Transcript Concept 3

Lecture V
Country Risk Assessment Methodologies:
the Qualitative, Structural Approach to
Country Risk
–The Welfare and Social Dimension and
the Macroeconomic Fundamentals -
“Risk management is not a program but an
ongoing process that must be developed over
time. Our models are constantly reviewed and
improved. On the whole, they have proven their
worth. But good risk management isn't just
about mathematical models and systems – it
also requires an understanding of the market,
intuition and the ability to weigh up what
proportions of risk are healthy. In that respect,
the abbreviation CS in my opinion doesn't just
stand for Credit Suisse, but also for common
sense, which plays a key role in risk
management.”
Hans-Ulrich Doerig
Chairman of the
Board of Directors
of Credit Suisse
The Qualitative Approach

A robust qualitative approach leads to
comprehensive country risk report that tackle
the following six elements:
 Social and welfare dimension of the
development strategy;
 Macroeconomic fundamentals;
 External indebtedness evolution, structure
and burden;
 Domestic financial system situation;
 Assessments of the governance and
transparency issues;
 Evaluation of the political stability.
Inequality
Inequality
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The richest 10% of the population in a
European nation may receive 20.1% of
national income, as they do in Sweden, or
27.3%, as they do in the UK and Ireland.
USA (2005):The top 10 percent of the
population carried away some 48.5 percent
of all reported income in the US in 2005—
also the highest percentage since 1928, on
the eve of the Depression—an increase of 2
percent from 2004, and up from 33 percent
of the reported total in the late 1970s.
Poverty VS Inequality
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Multi-dimensional concepts:
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income, wealth, assets, opportunities;
Poverty  people below the poverty
line;
Inequality  whole population.
We will focus on INCOME as an
indicator for inequality.
Inequality: definition
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DEF: “Distribution of income and
wealth among different groups in
the society and it concern variation
in living standards and in wealth
itself across a whole population.”
Why inequality matters?
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Philosophical and ethical reasons;
Functional level
Three Concepts of Inequality
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Concept 1: Unweighted inter-national inequality
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converging issues.
Concept 2: Weighted inter-national inequality
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Unit of observation: country;
Measure: income per capita;
within country distribution is equal;
country size doesn’t matter;
The same features as the previous one but COUNTRY
SIZE matters;
Concept 3: True world inequality
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Unit of observation: individual (no matter the country
of origin);
Our benchmark!
Measurement Issues

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Which currency unit?
Convert local currency into dollar;
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International purchasing power
Purchasing Power Parity exchange rate
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This purchasing power rate equalizes the
purchasing power of different currencies in
their home countries for a given basket of
goods.
Measurement Issues
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Survey based mean income from
survey or GDP per capita?
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Mean income from survey ≠ GDP per
capita:
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Key factors: taxes and consumption;
Gap is bigger in developed countries.
Concept 1 and 2  GDP per capita
Concept 3  distribution of income
across individuals
Measurement Issues
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Income or Expenditure?
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Expenditure  actual living standards;
Income  potential living standards
Per Capita or Equivalent Adult?
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World income distribution  per-capita
basis
Equivalent adult: more complex, more
precise but difficult comparison across
countries.
Measurement Indicator (1)
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Variation of income distribution
(among nations or among individuals):
1
V 
N
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i 1
yrefers to the average world income (weighted or non weighted);
N refers to the number of countries.
Concept 3:
y
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2
(
y

y
)
 i
Concept 1 & 2:
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n
refers to the average income from the survey;
N refers to the number of people in the world.
Within a country:
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y
refers to the average income from the survey, based in the
population of ONE country;
Measurement Indicator (2)
Problem with V:
If I double everyone’s income  V would
quadruple
If country i is richer than country j 
inequality is higher in j
 Solution  standardize V:
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V
c
y
Measurement Indicator (3)
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Lorenz Curve:
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Gini Coefficient:
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The greater the inequality, the further the
Lorenz curve will be from the 45° line.
It’s the area between the Lorenz curve and the
45°line;
Range [0,1];
the greater the inequality, the bigger the area,
the greater the Gini coefficient.
Wealthiest 10% share of national
income (%).
Trend in Inequality: Concept 1 VS
Concept 2
Trend in Inequality: Concept 1
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Why 1952? First Year China’s data are available;
Sharp increase in C1 after 1980s (i.e. 
divergence):
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Lost decade in Latin America;
Decline in income in Eastern Europe and former
Soviet Union;
Disastrous economic performance of many African
Countries;
Good economic performance of rich countries.
Since 2001: ↓ divergence!
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High economic growth rate!
 African Countries > 4%;
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Post-Communist countries > 6%;
Latin America ≈ 3%
BUT level of Inequality is much higher today than
in 1960s!
Trend in Inequality: Concept 2
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Higher level of Inequality if we
account for country’s size!
Decreasing trend mainly driven by
China’s economic growth (late
1980s);
BUT after 2000 the decline take
place even without China! Mainly
due to India great performance!
Trend in Inequality: Concept 3
Trend in Inequality: Concept 3
Trend in Inequality: Concept 3
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Inequality has increased between
1988 and 2002;
Why?
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Increasing GAP between rich countries
and large rural countries in Asia
(Bangladesh, rural India, rural China)
Rural china VS Urban china
Decline in income in Eastern Europe
Inequality and Poverty
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Small change in income distribution
can have a large effect on poverty:
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If the income of the poorest 20% of
population increases from 6 to 6.25%
 it represents an increase of 4% in
their total income  it has the same
effect on poverty as doubling the
annual growth of GDP from 4% to 8%
Inequality, Poverty and Growth
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High Inequality may have a dampening effect on
growth:
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Political Reasons:
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Demand Mechanism:
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low demand for domestic products and high imports
Human capital:
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lobbies  inefficiency;
lower investment in HC and less positive externalities;
Conflict Mechanism
✔ Social Discontent and Uncertainty
Lower Investment
Higher Social rRisk
=
higher country risk!
CRA and Social/Welfare Indicators
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To decrease the Country Risk Level
a country should:
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Boost Development;
Favour Gender Equality and
Empowerment;
Control Demographic Trend;
Reduce Poverty;
Reduce Inequality.
The Qualitative Approach

A robust qualitative approach leads to
comprehensive country risk report that tackle
the following six elements:
 Social and welfare dimension of the
development strategy;
 Macroeconomic fundamentals;
 External and internal indebtedness
evolution, structure and burden;
 Domestic financial system situation;
 Assessments of the governance and
transparency issues;
 Evaluation of the political stability.
Macroeconomic Structures of Growth
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Country’s main challenge = capacity
to preserve sustainable growth!
Excessive growth (of spending,
debt, money supply, GDP,
investment, domestic credit) is NOT
POSITIVE because it creates
bubbles and costly imbalances!
Macroeconomic Structures of Growth:
GDP def
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GDP combines in a single figure, and with
no double counting, all the output (or
production) carried out by all the firms,
non-profit institutions, government bodies
and households in a given country during
a given period, regardless of the type of
goods and services produced, provided
that the production takes place within the
country’s economic territory.
It’s calculated quarterly or annualy or
monthly.
Macroeconomic Structures of Growth
(2)
Macroeconomic Structures of Growth
(3)
Macroeconomic Structures of Growth
(4)
Macroeconomic Structures of Growth
(5)
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Growth is the product of:
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Capital accumulation:
Physical (land and infrastructure);
 Human (education, incentives);
 Institutional;
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Factor Productivity  technology!
( Growth Theory? The Solow Model!)
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Globalisation (Trade and capital inflow);
Good governance;
Solid macroeconomic environment.
References
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Bouchet, Clark and Groslambert (2003): “Country Risk
Assessment”, Wiley finance (Chapter 4).
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Human Development Report –UNDP web site-
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Milanovic, B. (2009): “Global Inequality Recalculated: the
effect of new 2005 PPP estimates on global inequality”,
World Bank.
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Grusky, D.B and Kanbur, R. (2000): “Poverty and
Inequality”, Stanford University Press, Stanford, California.
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Miles, D. and Scott, A. (2005): “Macroeconomics :
understanding the wealth of nations” Chichester; Wiley.
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The Economist (2007): “Guide to Economic Indicators:
Making sense of economics”. - 6th ed. - New York :
Bloomberg.