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The Missing Link in Economic Development

Like the proverbial man with a hammer who sees every problem as a nail, economists study the world through the lens of incentives, and have developed a rich understanding of how market participants make decisions. But although incentives are important, developing countries must do more than institute the right ones.

CAMBRIDGE – You don’t have to be a neuroscientist to understand that your brain determines what you see at least as much as the objects of perception do. This is even more the case in the social world, which generally reflects concepts – such as freedom, democracy, corruption, or poverty – that one already has in mind. But if you are an economist, your mind has been trained to see the world through the additional layer of incentives.

Incentives are everywhere, and economics has developed a rich and subtle conceptual framework for understanding all the ways in which they might get distorted. We talk about moral hazard, adverse selection, common-pool problems, agency problems, externalities, rent-seeking, excludability, rivalry, and market power. With these concepts, economists can explain why someone might do too little of a good thing (like investing, working, or providing public goods), or too much of a bad thing (like taking reckless risks or polluting). Viewed this way, most problems in the world can be attributed to distorted incentives.

But an old proverb cautions against seeing every problem as a nail just because you are holding a hammer. Though economics can capture many of the subtleties of incentives, it has developed a relatively narrower palette with which to describe capabilities and how they grow. But capabilities clearly matter. If someone is not doing something that we as a society value, it might be because they can’t, not because they don’t want to. This weakness in economics has far-reaching implications for our understanding of economic growth and development, which is fundamentally about the social accumulation of productive capabilities.