Long-run Economic Costs of AIDS: Theory and an Application to South Africa
This World Bank Working Paper (No. 3152) was published in June 2003. The authors are [alphabetically] Clive Bell, Shantayanan Devarajan, and Hans Gersbach.
The paper is available as a pdf file on the World Bank website at: http://econ.worldbank.org/files/30343_wps3152.pdf. A technical analysis suggests that in countries where HIV/AIDS is widespread, the economic costs may be much higher than previously estimated. If nothing is done to control the epidemic, the peak of disease prevalence may be followed, generations later, by complete economic collapse. The following summary appears on the World Bank website:
"Most existing estimates of the macroeconomic costs of AIDS, as measured by the reduction in the growth rate of GDP, are modest. For Africa—the continent where the epidemic has hit the hardest—they range between 0.3 and 1.5 percent annually. These estimates are based on an underlying assumption that the main effect of increased mortality is to relieve pressure on existing land and physical capital. The research conducted work by Clive Bell, a professor of economics at the Heidelberg University, Shanta Devarajan, chief economist of the World Bank's Human Development network, and Hans Gersbach of Heidelberg University, suggests this emphasis is misplaced. They argue that over the long run, the economic costs of AIDS are almost certain to be much higher.
"The research takes an innovative approach to estimating the macroeconomic costs of HIV/AIDS. By analyzing how the economy functions over the long term, they sought to show that AIDS not only destroys existing human capital, but also weakens how knowledge and experiences are transmitted from one generation to the next. Since the disease affects mostly young adults, the children of HIV/AIDS victims are often left without one or both parents to raise and educate them.
"To conduct the analysis, the researchers used an overlapping generations (OLG) model, in which parents have preferences over current consumption and the (expected) human capital attained by their children. Two family structures are analyzed: ‘nuclear’ and ‘pooling’, whereby under the latter all children are cared for within an extended family. The outbreak of AIDS leads to an increase in premature adult mortality, and if the prevalence of the disease becomes sufficiently high, there may be a progressive collapse of human capital and productivity (e.g., if one or both parents die while their offspring are still children, the transmission of knowledge across generations is weakened.)
"Policy options to avoid such a collapse may include: (i) spending on measures to contain the disease and treat the infected, (ii) aiding orphans, in the form of either income-support or subsidies contingent on school attendance, and (iii) taxes to finance these expenditures. It should be noted the model yielded grim results when calibrated for South Africa. In the absence of AIDS, the counterfactual benchmark, there is modest growth, with universal education attained in three generations. However; if nothing is done to combat the epidemic, a complete economic collapse will occur within four generations. With optimal spending on combating the disease, and if there is pooling, growth is maintained, albeit at a somewhat slower rate than in the benchmark case. If pooling breaks down, and is replaced by nuclear families, growth will be slower still, even with the optimal combination of spending.
"Maureen Lewis, a sector manager with the Bank's Human Development network, provided opening comments. She noted there was a disconnect between what data suggests and what is apparent on the ground with respect to the economic impact of AIDS. She also said that while the research by Bell, Devarajan and Gersbach was dramatic, it was still a work in progress. Bell cited the 14th century plague as one of the great demographic events of history, in part because it was responsible for breaking down the feudal structure of Europe. But the plague hit all ages and classes indiscriminately, AIDS affects mostly young adults during their most productive years. AIDS
destroys not just human capital, Bell said, but the mechanism for building it progressively with succeeding generations. It will have a cumulative effect over time. As the human capital is reduced, larger quantities of physical capital (such as land) are available per person. Average and marginal products of labor can actually rise.
"The disease usually impacts the victim in five to seven years. Bell said the premature adult mortality introduces heterogeneity in the form of inequality in family structure. In what Bell called an idealized African classical form, the orphans are taken into an extended family structure where the adopting parents treat the orphans as completely equal with their own children. This pooling of human capital offers the advantage of social insurance. Under a nuclear structure, the surviving parent continues the care of the children or the children are completely orphaned. Decreases in adult mortality generally increases the years of the children's education. The condition of the family is a significant factor in determining education of the children. He concluded that a rise in premature adult mortality decreases investments in education, and the proportion of households that can best afford it. Therefore a rise in mortality may precipitate a collapse in the economy. Orphans fall into the poverty trap immediately unless they receive help from the state or relatives.
"The hope is to avoid collapse as well as avoid inequality. The first instrument available to any country would be to combat the disease through preventative measures and by prolonging the life of the infected through treatment. The external effects of such steps, Bell said, were very large. Subsidies to promote education is an important option. This can be in the form of direct family support or subsidies to induce parents to send their children to school. With nuclear families, policy influences the distribution of family types through spending on combating the disease. With pooling structures, results are more tractable analytically. Under this structure, targeting income support will be rendered ineffective by the altruism of the adopting parents.
"The model was applied to South Africa. Its economy grew well from 1960 until the mid-1970s when the effects of apartheid and the dissolution of the country's political structure began to take shape. Bell said this earlier period of growth served as a good example of South Africa's economic potential under optimal conditions. Three results were derived. If all children attended school, the South African economy would experience a productivity increase per person of 64 percent per generation. A second result found families with both parents would have an annual income of $3400, not much above the poverty trap. According to the data from 1960, South Africa was well above the level of $3400 and experiencing continuous growth before the outbreak of AIDS. Looking at data from 1990, the researchers found that 32% of males aged 15 would die before age 60, as would 22 percent of females. At this time, only 1% of the adult population was infected by AIDS. Projecting from current data to 2010, the data suggests mortality levels rise dramatically to 36 percent and 54 percent respectively. Only 29 percent of children would not experience a parental loss.
"In the absence of intervention, the results would be extremely tragic. Bell set up a calibration that tied public spending to mortality. He said if the government does nothing, the result will be the projections for 2010. If the disease did not exist, then the data would reflect 1990 results again. An important policy intervention would be to target prostitutes and their clients, providing free condoms. Another is providing the infected with anti-retroviral drugs, projected at $400 per year. Bell set out several additional policy options already noted above. By implementing these policy options, including full-time education, Bell projects affluence for the country by 2080. One of the policy options currently being explored by the government of providing families with subsidies is, in part, undermined because families spend on daily consumption needs and not fully on their children's education. Under this scenario, the researchers project growth, but very slowly."
