The Economics of Preconditions Changing Perspectives on Development

Célestin Monga

The World Bank

Hanoi, Vietnam , June 29, 2014

Outline

• 1. Prelude: background

• 2. Traditional formula for prosperity

• 3. Some lessons from history and experience

• 4. Beating the odds: a different perspective

1. Prelude: background

• Oxford Handbook of Africa and Economics – Objectives – Support from UNU-Wider, the AfDB, the WBG, Peking

University

• A project that cannot be summarized – 2 volumes, 93 chapters, 720,000 words, – 143 contributors/wide variety of views

• T. Addison, E. Akeampong, E. Aryeetey, A. Basu & K. Basu, A. Berg, J.-C. Berthelemy, H. Bhorat, A. Bigsten, F. Bourguignon, H.-J. Chang, P. Collier, J. de Melo, A. Demirguc-Kunt, I. Elbadawi, A. Fosu, A. Gelb, S. Golub, J. W. Gunning, M. Jerven, C. Juma, D. Leipziger, P. Masson, A. Mbaye, M. McMillan, R. Myerson, M. Nabli, M. Ncube, B. Ndulu, Y. Nyarko, J. Page, C. Pattillo, J.-P. Platteau, S. O’Connell, V. Ramachandran, J. Sachs, J. Stiglitz, F. Tarp, N. van de Walle, T. Yousef

• This presentation is just one small theme among many takeaways

2. Traditional recipe for prosperity

Economic Prosperity

Macro Stabilization

Structural and Institutions

Reforms

A well-known formula

The typical policy prescription: why can’t we read this table?

Policy Recommendations Justification

Macro Stabilization Fiscal Discipline To curb large deficits that led to balance of payments crises and high inflation

Tax reform To construct a tax system that combines a broad tax base with moderate marginal tax

rates

Reordering Public Expenditure Priorities To switch expenditure in a pro-poor way, from things like indiscriminate subsidies to

basic health and education

Restrictive monetary policy To keep inflation in check and gain credibility

A Competitive Exchange Rate To mitigate external shocks and limit balance of payments deficits

Structural and Institutional Reforms Liberalizing Interest Rates To end financial repression and capital flight

Liberalizing the financial sector To end financial repression and improve intermediation

Liberalization of Inward Foreign Direct Investment To attract foreign savings and stimulate knowledge transfers

Trade Liberalization To eliminate distortions and stimulate competitive exports

Privatization To eliminate distortions, alleviate the cost of poorly-managed public enterprises on

public finance, and encourage competition

Public sector reform To alleviate the burden of the public administration on public finance and make it more

consistent with the needs of a “modern” economy

Deregulation To ease barriers to entry and exit and establish a level playing field among firms

Protecting Property Rights To provide the informal sector with the ability to gain property rights at acceptable cost

Liberalizing labor markets To provide the flexibility that firms need to be able to hire and fire workers

Human capital To provide the public sector and private sector firms the skills base needed for

development

Improve the Business Environment To remove all binding constraints to growth, build infrastructure, and stimulate private

sector development

Improve Governance To strengthen administrative institutions, fight corruption and rent-seeking, and create a

transparent public sector

Sectoral Reforms and Strategies of various kinds

(agriculture, electricity, water, telecommunications, etc.)

To set objectives that are consistent with the medium-term budget framework and the

long-term development goals

Do preconditions really matter? (1) Institutions

Who is Corrupt? “Us” versus “Them”?…

3. Some lessons from history and experience

Denmark USA

Kenya Cameroon

1st 19th

139th 144th

Who is Corrupt? Digging Deeper…

Corruption Perceptions Index 2012 (TI)

Vietnam China

Brazil

80th

Namibia

69th

123th

58th

…Digging Deeper: Are we missing something?

Corruption Perceptions Index 2012 (TI)

Economy

Average GDP

Growth Rate

(in real terms)

Control of Corruption

Estimated Score for 2012

(score range:

[-2.5, 2.5])

Ranking Control

of Corruption in

2012

Equatorial Guinea 19.2 -1.560085255 209

China 10.9 -0.479073297 128

Bosnia and H. 10.8 -0.295258322 107

Liberia 10.4 -0.572920228 139

Cabo Verde 9.3 0.805703921 55

Macao SAR, China 8.9 0.449983828 64

Bhutan 7.8 0.823781825 48

Qatar 7.6 1.188926581 35

Vietnam 7.4 -0.556690187 136

Cambodia 7.4 -1.044015514 180

Lao PDR 7.3 -1.040884898 179

Uganda 7.2 -0.952185531 173

Mozambique 7.2 -0.589683048 141

India 7.1 -0.565264835 137

Angola 7.0 -1.294966715 200

Ethiopia 6.9 -0.604427096 144

Chad 6.8 -1.250439897 198

Rwanda 6.5 0.655002436 58

Singapore 6.5 2.153674165 7

Panama 6.3 -0.385142527 118

Myanmar 6.2 -1.115515598 186

Dominican Republic 6.1 -0.83285887 162

Malaysia 6.0 0.299848067 73

Ghana 6.0 -0.086503059 94

Jordan 5.9 0.069474877 83

Burkina Faso 5.9 -0.519267661 130

Kuwait 5.9 -0.16094733 99

Bangladesh 5.8 -0.86536479 166

Sri Lanka 5.7 -0.239610237 102

Azerbaijan 5. 7 -1.073756953 182

Puzzling! The Top 30

Fastest-Growing Economies in the World, 1992-2012

Control of Corruption: Estimated Score from the WGI project

-2-1

01

2

Ag

gre

ga

te W

GI in

dic

ato

r

0 20000 40000 60000 80000GNI per capita (Atlas Method, Current US$)

The Algebra of Mystery: Solving the Puzzle

Per Capita GNI and WGI in a Sample of Countries, 2010

Correlation

Coefficient with

GNI per capita

(2010)

Correlation

Coefficient

with GNI

per capita

(2002)

Correlation

Coefficient

with GNI

per capita

(1996)

Rule of Law 0.7853* 0.7524* 0.7247*

Control of Corruption 0.7966* 0.7977* 0.7335*

Voice and Accountability 0.6339* 0.5384* 0.5618*

Political Stability and

Absence of Violence 0.4972*

0.5709*

0.5340*

Government Effectiveness 0.8003* 0.7852* 0.7533*

Regulatory Quality 0.7491* 0.7287* 0.6698*

Number of Observations 172 172 172

Economic Performance and Quality of Governance, 2010 Correlation Coefficients for 3 different years

Do preconditions really matter? (2) Physical capital

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

195

0

195

2

195

4

195

6

195

8

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0

196

2

196

4

196

6

196

8

197

0

197

2

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8

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0

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2

199

4

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6

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8

200

0

200

2

200

4

200

6

200

8

201

0

China: Real GDP per Capita

(1990 International Geary-Khamis dollars)

1979: China only had 2,874 km of railways.

Less than Zimbabwe, Mozambique, Uruguay today

Compare with India’s 64,500 km in 2013

and Russia’s 128,000 km in 2012

Do preconditions really matter? (3) Human capital

0

1000

2000

3000

4000

5000

6000

7000

8000

1870

1874

1878

1882

1886

1890

1894

1898

1902

1906

1910

1914

1918

1922

1926

1930

1934

1938

1942

1946

1950

1954

1958

1962

1966

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

2010

:

Brazil: Real GDP per Capita

(1990 International Geary-Khamis dollars)

1993: Average years of schooling: about 4 (lower than Cuba or

Ghana)

1968: Average years of schooling: about 2

020

40

60

80

1950 1970 1990 2010Year

Any college (%) High school or more (%)

.05

.1.1

5.2

.25

.3

Any c

olle

ge/H

igh s

chool or

more

0 20 40 60 80High school or more (%)

China

China: did not meet any precondition on human capital

Source: Paxson (2013)

Do preconditions really matter ? (3) Human capital

Italy: Average Years of Schooling and GDP Per Capita, 1870-2010

1980 2012 United States 11.9 13.3

Poland 7.7 11.6

France 6 11.9

Italy 6.1 11.7

Spain 5 10.8

Portugal 4.8 10

Singapore 3.7 10

China 3.7 10.7

Vietnam 4.3 5.8

Brazil 2.6 8.3

Cuba 6.5 11.7

Ghana 3.6 5.6

https://data.undp.org/dataset/Mean-years-of-schooling-of-adults-years-/m67k-vi5c

Average Years of Schooling (25 years and older), 1980 and 2012

Do preconditions really matter ? (3) Human capital

Do preconditions really matter? (4) Financial institutions

Stock Market Capitalization and GDP Private Credit and GDP

'Obstacle' Mean Reported Value

Overall Bangladesh Nigeria Singapore

Taxes and Regulation 2.97 3.03 3.10 1.55

Political Instability 2.83 3.08 3.43 1.50

Inflation 2.83 2.86 3.21 1.61

Financing 2.81 2.60 3.11 1.97

Exchange Rate 2.59 3.09 2.92 1.88

Street Crime 2.54 3.07 3.30 1.22

Corruption 2.54 3.61 3.37 1.28

Anti-Competitive Behavior 2.39 2.40 1.58

Infrastructure 2.27 3.68 1.42

Judicial Efficiency 2.16 2.38 1.32

Obstacles to firm growth reported by over 6000 firms in 80 countries. Reported value between 1 and 4, where 1 indicates no obstacle and 4

indicates major obstacle.

Source: Ayyagari, Demirguc-Kunt, and Maksimovic (2005)

Do preconditions really matter ? (5) Investment climate variables

Responses to surveys can be misleading

Obstacle Estimated Economic Impact

Overall Bangladesh Nigeria Singapore

Financing -0.101** -0.094** -0.112** -0.070**

Street Crime -0.096** -0.117** -0.125** -0.046**

Political Instability -0.074** -0.080** -0.089** -0.039**

Inflation -0.031 -0.031 -0.035 -0.018

Judicial Efficiency -0.011 -0.012 -0.007

Taxes and Regulation -0.006 -0.006 -0.006 -0.003

Corruption 0.013 0.018 0.017 0.006

Infrastructure 0.018 0.029 0.011

Exchange Rate 0.041 0.049 0.047 0.030

Anti-Competitive Behavior 0.043 0.043 0.028

Estimated Economic Impact is the effect on Firm Growth of a change in the Obstacle by its relevant (overall or country-specific) sample mean.

Investment Climate Variables: Estimated Impact on Firm Growth

Managers often get it wrong when reporting on preconditions!

Source: Ayyagari, Demirguc-Kunt, and Maksimovic (2005)

• Wrong reference (model-economy) • Extraverted intellectual focus • Obsessive search for the “missing” elements—

open-ended exercise • Large number of “binding constraints” and policy

frameworks as laundry lists • Limited resources and administrative capacity

stretched too thin • Political feasibility considerations and issues of

political timing

The trouble with traditional approaches and preconditions

400

2700

1100

1600

0 500 1000 1500 2000 2500 3000

Scenario A

Scenario B

Increase in Global Exports Increase in Global GDP

Good prospects ahead: GVC as game changers

Reducing supply chain

barriers (Scenario B)

could increase global GDP up

to 6 times more

than removing all import

tariffs (Scenario A)

4. Beating the odds: New perspectives

Employment levels: there are opportunities out there for LICs

22

China

Source: Haraguchi (2014)

Tanzania’s example: Not everything everywhere is critical!

7/1/2014 23

Source: Dinh and Monga (2013)

• Focusing on existing conditions and making the most of them—complete change of perspective: no ideal world

• Using limited state resources strategically and wisely Selecting areas of focus: More strategically-targeted infrastructure and institutional

settings

Roles of various levels of government

Rules of the game (transparency, time-limits, collective action, etc.)

• Pragmatic government interventions to overcome issues of coordination and externalities, which no individual firm can address alone effectively.

• Importance of quick wins/political economy considerations

• Focus development thinking on jobs and productivity growth

• Encourage learning not only within firms but also among firms

• Proactive strategies to attract FDI and develop manufacturing

• Encouraging trade through clustering (industrial parks with forward and backward linkages to the national economy; role for development banks with transparent rules and competent staff).

Summing up: a few (random) thoughts