Transcript Doing growth diagnostics in practice

Private appropriability issues:
Government and market failures
Elena Ianchovichina
PRMED, World Bank
Joint Vienna Institute
July 2009
Government failures

Macroeconomic risks



Macro stability is a necessary condition
for growth
Elements of macro stability
Microeconomic risks
Macroeconomic risks

Macro stability is a necessary condition for
growth



Poor macro management could result in macro
volatility which has a negative impact on long run
growth
Poor macro management could discourage long
term investments by making it hard to predict
future outlook
Elements of prudent macro management
Elements of prudent macro
management

Fiscal policy discipline






Is the fiscal policy consistent with monetary policy?
Is fiscal policy consistent with debt sustainability?
Price stability
Interest rates that are positive, but moderate in
real terms
Competitive real exchange rates
Adequate international reserves
Issues are country specific and change
over time



Difference between market-access and lowincome countries relying on official aid
Most countries ensured macro stability in
recent years, but the current financial crisis
calls for renewed focus on macroeconomic
management
Good starting point: IMF’s special issues
papers as well as any country analytic papers
and CPIA ratings/discussions
Links between constraints

Poor macroeconomic management may be a
reason for low domestic savings or high
spreads on foreing borrowing


In this case, it is poor macro management that is
the actual constraint manifesting itself in high
cost and poor access to finance
But macro stability does not preclude
problems in the financial sector
Short-run output contractions due to
external shocks

Many developing countries have felt the financial
crisis in the developed world through its impact on:





Volume of exports and a drop in export prices
Drop in remittances and capital flows
A rise in cost of finance
Implications – foreign exchange shortages in LICs
Given limited substitutability between domestic
and imported goods, there will be a need for both:


Expenditure switching
Expenditure reduction -> drop in aggregate demand
Adjustment to a decline in
aggregate demand
Price
AS
P’
prices and output
decline, wage stickiness
prevents return to full
employment;
2. As recession persists,
wages adjust and growth
resumes
E
P
E’
P”
1. In the short run both
E’’’
AD
AD’
Y’
Y
Output
Macroeconomic risks
Examples



Tajikistan – weak macroeconomic
management since mid-2000 make its
economy vulnerable
Zambia – RER appreciation: a threat to
inclusive growth before 2008
Brazil – a case of an over-borrowing state
The case of Tajikistan
% of GDP
Macroeconomic performance
deteriorated in Tajikistan after 2006
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%

General Government Revenues, Expenditures
and Overall Balance. 2000-2008

2000
2001
Overall Balance
2002
2003
2004
Total revenues
2005
2006
2007
2008
Total expenditures
Fiscal policy was
pro-cyclical,
exacerbating the
remittance
fuelled private
consumption
boom;
The fiscal deficit
rose to about 7.3
percent of GDP
in 2008
Inflation accelerated to over 20 percent
by 2008
50%
40%
30%
20%
10%
Overall CPI
Foodstuff
Nonfood
Services
Jul-08
Jan-08
Jul-07
Jan-07
Jul-06
Jan-06
Jul-05
Jan-05
Jul-04
Jan-04
Jul-03
Jan-03
Jul-02
Jan-02
Jul-01
Jan-01
Jul-00
0%
Jan-00
percent per year
60%
Average Consumer Inflation. Overall and Main
CPI Groups. Jan.00-Aug.08
% of GDP
The current account deteriorated…
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%

GoodsExports and Imports, Remittances and
Current Account Balance. 2000-2008


2000
2001
Current Account
2002
2003
Exports
2004
2005
Imports
2006
2007
2008
Remittances

Net foreign
reserves
deteriorated;
Fragile domestic
banking sector
Contingent
liabilities and
quasi-fiscal
activities of
SOEs
Occurrence of
expenditure
arrears
Remittance inflows have fallen sharply

Reasons for the contraction



Contraction of Russia’s economy
The depreciation of Russia’s currency against a basket
of major international currencies
Reasons for the big impact on the BOPs


Tajikistan is one of the most remittance-dependent
countries in the world
Remittances provide more than 3 times as much
foreign exchange as all exports combined and amount
to 80 percent of the value of total imports
Tajikistan is a remittance dependent
country
Remittances (% of GDP) vs. per capita GDP (Average, 2006-07)
40%
30%
y = -0.0145x + 0.1505
R² = 0.1341
Tajikistan
Percent
20%
10%
0%
-10%
-20%
4
5
6
7
8
9
LN(GDPpc Current US$)
10
11
12
Composition of foreign exchange
earnings, Tajikistan
Foreign Exchange Earnings Sources
100%
4,000
3,500
80%
3,000
2,000
40%
USD mln
2,500
60%
1,500
1,000
20%
500
0%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Alum inum
Cotton
Other Exports GNFS
Factor Incom e
Transfers
Total FOREX sources (USD m ln)
Expected short-run effect of shortage
in external financing on output
Price
AS
E
P
P’
Very limited fiscal
space in TJK for
public spending to
stimulate aggregate
demand
E’
AD
AD’
Y’
Y
Output
Weak macroeconomic management in the face of rising
remittance inflows has resulted in RER appreciation in
recent years
And Dutch disease type effects…
Shares in world exports
7.0%
0.010%
0.009%
6.0%
0.008%
Percent of World Exports
5.0%
0.007%
0.006%
4.0%
0.005%
3.0%
0.004%
0.003%
2.0%
0.002%
1.0%
0.001%
0.0%
0.000%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
ECA
Source: COMTRADE, United Nations
Tajikistan
TJK excl, cotton and aluminum
and a loss in competitiveness…
Tajik real unit labor costs have risen even after
adjustments for productivity are taken into account
200
180
160
140
120
100
80
60
40
20
0
2000
2001
2002
2003
2004
2005
Real Unitl Labor Costs Index (2000=100)
Implict exchange rate Somoni /Ruble (2000=100)
Source: COMTRADE, United Nations
2006
2007
The case of Zambia
Main macroeconomic concerns in Zambia:
2007 and first half of 2008

The appreciation of the Kwacha




Stable path from 2002 to early 2005
Rapid rise from 2005 to first half of 2008
Depreciation in the second half of 2008
Led to substantial real exchange rate
appreciation
Real exchange rate appreciation in
Zambia

Factors driving these movements included:







Debt relief (Zambia passed HIPC completion point in
2005)
Scaling up of aid
Foreign direct investment flows into mining
Strong export perfomance
Tight monetary policy
At the time this effect was considered a major
constraint to inclusive growth due to negative
impacts on employment and exports in the tradeables
sectors, e.g. agriculture
Underscored the need for productivity improvements
Changes in the second half of 2008

Kwacha significantly depreciated





Strengthening of the US dollar
Falling copper prices
Large withdrawal of portfolio investment
Domestic political uncertainty
This depreciation represents a correction of
the overvaluation observed earlier
The case of Brazil
(Domestic Credit to private Sector / GDP)*100
Domestic Credit to Private Sector (% of GDP) vs Real
Interest Rate. Constrained Countries 2000-2007
Mean Real Lending Rate = 8.4%
50
Mean Dom Cred to Priv / GDP = 49.5%
40
Mean Real Lending Rate + 1 std Dev = 15%
Brazil
30
Mongolia
20
Tajikistan
10
Benin
Zambia
(Mean Dom Cred to Priv / GDP) -1 Std Dev= 3.8%
0
0%
5%
10%
15%
20%
25%
30%
Real Lending Rates
35%
40%
45%
50%
Brazil’s macroeconomic problems and
links to the cost of capital story

Brazil faced the problems of a liquidity constrained country
due to excessive debt accumulation



High real exchange rate volatility


As foreign debt accumulates concerns crop up about the ability or
willingness to pay
Cost of foreing borrowing rise or there may be a sudden stop (Brazil,
2002-2003)
Instability in the access to foreign savings may be an important source
of exchange rate volatility
RER appreciation – foreing savings increase demand for all
goods but they typically fund imports


Price of tradables falls relative to non-tradables
Negative impact on growth
Microeconomic risks



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
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High and distortionary taxes
Government ineffectiveness
Corruption
Poor regulatory quality
Poor contract enforcement
Labor market rigidities
When does the tax code become a
constraint to growth?




Firm surveys often identify taxes as one of the top-most
constraints to growth
Subjective firm and household data cannot be used as the
only evidence that the tax code is a bottleneck to growth
Use indirect data: size of informal sector is an indicator that
tax rates distort incentives and create activities designed to
avoid paying taxes
Use objective data on several aspects of the tax code and
enforcement:




Tax rates
Tax base
Complexity of tax rules
Tax administration
Indicators

Taxes







Tax base



Number of firms paying 90% of tax revenues
Number of firms reporting no profit or loss
Complexity of tax rules



Corporate income tax
Labor tax
Other taxes
Total tax burden (% of profit)
VAT
Trade taxes
Number of payments
Time to pay taxes
Tax administration

Number of days spent meeting tax inspectors
Tax code a binding constraint in Mongolia
2006




Mongolia’s informal sector was large and growing,
signaling indirectly that the tax code is a binding
constraint to growth
The tax base was narrow: 100 taxpayers provided
over 90% of revenues
Tax administration was weak; rent-seeking and tax
evasion were wide spread
The tax code created:




incentives to avoid paying taxes by staying small
disincentives to start-up businesses
The windfall profit tax on copper and gold created
issues with foreign investors
Export tax on raw cashmere encouraged smuggling
to China, not downstream processing
Excessive taxes and tax policy that is inconsistent with
the growth strategy of Tajikistan





Enterprises pay social security taxes that are 25% of
their monthly wage bill -> discourages job creation
VAT taxes are 20% - at the high end of VAT
worldwide
Some sectors are taxed excessively, and at the same
time enjoy subsidized inputs
Number of taxes paid and the time it takes to
prepare, file and pay taxes is substantial
Tax collection is hampered:




Corruption
Structure of tax collection department
Lack of computerization
Tax administration reflects an uncertain,
nontransparent process that can lead to business
closure or suspension
Government effectiveness
Major obstacle to growth in Benin





Corruption was cited as the third most binding constraint to
business growth in Benin’s 2004 ICA report
Nearly 85 percent of firms identified corruption as a severe
obstacle to their operations
Benin’s rank on voice and accountability, political stability,
government effectiveness, regulatory quality, and rule of law
declined during the period 1998-2006
Courts wer not operating in a transparent and independent
fashion
Weak contract enforcement distorted incentives and raised
transaction costs

According to Doing Business (2008), it costs 60% of a claim to enforce a
contract in Benin. This is higher than all regional averages
Poorly defined property rights are a binding
constraint to inclusive growth in Tajikistan
Investor Protection Index
Ta
jik
is
ta
Uk n
Su
r
b- Uzb ain
Sa ek e
h a is
ra tan
n
M
Af
id
ri
dl
e
Be ca
Ea
la
st
ru
& Mo s
No ld
rth ova
Af
ri
Ar ca
La
m
R
en
tin u s
ia
A m s ia
C
n
er
h
ica Fed ina
& er a
Ca tio
Ea
rib n
st
Ea
er
be
S
n
Eu st A ou an
r o si th
pe a & As
&
P a ia
C
en cif
tra ic
Ka l A
za sia
kh
st
an
O
EC
G D
eo
M rgia
on
g
A
Ky z olia
e
rg
r
yz bai
R jan
ep
ub
lic
9
8
7
6
5
4
3
2
1
0
Source: Doing Business 2009

Country-level studies show that less secure property rights are correlated with lower aggregate
investment and slower economic growth (Johnson, McMillan and Woodruff, 2002)
Market failures

Coordination failures


markets fail to respond to potential investors’ demand for
services enabling scaling up, innovation and marketing of
products
Information failures


firms fail to “discover” which products they can produce
at low enough cost to be profitable and competitive
“Innovation” efforts


Defined in terms of what’s new to a country’s sector or groups of
firms
Not defined as a shift of the global production frontier
Different types of coordination
activities

Examples






Prioritizing the development of different types of
infrastructure
Making decisions on the location of basic infrastructure to
support agglomeration
Providing marketing training and information
Providing product quality and safety information
Establishing and supporting institutions involved in
research and development, agricultural extension services
Limited incentives for firms in an industry to
provide these kinds of services; efforts require multiindustry collaboration
Spatial economics

Resource allocation across regions



Especially challenging in LICs with limited resources,
low population density and geographically-dispersed
population (e.g. Mongolia, Zambia)
Difficult geographic terrain (e.g. Tajikistan)
Differences in country’s needs and circumstances



In China, where most of the poor are differs from where
the highest incidence of poverty is
In India, the location of most poor people and the highest
poverty incidence coincide
The use of maps to do analysis
Different activities have different
needs


Activities grounded in natural resources will
benefit from investment in the regions where the
resources are located
Activities grounded in new economy will benefit
from agglomeration effects -> importance of
giving poor people opportunity to invest in
portable assets – education, health
Types of countries
1.
Distance to markets is large: a challenge for landlocked
countries


2.
Distance and density, i.e. many poor people far from
economic areas

3.
Lack of access to inputs, lack of access to export markets
Development of infrastructure with a thought to where
demand is: local or global
Solution – improving connectivity and investment in portable
assets
Distance, density and conflict acting as a barriers to
factor mobility and delivery of services
The role of knowledge clusters


Network organizations – or knowledge clusters – are
the main strategic competitive assets of the Swedish
forest industry
The network of institutions is essential to:



developing and maintaining international competitiveness;
dissemination of skills and research from universities and
research organizations to the industry
Undertaking multi-industry projects
Negative coordination externalities in
Mongolia in 2006

Large informal exports of raw cashmere to China were indirect signal that
the government had failed to address coordination issues in the cashmere
industry



Herders lacked finance, information and infrastructure to improve raw
cashmere quality
Processors lacked incentives and were reluctant to form strategic links with
herders
Some of the consequences were:

Shortages of quality raw cashmere






forced processors to operate below capacity
Were an obstacle to FDI from luxury makers of cashmere goods
Environmental degradation
Coordination of transit trade and logistics had been poor
SPS restrictions on meat products in China and Russia had eliminated meat
exports from Mongolia to these markets
Firms were competitive in global markets as they did not have access to
modern technologies, market, and product quality information
Rural-urban differentials in connectivity
service provision in Zambia in 2007


Poor access and high cost of basic services were major constraints to growth
Rural areas were at a disadvantage relative to urban areas
Number of households with access to facilities within 5 km
120
100
80
Rural
60
Urban
40
20
0
Food
Market
Input
Market
Post Office
Public
Transport
Public
Phone
Source: CSO (forthcoming)
Internet
Cafe
Farm level productivity was negatively correlated with weak service performance
 Examples where there were positive coordination externalities (e.g. outgrower schemes)

Coordination externalities were not a binding
constraint to growth in Benin in 2008

Effective coordination with domestic and international partners


Benin had taken an active role in coordinating its policies, laws and
regulations with WAEMU and ECOWAS
Success stories where coordination had created positive
externalities



Mutual saving and loan associations were established to remedy the
lack of financing through official channels
Common facilities workshops were established to provide production
services on a fee-paying basis for some types of equipment
The networks enabling re-export trade were dynamic, organized,
sophisticated and ingenious, indicating high potential for a thriving
market economy; The challenge is to steer this creativity and energy in
a productive direction and away from illegal activities
Innovation strategies



Draw on global knowledge
Create and disseminate knowledge
domestically
Innovation activities depend on



Broader economic incentives and institutional
regime
Education and training
Underlying ICT infrastructure
Indicators of innovation efforts

Measures of innovation efforts



Education



Number and value of new exports
Number and value of new exports that disappear the next
year
Skilled labor training
Tertiary education
Acquiring Global Knowledge - Trade




Trade as a share of GDP
Exports as a share of GDP
Tariff and non-tariff barriers
Export processing arrangements
Indicators of innovation efforts

Acquiring global knowledge – FDI and licensing




FDI as a share of GDP
Royalty and license fee payments/million population
Number of export processing zones and number of firms
in export processing zones
Investing in domestic R&D





Researchers in R&D
Researchers per million population
R&D spending as a percent of GDP
Scientific and technical articles
Patents per million population
Disseminating knowledge



Wide productivity differences across firms in
any sector in developing countries
Raising the average level to the best local use
can lead to sizable gains in efficiency
Still more can be gained by raising average
best local use to global best practice
Did Mongolian firms “innovate”?


Mongolia’s manufacturing base has been narrow but this
is not because firms have not attempted to export new
products
Every year in the period 2002-06




New exports were 30% of exports at the 4 digit HS level
Of these, 70 to 80% were new manufactured exports
But half of new exports were discontinued the following year,
and manufactured exports represented a large share of these
discontinued exports
The process of “self-discovery” has been hampered by
limited access to new technology & knowledge and access
to markets
Did Beninese firms “innovate”?

“Innovation” efforts in Benin have been low relative to other
countries in the region and the rest of the world


Contribution of manufacturing to value added was insignificant and
stagnated
Exports of manufactured goods declined dramatically as a share of gross
exports (from 22% to 1%)
Measuring “innovation” effort in Benin
Number of:
Exported goods
New exports
Discontinued exports
New exports discontinued next year
Export partners
2002
2003
2004
2005
2006
164
374
414
419
276
245
178
124
68
35
138
119
211
124
78
85
68
87
85
79
81
Source: Staff estimates using UN COMTRADE data, HS 4 digits.