Location: Global
Is Local Monetary Policy Less Effective When Firms Have Access to Foreign Capital?
Central banks affect growth in part by raising or lowering the cost of investment through their influence over local interest rates. We examine whether the ability of local firms to raise money abroad reduces the influence of local monetary policy authorities. Surprisingly, it does not. In fact, we find that firms that are able to raise equity capital from foreign investors are more responsive, not less, to local monetary policy shocks than those that raise capital only in the domestic market. These findings suggest that foreign investors confer an efficiency effect, improving the sensitivity of stock prices to local monetary policy shocks.
One means by which central banks affect economic growth is by influencing interest rates that impact the cost of financing for firms. For example, when a central bank lowers interest rates, those lower rates make new investment cheaper and more profitable. That encourages companies to invest more. Profits rise, firms hire more and we see growth in the economy as a whole.
When firms are able to raise money abroad, they are no longer as dependent on the local economy for financing. This potentially causes problems for central banks and other local monetary policy authorities who wish to influence the local economy by controlling interest rates.
This brief summarizes the results of Francis, Hunter and Kelly (2016), where we examine the extent to which monetary policy authorities’ influence differs across firms that are able to access foreign capital (also called “investable stocks”) and those that are largely dependent on the local market (also called “non-investable stocks”). Contrary to expectations, the evidence shows that firms that are able to raise foreign capital by being open to foreign equity investment are actually more sensitive to local monetary policy shocks than those that are not.
The perks and perils of financial liberalization
Over the last 30 years, the authorities in several less developed countries liberalized their domestic financial markets by allowing foreign ownership of local stocks. There are tremendous benefits for the local firms that became ‘investable’ as these countries liberalized, relative to firms that remained dependent solely on domestic stock markets. These include, inter alia, (1) being able to raise large tranches of foreign capital at lower rates than available in the domestic market, which reduces their financing constraints and increases their ability to invest, (2) substantial improvement in the liquidity of their stocks, (3) improvements in corporate governance and reporting (see Reese and Weisbach, 2002), and (4) greater efficiency with which their stocks incorporate value-relevant information.
Despite these benefits, there is widespread concern that liberalization comes with several problems. First, foreign capital flow (“hot money”) can cause excess volatility in local stock markets and exchange rates when foreign investors rapidly repatriate their funds. Second, local firms may become sensitive to foreign monetary policy shocks, and those foreign monetary shocks may be contrary to what is needed in the local economy. Third, and perhaps chief among the problems, is that if a large segment of domestic firms is able to raise capital abroad, then local monetary authorities may lose their ability to influence the domestic economy through their control of local policy interest rates. We examine this last concern in this policy brief below.
What does the research tell us?
One of the big challenges when measuring the impact of changes in monetary policy on an economy is the fact that the effects of investment started or stalled by changes in monetary policy may take months, or even years, to play out. The long time frame makes it very difficult to tell whether changes in monetary policy affect the macro economy. To solve this problem we follow in the footsteps of the former Chair of the U.S. Federal Reserve, Ben Bernanke (see Bernanke and Blinder, 1992, and Bernanke and Kuttner, 2005) and examine the impact of monetary policy shocks on stock returns. We do this because stock prices reflect anticipated changes in the economy and they are one of several channels through which monetary policy actions are transmitted to the real economy. That is, if local stock prices respond to monetary policy changes, it is likely the local economy will respond as well.
Because stock prices move in anticipation of future improvements in the economy, it is very important that we measure monetary policy surprises (also referred to as shocks) and not merely observed changes in monetary policy. To do this we model expectations about local monetary policy as a function of changes in oil price, changes in the U.S. Fed-funds rate (a proxy for changes in U.S. monetary policy), local industrial production growth, inflation rate and exchange rate changes. Details are described in the companion paper to this brief, Francis, Hunter and Kelly (2016).
We examine the impact of local monetary policy shocks on local stock returns. We find that for 17 of the 24 developing markets in our sample a one-standard-deviation surprise increase in local monetary policy interest rates results in an immediate and statistically significant 1.06% decline in the country’s overall stock market index. Interestingly, the unresponsiveness of the remaining seven stock markets to local monetary policy is not entirely due to the dominance of foreign (U.S.) monetary policy. In only four of the seven markets is foreign monetary policy simultaneously significant.
As noted above, one possible concern is that local monetary policy influences the investment and financing decisions of only non-investable firms. However, we find that firms that have access to foreign equity capital are at least as sensitive to local monetary policy shocks as are firms that are closed to foreign equity investment. In about 30 percent of our sample, Chile, Mexico, Venezuela, Jordan and Russia, firms that are open to foreign investment are even more sensitive than the ones that are closed. This evidence is consistent with the hypothesis that foreign investor participation in investable stocks improves the informational efficiency of investable firms’ stock prices, making them more sensitive to local monetary policy shocks. We call this an “efficiency” effect. This is counter to the predictions of the “integration” effect, whereby local stocks that are accessible to foreign investors are more responsive to foreign, not local, monetary policy shocks.
As an example, consider the impact of local monetary policy shocks on the returns of Brazilian stocks that are open and closed to foreigners, as depicted in Figure 1. In both panels the stock market is subjected to a one- standard-deviation surprise tightening of monetary policy, which is equivalent to 0.52% higher policy interest rates. In the top panel, the response is a statistically significant decline of 1.9% in the stock prices of firms that are open to foreign investment. In the bottom panel, the same monetary policy surprise translates into a statistically insignificant 0.9% lower prices for stocks that are closed to foreign investment. These findings are typical of the other countries in our companion study.
Figure 1. Impulse Responses of Brazilian Stock Returns to a One-Standard-Deviation Structural Shock in Local Monetary Policy
Investable stocks – open to foreign investment
Non-investable stocks – closed to foreign investment
Source: This figure reports impulse responses (center line) of investable and non-investable stock returns over 24 months in response to a one-standard-deviation structural shock in local Brazilian monetary policy. The impulse responses are obtained from a structural VAR model with eight endogenous variables: oil prices, the U.S. Fed-Funds rate, local industrial production growth, inflation, exchange rates and investable and non-investable Brazilian stocks. The left axis is in percent and the horizontal axis is months after a policy shock. The outer bands are probability bands used to determine statistical significance. The impulse response in a given period is significant, if both outer bands are on the same (lower or upper) side of the horizontal line at zero.
Ruling out alternate interpretations
One concern with the above results is that they might be driven by the simultaneous response of stock prices and monetary policy to emerging market crises that occurred during our sample period. However, the results when controlling for the Mexican and Asian currency crises are materially the same. The Russian default in 1998 is prior to the start of our data for Russia.
Additionally, one might be concerned that when we separate stocks into investable and non-investable, what we are really doing is separating firms on the sensitivity of their product markets to changes in the local economy. To examine this, we determine whether our results hold for stocks that operate in traded-goods markets and for those that operate in non-traded goods markets. We continue to find that investable stocks are more sensitive than non-investable stocks to local monetary policy in both markets.
Summary and policy implications
Our research suggests that firms that are open to foreign investment are at least as sensitive to local monetary policy as are firms that remain closed to foreign investment. These findings assuage a non-trivial concern among monetary policy authorities that while access to foreign capital has many benefits, it may come at the cost of a loss of ability to influence one’s own local economy. The primary policy implication of our work is that foreign investment in local stocks does not result in a loss of monetary policy control. In fact, our results suggest that foreign investment makes local firms more responsive to monetary policy shocks.
Strategic Aid Financing
Donor countries often face a Samaritan’s dilemma when trying to implement political conditionality in bilateral aid. Giving through multinational organizations can mitigate this problem: Recipient nations are de-facto competing for funds, which restores their incentives to comply even with non-enforceable conditions. Donor nations might therefore find it useful to set up multinational aid funds, rather than to disseminate aid bilaterally, even if they have to give up control over where the money is spent.
In the last decade, global challenges like climate change or the fight against epidemics have become the focus of aid projects. In order to make progress on these large-scale issues, donor nations increasingly recognize that simply giving money to a developing region does not ensure success. Instead, the impact of aid spending depends crucially on efforts undertaken in the partner countries. Reforms of the local economic and judicial system, fighting corruption and general good governance are just a few of the demands on donor countries’ wish lists.
However, many of the conditions set by donating governments are hard to enforce, especially since they nowadays often fall in the category of “political conditionality,” aiming at broader political improvements rather than simple, measurable economic indicators (see for example Molenaers et.al., 2015). The crucial question for aid giving countries therefore remains how to strategically structure aid, so that recipient governments can be incentivized to cooperate also on intangible or non-enforceable conditions.
The Samaritan’s Dilemma
Indeed, the theoretical literature on aid conditionality finds that optimal contracts should be self-enforcing, i.e. the threat of aid sanctions should be large enough to ensure that the recipient government has an interest in fulfilling the conditions (see for example Scholl, 2009). That, however, might be easier said than done: Svensson (2000) argues that the threat of cutting aid in case conditions are violated is hard to credibly sustain, at least for individual donor countries. They often face political constraints to spend a certain amount of money on aid. This opens the possibility for a classic hold-up problem: If the donor country cannot commit to giving aid only conditional on reform efforts, the recipient country, knowing it will receive assistance in any case, has no incentive to implement costly reforms. From the donor’s perspective, this is also known as the Samaritan’s dilemma.
Multinational Funds Can Help
Svensson goes on to argue that transferring the responsibility of allocating aid to a multilateral organization might solve the Samaritan’s dilemma outlined above. He notes that if donors are lacking a commitment technology (that helps them to actually implement aid sanctions in case a recipient government shirks on the agreed aid conditions), “delegation of part of the aid budget to an (international) agency with less aversion to poverty will improve welfare of the poor.” Such organizations will have less of a commitment problem and should therefore better be able to enforce aid conditionality.
Competition Restores Incentives
There is, however, no a priori reason to think that multilateral organizations have a different objective than individual donor countries in terms of eliminating poverty and achieving growth and prosperity for developing countries. After all, these organizations’ founding principles are set by the donor countries that fund them. An international organization’s objective, as represented by how it actually allocates funds across causes and recipient countries, should reflect an aggregation of the individual preferences of donor nations.
In a new study, Simon and Valasek (2016) argue that precisely this stage of preference aggregation enables multilateral organizations to better implement aid conditionality. How non-earmarked funds given to multilateral organizations are allocated is determined in a bargaining process between representatives of the different donating nations. Individual preferences might differ; the bargaining outcome thus has to reflect a compromise between them. The bargaining position of each donor will in part depend on intrinsic values, but importantly also on the reform efforts and willingness to cooperate of the potential recipient nations. Intuitively, the better the government of an aid receiving country behaves, the better the bargaining position of donor countries lobbying on its behalf.
This constitutes a new strategic reason for pooling resources in large aid funds rather than implementing aid bilaterally: When resources are pooled, recipient nations have to compete for their share of aid. It is precisely the heterogeneity of donor country preferences that induces (or enhances) such competition. Bilateral aid relations thus cannot replicate the effect to the same extend. This competition restores incentives to invest in costly reforms and circumvents the hold-up problem.
Conclusion
Donor nations should consider pooling their resources in multinational funds when they fear that their partner governments are reluctant to implement political reforms. This is especially relevant for aid aimed at common global issues like climate change or disease control.
Simon and Valasek show that the payoff from joining an aid fund is especially high when donor nations represented in the fund have relatively homogenous goals for their foreign aid programs, but differ in terms of where in the world they would like to send their aid money. Then the disadvantage from losing the direct say over which recipient nations get the most funds is far outweighed by the gain from inducing investment and reform incentives in the aid receiving nations.
References
- Molenaers et al. (2015): “Political Conditionality and Foreign Aid,” World Development Vol. 75.
- Scholl (2009), “Aid Effectiveness and Limited Enforceable Conditionality,” Review of Economic Dynamics 12(2).
- Simon & J.M. Valasek (2016), “The Political Economy of International Aid Funds,” Working Paper.
- Svensson (2000): “When is Foreign Aid Policy Credible? Aid Dependence and Conditionality,”, Journal of Development Economics Vol. 61.
Changes in Oil Price and Economic Impacts
Authors: Chloé Le Coq and Zorica Trkulja, SITE.
Oil has for decades been perceived as a necessary and highly addictive energy commodity, fueling the world economy. It is a crucial input good for most of the net-oil consumer countries, and it is an important source of revenue for the net-oil supplier countries. This means that any changes in the oil price will affect the entire world economy. However, the extent to which the oil-price fluctuations matter for the economy depends on the perspective (e.g. whether it is that of the macro economy, international trade, firm strategies, or the climate economy). In this policy brief, we outline the answers to this question that were provided at the 9th SITE Energy Day, held at the Stockholm School of Economics on November 5, 2015.
SITE 9th Energy Day: Economic Impacts of Oil Price Fluctuations
The Stockholm Institute of Transition Economics (SITE) has the pleasure of inviting you to our 9th Energy Day – Economic Impacts of Oil Price Fluctuations.
This year’s SITE Energy Day will be devoted to discussing the consequences of oil price fluctuations for markets and actors of the economy. In particular, we will discuss the impact of oil price fluctuations on macro fundamentals, international trade, strategies of oil cartels, strategic risk management, and opportunities for change in energy systems.
We are looking forward to a lively discussion and invite you to register for the event until Friday, October 30, 2015 using the Eventbrite registration form or via email: gun.malmquist@hhs.se, phone: 08-736 96 72.
Please find more details about the event on seminar program.
To register for the seminar please visit the website of the Stockholm Institution of Transition Economics (see here).
Disclaimer: Opinions expressed during. events, in policy briefs and other publications, are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.
Finance for Sustainable Development
This policy brief covers a discussion on finance for sustainable development held during a full day conference at the Stockholm School of Economics on May 11, 2015. The event was organized jointly by the Stockholm Institute of Transition Economics (SITE) and the Swedish Ministry for Foreign Affairs, and was the fifth installment of Development Day – a yearly development policy conference. With the Millennium Development Goals (MDGs) expiring in 2015, the members of the United Nations are now in the process of defining a post-2015 development agenda. The Sustainable Development Goals (SDGs) build on the eight anti-poverty targets in the MDG but also include a renewed emphasis on environmental and social sustainability. Whatever targets or goals will be agreed upon in the end, we know for certain that reaching the objectives will require substantial financial resources, far beyond the current levels of official development assistance (ODA). To discuss this issue, the conference brought together a distinguished and experienced group of policy-oriented scholars and practitioners from government agencies, international organizations, civil society and the business community.
Evaluating the Political Man on Horseback – Coups and Economic Development
In a new paper (Meyersson, 2015) I examine the development effects of military coups. Coups overthrowing democratically elected leaders imply a very different kind of event than those overthrowing autocratic leaders, and these differences relate to the implementation of authoritarian institutions following a coup in a democracy. Although coups taking place in already autocratic countries show imprecise and sometimes positive effects on economic growth, in democracies their effects are distinctly detrimental to growth. Moreover, when coups overthrow democratic leaders, they fail to promote economic reforms, stop the occurrence of economic crises and political instability, as well as have substantial negative effects across a number of standard growth-related outcomes including health, education, and investment.
Do military coups matter for economic development? After all, successful coups – i.e. where the military or state elites have unseated an incumbent leader – have occurred 232 times in 94 states since 1950 (see Figure 1). Moreover, around a quarter of these overthrew democratically elected governments (Powell and Thyne, 2012). The prevalence of military coups has not been lost on researchers, yet despite an abundance of research aiming to explain the occurrence of coups (see for example Acemoglu and Robinson, 2001; Collier and Hoeffler, 2006 & 2007; Leon, 2014; Svolik, 2012) much less research has focused on its economic effects (two exceptions are the papers on covert US operations during the Cold War by Dube, Kaplan, and Naidu, 2011 and Berger, Easterly, Nunn, and Satyanath, 2013). Olsen (1963), for example, claimed that coups “often bring no changes in policy.” Londregan and Poole (1990), in their panel-data analysis, find no effects of coups on income.
By now, there is mostly a consensus that significant military influence in politics is detrimental for democracy (Dahl, 1971; Huntington, 1965; Linz and Stepan, 1996). Nonetheless, military coups overthrowing democratically elected governments are often met with ambiguity. Western governments have a long history of tacit support for military coups overthrowing democratic governments, be it left-leaning governments in Latin America or Islamist governments in the Middle East and North Africa (Schmitz 2006). Commentators expressing support for coups often do so invoking extreme outcomes to represent the counterfactual to the military coup; if Pinochet had not overthrown President Allende, the latter would have created a Castro-style regime in Chile; if the Algerian army hadn’t annulled the elections in 1992, the Islamist FIS would have turned Algeria into an Islamist dictatorship in the Maghreb, and so on (Los Angeles Times 2006, Open Democracy 2013). Similarly, the fault for the coup and preceding problems fall invariably upon the ousted leader, with the coup constituting an unfortunate, but necessary, means to rid the country of an incompetent, if not dangerous, leader (Foreign Policy, 2013).
Other commentators have pointed out the risks of allowing a military to intervene and dictate post-coup institutions to their advantage; a “Faustian” bargain likely to bring regime stability but no solution to the real underlying problems behind the conflict in the first place. Yet others lament the human rights abuses following coups, and the inherent ineptitude of military leaders in running the economy (NYT, 2013; New Republic, 2013; Washington Post, 2013).
Figure 1. Successful and Failed Coup Attempts by Country and Year
Notes: The graph shows successful (solid circles) and failed coup attempts (hollow circles) by country and year, and aggregated by country (right graph) as well as by year (top graph). A circle in blue means the political regime was classified by Cheibub et al 2010 as a democracy in the year before the attempt and a red circle means they classified the regime as an autocracy.
Military coups tend to be endogenous events, and establishing a causal relation between coups and development is therefore a challenge. The unobservable likelihood of a coup – often referred to as coup risk (Collier and Hoeffler, 2006 & 2007; Londregan and Poole, 1990; Belkin and Schofer, 2003) – may be driven by many factors also affecting a country’s development potential, such as weak institutions, the military’s political power, social conflict, and economic crises etc.
In order to address this problem, I employ several empirical strategies including comparing successful versus failed coup attempts, matching methods, as well as panel data techniques, using a dataset of coup attempts during the post-World War II era. These methods facilitate, in different ways, comparisons of development consequences of coups in situations with arguably more similar degrees of coup risk.
Of significant importance is distinguishing coups when they occur in clearly autocratic settings from those where they overthrow democratically elected governments. I show that a military coup overthrowing a regime in a country like Chad may have very different consequences than a military leader overthrowing a democratically elected president in a country like Chile. In the former, a coup appears to constitute the manner in which autocracies change leaders. In the latter, coups typically imply deeper institutional changes with long-run development consequences.
I find that, conditional on a coup-attempt taking place, the effect of coup success depends on the pre-intervention level of democratic institutions. In countries that were more democratic, a successful coup lowered growth in income per capita by as much as 1-1.3 percent per year over a decade. In more autocratic countries, I find smaller and more imprecisely estimated positive effects. This effect is robust to splitting the sample by alternative institutional measures, as well as to a range of controls relating to factors such as leader characteristics, wars, coup history, and natural resources. As Figure 2 illustrates, the economic effect of coups tend to worsen over time. Extending the analysis to matching and panel-data methods reveal these results to be highly robust.
Figure 2. Relationship between a Successful Coup and Growth in GDP per capita
Notes: The three graphs represent the coefficient on a successful coups on growth in GDP per capita (PPP) between year t-1 and t+s with s given by the x-axis for all regimes(left), autocracies (middle), and democracies (right). Controls include period t-1 values of log GDP per capita, annual growth, log population, PolityIV index, annual change in the PolityIV index military expenditures as a share of GDP, annual change in military exp/GDP, military personnel as a share of population, years since the last coup, total number of previous coups, social unrest, leader tenure, as well as continent and year dummies respectively. See Meyersson (2015) for details.
A commonly held view is that coups overthrowing democratically elected leaders often provide an opportunity for engaging in unpopular but much needed economic reforms. Not only do I show that coups fail at this, but also that they tend to reverse important economic reforms, especially in the financial sector, while also leading to increased indebtedness and an overall deteriorating net external financial position, and an increased propensity to suffer severe economic crises. A documented reduction in social spending suggests a shift in economic priorities away from the masses to the benefit of political and economic elites.
Whereas coups occur mostly in dire situations, their prescriptions, as shown, rarely constitute adequate remedies to the underlying problems, as the institutional changes brought by these events show clear detrimental development consequences. Any short-lived benefit of regime stability a coup brings, comes at a steep economic, political, and human cost in the longer run.
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References
- Acemoglu, Daron and James A. Robinson, “A Theory of Political Transitions,” The American Economic Review, Vol. 91, No. 4 (Sep., 2001), pp. 938-963
- Berger, Daniel, William Easterly, Nathan Nunn, and Shanker Satyanath. 2013. ”Commercial Imperialism? Political Influence and Trade during the Cold War.” American Economic Review, 103(2): 863-96.
- Belkin, Aaron, and Evan Schofer, 2003,“Toward a Structural Understanding of Coup Risk”, Journal of Conflict Resolution, Vol. 47 No. 5, October 2003 594-620
- Cheibub, Jos ́e Antonio, Jennifer Gandhi, and James Raymond Vreeland, 2010, “Democracy and dictatorship revisited,” Public Choice (2010) 143: 67-101.
- Collier, Paul and Anke Hoeffler, 2006, “Grand Extortion: Coup Risk and the Military as a Protection Racket,” working paper
- Collier, Paul and Anke Hoeffler, 2007, “Military Spending and the Risks of Coups d’ ́etat,” working paper.
- Dahl, Robert A., Polyarchy: Participation and Opposition, Yale University Press 1971.
- Dube, Arindrajit, Ethan Kaplan, and Suresh Naidu, “Coups, Corporations, and Classified Infor- mation”, Quarterly Journal of Economics, Quarterly Journal of Economics, 2011 (Vol. 126, Issue 3)
- Foreign Policy, “Blame Morsy,” Michael Hanna, July 10 2013,
- Huntington, Samuel P., 1965, “Political Development and Political Decay,” World Politics, 386- 429
- Leon, Gabriel, 2014, “Loyalty for Sale? Military Spending and Coups d’Etat,” Public Choice 159, 363-383
- Linz, Juan, and Alfred Stepan, Problems of Democratic Transition and Consolidation: Southern Europe, South America, and Post-Communist Europe, Johns Hopkins University 1996
- Los Angeles Times, “Iraq needs a Pinochet”, Jonah Goldberg, December 14, 2006
- Londregan, John B and Kenneth T. Poole, “The Coup Trap, and the Seizure of Executive Power,” World Politics, Vol. 42, No. 2 (Jan., 1990), pp. 151-183
- Meyersson, Erik, 2015, Political Man on Horseback – Military Coups and Development, working paper, http://erikmeyersson.com/research/
- Olsen, Mancur, “Rapid Growth as a Destabilizing Force,” The Journal of Economic History, Vol. 23, No. 4 (Dec., 1963), pp. 529-552
- Open Democracy, February 11 2013, https://www.opendemocracy.net/arab-awakening/hicham-yezza/how-to-be-different-together-algerian-lessons-for-tunisian-crisis.
- Powell, Jonathan M, and Clayton L Thyne, 2012, “Global instances of coups from 1950 to 2010: A new dataset,” Journal of Peace Research 48(2) 249-259
- Schmitz, David F. “The United States and Right-Wing Dictatorships”, Cambridge University Press 2006
- Svolik, Milan W., The Politics of Authoritarian Rule, Cambridge University Press 2012.
- The New Republic, “Egypt Officially Declares What Is and Isn’t Important”, Nathan J. Brown, July 9 2013, http://www.newrepublic.com/article/113792/egypt-president-adli-mansour-makes-constitutional-declaration.
- The New York Times, “A Faustian Pact: Generals as Democrats”, Steven A. Cook, July 5, 2013
Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.
Non-Tariff Measures in the Context of Export Promotion Policies
This brief focuses on the role of non-tariff measures (NTMs) in international trade. While multilateral and bilateral trade negotiations have resulted in worldwide reductions in tariffs, we observe an increasing trend in the application of non-tariff measures. In this brief, we will discuss the evidence of the effect of such measures on exports. The brief also contributes to the discussion of export promotion policies: whether governments, especially in developing countries, should concentrate their efforts to remove only external barriers since there is empirical evidence that internal barriers are no less important for exports.
Economists, policy makers and international organizations are increasingly recognizing the importance of non-tariff measures (NTMs) as substantial impediments to international trade. A survey conducted by UNCTAD among exporters in several developing countries ranks SPS and TBT measures the top trade barriers with on average 73 percent of the respondents viewing them as the primary trade barrier (UNCTAD 2010). The World Bank published a book on NTBs where different authors contributed chapters addressing many aspects of the NTMs (World Bank, 2012). The World Trade Organization (WTO) itself devoted its entire 2012 World Trade Report to such measures with a particular focus on technical barriers to trade (TBT) and sanitary and phytosanitary (SPS) measures. Availability of the new datasets on NTBs allowed researchers to study the effect of these measures on intensive (changes for existing exports) and extensive margins (changes due to entry and exit into exporting) of trade.
Even though trade theory does not specifically address the question of non-tariff barriers that include (but are not limited to) technical regulations, sanitary and phytosanitary measures, the logic of traditional models can easily be extended to these measures. In particular, they can be thought of as part of the fixed/additive costs for exporting firms as they impose compliance costs on exporters. These compliance costs are related to potential adjustments of production processes, and certification procedures needed to meet the requirements of countries imposing such regulations and standards (Schlueter et al., 2009). In a Melitz-type model, these costs are expected to have a negative impact on volumes of trade, number of exporters and number of goods exported. At the same time, average exports per firm may actually increase as the export market-shares are reallocated towards firms that are more efficient.
The existing empirical evidence of the impact of NTMs is mixed; researchers have found both positive and negative effects. The differences in results depend largely on the sector, country and type of NTM imposed. While the effect may overall be negative or null, for some sectors the effect is found to be positive (Moenius, 2004; Fontagné et al., 2005; Chen et al., 2006; Disdier et al., 2008; Medin and Melchior, 2015).
In a recent working paper, Besedina (2015) investigates the effect of introducing an NTM (either SPS or TBT) on export dynamics (in particular, exports concentration and entry and exit into exporting) using the World Bank Exporters database, with a special focus on trade in foodstuff. In particular, we examine how TBT and SPS measures affect export concentration and diversification (both at product and destination level) as well as entry and exit of firms into exporting. If introduction of an NTM increases costs of exporting, the ‘new’ trade theory started by Melitz (2003) predicts that some exporters will stop to export and thus the number of exported product varieties will fall as well (change in extensive margin).
The most important result from our analysis is that the introduction of a TBT or an SPS measure does not seem to affect sectoral export dynamics. Given the above discussion, this result may appear surprising at first. What can possibly explain this zero effect?
First, one may argue that the sector dynamic variables we use in our analysis may not capture changes in the behavior of economic agents (firms) well: while marginal firms may be affected by technical barriers and SPS, averaging across firms may actually conceal this. However, in our analysis we investigate exports at a relatively disaggregated level (4-digit product lines). So while averaging might be a concern, we believe it is not likely to be driving the zero effect.
Second, the concern is that the effect of introducing an NTM measure may not be felt immediately (within one year). In order to verify this, we include lagged trade-barrier variables two periods, but the results were unchanged. Third, it may be the case that it is the number of NTMs rather than the introduction of them that matters. In order to address this point, we performed the same type of analysis using the change in the number of measures introduced. The results were again not affected, and we still do not find any statistically significant relationship between NTMs and exports dynamics.
Despite the absence of an effect of NTMs, this paper reveals an important and policy-relevant finding: the home country’s business environment and institutional factors are important determinants of export performance. It is rather the monetary costs and more complicated exporting procedures imposed by the NTM measures that hamper product and market diversification of the country’s exporters. Hence, policy makers, especially in developing countries, should not only be concerned with removing external barriers to exports (like NTMs) but should also aim to reduce internal barriers and costs imposed on exporting firms by corrupt practices and burdensome regulatory procedures.
Another important dimension for domestic policies towards exporters stems from the work by Melchior (2015, forthcoming) who studies Norwegian exports to BRICS countries overtime and shows that export growth largely depends on the intensive margin (it explains 93 percent of the export growth). Using firm-level data for seafood exports, he finds that only 54% of “trades” – measured as firm/importing country/product combinations – survive from one year to the next. Hence, there is massive “churning” (entry and exit at the same time), and churning is relatively more important in small and in growing export markets. In other words, exporting companies constantly enter and exit foreign markets, add new products, or discontinue exporting some products. A policy implication from this finding is that export-promotion offices should help firms stay in export markets rather than focus on entering these markets. Hence, while it is important to enable domestic firms to enter foreign markets, it seems equally important to ensure their survival in foreign markets, which can be facilitated by a removal of both external and internal barriers.
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References
- Disdier, A-S, L. Fontagné and M. Mimouni (2008), “The Impact of Regulations on Agricultural Trade: Evidence from the SPS and TBT Agreements”, American Journal of Agricultural Economics 90(2): 336-350.
- Fontagné, L., F. von Kirchbach, and M. Mimouni (2005). “An Assessment of Environmentally-related Non-tariff Measures”, The World Economy 28(10): 1417-1439.
- Medin H. and A. Melchior (2015) ”Trade barriers or trade facilitators? On the heterogeneous impact of food standards in international trade”, NUPI mimeo
- Melchior (2015) ” Non-tariff barriers, firm heterogeneity and trade: A study of seafood exports, with a particular focus on BRICs”, NUPI mimeo
- Melitz, M. J. (2003), “The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity,” Econometrica, 71(6): 1695–1725.
- Moenius, J. (2004), “Information versus Product Adaptation: The Role of Standards in Trade”, Working Paper, International Business & Markets Research Center, Northwestern University mimeo.
- UNCTAD (2010), Non-Tariff Measures: Evidence from Selected Developing Countries and Future Research Agenda (UNCTAD/DITC/TAB/2009/3). New York and Geneva.
- World Bank (2012), Non-Tariff Measures – A Fresh Look at Trade Policy’s New Frontier, ed. O. Cadot and M. Malouche, The World Bank, Washington D.C.
Did the Fertilizer Cartel Cause the Food Crisis?
Authors: Hinnerk Gnutzmann, Catholic University of Milan, and Piotr Spiewanowski, Polish Academy of Sciences.
Food prices escalated during the 2007/2008-food crisis and have remained at historically high levels since. We show that an international export cartel for fertilizers was an important driver of the crisis, explaining up to 60% of the price increase. While biofuel subsidies, high energy prices and financial speculation doubtlessly put stress on food markets, our findings suggest new avenues for policy in the fertilizer market to stabilize food markets.
The Aid Effectiveness Literature: Is It Over Yet?
Author: Maria Perrotta Berlin, SITE.
After several decades of studies, the academic community still does not have an answer to whether foreign aid affects growth, and in which direction. Part of the reason for such an outcome may lie in a wide variety of models, techniques and data used. However, the main reason is probably that the broad spectrum of effects is difficult to disentangle when looking at the question at an aggregated level.
Green Transition: Adapting Markets and Policies
This policy brief summarizes the discussion at the 8th annual SITE Energy Day conference, devoted to market adaptations and policies necessary to address the green transition. Recent energy trends with ever more green energy-mixes will have consequences for the functioning of related markets as well as implications for appropriate policy responses. New financial solutions, technological developments, international cooperation, and national policy initiatives in both developing and developed countries are examples of adaptations to this transition process. To discuss these issues, the conference brought together a group of distinguished experts from the energy industry, policy community and academia.
In December 2014, world leaders have gathered in Peru (Lima) for the 20th annual meeting of the United Nations Framework Convention on Climate Change. This convention has as an objective to “stabilize greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system” (see UNFCCC’s webpage). Even though the agreement to reduce emissions to a sustainable level may take years to be negotiated, at least 195 countries have ratified the UFCCC convention. The willingness to reduce environmentally harmful emissions has led to many countries changing their energy profile to include more green energy, a process that is often referred to as “green transition”.
It may be worth mentioning that the label “green transition” consists of two conceptual components. “Green” refers to the ability to generate environmentally friendly energy, which has become a key challenge for our society. Indeed, a majority of people now recognize the pressing need to cut pollution in the face of climate change and environmental degradation. The wording “transition” acknowledges that a shift toward a greener energy mix seems unavoidable, but this shift may not occur immediately or uniformly around the globe. The required time for change is long and the shift itself may not be smooth. To put it differently, the green transition has had and will continue to have wide-ranging consequences for businesses, governments, and the international community.
As a result, there is a need to carefully address the potential implications for the existing energy and related markets and market players, and for government policies, as well as new markets and new policies triggered by the green transition. These topics were the focus of the 8th SITE Energy Day, a half-day conference held at the Stockholm School of Economics on December 2, 2014.
Green Transition and the Energy Markets
The first panel focused on how energy markets have responded to green transition and how they may react in the future. Speakers from electricity companies, regulatory bodies and think tanks discussed how the green transition may affect the use of traditional financial instruments by energy companies; the choice of economically viable technology for producing green energy; and the way markets could be integrated to increase the efficiency of green energy.
As green transition almost always introduces more intermittent production, it is likely that market uncertainty will increase. This is one of the reasons why traditional financial instruments may not be fully adequate. The first speaker Laurent Cheval, Head of Nordic and Fuel Origination in the business division Asset Optimization & Trading at Vattenfall discussed this issue extensively. Energy companies face substantial financial risks since both prices and quantities may be highly volatile. To mitigate these risks, market participants may use an array of financial products. In mature energy markets, the products are fairly standardized. However, more complex and tailor-made financial products are required to face the ongoing changes in the sector. For example, the increased share of renewable energy combined with more interconnected markets create specific market risks. To hedge against risks associated with weather changes, future fuel costs, interest rates and so on, more and more energy providers trade customized derivatives “over-the-counter” (OTC) rather than through a centrally-cleared exchange. Another example is the development of decentralized power production and the rise of the “Prosumer” who simultaneously produces and consumes power. So far, the relevant regulation is underdeveloped and there is an additional demand for innovative financial solutions. Large energy companies such as Vattenfall are for instance offering a range of financial hedging solutions combined with actual physical handling and delivery of energy products.
Green transition should in the long run lead to a domination of environment friendly energy. However it is important that only economically viable technologies subsist. It is therefore necessary to assess the cost of producing green energy. Lars Andersson, Head of Wind Power Unit at the Swedish Energy Agency, reported on an extensive study done by the Agency on this issue. Over the last five years, the production cost of wind power has fallen consistently and capacity usage has increased. This dramatic change in the wind power industry likely implies that the existing subsidies for building wind power plants gradually will be phased out. It is unclear how the industry will react to these cuts in subsidies. Furthermore, according to Andersson, wind production faces at least two challenges. Without developing the capabilities for energy storage, electricity markets will face more energy imbalances as the share of wind power increases. Additionally, the support from the local communities is needed to ensure an expansion of wind power. Addressing these issues requires the development of new regulation and defining a common goal which may promote cooperation between stakeholders.
Ultimately the green transition will end when and if the green energies are largely adopted around the globe. One way to accelerate this green transition may be to coordinate action and development of governmental policies. Martin Ådahl, Chefsekonom at Centerpartiet, and Daniel Engström, Programchef Miljö och Klimat at Fores, presented the current state of the international climate policy and discussed the benefits of linking carbon emission rights markets. Because of conflicting interests, the likelihood of reaching an agreement within the current United Nations climate negotiations is rather small.
However, Ådahl and Engström suggested that the focus should instead be on reaching agreements between big polluter countries that contribute the lion’s share of global emissions. Indeed, regional emission trading schemes already exist in the EU, the US and China, the three regions which together account for over 50 percent of global emissions. One potential shortcoming of this suggestion is that it may not be enough to stabilize greenhouse gas concentrations in the atmosphere. Thereby, Ådahl and Engström discussed the possibility to link current cap-and-trade markets, as a first step toward an international system with a more formal global agreement. Linking cap-and-trade markets has many benefits, especially in the form of efficiency gains. However, emission caps vary across countries and regions because of different political goals or priorities. When markets are linked, difference in abatement costs (or allowance prices) would lead to a flow of allowances and emissions from countries/regions with low abatement cost to countries with higher ones. Thereby prices would be equalized, benefiting entities with cheaper allowances. To avoid opportunistic behavior, countries would first have to agree ex ante on an exchange rate between different countries’ emission rights. Second, a clear regulatory framework is required. Both Ådahl and Engström emphasized the need of an international organization devoted to climate economics. Such an institutional body could not only regulate the links between cap-and-trade markets, but also provide concrete solutions and technical models to improve on the market design.
Environmental Policies: International Experience
The second panel focused on how governments may promote green transition. Anna Pegels, Senior Researcher at the German Development Institute (DIE), reviewed green policy initiatives in developing countries. Pegels argued based on evidence from e.g. India and South Africa that it is possible to combine substantial growth with green energy. This is good news since emerging countries are among the highest polluters. However, to change a country’s energy profile, governments need to intervene and develop new industrial policies.
Governments can set long-term goals, which are supported by short- and mid-term targets. However, given the large profits that are at stake, officials may likely be subject to the risk of capture and corruption. To limit such risks, Pegel emphasized the need to introduce competition in the energy sector as a whole. Subsidized feed-in tariffs for renewable energy for example should be only a first step, to reach a certain scale of production. But the technology is mature enough that producers should be able to bear some additional risk in their current activity. This should increase the scope for competition. Finally, it is essential that governments continuously engage in policy revision cycles and learn from other countries’ experiences.
Benjamin Sovacool, Professor of Business and Social Sciences at Aarhus University and Director of the Danish Centre for Energy Technologies, talked about the process of low carbon transition in the Nordic region. In spite of large investments into renewable energy, fossil fuels still dominate the consumption in the Nordic countries and considerable measures need to be taken in the decades ahead to make the transition to a greener energy mix. Sovacool highlighted four areas which could help reduce the carbon footprint of the Nordic countries: renewable energy, increased energy efficiency of buildings, transportation, and carbon capture and storage (CCS). In order to be successful, the green transition has to bring about a systemic change engaging actors across the economy, particularly including end-users. There should also be a focus on additional technological progress. Finally, Sovacool noted that a rapid emission reduction such as the one planned in the Nordic countries is unlikely to be followed on a global scale in the near future due to a lack of political feasibility.
Conclusion
The green transition is expected to have a profound impact on the functioning and structure of energy markets as well as the policies that facilitates this transition.
There is an ongoing process of decentralization in the energy sector, with the rise of “prosumer” market places that alter market dynamics. Moreover, market uncertainty is increasing due to more intermittent production (due to renewables) and a stronger interconnectedness between energy markets. It is likely that energy imbalances will be a major concern and that more and more energy trade will take place on real time markets (as opposed to e.g. on the day-ahead market). As markets’ linking becomes stronger, the interdependence between markets in terms of energy type and geographical location will be intensified. The need for coordination and international cooperation will be even more pressing. The uncertainty regarding the development of international cooperation, but also regarding national policy changes, may however disrupt energy markets. Measures such as withdrawing existing subsidies must be handled in a gradual and strategic manner so as not to discourage investment. A key issue for governments is to have a credible green policy in the long-term. Such credibility will also depend on the level of involvement of different actors in the green transition, including the necessity to have a multilevel engagement of the end-users.
References
- Energimyndigheten, (2014), Produktionskostnads-bedömning för Vindkraft i Sverige, ER 2014:16
- Pegels, A. (Ed.). (2014), Green industrial policy in emerging countries, Vol. 34, Routledge
- Rutqvist, J., Engström, A.and Ådahl, M., A Bretton Woods for the Climate. Fores, 2010
- SITE 8th Energy Day, http://www.hhs.se/en/about-us/calendar/site-external-events/2014/site-energy-day/
- UNFCCC, (n.d). First steps to a safer future: Introducing The United Nations Framework Convention on Climate Change, http://unfccc.int/essential_background/convention/items/6036.php [8 December 2014]