How can developing countries stimulate their growth?

Michael Spence is the former Dean of the Stanford Graduate School of Business, a professor at NYU Stern and chairman of the independent Commission on Growth and Development. His colleagues call his mind a race car and describe this leader as a companion. Spence changed microeconomics by teaching that markets aren’t always equipped with perfect information. His work on signaling and screening significantly influenced how employees and employers can improve their skills. Since he was awarded the Nobel Prize on its 100th anniversary, Spence is above all a macroeconomist, focused on growth and poverty reduction. As a Canadian-born US citizen living in the US, Asia, and Europe, he’s trotting the globe like no other. He considers this rewarding because it helps him to understand "each individual place, to some extent, less from a distance, through eyes across the Atlantic."

Michael Spence

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (shared), 2001

At a glance

Born: 1943, Montclair, New Jersey, US

Field: Microeconomics, later macroeconomics

Prize-winning work: The dynamics of information flow and market development

Most famous students: Bill Gates and Steve Ballmer (who didn’t show up much)

Best aha-moment: Tom Schelling taught him that surfers and swimmers are dangerous to each other.

Favorite Italian phrase when making a mistake: "Senza speranza!"(Without hope!)

A Nobel Laureate of the world

Any expectation of spotting the hottest trends in ultra-modern Italian interior design are nipped in the bud when entering Michael Spence’s Milan apartment. There’s no majestic view of the Teatro alla Scala, only a huge tipi-tent in the living room, with Lego scattered across the floor. Here in Italy, where Spence lives with his wife Giuliana and his two youngest kids, he’s in easy-going dad-mode as opposed to the jet-setting Nobel Laureate version.

Once all the toy fire trucks are parked and the Lego towers are set aside, Spence highlights the benefits of frequenting so many countries. "For a lot of people, reading about life in Peru is sort of like reading about people on Mars," he says, and recommends that everybody explores as many places and people as possible because, "It doesn’t have to be like that".

Can we design a framework that leads to growth in every country?

Spending more time in the air than on solid ground, it’s not surprising that Spence dedicates himself to global belonging. Right after receiving the Nobel Prize, he took on a big project initiated by the World Bank. The challenge: to constitute a framework for growth. "We went and looked for countries that had grown at a very high rate. Seven percent or above for 25 years and more", he says, looking back to his start as a "newbie" macroeconomist.

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When trying to find the magic formula for rapid growth in these countries, Spence says the answer is pretty simple: "they are open to the global economy". There are two crucial factors in this: "the single most important one is, whatever you want to call it, knowledge, or technology. There have to be channels where all that comes in and then they use the global economy’s huge marketplace." By noting Asia as a successful example of a region that used the global market for the distribution of its textiles and apparel, Spence leads to the second point: investing money in the future at a very high rate. "What it means in a country whose per capita income is say 400 US dollars a year, is that a third of the 400 dollars is being used to invest in the future. By my calculation, that doesn’t leave much left to live on."

What are the obstacles to growth?

Even if growth takes its time, and runs costs and risks, factors that harm growth also spread rapidly. To Spence, the biggest threats are rising inequality, economic waste, and failures of political and social cohesion. "It’s sort of happening again now in lots of places", he says, with a twinge of sadness. "With polarization, young people unemployed and so on." Of course, these are just a few of the outcomes, but conflicts he must constantly face. Especially since living in Europe.

How should Europe rewrite its rules?

Portugal, Spain, Italy and, above all, Greece are the countries that went sailing into oblivion, as he describes it. "We don’t have inflation to accelerate the process of reducing the public debt overhang," Spence says. "Without meaning to, we created an economic structure that’s very short on adjustment mechanisms and therefore it’s very difficult to see anything other than a prolonged period of rebalancing that takes a long, long, time."

Even if there might be better long-term answers, as he acknowledges, it leads to the immediate important question: what are we going to do now?

"We need to rewrite the rules to create more unity, a centralized banking, regulatory structure under the ECP, a system-wide attempt to overcome the obstacles to growth, including, when necessary, fiscal transfers." He adds that there’s a huge fund in Europe to invest in underdeveloped parts of the EU, but as reality shows the current financial policies aren’t working.

The other alternative is to back out and say we can’t have a common currency, let’s give up on that, and just have an effective, extremely free economy in terms of the flow of people, capital and goods.

Spence speaks as if this would be the easiest thing to do to create a bright future. But maybe it’s that kind of Spence-made confidence and courage our modern societies need.

Economics of information serves the people

Spence never saw his Nobel Prize in microeconomics coming. His original paper on the signaling effect, a solution for informational gaps in markets, was a short one and not something he ever expected to go virtually through the roof. But it did.

People counted (and some still do) on the assumption that the informational surroundings of a market would be complete and accessible to everybody. “If that were true,” Spence counters, "the internet wouldn’t be a very interesting thing. It would give people information that they might have been able to get before but slower, and at a much higher cost."

"What buyers are buying is a lottery"

In markets, buyers and sellers hold different amounts and types of information. People who have ever bought a used car would probably agree. "The way buyers are really buying is like a lottery. If there’s no feasible way to do something that distinguishes the sellers as owners of a high-quality product, they look at the price which reflects the average quality, and the actual quality of their product and they say: well, that’s not a very good deal. And if there’s no demand, sellers will take their product off the market."

That scenario can then lead to a significant price drop and an exodus of people at the top of the quality spectrum. Spence goes further by saying that in extreme cases the market simply collapses, or, as we have seen in multiple cases, "It becomes a market for low-end goods."

How can we close information gaps?

"Sometimes", says Spence, "there are ways to solve the problem; with contracts, for example, which guarantee the maintenance of the product for a certain time. The low-end quality spectrum won’t do that. So there is a way to distinguish between quality and low-end products," he explains.

Signaling and screening, the major part of his work, is sometimes strategic. It sounds academic, but in real-life it’s actually common practice. People study at elite universities like Stanford to expand their job opportunities later on. But those students, in Spence’s opinion, aren’t being strategic. They’re just responding to a set of incentives that already exist. "If you have the ability to get into them", Spence emphasizes, "what you get in return is really two things: one is what you learn, and the other is the signaling effect."

When information gaps are closed, success is automatic

It all sounds easy and logical; but the real breakthrough actually rests within the every-day application that everybody takes for granted. "Let’s take a modern example," he introduces, to show how these theoretical "agents" function in our daily routine. "Airbnb", he exclaims. "Airbnb does two things: they create a market using a network structure and they solve an informational problem. Because I, as a host of an apartment, I am not in the market all that much, and you as a guest may not be in the market that much, but you’re in it often enough for the central player, who keeps very big databases, to be able to evaluate you. And so the other crucial part of these platforms is the two-way evaluation system, closing informational gaps."

Can digital technology become a threat?

Using digital technology has not only had a fairly profound effect on the informational structure of markets, but also on their very existence. Spence, who keeps his tablet close at hand, knows that many people his age are digitally illiterate. But, in his opinion, the "increasing importance" of social networks is undisputed.

His mind wanders: "So a lot of what enables artificial intelligence is that you have very fast machines connected to very fast networks, connected to gigantic databases including images and other data. So for example the way machines recognize chairs is, they take half a second and go look at 80.000 chairs, and they have pattern recognition capabilities, and now they sort of know what a chair is the same way we do. Instead of telling a machine how to do something, you tell it on a much deeper level how to learn."

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Spence is curious about technology’s potential, and also a bit frightened of where robots might lead us. His concerns address the impending rise of artificial intelligence in the labor market. But as his Nobel work had a profound influence on the labor market, changing its structure and the way it’s applied, there’s still a way to avoid markets (or in this case the human job market) collapsing. And we can be pretty sure that even more important work is waiting around the corner tomorrow. Luckily, Michael Spence is always on the run.

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