54321 ResearchDigest World Bank VOLUME 4 L NUMBER 3 L SPRING 2010 What Constrains Africa's Exports? I n a recent paper Freund and Rocha While all types of delays (and for- IN THIS ISSUE focus on three trade costs that con- eign tariffs) are found to reduce ex- What Constrains Africa's strain Sub-Saharan Africa's exports: ports, inland-transit delays have the Exports? ... page 1 inland transit, bureaucracy, and cus- largest negative impact on the export Analysis of how different trade costs affect toms and ports. Using detailed data values of new products. It is estimated Africa's exports shows that uncertainty in from the World Bank's Doing Business that a one-day decrease in the inland- road transport has the biggest impact report, the authors test whether these transit time increases exports of new costs have different effects on trade. products by 7 percent and is equiva- FOCUS Doing Business provides informa- lent to about a 1.5 percent decrease in Different Paths to a Global Climate tion on the average time it takes for all import tariffs of partner countries. Agreement ... page 2 an exporter to complete a series of What explains the dominance of One approach to reducing global emissions procedures when moving goods from transit time? In African countries tran- could bring initial successes that pave the the country's principal city to the sit time is highly variable and little can way to harder targets port of exit and onto a ship. Getting a be done to mitigate the uncertainty. Economic Shocks and Labor Market product from factory to ship takes far This means that exports cannot be Outcomes ... page 3 longer in Sub-Saharan Africa than in guaranteed for a specific date. The A study of how economic shocks affect labor other regions. In Sub-Saharan Africa authors show that only uncertainty in markets suggests where to focus policy documentation procedures take nearly road transport (measured as the maxi- responses four times as long as in developed mum time less the average time in the countries on average, while customs country) has a negative and signifi- Why Have Developing-Country Data and port procedures and inland transit cant effect on exports. Uncertainty in on Real Incomes Been Revised take three times as long. documentation times may be less im- So Much? ... page 4 To examine which cost is most det- portant because documents often can A new paper explains the reason for the rimental, the authors use the gravity be prepared in advance. In addition, large data revisions--and proposes a way to equation, which describes aggregate while exporters may be able to pay at reduce the need for them bilateral trade as a function of the size the port to get things out more quickly What Does the Financial Crisis Teach Us of two countries and the distance be- when necessary, little can be done on about Different Banking Models? ... page 5 tween them. After controlling for these the road. There may be limits to how far banks can standard determinants of trade, the The results point to improvements steer away from the traditional banking analysis includes the variables of in- in inland transit as key to stimulat- model terest: documentation, inland transit, ing Africa's exports. The focus should and customs and port delays. be on road systems--especially in- Density and Disasters: Economics of Urban To ensure that the results are not frastructure, security, and policies Hazard Risk ... page 6 biased because of a positive effect of that improve competition in trucking. How people respond to the risk from natural trade on trade facilitation, the authors While improving ports and customs hazards in a city can depend on its size investigate the effects that documen- and reducing bureaucracy would help, tation, inland transport, and customs improving inland transit would have How Financial Crises in Donor Countries and port times have on exports of roughly five times the impact. Affect Aid ... page 7 products that were new to the country What do patterns of aid giving by donor in 2005­07. The intuition is that trade countries hit by financial crises in the past Caroline Freund and Nadia Rocha. 2009. "What suggest about what may lie ahead? in new goods cannot affect the quality Constrains Africa's Exports?" Policy Research of trade facilitation infrastructure or Working Paper 5184, World Bank, Washington, the bureaucracy in place for exporting. DC. 2 World Bank ResearchDigest FOCUS Different Paths to a Global Climate average greenhouse gas emissions per Agreement unit of electricity produced could be negotiated separately. Financial and to engender broad participation and technical cooperation to change incen- A sector-focused approach to significant commitments to reduce tives leading to deforestation could be reducing greenhouse gas emissions emissions. expanded following approaches already offers promising potential The main approach to establishing being implemented--and incorporating C international agreement on limiting a range of environmental values such as ontrolling the greenhouse gas greenhouse gas emissions has focused biodiversity as well as reduced releases emissions that lead to climate on negotiating national emissions tar- of carbon dioxide from tree cutting and change is a global challenge. gets and timetables for meeting them. burning. Global emissions continue to grow This approach provides flexibility for Barrett and Toman observe that at a rate that leaves many scientists countries to cost-effectively meet their implementing different targets and greatly concerned about the longer- national targets by tailoring their own compliance strategies for different term risks to agriculture, water re- mitigation policies. It also provides emissions sources is likely to be cost- sources, coastal areas, ecosystems, scope for mutually beneficial coopera- lier than implementing national tar- and human health. Moreover, unlike tion in emissions reduction through gets and timetables, because the cost more local or regional pollution prob- investment by developed countries per unit of emissions avoided could lems, the effects of greenhouse gases to reduce greenhouse gas emissions vary considerably across sources. But do not depend on where the emis- in developing countries, in exchange the advantage of the approach based sions occur. for "credits" that count toward the in- on national targets cannot be real- Most of the accumulation of vesting country's national emissions ized if political economy challenges greenhouse gases in the atmosphere target. preclude agreement. Moreover, nego- today is a result of emissions by This approach to agreement may tiations over sector-level performance wealthier countries since the begin- have to be fairly weak to attract suf- standards, and targeted assistance in ning of industrialization. But emis- ficiently broad participation, thus de- technology innovation and transfer, sions are growing much more rapidly feating the purpose. Agreement that provide clear links to country develop- in the developing world, as a result of entails negotiation over national tar- ment strategies (such as power sector economic advances associated with gets involving major, costly actions to modernization). In contrast to what greater use of fossil fuels, as well as reduce emissions may be quite hard to are sometimes perceived as "zero population increase and impacts of achieve or sustain; either compliance sum" negotiations to divide the costs deforestation. (Emissions in Sub- costs will be very unevenly distributed of greenhouse gas mitigation among Saharan Africa remain small, but this across countries or large and political- countries, the sectoral approach of- is not good news because it reflects ly problematic resource transfers may fers greater prospects for countries the stagnation of economic progress be required to induce broad participa- to achieve meaningful agreement on there.) tion. The difficulties encountered in limiting emissions that they can see as Arresting climate change therefore agreeing on follow-on targets for emis- being in their own interest. requires coordinated international ac- sions limits during the December 2009 Ultimately, the sectoral approach tions. To succeed, international agree- Copenhagen negotiations underscore does not provide assurance that ments need to provide shared benefits the challenges. growth in greenhouse gas emissions and maintain broad participation over A recent paper by Barrett and Toman can be arrested and reversed to protect the long run by developed and de- examines another approach for future against dangerous human-induced veloping countries alike. Agreements climate change mitigation, involving a changes to the global climate sys- also need to incorporate credible set of loosely coordinated international tem. But the two approaches are not and significant obligations to reduce agreements on specific policy measures mutually exclusive. Initial successes emissions. to address different emissions sources. in reducing emissions through sec- Meeting all these conditions is re- For example, emissions in the trans- tor- and technology-based approaches markably difficult. Broad participation port sector could be addressed through could produce enough confidence, and can be achieved by incorporating only negotiation of common targets for in- enough affordable low-carbon energy minimal obligations, but this does creasing vehicle fuel economy and col- alternatives, to ease the international little to reduce the risks of climate laborative research and development community's transition to harder tar- change. The same is true if countries to expand options for affordable shifts gets for reducing global emissions. that contribute significantly to global to lower-emission renewable energy emissions do not participate. Yet the sources. Similarly, energy efficiency Scott Barrett and Michael Toman. 2010. "Con- widely varying socioeconomic circum- standards for appliances and heating trasting Future Paths for an Evolving Global stances of countries make it difficult and cooling systems could be coordi- Climate Regime." Policy Research Working Paper to ensure sufficient shared benefits nated. Common targets for reducing 5164, World Bank, Washington, DC. World Bank Research Digest 3 Economic Shocks and Labor Market Outcomes New research explores mechanisms knowledge using an adaptation of comparatively lower, but so was job through which economic shocks "search and matching" models to ac- creation. More generally, the simula- affect labor markets commodate the complex nature of tions show that the overall effect of W labor markets in de- the shock is smaller hile the developing world veloping countries. The effectiveness of when it is highly con- has made steady progress The model allows for centrated in the most in recent years in creat- the existence of dif- any policy response dynamic segment of ing more and better jobs, there is a ferent labor market to an economic shock the labor market-- growing concern that the recent eco- segments that pay manufacturing--and nomic downturn may threaten or even different wages, have hinges on a sound the other sectors can overturn this progress. If it does so, different outputs per understanding of how act as a buffer. prompt intervention may be required worker, and are sepa- These results, to avoid irreparable long-term dam- rated by barriers to labor markets adjust which are consistent age. The effectiveness of any policy mobility such as mi- with evidence from response hinges on a sound under- gration costs. Workers other crises, suggest standing of how labor markets adjust either are employed in agriculture or that policy responses to economic cri- to shocks, such as through a reduction the formal or informal urban sector or ses should focus on: in the number of people employed or are unemployed, and they can move · Reducing turbulence by prevent- wage adjustments that occur through between sectors. Economic shocks are ing excessive job shedding ("over- across-the-board wage reductions or a manifested as either increased turbu- churning") in the formal sector shift into lower-paying jobs. The opti- lence (firms are more likely to face bad · Strengthening the buffering abil- mal policy response will depend on times) in the formal or informal sector ity of the informal and agricultural the adjustment mechanism: programs (or both) or a decrease in overall sec- sectors and facilitating relocation that target the working poor, such as toral productivity (all firms in the given · Providing, at the same time, cash transfers or income tax credits, sector face bad times). income support for those who may be a more appropriate response By calibrating the model to the lose out in the process to reductions in earnings, while pro- Indonesian and Mexican econo- The types of interventions that can grams such as unemployment insur- mies, the authors explore how the be used to achieve these objectives ance or public works would mitigate Indonesian crisis in 1998 and the vary from temporary payroll holidays job loss. Mexican recession in 2001 translated or wage subsidies to improved access While such adjustment mecha- into observed labor market outcomes. to credit--and, more generally, fiscal nisms are well documented, the They then use the information derived stimulus to boost demand. But hard channels through which they occur from these experiences to simulate the evidence on the relative effectiveness are poorly understood, and formal expected impact of the recent financial of these policies in times of crisis is models of the labor market used in crisis on labor market trends in the very limited and remains an area open research studies are not equipped to same countries. for future research. make predictions about the effects of The results suggest that in both policy responses to economic crises. countries past crises have increased Moreover, since high-frequency data the turbulence in the formal sec- on labor market outcomes are rarely tor, with higher job shedding but available in developing countries, pol- no decline in job creation. But the icy responses to economic shocks are adjustment mechanisms in both the often designed using anecdotal infor- formal and the informal sector dif- mation, evidence from past crises, and fered between the two countries. In extrapolations that are based on the Indonesia the crisis led to a reduction experience of developed economies. in productivity and wages in the formal This is clearly unsatisfactory, because sector and to an increase in turbulence a growing body of evidence suggests and job destruction in the informal Catalina Gutierrez, Pierella Paci, and Beom that labor markets in the developing sector, which limited the capacity of S. Park. 2010. "Understanding the Impact of world operate very differently from this sector to cushion the adjustment. Economic Shocks on Labor Market Outcomes in those in advanced economies. The country actually benefited from Developing Countries: An Application to Indone- A recent paper by Gutierrez, Paci, an exogenous increase in the price of sia and Mexico." Policy Research Working Paper and Park seeks to bridge this gap in rice. In Mexico job destruction was 5283, World Bank, Washington, DC. 4 World Bank ResearchDigest Why Have Developing-Country Data on Real Incomes Been Revised So Much? A new method for updating PPPs in countries where real wage rates are surveys (which are many years apart) between survey rounds could lower. This is the essence of the well- do not take account of how economic greatly reduce the need for large known Balassa-Samuelson model. growth affects the price structures data revisions in the future By considering both traded and non- within developing economies--that traded goods, PPPs allow more valid is, they essentially ignore the Balassa- T real income comparisons. Because Samuelson mechanism--even though he International Comparison real wages tend to be this was the main Program (ICP) collects the survey lower in poorer coun- reason that PPPs data on prices across countries tries, we also observe The methods currently were estimated in that are used to estimate purchasing lower price-level used for updating the first place. The power parity exchange rates ("PPPs" indices--the PPP de- current method used for short). These are then used to flated by the market PPPs in lieu of new by the World Bank's make international comparisons of exchange rate, or the ICP price surveys do World Development real incomes and for other purposes, inverse of the real Indicators (and oth- including measuring global poverty exchange rate--in not take account of ers) simply adjusts and inequality. those countries. This how economic growth for inflation since the The results of the latest ICP round, is often called the last ICP round. That for 2005, led to downward revisions to Penn effect, after the affects the price means that, for ex- real GDP for many developing coun- Penn World Tables. structures within ample, all the growth tries. In one dramatic and much- The motivation and structural change publicized example the World Bank's for the new empiri- developing economies in China between estimate of China's real GDP for 2005 cal work summarized 1993 and 2005 were fell by 40 percent. There were other here is the observa- essentially ignored in large revisions, stemming entirely tion that the Penn effect should also updating the country's PPP before the from the new PPPs from the 2005 ICP. hold over time if the data are in rea- 2005 ICP. That is the main reason why The interpretation of these revi- sonable accord with the assumptions such a large data revision was needed sions is clouded by the fact that many of the Balassa-Samuelson model. As when the new data on prices in China changes in data and methods were poor countries grow, the labor produc- became available from the 2005 ICP introduced in the 2005 ICP round. tivity of their traded-goods sector will round. These changes have cast doubt on the tend to rise, spilling over to wages in A better approach would be to intertemporal comparability of the producing nontraded goods, and so bring the dynamic Penn effect explic- resulting PPPs. Some observers have their price structures should become itly into the model for updating the questioned the new PPPs; one promi- more like those of developed coun- price-level index for nonbenchmark nent academic wrote that the new PPP tries. The PPP will move closer to the years, and then use market exchange for China was "weird" and "implau- market exchange rate. We can call this rates to back out the implied PPPs. sible." Some have been led to doubt the dynamic Penn effect. Ravallion proposes a simple and fea- the veracity of the whole exercise of The paper finds strong evidence sible way of doing this, and shows that making international comparisons of of the dynamic Penn effect. On its this method could greatly reduce the real incomes and poverty measures. own, this effect accounts for about a need for such large data revisions in Can we make sense of the changes fifth of the variance in the proportion- the future. in PPPs between ICP rounds? What ate changes in the log price levels in accounts for the large revisions to es- 1993­2005. An augmented version of timates of real GDP for the same year? the basic model, allowing for measure- A new paper by Ravallion tries to ment error in the PPPs not based on answer these questions by comparing ICP price surveys, can explain almost the latest PPPs with those from the half the variance in the proportionate previous round, for 1993. To motivate changes in price levels. For the pur- the empirics, we need to step back a pose of predicting changes in PPPs, bit to recall why we use PPPs in the the paper finds that 99 percent of their first place. Market exchange rates can variance between the 1993 and 2005 be expected to (eventually) equate ICP rounds can be explained by just purchasing power only over inter- two variables: GDP growth rates and Martin Ravallion. 2010. "Price Levels and Eco- nationally traded goods. There are changes in nominal exchange rates. nomic Growth: Making Sense of the PPP Changes also nontraded goods, such as most But the methods currently used for between ICP Rounds." Policy Research Working services, which are naturally cheaper updating PPPs in lieu of new ICP price Paper 5229, World Bank, Washington, DC. World Bank Research Digest 5 What Does the Financial Crisis Teach Us about Different Banking Models? Banking strategies that rely of banks' activity mix and funding strat- So how do these two strategies preponderantly on noninterest egy for their risk and return, using a affect a bank's risk and return? The income or nondeposit funding sample of 1,334 banks in 101 countries authors measure a bank's return by appear to be very risky leading up to the 2007 financial crisis. its return on assets. The main mea- On the funding side, the crisis has sure of bank risk used is the distance T clearly exposed the dangers of a bank's to default or z-score, defined as the he recent financial crisis has excessive reliance on wholesale fund- number of standard deviations that a seen the demise of large invest- ing. Similarly, on the asset side, weak- bank's return on assets has to fall for ment banks in the United States. nesses were exposed when large U.S. the bank to become insolvent. The au- This major change in the financial investment banks, faced with the crisis, thors find that a bank's rate of return landscape has rekindled interest in disappeared from the banking scene. and its risk both increase with its fee discussion of optimal banking mod- To understand differences in bank as- income share, suggesting trade-offs. els. Around the world, perceived costs set and funding strategies, or business The results suggest that increasing the and benefits of combining bank ac- models, the authors construct bank- fee income share can yield some risk tivities of different kinds have given level indices of the share of noninterest diversification benefits when starting rise to a wide variation in the activi- (fee) income in total income and the from very low levels. In contrast, non- ties allowed. Should banks operate share of nondeposit funding in total deposit, wholesale funding lowers the as universal banks, a model allowing short-term funding. The results sug- rate of return on assets, though it can banks to combine a wide range of gest substantial cross-bank variation also offer some risk reduction benefits, financial activities, including commer- in business models employed in the again at low levels. cial banking, investment banking, and 1995­2007 period. These results provide a strong indi- insurance? Or should their activities On average, financial institutions cation that banking strategies that rely be restricted? Is the universal bank- substantially combine interest-gen- preponderantly on noninterest income ing model more resilient to adverse erating and other income-generating or nondeposit funding are indeed very shocks or more conducive to exces- activities, with fees typically account- risky. This does not necessarily mean sive risk-taking, maximizing the costs ing for 35 percent of total income. But that banks should completely eschew to taxpayers when the crisis inevitably this figure masks large differences noninterest income generation and occurs? across different types of institutions: nondeposit funding, suggesting that Theory provides conflicting predic- while commercial banks, which make universal banking can be beneficial. tions about the optimal asset and up most of the sample, obtain about But evidence of diversification benefits liability mix of an institution. On the a third of their income from fee-gener- is weak. Thus while the universal bank- one hand, banks gain information on ating activities, for investment banks ing model may still be the best way to their customers in providing one fi- this share is more than 75 percent. conduct investment banking in a safe nancial service that may prove useful Moreover, the fee income share rose and sound manner, the paper's results in providing other financial services to for all institutions over the sample pe- also suggest that there may be limits these same customers. Thus combin- riod, with particularly steep increases to how far banks can steer away from ing different types of activities--non- in 2007 for investment banks, nonbank the traditional model of interest in- interest income generation as well as credit institutions, and other financial come generation and deposit taking. interest-earning assets--may increase institutions (such as real estate mort- return as well as diversify risks, boost- gage banks and savings banks). ing performance. This argues for the On the funding side, most banks merits of universal banks. attract only a small share of their On the other hand, if a bank be- short-term funding in the form of comes too complex, bank managers nondeposits, with an average share of may start taking advantage of this 8 percent. But the distribution of the complexity for their own private ben- nondeposit funding share has a fat tail efit (sometimes known as "agency of banks that raise more than half their costs") at the expense of the bank. So, short-term funding in the form of non- too much diversification may not be deposits. And just as with the share of optimal, increasing bank fragility and fees in total income, the reliance on reducing overall performance. This nondeposit funding increased signifi- tends to support the separation of cantly for investment banks, nonbank Asli Demirgüç-Kunt and Harry Huizinga. Forth- commercial and investment activities. credit institutions, and other financial coming. "Bank Activity and Funding Strategies: In a recent paper Demirgüç-Kunt institutions--and markedly so in 2007 The Impact on Risk and Returns." Journal of and Huizinga examine the implications leading up to the crisis. Financial Economics. 6 World Bank ResearchDigest Density and Disasters: Economics of Urban Hazard Risk informal sector residents move into better-quality dwellings. Investments in affordable transport can eliminate What are the policy options for more dynamic cities or to invest in the need for households to locate in reducing the risk from natural mitigation. But cost-benefit analysis informal settlements in hazard-prone hazards in cities? It can depend on may not generate long-term positive parts of the city. yields from large-scale mitigation ef- Provision of information. Credible in- the size of the cities forts, and insurance options can be formation on the source and location R stymied by limited market size and in- of hazards helps people and busi- ecent disasters in cities remind formation failures. For smaller market nesses make better choices on where us of the large and perhaps towns and incipient urbanizers, mov- to live and where to invest. Informed growing risk that natural hazards ing out of harm's way is likely to be the residents can choose among transfer- pose for urban areas, where the large dominant response for reducing risk. ring risk through insurance (where it concentration of people and assets Significant investment in mitigation is is available), investing in mitigation tends to increase the impacts from unlikely to be cost-effective, and insur- in situ (such as retrofitting houses), or storms, floods, and earthquakes. How ance markets are unlikely to extend to moving to less risky locations. Places can public policy help manage risks the smallest towns. close to economic density are likely from natural hazards in urban areas? Urban management. Reducing hazard to see market-induced self-discipline, A new paper by Lall and Deichmann risk in cities requires, first and fore- where individuals comply with build- explores a cope-mitigate-transfer most, good general urban manage- ing practices to lessen physical harm framework, which can inform options ment. Urban disasters are often the and disruption in business. In places for natural hazard management--and consequence of poor urban manage- far from economic density, where land emphasize the importance of good ment. Three aspects are particularly values are low, people are more likely urban management and public disclo- important. to move into lower-risk locations. sure of information in reducing hazard First, hazard proofing new urban Credible and public information risk. infrastructure. This includes imple- also provides a basis for the emer- The framework. Seminal work by Isaac menting structural engineering stan- gence of efficient private insurance Ehrlich and Gary Becker emphasized dards for public buildings but also siz- markets--reducing the disadvantage the interaction among self-protection, ing drainage systems for peak events that residents face when risk assess- self-insurance, and market insurance and developing steeply sloped land ments are generated by the insurer in managing hazardous events. This without increasing the probability of and not disclosed. Finally, public risk framework can inform natural hazard landslides. information serves as a sound basis management options for cities across Second, maintaining infrastructure for transparent and less distortionary the spectrum of sizes and types. and providing good basic services. zoning decisions and other land use For the largest and most dynamic Inadequate provision of such public restrictions. cities, the benefits from agglomera- services as water, sanitation, sewer- But encouraging data sharing, even tion economies can be expected to age, lighting, and health services can when data generation was funded with outweigh greater risk, especially when turn everyday hazards into disasters. public resources, is not a trivial task. the hazard probabilities are relatively For example, where drainage networks Public agencies often see data as a small for any reasonable period (as are poorly maintained, even moderate strategic or marketable asset rather in the case of earthquake risk). The floods can cause deaths from water- than as a public good whose wide and stakes are too high for people to be borne diseases and from cross- inexpensive distribution increases deterred, so they are unlikely to move contamination between water and overall welfare. or stay away. The main responses sewer lines. Payoffs. Many cities in developing will instead be risk mitigation (for Third, implementing land use countries will double in size over the example, retrofitting buildings) and management, particularly zoning, to next few decades, providing an op- risk transfer (for example, insurance). prevent settlement of the most haz- portunity to channel this growth so Mitigation is likely to have a posi- ardous areas. While enforcement of that hazard risk is minimized. This will tive benefit-cost ratio and will be the zoning laws may limit development in challenge management capacity at mainstay of efforts in countries with hazardous locations, it can cut poor all levels of government--from urban weak information. In the longer term, people off from labor market oppor- development ministries to small-town as credible information on risk be- tunities by forcing them onto cheaper mayors. But the payoffs in saved lives comes available, the large market will land far from the city's economic and avoided damages will be high. be attractive for risk pooling through center. Complementary demand-side insurance. policies--such as reforming land use Somik V. Lall and Uwe Deichmann. 2009. "Den- For secondary or intermediate cit- regulations for higher-density growth, sity and Disasters: Economics of Urban Hazard ies, the options are less clear. Here, providing rent vouchers, or improving Risk." Policy Research Working Paper 5161, people are more likely to move to access to housing finance--can help World Bank, Washington, DC. World Bank Research Digest 7 How Financial Crises in Donor Countries Affect Aid If aid flows follow historical financial crises, together with aid data banking-crisis effects is fiscal. In the patterns, the global financial crisis from the Development Assistance wake of a crisis, aid is forced to com- could reduce aid significantly over Committee (DAC) of the Organisation pete in the budget with financial sec- the medium term for Economic Co-operation and tor bailouts and other crisis-related Development. expenditures. The fiscal channel could T They find that donor-country bank- also explain why aid stagnates for so he global financial crisis has ing crises are associated with a sharp long after a banking crisis hits. Major been a major shock to the de- and long-lived drop in aid disburse- banking crises have effects on fiscal veloping countries, reducing ments, over and above income effects. positions that are especially large and their income growth rate by 7 per- Five years after a systemic banking long lasting, with public debt increas- centage points between 2007 and crisis hits, aid from the crisis country ing by a daunting 86 percent on aver- 2009. International aid has helped to is an estimated 17 percent lower than age in the first three years of crisis, cushion this shock, but there is now it would have been in the absence of according to Carmen Reinhart and Ken a risk that aid budgets could come a crisis. Surprisingly, at that point aid Rogoff ("The Aftermath of Financial under pressure. It is the donor coun- is still declining (again, relative to the Crises," American Economic Review 99 tries that were hit first by the crisis, no-crisis counterfactual): it does not [2009]: 466­72). Given these magni- and as a group they suffered steep bottom out until 10 or 11 years after tudes, it is quite plausible that debt declines in income last year. Given the crisis hits, at which point aid is pressures lead governments to cut the strains on their economies, do- down by an estimated 24 percent. back or at least restrain growth in aid nors' willingness to give aid could fall, Nor does the result hinge on just for years afterward. even though the need for aid remains a few outliers. Analysis based on What do these results imply for the great. a broader World Bank data set on likely path of aid disbursements over A recent paper by Dang, Knack, banking crises--which includes both the next decade? If aid flows follow and Rogers looks at patterns of aid systemic and nonsystemic crises, for historical patterns, the global financial giving by donor countries hit by finan- a total of 23 crises in 17 countries in crisis could reduce aid significantly cial crises in the past, to give some recent decades--strongly confirms the over the medium term (at least relative insights into what may lie ahead. finding that banking crises reduce aid. to the counterfactual). Not only have There is clearly cause for concern, Moreover, these banking-crisis effects donor-country incomes dropped, but because past experience shows that come in addition to the direct effects several donors have suffered banking donor-country financial crises may be that declining incomes could have on crises or severe strains on their bank- especially detrimental to aid giving. aid: over the long run, each 1 percent ing systems--including the United When banking crises hit five donor decrease in GDP per capita is associ- States, the United Kingdom, and countries (Finland, Japan, Norway, ated with a drop of about 3 percent in Sweden, and the United States) in the aid outflows. 1980s and 1990s, average aid from One likely channel for these large (continued on page 8) these donors stagnated for a decade or more while aid from other donors Figure 1. Trends in Mean Aid Disbursements from Crisis and Noncrisis continued to rise steadily (figure 1). Countries, 1977­2007 Of course, these drops in aid from 200 crisis countries could reflect other factors--most obviously, the fall in Disbursed aid index (= 100 in year 0) Crisis hits per capita income that tends to ac- company banking crises. Finland's 150 overall economic crisis in the early 1990s, for example, was especially deep and could have led to a sharp decline in aid even had there been no 100 banking crisis. The authors therefore explore the relationship between banking crises and aid econometri- cally, to take account of such income 50 effects and other important predictors -10 -5 0 5 10 of aid levels. They base their analysis Year on a comprehensive International Crisis countries Noncrisis countries Monetary Fund database of systemic Note: First year of crisis normalized to year 1 for crisis countries. 8 World Bank ResearchDigest (continued from page 7) How Financial Crises in Donor Recent Policy Research Countries Affect Aid Working Papers Ireland, which together accounted for 5197 New Structural Economics--A Framework 5272 Openness and Technological Innovation in a third of DAC aid in 2008. Historical for Rethinking Development East Asia: Have They Increased the Demand patterns suggest that aid from these Justin Yifu Lin for Skills? 5198 Safe and Sound Banking: A Role for Rita K. Almeida crisis-hit countries could fall by a fifth Countercyclical Regulatory Requirements? 5273 Internal Migration in Ghana: Determinants to a quarter in the coming years (again Gerard Caprio Jr. and Welfare Impacts 5202 Mortgage Finance in Central and Eastern Charles Ackah and Denis Medvedev relative to the counterfactual). Europe--Opportunity or Burden? 5274 Is Protectionism on the Rise? Assessing Past is not necessarily prologue, Thorsten Beck, Katie Kibuuka, and Erwin National Trade Policies during the Crisis Tiongson of 2008 of course. This analysis does not take 5204 Measuring Inequality of Opportunity with Hiau Looi Kee, Cristina Neagu, and into account any possible strategic Imperfect Data: The Case of Turkey Alessandro Nicita Francisco H. G. Ferreira, Jérémie Gignoux, 5275 Water, Sanitation and Children's Health: interactions among donors, which may and Meltem Aran Evidence from 172 DHS Surveys be particularly important at a time 5234 Benefit Incidence Analysis: Are Government Isabel Günther and Günther Fink when the macroeconomic downturn Health Expenditures More Pro-rich Than We 5276 Designing the Payout Phase of Funded Think? Pension Pillars in Central and Eastern and banking crises have been highly Adam Wagstaff European Countries Dimitri Vittas, Heinz Rudolph, and John synchronized across donor and recipi- 5235 Incomplete Markets and Fertilizer Use: Pollner Evidence from Ethiopia ent countries. If donors coordinate, Daniel Zerfu and Donald F. Larson 5277 Rethinking Multipliers in a Globalized World they may be able to reduce the col- 5236 The Ethnicity Distraction? Political Credibility Raj Nallari and Leopold Engozogo Mba and Partisan Preferences in Africa 5279 Trade and Financial Sector Reforms: lateral damage to aid. But if donors Philip Keefer Interactions and Spillovers respond to others' aid cuts by cutting 5244 Going Digital: Credit Effects of Land Registry Ashley Taylor Computerization in India 5280 Vulnerability of Bangladesh to Cyclones in a back themselves, aid could take a se- Klaus Deininger and Aparajita Goyal Changing Climate: Potential Damages and vere hit in the years ahead. 5249 A Counterfactual Analysis of the Poverty Adaptation Cost Impact of Economic Growth in Cameroon Susmita Dasgupta, Mainul Huq, Zahirul B. Essama-Nssah and Léandre Bassolé Huq Khan, Manjur Murshed Zahid Ahmed, Hai-Anh Dang, Steve Knack, and Halsey Rogers. Nandan Mukherjee, Malik Fida Khan, and 5253 Measuring Financial Access around the Kiran Pandey 2009. "International Aid and Financial Crises in World Jake Kendall, Nataliya Mylenko, and 5281 The Global Apparel Value Chain, Trade and Donor Countries." Policy Research Working Paper Alejandro Ponce the Crisis: Challenges and Opportunities for 5162, World Bank, Washington, DC. Developing Countries 5254 Can Disaggregated Indicators Identify Gary Gereffi and Stacey Frederick Governance Reform Priorities? Aart Kraay and Norikazu Tawara 5284 Poverty Lines across the World Martin Ravallion 5259 Cash or Condition? Evidence from a Randomized Cash Transfer Program Sarah Baird, Craig McIntosh, and Berk Özler 5260 The Remitting Patterns of African Migrants in the OECD Albert Bollard, David McKenzie, and Melanie Morten 5266 Within-School Tracking in South Korea: An Analysis Using Pisa 2003 Kevin Macdonald and Harry Anthony Patrinos 5271 Cambodia 1998­2008: An Episode of Rapid Working Papers can be downloaded at http://econ.worldbank.org Growth To download the World Bank Research E-Newsletter, Stéphane Guimbert go to Data & Research at http://www.worldbank.org The World Bank Research Digest is a quarterly publica- The Research Digest is financed by the Bank's Editorial Committee: Jean-Jacques Dethier (managing tion disseminating findings of World Bank research. Research Committee and managed by DECRS, the editor) and Asli Demirgüç-Kunt. 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