Leakage: Increasing Returns from Capital Investment

Today while our project assistant Didier and I were hiking through the marshy wetland we are converting into fishponds he told me how glad he was to have been involved in every stage of the Camp Base Agricultural Initiative. He told me that even though it’s a good project and will hopefully make a difference, what he is truly excited about is to have learned how a project like this is run. In the past year and a half, he’s learned how to construct and manage a farm. He’s also learned everything that goes into the construction of a fishery including things like the proper size, ways to fill it with water from a source, how to cycle the water while preventing fish from escaping, and soon he’ll learn how to harvest the fish. He’s excited that in the future he’ll be able to take these new skills and ideas with him to further his career.

Other locals working on this project have learned comparable skills. Soldiers in the Ag Company will have a better understanding of agriculture when they’re finished with their service and will be much more valuable in the professional world. Our engineer will have taken ideas which he had only seen on paper and transformed them into a series of working fisheries like you’d find in a developed nation. And others will have gained ideas from our work which we can’t possibly quantify.

What is happening is leakage. We are investing capital to teach these people how to complete this project, but the ideas are still in their heads when we leave. Now, none of them would have the funding to just go out and replicate this project, but it’s not impossible for some of them to create a working fishery, or put better agricultural practices into place, or end up working for some company where they in turn train others from their own experience.

In his book The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics, William Easterly explains how leakage causes increasing returns on a capital investment, but the returns are usually now given to the investor, rather to society. As he says:

As a society gets more and more productive ideas, each additional idea contributes more and more additional production. If this investment in knowledge leaks to everyone, then this new knowledge raises the productivity of all existing knowledge and machines throughout the economy.

So, doesn’t this just tell us that we should invest all our development work in education, particularly practical education directed towards skill building? Well, there’s a problem of course:

If at the beginning there is little knowledge, then there is a low rate of return. If this low reate of return falls below the minimum required rate of return, that is, the discount rate, then there will be no investment in new knowledge.

No one is going to spend money training workers if the expected return doesn’t include a profit. In Easterly’s example, he talks about a Korean clothing manufacturer which partnered with a Bangladeshi factory. The Korean company paid to have 120 workers come to work in their factory for six months to be trained to manufacture clothing. This initial capital investment was huge, and it was not something that could have been made in Bangladesh as the return would be low. But the Korean firm also had additional knowledge including how to set up lines of credit and how to create import and export deals around the globe. Because of these things, the Korean firm knew that it would turn a decent profit from the joint venture. Had Bangladesh had to invest enough capital to create all of these things it would have taken many years to turn a profit, so no one would have every invested.

In Easterly’s example, after the initial factory was a major success, many of those 120 workers took their knowledge and opened their own manufacturing centers. Within a few years, Bangladeshi exports of clothing went from $50,000 to over $2 billion. Neither the Koreans nor the Bangladeshi firm benefited to that extent, instead the increasing returns went to the society.

So, what can we hope for in the DRC? Well, it’s not unrealistic to think that a few man-made fish ponds might pop up around Kisangani or in other regions of the DRC from knowledge that leaked during this project. Plus, in a few years there will be many highly trained farmers leaving the military and entering the workforce, so it could help to change the agricultural practices of the people in the area.

It’s not $2 billion in exports, but it’s a start for a place where knowledge is incredibly low so returns on the investment are still low.

There are leaks nonetheless, and those leaks will help things grow.

Here is a link to a very interesting guest blog post Didier Lifenya Kombozi wrote for A Crowing Hen.

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