Undercover Economist

The weakest link theory that explains our economic woes

 

I was delighted to see Abhijit Banerjee, Esther Duflo and Michael Kremer announced as winners of the Nobel memorial prize in economics. By championing the use of randomised controlled trials in development projects, they have added large and useful doses of rigorous evidence to a discipline that can be overfond of reasoning from a comfortable armchair.

The spotlight this week has understandably been on Prof Duflo. She is a superb economist, highly charismatic and the youngest winner by far. She is also only the second woman to win the prize, after Lin Ostrom in 2009. Since Prof Ostrom was a political scientist, and not as well known in the economics profession as she should have been, Prof Duflo is arguably the first female economist to win the prize. That has huge symbolic importance for a profession that continues to struggle with diversity.

All three winners have made major contributions beyond the championing of randomised trials that won them the prize. Prof Kremer, in particular, has made an unusual series of insights. With Seema Jayachandran, he proposed a way to constrict funding to oppressive or corrupt regimes. An international court could declare that their borrowing was “odious” and need not be repaid by a successor government. This declaration would dissuade banks from lending in the first place.

With his wife, Rachel Glennerster, now chief economist of the UK’s Department for International Development, he set out the case for an “advanced market commitment” to fund the development of vaccines and medicines that the market would otherwise be unlikely to provide. That proposal later took shape as a $1.5bn fund to pay for a pneumococcal meningitis vaccine that did not yet exist. Several hundred million children have since received the vaccine.

Then there’s Prof Kremer’s O-ring Theory of Development, which demonstrates just how far one can see from that comfortable armchair. The failure of vulnerable rubber “O-rings” destroyed the Challenger space shuttle in 1986; Kremer borrowed that image for his theory, which — simply summarised — is that for many production processes, the weakest link matters.

Consider a meal at a fancy restaurant. If the ingredients are stale, or the sous-chef has the norovirus, or the chef is drunk and burns the food, or the waiter drops the meal in the diner’s lap, or the lavatories are backing up and the entire restaurant smells of sewage, it doesn’t matter what else goes right. The meal is only satisfactory if none of these things go wrong.

Once you start to think about O-ring problems, you see them everywhere. A bank is useless if you can’t trust it to keep your money safe from hackers. The most stylish and comfortable car is worth nothing without reliable brakes. You can build a sophisticated factory in a jungle but your efforts will be in vain if you can’t keep the road to it open.

What’s less obvious is that the logic of O-ring problems dramatically changes the way an organisation — or an entire economy — works. Because a single failure can doom an entire project, several things follow. The first is that like attracts like: the best chef does his or her best work with the best suppliers and the best waiters in the best kitchen. It is pointless to ask the best waiter to serve poisonous slop made by an incompetent chef, and pointless to ask the best chef to prepare meals into which an incompetent waiter will sneeze. To spread out the talent is to squander it.

(Prof Kremer’s own career offers an example: he was a research assistant for a paper co-authored by Larry Summers, future US Treasury Secretary. Another assistant was Sheryl Sandberg, future Facebook chief operating officer. High performers seek out high performers.)

The second implication is that inequality is endemic. Since the most skilled workers have the most skilled colleagues and the best equipment, they are vastly more productive than others who are only fractionally less skilled. A modest variation in skills leads to a huge variation in wages. This is why blue-chip companies recruit only from elite colleges and universities. Why take a chance on someone whose face doesn’t fit? Policymakers trying to create a more equal society must find some way to swim against this tide.

Third, O-ring economies are self-perpetuating. If an economy has undrivable roads, unreliable electricity, impassable queues at customs, corrupt courts, and untrained workers . . . well, where is progress to come from? Improve the roads and you’ll still be foiled by the electricity; train the workers and the crooked legal system will still take you down.

For an individual, the question is how much education should I try to acquire? It depends on how much skill others have. If I can’t reach a job market full of highly competent people, there is little point in wasting time and effort developing skills that will be wasted.

The O-ring model is merely a simple way of thinking about how an economy might work — albeit one that seems packed with insight. Prof Kremer didn’t stay in his armchair for long. He and this year’s other winners have been demonstrating just how much economics, wisely used, can deliver.

 

Written for and first published in the Financial Times on 18 October 2019.

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