Posted by Ignacio on
Wed, 31/05/2006
The World Bank has just launched the Moving Out of Poverty study website.
Moving Out of Poverty: Understanding Democracy, Freedom and Growth from the Bottom-Up is an ongoing global study to learn retrospectively from men and women who have moved out of poverty over the last decade. A follow-up to Voices of the Poor, the study explores from the bottom-up processes that shape people’s access to economic opportunities.
This is an ongoing project. Reports will be posted in the web site as they become available. As it was the case with Voices of the Poor, this will be an excellent opportunity to learn directly from the actual protagonists of poverty.
Posted by Ignacio on
Wed, 31/05/2006
The June issue of IMF's Finance and Development magazine is out. Focus is on Asia.
In Asia's Winds of Change, David Burton, Wanda Tseng, and Kenneth Kang analyze Asia's growth over the last 50 years, the crisis in the late 1990s and the new challenges of globalization.
This is their take on Growth and Poverty in Asia.
Although globalization has helped improve growth prospects in Asia, the benefits from this growth have not been evenly shared. Asia remains home to some of the poorest countries in the world, and even in the fastest-growing economies, such as China and India, vast areas remain poor and underdeveloped. In many countries, including the more developed ones, like Japan and Korea, income inequality is widening, and economies are becoming increasingly polarized, as some sectors and groups have surged ahead of others.
To ensure that the benefits from globalization are more evenly shared, Asian countries will need to pursue reforms that will expand opportunities for the poorest groups and regions to catch up. These would include broadening financial systems to improve access to credit and insurance, particularly by small enterprises and the working poor; adopting labor reforms that strike the right balance between flexibility and protection of basic employee security; establishing social safety nets that encourage labor flexibility; and, in some countries, improving the functioning of land markets to unlock their productive potential. Policies to improve the poor's access to quality health care, education, and infrastructure will also assist in enhancing their economic contribution. Finally, prudent macroeconomic policies that promote financial stability can help protect the poorest groups, who, because of a lack of assets and instruments, are more vulnerable to financial crisis.
(Hat tip PSD and Truck and Barter)
Posted by Ignacio on
Tue, 30/05/2006
Posted by Ignacio on
Mon, 29/05/2006
DFID is preparing a new White Paper on International Development which "will set out what the UK government will do - in developing countries, in the UK and internationally to translate the promises of 2005 into better lives for poor people in poor countries".
One of the speeches by Hilary Benn (Secretary of State for International Development) that will serve as background for this new White Paper dealt with the relationship between growth and poverty reduction. This speech and the consultation document Eliminating World Poverty laid out a series of questions on issues that the White Paper will address.
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How do factors such as a government’s macroeconomic policy, investment, trade, the environment, or regional markets and institutions affect the private sector’s ability to raise the levels of growth?
The new White Paper will be available this summer.
Posted by Ignacio on
Fri, 26/05/2006
From Raj Nallari and Breda Griffith's lecture notes. This and upcoming Fridays we will analyze the interrelationships between economic growth, poverty and inequality. In recent years there has been a lot of discussion on pro-poor growth, which is essentially an attempt to examine the degree to which economic growth benefits the poor. This topic will also be examined.
Economic Growth and Poverty Reduction
Sustained economic growth has a positive impact on poverty reduction. The literature is firm on this point. Numerous cross country studies indicate that the main determinant of poverty reduction is the pace of economic growth.
The evidence
Kraay (2004) finds that approximately “half of the variation in short-run changes in poverty can be explained by growth in average incomes. In the medium to long run, between 66 and 90 percent of the variation in changes in poverty can be accounted for by the growth in average incomes.” The recent report from the Operationalizing Pro-Poor Growth research program showed that in those countries (11 of the 14 studied) that experienced economic growth, a 1 percent increase in GDP per capita reduced poverty by 1.7 percent during the study period (1990 to 2003). For some countries, such as Vietnam, the reduction in poverty was spectacular – a halving of the poverty rate from 58 percent to 29 percent (or almost 8 percent a year). Furthermore, poverty declined by rates of between 3 and 6 percent per year in El Salvador, Uganda, Ghana, India and Tunisia.
Consistent with the positive relationship between growth and poverty reduction, it has also been found that incomes of the poor appear to rise proportionately with average incomes (Dollar and Kraay, 2001). Plotting per capita incomes of the poor against average per capita income for 137 countries they find a strong, positive linear relationship between the two variables (with a slope of 1.07). Moreover, plotting the annual average growth in incomes of the poor against average annual growth in average incomes for 92 countries also yields a strong positive, linear relationship between the variables (with a slope of 1.19). Other researchers have also found that poverty trends tracked growth trends very closely in the 1980s and 1990s. For example, according to Chen and Ravallion (2000), on average, growth in the consumption of poorest fifth of the population tracked economic growth one-for-one over this period.
Source: Dollar and Kraay (2001)
Unsurprisingly, the converse also holds: low or declining economic growth leads to increases in the incidence of poverty. Thus, in the vast majority of countries studied by Chen and Ravallion (ibid.) growth led to rising consumption in the poorest fifth of the population, they also found that economic decline led to falling consumption. In a more recent study, Lopez (2005) found that economic decline in per capita income in Argentina (1993 to 2002) and Zambia (1991 to 1998) led to increases in the incidence of poverty. Similarly, three of the countries – Zambia, Indonesia and Romania – in the Operationalizing Pro-Poor Growth study that exhibited little or no economic growth over the study period (1990 to 2003) experienced increases in poverty.
Country examples of the link between economic growth and poverty
Few economists doubt that economic growth is necessary for the long-term reduction of poverty. But how close is the link between the two? Dollar and Kraay (ibid.) gathered information on the per capita income of the poor (the bottom quintile of the income distribution) and on overall per capita income. The data come from 80 countries over four decades, and Dollar and Kraay were able to piece together 236 "episodes," - periods during which it was possible to measure changes in the income of the poor and of the country overall. The main conclusions of this study have been that:
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The per capita income of the poorest quintile grew in line with overall per capita GDP for the 80 countries in the same over the four decades covered. In short, growth matters and the poor are not generally left behind in the process.
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The relationship in equation has not changed over time, and applies both in rich and poor countries. In short, growth still matters.
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The incomes of the poor do not fall disproportionately during an economic crisis.
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Greater economic openness, the rule of law, fiscal discipline, and low inflation all contribute to (or are at least associated with) faster economic growth, and in this manner help the poor.
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Democracy, and higher public spending on health and education, does not have a measurable effect, one way or another, on the incomes of the poor.
The relationship between economic growth and poverty reduction appears to hold for both absolute and relative measures of poverty (Lopez, 2004). The former is defined as an income level below a pre-specified threshold, e.g. PPP adjusted US$1 per person per day, or a country-specific poverty line based on subsistence needs, while the latter is defined as a pre-specified proportion of the population, usually the lowest quintile of the population.
Growth derives from economic inputs – capital and labor – and how efficiently these inputs are used. Because simply adding inputs typically becomes less effective in terms of generating growth over time – referred to as diminishing marginal returns in the literature – sustaining good growth performance typically requires making factors more productive. This can be achieved in turn, through, for example technological advances, improved management know-how and/or skills acquired through education. Viewed through this prism, the robust growth experience of Uganda (more than 6 percent a year on average since the mid-1980s) and the consequent success in lowering poverty is not as impressive as commonly thought. Specifically, Pattillo, Gupta and Carey (2005) find that Uganda’s growth achievements were predominantly due to capital accumulation (investment) and very little to do with productivity gains. As noted by the authors ‘because increasingly higher investment rates (and consequently, rising national or external saving) are not feasible, low TFP growth seriously threatens Uganda’s achievement of sustained high growth and poverty reduction’.
Next Friday: Variations in Poverty Responses / Pro-Poor Growth
Posted by Ignacio on
Thu, 25/05/2006
The Social Policy and Development Center (SPDC) in Karachi released recently its Annual Review of Social Development in Pakistan, this year focused of Trade Liberalization and its impact on Growth and Poverty in that country.
Presenting the report, Dr. Shaghil Ahmed, Acting Managing Director, highlighted that the empirical results indicate that there is an important channel through which trade liberalization has a poverty-reducing effect. This is through its positive impact on investment and productivity and thereby growth.
At the same time, the results also show that there are important adjustment costs associated with trade liberalization that have, to a large extent, suppressed the benefits mentioned above. Trade liberalization resulted in a reduction in collection of custom duties and thus overall tax revenues, which impacted negatively on pro-poor development expenditures.
Future simulations using SPDC's model of the Pakistan economy indicate nonetheless that if the process of further trade liberalization is accompanied by other appropriate policies, including pro-poor fiscal policies, then trade liberalization can help rather than hinder the national goal of poverty alleviation.
Read a brief summary of the report, or download the whole report.
See also DFID's recent publication on Trade Matters in the Fight Against Poverty.
Thank you to Haider Hussain from the SPDC.
Posted by Ignacio on
Wed, 24/05/2006
From PGP's Raj Nallari.
Economic theory suggests that globalization should have a positive impact on growth but does not indicate the impact of globalization on volatility in economic growth. Until mid-1980s, the impact of volatility on economic growth was found to be minor at best. However, since then, as a growing number of developing countries began to integrate into the global economy through trade and financial liberalization, greater openness coincided with greater volatility as evidenced by the financial crises of the 1980s and 1990s, primarily in the emerging markets. For example, work by Hausmann, Garey and Ramey indicated earlier on that macroeconomic volatility due to shocks and policies may actually reduce long-term growth. While output volatility has increased, relatively open economies also recorded higher than average growth rates. Does this mean that in a period of rising globalization, the negative relationship between growth and volatility has changed?
Analysis of data from 85 countries, of which 21 are industrial countries and 64 developing countries, indicates that during 1985 and 2000, the countries that liberalized their trade regimes increased from 30 percent of the sample countries in 1985 to almost 85 percent by 2000. The share of countries with open financial accounts rose from 20 percent to about 55 percent over this period. So trade and financial liberalization seems to go hand in glove and these liberalizations were a contributing factor in almost doubling the volume of international trade during 1985-2000, and private capital flows from industrialized to developing economies have also increased dramatically since the mid-1980s, with the bulk of these flows going to 23 emerging market economies in the sampled countries.
There is a negative relationship between growth and volatility as measured by standard deviation of per capita output growth during the period 1960–2000. However, when the countries are disaggregated by stages of development, the relationship in fact appears positive for industrial economies, indicating that, for economies at an advanced stage of development, volatility is not necessarily associated with lower growth. For emerging markets, the relationship looks positive while it is negative for other developing economies that have not participated as much in the process of globalization.
For the emerging markets, the relationship between growth and volatility is negative before trade liberalization and positive after. In other words, there is suggestive evidence from these economies that trade integration changes the sign of this relationship. One is that the level of development appears to matter, as the sign of the relationship varies across different groups of countries. The second is that trade and financial integration affect the nature of this relationship.
In addition, there could be other factors that affect growth and volatility independently as well as the relationship between these two variables —such as a country’s initial income level, the national investment rate, population growth, the fraction of the population that has at least a primary-level education, and trade and financial integration. When these potential determinants of growth are included, on average volatility is still negatively associated with growth; while that trade integration clearly has a positive effect on growth, the effect of financial integration is less obvious.
When the interaction between trade and financial integration are included, the interaction terms generally have a positive relationship with growth, implying that although the basic relationship between volatility and growth is negative, higher levels of trade and financial integration make this relationship much weaker. The implication of these findings is that economies that are more open have the ability to withstand higher levels of volatility without adverse effects on growth.
Despite experiencing a similar level of volatility, the greater degree of trade openness of emerging markets still allowed them to post higher growth rates. We find a similar result for financial integration, which also explains close to half of the observed differences in growth rates between these two groups of countries.
Source: Kose, Prasad, and Terrones, 2004.
Posted by Ignacio on
Tue, 23/05/2006
The World Bank's Africa Capacity Development Task Force has produced the report "Building Effective States, Forging Engaged Societies".
This report of the Task Force on Capacity Development in Africa analyzes four decades of capacity development experiences in Africa and offers key messages for African countries and their international partners that should underpin a renewed effort to develop, use and retain capacity for development in Sub Saharan Africa.
It also presents specific recommendations of how the World Bank, as a leading development agency in the region, should step up its analytical, financial and operational contribution to capacity development as part of a coordinated international effort under the Paris Declaration on Aid Effectiveness.
This extensive report is available in English and in French.
Posted by Ignacio on
Mon, 22/05/2006
Fifty years ago, Robert Solow published the first of two papers on economic growth that eventually won him a Nobel prize. Celebrated and seasoned, he was thus a natural choice to serve on an independent “commission on growth” announced last month by the World Bank. (The commission will weigh and sift what is known about growth, and what might be done to boost it.) Natural, that is, except for anyone who takes his 1956 contribution literally. For, according to the model he laid out in that article, the efforts of policymakers to raise the rate of growth per head are ultimately futile.
A government eager to force the pace of economic advance may be tempted by savings drives, tax cuts, investment subsidies or even population controls. As a result of these measures, each member of the labour force may enjoy more capital to work with. But this process of “capital-deepening”, as economists call it, eventually runs into diminishing returns. Giving a worker a second computer does not double his output.
...
The law of diminishing returns holds great sway over the economic imagination. But its writ has not gone unchallenged. A fascinating new book, “Knowledge and the Wealth of Nations” by David Warsh, tells the story of the rebel economics of increasing returns.
The hero of the second half of Mr Warsh's book is Paul Romer, of Stanford University, who took up the challenge ducked by Mr Solow. If technological progress dictates economic growth, what kind of economics governs technological advance? In a series of papers, culminating in an article in the Journal of Political Economy in 1990, Mr Romer tried to make technology “endogenous”, to explain it within the terms of his model. In doing so, he steered growth theory out of the comfortable cul-de-sac in which Mr Solow had so neatly parked it.
...
Related:
Read our posting on the Commission on Growth.
Read one of Solow's article on economic growth.
Posted by Ignacio on
Fri, 19/05/2006
As every Friday we are posting a lecture note prepared by Raj Nallari and Breda Griffith. This week we finish our review of the National Income Accounts.
Basic Accounting Relationships
This section links four of the macroeconomic sectors – households, enterprises, government, financial sector and rest of the world – with the key macroeconomic concept of GDP. The relationships derived are accounting relationships and, while providing insights into how policy might be designed, they say nothing about the theory underlying the behavior of the sectors. We introduce two sets of interrelations between a country’s national accounts and its balance of payments. These interrelationships are basic accounting relationships that lie at the heart of macroeconomic analysis. The first examines the links between aggregate income and demand and the external current account balance. Viewed from a different angle this examines the linkages between aggregate savings and investment and the external current account balance. Second, we look at the resource gap of the non-government (private) sector and its financing.
Aggregate income, Absorption and the Current Account Balance
Gross domestic product (GDP), or the value of goods and services that are produced by the domestic economy, can be derived from a basic macroeconomic relationship stating that the value of domestic production must be equal to the value of incomes that are domestically generated. Thus:
GDP = C + I + (X-M)
given that:
A = C + I
then:
GDP = A + (X-M) or total income equals domestic demand (absorption) plus net exports
given that:
GNI = GDP + Yf
then:
GNI = A + (X-M+Yf)
given that:
GNDI = GNI + TRf
then:
GNDI = A + X-M+Yf+TRf
and so:
GNDI – A = X-M+Yf+TRf
X-M+Yf+TRf equals the Current Account Balance (CAB)
The identity GNDI – A = CAB is the absorption approach to the balance of payments.
Basically the identity states that a current account deficit arises whenever an economy spends beyond its means or absorbs more than it produces. Thus to reduce a current account deficit, a country must increase its income and/or reduce absorption. In the short term, increasing income requires unused production capacity, while in the medium and long-term structural policies to help boost capacity are required. Reducing domestic absorption can come from shrinking either private or government consumption of goods and services.
We can go one step further by remembering that:
GNDI – C = S
thus:
GNDI = S + C
substituting this for GNDI gives:
S + C – A = X-M+Yf+TRf
given that:
A = C + I
then:
S – I = X-M+Yf+TRf
or:
S – I = CAB
The relationship between the national accounts - as summarized by the savings-investment balance - and the current account balance is another implication of basic national accounts relationships. Thus the current account of the balance of payments is equal to the gap between savings and investment in an economy. Accordingly, the current account balance may be viewed as the country’s use of foreign saving. In a closed economy setting, savings must equal investment but in an open economy framework any excess of investment over savings must be met by recourse to foreign savings. A current account deficit must be covered by increased savings and/or reduced investment. As before, the accounting relationships hold, making the identities true but they provide no theory or explanations of the underlying concepts.
The Resource Gap of the Nongovernment Sector and its Financing
The real or private sector is defined as the sum of the household and enterprise sectors. The income-expenditure gap of the private sector needs financing. The relationship can be identified through accounting relationships. Savings by the private sector equals the difference between the private sector’s disposable income and its consumption. The private sector or nongovernment sector is denoted by the subscript p in the following identities.
Sp = GNDIp – Cp
The private sector’s absorption or aggregate demand can be written as:
Ap = Cp + Ip
where:
Ip is private sector gross investment.
It therefore follows that
Ap = GNDIp – Sp + Ip
Ap – GNDIp = - (Sp – Ip)
Fp = - (Sp - Ip)
where:
Fp = financing gap
Thus the private sector’s gap between savings and investment reflects an excess of absorption over income. The gap must be financed by the rest of the economy including the rest of the world sector. Examples of financing include foreign direct investment from abroad (FDIp), net borrowing by the private sector from abroad (NFBp), and private sector borrowing from the banking system – identical to net credit from the banking system to the private sector (ΔNDCp). These financial inflows are offset by financial outflows from the private sector, i.e. lending to the banking system in the form of increased currency holdings and deposits (ΔM2) and its lending to the government or nonbank borrowing of the government from the private sector (NB). Therefore
Fp=FDIp+NFBp+ΔNDCp-ΔM2-NB
It follows that:
Sp-Ip + FDIp+NFBp+ ΔNDCp-ΔM2-NB = 0
Conclusion
The second step in measuring how economic policies can impact the poor is in understanding the key relationships between the various economic agents in an economy. (These include households, firms, the financial sector, government, and the rest of the world.) Macroeconomics is the branch of economics that attempts to study the aggregate economy and these important relationships. The measurement of economic activity or economic growth, captured by GDP and its movements, is the central concern of macroeconomics. Three approaches were identified in past postings for measuring GDP, the production, expenditure, and income approaches. An economy’s external position vis-à-vis other countries is measured by the balance of payments. We have concluded with a number of accounting relationships illustrating the links between the domestic economy and the rest of the world. We are now equipped to analyze the important questions of how various policies influence poverty in developing countries.
Next Friday: Economic Growth and Poverty
Posted by Ignacio on
Thu, 18/05/2006
From PGP’s Hippolyte Fofack
The Nelson Mandela Institution for Knowledge Building and the Advancement of Science and Technology envisions the transformation of Sub-Saharan Africa’s industrial and economic landscape and the strengthening of its socio-cultural foundation. Conceived by Africans, this initiative is rooted in a strong public-private and industry-academy partnership for long-term overall sustainability. It has received overwhelming support from leading institutions of excellence, the business community and scientists around the world.
This Institution has two key pillars: The Sub-Saharan African Learning Network (SSALN) and the African Institute of Science and Technology (AIST). The AIST is a world-class institution inspired by the very successful model of the Indian Institute of Technology (IIT) and other leading Institutions of excellence in science and engineering around the world.
The Institution plans to establish four regional AISTs (central, eastern, southern and western Africa). At full capacity, the four regional institutes will produce about 5,000 world-class scientists and engineers every year, with the mission to enhance and accelerate the development of Sub-Saharan Africa.
The potential development impact of this initiative is expected to be significant, including:
Do you want to learn more about these initiatives? Please contact Hippolyte Fofack at hfofack [@] nmiscience.org
Posted by Ignacio on
Wed, 17/05/2006
Third and last part of Raj Nallari's note on corruption.
Persistence of Corruption. Is corruption the norm in certain countries or is it an ‘abberation’ or deviation from the norm? The very definition of corruption as a misuse of public duties for private gain implies a deviation. It also raise the questions of ethics (morality), cultural values, and social behavior. Norms are persistent social traditions or behavior. Corruption persists because of imperfect information or underlying beliefs or the ease of collusion at all levels or is it because corruption is self replicating? Does the introduction of a few corrupt individuals into an other wise honest society lead to spreading of bad influence and pervasive corruption over time? Mishra 2003 suggests that self-replicating behaviour may be the problem as youth look at corrupt but successful people and want to follow in their footsteps.
Economists view this as a multiple equilibria problem – different societies at similar level of economic and political development (per capita incomes, political structures, judicial efficiency) may exhibit varying degrees of corruption, tax evasion and other non-compliant behavior. This multiplicity of equilibria may arise due to complementarities, but the key question is why do societies get trapped in such bad equilibrium? The answers are complex. If people in a country expect more people to be corruption then the expected cost of being corruption and caught would be less, which then leads to more people becoming corrupt. While incentives and rewards can get one out of a bad equilibrium and move from high to low corruption, these do not solve other problems, such as agency costs and costly information gathering, which also lead to multiple equilibria.
We may have high-corruption equilibria with fever firms choosing to pollute or if the inspector spending more time and effort to be informed about ‘when and how firms pollute or not pollute.’ On the other hand, we may have a low-corruption equilibrium where the inspector is uninformed about firms (and wants to be uninformed) and a greater proportion of firms take a chance and pollute.
Evolutionary social dynamics can also explain multiplicity of equilibria. One chooses to be corrupt because everyone else is corrupt in the country and this is accepted social norm. How does individual (say an honest leader) bring about new social norm of low-corruption?
Recantini et al (2005) find that both corruption and the design of the organization can be influenced by the individuals at the very top of the agency. This is suggested by the finding that the procedure for appointing the head of the agency is one of the major determinants of corruption, as well as of the design of its internal organization. Agencies whose head is popularly elected are systematically more corrupt and adopt worse internal organizations. Independent agencies whose head is appointed by a political body tended to adopt better organizational design. Finally, the data show that corruption is also influenced by demand-side factors, and not just by its internal organization. Agencies that provide services to firms (rather than households) are more prone to corruption; and corruption is more likely if the service provided by the agency has no easily available substitute in the market place or elsewhere.
Impact of corruption on economic performance. Widespread bribery is found in many countries with significant variation across and within countries. Bribery raises transactions costs and uncertainty in an economy, leads to inefficient economic outcomes, impedes long-term foreign and domestic investment, misallocates talent to rent-seeking activities, distorts sectoral priorities say from agriculture and rural development towards ‘roads to nowhere’ and large defense projects, pushes firms underground, lowers revenue collection, acts as a regressive tax against the smaller firms, and is the root cause of several other ills, all compounding to economy in a vicious spiral downward.
The World Economic Forum’s Global Competitiveness Survey for 1997 indicates that enterprises reporting a greater incidence of bribery also tend to spend a greater share of management time with bureaucrats and public officials negotiating licenses, permits, signatures, and taxes
In a seminal paper, Mauro (1995) showed the negative impact of corruption on investment and thereby on growth. In a recent IMF book titled Governance, Corruption, and Economic Performance, edited by George T. Abed and Sanjeev Gupta, 2002, cross-country details a high-corruption countries having lower tax revenues, lower per capita income and higher incidence of poverty, and worse social indicators. Of course, the causation is an issue in all such countries. Are poorer countries with weak implementation capacity in all facets of economic management likely to have higher levels of corruption or do corrupt countries likely to have lower per capita income and higher incidence of poverty. Is corruption more in stagnating countries or are countries stagnating due to high levels of corruption.
How to reduce corruption? The above discussion depicts the complexity of dealing with ‘corrupt’ behavior. While higher wages to government employees, with incentives and penalties can reduce the bribery, other studies indicate the need to implement major policy changes that will ‘boldly’ move to reduce opportunities for corruption. These include need to enhance transparency in public transactions, accountability of public officials, which calls for media and civil society playing a ‘watch dog’ role. Other common prescriptions for lowering corruption include, lowering tariffs and other barriers to international trade; unifying market-determined exchange rates and interest rates; eliminating enterprise subsidies; minimizing regulations, licensing requirements, and other barriers to entry for new firms; price liberalization and privatizing government assets; and transparently enforcing prudential banking regulations and auditing and accounting standards. The reform of government institutions may include civil service reform; improved budgeting, financial management, and tax administration; and strengthened legal and judicial systems. Such reforms should involve changing government structures and procedures, placing greater emphasis on competition and incentives within the public sector, and strengthening internal and external checks and balances. As a complement to these broader reforms, the transparent implementation of enforcement measures, such as prosecuting some prominent corrupt figures, can also have an impact.
Other studies point to the role of role of timely audits and monitoring. For example, a randomized field experiment examined several approaches to reducing corruption in over 600 village road projects in Indonesia by having engineers independently estimate the prices and quantities of all inputs used in each road, and then comparing these estimates to villages’ official expenditure reports. Announcing the certainty of a government audit (top-down monitoring) reduced theft by 8% of expenditures, and increasing grass-roots participation in the monitoring process reduced theft of villagers’ wages (but that this was almost entirely offset by corresponding increases in theft of materials, which are public goods).
The score-card method advanced by The Bangalore (India) NGO, whereby users rated local service-providing agencies, has already resulted in firings of officials, improved service delivery, and a decreased incidence of bribery. This approach has been found to be effective in a number of other states and cities in India, and in several developing countries. Free press at least in some case disseminated information about corruption and triggered some changes.
Future research. Much needs to be done in the area of micro-motives of corruption and the politics of it from the point of view of new institutional economics, the behavior economics, and empirical evidence from randomized experiments at the grass-roots level. One realizes that despite all the checks and balances, tightening of penalties and enforcement of civil service rules, and other major reforms, both the private sector representatives (givers) and the public employees (receivers) are jointly and separately finding ingenuous and unique ways of colluding sometimes but invariably ‘capturing the state’ and avoiding getting caught. What is the role of power, wealth and inequality in income and asset distribution in explaining corruption?
Corruption is a growing area of research but high corruption is only one indicator of misgovernance. So study of corruption may have to be done jointly with other governance issues such as rule of law, crime and violence, voice and accountability, transparency, etc. It is often said that ‘the fish rots at the head first’ implying that if ethical standards are reinstated at the highest level of the country or organization, corruption could be reduced. What is the role of ethical leadership in turning around countries with pervasive corruption?
One research area is to gain a better understanding of why the internal design of the organization varies so much across agencies. Why do some agencies adopt more open and transparent procedures, or rely on external auditors, while others do not? This would throw light on internal organizational structures and corruption and help in policy recommendations.
With rapid technological changes, the changing role of media in society and use of internet for information dissemination, greater transparency is being achieved. But the rich and powerful are the very owners of ‘media’ and even if the ‘captured media’ exposed the corrupt practices through greater transparency, in a world of pervasive corruption and likely corruption of ‘media’ how can one ensure truthful reporting and transparency?
How much do we know about corruption in private sector and motives driving this behavior?
Download the whole note on the economics and politics of corruption.
Posted by Ignacio on
Tue, 16/05/2006
A new publication on why trade matters, by DFID. The whole document can be downloaded for free from their site.
Via Development Gateway
Posted by Ignacio on
Tue, 16/05/2006
Part two of Raj Nallari's note on corruption.
Costs and Benefits of Corruption. There is no evidence that corruption has any positive benefits. The argument that ‘speed money’ or ‘grease the wheels’ or ‘grist that helps grind’ is ultimately beneficial by cutting down red-tape and bureaucratic inefficiency has no empirical basis. It only creates opportunities at every level of bureaucracy and even honest officials are tempted to increase red-tapism by spreading and slowing down the processing of requests as the honest officials do not want to be responsible for any decision that they might regret in the future. If corruption was beneficial to society, one would have legalized such corrupt practices!
How does one explain the high level of corruption in a large number of countries despite repressive laws to control it? Everyone now accepts that some level of corruption is inevitable in every mix of market and government. Politicians and bureaucrats have vested interest in increasing and over-extending themselves into market place to maximize corruption. Therefore, a minimalist state would be helpful in curbing corruption and corrupt practices.
There appears, however, to be a trade-off between government corruption and market failures. Governments intervene with the best of intentions in the case of ‘market failures’ and use subsidies and transfers as mechanisms to divert resources from gainers of market failures to losers or vulnerable groups. This creates corruption opportunities but corruption undermines the very purpose of government intervention. Government intervention requires bureacrats (agents) to collection information, make decisions and implement policies and programs. This situation gives rise for self-interest of bureaucrats to kick-in by virtue of their information gathering duties and makes it hard to monitor their action properly. In addition, if the government is keen to control corruption, it will hire officials to prevent corruption. As such, there is a misallocation of talented individuals away from productive activity towards corruption control. All this means that corruption in the form of rents for bureaucrats induces a misallocation of resources and rapidly expands the size of the bureaucracy. Corruption is difficult to eliminate completely, which means that we are living in a ‘second best’ world, in which some bureaucrats will always be taking bribes.
Causes of Corruption. First, the motivation to earn higher income is extremely strong, compounded by poverty and by low and declining civil service salaries. Second, opportunities to engage in corruption are numerous. Given the government intervention in several aspects of economic life, rent-seeking and the discretion of many public officials is broad in developing countries. Third, accountability is typically weak, political competition and civil liberties are restricted, laws and penalties are poorly developed and enforced.
Low wages of government employees is often cited as a major inducement for corrupt behavior in the government. First, when low paid employees meet wealthier private sector clients, the wide difference in living standards between the two groups provides an inducement for corruption so as to climb the social ladder (catch up with Jones’). Second, high wages if paid to the government employees effectively work as fines for bribe-taking and act as ‘efficiency wage’ that could deter corrupt behavior. However, in a country, where corruption is harder to eliminate, there may be higher public sector wages and more bureaucracy (and high corruption) all at the same time. Another cause not related to wages, is whether governments intervene to redress market failures or for furthering their own careers and wealth.
The causes can be quite complex, including rational but inconsistent human behavior (as proclaimed by behavioral economists). For example, if by paying a bribe, I can avoid non-compliance with pollution regulations or tax payments, I will be tempted to try this approach. Similarly, if I am an honest firm and the inspector is trying to extort a bribe, I will be equally tempted to evade paying taxes. Also, there may be several layers in government and collusion between supervisor and inspector combined with an inept judiciary will leave the citizen with little choice but to pay bribes.
What is the optimal wage and commission rate to prevent bribery and ensure higher monitoring and truthfully reporting (say of pollution levels or tax evasion)? When greed exceeds penalty for taking bribes or compensation for truthful reporting, what is the outcome? Only large penalty for bribery tends to contain corruption because providing commission or incentives can induce truthful reporting or can lead to over-reporting by the corruption inspection about the firms’ pollution level (leading to extortion). Rijckingham and Weder (1997) find that in a study of 28 countries when wages were higher then in the manufacturing sector, there was a lower level of corruption. Other studies did not find a strong support for this negative relationship between relative wages and corruption.
There is some evidence that countries dependent upon extraction of natural resources have higher economic rents which is a breeding ground for higher corruption. Similarly, highly-aided countries (higher per capita aid flows) generate rents and lead to corruption. While one study has found that higher educational spending does not coincide with higher corruption, other studies indicate that social sectors and infrastructure sector (compared with agriculture, industry, services sectors) are prone to higher corruption because these are largely financed by aid and involve ‘brick and mortar’ activities.
Corruption varies across countries as well as within countries. In a study of 8 countries to explain the pattern of corruption across public agencies using micro-data, Recantini et al (2005) found that (i) the internal design of the organization is systematically associated with perceptions of corruption, both by agency insiders and by its customers; (ii) corruption is lower when internal decisions on budget, procurement and personnel are regularly audited, and when these same decisions are taken with open and transparent procedures. Corruption in personnel is also lower when such decisions are based on merit and clearly stated professional criteria.
Decentralization. Different organizational structures create different opportunities for corruption. While a centralized state may reward the bribe-paying rich in the country, a decentralized system could also be favoring the local rich people. Decentralization may not necessarily reduce corruption because capture of state by local elites is an obvious possibility. However, in a randomized experiment in India, Duflo et al find little state capture by powerful elites in villages and that inclusion of minorities in decision making increases the likelihood of ensuring minimum redistribution to disadvantaged groups.
Moreover, at all levels of organization it is easier to lobby for a particular design of law or policy because then there is no need for paying bribes regularly to avoid rules and regulations. Prevention is better than cure and offense is the best defense. So corruption at upstream design stage may be more effective for the giver then at the enforcement stage. Further, in several countries you now find that rather than even engage in paying lobbyists and bribes to corrupt officials, rich individuals and elites themselves run for political offices and influence policy design and enforcement (e.g. Italy’s Berlusconi)
Constitutional Design. Monarchies and oligarchic republics have more corruption compared with mature democracies. Countries with long periods of democratization are perceived to have less corruption. However, East Asian countries has achieved higher GDP growth rates with economically viable levels of corruption. So the direction of causation between democracy and corruption is ambiguous because higher corruption can destabilize democracy but more mature democracies have lower corruption!
Economic and Political Competition. Increases in competitiveness within an economy means that many firms are competing in the same market, which means lower profit rates and lower corruption (especially in pollution or other areas of market failure). However, firms could be operating in the product market while corruption could be happening in other markets of the economy. Competition among firms and relation to corruption is therefore not straight forward. For example, high-cost and low-profit firms having to pay bribes may exit the market, thereby reducing competition and leading to higher profit margins for the remaining firms. It is also possible that low-profit firms are willing to pay lower bribes to inspectors, who are willing to accept varying rates of bribes. Ande and di Tella (1999) find evidence of a negative relationship between competitiveness of firms and corruption perception index. When firms enjoy higher rents, bureaucrats will have greater incentive to engage in corruption. But one finds that in most countries, despite deregulation and price liberalization during the 1980s and 1990s under the adjustment programs countries have observed an increase in corruption. It is possible for greater competition to coexist with higher corruption.
The degree of political competition also matters. For example, proportional representative elections with lower weight for individual accountability are associated with higher corruption.
Posted by Ignacio on
Mon, 15/05/2006
From PGP's Raj Nallari.
This is a summary essay adapted from Ajit Mishra (2005). The literature on corruption is large and growing and this is an initial attempt to capture the essence of the arguments and provide some empirical evidence. We will divide it in three or four postings.
Definition. Corruption, which includes bribery, rent-seeking, extortion, embezzlement, is perceived as a major problem facing many countries. Corruption has therefore been variously defined to mean ‘the misuse of public office for private gain.’ This does not mean that there is no corruption in the private sector because this is quite common in (private) financial firms. But, corruption is more severe in the public sector than in the private sector. One of the first known articles on corruption and its punishment is in Kautilya’s Arthasastra (dating back to 14 BC). Does this mean that corruption is a cultural and social phenomenon? No matter what, corruption connotes illegal or improper (moral) behavior. From political science point of view, high level of corruption coincides with political instability and tends to reduce citizen’s trust and faith in institutions.
Measurement. Corruption is measured by perceptions index and is subject to victimization bias. That is only aggrieved parties who suffered in such ‘illicit’ transactions speak out while the vast majority who benefited from giving and receiving bribes may not speak out or provide information. Like black economy and capital flight, only indirect measures can be used. Firms may be paying bribes to officials to avoid legal problems or paying taxes or to hide their non-compliance with regulations. Obviously, such transactions are not reported or recorded. Also, different branches of government (Parliament, Executive, Judiciary, day to day administration) may have different degrees of corruption. The corruption perception index (CPI) of the Transparency International, the ‘control of corruption’ indicators of Kaufmann et al of the World Bank Institute, the Business Environment and Enterprise Performance Survey (BEEPS, a World Bank survey of 26 countries on the extent of bribe payments in 1999), and the Bureaucratic Efficiency index are some of the attempts at measuring corruption.
Principal-agent relationship is the main framework under which corruption is studied. The central dilemma in this relationship is how to get the agent (employee or contractor or tax inspector or borrower) to act in the best interests of the principal (employer, owner or government or banker) when the agent has an informational advantage over the principal and has different interests from the principal. This is the inability of the principal to write a complete contract or put in place an incentive mechanism to induce the agent to act optimally on behalf of the principal. This inherent problem to prepare a complete contract is due to lack or incomplete information, presence of unforeseen contingencies, and informational asymmetry between the principal and the agent. The agent has a loophole to raise money for himself in such a relationship between government-tax inspector and tax payer; regulator of say pollution and firm, police and potential criminal, government provider of services and consumers and so on. Corruption occurs when a third person, say a polluting firm offers money to the inspector (agent), which is not passed onto the principal (regulator or government).
Some economists use the principal-agent-client relationship or the principal-supervisor-agent relationship or the government-provider-consumer of services relationship to reflect the three-tier connection.
Different scenarios are likely in real world. First, the supervisor may have a purely informational gathering role (say estimates of individual incomes or pollution levels among firms). As such, his power comes from an ability to distort such information (e.g. in enforcement cases of tax, regulations, policing). Second, the principal (government) set’s broad objectives for the supervisor (say tax revenue targets) but delegates to the supervisor some control as well as the authority to put in place any incentive mechanism for the agent (e.g. large bureaucracies in policy design and provision of social services reflect this situation). Third, the principal (government) may transfer all the power to the supervisor (e.g. monopoly power to issue permits, licenses, set import-export quotas). The supervisor and his inspectors can vary the price of permits sold to individual businesses, especially when the government does not or cannot monitor the number of permits sold and the price of each permit.
Fourth, in several such cases, collusion is possible between the supervisor who has information gathering (income tax estimates) responsibility and the agent (inspector) who uses the information to collect taxes. The principal (government) has to put in place incentives to prevent such collusion between supervisor-agent or has to hire additional staff to monitor the supervisors-agents (e.g. monitoring the monitor in the financial system and ‘special internal inspectors in several government departments whose mandate is to undertake surprise inspection of the inspectors). With the introduction of collusion possibilities, the bureaucracy expands further and the principal is limited in his ability to implement a range of policies and incentives mechanisms.
Fifth, in real world, the supervisor has the option of colluding with agent to give an agent-favorable report or not colluding and giving an agent-unfavorable report with the intention of taking bribe from agent (e.g. extortion of a lower level staff by a higher level official).
Sixth, several forms of corruption and many such economic scenarios which are complex cannot be understood within this framework. For example, political corruption where the citizens could be considered principals and the elected politicians as agents is more complex. The incentive system here is different – the citizens have limited control except not to re-elect the corrupt politician. The citizens here are multiple principals, and rent-seeking plus state capture by a few adds to the complexity of the problem, which cannot be analyzed by principal-agent theory.
Posted by Ignacio on
Mon, 08/05/2006
Just released by the World Bank's Independent Evaluation Group.
This evaluation finds that debt relief has become a significant vehicle of resource transfer to HIPC countries. But debt reduction alone is not a sufficient instrument to affect the multiple drivers of debt sustainability, which also requires improvements in repayment capacity. Maintaining policy performance is essential for countries not yet at completion point to reap the benefits of debt reduction.
Access the complete report.
Posted by Ignacio on
Fri, 05/05/2006
From the lecture notes prepared by Raj Nallari and Breda Griffith, this Friday we review the Balance of Payments.
In previous Fridays we examined how we assess and measure a country’s economic position as measured by GDP. The Balance of Payments (BOP) allows us to assess and measure a country’s external position. The BOP refers to economic transactions and financial flows between a country and the rest of the world for a given time period, keeping account of payments to and receipts from nonresidents.
Based on the double-entry accounting system whereby each recorded transaction is represented by two entries with equal values but opposite signs – a credit (+) and a debit (-) –the sum of all credits should be equal to the sum of all debits. Therefore the balance of payments should always be in balance.
Examples of items recorded as credits and debits:
- Exports of goods and services Credit (+)
- Imports of goods and services Debit (-)
- Increase in financial liabilities Credit (+)
- Decrease in liabilities Debit (-)
- Increase in financial assets Debit (-)
- Decrease in assets Credit (+)
In reality of course, accounts tend not to balance and thus all balance of payments accounts include an item ‘net errors and omissions’. The item is recorded as a net item because of the possibility that credit errors will offset debit errors, e.g. an underestimation of exports may be offset by an overestimation of imports. Thus the size/value of net errors and omissions cannot be taken as an indicator of the relative accuracy of the balance of payments.
Main components
There are three main components to the balance of payments accounts – the current account, the capital account and net errors and omissions discussed above.
The Current Account
The current account is subdivided into four smaller accounts, the merchandise trade account, the services account, the investment income account, and the transfer payments account.
- The merchandise trade account includes imports and exports of tangible goods such as cars, computers, clothes, televisions, etc. If a country’s imports more than it exports in this category, then it is said to have a trade deficit.
- The services account includes flows of payment in exchange for services countries provide to each other: transportation, insurance, banking, tourism, etc.
- The investment income account reflects domestic resident investment earnings from foreign stocks, bonds, real estate, etc., minus foreigners’ investment earnings from domestic stocks, bonds, real estate, etc.
- The fourth sub-account of the current account is the transfer payments account. This account includes gifts or payments from private citizens and government of a country to people living abroad or vice versa.
Capital Account
The capital account includes a variety of sub-accounts all dealing with purchases and sales of financial assets or real estate (stocks, bonds, land, buildings, businesses, etc.).
The balance on the capital account is the sum of the changes in the above-mentioned capital sub-accounts. This amount, added to central bank build-up or drawdown of reserves during the given period, should equal the balance on the current account. However, if it does not, there is a statistical discrepancy, which given the size of the money flows and the difficulty in measuring the literally millions of international trade transactions, is sometimes a substantial number.
Analyzing the External Position
Under the double-entry accounting system, the sum of credits equals the sum of debits so that the overall balance is zero. However, it is possible to have imbalances in the external account. We speak of surpluses and deficits in the trade and current account. A surplus arises in the trade account if we export more than we import; a deficit arises if the converse holds. The trade balance is often a timely indicator of trends in the current account (as trade data are often easier to collect and more readily available than trade in services). The current account balance is the difference between credits and debits of goods, services, income and transfers. It is one of the most useful indicators of an external imbalance. Persistent large current account deficits call for policy adjustments since a country cannot continue to finance deficits indefinitely by borrowing abroad or running down international reserves.
The overall balance equals the current account balance plus all capital and financial transactions that are not considered to be financing items. The overall balance is an important indicator of the external payments position. Deficits are usually financed by a decline in net foreign assets or reserves, which illustrates the extent to which the Central Bank has been financing payments imbalances.
Posted by Ignacio on
Thu, 04/05/2006
Posted by Ignacio on
Wed, 03/05/2006
World Development Indicators (WDI) publication is the World Bank's annual compilation of data about development. The newly-released 2006 edition includes more than 900 indicators in over 80 tables organized in 6 sections: World View, People, Environment, Economy, States and Markets, and Global Links.
François Bourguignon, the World Bank's Chief Economist and Vice President for Development Economics, is optimistic about data showing that economic growth in the developing world has averaged 4.8 percent a year since 2000 and was 4.8 percent in Sub-Saharan Africa in 2004, exceeding the 2004 global growth rate of 4.1 percent.
Growth is essential to reduce poverty, and we see evidence of this in the data. That's why this boost in growth in Africa is promising. After many years, the continent is showing growth that could deliver much more poverty reduction than in the recent past. It is important for Africa to build on this growth, which is partly driven by higher commodity prices and partly by fundamentals, to keep closing the gap with the rest of the world.
Read the whole press release.
Posted by Ignacio on
Tue, 02/05/2006
From PGP’s Raj Nallari.
All societies want to take care of aging populations, one way or another. For example, in industrial countries, pension systems that have been long-established are now threatened by the mismatch between expanding populations of pensioners and a shrinking base of productive workers. This demographic time bomb is forcing, both developed and developing (including transition) countries, to assess whether it is necessary or desirable to move from current (government) pay-as-you-go (PAYG) pensions toward private or publicly funded plans.
Objectives of pension systems are:
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To provide security against destitution in old age (first tier pension system that is mandatory, normally government-owned PAYG; e.g. several developing countries);
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Smoothen the distribution of consumption spending over a life time (second tier system that can be publicly or private managed, PAYG and may be integrated with first-tier as in the USA); and
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Provide insurance to those with exceptional longevity (third tier, privately funded, voluntary and intended to increase individual choice)
Although the basic requirements for all sound pension systems are extensive, countries must make a range of difficult, often controversial, choices to meet their varied capacities and needs. The following questions pose some of the key choices.
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How large should the first-tier pension be?
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To what extent should the first tier redistribute income?
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Should there be a second-tier pension that provides for spreading consumption more equally between working and retirement years?
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Should a second-tier pension be pay-as-you-go or funded?
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Should the second tier be defined-contribution or defined-benefit?
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Should the second tier be managed publicly or privately?
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Should opting out of state arrangements be allowed?
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To what extent does the state assist with indexing pensions?
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What should be the tax treatment of contributions to the third tier?
Read the whole note.
Posted by Ignacio on
Mon, 01/05/2006
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The Economist 
