there are a ton of other factors involved too. When there is a problem of poverty, few people, least of all Libertarians, are willing to look at the situation more closely. Poverty, whether domestic or foreign, is uncomfortable, and is kept far away and vague. Maybe you throw some money at it. Maybe you don't. But you certainly are not going to look at the specifics of what is going on or why. So you grab a factor like the dollar amount of aid and say that this causes some outcome.

Haphazardly throwing a certain dollar amount of aid at poverty, is somehow treated as a distinct variable. But it's not. Things like exactly who gets the money, what purposes it is or can be used for, whether those uses address any of the needs of the population at all vs. getting funneled to corrupt leaders and/or their cronies, and what the results are-- these are considerations that should start to be noted.

You're getting too caught up in trying to play ideological games. It needn't be a libertarian point at all: the argument Alex is making is that aid causes WEAK GOVERNANCE, which causes poverty. Some libertarians (Alex included) might sometimes argue that weak governance is a good thing (depending on what exactly that term means). But here, he is arguing that weak governance leads to poverty, and that patterns of aid distribution can create that weak governance in the first place, leading to poverty. It is, in a way, an argument for a stronger and more effective State.

You are playing stupid word games with "strong/weak."

In the paper, "strong/weak governance" is measured by how much less/more electrical power is lost during transmission and distribution. Is there any possibility that this association could be misleading? Is there an obvious correlation with the degree that the State is willing to intervene in markets?

How am I playing any word games? How does weak governance mean something besides a weaker and/or less effective State?

Your criticism isn't of their "strong/weak" framework, but of how they operationalized "strong/weak governance."

He very explicitly suggested that causality was bidirectional and didn't seem to suggest that things were as simple as the stats approach suggested.

However, it's quite clear that libertarians tend to have an ideological predisposition against state aid, and only seem to tolerate them when extremely convincing evidence is presented repeatedly and risk factors have been well assessed.

It is more than just "aid". The worse performing states are all on the border (Nagaland, Manipur, Arunachal Pradesh); federal transfers are made to keep the "natives" from revolution. This suppresses entrepreneurship, and anyone with any sort of ambition leaves the moment they can.

Seems like a mostly confounded chicken and egg issue, not a "maybe there's a little bit of the other direction of causality going on".

A priori, areas with lower per capita assumption, lower growth, lower public revenue mobilization capacity and weak governance ... are probably going to have more need and demand for internal aid.

Is it the aid that causes these problems? Maybe sometimes, but it would be kind of like observing a $1000 gift to a homeless man who could then pay a month's rent and get some decent clothes to get into a job, and then claiming that the cause of his low income was the fact of giving him $1000.

Does helping people cause low income as a simplistic stats approach might show, or is their income still lower than average but higher than it would otherwise have been?

Wherever this logic is absurd, of course things should be discussed openly, and a number of practices in India, such as hugely ramping up make-work projects during famine years, are perhaps not "economically optimal", if you don't count for the additional political instability that could otherwise come.

Comments for this post are closed