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Working Paper No. 201
Network Effects and the Dynamics of Migration and Inequality: Theory and Evidence from Mexico
David McKenzie and Hillel Rapoport January 2004
International migration is costly and initially on the middle class of the wealth distribution may have both the means and incentives to migrate, increasing inequality in the ending community. However, the migration networks formed lower costs for future migrants, which can in turn lower inequality. This paper shows both theoretically and empirically that wealth has a nonlinear effect on migration, and then examines the empirical evidence for an inverse U-shaped relationship between emigration and inequality in rural sending communities in Mexico. After instrumenting, we find that the overall impact of migration is to reduce inequality across communities with relatively high levels of past migration. We also find some suggestive evidence for an inverse U-shaped relationship among communities with a wider range of migration experiences.
Working Paper No. 202
China's Emerging Domestic Debt Markets
Pieter Bottelier, January 2004
In spite of the exponential growth of Government bond issues in recent years, China's debt markets remain relatively narrow, illiquid and segmented, while the aggregate supply of tradable bonds appears low relative to market demand. Domestic demand for bonds has soared in recent years, partly as result of a sharp decline in equity prices. The range of bond instruments in terms of issuers, maturities and yields needs to be broadened, while new financial instruments, such as asset-backed securities need to be developed. The Government should discontinue using the domestic bond market exclusively or primarily for fiscal purposes. Domestic debt markets have to play a larger role in corporate finance, in meeting the requirements of institutional investors and in facilitating a market-based process of non-performing loan clean up, which remains a huge challenge. To accelerate development of more diversified domestic bond markets, the Government should permit high-quality domestic and foreign firms as well as multilateral development banks to enter the primary market as issuers, both in local currency and in foreign exchange (forex). In due course, issuing rights should be extended also to selected provinces and municipalities. Permitting the simultaneous issue and trading of bonds in multiple markets with full arbitrage between them would reduce market segmentation. Government should develop and perfect as rapidly as possible the legal and institutional framework for domestic debt markets, including bankruptcy and foreclosure laws and procedures, reliability and efficiency of courts, independent rating agencies and enforceability of court decisions. To avoid market disruption and unhealthy competition, domestic interest rates, still largely Government-controlled, should only be liberalized gradually. As financial sector reforms, including state bank recapitalization and listing, progress, controls on interest rates and on capital account transactions can be relaxed. It is to be expected that yield curves for RMB-denominated bonds, which are remarkably flat compared to yield curves for US Treasuries, will gradually become more upward sloping as domestic capital markets in China develop and interest rates begin to reflect market realities.
Working Paper No. 203
China's Labor Market
Belton M. Fleisher and Dennis Tao Yang, January 2004
More than two decades into an era of sustained reform, China's labor force has experienced fundamental transformations. At the inception of the reform in 1978, an overwhelming majority of the labor force was either employed in urban state-owned enterprises (SOE) or as agricultural workers in rural communes. The reform has led to dramatic changes in the distribution of jobs. Prior to reform, job changes were either prohibited or controlled by responsible government agencies. The fundamental shifts in the distribution of employment across sectors and ownership categories that have occurred under reform require an allocative mechanism for labor far more flexible and sensitive than nations have ever achieved with administrative controls. The emergence of a functioning labor market has been essential to this transformation, a fact that the Chinese Government recognizes. Dealing with this labor-market transformation is one of the most challenging tasks facing the Government and the Chinese Communist Party, and the ways in which laws, regulations, and institutions evolve in response to this challenge raise a series of questions of great academic and policy interest. We address the following two main questions that China's ongoing economic reform raise for the labor force and labor markets: (1) what are the implications of economic reform in general for labor-market institutions, and (2) what are the current conditions of the labor markets and what are the major challenges for further reform? We examine the progress of economic reform to date and how it has led to the need for radical changes in labor-market laws and regulations; and, most important, how have these laws and regulations been applied and what are the implications for the allocation of labor? We also discuss continuing labor-market problems and the policy choices confronting policy makers today.
Working Paper No. 204
SOE Restructuring in China
Ross Garnaut, Ligang Song and Yang Yao, January 2004
Based on a recent 683-enterprise survey done in 11 cities, this paper reviews the recent history of state-owned enterprise (SOE) reform, the forms of restructuring, the handling of state assets, reemployment of workers, and firm performance after restructuring in China. Restructuring in many cases involves privatization. The process has been a result and part of the market liberalization process dating back to the mid-1980s. The most popular way to privatize has been employee shareholding, but open sales and leases have become more frequent in recent years. Considerable discounts on privatization prices are often given to buyers in exchange for fewer layoffs of workers. The outcome of restructuring is encouraging. Restructured firms have been found to have higher productivity and profitability than the SOEs.
Working Paper No. 205
Related Lending and Economic Performance: Evidence from Mexico
Noel Maurer and Stephen Haber, January 2004
There is a broad consensus that bankers in LDCs engage in related (insider) lending. There is also a consensus that the practice should be discouraged through close supervision and regulation. We argue that such policy recommendations, in the context of high default risk, will not produce arm's length lending by LDC bankers. Rather, it will produce little lending at all. In fact, related lending exists precisely because bankers in LDCs face high levels of default risk. This does not mean, however, that related lending is economically efficient. Our empirical analysis indicates that related lending produces a second best allocation of capital compared to that which would be obtained in an efficient capital market. Bankers choose borrowers based on pre-existing family or business relationships, not their entrepreneurial or managerial talent. We operationalize this argument by looking at the lending strategies of Mexican banks during the period 1880-1913, and then analyze the effect of related lending on a large and finance-dependent industry - cotton textile manufacturing - by constructing a panel of mills that we follow over a 25 year period.
Working Paper No. 206
East Asian Trade Relations in the Wake of China's WTO Accession
David Roland-Holst, February 2004
China's accession to the WTO is a watershed event for East and Southeast Asian trade relations, and many of the more established regional agreements (ASEAN, etc.) are being re-examined in this light and even challenged to include China directly. From another perspective, the commitment of such a prominent Asian economy to WTO standards for globalization calls into question the basic tenets of regionalism, even as an intermediate step to full multilateralism. In this paper, I examine these issues empirically, using a multi-country dynamic CGE model to appraise a variety of East Asian trade regimes as they might evolve over the next fifteen years. My results have two salient features. First, I predict the emergence of a Trade Triangle that will leverage regional exports via China's expanding exports and induced domestic growth. Second, I find that for China's neighbors, the greatest national, regional, and global, gains would accrue if all countries in the region followed China's example and, more generally, pursued globalism through more comprehensive regionalism.
Working Paper No. 207
Fiscal Policy in India: Lessons and Priorities
Nirvikar Singh and T.N. Srinivasan, February 2004
This paper assesses India 's current fiscal situation, its likely future evolution, and impact on the economy. We examine possible reforms of macroeconomic policy (including fiscal, monetary and exchange rate policy) and broader institutional reforms that will bear on the macroeconomic situation. We also consider the political feasibility of possible reforms. We examine both medium and longer run scenarios, and fiscal sustainability and adjustment going beyond conventional government budget deficits, to include off-budget liabilities, both actual and contingent. We conclude with our assessment of reforms focused on improving the fisc.
Working Paper No. 208
Reform Stretegies in the Indian Financial Sector
Saugata Bhattacharya and Urjit R. Patel, February 2004
The financial sector in India – banking, capital markets, insurance, mutual funds, etc. – has changed during the decade of reform of the nineties. Although many improvements have been effected, this paper argues that the scope of many of these changes has been relatively narrow and predominantly mechanistic. It is not surprising, therefore, that the outcomes of these actions have not been as far-reaching as required. While the sector is probably more robust than at the beginning of reforms, it is still susceptible to inefficiencies engendered inter alia by the blunted incentives associated with large public sector involvement in the sector, institutional rigidities and regulatory forbearance.
Working Paper No. 209
Mineral Resources and Economic Development
Gavin Wright and Jesse Czelusta, February 2004
Recent studies assert that natural resource abundance (particularly minerals) has adverse consequences for economic growth. This paper subjects this “resource curse” hypothesis to critical scrutiny. Our central point is that it is inappropriate to equate development of mineral resources with terms such as “windfalls” and “booms.” Contrary to the view of mineral production as mere depletion of a fixed natural “endowment,” so-called “nonrenewable” resources have been progressively extended through exploration, technological progress, and advances in appropriate (often country-specific) knowledge. Indeed, minerals constitute a high-tech knowledge industry in many countries. Investment in such knowledge should be seen as a legitimate component of a forward-looking economic development program.
Working Paper No. 210
China's Transition to the Market: Status and Challenges
Nicholas Hope and Lawrence J. Lau, March 2004
China 's transition to the market has been astoundingly successful, the more so as its reforms, though far-reaching, are incomplete in many important dimensions. Although China has irrevocably committed to establishing a market economy, the situation is yet to progress to the point where the markets are entrusted, with minimum encumbrance, to allocate goods, services and factors of production. The Government reserves the right to intervene in markets when developments are not to its liking, even where the better (meaning more market friendly) policy might be to liberalize further rather than to re-impose administrative controls. Our review suggests that market development has progressed most in the goods markets, with services next, and factor markets still lagging.. To improve the function of China 's markets, more of the right sort of competition is needed. We hypothesize that four broad types of government actions can heighten fair competition and improve the way in which Chinese markets work. In the approximate order in which they are likely to contribute to efficiency gains, they are: (1) phase out remaining barriers to the freedom of movement of goods, services and factors of production in the domestic markets, (2) roll back the barriers to foreign participation in the Chinese economy in accordance with, but not limited to, the undertakings for accession to the WTO, (3) compile and disseminate more information of all kinds to improve participants' knowledge of China's market environment, and (4) experiment in introducing more complementary markets (for example, forward markets, markets for derivatives) and market supporting services (rating agencies, specialists in grading products and valuing assets, marketing, and more).
Working Paper No. 211
Economic Governance and Growth in Chile, 1984-2004
Jorge Marshall, March 2004
Chile has undergone profound economic, social and political changes over the past two decades, marked by high growth and poverty alleviation. Strong economic governance is the main factor behind this performance. Policy quality, institutional capacity and reasonable consensus have created a propitious environment for growth. This paper analyzes the interplay between the governance factors and growth in Chile during five periods from 1984 to 2004. Considering that this transformation has not been a smooth process, changes in the pace of reforms are analyzed to better understand the positive, as well as the negative, interactions between governance factors. This analysis shows that when policies, institutions, and consensus operate in a consistent environment, sustained progress follows. This view demands a balanced agenda that simultaneously strengthens these three spheres.
Working Paper No. 212
The Emergence of Agricultural Commodity Markets in China
Jikun Huang and Scott Rozelle, April 2004
In this paper, we have shown in a number of ways the steady improvement in agricultural commodity markets that have occurred in China during the past decade. Regardless of whether we employ descriptive statistics or more formal techniques, our results are consistent with the emergence of integrated markets for rice, maize and soybeans. Transaction costs also appear to have continued to fall. These advances have come despite recurring attempts to slow down or halt the operation of markets during this time. The erosion in the power of the state to control agricultural markets by traditional command and control methods has been largely due to the enfranchisement of millions of individuals to trade commodities. Our results suggest that if the nation's leaders want to control markets in the future they will have to devise new ways to intervene – probably by using indirect methods instead of trying to suppress traders. One of the real lessons of our work is that Chinese leaders, domestic and foreign traders, and other observers all should recognize that rural China now has one of the world's least distorted and most integrated agricultural markets. Of course, for poverty alleviation and other purposes this can be a two-edged sword. Nevertheless, if policy makers make productive investments and promulgate sound policies, well-functioning markets enable those involved in agricultural production and consumption activities to benefit and facilitate the implementation of policies with minimal distortion.
Working Paper No. 213
How to Subvert Democracy: Montesinos in Peru
John McMillan and Pablo Zoido, April 2004
Which of the democratic checks and balances—opposition parties, the judiciary, a free press—is the most critical? Peru has the full set of democratic institutions. In the 1990s, the secret-police chief Montesinos systematically undermined them all with bribes. We quantify the checks using the bribe prices. Montesinos paid television-channel owners about 100 times what he paid judges and politicians. One single television channel's bribe was five times larger than the total of the opposition politicians' bribes. By revealed preference, the strongest check on the government's power was the news media.
Working Paper No. 214
Organized Crime, Corruption, and Punishment
Maurice Kugler, Thierry Verdier, and Yves Zenou, May 2004
We analyze an oligopoly model in which differentiated criminal organizations globally compete on criminal activities and engage in local corruption to avoid punishment. When law enforcers are sufficiently well paid, difficult to bribe, and corruption detection highly probable, we show that increasing policing or sanctions effectively deters crime. However, when bribing costs are low, that is, badly paid and dishonest law enforcers work in a weak governance environment, and the rents from criminal activity relative to legal activity are sufficiently high, we find that increasing policing and sanctions can generate higher crime rates. In particular, the relationship between the traditional instruments of deterrence, namely intensification of policing and sanctions, and the crime rate is non-monotonic. Beyond a threshold, further increases in intended expected punishment create incentives for organized crime extending corruption rings, and ensuing impunity results in a fall of actual expected punishment that yields more rather than less crime.
Working Paper No. 215
Mexico's Experiments with Bank Privatization and Liberalization, 1991-2002
Stephen Haber, June 2004
During the 1990s Mexico conducted two experiments with its banking system. In the first experiment (1991-96) it privatized the banks. This experiment took place with weak institutions to enforce property rights. It also took place without institutions that encourage prudent behavior by bankers. The result was reckless behavior by banks, and a collapse of the banking system. In the second experiment (1997-2002), Mexico reformed many of the institutions that promoted bank monitoring and it opened up the industry to foreign investment. It did not, however, reform the institutions that promote the enforcement of property rights. The result was that bankers behaved prudently, but prudent behavior means that they do not lend to firms or households.
Working Paper No. 216
China's Emergence as the Workshop of the World
Will Martin and Vlad Manole, June 2004
China’s emergence as a major exporter of manufactures is well-known. Less well-known perhaps is the rapid transformation towards manufactures of other countries that were poor in 1980. The rapidity of this transformation suggests that common factors, such as vertical specialization in production, may have played an important role. We examine the transformation of China’s exports relative to those of India and other low-income exporters. We find that the share of manufactures rose rapidly in each case, and that the most rapid growth was in relatively skill-intensive manufactures. A key part of China’s export growth came from the emergence of new exports, which occurred rapidly in the 1980s, and less rapidly in the 1990s. In India, by contrast, this process did not begin until the 1990s. Reductions in protection in China and India disproportionately reduced the cost burden on manufactures and agricultural processing. Textiles and clothes are an important special case, with the outcome very heavily distorted by protection imposed under the Multi-Fiber Arrangement. Because of the abolition of those quotas, expansion of China’s exports of these products after 2005 is likely to be very rapid, relative to other, more skill-intensive goods.
Working Paper No. 217
China's Monetary Policy: 1998-2002
Ping Xie, June 2004
This paper analyses monetary policy evolution in China , focusing on the period from 1998 to 2002. Using correlation analysis and Granger-causality tests, this paper demonstrates that there is not a strong relationship between China ’s base money and monetary aggregates M1 and M2, and, to some extent, money supplies are endogenously determined. A cointegrated vector autoregression and vector error-correction model is established to investigate relationships among China ’s money supply, inflation rate and economic growth. Empirical evidence shows that within a long-time horizon, monetary aggregates are neutral and do not affect economic growth, but do determine the inflation rate in both the short and long term. In addition, this paper discusses the pros and cons of China ’s various monetary policy instruments, the effectiveness of interest rate policy and the monetary authority’s offsetting operations of foreign reserve purchases.
Working Paper No. 218
Incentive Structures in the Presence of Subsidies: Optimal Contracts in Infrastructure Utilities
Saugata Bhattacharya and Urjit Patel, June 2004
A significant source of uncertainty for utilities and regulators, especially in developing countries where they are pervasive in one form or the other, is the level and timing of subsidy transfers, which also act as a wealth constraint on the utility. The paper explores the properties of “menus of incentive contracts” that may be offered by a utilities regulator in the context of the hitherto unexamined interaction between subsidy delivery and regulation. These menus normally are designed as revelation mechanisms to incentivize self-screening by utilities with different cost characteristics by endogenously revealing information about them; depending on the asymmetry, both pooling and separating equilibria emerge. The paper shows that menus which are in current use are unlikely to achieve separating equilibria with multiple sources of information asymmetries, for example, when uncertainty over subsidy payments is introduced.
Working Paper No. 219
Regional Decentralization and Fiscal Incentives: Federalism Chinese Style
Hehui Jin, Yingyi Qian and Barry Weingast, July 2004
Aligning the interests of local governments with market development is an important issue for developing and transition economies. Using a panel data set from China, we investigate the relationship between a provincial government’s fiscal incentives and provincial market development. We report two major empirical findings. First, we find a much higher correlation, about four times, between the provincial government’s budgetary revenue and its expenditure after the reform as compared to that before the reform, demonstrating that provincial governments faced much stronger ex post fiscal incentives. Second, we also find that stronger ex ante fiscal incentives, measured by the contractual marginal retention rate of the provincial government in its budgetary revenue, is associated with faster development of the non-state sector as well as more reforms in the state sector in the provincial economy, even controlling for the conventional measure of fiscal decentralization. We compare federalism, Chinese style, to federalism, Russian style.
Working Paper No. 220
From Economics to Politico-Economics: Evolution of the Analysis of Federalism
T.N. Srinivasan and Jessica Wallack, July 2004
This essay places the eight country case studies of federalism, economic reforms, and globalization (available as SCID working papers 147-153) in context. We trace the evolution of the literature on federalism from its early focus on the design of fiscal arrangements to achieve efficient outcomes in a world of benevolent social planners and closed economies to later work relaxing these assumptions and exploring different policy areas. The essay also discusses the motivating questions for the collection of case studies.
Working Paper No. 221
Federalism, Economic Reform, and Globalization: Conclusions and Lessons for Future Study
T.N. Srinivasan and Jessica Wallack, July 2004
This paper discusses the findings of a multi-country study on the interaction of federalism, economic reform, and globalization in Argentina, Australia, Brazil, Canada, China, India, Mexico, and Nigeria. We compare and contrast the division of expenditure responsibilities and taxation powers in the federations. The countries studied had a common pattern of centralized taxation and tangled subnational and federal responsibilities in many policy areas. The second part of the paper focuses on the dynamics of federalism, illustrating the ongoing political bargains in the countries studied. We review the countries’ experience with globalization and draw out some of the common strains that integration with the international economy places on federalism. The final section compares countries’ institutions for managing central and subnational government cooperation (and conflict) in economic reforms.
Working Paper No. 222
The Return to Soft Dollar Pegging in East Asia: Mitigating Conflicted Virtue
Ronald McKinnonand Jessica Wallack, July 2004
Before the 1997-98 crisis, the East Asian economies—except for Japan—informally pegged their currencies to the dollar. These soft pegs made them vulnerable to a depreciating yen thereby aggravating the crisis. To limit future misalignments, the IMF wants East Asian currencies to float freely. Alternatively, authors have proposed increasing the weight of the yen in East Asian currency baskets. However, dollar pegs are entirely rational from the perspective of each Asian country—both to facilitate hedging by merchants and banks against exchange risk, and to help central banks anchor their domestic price levels. Post-crisis, as the East Asian economies transform themselves from being dollar debtors into dollar creditors, they face “conflicted virtue”: pressure to appreciate their currencies that could lead to a deflationary spiral. Rather than undervaluing their currencies to promote exports as commonly alleged, East Asian governments are trapped into returning to—and then maintaining—soft dollar pegs.
Working Paper No. 223
The Effects of Structural Reforms and Productivity Enhancing Reallocation: Evidence from Colombia
Marcela Eslava, John Haltiwanger, Adriana Kugler,and Maurice Kugler, August 2004
Estimates for the U.S. suggest that at least in some sectors productivity enhancing reallocation is the dominant factor in accounting for productivity growth. An open question, particularly relevant for developing countries, is whether reallocation is always productivity enhancing. It may be that imperfect competition or other barriers to competitive environments imply that the reallocation process is not fully efficient in these countries. Using a unique plant-level longitudinal dataset for Colombia for the period 1982-1998, we explore these issues by examining the interaction between market allocation, and productivity and profitability. Moreover, given the important trade, labor and financial market reforms in Colombia during the early 1990’s, we explore whether and how the contribution of reallocation changed over the period of study. Our data permit measurement of plant-level quantities and prices. Taking advantage of the rich structure of our price data, we propose a sequential methodology to estimate productivity and demand shocks at the plant level. First, we estimate total factor productivity (TFP) with plant-level physical output data, where we use downstream demand to instrument inputs. We then turn to estimating demand shocks and mark-ups with plant-level price data, using TFP to instrument for output in the inverse-demand equation. We examine the evolution of the distributions of TFP and demand shocks in response to the market reforms in the 1990’s. We find that market reforms are associated with rising overall productivity that is largely driven by reallocation away from low- and towards high-productivity businesses. In addition, we find that the allocation of activity across businesses is less driven by demand factors after reforms. We find that the increase in aggregate productivity post-reform is entirely accounted for by the improved allocation of activity.
Working Paper No. 224
Household Water Delivery Options in Urban and Rural India
David McKenzie and Isha Ray, August 2004
This paper provides an overview of the current state of drinking water provision in urban and rural India, and discusses technological, economic, and political areas for reform. The status quo of municipal water provision in urban areas is shown to have resulted in many poor households being excluded from the water network, while even those with a piped connection generally do not receive a regular supply of good quality water. We discuss the scope for pricing reform and actions which could be taken to make this more politically feasible, and describe the preconditions needed for private-sector involvement. In rural and peri-urban areas we make the case for ‘intermediate’ technological options and multi-institutional partnerships. We then outline low- to intermediate-cost options for water delivery, water augmentation and water treatment. In each case, we review the technology, give examples of the capital and operational costs, discuss the challenges to extending access through this means, and cite case studies showing how access was extended to previously underserved populations. We conclude by delineating key institutional and informational concerns which must be addressed in order for India to successfully alleviate its household drinking water deprivation.
Working Paper No. 225
Private Capital Flows, Capital Controls, and Default Risk
Mark L.J. Wright, August 2004
What has been the effect of the shift in emerging market capital flows toward private sector borrowers? Are emerging market capital flows more efficient? If not, can controls on capital flows improve welfare? This paper shows that the answers depend on the form of default risk. When private loans are enforceable, but there is the risk that the government will default on behalf of all residents, private lending is inefficient and capital controls are potentially Pareto-improving. However, when private agents may individually default, capital flow subsidies are potentially Pareto-improving.
Working Paper No. 226
Effects of Tariffs and Real Exchange Rates on Job Reallocation: Evidence from Latin America
John Haltiwanger, Adriana Kugler, Maurice Kugler, Alejandro Micco, and Carmen Pages, September 2004
Openness to international competition can lead to enhanced resource allocation in the long run. While factor reallocation is essential if net benefits are to be derived from trade liberalization, the process generates costs both for transitioning workers and for employers undergoing personnel turnover. Net welfare gains depend on adjustment costs. Understanding of these issues has been hampered by data limitations. In this paper, we overcome some of these limitations by using new, harmonized measures on job creation and destruction for a number of countries in Latin America. We use these new series to investigate the impact of the removal of protectionism on net employment and gross job reallocation in Latin America. We find a robust pattern showing that reductions in tariffs and exchange rate appreciations increase the pace of job reallocation within sectors. We also find, however, some evidence of declining net employment as trade exposure increases. For example, we find some evidence that in the wake of tariff reductions, there is lower net employment growth.
Working Paper No. 227
The Effects of Enforcement on Illegal Markets: Evidence from Migrant Smuggling along the Southwestern Border
Christina Gathmann,September 2004
Since 1986, enforcement along the Southwestern border has more than tripled. Using a unique dataset, the paper analyzes the effects of this dramatic increase on the illegal border crossing market. Controlling for endogeneity, increased enforcement has reduced illegal migration by only 10 percent, while increasing the prices charged by migrant smugglers (“coyotes”) by 30 percent. Few migrants have switched to smugglers, but the demand for border smugglers is more price elastic than the demand for illegal drugs. Further evidence shows that illegal migrants have substituted away from heavily partrolled to more remote crossing routes. The resulting additional migration costs are roughly three times the direct effect of enforcement on smuggling prices.
Working Paper No. 228
Foreign Banks and the Mexican Economy, 1997-2004
Stephen Haber and Aldo Musacchio, October 2004
In 1997 Mexico ’s banking laws were reformed, allowing foreign banks, for the first time since the nineteenth century, to purchase controlling interests in the country’s largest banks. Foreign banks controlled 16 percent of Mexican bank assets in March 1997. By June 2004 they controlled 82 percent. What impact did foreign mergers and acquisitions have on the strategy and performance of Mexico ’s banks? We find that all banks in Mexico (both domestic and foreign) have become increasingly risk averse. We also find that foreign banks are more risk averse than domestic banks: they allocate less of their assets to loans for private consumption and investment and screen borrowers more intensively than domestic banks. As a consequence of their risk aversion, foreign banks charge lower interest rate spreads than domestic banks. We find, however, that the lower interest rate spreads charged by foreign banks do not translate into lower rates of return on equity. Given the weak property rights environment in Mexico, a risk averse asset allocation strategy is economically rational.
Working Paper No. 229
Global Outsourcing and FDI: Can the Least Developed Countries Participate in the Process?
David Bigman, October 2004
Today’s corporations have a much wider set of options how and where to organize their production and sales, including options to outsource the supply of certain parts to external producers – either in their home country or offshore. These changes in the structure, scale and geographical distribution of the production and supply chain of the multinational corporations, were set off by the rapid technological progress, the sharp reduction in transport costs, the wide range of international agreements to facilitate trade and, in particular, by the spread of global and highly effective information and communication technologies. These changes contributed, in turn, to wider changes in the structure of international trade. The paper examines the forces that drove these changes and their impact on the less developed countries.
Working Paper No. 230
Foreign Portfolio Investors and Financial Sector Stability: Lessons from the Asian Crisis
Jeong Yeon Lee, October 2004
Under asymmetric information and imperfect contract enforcement, foreign portfolio capital flows inevitably entail the interplay of benefits and risks. Given the considerable advantages foreign investors offer, however, a country cannot afford simply to walk away from global capital markets by imposing strict capital controls and /or severely limiting the activities of foreign portfolio investors within its borders. The best way to maximize net benefits is to keep the door open to global capital flows while minimizing the risks they pose to financial sector stability by attacking unwanted distortions at their sources. The Asian crisis demonstrated that major weaknesses in the domestic financial system can magnify risks to the extent that host economies eventually incur a financial crisis. Problems that intensify risks are: (i) inconsistent and shaky macroeconomic management; (ii) severe asymmetric information problems (e.g. inadequate accounting, auditing, and disclosure practices) in the financial and corporate sectors; and (iii) inadequate prudential supervision and regulation of domestic financial institutions and markets. The Asian experience also suggests that short-term foreign debt poses special problems for the maintenance of financial sector stability.
Working Paper No. 232
The Privatization Two-Step at China's Listed Firms
Stephen Green, November 2004
During the 1990s, China’s stock market was subordinated to industrial policy and as a result it did not facilitate privatization. The majority of listed companies’ shares were non-tradable and held by state organs. However, since 1997 an off-exchange market in these non-tradable shares has developed. State entities are deciding, in ever-greater numbers, to sell their holdings to private investors, and control rights over the firms involved often change as a result. This market is facilitating corporate restructuring which should lead to improved firm performance. China’s capital market will only mature if this occurs. This paper provides an analysis of the non-tradable share market and reviews evidence on the impact of privatization on firm performance.
Working Paper No. 233
Foreign Direct Investment in China and East Asia
Busakorn Chantasasawat, K.C. Fung, Hitomi Iizaka and Alan Siu, November 2004
By any measure, China's policy to attract foreign direct investment (FDI) as a pillar of its development strategy has been a huge success. This FDI policy is promoting growth in China. But is this development strategy beggar-thy-neighbor? In other words, is China taking direct investment away from other Asian developing economies? Theoretically, a growing China can add to other countries’ direct investment by creating more opportunities for production-networking and raising the need for raw materials and resources. At the same time, the extremely low Chinese labor costs may lure multinationals away from other Asian sites when the foreign corporations consider alternative locations for low-cost export platforms.
In this paper, we explore this developmental issue empirically. We use data for eight Asian economies ( Hong Kong, Taiwan, Republic of Korea, Singapore, Malaysia, Philippines, Indonesia and Thailand) from 1985 to 2001 and control for the determinants of their inward direct investment. We then add China’s inward foreign direct investment as an indicator of the “China Effect”. Due to issues of simultaneity, we use a random effects simultaneous equation model to estimate our coefficients.
We have three results: (1) The level of China’s foreign direct investment is positively related to the levels of these economies’ inward direct investments; (2) the level of China’s foreign direct investment is negatively related to the direct investment of these economies as shares of total Asian foreign direct investments; (3) The China Effect is generally not the most important determinant of the inward direct investments of these economies. Policy and institutional factors such as openness, corporate tax rates and the level of corruption tend to be more important.
Why Institutions Matter: Banking and Economic Growth in Mexico
Stephen Haber, November 2004
Mexico has grown at a remarkably anemic pace under free trade. One of the principal reasons has been the paucity of finance for firms and households, but understanding why there is so little private bank credit requires and understanding of the institutions that structure the incentives of bankers, investors, and the government. However, institutional reform is not independent of Mexico 's current process of political reform. This paper develops and discusses the logic and evidence of this argument.
Some Light at the End of the Tunnel: Ingredients of Power Sector Reforms in India
N.K. Singh and Jessica S. Wallack, December 2004
India 's electricity sector is at a crossroads. The 1990s have brought a fundamental policy shift in sector governance, including restructuring monolithic State Electricity Boards (SEBs), increasing the private sector's role in generation, transmission, and distribution of electricity, and developing a new regulatory framework. The current wave of reforms envisions even farther-reaching reforms such as a national wholesale power trading market. Nevertheless, important challenges lie ahead. The country's enormous geographical size, dispersed population, and regionally concentrated energy sources pose particular challenges for provision of low-cost, reliable electricity. Governance of the sector is also complicated by the fact that power has been a concurrent responsibility of center and state governments. The policy tasks of upgrading and expanding the sector are daunting. This paper focuses on priorities for overcoming these challenges. The past decade of reforms in the Indian electricity sector have been focused on increasing generation capacity, but we advocate greater attention to the distribution and transmission aspects of the power sector. We emphasize the importance of creating a clear regulatory framework, tightening the link between actual costs of service and pricing, and removing transmission capacity constraints before moving to the more ambitious changes in the power market.
The Economics of Migrants' Remittances
Hillel Rapoport and Frederic Docquier, December 2004
This paper reviews the recent theoretical and empirical economic literature on migrants' remittances. It is divided between a microeconomic section on the determinants of remittances and a macroeconomic section on their growth effects. At the micro level we first present in a fully harmonized framework the various motivations to remit described so far in the literature. We show that models based on different motives share many common predictions, making it difficult to implement truly discriminative tests in the absence of sufficiently detailed data on migrants and receiving households' characteristics and on the timing of remittances. The results from selected empirical studies show that a mixture of individualistic (e.g., altruism, exchange) and familial (e.g., investment, insurance) motives explain the likelihood and size of remittances; some studies also find evidence of moral hazard on the recipients' side and of the use of inheritance prospects to monitor the migrants' behavior. On the whole, the incentive structure leads to patterns of migration and remittances that can raise inter-household inequality at origin. At the macro level we first briefly review the standard (Keynesian) and the trade-theoretic literature on the short-run impact of remittances. We then sue an endogenous growth framework to describe the growth potential of remittances and present the evidence for different growth channels. There is considerable evidence that remittances (in the form of savings repatriated by return migrants) promote access to self-employment and raise investment in small businesses, and there is also evidence that remittances contribute to raise educational attainments within households having migrant members. Finally, the relationship between remittances and inequality appears to be non-monotonic: remittances seem to decrease economic inequality in communities with a long migration tradition but to increase inequality within communities at the beginning of the migration process. This is consistent with different theoretical arguments regarding the role of migration networks and/or the dynamics of wealth transmission between successive generations.
The Microeconomic Effects of Different Approaches to Bank Supervision
Ross Levine, December 2004
A large body of evidence finds that cross-country differences in banking sector development influences national rates of economic growth. To assess which policies enhance the functioning of banks, this paper evaluates two broad government approaches to bank supervision: official supervision, and private sector monitoring. The microeconomic evidence is inconsistent with the official supervisory approach to bank supervision and regulation and broadly consistent with the private monitoring view. The data do not suggest that strengthening the ability of official supervisors to directly monitor and discipline banks improves bank efficiency or the integrity of bank-firm relations. Rather, the data indicate that empowering official supervisors tends to increase the degree to which the corruption of bank officials curtails firm growth. The results empirically verify the private monitoring approach. Empowering private monitoring of banks tends to enhance the efficiency of intermediation and enhance the integrity of bank-firm relations. While confirming the private monitoring view, the data strongly reject the official supervisory approach to bank supervision.
Economic Reforms, Financial Development, and Growth: Lessons from the Chilean Experience
Leonardo Hernandez and Fernando Parro, January 2005
Despite the reform effort of the past decade, the economic and social performance of Latin American countries during the 1990s was quite disappointing. The exception was Chile , which grew at a rate near 7% for most of the decade and reduced its poverty rate significantly. This paper tries to explain this striking difference. Following the most recent literature that highlights the role played by institutions and policies on growth, we argue that Chile 's better performance was due to the country undertaking reforms that were much deeper and broader in scope than those in other Latin American countries. In the process, Chile ended up with stronger macro fundamentals and, most important, better institutions. Based on a cross-sectional econometric model estimated over the 1969-2000 period, we argue that Chile's better performance can be explained by the country's better institutions and better policies in equal shares (in contrast, East Asia's better performance is explained mainly by better economic policies). In addition, time series estimations show that Chile 's 1981 pension reform and 1986 banking sector reform were critical to foster the development of the financial sector and thus accelerate economic growth. We conclude that, in order to attain higher growth, Latin American countries should move forward in their reform processes and put more emphases on building and strengthening their institutions, which, based on Chile's experience, can be modified (albeit slowly).
Coordinating Creditors
Mark Wright, January 2005
The market for developing country sovereign debt has become increasingly competitive. Is this necessarily good for welfare? Or, is there scope for beneficial government intervention to reduce competition, and promote coordination, among creditors? This paper reviews recent theoretical work on the market for developing country sovereign debt that shows that competition can reduce welfare. Further, it argues that while private sector creditor organizations have been successful at coordinating existing creditors in history, government intervention to discourage entry by new creditors may be welfare improving today.
Public Debt in India: the Need to Separate Debt from Monetary Management
Charan Singh, February 2005
In India , traditionally, a large component of domestic government debt was incurred at low rates of interest, which was statutorily prescribed for subscription by the institutional investors. A substantial amount of domestic debt was also monetised. The fiscal domination of monetary policy left very little flexibility for the Reserve Bank of India , the central bank of the country, to pursue a monetary policy conducive to the overall objective of development of financial markets, price stability and economic growth. In the last decade, due to financial sector reforms undertaken since 1991, the money and government securities markets have developed with the offering of market-related rates of interest on government securities, introduction of new instruments, setting up of trading institutions, and improved regulatory and technological developments. The interest rates in the financial markets are converging and the markets are becoming integrated. The debt management functions and practices have also developed substantially since 1991. In view of the developments in the markets and the commitment on the part of the central government to contain the fiscal deficit, it would be prudent to consider now the separation of monetary and debt management. The separation would provide the central bank with necessary independence in monetary management and an environment to pursue an inflation target, if assigned by the government. The separation of debt management would provide focus to the task of asset-liability management of government liabilities, undertake risk analysis and also help to prioritise government expenditure through higher awareness of interest costs.
Financial Sector Reforms in India
Charan Singh, February 2005
The performance of the Indian economy in the last decade has been remarkable. This can be partly attributed to the multi-sector structural reforms, undertaken simultaneously in 1991, aimed at enhancing productivity, efficiency and international competitiveness of the economy. The reforms in the financial sector have been most effective. The main thrust of the financial sector reforms has been the creation of efficient and stable financial institutions and development of the markets, especially the money and government securities market. In addition, fiscal correction was undertaken and reforms in the banking and external sector were also initiated. The reforms have been undertaken gradually with mutual consent and wider debate amongst the participants and in a sequential pattern that is reinforcing to the overall economy. The financial markets have developed and are more integrated after the reforms, and regulatory and supervisory institutions have been set-up. The reforms, though slow paced initially but well synchronized, have begun to yield results. The economy has recorded consistently high growth rates, avoided any adverse impact from the South East Asian Crises, built substantial foreign exchange reserves, pre-paid some of its external debt and restructured its domestic debt.
A New Test of Long-Run PPP Based on Cross-Country Data
Pan A. Yotopoulos and Yasuyuki Sawada, March 2005
We formulate and implement a new empirical procedure to examine the validity of PPP in the long-run for 153 countries by using the familiar cross-country data set of Heston, Summers, and Aten (2002). Unlike the existing studies that rely on mean reversion of real exchange rates, we explicitly examine country-specificity in the deviations of the nominal exchange rate from PPP. We find, first, that out of a total of 153 countries, 132 countries have achieved PPP within twenty years, 1980-2000 and 105 countries have attained PPP over ten years, 1990-2000. Second, according to the results, our method can be accepted as a workable shortcut of the direct, full-information approach of Yotopoulos (1996) that tests for long-run PPP utilizing micro-ICP data. This becomes an important characteristic of this paper since comprehensive micro-ICP data are no longer easily available. As a by-product of the empirical validation of our shortcut approach, our empirical results are in favor of the Ricardo-Samuelson-Balassa effect.
The Idea of South Asia and the Role of the Middle
Class
Nirvikar Singh, April 2005
In the post-colonial world, the countries of South Asia have evolved politically in different ways, amidst internal and regional conflicts, but retained some commonality of institutions and cultures. Since the 1990s, the promise of market-led development and the growth of a middle class, especially in India, have reshaped expectations in a way not seen since the immediate post-colonial period, and provided the prospect of a region that combines its particular approach to governance with common aspirations and achievement of economic well-being – what might be a new “idea of South Asia.” This paper examines some aspects of the development of the South Asian middle class, their role in economic development, and the potential of the idea that shared middle class aspirations of material consumption can be a regional driving force. The paper argues that, for this potential to be realized, the middle class in South Asia may need to aspire to something more than private affluence in the midst of public squalor. In that case, a new idea of South Asia will require building social capital in ways that will challenge all of the region’s societies. Effective collective action across, but first within, the nations of South Asia will be the true test of whether this potential South Asian identity emerges.
The Chinese Approach to Capital Inflows: Patterns and Possible Explanations
Eswar Prasad and Shang-Jin Wei, April 2005
In this paper, we adopt a cross-country perspective to examine the evolution of capital flows into China, both in terms of volumes and composition. China’s inflows have generally been dominated by foreign direct investment (FDI), a pattern that appears to be favorable in light of the recent literature on the experiences of developing countries with financial globalization. We provide a detailed documentation of the evolution of China’s capital controls, a proximate determinant of the pattern of capital inflows. We also discuss a number of other intriguing hypotheses that attempt to capture the “deeper” causes underlying China’s approach to capital flows. In particular, we argue that some popular mercantilist-type arguments are inconsistent with the facts. We also analyze the recent rapid rise of China’s international reserves and discuss its implications. Contrary to some popular perceptions, the dramatic surge in foreign exchange reserves since 2001 is mainly attributable to non-FDI capital inflows, rather than current account surpluses or FDI.
Making Monetary Policy Work in China: A Report from the Money Market Front Line
Stephen Green, July 2005
This paper examines the current state of monetary policy in China: its institutions, effectiveness and limits. It explains the reasons why the transmission mechanisms of monetary policy do not yet work effectively in China and some of the broad policies that are required in order to meet this challenge. The problem is primarily explained by excess liquidity in the banking system and a lack of investible debt instruments. The paper also assesses and measures the PBoC’s three-pronged efforts to sterilise FX inflows (bill issuance, reserve requirement increases and window guidance), estimating that the authorities managed to sterilise some 47% of inflows in 2004. However, analysis of the flows involved suggest that proportionally more are being added to base money at present, and that the domestic costs of sterilisation are rising. It also shows that FX inflows are undermining China’s monetary policy independence, causing money market rates to fall, undermining bank profitability as well as causing other micro-economic problems.
Skilled Emigration, Business Networks and Foreign Direct Investment
Maurice Kugler and Hillel Rapoport, July 2005
In a global context foreign direct investment (FDI) and migration substitute one another in the matching process between workers and firms. However, as labor flows can lead to the formation of business networks, migration can actually facilitate FDI in the long-run. We first present a stylized model for a small open economy illustrating these offsetting effects. We then use U.S. data on bilateral labor in- flows and capital outflows to measure the extent of contemporaneous substitutability and dynamic complementarity between migration and FDI. We find that brain drain and FDI inflows are negatively correlated contemporaneously but that skilled migration is associated with future increases in FDI inflows. We also find suggestive evidence of substitutability between current migration and FDI for migrants with secondary education, and of complementarity between past migration and FDI for unskilled migrants.
Accrual Reform in the Public Sector in China
Yinghua Shi, August 2005
Since the 1990s, the move to the accrual basis for government accounting and budgeting has been one of the main pillars of the on-going reform in international public finance. Analysis of the existing budget accounting system in China shows that transition to the accrual basis is essential to deepen current and future fiscal management reform. Cost-benefit analysis indicates that introducing the accrual basis can make government accounting information more comprehensive, transparent, consistent and sustainable, and thus reduce the financing costs of the government. The author suggests that conversion of the public accounts should follow a gradual, well-planned path, be harmonized with fiscal management reform, and take full account of the demand for information from within and outside of the government. A realistic option would be to apply a modified accrual basis to government accounting and a cash basis to the government budget. The sequence of reform would deal with financial assets and liabilities first, followed by real assets, then contingent liabilities and political promises. The scope for applying the accrual basis should reflect the principles of feasibility and ease of measurement. Simultaneously restructuring the government accounting system and developing accounting standards and a system for financial reporting are fundamental steps for the transition. Staff training, software development and legislative revisions are also necessary to the reform.
Estimating the Effect of Direct Democracy on Policy Outcomes: Preferences Matter!
Patricia Funk and Christina Gathmann, August 2005
Previous studies have found large negative effects of direct democracies on government spending. Since they do not control for preference heterogeneity, these estimates suffer from omitted variable bias. If citizens in areas with stronger direct democracy have lower tastes for government, the restraining effect of institutions is overstated. Exploiting a unique dataset in Switzerland, we demonstrate substantial preference heterogeneity across cantons with different direct democratic regimes. Conditional on voter preferences, the effect of direct democracy declines by more than 40 percent relative to earlier estimates. However, access to direct democratic instruments still decreases canton expenditures by 8 percent, while raising expenditures at the local level by 20 percent. In the Swiss case, a mandatory budget referendum decentralizes expenditures, but has no effect on the size of canton and local governments combined. Our results speak against a pure median voter model and strengthen the view that political institutions have a strong and persistent influence on policy outcomes.
Property Rights for the Poor: Effects of Land Titling
Sebastian Galiani and Ernesto Schargrodsky, August 2005
Secure property rights are considered a key determinant of economic development. The evaluation of the causal effects of land titling, however, is a difficult task as the allocation of property rights is typically endogenous. We exploit a natural experiment in the allocation of land titles to overcome this identification problem. More than twenty years ago, a group of squatters occupied a piece of land in a poor suburban area of Buenos Aires. When the Congress passed a law expropriating the land from the former owners with the purpose of entitling it to the occupants, some of the original owners accepted the government compensation, while others are still disputing the compensation payment in the slow Argentine courts. These different decisions by the former owners generated an allocation of property rights that is exogenous in equations describing the behavior of the squatters. We find that entitled families increased housing investment, reduced household size, and improved the education of their children relative to the control group. However, effects on credit access are modest and there are no effects on labor income.
Membership Has Its Privileges:
The Impact of GATT on International Trade
Michael Tomz, Judith Goldstein, and Douglas Rivers, August 2005
Recent research concludes that membership in the GATT/WTO had no effect on foreign trade. By mistakenly classifying many countries as outsiders, even though they had rights and obligations under the agreement, this work systematically underestimates the effect of GATT. We correct the downward bias in previous estimates. Our analyses show that GATT substantially increased trade, and that its effects were relatively stable across countries and over time.
Productivity and Economic Growth
T.N. Srinivasan, September 2005
The author reviews modern academic thinking on the interactions between total factor productivity (TFP) and economic output growth. He pays special attention to the theoretical potential sources of TFP improvements, namely, efficient resource allocations, exploitation of scale economies and positive externalities, and technological progress. He then illustrates by considering the specific historical experiences of China, India, Mexico and South Africa while focusing on the importance of both country-specific institutions and international cooperation.
Doha Round of Multilateral Negotiations and
Development
T.N. Srinivasan, September 2005
The author critically discusses the Doha, Qatar, round of multilateral negotiations to reduce trade barriers under the auspices of the World Trade Organization (WTO). He pays specific attention to whether or not the WTO should adopt general welfare or “development” goals in addition to its main function as the chief facilitator and policy-making body in the governing of international trade and investment. The author frames his discussion in the historical context of the General Agreement on Tariffs and Trade (GATT) and other multilateral trade negotiations and critically reviews Stiglitz and Charlton (2005), a previous examination of this question. He concludes that the WTO should restrict itself to trade-related issues, that civil society organizations should not be granted direct representation, that the “ultra-legalistic” system of dispute resolution developed at the Uruguay Round is biased toward countries that can afford expensive legal expertise, that the accession process needs to be streamlined, and finally that the WTO’s Anti-Dumping Measures (ADMs) should be repealed.
Challenges of Economic Reform in Egypt
T.N. Srinivasan, September 2005
The paper takes its foundation from a previous version presented in Cairo at a June 2004 conference entitled "Revisiting Egypt's Competitiveness: The Road Ahead for Building Leading Sectors." The conference was sponsored by the Center for Economic & Financial Research & Studies (CEFRS), Faculty of Economics and Political Sciences (FEPS) of Cairo University in collaboration with the United States Agency for International Development and the Egyptian Competitiveness Council. Heba Nassar, mentioned in the introduction, was Director of CEFRS, FEPS at the time of the conference and Heba Handoussa was fellow presenter.
In this followup study, Srinivasan cites his 2004 analysis of the Egyptian economy and discusses positive progress since. However, he warns that total factor productivity (TFP) gains due solely to improved capacity utilization (without physical capital investment) are unsustainable, and stresses the importance of consistent and reliable collection of relevant economic data. He advises the consideration of fiscal reform and budget management laws modeled after past enactments in India. Srinivasan praises Egypt’s recent tariff cuts and comments on the challenges posed by poverty elimination in the coming decade.
Earnings Mobility and
Measurement Error: A Pseudo-Panel Approach
Francisca Antman and David J. Mckenzie, September 2005
The degree of mobility in incomes is often seen as an important measure of the equality of opportunity in a society and of the flexibility and freedom of its labor market. However, estimation of mobility using panel data is biased by the presence of measurement error and non-random attrition from the panel. This paper shows that dynamic pseudo-panel methods can be used to consistently estimate measures of absolute and conditional mobility in the presence of non-classical measurement errors. These methods are applied to data on earnings from a Mexican quarterly rotating panel. Absolute mobility in earnings is found to be very low in Mexico, suggesting that the high level of inequality found in the cross-section will persist over time. However, the paper finds conditional mobility to be high, so that households are able to recover quickly from earnings shocks. These findings suggest a role for policies which address underlying inequalities in earnings opportunities.
Two Types of Regional Integration Processes: The
FTAA and its comparison with the EU and MERCOSUR
Armando Di Filippo, September 2005
The Introduction tries to explain the reasons, beliefs, and prejudices of the author that led him to write this essay. The first section sets out the historical background and features of regional integration in Latin America between 1960 and 1990. The second section examines the one-dimensional, so called, Free Trade Agreements that have been signed (or are being negotiated) in the hemisphere. The third section describes Latin American and Caribbean (LAC) multidimensional schemes. The fourth examines the degree of compatibility between both types of agreements. The fifth, departing from USA and EU experiences, explains the decisive importance that the political dimensions of regionalism have acquired after the re-democratization process, and the sixth section discusses the economic benefits of multidimensional integration.
Should India Use Foreign Exchange Reserves for Financing Infrastructure?
Charan Singh, September 2005
India's foreign exchange reserves have increased from US$5.8 billion at end-March 1991 to US$140.1 billion at end-March 2005 as a result of measures introduced to liberalize capital inflows under the financial sector reforms undertaken since 1991. The Reserve Bank of India, in consultation with the government, currently manages foreign exchange reserves. As the objectives of reserve management are liquidity and safety, attention is paid to the currency composition and duration of investment so that a significant proportion can be converted into cash at short notice. The Government of India intends to use a part of its foreign exchange reserves to finance infrastructure. Infrastructure projects in India yield low or negative returns due to difficulties – political and economic – especially in adjusting the tariff structure, introducing labor reforms and upgrading technology. There is no evidence that any other country has used foreign exchange reserves to finance infrastructure. The amount of foreign exchange reserves in India is modest when compared to some of the other countries in the region and it can be argued that the proposed plan may lead to more economic difficulties than anticipated benefits.
Bonds or Loans? The Effect of Macroeconomic Fundamentals
Galina Hale, September 2005
The costs of debt crises are not invariant to the foreign debt instrument composition: bank loans or bonds. The lending boom of the 1990s witnessed considerable variation over time and across countries in the debt instrument used by emerging market (EM) borrowers. This paper tests how macroeconomic fundamentals affect the composition of international debt instruments used by EM borrowers. Analysis of micro–level data using ordered probability model shows that macroeconomic fundamentals explain a significant share of variation in the ratio of bonds to loans for private borrowers, but not for the sovereigns.
Migration and education inequality
in rural Mexico
David McKenzie and Hillel Rapoport, September 2005
This paper examines the impact of migration on education inequality in rural Mexico. Using data from the 1997 National Survey of Demographic Dynamics (ENADID), we first examine the impact of migration on educational attainment for males and females aged 12-15 and 16-18. We then build on the results on attainments to compute education inequality indicators for a large sample of communities throughout Mexico. After instrumenting, we find no significant impact of migration on educational attainment of 12 to 15 year olds. In contrast we find evidence of a strong disincentive effect of migration on schooling levels of 16 to 18 year olds, resulting in less education. This effect is strongest for males and for children of highly educated mothers. As a result of this, migration tends to lower educational inequality, in particular for females, but changes in inequality are driven mainly by reductions in schooling at the top of the education distribution rather than by increases in schooling from relaxing liquidity constraints at the bottom.
Exchange Rates and Trade Balances under the Dollar
Standard
Hong Qiao, September 2005
The author argues that forcing creditor countries to appreciate or freely float their currencies is an ineffective strategy for reducing the U.S. trade deficit. To this end, the paper considers impacts of discrete exchange rate changes in open economies with net foreign exchange liabilities and assets. The author finds that wealth, investment, and indirect investment effects (when present) increase the complexity of forecasting current account movements following exchange rate changes, in many cases leading to ambiguous results.
Poverty Traps and Nonlinear
Income Dynamics with Measurement Error and Individual Heterogeneity
Francisca Antman and David J. Mckenzie, September 2005
Theories of poverty traps stand in sharp contrast to the view that anybody can make it through hard work and thrift. However, empirical detection of poverty traps is complicated by the lack of long panels, measurement error, and attrition. This paper shows how dynamic pseudo-panel methods can overcome these difficulties, allowing estimation of non-linear income dynamics and testing of the presence of poverty traps. The paper explicitly allows for individual heterogeneity in income dynamics, to account for the possibility that particular groups of individuals may face traps, even if the average individual does not. These methods are used to examine the evidence for a poverty trap in labor earnings, income, and expenditure in Mexico and are compared to panel data estimates from a short rotating panel. The results do find evidence of nonlinearities in household income dynamics, and demonstrate large bias in the panel data estimates. Nevertheless, even after allowing for heterogeneity and accounting for measurement error, we find no evidence for the existence of a poverty trap for any group in our sample.
Growth and Poverty Reduction
under Globalization: The Systematic Impact of Exchange Rate Misalignment
Yasuyuki Sawada and Pan A. Yotopoulos, September 2005
This article presents an assessment of the role of economic growth under globalization in achieving the first target of the Millennium Development Goals (MDGs), namely to halve the incidence of abject poverty in the world by year 2015. The analysis is composed of two parts. First, by following the consensus in the relevant literature we address economic growth as the most effective instrument for achieving poverty reduction. In evaluating the feasibility of this approach we extend the exit-time concept (Kanbur, 1987; Morduch, 1998) and we find that at least one half of all the targeted countries, and the totality of countries in the poorest group, will not achieve the first target of the MDGs if they continue on their historical trajectory of economic growth in the future. This finding highlights the importance of increasing the rate of economic growth, especially for the poorest countries, as a necessary condition of effective poverty reduction. Next we focus on the imperative of accelerating the rate of growth in the poorest countries of the world if the MDGs were to be achieved. In a standard reduced-from growth regression model fitted with cross country data we introduce the exchange rate misalignment defined as the deviation between the nominal and the real exchange rate (Yotopoulos and Sawada, 2006). We confirm the negative relationship between misalignment and growth and, most importantly, the analysis points to the misalignment of exchange rates as originating in the currency substitution that takes place in developing countries and results in the systematic devaluation of their currencies that, in turn, further exacerbates exchange rate misalignment. This finding highlights the importance of the proper combination of trade and exchange rate policies in fostering growth in developing countries in the current environment of globalization.
Health Uncertainty
and Precautionary Saving: Evidence from Korea
Moon Kee Kong, Jeong Yeon Lee, and Hoe Kyung Lee, October 2005
This paper considers a model of precautionary behavior under health uncertainty and derives testable equations for changes in consumption and medical expenditures. Under this framework, individuals who face future health uncertainty will exhibit precautionary behavior by depressing consumption and at the same time increasing medical care expenditures. In testing the precautionary motive, the paper uses the conditional variance of health disturbances as the direct measure of health uncertainty. Empirical findings suggest that the uncertainty about future health outcomes motivates elderly Koreans to hold down their levels of overall spending during the early years of retirement.
Disparities and Income Mobility in China
Niny Khor and John Pencavel, October 2005
Using household surveys from both China and the U.S., the authors compare and contrast income inequality and income mobility in these labor markets. In the paper, Khor and Pencavel focus on answering the following questions: To what extent are measures of annual income inequality in China misleading indicators of long-run income inequality? How much income mobility was there in urban China in the first half of the 1990s and how did this compare with mobility in other countries? Have real income increases been greater for the poor or the rich? How important is the variation in permanent incomes in China and how has this changed? Among their conclusions, the authors establish that China experienced a greater level of income mobility across quintiles in the 1990s than did the U.S. and/or other high-income countries. In addition, correlation coefficients between incomes in different years in China have been falling, suggesting even greater income mobility over time.
Universal Telecommunications Service in India
Roger G. Noll and Scott J. Wallsten, October 2005
Nearly every country in the world, including India, has policies intended to promote universal access to telecommunications services, despite the absence of evidence of a market failure in the industry. Universal service policies typically involve cross-subsidies among types of telecom consumers and among telecom providers. India’s New Telecom Policy of 1999 set goals of providing telephone and Internet access in all villages by 2002. This plan was not successful, so in 2003 DoT established a program to subsidize some telecommunications services in Indian villages. Taxes on all providers, raised mostly from private entrants, are transferred to the state-owned incumbent, BSNL, to cover part of the costs of its local network. Additional funds are distributed via auction to the firm requesting the smallest subsidy to provide service in a given area. The auction design discourages competition, so that the initial subsidies went primarily to the incumbent, BSNL. To be effective, policies intended to bring telecommunications services to people who otherwise would not have access should focus on encouraging competition, which has proven worldwide to be the most effective mechanism for encouraging investment and reducing prices.
Would the Provisions of the Doha Round Benefit the Least Developed
Countries?
David Bigman, November 2005
The prescriptions of earlier years for helping countries
grow call for leveling the "playing field" of international trade by
removing distorting restrictions on trade in both developed and developing
countries and subsidies that main developed countries give to their
agricultural producers. This has been the general direction of the reforms
planned at the Doha Round that were aimed at giving developing countries
an equal opportunity to compete in the world market of agricultural
commodities in which their comparative advantage promises them the greatest
potential to expand their exports.
The paper evaluates the effectiveness of these reforms in light of changes that took place in the past decade in the structure of world production and trade due partly to accelerating technical changes and the dominating role of multinational corporations, and partly to changes in the institutions and rules that regulate international trade. The paper focuses on the impact of the reforms negotiated at the Doha Round on the least developed countries (LDCs) and examines whether these reforms will indeed help the LDCs in light of all these changes. This analysis and experience, raises doubts whether the current trade reforms would indeed benefit the LDCs and help them to increase their agricultural exports.
Banking With and Without Deposit Insurance: Mexico’s Banking Experiments,
1884-2004
Stephen Haber, November 2005
The author examines the long history of banking regulation in Mexico from 1884-2004. He identifies three "experiments" in Mexico's banking history (1884-1911, 1924-1982, 1991-1996) during which banking regulation and the political environment differed, and analyzes reasons why deposit insurance was or was not adopted in each. He observes that unlimited deposit insurance requires effective corporate governance and regulation, that government-run development banks may implicitly substitute for deposit insurance when it is absent, and that the existence of a stable banking system is possible even when deposit insurance does not exist.
Foreign Banks and the Mexican Economy, 1997-2004
Stephen Haber and Aldo Musacchio, November 2005
In 1997 Mexico allowed foreign banks unrestricted entry to the market, allowing multinational banks to acquire almost all of Mexico's large banks. At the same time, the Mexican banking system began to limit private credit, in both absolute and relative terms. We investigate the hypothesis that these phenomena are related, and find for the null hypothesis: the contraction in credit is not related to foreign entry. The evidence does suggest, however, that foreign banks are better able to screen borrowers and charge lower interest margins than domestic banks. The evidence also suggests that foreign entry is associated with increased bank administrative efficiency. The implication is that foreign entry has produced welfare gains to consumers.
Political Institutions and Financial Development: Evidence from the
Economic Histories of Mexico and the United States
Stephen Haber, November 2005
Why is there considerable variation across countries in levels of financial development? The extant literature points to two explanations: legal origin and political institutions. This paper adjudicates between these two explanations by tracing the process by which the banking systems of the United States and Mexico developed from independence to 1913. This analysis indicates that political institutions- particularly those that created institutionalized competition among political entities- played a determinative role in the size and structure of each country's banking system. It therefore lends considerable support to the political institutions view of financial development, while providing no support for the legal origins view.
Development Strategy or Endogenous Process? The Industrialization
of Latin America
Stephen Haber, November 2005
The author "reinterprets" the history of Latin American industrialization arguing that the contrast between a period of export-oriented growth and a period of import-substituting industrialization is less clear cut than suggested in the Latin Americanist literature. Furthermore, Latin American industrialization began as an endogenous outcome of the growth of the export sector (rather than as the result of a rethinking of export-led development), and once industrialization began, governments haphazardly enacted protectionist policies at the behest of manufacturers.
Asymmetric Globalization: Impact on the Third World
Pan Yotopoulos, January 2006
Globalization in the form of free markets and free trade is based on comparative advantage trade that delivers mutual benefits to the parties involved. This paper focuses on the special case where the benefits of free trade are captured asymmetrically by the more developed countries, at the expense of their poorer trading partners. One common but nontrivial case is when poor countries lack and cannot afford the basic Smithian (enhanced) infrastructure that free trade requires. Any attempt at globalization that does not rest on a solid foundation of extant market institutions is doomed to fail, and it is poverty itself that becomes the cause of this asymmetry of globalization. A more important asymmetry arises when international exchange transcends the traditional trade in commodities and extends to trade in services – including trade in “pure” services but also a broad range of more-or-less “decommodified” trade. This is the signature trade of the modern era of globalization; it incorporates “reputational payoffs” whether as monopoly returns to patents and international property rights and/or in the form of the economic rents of advertising and brand-name recognition. Decommodified trade becomes trade in positional goods and the developed countries are better structured in capturing its reputational payoffs. Finally, trade in currency that is used as an asset also becomes trade in positional goods with the payoffs of currency substitution going to the reserve (and partly to hard) currency countries. This is the worst case of asymmetries of globalization since not only it delivers asymmetrically its payoffs, but it also metes out to the poorer countries the hard punishment of a “misaligned” exchange rate and contractionary devaluations that often develop into full-blown financial crises.
Wages and Returns to Education in Chinese Cities
Dennis T. Yang, February 2006
This paper uses 1988 and 1995 data from a national household survey to document wages and returns to education for a large number of cities during China’s economic transition. Between these two years, average real wages and returns to education increased, yet their spatial dispersions across cities widened dramatically. While market-oriented reforms were expected to equalize returns to human capital across regions, there was no sign of significant wage convergence in Chinese cities during this period. I argue that coordinated reforms in pension systems, housing markets, hukou registration, and local government behavior are imperative for improving the integration of local labor markets in China.
China's Exchange Rate Appreciation in the Light of the Earlier Japanese Experience
Ronald McKinnon, March 2006
For creditor countries on the periphery of the dollar standard such as China with current account surpluses, foreign mercantile pressure to appreciate their currencies and become more flexible is misplaced. Just the expectation of variable exchange appreciation seriously disrupts the natural tendency for wage growth to balance productivity growth and thus worsens the (incipient) deflation that China now faces. It could create a zero-interest liquidity trap in financial markets that leaves the central bank helpless to combat future deflation arising out of actual currency appreciation, as with the earlier experience of Japan. Exchange rate appreciation, or the threat of it, causes macroeconomic distress without having any predictable effect on the trade surpluses of creditor economies.
Can Aid Reform Institutions?
Mary Shirley, March 2006
Can aid reform institutions? The realities of foreign aid and the nature of aid-giving organizations are at odds with what we know about institutional change: that it is often gradual, path dependent, context specific, and contrary to notions of best practice in Western countries. Empirical analyses find no positive correlation between aid and better institutions or between aid and growth in GDP per capita. If aid cannot reform institutions, can aid avoid damaging institutions? Efforts to avoid the ill effects of damaging institutions by insulating aid projects or by relying on NGO's or beneficiary participation, have met with mixed success. Efforts to aid only those poorer countries that are already improving their institutions confront serious measurement problems. This paper calls for more experiments, better local information, more case studies of the institutional prerequisites for the implementation of high priority policies, and greater local capacity to study institutional problems and design sustainable institutional reforms.