Journal Issue: World Bank Economic Review, Volume 21, Issue 3
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21
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3
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Journal ISSN
1564-698X
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World Bank Economic Review
1564-698X
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Publication
Macroeconomic Volatility and Welfare in Developing Countries
(World Bank,
2007-09)
Macroeconomic Volatility and Welfare in Developing Countries: An Introduction Norman V. Loayza, Romain Ranciere, Luis Serven, ` and Jaume Ventura Macroeconomic volatility, both a source and a reflection of underdevelopment, is a fundamental concern for developing countries. This article provides a brief overview of the recent literature on macroeconomic volatility in developing countries, highlighting its causes, consequences, and possible remedies. to reduce domestic policy-induced macroeconomic volatility by controlling the level and variability of fiscal expenditures, by keeping inflation low and stable, and by avoiding price rigidity (including that of the exchange rate), which eventually leads to drastic adjustments. The ability to conduct countercyclical fiscal policies is crucial, and it depends largely on the ability of the authorities to reduce public indebtedness to internationally acceptable levels, establish a record of saving in good times to provide for bad times, and develop credibility that forestalls perceptions of wasteful spending and default risk. Governments can reduce financial fragilities and deepen financial markets by eliminating implicit insurance schemes (such as fixed exchange rate regimes) and credit restrictions that distort the valuation of financial assets and liabilities. Following Ehrlich Becker's (1972) classic "comprehensive insurance" framework, three possible options can be identified: Self-protection (reducing the exposure to risk through, for instance, limited trade and financial openness). Primiceri and van Rens (2006*) explore the source of this increase by examining the consumption behavior of a large panel of individuals, finding that their behavior is consistent with an increase in the persistence of individual income shocks. Loayza and Raddatz (2007*) analyze how financial openness and trade openness, as well as product-market flexibility, factor-market flexibility, and domestic financial development, influence the impact of terms of trade shocks on output. To obtain their measure of policy volatility, the authors construct a measure of exogenous policy decisions unrelated to the state of the economy and take the standard deviation of this measure as a proxy for policy volatility. Even so, the literature and the lessons from the Barcelona conference reviewed here can provide some elements of sensible policy recommendations and identify areas where research is especially needed.
Publication
Earnings, Schooling, and Economic Reform
(World Bank,
2007-09-30)
Earnings, Schooling, and Economic Reform: Econometric Evidence From Hungary (1986 2004) Nauro Campos and Dean Jolliffe How does the relationship between earnings and schooling change with the introduction of comprehensive economic reform? This article sheds light on this question using a unique data set and procedure to reduce sample-selection bias. The principal assumptions are that sample-selection bias was minimal in 1986 and that the decision to participate in the wage market after 1986 is correlated with age, gender, and schooling demographics. Once corrected for sample selection on observables, the increase in returns is smaller, suggesting the existence of the positive correlation between education and the decision to participate in the wage sector that was discussed above. 16 Comparing the panels shows that sample-selection bias is positive and quite large throughout the period of analysis. An advantage of the Wage and Earnings Survey design is that the sample was selected in a single stage, and thus there is no need to correct estimates of the sampling variance for any design-induced dependence. Returns to Years of Schooling, 1986 2004: Spatial and Industry Fixed-effects Estimation of Equation (1) 1986 Panel A: Selection-corrected estimates Years of schooling Gender dummy variable (male 1) Potential experience Experience squared/100 Firm size dummy (300 employees 1) Number of observations R2 Panel B: Uncorrected estimates Years of schooling Gender dummy variable (male 1) Potential experience Experience squared/100 Firm size: 300 employees Number of observations R2 1989 1992 1995 1998 Although the Wage and Earnings Survey data include no direct measures of school quality, it is possible to provide limited supporting evidence. Studies that are based on multiple survey instruments for temporal analysis face the difficult question of whether the observed change results from changes in the examined population or changes in the survey instrument. The analysis showed that the 75 percent increase in returns to a year of schooling between 1986 and 2004 is evidence that the planned economy Campos and Jolliffe 525 undervalued education and that liberalization has allowed markets to correct this.
Publication
The Structural Determinants of External Vulnerability
(World Bank,
2007-09-30)
The Structural Determinants of External Vulnerability Norman V. Loayza and Claudio Raddatz This article examines empirically how domestic structural characteristics related to openness and product- and factor-market flexibility influence the impact of terms of trade shocks on aggregate output. Applying semistructural vector autoregressions to a panel of 88 countries with annual observations for the period 1974 2000, the analysis isolates and standardizes the shocks, estimates their impact on GDP, and examines how this impact depends on the domestic conditions outlined above. This article takes a different approach and directly estimates the output impact of external shocks using semistructural vector autoregression analysis, as applied to panel data (cross-country, time-series) of aggregate variables. Controlling for the size of the shock, the analysis accounts for its interaction with the set of country characteristics under analysis and estimates its conditional output impact. The Chinn Ito index corresponds to the first principal components of the following four binary variables reported in the International Monetary Fund's Annual Report on Exchange Arrangements and Exchange Restrictions (various issues): existence of multiple exchange rates, restrictions on current account, capital account transactions, and the existence of requirements to surrender export proceedings. Robustness This section examines the robustness of the basic results to changes in measurement of the terms of trade shock, in the sample of countries, the application of a longer lag structure in the estimated vector autoregressions, the inclusion of the exchange rate regime as a country characteristic, and implementation of an alternative method of estimating the effects of structural characteristics. This result is only tentative, however, as a complete analysis of the role of the exchange rate regime requires treatment of measurement issues that is outside the scope of this article. In contrast to the basic case, the interactions model indicates a relevant though nuanced role for financial depth in affecting the impact of external shocks: deepening domestic financial markets can reduce the impact of external shocks when international trade and financial markets are open. These results are robust to checking for mechanical interpretations of the trade-related results, placing stricter restrictions to guarantee shock exogeneity, concentrating exclusively on developing countries, using a longer lag structure for the vector autoregressions, controlling in addition for the exchange rate regime and allowing full heterogeneity in the estimation of country impulse responses. Similarly, the findings indicate that greater financial openness in an environment of underdeveloped local financial markets may result in an increase in the impact of external shocks.
Publication
Is Land Titling in Sub-Saharan Africa Cost-Effective?
(World Bank,
2007-09-30)
Is Land Titling in Sub-Saharan Africa Cost-Effective? A cost benefit analysis suggests that the current system of formal titling should not be extended in rural Madagascar and that any new system of land registration would have to be quite inexpensive to be worthwhile. Indeed, establishing a modern property rights system without legally recognizing informal rights may expand the scope for rent-seeking, thus creating additional insecurity (Atwood 1990). Purchasing a titled plot without easily being able to update the name on the document exposes the buyer to the risk that a relative of the seller, sharing the family name, might subsequently claim the plot or challenge the transfer. Analyses omitted here for brevity indicate that there is no significant advantage to owning titled land in terms of a household's access to formal credit, after controlling for the household's landholdings within the mailles (such land being much more likely to be titled), and titled plots are no more likely to be used as collateral for formal loans than are untitled plots of equivalent size, after also controlling for their position in the mailles (see Jacoby and Minten 2006). At any rate, this impact, at about 7 percent, is not large (the ceteris paribus productivity effect of having a plot in the mailles, by comparison, is on the order of 30 percent), and as argued earlier should be viewed as an upper bound on the true effect. The value of land incorporates any productivity effect of titling operating through increased land-specific investment, as well as the direct effect of expropriation risk operating through the risk-adjusted discount rate, r u. Finally, market values should also reflect the extent to which titled land is easier (or more difficult) to transact. If reported plot values reflect their true market valuation and all relevant plot characteristics can be controlled for, then OLS should produce unbiased estimates of the titling effect. The findings of this study are based on a very large sample of plots and support the notion that indigenous tenure provides adequate security for farmers to undertake the limited range of investment activities commensurate with the prevailing agricultural technology. Given this potential cost, future research should strive to determine whether such negative titling externalities are indeed empirically important.
Publication
Creditor Protection and Credit Response to Shocks
(World Bank,
2007-09-30)
Creditor Protection and Credit Response to Shocks Arturo Jose Galindo and Alejandro Micco This article studies the relationship between creditor protection and credit responses to macroeconomic shocks. Using a data set on legal determinants of finance in a panel of data on aggregate credit growth for 79 countries during 1990 2004, it is shown that credit is more responsive to external shocks in countries with weak legal creditor protection and weak enforcement. The results are statistically and economically significant and robust to alternative measures of creditor protection, to the inclusion of variables that reflect different stages of economic development, to the restriction of the sample to only developing economies, to the controls for systemic crises, to alternative shock measures, and to vector autoregressive specifications. One strand of the literature has shown that an institutional setup that adequately protects creditor rights (CR) can align the incentives of debtors and lenders, increase the expected payoffs of lending, and deepen financial markets. Source: Authors' analysis is based on the data noted in table A-1. Panel a shows how the development of credit markets (as measured by the ratio of credit to the private sector supplied by the financial sector to GDP) is strongly related to a measure of legal protection to creditors: an index of effective creditor rights (ECR) protection that combines legal protection to creditors and their enforcement (higher values indicate stronger protection). Panel data on aggregate credit growth for 79 countries during 1990 2004 support the claim that better legal protections significantly reduce the sensitivity of credit to shocks. Rather than exploring the impact of shocks on output under different scenarios of financial development, it explores the impact of shocks on financial markets, under different institutional setups. Controlling For Systemic Banking Crises And Financial Liberalization Dependent variable: D log(Credit/GDP) (1) External shock External shock* ECR External shock* CL External shock* developed Systemic crisis dummy variable Financial liberalization 1 Financial liberalization 2 Number of observations Number of countries Country-fixed effects Year-fixed effects R-squared Sample 5.656 (1.395)*** 0.665 (0.229)*** -- 21.035 (1.824) 20.062 (0.016)*** -- -- 1.022 79 Yes Yes 0.16 (2) 6.804 (1.663)*** -- 23.198 These results are robust to alternative measures of creditor protection, to the inclusion of variables that reflect different stages of economic development, to the restriction of the sample to developing economies, to controlling for systemic crises and financial liberalization, to alternative shock measures, to possible asymmetric responses, and to vector autoregression dynamic specifications.
Publication
Crises, Volatility, and Growth
(World Bank,
2007-09-30)
When credit is constrained, a bias toward short-term debt can arise in financing long-term investments, generating maturity mismatches and leading potentially to liquidity crises. After the financial crises of the 1990s many voices rose to explain that the causes of these crises were new (Radelet and Sachs 1998; Corsetti, Pesenti, and Roubini 1999). According to the first, "crony capitalism" can explain the imbalances (Krugman 1999), because in distorting individual incentives, it encouraged firms to make inefficient decisions (about investments, risks, and so on). Understanding how economic and financial development modifies financial contracts requires understanding original sin. THE MACROECONOMIC MOD EL This section introduces this capital market framework in a macroeconomic model to shed light on the aggregate consequences of the structure of financial contracts. Long-term contracts are imperfectly enforceable; default is possible, but an entrepreneur needs to pay a marginal cost on the final output (t when the entrepreneur can carry out an illiquid long-term project and t when the entrepreneur violates the illiquidity constraint and reinvests in the storage technology). The case where entrepreneurs pay for their debts if and only if they can carry out their illiquid project until maturity (not considered here) is always dominated; entrepreneurs have to pay for default costs and there are no benefits for the debt portfolio (size being identical and risk premium being actuarially fair). These two sources of aggregate volatility reduce growth through independent channels; the probability of a run reduces the average return on the entrepreneur's projects, whereas the volatility R 2 r on the return on entrepreneur's projects increases the average return on the entrepreneur's projects but imposes a negative effect on the storage technology that always dominates at the aggregate level. Interaction Effects of Financial Development and Different Volatility Measures Dependent variable: GDP per capita growth Regression 1 Log of initial GDP per capita Population growth Credit to GDP Growth volatility Low-growth frequency Growth volatility  credit to GDP Low-growth frequency  credit to GDP Hausman test (p-value) Sargan test (p-value) Number of observations 2 3 4 5 6 20.965** 20.728*** 20.657** 20.738*** 20.790*** 20.995** 20.894*** 20.634** 20.774*** 20.506** 21.974*** 20.724*** -- 1 À a l ars m t 458 THE WORLD BANK ECONOMIC REVIEW If an entrepreneurs can carry out a project in the production technology with a debt portfolio (a,m), it is then incentive-compatible to exchange this portfolio against a portfolio (b,m) if and only if (1 m 2 bmrs)R 2 2 t).
Publication
Do Some Forms of Financial Flows Help Protect Against "Sudden Stops"?
(World Bank,
2007-09-30)
Do Some Forms of Financial Flows Help Protect Against "Sudden Stops"? Using a large panel data set that includes advanced, emerging, and developing economies during 1970 2003, this article analyzes the behavior of several types of flows: foreign direct investment (FDI), portfolio equity investment, portfolio debt investment, other flows to the official sector, other flows to banks, and other flows to the nonbank private sector. Financial Account and Subcomponents: Median Values across Economies within Each Group 1970 2003 Other flows to official sector 0.02 0.10* Other flows to nonbank private sector 0.04 0.04* Summary statistic and economy Financial account Foreign direct investment Portfolio debt investment 0.25 0.17* Portfolio equity investment Other flows to banks 0.42 0.01* Average of capital flows Advanced 1.38 20.02 economies Emerging 1.89 1.30 market economies Developing 2.98 1.88 economies Standard deviation Advanced 2.72 1.31 economies Emerging 4.39 1.50 market economies Developing 4.86 2.08 economies Coefficient of variation Advanced 1.37 2.20 economies Emerging 1.88 1.00 market economies Developing 1.41 0.96 Economies Correlation with domestic growth Advanced 0.10 0.00 economies Emerging 0.24 0.10 market economies Developing 0.16 0.17 economies Correlation with G-7 growth Advanced 20.01 0.03 economies Emerging 20.08 20.07 market economies Developing 0.01 0.04 economies Correlation with U.S. interest rate ( Continued Other flows to official sector 0.27* Other flows to nonbank private sector 0.13* Summary statistic and economy Financial account Foreign direct investment 20.29 Portfolio debt investment 20.07 Portfolio equity investment 20.08* Other flows to banks 0.03* Emerging 0.07 market economies Developing 0.10 economies Persistence (AR1 pooled) Advanced 0.68 economies Emerging 0.52 market economies Developing 0.51 economies First principal component Advanced 0.30 economies Emerging 0.24 market economies Principal Components Analysis This section analyzes the relationships of financial flows across income groups using principal components analysis, focusing on the share of variation explained by the first principal component--a standard measure of comovement--for each country group. Levchenko and Mauro 399 The empirical findings indicate that for total financial flows the patterns across advanced and developing economies are quite similar, with the first principal component accounting for 25 30 percent of the variation in financial flows. Replicating the analysis in figure 1 for gross inflows and gross outflows (analogous charts are available from the authors on request) shows that the results for gross inflows are strikingly similar to those reported in figure 1, whereas the results for gross outflows show far more limited action. A similar message emerges when considering the response of different components of financial flows at the quarterly frequency around the Russia/ Long-Term Capital Management crisis of August 1998, for all emerging market economies (figure 2, which--for the sake of brevity--reports data only for countries whose financial account balance was most affected by the crisis. Third, the analysis could explore the consequences of financial flows, looking at whether sudden stops in financial flows (and, more specifically, in non-FDI flows) have a large adverse impact on the deviation of output from forecast output--suggestive evidence that the causal relationship goes from capital flows to output, rather than the other way around.
Publication
Land Tenure, Investment Incentives, and the Choice of Techniques
(World Bank,
2007-09-30)
Land Tenure, Investment Incentives, and the Choice of Techniques: Evidence from Nicaragua Oriana Bandiera The choice of cultivation techniques is a key determinant of agricultural productivity and has important consequences for income growth and poverty reduction in developing countries. Further evidence indicates that the result follows from landlords' inability or unwillingness to commit to long-term tenancy contracts rather than from agency costs due to risk aversion or limited liability. This finding is in line with the observation that since a tenant's effort affects tree productivity in the future, proper incentives can be provided only by offering a long-term contract that makes the tenant's pay conditional on future output. Nevertheless, models of moral hazard with either risk aversion or limited liability indicate that tenants' wealth determines the cost of providing incentives for noncontractible effort and hence the choice of cultivation techniques when these are complementary to effort. To this purpose, the remainder of the 496 THE WORLD BANK ECONOMIC REVIEW analysis focuses on the cross-sectional evidence from the sample of pure owners and pure tenants. Cross-Section Specification: Matching Estimates Nonexperimental matching procedures might yield estimates that improve over linear regression estimates in the sense of being closer to those produced by a randomized experiment. Land Ownership and Trees: Linear Probability Model Fixed-Effect and Cross-Section Estimates Cross-section Fixed effects Tree mix Variable Farmer owns plot Household wealth*1026 Farmer's age Farmer's gender Farmer's education (years) Household size Farm size*1023 Plot size*1023 Town size*1026 Average distance to market town Percent increase in probability when moving from tenancy to ownership Province fixed effect Number of observations (farmers) R2 No 86 0.08 29 Yes 1172 0.02 2668 (1.25) 0.354 (0.228 The results also show that trees are more likely to be grown on smaller farms, which rules out the hypothesis that there are increasing returns to scale to tree cultivation and that the observed difference between owners and tenants is due to the fact that owners farm larger plots. Observations are matched on the same farmer and town characteristics used in table 3 Source: Author's analysis based on data from the 1998 Nicaragua Living Standards Measurement Study survey. Since poorer tenants are more likely to be risk averse (Binswanger 1980) and because the limited-liability constraint is more likely to be binding for poor tenants, models of risk aversion or limited liability share the prediction that tenants' wealth determines the cost of providing incentives and hence effort and the choice of production techniques.