Location: Global
Expanding Leniency to Fight Collusion and Corruption
Leniency policies offering immunity to the first cartel member that blows the whistle and self-reports to the antitrust authority have become the main instrument in the fight against cartels around the world. In public procurement markets, however, bid-rigging schemes are often accompanied by corruption of public officials. In the absence of coordinated forms of leniency for unveiling corruption, a policy offering immunity from antitrust sanctions may not be sufficient to encourage wrongdoers to blow the whistle, as the leniency recipient will then be exposed to the risk of conviction for corruption. Explicitly introducing leniency policies for corruption, as has been recently done in Brazil and Mexico, is only a first step. To increase the effectiveness of leniency in multiple offense cases, we suggest, besides extending automatic leniency to individual criminal sanctions, the creation of a ‘one-stop-point’ enabling firms and individuals to report different crimes simultaneously and receive leniency for all of them at once if they are entitled to it.
Leniency provisions to fight corruption
It has been noted that leniency policies and other schemes that encourage whistleblowing — such as reward and protection policies — should work in the fight against corruption as it does in the fight against collusion (Spagnolo, 2004; Spagnolo 2008; Buccirossi and Spagnolo, 2006). Cartels, corruption, and many other types of multi-agent offenses depend on a certain level of trust among wrongdoers, which is precisely what leniency programs aim to undermine by offering incentives for criminals to betray their partners and cooperate with the authorities (Bigoni et al., 2015; Leslie, 2004).
Of course, for offenses not covered by antitrust law, such as corruption, relevant authorities may have their own ways of granting leniency and encourage reporting, such as plea bargaining, whistleblower reward programs, deferred prosecution agreements (DPAs) and non-prosecution agreements (NPAs). On the other hand, some countries have recently introduced explicit leniency programs for corruption (for example, Brazil and Mexico). Yet, we observed that those instruments do not always cover all types of sanctions, are seldom integrated with antitrust leniency, and are often under the responsibility of multiple law enforcement agencies. Hence, improvements in the legal frameworks seem to still be necessary.
Leniency in a multi-offense scenario: the case of corruption cartels
Cartel offenses may be connected to other infringements. A particularly frequent and deleterious example of a multiple offense situation is the simultaneous occurrence of collusion (bid rigging) and corruption in public procurement (OECD, 2010). While cartels are estimated to raise prices by 20% or more above competitive levels (Connor, 2015; Froeb et al., 1993), corruption may add 5–25% to total contract values (EU, 2014; OECD, 2014b). Since public procurement is a market amounting to 13–20% of GDP in developed countries (OECD, 2011), it is clear that collusion and corruption represent a serious waste of public funds, negatively impacting the quality of public infrastructure and services provided by a state to its citizens.
Authorities face then two distinct, yet inter-related, challenges to guarantee the effectiveness of public procurement: ensuring integrity in the procurement process and promoting effective competition among suppliers (Anderson, 2010). Considering that success in deterring cartels and corruption depends largely on the incentives provided to infringers to self-report, the interaction between leniency provisions for cartels and the legal treatment of corruption adds a powerful new channel to the above-noted interdependence and thus should be — and already is — a concern to antitrust and anti-corruption authorities (OECD, 2014a).
A member of a corrupting cartel that blows the whistle on the cartel and applies for leniency to the antitrust authority will likely have to disclose information on the other infringement. Such information may then be used by the relevant law enforcement authority to prosecute and punish the applicant. Thus, the risk of prosecution for other cartel-connected offenses (corruption in this case) may reduce the attractiveness of reporting the cartel (Leslie, 2006). This kind of uncertainty works against the leniency policy’s deterrence goals and may even stabilize the cartel by providing its members with a credible threat to be used to prevent betrayal among them.
Existing leniency provisions for corrupting cartels
Antitrust leniency provisions are very similar worldwide, differing mainly in terms of whether cartels are only considered administrative infringements or are also criminally liable offenses. Where there is individual criminal liability, leniency programs should cover it. Surprisingly, Austria, France, German and Italy, where cartel, or at least bid rigging, is a criminal offense, do not follow this guideline. In these jurisdictions the co-operation of an individual with the antitrust authority during the administrative proceedings may be considered a mitigating circumstance, reducing imposed penalties or even allowing a discharge, but at the discretion of the court or the prosecution, which is likely to greatly reduce the propensity of wrongdoers to blow the whistle.
On the other hand, countries do not usually have specific leniency programs for corruption. Nonetheless, self-reporting and cooperation in bribery cases are usually given great importance by authorities and may lead to leniency and even immunity, through other mechanisms such as plea agreements, no-action letters, NPAs or DPAs, but those instruments rely on prosecutorial or judicial discretion. Brazil and Mexico do have formal leniency programs for corruption, providing more certainty and thus being more attractive to an applicant, although restricted to administrative liability. Individual corruption-related criminal provisions are laid down in each country’s criminal code and follow the recommendations made by the United Nations, in the 2003 Convention against Corruption, and by the Organization for Economic Co-operation and Development, under its 1997 Convention against Corruption of Foreign Public Officials in International Business Transactions.
Since enforcement authorities for collusion and corruption differ in most cases, such an arrangement demands that the infringer seek non-prosecution through at least two separate agreements, one with the antitrust authority and the other with the anti-corruption agency. The difficulty in coordinating such agreements is an obvious issue and will vary according to the number of authorities involved and to the proximity among them, that range from divisions of the same agency, in the case of the United States (Antitrust and Criminal Divisions of the Justice Department), to organizations from different government branches (Executive and Judiciary) in most jurisdictions.
In Brazil and the United States, antitrust leniency programs can provide protection for non-antitrust violations, committed in connection with an antitrust violation. While in Brazil, this provision does not currently include corruption infringements, in the United States it does, but only binds the Antitrust Division and not any other federal or state prosecuting agencies, i.e. leniency agreements may not prevent other authority from prosecuting the applicant for the non-antitrust violation.
How to improve the current legal framework
Countries should follow Brazil and Mexico’s example and create ex ante, non-relying on prosecutorial or judiciary discretion leniency programs for corruption infringements. Unlike these programs, leniency should also cover individuals, especially in terms of criminal liability for bid rigging and corruption. The protection from lawsuits for managers and directors could then become a primary incentive for them to blow the whistle on their and their companies’ illegal acts.
Additionally, it is advisable not to depend on collaboration between law enforcement groups, but to establish clear legal provisions to allow wrongdoers to report all illegal acts simultaneously and to be confident that they will escape sanctions upon co-operation with the authorities and presentation of evidence, i.e. the creation of a ‘one-stop point’.
This ‘one-stop point’ should be available for applicants at every law enforcement agency and must prevent other agencies from prosecuting the leniency applicant. In other words, when someone approaches—as an individual or as a representative of a legal person—any authority to report crimes he is involved in, it is important to allow him to report any other crimes that he knows about in exchange for lenient treatment. In order to prevent conflicts among agencies, the authority first contacted by the wrongdoer must be obliged to immediately involve any other one who may be competent over other possible reported infringements. The self-reporting wrongdoer must be reasonably certain that he will be granted leniency for all reported wrongdoings, provided that he fulfills the legal requirements for each infringement, obviously. Failing to report all known involvement in infringements may be a reason to reduce or even revoke leniency altogether, creating a penalty plus-like provision over different areas of law and a more powerful incentive to a thorough self-report.
Information about the possibility of reporting several illegal acts at the same time, and of obtaining leniency for each one, must be consistently disseminated to minimize detection and prosecution costs, as well as to contribute to the deterrence of future criminal behavior.
Finally, we note that companies and individuals from jurisdictions where leniency provisions for corruption are highly discretionary or non-existent would be less inclined to report cartel behavior abroad when bribing foreign public officials. Despite existing confidentiality rules on leniency programs, they might not want to risk being prosecuted for corruption at home. This would possibly block antitrust leniency agreements by removing the incentives to self-report, undermining the ability to catch international corrupting cartels. To prevent that, laws should be amended to allow leniency for a company or someone that self-reports abroad, and further coordination and collaboration between agencies from different countries would be necessary to avoid stabilizing criminal collusion and undermining the effectiveness of leniency programs.
Conclusion
The fight against cartels and bribery requires efforts on a national level as well as multilateral co-operation.
Creating leniency policies to fight corruption, including foreign, and coordinating them with antitrust leniency policies, emerges as an important priority. The absence of formal leniency programs for corruption, besides hindering anti-corruption enforcement, reduces wrongdoers’ incentives to blow the whistle and collaborate in corrupting cartel cases through the risk of criminal prosecution for the corruption offense. These programs must be carefully designed, however, to avoid opportunistic behavior and thus to achieve their goal of deterrence.
In order to increase the effectiveness of leniency programs in multiple offenses cases, we suggest the creation of a ‘one-stop point’, enabling firms and individuals to report different crimes simultaneously and obtain leniency, provided that they offer sufficient information and evidence for their partners in crime to be prosecuted.
References
- Anderson, R. D.; Kovacic, W. E.; Müller, A. C., 2010. Ensuring integrity and competition in public procurement markets: a dual challenge for good governance, in The WTO Regime on Government Procurement: Challenge ond Reform (Sue Arrowsmith & Robert D. Anderson eds.).
- Bigoni, M., Fridolfsson, S.O., Le Coq, C., Spagnolo, G., 2015. Trust, Leniency and Deterrence, 31 J. LAW ECON. ORGAN., 663.
- Buccirossi P.; Spagnolo, G., 2006. Leniency policies and illegal transactions, 90 J. PUBLIC ECON., 1281.
- Connor, J. M., 2014. Cartel overcharges, in The Law And Economics Of Class Actions (James Langenfeld ed.).
- European Commission, 2014. Report from the Commission to the Council and the European Parliament—EU Anti-Corruption Report 2014.
- Froeb, L. M.; Koyak, R. A.; Werden, G. J., 1993. What is the effect of bid rigging on prices?, 42 ECON. LETT., 419.
- Leslie, C. R., 2004. Trust, Distrust, and Antitrust, 82 TEX. L. REV. 515.
- Leslie, C. R., 2006. Antitrust Amnesty, Game Theory, and Cartel Stability, 31 J. CORP. L. 453.
- OECD, 2010. Global Forum on Competition Roundtable on Collusion and Corruption in Public Procurement.
- OECD, 2011. Public Procurement for Sustainable and Inclusive Growth – Enabling reform through evidence and peer reviews.
- OECD, 2012. Improving International Co-Operation in Cartel Investigations.
- OECD, 2014a. 13th Global Forum on Competition Discusses the Fight Against Corruption, Executive Summary.
- OECD, 2014b. OECD Foreign Bribery Report: An Analysis of the Crime of Bribery of Foreign Public Officials.
- Spagnolo, G. 2004. Divide et Impera: Optimal Leniency Programs, CEPR Discussion Paper nr 4840, available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=716143
- Spagnolo, G., 2008. Leniency and Whistleblowers in Antitrust, in Handbook of Antitrust Economics (Paolo Buccirossi ed.), Cambridge MA: MIT Press.
- Stephan, P. B., 2012. Regulatory Competition and Anticorruption Law, 53 VA. J. INT. LAW 53.
- Waller, S. W., 1997. The Internationalization of Antitrust Enforcement. 77 BOSTON U. LAW REV. 343.
Culture and Interstate Dispute
The debate on the impact of culture on the conduct of international affairs, in particular on conflict proneness, continues. Yet, the question of whether markers of identity influence conflicts between states is still subject to disputes, and the empirical evidence on Huntington’s clash of civilizations thesis is ambiguous. This policy brief summarizes a recent study where we employ an array of measures of cultural distance between states, including time-varying and continuous variables, and run a battery of alternative empirical models. Regardless of how we operationalize cultural distance and the empirical specification, our models consistently show that conflict is more likely between culturally distant countries.
In his controversial “The Clash of Civilizations” thesis, Samuel Huntington argues that cultural identity is to become the principal focus of individual allegiance and could ultimately lead to an increasing number of clashes between states, regardless of political incentives and constraints. In the post-Cold War world in particular, Huntington (1993) argues that the main source of conflict will not be ideological, political or economic differences but rather cultural. In other words, fundamental differences between the largest blocks of cultural groups – the so-called “civilizations” – will increase the likelihood of conflict along the cultural fault lines separating these groups.
According to Huntington (1996, p.41), a civilization is “the highest cultural grouping of people and the broadest level of cultural identity people have.” Huntington argues that the world could be divided into discrete macro-cultural areas: the Western, Latin American, Confucian (Sinic), Islamic, Slavic-Orthodox, Hindu, Japanese, Buddhist, and a “possible African” civilizations. As the list makes clear, the central defining characteristic of a civilization is religion, and in fact, conflicts between civilizations are mostly between peoples of different religions, while language is a secondary distinguishing factor (Huntington, 1996).
This brief summarizes the findings of our paper (Bove and Gokmen, forthcoming), which offers an empirical analysis of the relationship between identity and interstate disputes by including measures of cultural distance in the benchmark empirical models of the likelihood of militarized interstate disputes. By moving beyond simple indicators of common religion or similar language, our findings suggest that conflict is more likely between culturally distant countries. For example, the average marginal effect of international language barrier on the probability of conflict relative to the average probability of conflict is around 65%. Overall, we find that the average marginal impact of cultural distance on the likelihood of conflict relative to the average probability of conflict is in the range of 10% to 129%.
Measuring cultural distance
To effectively capture cross-cultural variations between states, we employ five different indexes along linguistic and cultural distances. First, to capture the linguistic distance between two countries, we use the language barrier index (Lohmann, 2011). It ranges between 0 and 1 where 0 means no language barrier, i.e. the two languages are basically identical, and 1 means that the two languages have no features in common (e.g., Tonga-Bangladesh). Since more than one language is spoken in some countries, we employ two alternative indexes: the basic language barrier, which uses the main official languages, and the international language barrier, which uses the most widely spoken world languages.
Second, we adopt Kogut and Singh’s (1988) standardized measure of cultural differences, as well as an improved version provided by Kandogan (2012). Although the degree of cultural differences is notably difficult to conceptualize, Kogut and Singh (1988) offer a simple and standardized measure of cultural distance, which is based on Hofstede’s (1980) dimensions of national culture. In particular, Kogut & Singh (1988) develop a measure of “cultural distance” (CD) as a composite index based on the deviation from each of Hofstede’s (1980) four national culture scales: power distance, uncertainty avoidance, masculinity/femininity, and individualism.
These dimensions of culture are rooted in people’s values, where values are “broad preferences for one state of affairs over others […]; they are opinions on how things are and they also affect our behavior” (Hofstede, 1985). As such, by explicitly taking into account the values held by the majority of the population in each of the surveyed countries, these dimensions can effectively capture differences in countries’ norms, perceptions, and ways to deal with conflicting situations. Higher cultural distance pertains to higher divergence in opinions, norms, or values.
Third, to cross-validate our empirical findings on cultural distance and to duly take into account societal dynamics and changes in the composition of societies, we use another popular quantitative measure of cultural distance based on The World Values Surveys (WVS). From 1998 to 2006, we use the composite value of two dimensions of values, traditional vs. secular-rational values and survival vs. self-expression values, which account for more than 70% of the cross- cultural variance (Inglehart and Welzel, 2005). The traditional vs. secular-rational values dimension captures the difference between societies in which religion is very important or not. The second dimension is linked to the transition from industrial society to post-industrial societies. Societies near the self-expression pole tend to prioritize wellbeing and the quality of life issues, such as women’s emancipation and equal status for racial and sexual minorities, over economic and physical security. Broadly speaking, members of the societies in which individuals focus more on survival find foreigners and outsiders, ethnic diversity, and cultural change to be threatening.
Impact of culture on militarized interstate dispute
We estimate the benchmark model of Martin et al. (2008), which uses a large data set of military conflicts in 1950-2000. We choose this model over other alternatives as it possibly has the most exhaustive list of controls that can potentially affect the probability of militarized interstate disputes (MIDs). We assess the impact of our cultural distance measures on conflict. All five measures of cultural distance have a positive effect on conflict involvement. In other words, culturally more distant states fight more on average. In column (i) of Table 1, we see that Language Barrier positively affects conflict, although insignificant. When we take into account International Language Barrier in column (ii), however, it has a positive and significant effect on conflict involvement. This should not come as a surprise as the part of the culture of a country that is reflected in a language should be more related to the spoken languages rather than the official ones.
To assess the magnitude of the effects, we calculate for each model the standardized marginal effect as the average marginal effect of a cultural distance variable on the probability of conflict relative to the average probability of conflict, which is about 0.0066. This effect is sizeable for International Language Barrier and is around 65%. When we use the Cultural Distance (Kogut) measure, instead, the results are qualitatively similar. The standardized marginal effect, however, is reduced and is now about 14%. The standardized marginal effect of Cultural Distance (Kandogan) on conflict probability is similar at 11. The effect of Cultural Distance (WVS) is also positive and significant. However, the large standardized marginal effect should be interpreted with caution, as the number of countries that are in the WVS is limited due to data availability. All the results from our cultural distance measures considered together, evidence suggests that cultural distance increases the likelihood of interstate militarized conflict.
Table 1. Cultural distance and International conflict
Additionally, in Figure 1, holding all other variables constant, we see a 25% and 19% increase in the odds of conflict for a one-unit increase in Cultural Distance (Kogut) and Cultural Distance (Kandogan) variables, respectively; while the same increase in Language Barrier raises the odds of conflict by 52%.
Figure 1. Odds ratio of coefficients in Table 1
Note: Cultural distance (WVS) is scaled down by 100 for the sake of readability.
Discussion and conclusion
Samuel Huntington’s thesis on the “Clash of Civilizations” is one of the most fascinating and debated issues in the field of international relations, and has sparked a long-lasting debate about its validity among academics, practitioners and policy-makers. The scholarly literature on international studies has long grappled with how to define, characterize, and analyze his thesis. Although some of the seminal works provided little support to Huntington’s thesis, later studies seemed to partially confirm it. While most of these studies use Huntington’s measure of the concept of civilizations, his classification was tentative, imprecise and difficult to operationalize. Moreover, previous studies rely on a “dichotomization” of civilizations, which is a continuous concept, and treat it as an immutable object, while it is certainly subject to variation over time.
Political events in recent years, such as the NATO-Russia confrontation over Ukraine, Russia’s attempts to resurrect its cultural and political dominance in the former Soviet sphere, the unprecedented rise of Islamic extremism in the Middle East, the foundation of an organization like ISIS with a declared aim to build a Muslim caliphate and wage war on Western civilization, or the rise of independence and anti-EU movements in Europe, have been attributed by many political observers to cultural clashes. We argue that whether and how identity impacts the likelihood of MID hinges crucially on the definition and operationalization of “civilizations” or cultural similarity.
We therefore introduce a number of ad-hoc measures of cultural distance in the benchmark empirical models on the likelihood of MIDs. Regardless of how we deal with the definition of cultural distance, the empirical evidence points consistently towards the importance of cultural distance in explaining the odds of interstate conflict. Although the extent of evidence for an effect of cultural distance on conflict clearly depends on model specification and data considerations, in particular the size of the effect, our results suggest that conflict is more likely between culturally distant countries.
Our study highlights the importance of the awareness of the impact of culture in international relations. Culture can be an important determinant of foreign policy as pronounced differences in social norms and behaviors of collective groups might create frictions between states and shape the way they interact. Thus, educating people in cross-cultural sensitivity should be a policy priority. That is to say that the knowledge and acceptance of other cultures are important to avoid tensions and potential conflicts.
References
- Huntington, Samuel P. 1993. “The clash of civilizations? Foreign affairs”, 22–49.
- Huntington, Samuel P. 1996. “The clash of civilizations and the remaking of world order”. Penguin Books India.
- Inglehart, Ronald, & Welzel, Christian. 2005. “Modernization, cultural change, and democracy: The human development sequence.” Cambridge University Press.
- Kandogan, Yener. 2012. “An improvement to Kogut and Singh measure of cultural distance considering the relationship among different dimensions of culture.” Research in International Business and Finance, 26(2), 196–203.
- Kogut, Bruce, & Singh, Harbir. 1988. “The Effect of National Culture on the Choice of Entry Mode.” Journal of International Business Studies, 19(3), 411– 432.
- Lohmann, Johannes. 2011. “Do language barriers affect trade?” Economics Letters, 110(2), 159–162.
- Martin, Philippe, Mayer, Thierry, & Thoenig, Mathias. 2008. “Make trade not war?” The Review of Economic Studies, 75(3), 865–900.
Time to Worry about Illiquidity
At a time when central banks have injected unprecedented amounts of money, worrying about illiquidity may appear odd. However, if poorly understood and unaddressed, illiquidity could be the foundation of the next financial crisis. Market liquidity is defined as the ease of trading a financial security quickly, efficiently and in reasonable volume without affecting market prices. While researchers find that it has been positively correlated with central bank’s liquidity injection, it may no longer be the case. The combination of tightly regulated banks, loosely regulated asset managers, and zero (or negative) policy rates could prove toxic.
One recent volatile day on the markets, an investor called her bank manager asking to convert a reasonably small amount of foreign currency. The sales person was quick to respond: “I will hang up now and we will pretend this call never happened”. In other words, the bank was not ready to quote her any price. The typical academic measures of market liquidity, such as bid-offer spreads, remained tranquil on Bloomberg, there was no transactions taking place.
When the investor was finally forced to exchange, the result was messy: currency price gapped—fell discontinuously—causing alarm among other market participants and policymakers. All that due to a transaction of roughly $500,000 in one of the top emerging market currencies in the world according to the BIS Triennial Central Bank Survey at an inopportune moment.
Markets becoming less liquid
Post crisis, G-7 central banks have embarked on unconventional monetary policy measures to boost liquidity and ease monetary policy at the zero-lower-bound, while tightening bank regulation and supervision. On net, however, the ability to transact in key financial assets in adequate volumes without affecting the price has fallen across a range of markets, including the foreign exchange markets that are traditionally assumed to be the most liquid compared to bonds, other fixed income instruments and equities.
Financial market participants have reported a worsening of liquidity, particularly during periods of stress. Event studies include the 2013 “taper tantrum” episode, where emerging markets’ financial assets experienced substantial volatility and liquidity gapping that did not appear justified by the Fed’s signal to reduce marginally its degree of monetary policy accommodation, as well as the recent shocks to the US Treasury market (October 2014) and Bunds (early 2015).
Banks are retreating
Market-makers (international “sell-side” or investment banks as in the introducing example), which used to play the role of intermediators among buyers and sellers of financial assets, are now increasingly limiting their activities to a few selected liquid assets, priority geographies and clients, thus leading to a fragmentation of liquidity. Market-makers have also been reducing asset holdings on their balance sheets in a drive to reduce risk-weighted-assets, improve capital adequacy and curb proprietary trading. As a result, they are less willing to transact in adequate volumes with clients.
In the past, leverage by banks has been associated with higher provision of market liquidity. Loose regulation and expansionary monetary policy has been conducive to higher leverage by banks pre-2008. It is therefore puzzling that, now, at the time of unconventionally large monetary expansions by central banks, sell-side banks are unwilling to provide market liquidity. The answer may lay in tighter bank capital and liquidity regulation as more stringent definitions of market manipulation. Risk aversion by banks has also become harsher, a trader stands to lose a job and little to gain on a $2 million swing in her daily profit and loss, while in the past a swing of $20 million at a same bank would have hardly warranted a telling-off. Banks have become safer, but can that also be said about the financial system?
Asset managers growing in importance
Ultra-accommodative and unconventional monetary policies have compressed interest rates across all maturities. In a world where US Treasuries at two-year maturity do not even yield 1%, and Bunds are yielding negative rates even beyond 5 years, investors in search for yield are looking at longer (and less liquid) maturities and riskier assets. If banks are unable to meet this demand, others will: assets under management (AUM) by non-bank financial institutions, specifically real asset managers have expanded dramatically in recent years. Total size of top 400 asset managers’ AUM was EUR50 trillion in 2015, compared to EUR35 trillion in 2011 according to IPE research, with the largest individual asset manager in excess of EUR4 trillion. A fundamental problem arises when such asset managers are lightly regulated and very often have similar investment strategies and portfolios.
In the industry jargon, these asset managers are called long-only or real-money. Why the funny names? Long-only means they cannot short financial assets, as opposed to hedge funds. For every $100 collected from a range of individual investors’ savings via mutual funds, pension and insurance fund contributions, a small share (say 5%) is set aside as a liquidity buffer and the rest is invested in risky assets. Real money refers to the fact that these managers should not be levered. However, that is true only in principle as leverage is related to volatility.
Performance of real-money asset managers is assessed against benchmark portfolios. For emerging markets, the portfolio would typically be a selection of government bonds according a range of criteria, including size of outstanding debt, ease of access by international investors, liquidity, and standardization of bond contracts. Investors more often than not do not hedge foreign currency exposure. The benchmark for emerging markets sovereigns could have 10% allocated to Brazil, 10% to Malaysia, 10% to Poland and 5% to Russia, for example. India, on the contrary, would be excluded, as it does not allow foreign investors easy access to government bonds.
Benchmarks and illiquidity dull investor acumen
Widespread use of benchmarks among institutional asset managers can steer the whole market to position in “one-way” or herding, contributing to illiquidity and moral hazard risks. Benchmarks by construction reward profligate countries with large and high-yielding stocks of government debt.
While each individual portfolio manager may recognize the riskiness of highly-indebted sovereigns, benchmarking makes optimal to hold debt by Venezuela, Ukraine or Brazil as each year of missed performance (before default) is a risk of being fired, while if the whole industry is caught performing poorly, it is likely that the benchmark is down by as much.
Furthermore, real-money asset managers have become disproportionally large relatively to the capacity of sell-side banks (brokers) to provide trading liquidity. In fact some positions have de-facto become too large-to-trade. Even a medium-sized asset manager of no more than $200bn under management (industry leaders have $2-$4 trillion AUM) that attempts to reduce holdings of Ukraine, Venezuela or Brazil at the signs of trouble, is likely to trigger a disproportionate move in the asset price. This further reduces incentives to diligently assess each individual investment. In such environment, risk management has become highly complex, stop losses may no longer be as effective, while more stringent cash ratios would put an individual asset manager at a disadvantage to others.
Conclusion
Anecdotal and survey-based measures from the market demonstrate that liquidity is scarcer and less resilient during risk-off episodes. While regulation has made banks stronger, it may have rendered the financial system less stable. Lightly regulated real asset managers are increasing assets under management, are often positioned “one-way” and are becoming too-large-to-trade.
Nonetheless, systemic risk stemming from illiquidity in the new structure of the market remains little researched and poorly understood by policymakers and academics. Most models of the monetary transmission mechanism and exchange rate management do not incorporate complexities of market liquidity.
While regulatory changes have been largely driven by policy makers in the developed markets (naturally since they were at the epicenter of the global financial crisis), it is the emerging markets that in my view are most at risk. They tend to have less developed and less liquid domestic financial markets, and be even more prone to liquidity gaps with higher risks of negative financial sector-real economy feedback loops.
References
- Sahay, R., et.al., “Emerging Market Volatility: Lessons from the Taper Tantrum”, IMF SDN/14/09, 2014 http://www.imf.org/external/pubs/ft/sdn/2014/sdn1409.pdf
- Shek, J., Shim, I. and Hyun Song Shin, (2015), “Investor redemptions and fund manager sales of emerging market bonds: how are they related?” BIS Working Paper No. 509, http://www.bis.org/publ/work509.pdf
- “Market-making and proprietary trading: industry trends, drivers and policy implications”, Committee on the Global Financial System, CGFS Papers, no 52, November 2014. www.bis.org/publ/cgfs52.pdf
- “Fixed income market liquidity”, Committee on the Global Financial System, CGFS Papers, no 55, January 2016. www.bis.org/publ/cgfs55.pdf
- Hyun Song Shin, “Perspectives 2016: Liquidity Policy and Practice” Conference, AQR Asset Management Institute, London Business School, 27 April, 2016. https://www.bis.org/speeches/sp160506.htm
- Fender, I. and Lewrick, U. “Shifting tides – market liquidity and market making in fixed income instruments”, BIS Quarterly Review, March 2015. www.bis.org/publ/qtrpdf/r_qt1503i.htm
- Tobias Adrian, Michael Fleming, and Ernst Schaumburg, “Introduction to a Series on Market Liquidity”, Liberty Street Economics, Federal Reserve Bank of New York, August, 2015.
Global Inequality – What Do We Mean and What Do We Know?
Concerns about global economic inequality have become central in today’s policy debate. This brief summarizes what is known about the development of inequality globally, emphasizing the difference between the developments within countries and between countries. In the former sense, inequality has risen in most countries in the world since the 1980s, but in the latter sense inequality, has (most probably) dropped. To ensure future progress in terms of continued decreasing global inequality, fighting increasing inequality within countries is likely to be central.
In recent years, the distribution of income and wealth has emerged as one of the most widely discussed issues in societies everywhere. US President Barack Obama has called rising income inequality the “defining challenge of our time”, the topic has been on the agenda at meetings of the World Economic Forum in Davos, and studies by the IMF and the OECD (e.g., OECD, 2014, and IMF, 2014) have associated income inequality with lower economic growth. Thomas Piketty’s best-selling book “Capital in the Twenty-First Century” (2014) has placed the topic center-stage well outside academic and expert circles. At the same time, some have argued that all the talk about increasing inequality is in fact wrong and that it misses what they perceive as the more important story, namely, the decreasing global inequality. So, which is it, and what conclusions can be drawn?
Different Ways of Viewing the Facts About Global Inequality
When people talk about global income inequality there are a number of things that could be referred to. First, one might think of the inequality within countries across the world. From this perspective, the question in need of an answer would be: “How has inequality within individual countries changed globally in recent decades?” The short answer is that it has increased in most places. This is certainly the case in most of the developed world since the 1980s, while in emerging markets and developing countries (EMDCs) there are greater differences across time and regions. Looking at disposable incomes at the household level (the most commonly used measure in international comparisons) most countries in Asia and Eastern Europe have seen marked increases of inequality, while the trend seems to have been the opposite in Latin America and in large parts of Africa. In level terms, the development has been one of convergence since, on average, the countries in Eastern Europe and Asia started at much lower levels than those in Latin America and Africa. The development has resulted in that inequality levels are today on average at similar levels, with a Gini coefficient of between 0.4 and 0.45, in Africa, Asia, and Latin America (see figure 1 below and IMF, 2015) The same is true for the average across OECD countries where inequality has increased the most in percentage terms in countries starting at low levels, with the US being an exception in that inequality has increased even though the level has always been at the higher end among developed economies (e.g., OECD, 2015). The European average is today around 0.3 while the household disposable income Gini in the US is just below 0.4.
Figure 1. Change in the net Gini Index, 1990-2012
Source: IMF, 2015.
Looking at other income inequality measures, such as top income shares, the picture is similar: inequality has increased in most countries for which we have data since the 1980s. While it is important to recognize that top income shares are a very different measure of inequality, it has been shown that there is a close relationship between top income shares and the Gini coefficient in terms of capturing both level differences across countries and trends in the development (e.g., Leigh, 2007 and Morelli, Smeeding and Thompson, 2015). This together with one of the main strengths of the top income measure, namely, the length of the time series, allows us to put the recent developments in a historical perspective.
Figure 2 shows the income share of the top decile group for a number of mainly developed countries over the 20th century, illustrating the surprisingly common trends over the past 100 years (but also important level differences). On average, top shares (driven mainly by what happened in the top 1 percent) dropped from the beginning of the century until about 1980 after which it has risen in a fanning-out fashion. The point of the figure is clearly not to illustrate any individual country but rather to illustrate the overall long-run trend. For details of the historical development of income as well as wealth distribution, see Roine and Waldenström (2015).
Figure 2. Top 10 percent income share over the 20th century
Source: World top income database (WTID).
While the overall picture of rising inequality in most countries over the past decades is pretty clear, the development between countries is less so. There are two main reasons for this. First, it depends on what is considered the unit of observation and how these units are weighted. Second, it depends on what one assumes about the vast gaps in data availability, in particular in EMDCs (see e.g., Lakner and Milanovic, 2013, for more details).
As explained by for example Milanovic (2012) there are essentially three different ways in which one might think about the global distribution of income: 1) Treat every country as one observation and use a country’s GDP per capita as the measure of income; 2) do the same as in 1) but give different weight to each country according to its population; 3) Treat individuals (or households) as the unit of observation regardless of where people live. In all three cases it is possible to line up all observations from the poorest to the richest (and, hence, also to calculate a Gini coefficient). In the first way of looking at the world, we treat everyone in each country as being represented by the country’s average income and we also give the same weight to Luxemburg and India. In the second case, we recognize that more people live in India and weight it accordingly but we still, by construction, force everyone in each country to have the country average, thus ignoring within country inequality. Only in the last approach do we actually take into account both relative population size and differences in development within countries. This clearly seems the most satisfactory way to look at what has happened, but it is also the most demanding in terms of data.
In terms of the first two approaches, inequality in the world has fallen in the past decades. This is especially clear when weighting countries by population size. Rapid growth in China and India has caused average incomes in the world’s most populous and initially poor countries to increase faster than the global average, implying a reduction in global inequality. Some may think that this is not surprising and only to be expected since these countries start at such low levels, but in fact, this development marks the reversal of a 200-year trend toward increasing global inequality. Even “catch-up growth” is certainly not to be taken for granted.
Now the real question is this: What has happened to the global income distribution if we take into account the recent increasing inequality within many countries, including China and India? The answer turns out to complicated and uncertain (see Lakner and Milanovic, 2013 for details) but in the end most of the evidence points to decreasing global inequality in this sense too. As François Bourguignon puts it in a recent article in the Foreign Affairs: “…the increase in national inequality has been too small to cancel out the decline in inequality among countries” (Bourguignon, 2016, p. 14).
To understand both of these counteracting forces it is illustrative to look at real income growth across the global income distribution. Figure 3 below is taken from a presentation by Branko Milanovic, organized by SITE in 2014 (and available online here). It shows the real income growth for different percentile groups in the global distribution over the period 1988-2008. Moving from left to right the figure shows positive but modest growth for the very poorest individuals in the world, and much higher growth for the groups just above, with rates increasing toward the middle of the global distribution. In the range of about 5 dollars/day (in PPP adjusted terms) growth has been the highest. By developed-country standards, these people are still very poor, but globally they are truly the “middle class” in the sense that they make up the middle of the global income distribution. Moving further right we see a sharp drop in real income growth at a level around the 80th percentile. This part of the distribution is mainly populated by the lower middle classes of the developed world, and here income growth has been essentially zero over the past decades. Moving further right we again see a sharp increase in real income growth illustrating the large gains going to individuals in the top of the global income distribution.
Figure 3 summarizes much of what has happened: the left part showing the rapid growth of income among most of the world’s relatively poor, while the right shows the increasing inequality in the developed world, with the top of the distribution gaining the most.
Figure 3. Real income growth at various percentiles of the global income distribution, 1988-2008 (in 2005 PPPs).
Source: Lakner and Milanovic (2013).
Why This Matters and What Should Be Done About Global Inequality?
The forces that explain what has happened are of course complex and differ over time and across countries but one thing seems clear, the growth of real incomes in developing countries as well as the relative decline of incomes in the lower end of the income distribution in developed countries have at least in parts been shaped by the same intertwined processes of globalization and technological development. Overall, these processes are powerful positive developments, but at the same time it is easy to see how those who perceive themselves as losers in these developments may try to resist them using their political voice. It is important to remember that globalization is the result of a combination of technology and political decisions, and consequently not an inevitable process. After all, the globalization backlash in the period 1914-1945 did not happen because the technological feasibility of the process suddenly disappeared.
The appropriate government responses are of course also likely to be different across countries, but here there are also some common factors that stand out. In the developing world, the most challenging aspects will have to do with maintaining state capacity and the ability to tax increasingly mobile tax bases. In many developing countries taxation will also be key, but here the challenge is more about creating a capable and accountable state in the first place. As succinctly and, I think, correctly put by Nancy Birdsall in a review of Thomas Piketty’s “Capital in the Twenty-First Century”: “(I)n the developing world, the challenge is not, at least not yet, the one Piketty outlines — that an inherent tendency of capitalism is to generate dangerous inequality that if left unchecked will undermine the democratic social state itself. The challenge is the other way around: to build a capable state in the first place, on the foundation of effective institutions that are democratically accountable to their citizens.”
References
- Atkinson, Anthony B. 2015. “Inequality – What can be done?” Harvard University Press.
- Birdsall, Nancy. 2014. “Thomas Piketty‘s Capital and the developing world”
- Ethics & International Affairs / Volume 28 / Issue 04 / Winter 2014, pp 523-538.
- Bourguignon, François, and Christian Morrison. 2002. “Inequality among World Citizens: 1820-1992”, The American Economic Review, Vol. 92, No. 4. (Sep., 2002), pp. 727-744.
- Bourguignon, François. 2016. “Inequality and Globalization. How the rich get richer as the poor catch up”, Foreign Affairs, Volume 95, Number 1, pp. 11-16
- Lakner, Christoph, and Branko Milanovic. 2013. “Global Income Distribution: From the Fall of the Berlin Wall to the Great Recession.” WB Policy Research Working Paper 6719, World Bank, Washington.
- Leigh, Andrew. 2007. “How closely do top income shares track other measures of inequality?”, The Economic Journal, 117 (November), 589–603.
- OECD (2015), “Growth and income inequality: trends and policy implications”, OECD Economics Department Policy Notes, No. 26 April 2015.
- OECD. 2011. Divided We Stand: Why Inequality Keeps Rising. Paris: OECD Publishing.
- OECD. 2012. “Reducing Income Inequality While Boosting Economic Growth: Can It Be Done?” In Economic Policy Reforms: Going for Growth. Paris: OECD Publishing.
- Ostry, Jonathan David, Andrew Berg, and Charalambos G. Tsangarides. 2014. “Redistribution, Inequality, and Growth”, IMF SDN, February 17, 2014
- Milanovic, B. 2013. “Global Income Inequality by the Numbers: in History and Now.” Global Policy 4 (2): 198–208.
- Morelli, Salvatore, Smeeding, Timothy, and Jeffrey Thompson. 2015. “Post-1970 Trends in Within-Country Inequality and Poverty: Rich and Middle Income Countries”, Chapter in Atkinson, A.B., Bourguignon, F. (Eds.), Handbook of Income Distribution, vol. 2A, North-Holland, Amsterdam.
- Piketty, Thomas. 2014. “Capital in the Twenty-first Century”. Cambridge, Massachusetts: Harvard University Press.
- Pritchett, Lant. “Divergence, Big Time.” Journal of Economic Perspectives, Summer 1997, 11(3), pp. 3-17.
- Roine, Jesper, and Daniel Waldenström. 2015. “Long-Run Trends in the Distribution of Income and Wealth”, Chapter in Atkinson, A.B., Bourguignon, F. (Eds.), Handbook of Income Distribution, vol. 2A, North-Holland, Amsterdam.
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.
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
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