How to kill growth: corruption and large military

While it is not a slam dunk, there is pretty good empirical evidence that corruption and government expenses that are not tied to public infrastructure are not good for economic growth. This evidence comes largely from linear cross-country regressions of the kind that anybody with a little sense of theory or econometrics shudder. But sometimes this is done a little bit better.

Giorgio d'Agostino, John Dunne and Luca Pieroni take a simple growth model where government expenses are divided in public infrastructure, public consumption and military expense. Along with private capital, all three enter the production function for reasons that are not entirely clear, but we can let the data speak here. In addition, each expense is adorned with a multiplier that identifies how much is lost through corruption. The result is an equation for the growth rate that can be brought to the data, specifically a set of 53 African countries over 5 years. This is were things become iffy, as it is by now well-known that using panel data in growth regressions leads to very spurious results, especially when African data is considered. Using instruments and GMM will not help you much when data is of poor quality, especially from one year to the next. And taking lags of growth rates will make things even worse.

Results show coefficients "of the right signs" and a particularly strong interaction between corruption and military expenses. I am not sure I can believe these results given the above problems, but they make sense. And if one can extrapolate this African result to other countries, I would be especially worried for the US, where military expenses are always high and bribery of politicians is common and legal.

Want more FDI in Africa? Get a foreign-trained leader

You know the mantra: if you want to get funding for a project, you need to be well connected. It turns out the same holds true at the macroeconomic level for foreign direct investment in Africa.

Indeed, Amelie Constant and Bienvenue Tien point out that have an head of state educated abroad increases on average FDI by up to 100%. And 40% of African leaders obtained their tertiary education outside of the continent. More importantly, it is once you have some FDI flows going that the foreign connection becomes important. Indeed, for countries in the lower quantiles of FDI, foreign education of the leader has no impact. But if there significant FDI, then it matters a lot. It is not clear why, perhaps part of the story is that low FDI countries cannot attract funds no matter what. And why would foreign education matter? It is probably not because of human capital, as those with tertiary education in Africa do worse, but still better than those without tertiary education. It must be the connections.

Time for an agricultural revolution in Africa?

When you think about income differences across the world, Africa is really depressing. It seems nothing is making a lasting impact in terms of policy for it to catch up with the others, and seeing how Asia managed to transform itself makes you wonder what is fundamentally wrong. While one may think this has to do with misguided policies, so much has been tried that something ought to have stuck. But no. One thing that helped Asia is that evolution in rice brought an agricultural revolution that freed human resources for manufacturing, so could such a revolution also happen in Africa?

Donald Larson, Keijiro Otsuka, Kei Kajisa, Jonna Estudillo and Aliou Diagne claim that several areas in Africa are suitable for rice, but local diets and tastes are too diverse for rice to have the success it had in Asia. The productivity of other crops needs to improve as well. So it does not look like there is a ready-made solution that will kick-start the agricultural revolution soon, despite some very localized successes.

That said, why insist of improving agriculture on a continent that is visibly not appropriate for this? Much like telecommunications in Africa jumped over landlines directly to mobile telephony, why not bypass agricultural development straight to manufacturing? One argument against this is the large transportation costs that make local agriculture essential and manufacturing away from the ports unprofitable. But why insist on keeping the population on the countryside? Why not develop coastal cities and take advantage from returns to scale there, like Singapore and Hong Kong did, and

Growth success in Africa: firms become smaller

How could one characterize a developing economy with little growth? Large informal sector, small firms, lots of red tape in the formal sector. As the informal sector typically has low productivity (before red tape), a typical prescription for growth is to move its activity into the formal sector. This can be achieved, for example, by reducing regulation in the formal sector.

Justin Sandefur looks at Ghana, which has recently experienced solid growth following some deregulation, and remarks that average firm size was halved over a 17 year period, while the share of the informal sector has increased. Using a manufacturing survey covering 1987 to 2003, Sandefur finds that aggregate growth did not come from firm growth, but from firm creation. These microenterprises stay tiny until they die, while the existing big firms stay as big.

While the growth experience of Ghana seems encouraging, one needs to realize that small informal firms stay small and informal. Thus once all entry opportunities have been used, growth will petter out.

The economics of piracy in Somalia

Piracy off the shores of Somalia has come to the front news after a few spectacular cases, prompting an international response, mostly in the form of military surveillance on the waters, which has not prevented pirates from extending their hunting grounds. But some people have argued that this patrolling is just treating a symptom. Short of establishing a lawful state in Somalia, which has proven impossible so far, providing alternative livelihoods for the pirates would work better.

Sarah Percy and Anja Shortland doubt this would work. They claim a stable state and economic growth would actually help piracy. Indeed, piracy is a business and any business becomes more difficult in unstable conditions. The way to think about it is that pirate get income from piracy, and they invest locally. The better the return on that investment, the more you want to conduct piracy. Naval operations are useful here because they raise the costs of operations of pirates, but they imply also that attacks are more likely to turn violent, in particular for hostages. But I digress. Another in which local stability would be detrimental is that the whole region may be destabilized, not only Somalia.

An alternative would be to buy off the pirates and turn them into coast guards who enforce fishing rights. This deters them from piracy and would allow the fishing industry to come back to life. But this could also backfire by creating a better trained and equipped pirate force. This is a really difficult situation. Percy and Shortland think things will improve once the stakes for insurance companies and shipping companies become higher: ransoms are getting larger, and violence is becoming more commonplace. At some point they will start intervening with more conviction.

National drought insurance

Some aggregate shocks can have a very large and costly impact. Not your typical business cycle in a developed economy, but rather shocks like earthquakes, droughts or major hurricanes. They put a lot of strain on affected regions, who would clearly gain from acquiring some sort of insurance against such adversities. Robert Shiller has been advocating cross-country insurance mechanisms against GDP fluctuations (say ... markets), but it calamities would have an even more pressing need for that.

Joanna Syroka and Antonio Nucifora explore this in the case for draught insurance in Malawi. With the help of the World Bank, this country is now offering a derivative contract based on index computed from the measurements of 23 weather stations in the country. The hope is that if international markets buy these instruments, the financial consequences of weather fluctuations will be born outside of the country, and macroeconomic stability will help growth and poverty alleviation.

It will be interesting to see whether there will be demand for these derivatives. Experiments have run in Ethiopia and Mexico, but in both cases it was with re-insurers. This time, a government is directly involved. If this works, there are many other candidates for this, think for example Bangladesh, whose GDP depends crucially from the yearly monsoon. And once such markets are well developed, smaller risks like GDP fluctuations in GDP countries may be insurable as well for governments.

A libertarian dream?

Libertarians, at least the most extreme ones, dream of a world without a government. The only example of such a society nowadays is Somalia, and it certainly is not a shining example. However, I came across this BBC story about the Ivory Coast that could provide a second, better example of a society without a government.

The Ivory Coast went recently through a brief civil war with the outcome that the government has lost control over the northern part of the country, held by "rebels." Civil servants, including teachers, have left this area which is now not governed and does not received any tax-funded public goods. Didi this turn into Somalia? Not quite, as people spontaneously stepped in and started teaching in schools as volunteers, or provide some postal service and policing. Is this how a libertarian society would look like?

There is one big difference between Somalia and the Ivory Coast: a reunification and a return of government will happen in a foreseeable future in the latter. The volunteers have thus stepped in temporarily to bridge the lack of government. In fact, they may be hired in their current roles once things return to "normal." Consider this as a variation of the open source movement where people contribute freely to show their skills and the be hired for pay. Would the Ivorian volunteers have done this forever? Most likely not, as they would still need to make a living. I am afraid Somalia is still the most appropriate example of extreme libertarianism.

Africa was underpopulated

There is a common perception that Africa is overpopulated. Historically, this was certainly not true, as there was such abundance of land relative to population that land had no value. In fact one traditional measures how well a society was developed in history by looking at population density, and it was very low for Africa.

I am mentioning this as I am reading a paper by James Fenske who is out to test some theories that, among others, the poor institutions of Africa originate in low population density. The logic is the following. If land has no value, it cannot be used as collateral or as a store of wealth. States could not tax land and thus had little means. Property rights were not defined as there was not property to give rights to. Wage employment was substituted by coerced labor and slavery.

Fenske tests this by using data from an ethnographic atlas and a model with endogenous institutions. And its predictions that land rights appear where population is more dense and/or where agricultural yields are higher holds true. He also looks at he Egba of Nigeria, who have abundant land but well established property rights. That institution emerged from their time of immigration, where land was scarce.

Institutions take a long time to change and Africa has poor institutions. Understanding where they come from can help in reforming them for the better. And by many accounts, Africa is still underpopulated. Following the results above, Africa still has a long way to go to reform its institutions.

How to forecast inflation in Sudan

We tend to get interested in large developed economies because this is where we live and where loads of data are available to make interesting observations and run empirical exercises. But there are also lots of issues elsewhere that need to be studied and that are relevant, at least locally. Those are harder, because data is scarce and also because theory that could guide us may not be available.

Take as an example a study by Kenji Moriyama and Abdul Naseer that tries to forecast inflation in Sudan. This is very important in an economy as disrupted as this one, because the lack of efficient financial markets and banking leaves only currency as a tool for savings. If inflation is high or uncertain, using it for savings is not likely either. The problem is that there is very little data available for Sudan. The authors use ARMA techniques, which at least rely on a limited number of series but require rather long samples. But they can rely only on eight years of monthly data.

Another way to work this out would be to have a structural model, but this requires quite a few additional data series, which are not likely to be available. Maybe then, letting theory guide us could be a solution. This is particularly important in a country where shocks are very important and regime changes are likely. The Lucas Critique has a lot of bite here, and you want to go as deep as possible in the structure in order to study the reactions of agents and markets to situations that may never have happened before. But do we really have a good theory to describe Sudan, with its civil war, population displacement, humantarian aid, etc.? This is the kind of theory that needs development, as this is where the marginal return of theory to real-world well-being is the highest. And this is not just about inflation in Sudan.

Zimbabwe: how to beat hyperinflation

Zimbabwe is in a truly horrible situation, including crippling hyperinflation. I am not quoting any numbers here, they would be obsolete to quickly... Mugabe has royally mismanaged his country, but he is not eternal. So, once the economy is half-way decently managed, how could one get out of hyperinflation?

The obvious answer is of course: stop printing money. But this is not that easy. Without confidence in the currency, prices will continue to rise, at least for a while. Government expenses still need to be met in the meanwhile, in particular civil servants, and there is no meaningful way to raise taxes. But even with a sound fiscal policy, there is no guarantee that hyperinflation can be beaten. For example, Beatrix Paal shows that a policy of stabilizing inflation though the management of public debt is essentially indeterminate and can lead to hyper-inflation, thus being ineffective. Thus, the critical point is to restore confidence in monetary policy while continuing to pay for government services.

Makinen and Woodward show that Taiwan managed to beat hyperinflation by guaranteeing high real interest rates on bank accounts. This seems like classic anti-inflationary monetary policy to the extreme.

I think the best solution is to delegate monetary policy to an entity outside of the country. This is what Cooper and Kempf advocate: dollarization or a currency board. Dollarization means abandoning local currency in favor of another one. But if one ultimately wants some control over monetary policy, this does not sound like a good policy.

In a currency board, the exchange rate with a base currency is set by law, thus difficult to change unlike a fixed exchange rate regime. In addition, every bit of currency in circulation is backed by the base currency (or titles in said currency): anybody can exchange at the predetermined rate at the central bank. Such currency boards have been very successful in creating confidence in the local currency in various countries from the former Eastern European Block, where the IMF helped building up the necessary foreign reserves. So far, the only currency board that failed was the Argentinean one, due to unsustainable local fiscal policy.

A currency board has worked superbly to end hyperinflation in Bulgaria, as shown by Stefka Slavova. But as the Argentinian example shows, and as Thomas Sargent argues in a celebrated book, sound fiscal policy is still needed from the start, but it is not sufficient, as also Gustavo Franco showed.

On the pitfalls of institutional reform in developing economies

What is Africa's problem. Many argue it is an issue of governance. One needs proper ownership rights, in particular for land, for an economy to function efficiently and to encourage entrepreneurship. For this reason, international organization, foreign governments and some NGOs insist on a regular basis on governance reform. This is not necessarily a good idea.

William Easterly and Dani Rodrik have for quite a while highlighted that such western style reforms may be ill-suited for developing economies. The main point is that these reforms are not performed in a vacuum. For example, there is typically already a system of ownership in place. It may not use the same institutions as in a Western economy, but it somehow works. Or business contracts are honored through "informal ways", like reputation.

In the latter case, imposing a system with formal courts may backfire: as they enforcement capability may not be high, people may want to opt out of contracts they would have kept in a reputation system. In this sense, the existing system may be a second best institution that would have to be reformed from the bottom up.