Posted by Ignacio on
Fri, 31/03/2006
As every Friday, we are posting one of the lecture notes on Economic Policies for Growth and Poverty Reduction, from Raj Nallari. This week the note deals with how to collect the data to support poverty analysis.
The main instrument for collecting data are household surveys. Measures of poverty and inequality are always based on data collected using sample surveys of households. The fact that actual measures of poverty and inequality are generated from a sample and not from the entire population has important implications.
Ideally, we should not have to rely solely on a household level survey in making interpersonal comparisons of welfare. A separate community survey can provide useful supplementary data on the local prices of a range of goods and local public services. By matching these to the household level data, one can greatly improve the accuracy and coverage of household welfare assessments. This has become common practice in the World Bank’s Living Standards Measurement Study surveys.
Read the whole note.
Next Friday: National Income Accounts / Introduction and Macroeconomic Sectors
Posted by Ignacio on
Wed, 29/03/2006
This is one of the main ideas proposed today in the presentation at the World Bank of the new flagship report from the Latin America and the Caribbean Region "Poverty Reduction and Growth: Virtuous and Vicious Circles".
The report provides new evidence on the virtuous relationship between growth and poverty reduction: growth is key for poverty reduction. But it also suggests that the relationship can be vicious too: poverty may be hindering growth in Latin America. The report estimates that a ten percent decrease in poverty levels could increase economic growth by one percent in the region.
In the words of the World Bank's Chief Economist for Latin America and the Caribbean and co-author of the report, Guillermo Perry, in a recent interview:
The report defends the idea that poverty and growth are part of the same problem and therefore growth and direct poverty reduction strategies have to be part of the same solution.
Posted by Ignacio on
Tue, 28/03/2006
The Development Gateway has prepared a extensive Special Report on Online Education. It looks at lessons learned, innovations that work, and the future of ICT in education for developing countries.
Seven of the world's largest distance education universities—where students and faculty alike all use some form of computer-assisted learning—are located in developing countries. For these communities, educational resources available via the Internet can offer cutting-edge applications of cyberspace. Yet, roadblocks—from inadequate national communications infrastructures to teachers reluctant to adapt to e-learning—exist for the full success of online education for higher education. Meanwhile, the use of online delivery in corporate training is predicted to overtake higher education usage in developing countries, becoming an estimated $150 billion industry by 2025.
Our own first experiences with Online Education at PGP have been very positive in the last couple of years, with advantages clearly outweighing roadblocks. Online courses on Poverty topics are now regularly offered in our catalogue of activities. They allow us to reach more participants in more places, at a lower cost per participant, while maintaining or increasing the quality of the teaching and the individual attention to participants.
Posted by Ignacio on
Fri, 24/03/2006
As every Friday, we are posting one of the lecture notes on Economic Policies for Growth and Poverty Reduction, from Raj Nallari.
Steps in Measuring Poverty
There are three main steps to be taken into consideration when measuring poverty.
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Define an indicator of welfare
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Establish a minimum acceptable standard of that indicator to separate the poor and the non-poor (often known as the poverty line) and
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Generate a summary statistic that aggregates the information we get from looking at the distribution of the welfare indicator that we have chosen, and its position relative to minimum acceptable standards.
Whilst the broader concept of well-being forms the basis of our overall approach in studying poverty, the most common approach to measuring poverty focuses on economic welfare, which looks at monetary aspects of poverty.
Measures of economic welfare are usually based on household consumption expenditure or household income, to which each resident in the household is assigned a share of the total amount.
Read the whole lecture note
Next Friday: Collecting the data
Posted by Raj on
Tue, 21/03/2006
After a few weeks of trials we are confident enough to take the plunge into the blogosphere and glad to present the Poverty and Growth Blog.
Maintained by the Poverty and Growth Program (PGP) of the World Bank Institute (WBI), the Poverty and Growth Blog will be one more instrument to share knowledge and help build capacity in poverty-related issues. It will bring together knowledge, news, resources, ideas and commentary on issues relating to the design, implementation, monitoring, and evaluation of poverty reduction policies and strategies, and on other issues related to poverty and growth. Finally, it will also allow us to maintain an open, on-going dialogue with participants in our courses, with partners and, in general, with the broad public interested in poverty reduction.
The Poverty and Growth Blog authors will post new comments or materials frequently and regularly, but we want this blog to become a lively dialogue. We hope you will join us in this new and exciting forum. Feel free to comment on any of the postings in this blog.
Over the past weeks we have been looking at other blogs on Development issues already out there. Thank you for taking the lead and for the inspiration; World Resources Institute, Center for Global Development, Global Voices Online, Overseas Development Institute, Center for International Private Enterprise, Globalization Institute and others. In particular, a great thank you goes to our neighbors and colleagues from the Private Sector Development Blog, and to Pablo Halkyard.
Our blogroll will keep growing ...
Posted by Ignacio on
Mon, 20/03/2006
A recent paper by Poverty and Growth Blog author Hippolyte Fofack investigates the leading causes of nonperforming loans during the economic and banking crisis that affected a large number of countries in Sub-Saharan Africa in the 1990s.
Empirical analysis shows a dramatic increase in these loans and extremely high credit risk, with significant differences between the CFA and non-CFA countries, and substantially higher financial costs for the latter sub-panel of countries.
The results also highlight a strong causality between these loans and economic growth, real exchange rate appreciation, the real interest rate, net interest margins, and interbank loans consistent with the causality and econometric analysis, which reveal the significance of macroeconomic and microeconomic factors.
The dramatic increase in these loans is largely driven by macroeconomic volatility and reflects the vulnerability of undiversified African economies, which remain heavily exposed to external shocks.
Simulated results show that macroeconomic stability and economic growth are associated with a declining level of nonperforming loans; whereas adverse macroeconomic shocks coupled with higher cost of capital and lower interest margins are associated with a rising scope of nonperforming loans.
Read the whole Paper.
Posted by Ignacio on
Fri, 17/03/2006
This is the second posting in the Fridays Academy series. This series is based on the lecture notes on Economic Policies for Growth and Poverty Reduction, by Raj Nallari. We will post a note every Friday.
What is Poverty and how do we measure it?
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To design effective policies and strategies aimed at reducing poverty, it is critical to understand the characteristics of poverty in a country or in a geographic area. Adequate Poverty measurement techniques are essential.
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To measure poverty we need to define well-being. This is often done looking only at the monetary aspects of poverty. Non monetary dimensions are equally important.
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Finally, there is no perfect measure of well-being or poverty. This does not mean we should avoid measuring poverty, but it does argue for approaching poverty measures with a degree of caution, and for analyzing carefully how the measures are constructed.
Percentage of population living with less than US$ 1 a day
Read the whole note by Raj Nallari.
Next Friday: steps in measuring poverty.
Posted by Raj on
Thu, 16/03/2006
What is the appropriate goal of economic policy? From 1950s to now, this measurement of economic performance has been steadily changing from monetary to non-monetary aspects -- increasing per capita incomes, to broad-based GDP growth, to human development, to sustainable environment, gender equity, development as freedom and empowerment, poverty reduction, equity in opportunities, and more recently, to happiness.
The ‘economics of happiness’ is an approach to assessing subjective welfare which combines the techniques used by economists and psychologists. Up to a certain threshold, increases in incomes result in increases in happiness, but beyond a certain level, further increases in incomes do not lead to higher levels of happiness. More specifically, recent findings from such statistical ‘happiness’ research include the following:
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For a person, money does buy a reasonable amount of happiness. But it is useful to keep this in perspective. Very loosely, for the typical individual, a doubling of salary makes a lot less difference than life events like marriage.
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For a nation, things are different. Whole countries -- at least in the West where almost all the research has been done -- do not seem to get happier as they get richer.
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Happiness is U-shaped in age. Women report higher well-being than men. Two of the biggest negatives in life are unemployment and divorce. Education is associated with high reported levels of happiness even after controlling for income.
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The structure of a happiness equation has the same general form in each industrialized country (and possibly in developing nations, though only a small amount of evidence has so far been collected). In other words, the broad statistical patterns look the same in France, Britain and Australia.
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There is some evidence that the same is true in panels of people, ie. in longitudinal data. Particularly useful evidence comes from looking at windfalls, like lottery wins.
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There is adaptation. Good and bad life events wear off -- at least partially -- as people get used to them.
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Relative things matter a great deal.
First, in experiments, people care about how they are treated compared to those who are like them, and in the laboratory will even pay to hurt others to restore what they see as fairness. Second, in large statistical studies, reported well-being depends on a person’s wage relative to an average or ‘comparison’ wage. Third, wage inequality depresses reported happiness in a region or nation (controlling for many variables), but the effect is not large.
Newer measures of well-being are also constructed in some countries using survey questions on happiness, family satisfaction, job satisfaction, work stress, and tiredness.
Posted by Raj on
Wed, 15/03/2006
Internet technology began as a Cold War communications network developed by America’s Department of Defense (DOD). Between 1968 and 1998, the DOD controlled the operation of internet protocols and was coordinated by a tech-god (late Jon Postel). Since 1998, a group called the Internet Corporation for Assigned Names and Numbers (ICANN) operating under the oversight of the American Government manages the dot-com addresses, names and routing numbers.
Overtime, internet communication became the platform domestic and international trade through e-commerce and business-to-business transactions. As a result of use of e-trade, world-wide trade of goods and services increased from nothing in early 1980s to $282 billion in 2000 to $6.9 trillion in mid-2005. Of this, USA accounts for almost half of the sales ($3.2 trillion in 2004), with Western Europe a close second at $1.5 trillion.
As other countries begin to enter e-commerce, with China, India, Japan, and South Korea making important technical contributions to Net, American-dominated ICANN’s control is not appreciated. The loudest critics have been monopoly telecom providers from developing countries seeking to enter the high-charges based, lucrative telecom traffic. At the United Nations’ World Summit on the Information Society in Tunis in November 2005, delegations from various countries agreed to establish an Internet Governance Forum in 2006. Some countries are considering creating of local dot-coms, such as .in for India, which could also permit web-addresses in local languages. This would create competition and require separating naming and numbering systems, in addition to ICANN. Will the governance of world.wide.web improve?
Posted by Yan on
Tue, 14/03/2006
How will global external imbalances adjust? Economists have vastly diverse views. The IMF presented two adjustment scenarios using its Global Economic Model, a benign baseline and a more abrupt adjustment. Depending on views regarding the probabilities of various adjustment scenarios, proposed policy responses differ. This note provides a survey of recent literature and summarizes diverse views on various assessment of the probability of a hard landing, and the proposed policy responses.
The benign adjustment scenario presented by the IMF requires a gradual reduction of current account surplus in emerging Asia, and a gradual rise in real interest rates in the US leading to an increase in savings rate, a slowdown in GDP growth and a reduction in the CA deficit to 3.5 percent of GDP by 2010. However, this scenario depends critically on the willingness of foreigners to accommodate a further buildup in US foreign liabilities without demanding a large risk premium. (IMF, 2005, WEO)
The second scenario looks at the impact of a more abrupt and disorderly adjustment –a hard landing. Assuming a combination of a rise in protectionism and a sudden decline in demand for US assets including an abandonment of pegs in emerging Asia, this will lead to a sharp contraction in the US economy. The sudden shift in portfolio preference away from US assets forces a large real depreciation of the dollar, and a sharp correction of the trade balance. Together with the rise in protectionism, this leads to rising inflationary pressure, requiring a significant monetary tightening in the short term, which amplifies the contraction in GDP growth. The emerging Asia experiences a sharp real appreciation, a deterioration in trade and current account balances and a slowdown in growth. Similar impact will be felt in Japan, euro area countries, and other developing regions. The hard landing will lead to a global slowdown with severe consequences to the poor.
Professor Roubini, among others, argued that the probability of a hard landing has increased for the following reasons.
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First, there is a great deal of complacency in the US, and it is quite apparent that the government is not doing anything to resume its fiscal discipline by cutting spending or increasing taxes. About 100 percent of US fiscal deficit has been financed abroad.
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Second, China may be forced to allow more exchange rate flexibility and adjust its portfolio allocation due to economic reasons. China’s economy is becoming increasingly imbalanced –with a large CA surplus and partially sterilized capital flows, there has been a rising money supply and abundant liquidity which feeds into a lending boom. With limited investment opportunities, this leads to overinvestment and declining returns from investment which exacerbate the NPL problems of the banking system. The asset /real estate bubbles and regional and sectoral imbalances may force the government to abandon the tightly managed exchange rate and allow the currency to appreciate. Recently, the State Administration of Foreign Exchange (SAFE) has indicated their intension of diversifying its asset holding.
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Third, if China does not adjust its exchange rate, the rest of emerging Asia is not likely to do anything for the fear of losing competitiveness. However, in his view, if China adjusts its exchange rate and asset holding, the rest of emerging Asia may follow suit. If a group of central banks takes similar actions, this may in turn lead to a sudden change in the investor sentiment, resulting in a sharp contraction in the global economy and a greater risk of financial market disruption.
Jury is still out as to which of these different views and scenarios turns out to be correct. However, the severity of the current global imbalances calls for concerted actions by all, including:
- A rapid fiscal consolidation to raise savings rate in the US;
- Greater exchange rate flexibility in Emerging Asia; and
- Structural reforms in Japan and the Euro area to boost growth and domestic demand through increasing labor market flexibility and competition.
This note provides a non-technical background briefing to policymakers and practitioners in developing countries. In particular, this will be useful as background for our Global Seminar on Capital Flows and Global External Imbalances, to be held in Paris, April 3-6, 2006.
Posted by Lauren on
Mon, 13/03/2006
At a high-level conference in Washington recently, World Bank President Paul Wolfowitz recollected an experience he had visiting a small town in Pakistan last summer.
“…development is like a cart with two wheels - one man and one woman. If one of the wheels isn’t moving, the cart won’t go very far,” one woman described to Wolfowitz.
President Wolfowitz reiterated this statement during the conference, stressing that gender equality is not only a women’s issue, but also a larger development issue. Gender is directly incorporated into the third Millennium Development Goal, however gender is intimately tied with other MDGs because of the role that women play in developing countries as mothers and caregivers. Danny Liepziger, VP and Head of the PREM network, stated that “if we are interested in the health of children, then we’re interested in the literacy of the mother.”
Yet, Wolfowitz warned that we are slipping behind in promoting gender equality. We have already missed the 2005 target of eliminating gender disparity in primary and secondary education. Unless we act now, by 2015 it is forecasted six million girls will be left out of school, the majority of which will be in South Asia and Sub-Saharan Africa.
Liepziger added that “the issue is really to bring the gender question down to the project level and to specific interventions in countries. We know for example that 30 percent of the difference between growth rates between Ghana and Botswana is explained by the difference in education levels of women.”
Now, the trick is to put these words into action.
Posted by Ignacio on
Fri, 10/03/2006
The following is the introduction to Raj Nallari’s lecture notes on Growth and Poverty Reduction. These materials are part of courses delivered during the last two years to analysts and policy makers around the world. We will be posting these notes every week, in our Fridays Academy series.
The overarching aim of these notes is to provide a broad understanding of the policies that are needed to reduce poverty in developing countries. After describing basic poverty and national account relationships, and confirming that growth is the most critical factor in alleviating poverty, the study turns to individual policy areas. These include the various roles of government, including providing a backdrop for the effective operation of a market economy, and conducting fiscal policy. Policies covering monetary and exchange rate issues, the financial sector, trade, and institutional development are also covered in the study, focusing in particular on their relationship with economic growth and poverty alleviation.
Read the whole index and summary of the lecture notes.
Next Friday: what is Poverty and how do we measure it?
Posted by Yan on
Thu, 09/03/2006
Although the world economy has been growing at a decent rate in the last three years, the global current account imbalances have reached unprecedented levels. On one hand, the US current account deficit rose from $665 billion in 2004, to $820 billion or 6 percent of GDP in 2005, and is expected to reach $900 billion in 2006. On the other hand, there is a rapid accumulation of foreign exchange reserves in Emerging Asia as well as in oil exporting countries. As global current account imbalances have grown, the dispersion in net foreign asset positions has also correspondingly increased. The US net foreign asset position steadily deteriorated between 1996 and 2002, while Japan, emerging Asia and oil exporters have built up significant creditor positions.
Economists have vastly diverse views on the causes and implications of the global external imbalances as well as their proposed policy responses. This note provides a survey of recent literature and summarizes those views.
Three Different Views on the Causes of the Global Imbalances
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The optimistic view is that we have entered a new golden age where the current international monetary and financial system is the Bretton Woods system reborn. Today, like 40 years ago, the international system is composed of a core, which has the privilege of issuing the currency used as international reserves, and a periphery, which is committed to export-led growth based on the maintenance of an undervalued exchange rate (emerging Asia and in particular China). Defying all economic theories, the large current account deficit in the US has not let to a depreciation of the dollar, as 50 percent of this deficit has been financed by foreign central banks and another 50 percent by private investors. As a result, US interest rate has been kept low, and consumer spending has been resilient and corporate profitability has been strong even in the face of a roaring oil price, escalating budget deficit and the detrimental impact of Katrina. Some argued there is an overly optimistic expectation about future investment returns in the US based on the high productivity growth in the 1990s. Thus, a large amount of oil revenue has been recycled back to the US which is one of the reasons that the US dollar remains strong. According to this view, there is no real reason for concerns as long as foreign central banks and investors are willing to hold dollar and finance the US Current Account deficits. In this view, the current international settlement system can be maintained indefinitely, and there is little need for policy adjustment.
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The second group considers the global imbalances as mainly due to a “global saving glut” where the swing in the saving-investment gap from deficit to a large surplus in emerging Asia has resulted in an excess global supply of saving (a global saving “glut”) that has been channeled to the US to finance its large current account imbalances (Bernanke 2005, also Chapter II, IMF’s WEO). This would also explain the low level of long-term interest rate in the face of a low and declining rate of savings in the US and other industrial countries. According to this view, consumers in emerging Asia seem to have saved too much as compared to investment opportunities in their own economies. Several structural and policy issues in China have kept savings rate high and investment returns low including, e.g. inadequate provision of health and social insurance, and an inefficient banking system. A variant of this group focuses only on the exchange rate regime in China and emerging Asia as the main source of imbalances. According to this view, it is China and the rest of emerging Asia who need to adjust/reform their policies. Others, however, have argued that the US is the biggest beneficiary of high savings rate in China and other Asian countries, and that US economy has been riding on the high savings rates in these countries (Fehr, Jokisch, and Kotlikoff 2005). Using the overlapping generations model they predict that in the long term interest rates will continue to be kept low and the real wage rates will rise, rather than fall, thanks to the high savings rate in China. “China eventually becomes the world’s saver and the developed world’s savoir with respect to its long term supply of capital and its long-run general equilibrium prospects.” (Fehr, Jokisch, and Kotlikoff 2005, p.1).
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The third group has argued that the sharp drop in the national saving in the US --reflecting the deterioration in the fiscal position and the increase in housing wealth-- and the recent rebound in investment are at the root of current account imbalances (see, for example, Roubini and Setser 2005). Indeed, the CA deficit was widened by 2 percentage points, and fiscal deficit worsened by 6 percentage points, but dollar remained strong in 2005. The increase in saving in China and other Asian economies has contributed to keeping the interest rate low. But this “ideal” world of Bretton Woods 2 system will not last long. Roubini argues that it will unravel “in less than 5 years”. Sooner or later, the willingness of central banks and private investors of holding dollar denominate asset will decline. And many worry that Bretton Woods 2 will unravel in a disorderly fashion, resulting in a hard landing. Why? “Because the global imbalances have been worsening and currently no one is doing anything about it. The US is not doing much on its twin deficits and China is not likely to budge on exchange rate appreciation.” Therefore, Roubini argues that the probability of a hard landing is rising.
Posted by Raj on
Wed, 08/03/2006
This is a book review of the Economic Origins of Dictatorship and Democracy by Daron Acemoglu and James A. Robinson.
The authors' main thesis is that the interplay between elites and common citizens determines the transition from nondemocracy to democracy. Elites prefer nondemocracy, while citizens prefer democracy. Both elites and citizens want right (beneficial to each group) policies not only for today but also tomorrow (sustainability). Political institutions, which are durable today and tomorrow, can act as a negotiating mechanism and help in regulation and persistence of policies over time.
In nondemocracy, the elites have de jure political power and, if there are no checks on their power, the elites would generally choose the policies that are most beneficial to them (e.g. low taxes and tariffs and no redistribution to the poor or middle classes). However, sometimes, nondemocracy is challenged by the vast majority of citizens (e.g. through revolution the poor could have a temporary de facto political power). But, this power is transitory as the majority could have it today but unlikely to have it tomorrow. So the majority group could use this transitory power gained possibly through a revolution and try to change the system to their benefit (today and tomorrow) creating major losses to the elites along with significant collateral losses to the society as a whole. The elites in order to prevent such a revolutionary situation could make (empty) promises such as pro-majority policies would be followed in the future but within the existing political system (these are often not credible). To make them credible, some power is transferred to the majority, which is how democratization begins in fits and starts and takes time.
The reason that the transition does not generally take place (e.g. Argentina) is that the elites controlling the current political system do not want to create political institutions/mechanisms that extend voting rights to the citizens or transfer political and economic power to the citizens. Democratic transition will not occur unless there is a threat of revolution (implying that citizens need to be organized, otherwise the transition is delayed indefinitely). The strength and nature of civil society organizations is important to the creation and consolidation of democracy.
Later in the book, a third group, the middle class, who are materially more comfortable and educated, is introduced as a driver of change during transition of power from the elites to the great mass of citizens. The middle class acts as a buffer between two extremes, ensure consolidation of democracy by limiting redistribution (e.g. Costa Rica and Colombia). The lack of middle class is said to be a problem in El Salvador and Guatemala, where democracy is not being consolidation.
Posted by Ignacio on
Tue, 07/03/2006
The term “Dutch Disease” originated in the Netherlands during the 1960s, when the high revenue generated by its natural gas discovery led to a sharp decline in the competitiveness of its other, non-booming tradable sector. Despite the revenue windfall the new discovery brought, the Netherlands experienced a drastic decline in economic growth. This economic paradox has since been recognized as the situation in which a booming sector adversely affects the performance of other sectors of an economy, and in particular, the non-booming tradable sector. In the past two decades, a sizable literature on the Dutch Disease has examined the commodity booms experienced by some countries. The petroleum boom from 1973 to 1979 produced the most generally significant consequences.
Read the whole paper by Poverty and Growth Blog regular, Migara de Silva.
Posted by Ignacio on
Mon, 06/03/2006
A comment on Blogs and Development from Enrique Mendizabal at ODI, very nicely explained (a while ago) how Blogs can help us in our work.
At its best, blogs can filter information from previously inaccessible sources; can convene different groups around a single issue providing a menu of options and links to further resources that conventional media finds it difficult to deal with; may offer the basis of a tightly knitted community of practice or interest group; and constitutes a cost-effective platform for individuals and organizations to join the global development debate.
We agree.
Posted by Raj on
Mon, 06/03/2006
Equity is defined as equality of opportunity or equality in access to goods and services. Inequities between boys and girls in educational access, between males and females in access to credit and job opportunities, inequities between the poor and the rich in access to land, education, essential health, water and other services, all have a bearing on poverty reduction. In other words, a person's life prospects should not be influenced by circumstances of birth, gender, race, family wealth and class or creed. These factors are outside his or her control and social ethics demands that these factors not determine the destiny of a person.
Inequities abound before a child is born, during early childhood and remainder of one’s life on earth. It is now recognized that one's parental heritage, nationality, social-pecking order, class, religious up-bringing, and incomes of parents and assets of family make a large difference to a person's opportunities in terms of life expectancy, education, access to services, and economic prospects. For example, infant mortality rates vary markedly both within and across countries. In El Salvador and most developing countries, babies born to mothers with no schooling are four times more likely to die before their first birthday than babies whose mothers are better educated. Similarly, children from the wealthiest quartile of households, or with mothers with more than 12 years of education, experience cognitive development in line with international norms (normalized to stay at 100 for all age groups). Inequalities in opportunity are repeated over time and across generations, through economic, sociocultural, and political mechanisms, which are called Inequality Traps.
To provide for greater equity, policymakers need to begin with protection of the poorest and vulnerable (i.e. reverse the order of things). There is a need to invest in people; expand access to justice, land, and infrastructure; and promote fairness in markets domestically but also in the international arena by focusing on the functioning of global markets and the rules that govern them. All this involves improving the quality of basic education for all, preventive health care, and risk management to deal with shocks associated with the weather, health, and labor incomes; to improve market functioning the policy makers need to focus on rural roads for market access, tenurial security for peasants and slum dwellers, and microcredit. In the political arena, access to justice, accountability of basic service providers, and local democracy are important. The relationship between the powerful, the privileged and growth-sapping structures of protection and rents is mirrored in many countries sustaining regressive subsidies for university schooling, pensions, and health services, protecting industrial sectors, concentrated financial systems, and corrupt-privatizations dominated by the powerful.
Posted by Ignacio on
Mon, 06/03/2006
Posted by Raj on
Mon, 06/03/2006
Aid and Growth Nexus. Dollar and Burnside (2000) argue that aid positively influences long term growth in countries with good policy environment. This is intuitively correct because we all accept that humanitarian assistance by averting crises and human suffering is generally considered. In addition, no one can deny that building schools, hospitals, roads and power plants and paying teachers, doctors, nurses and engineers under aid projects complements private investment and contributes to overall human development, growth and development. But, there are complementarities involved in aid-growth nexus – building schools has to be accompanied by teachers who are present regularly to reach, hospitals need pharmaceuticals and doctors as well as nurses simultaneously for health care to improve. Further, country absorptive capacity, aid management, including project implementation and recurrent budget availability, have differential aid impact on growth. While some countries utilize aid inflows effectively, most countries do not and the aid effectiveness and growth relationship is very complex, possibly nonlinear in relationship, and its quality cannot be captured by indices such as Bank’s CPIA (country policy and institutional assessment).
Aid could hurt growth through two channels. First, aid inflows push the price of goods and services, such as aid managers, engineers that work on roads, power, and school building, doctors and nurses, and building contractors because of demand for such services. These goods and services are needed by both traded and non-traded sectors. For example, aid projects that utilize such services will drive up the wages of such service workers. If wages are pushed up for these qualified personnel, non-tradable sector is likely to increase prices of its output to compensate for the higher costs so as to maintain its profitability. On the other hand, the tradable sector because it faces external competition and the price for its output is fixed will run into a loss-making situation and is likely to lose its competitive edge because of the higher wages for the same qualified personnel.
Second, in a flexible exchange rate regime, aid inflows will push up the nominal exchange rate, thereby reducing the tradable sector’s competitiveness if wages do not adjust downwards. Third, large aid inflows are likely to create a ‘Dutch Disease’ phenomenon. Aid inflows by pushing up wages of certain goods and services, put upward pressure on all other sectors to increase wages. There is likely to be a generalized rise in wages through out the country. These effects of aid inflows on growth are not mutually exclusive but the loss of competitiveness, especially in the tradable sector. Fourth, aid inflows do not provide any incentive for a country to improve its tax collection and administration and perpetuate a culture of aid dependency. Aid inflows by relaxing the resource constraint of the government could weaken institutions of tax and expenditures, and allow for lack of transparency and corruption in the use of such resources.
To counter this, aid inflows have to be spent for the benefit of tradable sector (imported capital and machinery, intermediate goods etc) rather than non-tradable sector accompanied by fiscal adjustment. Only then will wages not rise and appreciate the exchange rate.
Resources are not everything. While construction of classrooms and hospitals will spur growth in the short term, in the longer term, the critical ingredients for contribution of human capital and physical capital to economic growth may be the right incentives to avoid absentee teachers and doctors, for availability of teaching materials and pharmaceuticals, and for ensuring adequate supply of power and water.
Aid inflows have some adverse effects on growth of tradable sector, overall wages, and employment, especially in labor intensive, low skilled, exporting sectors. Remittances, which are private-to-private transfers, do not generate adverse effects on competitiveness. Aid inflows go through recipient government to the final beneficiaries (i.e. citizens) and this could have a distortionary effect in the economy as described above. In contrast to aid inflows, inflows of worker remittances directly reach the beneficiaries and do not appear to have a distortionary effect.
While a scaling-up of aid promotes the transfer of real resources from rich to poor countries, beyond a certain threshold (of about 5 percent of GDP per year), a surge in aid poses macroeconomic problems and could have a negative impact on growth in the long term, particularly if aid is channeled more towards consumption and less towards investment. There is also evidence that revenue collections are lower in highly-aided countries.
Debt, Debt Relief and Growth. Studies investigating the link between external debt and growth place a strong emphasis on the role of investment. Large debt stocks are typically expected to lower growth through the channel of reduced investment which is usually described by the debt overhang hypothesis. Outstanding debt ultimately becomes so large that investment will be inefficiently low without sizable debt or debt service reduction. The burden of large debt sooner or later can lead to extreme scarcity in liquidity, negatively impacting upon capital formation, growth, and consumption. The incentive effect of this hypothesis refers to the low public and private investment because a larger and larger share of resources is transferred abroad for debt servicing. In other words, some of the returns from investing in the domestic economy are effectively taxed away.
Another strand of the debt overhang theory emphasizes the point that large debt stocks increase expectations that debt service tends to be financed by distortionary measures (inflation tax or cuts in public investment). Under such uncertainty, private investors will prefer to exercise their option of waiting and may choose to invest less, or divert their resources towards quick, financial returns with high risk, or resort to transfer their money abroad (capital flight).
The original Laffer-Debt curve graphed the expected repayment against the face value of debt service. It shows that as outstanding debt increases beyond a threshold level, the expected repayment begins to fall due to the adverse effects mentioned above. Patillo et al. (2002) discuss the possible nonlinear relationship between debt and growth.
There is enough evidence that external debt slows growth beyond a certain level (of about 50 percent of GDP or 20-25 percent of GDP in net present value terms). This is the so-called ‘Debt Laffer Curve.’ Therefore, substantial reduction in external debt as under the HIPC Initiative is estimated to add about 1 percent in per capita GDP growth (e.g. annual GDP growth of HIPC countries averaged about 1.2 percent per year during 2000-02 compared with 0.2 percent during 1990-99.
External debt also affect GDP growth indirectly through its effect on public investment. One reason is that the cost of servicing debt decreases fiscal revenues and tends to depress public investment. The crowding-out of investment intensifies with rising debt service to GDP ratio, thereby suggesting a non-linear relationship between debt, debt-service and growth. Policymakers are urged to use the resources released by HIPC debt relief for raising public investment, without increasing budget deficits, in an effort to increase growth.
Reducing the stock of debt alone, rather than immediately reducing debt service, is unlikely to induce governments to increase their allocation to public investment. Front-loading of debt relief and topping-up relief makes eminent sense if poorer countries are to be assisted through debt relief, but every one percent in debt relief by itself raises public investment, on an average, by only 0.2 percent.
In sum, on an average poorer countries, have to learn to manage with aid flows of about 5 per cent of GDP per year, while ensuring that the debt stock is maintained below the 50 percent of GDP threshold, and that the borrowing is on concessional terms to ensure low debt service obligations each year. Beyond these thresholds, aid and debt will negatively impact upon GDP growth. The above discussion points to prudent external borrowing strategy and maximizing aid effectiveness for ensring long term growth.
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