crises, what crises?

Crises, What Crises?

Nauro F. Campos

Brunel University,

CEPR (London) and

WDI - University of Michigan

Cheng Hsiao

Department of Economics

University of Southern California

Jeffrey B. Nugent

Department of Economics

University of Southern California

ICE-TEA 2006

Turkish Economic Association

Ankara, Turkey

Reform literature: studies show that crises beget economic reforms, but largely silent on the question of which crises matter most Our Questions:

Reform literature: studies show that crises beget economic reforms, but largely silent on the question of which crises matter most Our Questions:1. Which types of crises matter most?

2. Do the effects differ from one type of reform to another (trade and labor market reforms)?

3. Do the effects of the economic crises on reform differ from region to region?

4. Are the reforms interrelated?

5. Are the answers to these questions sensitive to:

a. the relations between the different kinds of reform,

b. the relations between the different types of crises

c. institutional and other conditions?

1. Which types of crises matter most?

2. Do the effects differ from one type of reform to another (trade and labor market reforms)?

3. Do the effects of the economic crises on reform differ from region to region?

4. Are the reforms interrelated?

5. Are the answers to these questions sensitive to:

a. the relations between the different kinds of reform,

b. the relations between the different types of crises

c. institutional and other conditions?

1.Put together a unique data set covering more than 100 developed and developing countries for 5-year periods from 1950 to 2000.

2. Develop measures of two types of crises – economic and political – and two types of reform.

3. Estimate the determinants of these two reform indexes (LMR and TL).

4. Determine the sensitivity of the results to different measures of each type of crisis, interrelationships between the crises and reforms.

1.Put together a unique data set covering more than 100 developed and developing countries for 5-year periods from 1950 to 2000.

2. Develop measures of two types of crises – economic and political – and two types of reform.

3. Estimate the determinants of these two reform indexes (LMR and TL).

4. Determine the sensitivity of the results to different measures of each type of crisis, interrelationships between the crises and reforms.

To answer these questions, we

I. Introduction: On Reform: Theory and Empirical EvidenceI. Introduction: On Reform: Theory and Empirical Evidence

Even though there is gradual convergence in some kinds of policy reforms, such as in fiscal and monetary policy reforms, in other areas of reform, there is little or no convergence, with major countries remaining unreformed and others even reversing their earlier reforms, often as the benefits of thsee reforms appear not to be as strong as they had been anticipated.

While theoretical literature quite developed, empirical literature has lagged. What there is has been of the case study type or for short periods of time or cross-sectional.

Even though there is gradual convergence in some kinds of policy reforms, such as in fiscal and monetary policy reforms, in other areas of reform, there is little or no convergence, with major countries remaining unreformed and others even reversing their earlier reforms, often as the benefits of thsee reforms appear not to be as strong as they had been anticipated.

While theoretical literature quite developed, empirical literature has lagged. What there is has been of the case study type or for short periods of time or cross-sectional.

Reform Theory: Alesina and Drazen (1991) Drazen and Grilli (1993)Reform Theory: Alesina and Drazen (1991) Drazen and Grilli (1993)

While reform (like financial reforms) with virtually no losers is easy, that with losers (structural reforms) may be more difficult (Rodrik 1996)

Key hypothesis: Structural reforms require agreements

among the contending groups. War of attrition: Each party has an incentive

to hold out until the other party or group decides to make a concession.

Existence of a crisis can shorten the delay, forcing compromise and concessions earlier

Examples and anecdotal evidence offered usually focuses on economic crises but we suggest political crises also.

While reform (like financial reforms) with virtually no losers is easy, that with losers (structural reforms) may be more difficult (Rodrik 1996)

Key hypothesis: Structural reforms require agreements

among the contending groups. War of attrition: Each party has an incentive

to hold out until the other party or group decides to make a concession.

Existence of a crisis can shorten the delay, forcing compromise and concessions earlier

Examples and anecdotal evidence offered usually focuses on economic crises but we suggest political crises also.

Existing Empirical Evidence

Existing Empirical Evidence

Bruno and Easterly (1996): effect of hyperinflation on stabilization policy

Drazen and Easterly (2001): Effects of economic crises on subsequent economic performance: Mixed results

Alesina, Ardagna and Trebbi (2006) Stabilization likely to occur noy only following crisis but also in “honeymoon period” of a new government in presidential systems

Tornell (1998) Trade reform more likely when both economic crisis and political crises occur

However, Lora (1998), for LA only, shows only economic crises to have effect

Bruno and Easterly (1996): effect of hyperinflation on stabilization policy

Drazen and Easterly (2001): Effects of economic crises on subsequent economic performance: Mixed results

Alesina, Ardagna and Trebbi (2006) Stabilization likely to occur noy only following crisis but also in “honeymoon period” of a new government in presidential systems

Tornell (1998) Trade reform more likely when both economic crisis and political crises occur

However, Lora (1998), for LA only, shows only economic crises to have effect

II. Measuring Trade Liberalization, Labor Market Reform and CrisesII. Measuring Trade Liberalization, Labor Market Reform and Crises

* Trade liberalization measure Follow Sachs and Warner (1995) dichotomous measure

“OPEN” as updated and corrected by Wacziarg and Welch(2003) for 114 countries, 1970s and 1980s

We extend this back wherever possible to the 1950s (with other data from Gwartney, Lawson and Damira (2000), Penn World Tables and Index of Economic Freedom

A country was classified as Closed, i.e., OPEN=0, if any one or more of the following dummy variables was positive: (1) an average tariff rate of 40 per cent or more, (2) non-tariff barriers covering 40 per cent or more of trade, (3) a black market exchange premium of at least 20%, (4) a state marketing agency or board for major exports, and

(5) a socialist economic system (as defined by Kornai 1992).

* Trade liberalization measure Follow Sachs and Warner (1995) dichotomous measure

“OPEN” as updated and corrected by Wacziarg and Welch(2003) for 114 countries, 1970s and 1980s

We extend this back wherever possible to the 1950s (with other data from Gwartney, Lawson and Damira (2000), Penn World Tables and Index of Economic Freedom

A country was classified as Closed, i.e., OPEN=0, if any one or more of the following dummy variables was positive: (1) an average tariff rate of 40 per cent or more, (2) non-tariff barriers covering 40 per cent or more of trade, (3) a black market exchange premium of at least 20%, (4) a state marketing agency or board for major exports, and

(5) a socialist economic system (as defined by Kornai 1992).

Indexes of Labor Market Reform (LMR)

Indexes of Labor Market Reform (LMR)

These are all based on indexes of labor market rigidities or restrictions

For OECD countries: Blanchard and Wolfers (2000) (BW), index of

Employment Protection 1960-2000 for 5 year periods only

For LAC countries: Heckman and Pages (2000) from late 1980s to late 1990s. Computed as the present value of costs of dismissing a worker in formal sector according to job security regulation to the firm at time worker is hired (exclusive of court costs)

For other regions: Botero, Djankov, La Porta, Lopez-de-Silanes and Shleifer (2003) and extended by World Bank (2004) for other regions. This is a “Rigidity of Employment Laws Index based on three major subindices (difficulty of hiring, regidity of hours and difficulty of firing indexes), each of which is based on a number of more detailed indicators. This index is limited to the years beginning only in 1995

BW’s starting point is Index of Employment Protection (OECD 1999), OECD “late 1980s” and “late 1990s,” (based on inter alia ILO conventions, eg discrimination, child labor and fair dismissal), which they then extend by filling in in-between values by linear interpolation and then going back to 1960 on the basis of Lazear’s data and notice requirements and severance pay via backcasting

These are all based on indexes of labor market rigidities or restrictions

For OECD countries: Blanchard and Wolfers (2000) (BW), index of

Employment Protection 1960-2000 for 5 year periods only

For LAC countries: Heckman and Pages (2000) from late 1980s to late 1990s. Computed as the present value of costs of dismissing a worker in formal sector according to job security regulation to the firm at time worker is hired (exclusive of court costs)

For other regions: Botero, Djankov, La Porta, Lopez-de-Silanes and Shleifer (2003) and extended by World Bank (2004) for other regions. This is a “Rigidity of Employment Laws Index based on three major subindices (difficulty of hiring, regidity of hours and difficulty of firing indexes), each of which is based on a number of more detailed indicators. This index is limited to the years beginning only in 1995

BW’s starting point is Index of Employment Protection (OECD 1999), OECD “late 1980s” and “late 1990s,” (based on inter alia ILO conventions, eg discrimination, child labor and fair dismissal), which they then extend by filling in in-between values by linear interpolation and then going back to 1960 on the basis of Lazear’s data and notice requirements and severance pay via backcasting

Further Steps for LMR Indexes: What did we do?Further Steps for LMR Indexes: What did we do?

For LAC and other non-OECD countries: we backcasted and sidecasted these indexes for recent years backwards in time using variables like the following:

NEWEP = F (Dummy variables for Legal origins (French, English, German)

Time-Varying data on adoption of ILO Conventions (chldlb, forclb, abolfl, eqlrem, discrm)

Share of agriculture (and share squared) Quality of institutions index (property rights) Regional dummies

Key Data: Forteza and Rama (2001, World Bank) Number of obs = 148; R-squared = 0.8139;

Adj R-squared = 0.7928; Root MSE = 0.563

Used these coefficients and actual data to backcast and sidecast missing values.

For LAC and other non-OECD countries: we backcasted and sidecasted these indexes for recent years backwards in time using variables like the following:

NEWEP = F (Dummy variables for Legal origins (French, English, German)

Time-Varying data on adoption of ILO Conventions (chldlb, forclb, abolfl, eqlrem, discrm)

Share of agriculture (and share squared) Quality of institutions index (property rights) Regional dummies

Key Data: Forteza and Rama (2001, World Bank) Number of obs = 148; R-squared = 0.8139;

Adj R-squared = 0.7928; Root MSE = 0.563

Used these coefficients and actual data to backcast and sidecast missing values.

Convert TL and LMR indexes into the same 0-1 range

and same direction (higher values reflecting

Trade Liberalisation and Labor Market Reform as

in Lora (1998)

Subtract each value from the series maximum and

divide this by the series range (maximum minus

minimum value). Once all the variables are

collected, they are aggregated and transformed

into a 0 to 1 scale (with 1 indicating maximum

reform over countries and years

Convert TL and LMR indexes into the same 0-1 range

and same direction (higher values reflecting

Trade Liberalisation and Labor Market Reform as

in Lora (1998)

Subtract each value from the series maximum and

divide this by the series range (maximum minus

minimum value). Once all the variables are

collected, they are aggregated and transformed

into a 0 to 1 scale (with 1 indicating maximum

reform over countries and years

Next Step on LMR Indices

Measures of CrisesMeasures of Crises Political (3)

Political Instability: Principal components index of revolutions, coups, political assassinations during each 5 yr period (Banks 2005)

Inverse measure: Regime Durability (Polity IV) Civil War Intensity (Correlates of War Project)

Economic (4) Max fall in GDP No. of years in currency or debt crises Inverse Measure: Current Account Balance (CAB)

Political (3) Political Instability: Principal components index of

revolutions, coups, political assassinations during each 5 yr period (Banks 2005)

Inverse measure: Regime Durability (Polity IV) Civil War Intensity (Correlates of War Project)

Economic (4) Max fall in GDP No. of years in currency or debt crises Inverse Measure: Current Account Balance (CAB)

Measures of Political Institutions

Measures of Political Institutions

Party Fractionalization Index

Political Constraints Index (Henisz

2000)

Party Fractionalization Index

Political Constraints Index (Henisz

2000)

Figure 1. Trade Liberalisation and Labour Market Reform in Asia (n max=19)

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Trade liberalisation Labour market reform

Figure 2. Trade Liberalisation and Labour Market Reform in Europe (n max=21)

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Figure 3. Trade Liberalisation and Labour Market Reform in Africa (n max=44)Note: in 1950-54, 1955-59 and 1970-74 the average for trade liberalisation is zero.

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Figure 4. Trade Liberalisation and Labour Market Reform in Latin America (n max=24)

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Figure 5. Trade Liberalisation and Labour Market Reform in MENA (n max=18)

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Figure 6. Trade Liberalisation and Labour Market Reform in USA, Canada, New Zeland, Australia (n max=4)

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Panel Data EstimationPanel Data Estimation

Each Reform Index = F( Economic Crises, Political Crises,

Institutions) Test for Pooling across Regions:

Homogeneity across regions rejected Sensitivity Analyses

Alternative Measures of Crises Allowing feedbacks between the two

types of reforms both contemporary and with lags

Each Reform Index = F( Economic Crises, Political Crises,

Institutions) Test for Pooling across Regions:

Homogeneity across regions rejected Sensitivity Analyses

Alternative Measures of Crises Allowing feedbacks between the two

types of reforms both contemporary and with lags

Initial Model with No Feedback between Reform

Types

Initial Model with No Feedback between Reform

Types Ritc = α +β1Ptc + β2 Etc + β3Xtc + ε

where Ritc is reform index i at time t in country c

P = Intensity of Political Crises

E = Intensity of Economic Crises

X = Institutional and Other Controls

Ritc = α +β1Ptc + β2 Etc + β3Xtc + ε

where Ritc is reform index i at time t in country c

P = Intensity of Political Crises

E = Intensity of Economic Crises

X = Institutional and Other Controls

121 tctctcitc XEPR 121 tctctcitc XEPR 121 tctctcitc XEPR 121 tctctcitc XEPR 121 tctctcitc XEPR

Table 1 Effects on Trade Lib.Table 1 Effects on Trade Lib.SIGNS EXPECTED

ALL DEVEL AFRICA ASIA LAC

Max fall GDP +

+ *

Curr. Crises +

- *** - ** - ** - **

CAB - + ** + **

Regime Durab -

- ** + ** - **

Polit. Inst. +

+ ** + ** + **

Table 2 Labor Market Liberalization

Table 2 Labor Market LiberalizationSIGNS

EXPECTED

ALL DEV. AFRICA ASIA LAC MENA

Max fall GDP +

- * - ** - ***

Curr. Crises +

CAB - + *** + * + ***

Regime Durab -

+ *** + * + ***

+ **

Polit. Inst. +

- ** - **

Next Step: Sensitivity Analysis

Next Step: Sensitivity Analysis

Use alternative measures of both Economic and Political Crises Debt Crises (Economic) Civil War Intensity (Political)

Repeat Tables 1, 2 substituting these alternative measures for Currency Crises and Regime Durability

These results given in Tables 3, 4

Use alternative measures of both Economic and Political Crises Debt Crises (Economic) Civil War Intensity (Political)

Repeat Tables 1, 2 substituting these alternative measures for Currency Crises and Regime Durability

These results given in Tables 3, 4

Table 3 Trade LiberalizationTable 3 Trade LiberalizationSIGNS EXPECTED

ALL DEVEL AFRICA ASIA LAC

Max fall GDP +

+ *

Debt Crises +

- ** - * - * - **

CAB - + **

Civil War Intensity-

- ** * - ** - ** - *

Polit. Inst. +

+ *** + * + **

Table 4 Labor Market Reform

Table 4 Labor Market Reform

Neither Debt Crises nor Civil War Intensity has a significant effect in any region

While effects of Max Fall GDP no longer significant , those of CAB and Political Instability have very similar effects as in Table 2

Neither Debt Crises nor Civil War Intensity has a significant effect in any region

While effects of Max Fall GDP no longer significant , those of CAB and Political Instability have very similar effects as in Table 2

Next Step: Allow for lagged effects across Reforms

Next Step: Allow for lagged effects across Reforms

Trade Lib affected by Lagged LMR

Ritc= α0+α1Rjt-1c+β1Ptc+β2Etc+β3Xtc+ ε LMR affected by Lagged Trade

Liberalization Tables 5, 6 repeat the

specifications of Tables 1, 2, respectively, with this added variable in each case

Trade Lib affected by Lagged LMR

Ritc= α0+α1Rjt-1c+β1Ptc+β2Etc+β3Xtc+ ε LMR affected by Lagged Trade

Liberalization Tables 5, 6 repeat the

specifications of Tables 1, 2, respectively, with this added variable in each case

Table 5 for Trade Liberalization

Table 5 for Trade Liberalization

Lagged Labor Market Reform Variable has significant negative effects in Africa, LAC

The Max Fall GDP still has positive effect only in LAC

Currency Crisis still has negative effects in All, DEV, Africa and LAC

CAB still has positive effects in All, Africa Regime Durability still has positive effects

in DEV, negative effects in All, Africa Political Instability still has positive effects

in All, DEV, LAC and MENA

Lagged Labor Market Reform Variable has significant negative effects in Africa, LAC

The Max Fall GDP still has positive effect only in LAC

Currency Crisis still has negative effects in All, DEV, Africa and LAC

CAB still has positive effects in All, Africa Regime Durability still has positive effects

in DEV, negative effects in All, Africa Political Instability still has positive effects

in All, DEV, LAC and MENA

Table 6 for LMRTable 6 for LMR Lagged Trade Liberalization has

significant positive effects on LMR in All, Africa, and Asia

Effects of Max Fall GDP remain Negative and Significant in All, Asia and Transition

Effects of CAB remain Positive and Significant in All, DEV and Africa

Effects of Political Instability remain negative in All, Africa

Effects of Regime Durability Remain Positive in All, DEV, Asia, MENA

Lagged Trade Liberalization has significant positive effects on LMR in All, Africa, and Asia

Effects of Max Fall GDP remain Negative and Significant in All, Asia and Transition

Effects of CAB remain Positive and Significant in All, DEV and Africa

Effects of Political Instability remain negative in All, Africa

Effects of Regime Durability Remain Positive in All, DEV, Asia, MENA

Final Step: Allow for Simultaneous Interaction between the Two

Reform Variables: 2SLS Estimates

Final Step: Allow for Simultaneous Interaction between the Two

Reform Variables: 2SLS Estimates Ritc= α0+α1Rjtc+β1Ptc+β2Etc+β3Xtc+ ε Difficulty of Identifying Good Instruments. Can no longer

have identical specifications. We exclude Max Fall GDP from Trade Lib, Currency Crises and CAB from LMR

Multicollnearity also present Results in Table 7 for Trade Lib. weaker, with fewer

significant determinants. But in No case is there a sign reversal. No support for

Econ. Crisis Begets Reform (Curr Crisis, CAB) have opposite sign

Support for Political Crisis remains: Regime Durability negative, significant,in Africa, Pol Instability positive, though not statistically significant

For no region and for each reform is there evidence of simultaneous feedback between the reforms.

Ritc= α0+α1Rjtc+β1Ptc+β2Etc+β3Xtc+ ε Difficulty of Identifying Good Instruments. Can no longer

have identical specifications. We exclude Max Fall GDP from Trade Lib, Currency Crises and CAB from LMR

Multicollnearity also present Results in Table 7 for Trade Lib. weaker, with fewer

significant determinants. But in No case is there a sign reversal. No support for

Econ. Crisis Begets Reform (Curr Crisis, CAB) have opposite sign

Support for Political Crisis remains: Regime Durability negative, significant,in Africa, Pol Instability positive, though not statistically significant

For no region and for each reform is there evidence of simultaneous feedback between the reforms.

Table 8 for LMRTable 8 for LMR

No Simultaneous feedback in Reforms

For DEV only is there a positive, significant effect of Economic Crisis on LMR

Political Instability Hinders LMR Because of multicollinearity and

identification problems, cannot reject possibility of feedbacks between the two reforms, but certainly does not support this.

No Simultaneous feedback in Reforms

For DEV only is there a positive, significant effect of Economic Crisis on LMR

Political Instability Hinders LMR Because of multicollinearity and

identification problems, cannot reject possibility of feedbacks between the two reforms, but certainly does not support this.

CONCLUSIONSCONCLUSIONS Robustness checks of Tables 3-8 generally find

very similar results as in Tables 1, 2 Political Crises seem to be more important

determinants of reform than Economic Crises For political crises the effects differ in sign

between the two reforms: Negative of LMR Positive on trade liberalization

Heterogeneity in results across regions: should not pool

Other determinants: Level of GDP, Institutions (Party Fractionalization) Both Positive for TL and negative for LMR

Robustness checks of Tables 3-8 generally find very similar results as in Tables 1, 2

Political Crises seem to be more important determinants of reform than Economic Crises

For political crises the effects differ in sign between the two reforms: Negative of LMR Positive on trade liberalization

Heterogeneity in results across regions: should not pool

Other determinants: Level of GDP, Institutions (Party Fractionalization) Both Positive for TL and negative for LMR

Future ResearchFuture Research Instead of determining only levels

of TL and LMR in each country and period, should also determine Speeds of implementation

Conduct detailed case studies to determine why the effects of political crises vary across regions as well as types of reform

Investigate the determinants of other reforms (financial sector reform, privatization, etc.

Instead of determining only levels of TL and LMR in each country and period, should also determine Speeds of implementation

Conduct detailed case studies to determine why the effects of political crises vary across regions as well as types of reform

Investigate the determinants of other reforms (financial sector reform, privatization, etc.

crises, what crises?

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