Tag: Institutional development

Russia in Africa: What the Literature Reveals and Why It Matters

Posted on September 23, 2024 | Policy Brief

Industrial oil factory in Africa symbolizing Russia’s influence on Africa's resources and economy.

Following the full-scale invasion of Ukraine in February 2022, Russia has become increasingly isolated. In an attempt to counter Western powers’ efforts to suppress its economy and soft power impacts, Russia has tried to increase its influence in other parts of the world. In particular, Russia is increasingly active in Africa, having become a key partner to several African regimes, typically operating in areas with weak institutions and governments. Additionally, Russia’s approach has a different focus and objectives compared to other foreign actors, which may have both short and long term consequences for the continent’s development. Deepening our understanding of Russia’s distinct approach alongside those of other global actors, as well as the future implications of their involvement on the continent is, thus, of crucial importance.

Introduction

The new Foreign Policy Concept, adopted by the Russian government in March 2023, dedicates, for the first time, a separate section to Africa. The previous versions of the policy grouped North Africa with the Middle East and contained only a single paragraph, kept unchanged over time, about Sub-Saharan Africa. In the midst of its war against Ukraine, Russia is getting serious about Africa. What do we know about the reasons for and implications of this trend?

A relatively large literature in economics, political science, international relations, and other related fields has dealt with the Soviet Union’s engagement with African regimes (see overviews in Morris, 1973 and Ramani, 2023). However, the number of studies following the evolution of these relations since the collapse of the Soviet Union is significantly smaller, reflecting Russia’s strategic withdrawal from the region between 1990 and 2015. Following the full-scale invasion of Ukraine, Russia’s increased interest in and engagement on the African continent has been increasingly discussed by security analysts and think tanks (see for instance Siegel, 2021; Stanyard, Vircoulon and Rademeyer, 2023; Jones, et al., 2021). Primarily highlighted are Russia’s interest in mineral deposits, its large-scale arms’ exports to African regimes, its dominance on the nuclear energy market with resulting dependency on Russian nuclear fuels, and its ambition to undermine Western capacities by the spread of Russian propaganda and anti-Western sentiments (Lindén, 2023). Each of these dimensions carries potentially profound and far-reaching implications for the continent’s development, as underscored by various strands of literature. Research contributions on this specific new trend are however still very limited and predominantly of a qualitative and exploratory nature.

There is, however, substantial general knowledge about the various forms that foreign interests can take, including trade, investment, development aid, propaganda, election interference, and involvement in conflicts, and their potential consequences for development. This brief presents an overview of selected literature that most closely relates to foreign influence in Africa.

Background: Theories of Foreign Policy

Two contrasting approaches are used to describe the way countries engage with the international community. The first one is the so-called realist perspective, which emphasizes the role of power, national interests, and security in shaping foreign policy (Mearsheimer, 1995). In this model, countries act in their self-interest, and often in competition or even conflict with other countries. Strategic alliances and a willingness to use force to advance one’s interests are contemplated under this perspective. The second approach is the idealist perspective, in which foreign policy is used to promote democratic values, human rights, and international cooperation, prioritizing tools such as diplomacy, international law, and multilateral institutions (Lancaster, 2008). For countries at the receiving end of major powers’ foreign policy agendas, and particularly for developing countries, the implications from the contrasting approaches will be widely different. While even a realist foreign policy may ostensibly incorporate concerns about the welfare and development of its allies, these are often not more than a thin disguise for the ultimate objective of buying political support and commercial advantages. A genuine interest in the welfare and development of receiving partners only finds a place under the idealist perspective, although even idealism is at times claimed to “greenwash” state actors’ own interests (Delmas and Burbano, 2011). While this claim has some substance to it, such accusations can also stem from the anti-western rhetoric typically pursued by Russia and aimed at undermining the credibility of actors with good intentions.

In practice, most countries’ foreign policies incorporate elements of both realism and idealism, although the balance between the two may vary. Some countries may have a predominantly realist approach, while others may prioritize idealist goals. Additionally, the same country may shift its approach over time, depending on changing circumstances and priorities. Idealism may be more prominent during periods of stability and prosperity, when countries have the resources and political will to pursue more ambitious foreign policy goals. Realism tends to become more prominent in times of crisis, when countries face serious threats to their national security or economic well-being. Historical examples of the latter are the aftermath of World War II, the Cold War, and even the 2008 global financial crisis (Roberts, 2020).

Comparative Analysis of Foreign Influence

A few studies, recent enough to encompass Russia’s renewed interest in Africa post-2015 but not enough to cover the current day resurgence, explicitly compare the strategy of different actors and their long-term influence. Trunkos (2021) develops a new soft power measure for the time-period 1995–2015, to test the commonly accepted claim in the political science literature that American soft power use has been declining while Russian and Chinese soft power use has been increasing. In the author’s own words, “the findings indicate that surprisingly the US is still using more soft power than Russia and China. The data analysis also reveals that the US is leading in economic soft power actions over China and in military soft power actions over Russia as well.”

Castaneda Dower et al. (2021) take a longer-term perspective and categorize African countries into two blocs one Western-leaning and one pro-Soviet, based on a game-theoretical model of alliances. This categorization aligns well with UN voting patterns during the Cold War, but it does not predict alignment as effectively in the post-Cold War period. The study finds no significant difference in average GDP growth between the two blocs for the period from 1990 to 2016. However, the bloc with Western-like characteristics shows higher levels of inequality and greater reliance on the market economy – as opposed to the planned one. It also has higher human capital, more gender parity (in education), and better democracy scores, but lower infrastructure capital compared to the other bloc.

Another strand of literature has looked into the deep changes that have occurred over time within the global development architecture, highlighting changes in donor and partner motivations after the end of the Cold War (Boschini and Olofsgård, 2007; Frot, Olofsgård and Perrotta Berlin, 2014), through the Arab Spring (Challand, 2014), and more recently under the emergence of new actors, chiefly China (Blair, Marty and Roessler, 2021). Studies in this area aim to highlight what implications the varying ideologies and motivation for cooperation in the donor countries have for countries at the receiving end. Competing aid regimes generate soft power through public diplomacy, often in the form of branding (for instance through putting origin “flags” on aid projects or investments). This type of positive association has been shown to generate ‘positive affect’ toward donors (Andrabi and Das, 2010), and to strengthen recipients’ perceptions of the models of governance and development that such donors promote – liberal democracy, for example, or free market capitalism (Blair, Marty and Roessler, 2021).

Emerging Players on the African Stage

An extensive literature has examined the various facets of established power actors’ presence on the continent, spanning foreign aid, diplomatic relations, and military involvement, revealing significant impacts on local economic development through multiple channels. The United States, along with other former colonial powers and major Western donors, plays a particularly prominent role in this context. Against this background, recent research has increasingly focused on the rise of new actors, and in particular China’s expanding role as a donor and investor in Africa (Bluhm, 2018; Brautigam, 2008; Brazys, Elkink and Kelly, 2017; Dreher et al. 2018). While the consensus is still unclear on whether China’s approach to aid attracts support among African citizens (Lekorwe et al. 2016; Blair, Marty, and Roessler, 2021), recent research also shows that Chinese aid exacerbates corruption and undermines collective bargaining in recipient countries (Isaksson and Kotsadam 2018a; 2018b).

As mentioned, there are as yet very few recent articles concerned with the reasons for Russia’s renewed interest in Africa (see Marten, 2019; Akinlolu and Ogunnubi, 2021; Ramani, 2023), and even fewer analyzing the potential impacts from it. One working paper, not citable due to the authors’ wishes, has quantitatively mapped and explicitly analyzed the impact of Russian military presence (in particular, of the Wagner Group) in Africa. The study found that the infamous paramilitary group faces fewer repercussions for human rights violations and commits more lethal actions than the state actors that employ them. In another recent study on the Central African Republic (CAR), Gang et al. (2023) found not only mortality levels in CAR to be four times higher than what estimated by the UN but also that Wagner mercenaries have contributed to “increased difficulties of survival” for the population in affected areas. Pardyak, M. (2022) explores the communication strategies employed by the key actors in the war, specifically focusing on how these strategies are received in African societies. Based on the analysis of over 140 media articles published in several African countries up to 15 October 2022, complemented by street surveys in Cairo, and in-depth interviews with Egyptians and Sudanese migrants, the study concludes that Russia’s multipolar perspective on the international order is more widely supported in Africa than Western strategies.

When viewed in a historical context, however, Russia’s actions reflect a longstanding adherence to a realist approach in its foreign policy endeavors. Throughout its trajectory, Russia has consistently prioritized national security and economic interests, frequently leveraging military and economic means to safeguard these interests (Tsygankov and Tsygankov, 2010). Presently, amid mounting pressures from the Western democratic world following the full-scale invasion of Ukraine in February 2022, Russia finds itself increasingly reliant on a realist approach. While the Chinese engagement in Africa is also characterized by realist principles, it’s important to emphasize that the Russian approach diverges from that of China. China is focused on a long-term presence, infrastructure building and investments. It has no interest in democracy and human rights, is efficient and cheap though not always loved (Isaksson and Kotsadam, 2018b). Russia’s interest is more short term and opportunistic, seeking out countries rich in natural resources with unstable governments and weak institutions, such as Libya, Sudan, Mozambique, the Central African Republic, Mali, Burkina Faso and Madagascar. Russia typically targets undemocratic elites or military juntas, offering political support, military equipment sales, and security cooperation (in particular through the Wagner Group) in exchange for access to natural resources, concession rights and influence. State of the art research on a previous period (Berman et al., 2017, spanning 1997 to 2010), although not exclusively focused on Russia, finds that rents from mineral contracts, captured by swings in global mineral prices for a causal interpretation, lead to a higher likelihood of local conflicts, and furthermore that the control of mining areas by rebel groups can escalate violence beyond the local level.

Russia is pursuing a range of strategic goals that include diplomatic legitimization, media influence, military presence, elite influence, arms export, and shaping voting patterns in international organizations (Lindén, 2023). Like China, Russia is uninterested in democracy or human rights. Moreover, what Russia stands for is in stark contrast to the Western model. Russia embodies autocracy and backward revisionist values (for instance in areas such as attitudes to gender equality and the sustainability agenda) while the West generally promotes democracy and progressive inclusive solutions (Lindén, 2023). What also especially characterizes Russia is the particular attraction towards the presence of anti-West sentiment, which it fuels through populistic anti-colonial disinformation and propaganda. This approach has been criticized for potentially weakening democratic norms and sidelining African agency (Akinlolu and Ogunnubi, 2021). Additionally, Russia’s disregard for the socio-political realities in Africa, typically associated with a self-interested realist approach, can lead to ineffective engagement and unintended negative consequences, undermining the long-term sustainability of both social and economic developments in the region.

Conclusion

Many African countries find themselves in a delicate balancing act, as they cannot afford to push away Russia nor displease their historical Western partners. This attempt to balance between actors poses several risks and potentially detrimental consequences, including reduced development cooperation, slower democratization, limited progress on human rights, and increased conflicts. Additionally, Russia’s growing presence in Africa can have implications for the interests and policies of the European Union (EU) and its member states as well as global actors, including impacts on migration, terrorism, the energy sector as well as on trade and aid flows.

In light of the diverse strategies foreign powers use in their relations with African countries and the significant impact these strategies have, it is crucial to deepen our understanding of foreign engagements in Africa. By examining Russia’s distinct approach alongside those of other global actors, we can gain valuable insights into the complex dynamics shaping the continent’s political, economic, and social landscape, both now and in the future. Expanding research in this area is not only desirable but essential for informing policy and development strategies.

References

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.

Investing, Producing and Paying Taxes Under Weak Property Rights

Posted on February 21, 2022 | Policy Brief

20220124 Gas Crisis European Energy Image 05

Oil majors often choose to operate in countries with weak property rights. This may appear surprising, since the lack of constraints on governments may create incentives to renege on initial promises with firms and renegotiate tax payments once investments have occurred and, in the worst case, expropriate the firm. In theory, backloading investments, production and tax payments may be used to create self-enforcing agreements which do not depend on legal enforcement. Using a new dataset covering the universe of oil majors’ assets that started production between 1974 and 1999, we indeed show in a recent CEPR Working Paper (Paltseva, Toews, and Troya-Martinez, 2022) that investments, production and tax payments are delayed by two years in countries with weak institutions relative to countries with strong institutions. Extending the dataset back to 1960 and exploiting the transition to a new world oil order where expropriation became easier, allows us to interpret our estimates as causal. In particular, prior to the transition expropriations were not feasible, due to the omnipresent and credible military threat imposed by the oil majors’ countries of origin. As the new order sat in, a new equilibrium emerged, in which expropriations became a feasible option. This transition incited an increase in expropriations and forced firms to adjust to the new reality by backloading contracts.

The Hold-up Problem

In December of 2006, when the oil price was climbing towards new heights, the Guardian reported that the Russian government was about to successfully force Shell into transferring their controlling stake in a huge liquified gas project back into the hands of the government. While officially this was motivated by environmental concerns surrounding the Sakhalin-II project, most observers agreed that this might be considered a textbook example of the hold-up problem faced by oil firms when investing in countries with limited constraints on the executive. At its core, the hold-up problem refers to the idea that the government may renege on the initial promise and appropriate a bigger share of the pie once investments have been made. Obviously, this is not an oil-specific issue and concerns any type of investment in countries with weak property rights. Academics, who worked on resolving these issues, suggest the use of self-enforcing agreements (Thomas and Worrall, 1994). These agreements use future gains from trade (as opposed to third-party enforcement) to incentivize the governments not to expropriate. And while the theoretical literature has prolifically developed over the last 30 years (Ray, 2002), to the best of our knowledge no empirical evidence has been provided on the use and dynamic patterns of self-enforcing backloaded contracts.

Data and Sample

In Paltseva, Toews and Troya-Martinez (2022), we rely on micro-level data on oil and gas projects provided by Rystad Energy, an energy consultancy based in Norway. Its database contains current and historical data on physical, geological and financial features for the universe of oil and gas assets. We focus on the assets owned by the oil majors (BP, Chevron, ConocoPhilips, Eni, ExxonMobile, Shell, and Total) using all assets that started production between 1960 and 1999, leaving us with a total of 3494 assets. An asset represents a production site with at least one well, operated by at least one firm, and with the initial property right being owned by at least one country. Being able to conduct the analysis on the asset level is particularly valuable since it allows us to control for a large number of confounding factors and rule out several alternative explanations of our main finding.

Moreover, there are three advantages of focusing our analysis on the oil and gas sector in general and the oil majors in particular. First, the sunk investments in the development of oil and gas wells are enormous, making the hold-up problem in the oil sector particularly severe. Second, oil majors have been around for many years since all of them were created before WWII. This provides us with a sufficiently long horizon to capture backloading over time. Third, the majors are simultaneously investing in many countries which provides us the necessary cross-sectional variation in institutional quality. To differentiate between countries with weak and strong institutions, we use a specific dimension from the Polity IV dataset measuring the constraints on the executive. The location of all the assets disaggregated by firm as well as a binary distinction in a country’s institutional quality is shown in Figure 1.

Figure 1. Spatial distribution of assets and institutional quality

Note: Location and ownership of assets are provided by Rystad Energy. The executive constraint indicator is taken from Polity IV and we use the median from the period 1950 to 1975 to define whether the country is considered to have strong or weak institutions. The cut-off of 5 implies that roughly 1/3 of the countries are defined as having strong institutions and roughly 50% of all the assets which started operation between 1950 and 2000 are located in countries with weak institutions.

A Stylized Fact

For the empirical analysis, our variables of interest are investment, production and tax payments normalized by the respective asset-specific cumulative sum over a period of 35 years. The resulting cumulative shares are depicted in Figure 2. We focus on physical production which, in addition to being considered the most reliable measure of an asset’s activity, does not require discounting. Real values of investment and tax payment depict a very similar picture. Most importantly, the dashed lines illustrate that 2/3 of cumulative production shares are reached approximately two years earlier in countries with strong institutions, in comparison to countries with weak institutions. The average asset size does not differ significantly between these groups. Such delays are costly for countries with weak institutions. Our back-of-the-envelope calculation suggests that the average country loses around 120 million US$ per year due to the delayed production and the respective tax payments. We confirm that the two-year delay cannot be explained by geographical, geological or financial confounders such as the location of the well, fuel type or contract features.

Figure 2. Years to reach 66% of cumulative flows in 35 years

Note: We use the Epanechnikov kernel with an optimally chosen bandwidth to plot the cumulative production over the 35-year life span of the asset. We group countries into two groups with weak and strong institutions according to Polity IV. This figure contains assets that started producing between 1975 and 1999.

The Transition to a New World Order

To push towards a causal interpretation of the results, we exploit the global transition to a new world oil order. This change affected the probability of expropriations in countries with weak institutions while leaving countries with strong institutions unaffected. In particular, the post-WWII weakening of the OECD members as political and military actors provides a natural experiment of global proportions. Expropriations are first viewed as impossible due to the military threat of British, French and US armies, and then become possible due to a global movement aiming at returning sovereignty over natural resources to the resource-rich economies. In the words of Daniel Yergin (1993): “The postwar petroleum order in the Middle East had been developed and sustained under American-British ascendancy. By the latter half of the 1960s, the power of both nations was in political recession, and that meant the political basis for the petroleum order was also weakening. […] For some in the developing world […] the lessons of Vietnam were […] that the dangers and costs of challenging the United States were less than they had been in the past, certainly nowhere near as high as they had been for Mossadegh, [the Iranian politician challenging UK and US before the coup d’etat in 1953], while the gains could be considerable.” Consequently, the number of expropriations has grown substantially since 1968, marking the transition to a new world order (Figure 3). However, Kobrin (1980) finds that even during the peak of expropriations in 1960-1976, only less than 5 % of all foreign-owned firms in the developing countries were expropriated. We suggest that this is, at least partly, thanks to the use of backloaded self-enforcing contracts.

Figure 3. Transition to a new world order

Note: Data on firm expropriations across all industries from Kobrin (1984).

Indeed, focusing on the years around the transition to the new world oil order, we show that there have not been any differences in investment, production or tax payments dynamics between countries with weak and strong institutions in the early years of the 1960s. But investment, production and the payments of taxes started experiencing significant delays after 1968 in the countries with weak institutions, using countries with strong institutions as a control. Intuitively, the omnipresence of a credible military threat in response to an expropriation served as an effective substitute for strong local formal institutions and eliminated the need for contracts to be self-enforced and backloaded in countries with weak institutions. Once this threat disappeared, contracts had to be self-enforcing and investment, production and tax payments had to be backloaded to decrease the risk of being expropriated by the governments of resource-rich economies. Theoretically, these initial differences in contract backloading between countries with strong and weak institutions should disappear in the long run, because the future gains from trade need to materialize eventually. We confirm empirically that this point is reached on average 20 years after firms start a contractual relationship with a country.

Conclusion

We provide evidence that oil firms seem to backload contracts in countries with weak institutions. We show that such backloading appears in the data during the transition to a new world order since 1968, when firms were in need of a new mechanism to deal with weak property rights and the risk of expropriations. We estimate the cost of such delays to be around 120 US$ per country and year. While this cost is high, it is important to emphasize that in the absence of such backloading, forward-looking CEOs of oil majors would often choose not to invest in the first place, since they would anticipate the severe commitment problems (Cust and Harding, 2020). Thus, as a second-best, the cost of the backloading may be marginal compared to the value added from trade when oil majors are willing to invest in countries with weak institutions and questionable property rights.

References

 

The Role of Partnerships in Economic Reforms of Fragile States: Perspectives from Somalia | Summary

Posted on November 30, 2020 | Policy Brief

Image of balancing stones representing Somalia as a fragile state and its reforms

Fragile states are particularly vulnerable to adverse economic shocks and in need of international support. Through constructive collaboration with international partners, however, fragile state governments can successfully pursue ambitious reform agendas for the short and long run. SITE and MISUM (Mistra Center for Sustainable Markets) invited the Minister of Finance of the Federal Republic of Somalia, Dr. Abdirahman Dualeh Beileh, and the Swedish ambassador to Somalia, Staffan Tillander, to discuss the role of international partnership in the recent development of economic reforms in Somalia. This policy brief provides a summary of the key points that were discussed in the webinar.

Introduction

Fragile states, characterized by poverty, weak governance, and conflict, now also have to confront additional challenges from the COVID-19 pandemic. Negative economic shocks arising from climate change, financial crises, conflicts, and pandemics are known to be particularly detrimental for these countries as the countries lack the resources to cushion the negative impact and are vulnerable to anything exacerbating latent socioeconomic challenges and conflicts. 

In these situations, international support becomes essential in reducing the immediate impact on human welfare and help sustain economic reforms that are necessary for long-run development. Somalia is a good case in point, where the recent consolidation of the country and an ambitious reform agenda together with international partners have set the country on a positive trajectory. This progress is challenged, though, by the pandemic, reinforced by drought and locust swarms.

From Independence to Civil War

Despite Somalia’s economically favorable geographical location and abundance of resources, the country has a turbulent history plagued by poverty, conflict, and humanitarian crises. Dr. Beileh provided thoughts on why the country failed to realize these opportunities and what factors led up to the civil war in 1991.

Following Somali independence in 1960, the country was lacking a sufficient level of educated citizens to run a modern government. In addition, tensions with neighboring countries and community demarcations within Somalia led to conflict and a constant struggle over resources. Also, Dr. Beileh argued that the former colonial powers had an interest in keeping the newly independent African states economically reliant in terms of imports of goods and sourcing of raw materials.

Dr. Beileh suggested that the combination of these factors contributed to the fall of the military regime in 1991 whereby Somalia plunged into civil war. With no recognized government over the following 20 years, this power vacuum became a black spot in Somalia’s history, characterized by war and poverty.

Political Consolidation and Debt Relief

After decades of suffering, in 2012 the Provisional Constitution established a federal political structure, with a parliament and the Federal Government of Somalia. Meanwhile, African Union forces liberated the major cities of Somalia from the terror of Al Shabab. In 2013 the government re-engaged with the World Bank and the IMF, and since 2016 the government together with international partners has engaged in numerous structural reforms. The main objective of the reform agenda was to qualify for international debt relief through the Heavily Indebted Poor Country (HIPC) Initiative introduced by the IMF and the World Bank in 1996 to reduce debt levels to sustainable levels in the world’s poorest countries. In Somalia’s case, this required laws and regulations that strengthened rule of law and sustainable economic management as well as poverty reduction strategies.

In March 2020, Somalia became the 37th country to qualify for the first step of debt relief under the HIPC initiative (“the decision point “) which meant that the country’s national debt was significantly reduced. This successful result was commended by the international community and Dr. Beileh stressed that it would not have been achieved without both international partnership and the resilience of the Somali people. Now, with continued successful reforms Somalia is projected to receive further debt reduction in 2023 (“the completion point”).  

Structural Reforms

Besides significantly reducing the national debt, the HIPC program requirements have led to development in many areas and opened new possibilities for international cooperation.

Laws and regulations that institutionalize the rule of governance and strengthen the federal system are essential HIPC prerequisites. Both Dr. Beileh and Ambassador Tillander stressed that strong governance is not only important for a clear division of tasks and competent and honest conduct within government bodies, but also an important cross-cutting issue that influences the ability of the state to achieve other goals.  Dr. Beileh described how far Somalia has come in this regard. When he started at the ministry of finance in 2017, wages, responsibilities, and accountability were up for negotiation. Today, there are rules and regulations in place that guide the responsibilities and accountability of civil servants. For instance, a public procurement authority has been established with the task of scrutinizing all government procurement and disposal of assets. Ambassador Tillander added that the strained regional tensions caused by the civil war and surrounding conflicts have been eased and the improvements in governance have led to a more constructive dialogue between the federal government and the member states.

Drawing on his experience as minister of finance, Dr. Beileh gave insight into the path of economic reform brought about by the HIPC process. The reforms focused on raising domestic revenue to achieve fiscal sustainability, keeping public expenditures at a sustainable level, and promoting various financial sector reforms. Dr. Beileh discussed the challenges related to gaining popular support for some of these reforms implemented in recent years. It is well known that economic reforms that are beneficial in the long-run often entail short-run costs which make them politically difficult to implement. To regain trust of taxpayers is of particular importance for Somalia given the need to increase domestic fiscal revenues.  Efforts have been made to actively inform the public about government activity and spending in order to increase transparency and convince Somalis that they will benefit from the system.

Ambassador Tillander provided examples of how countries like Sweden can help promote democracy and human rights in Somalia. For instance, Sweden has been working closely with the Somali government to help organize elections and increase voting participation, particularly for politically marginalized groups such as women and young adults.

Looking Forward

Despite Somalia’s recent success with debt forgiveness, both speakers acknowledged that much remains to be done.

The value of high-quality educational institutions and long-term investments in human capital is crucial in Dr. Beileh’s view. Having an educated population gives a country not only the skills and knowledge required to run a government but also helps a diverse society to move in the same direction. Although the need for infrastructure and investments in other areas is crucial for economic development, he insisted that it is educated people who in the end bring wealth, build infrastructure, and run governments.

Ambassador Tillander advocated for further promoting inclusion and merit-based selection in politics and business. He argued that progress is not possible if half of the population are excluded based on gender or age. Also, Somalia needs to move away from the clan as a basis for political power and position. As part of the solution, Ambassador Tillander suggested that Somalia should replace its provisional constitution with a new one that more strongly enshrines democratic elections, human rights, media freedom, and freedom of expression.

Although both speakers recognized that the reforms have been necessary, they mentioned that some reforms have also led to unintended negative consequences. For example, regulations to curb money-laundering and anti-terrorism financing have restricted the ability to transfer money to and from Somalia. As a result, many organizations and NGOs have found it hard to access financing, and it has made it hard for the diaspora to send remittances. To solve this issue, Dr. Beileh suggested policies that would improve the transparency of money flows, focusing on creating a personal id system and on strengthening the domestic financial institutions.

Another central topic at the webinar related to how Somalia and its partners should encourage and facilitate investments beyond foreign aid. Ambassador Tillander explained how there is an international misperception of Somalia and that his visit to the Mogadishu tech forum in 2019 was an eye-opener for him in this regard. These types of high-profile events, organized to attract foreign investments and display the opportunities that exist within Somalia, have attracted numerous young entrepreneurs who interact with their foreign counterparts, and showcase a dynamic and growing Somali business sector which is generally ignored in media-depictions of the country. In the context of the Swedish-Somali partnership, Ambassador Tillander suggested that there are enormous unexplored cross-border business opportunities between the countries, where the Somali diaspora in Sweden could play an important role.

Both speakers suggested that the foundations for communication and exchange are already in place. At this stage, the key to increase private investment is to reduce uncertainty for entrepreneurs and improve the predictability of the Somali financial system. People need to have better access to credit and financing, the banking system needs to become more formal, and the rule of law needs to apply more widely than it does today. Thanks to the HIPC process and the Somali government, steps in this direction are already underway but they must continue in order to build faith in the system, so that entrepreneurs, investors, and innovators are willing to take on the risks that new investments typically entail.

Reflecting on the start of the HIPC process, Ambassador Tillander argued that few people had anticipated the extent of progress that Somalia has achieved in only 4 years. Concluding the event, Ambassador Tillander and Dr. Beileh agreed that the cooperation between Somalia and the international community has been instrumental in encouraging and driving a reform process that would have been extremely difficult otherwise.

 

Speakers at the Event

  • Dr. Abdirahman Dualeh Beileh, Minister of Finance of the Federal Republic of Somalia.
  • Dr. Staffan Tillander, Swedish ambassador to Somalia.
  • Dr. Anders Olofsgård, Deputy Director SITE (moderator)

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.

The Economic Track Record of Pious Populists – Evidence from Turkey

Posted on November 21, 2016 | Policy Brief

FREE Network Policy Brief | A Case Study of Economic Development in Turkey under AKP

In this policy brief, I summarize recent research on the economic track record of the Justice and Development Party (AKP) in Turkey. The central finding is that Turkey under AKP grew no faster in terms of GDP per capita when compared with a counterpart constructed using the Synthetic Control Method (SCM). Expanding the outcome set to health and education reveals large positive differences in both infant and maternal mortality as well as university enrollment, consistent with stated AKP policies to improve access to health and education sectors for the relatively poorer segments of the population. Yet, even though these improvements benefited women to a large extent, there are no commensurate gains in female labor force participation, and female unemployment has increased under AKP’s watch. Of further concern is the degree to which the SCM method applied to institutional measures fail to find any meaningful early improvements along this dimension, and more often than not reveals adverse institutional trajectories.

The Turkish political economy represents something of a puzzle. After a traumatic financial crisis in 2001, a series of political and economic reforms brought higher economic growth and a promise of EU membership. An authoritarian political elite, spearheaded by a military with a troubled past of controversial coups ousting democratically-elected governments, looked set to give way to a new cadre of political and economic elites who, despite a recent past as radical Islamists, seemed to favor free markets as well as democratic reform.

News media, as well as several international organizations, heaped praise on the Turkish government. In some cases, these represented optimistic interpretations of events, whereas in some cases they inadvertently served to spread a misleading picture of the strength of the Turkish economy. A recent World Bank report described Turkey’s economic success as “a source of inspiration for a number of developing countries, particularly, but not only, in the Muslim world” (World Bank, 2014).

Today, the state of Turkey’s political economy is represented very differently. Several international rankings of political institutions (Meyersson, 2016b) and human rights show Turkey spiraling ever lower, following years of stifling freedom of speech, recurring political witch hunts, and escalating internal violence. Lower GDP growth rates, falling debt ratings and exchange rates are evidence less of a rising new economic giant than a stagnating middle income country under increasingly illiberal rule. A recent IMF staff report (IMF, 2016) noted how Turkey remains “vulnerable to external shocks” and a labor market “marred by rapidly increasing labor costs, stagnant productivity, and a low employment rate, especially among women.”

What has been the AKP’s track record on economic growth in Turkey? While some has described it as an economic success (as noted above), others have pointed out that Turkey’s economic development has not been much more than middling (Rodrik, 2015).

Evaluating the economic track record of the AKP faces numerous challenges. The rise to power of the AKP government came in the wake of one of the worst financial crises in modern history and following a number of substantial economic and political reforms. Finding a candidate for the counterfactual, a Turkey without AKP rule, is challenging and looking solely at time series of Turkish development omits significant trends that likely shape its trajectory.

The focus of my new paper (Meyersson, 2016a) is thus to examine the economic and institutional effects of the AKP in a comparative case study framework. Using the Synthetic Control Method (SCM), developed by Abadie et al. (2010, 2015), I estimate the impact of the AKP on Turkey’s GDP per capita by comparing it to a weighted average of control units, similar in pre-intervention period observables. The construction of such a “synthetic control” avoids the difficulty of selecting a single (or a few) comparable country, and instead allows for a data-driven approach to find the best candidate as a combination of many other countries. This avoids ambiguity about how comparison units should be chosen, especially when done on the basis of subjective measures of affinity between treated and untreated units. The method further complements more qualitative research with a research design that specifically incorporates pre-treatment dynamics, which due to the financial crisis preceding the election of AKP to power, is essential. Similar to a difference-in-differences strategy, SCM compares differences in treated and untreated units before and after the event of interest. But in contrast to such a strategy design, SCM allocates different weights to different untreated units based on a set of covariates.

Figure 1. Results for Turkey’s GDP per capita

fig1Note: Upper graph shows Turkey’s GDP per capita compared to a synthetic counterpart. The middle graph shows the difference between the former and the latter (black line) as well as placebo differences for untreated units (gray lines). The lowest graph plots the weights assigned to countries that constitute the synthetic control for Turkey. See Meyersson (2016a) for details.

As shown in Figure 1, I find that GDP per capita under the AKP in Turkey has not grown faster than its synthetic control. A “synthetic Turkey” (upper graph in Figure 1), which went through similar pre-2003 dynamics in its GDP per capita, also experienced an economic rebound very similar to that of Turkey.

This is robust to a range of specifications that in different ways account for the pre-AKP GDP dynamics. Restricting the set of control units to Muslim countries only, reveals Turkey to have actually grown significantly slower than the weighted combination of the Muslim counterparts. Moreover, a comparison of severe financial crises using SCM shows Turkey’s post-crisis trajectory in GDP per capita to be no faster than its synthetic control. The focus on post-crisis recoveries allows estimation of the composite effect, including both the financial crisis of 2001 as well as the election of AKP and, under the assumption that post-crisis – and pre-AKP – reforms were indeed growth enhancing, provides an upper bound for the effect of the AKP.

These results, however, hide some of the more transformative aspects of how the Turkish economy has changed during the AKP’s reign. Focusing on education outcomes, I instead find large positive effects on university enrollment for both men and women. These improvements are mirrored for key health variables such as maternal and infant mortality, and are likely responses to large-scale policy changes implemented by the AKP that are discussed in Meyersson (2016a). The policy changes include the extensive Health Transformation Program (HTP) implemented by the AKP government (Atun et al 2013), as well as mushrooming of provincial universities from 2006 and onward (Çelik and Gür, 2013).

As such, to the extent that the AKP has engaged in populism from a macroeconomic perspective, it has nonetheless also experienced a significant degree of social mobility, especially among the poorer segments of society. An exaggerated focus on economic output risks obfuscating the structural changes in key factor endowments that could very well prove beneficial in the long run. Still, the improved access to these areas has not been followed by improved outcomes in the labor markets, especially for women. The period under AKP has seen significant reductions in both female labor force participation as well as higher female unemployment. This raises concerns over to what extent the Turkish government has been able to put a valuable talent reserve to productive use, as well as allowing women meaningful labor market returns to education.

Figure 2. Results for Turkey’s gross enrollment in tertiary education

fig2Note: Upper graph shows Turkey’s gross enrollment in tertiary education compared to a synthetic counterpart. The middle graph shows the difference between the former and the latter (black line) as well as placebo differences for untreated units (gray lines). The lowest graph plots the weights assigned to countries that constitute the synthetic control for Turkey. See Meyersson (2016a) for details.

An evaluation of the AKP’s institutional effect using multiple institutional indicators, measuring various aspects ranging from institutionalized authority, liberal democracy, and human rights results in a failure to find any durable early positive effects during AKP’s tenure. In the longer run, for all outcomes the overall effect seems to have been clearly negative. Finally, the significant reduction in military rents, whether measured in terms of expenditure or personnel, is illustrative of the degree to which the military’s political power diminished relatively early on, and posits concerns over lower economic rents as another source of friction between the civil and military loci of power in the country.

Overall, the results point to Turkey undergoing a transformative period during the AKP, socioeconomically as well as politically. Even though the initial years of higher GDP per capita growth under the AKP, in absolute terms, dwindle significantly in comparison to a synthetic counterpart, increased access to health and education provide reasons for political support of a government that has extended a socioeconomic franchise to a larger segment.

References

  • Abadie, Alberto, Alexis Diamond, and Jens Hainmueller, “Synthetic Control Methods for Comparative Case Studies: Estimating the Effects of California’s Tobacco Control Program,” Journal of the American Statistical Association, 105 (2010), 493-505.
  • Abadie, Alberto, Alexis Diamond, and Jens Hainmueller, “Comparative Politics and the Synthetic Control Method,” American Journal of Political Science, 2015, 59 (2), 495-510.
  • Atun, Rifat, Sabahattin Aydin, Sarbani Chakraborty, Safir Sümer, Meltem Aran, Ipek Gürol, Serpil Nazlıoğlu, Şenay Özğülcü, Ülger Aydoğan, Banu Ayar, Uğur Dilmen, Recep Akdağ, “Universal health coverage in Turkey: enhancement of equity,” The Lancet, Vol 382 July 6, 2013.
  • Çelik, Zafer and Bekir Gür, “Turkey’s Education Policy During the AKP Party Era (2002-2013),” Insight Turkey, Vol. 15, No. 4, 2013, pp. 151-176
  • International Monetary Fund, “Staff Report for the 2016 Article IV Consultation: Turkey,” IMF Country Report No. 16/104
  • Meyersson, Erik, 2016a, “’Pious Populists at the Gate’ – A Case Study of Economic Development in Turkey under AKP”, working paper.
  • Meyersson, Erik, 2016b, “On the Timing of Turkey’s Authoritarian Turn”, Free Policy Brief, http://freepolicybriefs.org/2016/04/04/timing-turkeys-authoritarian-turn/
  • Rodrik, Dani, 2015, “Turkish Economic Myths”, http://rodrik.typepad.com/dani_rodriks_weblog/2015/04/turkish-economic-myths.html
  • “The World Bank, Turkey’s Transitions: Integration, Inclusion, Institutions.” Country Economic Memorandum (2014, December).

Traces of Transition: Unfinished Business 25 Years Down the Road?

Posted on June 13, 2016 | Policy Brief

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This year marks the 25-year anniversary of the breakup of the Soviet Union and the beginning of a transition period, which for some countries remains far from completed. While several Central and Eastern European countries (CEEC) made substantial progress early on and have managed to maintain that momentum until today, the countries in the Commonwealth of Independent States (CIS) remain far from the ideal of a market economy, and also lag behind on most indicators of political, judicial and social progress. This policy brief reports on a discussion on the unfinished business of transition held during a full day conference at the Stockholm School of Economics on May 27, 2016. The event was organized jointly by the Stockholm Institute of Transition Economics (SITE) and the Swedish Ministry for Foreign Affairs, and was the sixth installment of SITE Development Day – a yearly development policy conference.

A region at a crossroads?

25 years have passed since the countries of the former Soviet Union embarked on a historic transition from communism to market economy and democracy. While all transition countries went through a turbulent initial period of high inflation and large output declines, the depth and length of these recessions varied widely across the region and have resulted in income differences that remain until today. Some explanations behind these varied results include initial conditions, external factors and geographic location, but also the speed and extent to which reforms were implemented early on were critical to outcomes. Countries that took on a rapid and bold reform process were rewarded with a faster recovery and income convergence, whereas countries that postponed reforms ended up with a much longer and deeper initial recession and have seen very little income convergence with Western Europe.

The prospect of EU membership is another factor that proved to be a powerful catalyst for reform and upgrading of institutional frameworks. The 10 countries that joined the EU are today, on average, performing better than the non-EU transition countries in basically any indicator of development including GDP per capita, life expectancy, political rights and civil liberties. Even if some of the non-EU countries initially had the political will to reform and started off on an ambitious transition path, the momentum was eventually lost. In Russia, the increasing oil prices of the 2000s brought enormous government revenues that enabled the country to grow without implementing further market reforms, and have effectively led to a situation of no political competition. Ukraine, on the other hand, has changed government 17 times in the past 25 years, and even if the parliament appears to be functioning, very few of the passed laws and suggested reforms have actually been implemented.

Evidently, economic transition takes time and was harder than many initially expected. In some areas of reform, such as liberalization of prices, trade and the exchange rate, progress could be achieved relatively fast. However, in other crucial areas of reform and institution building progress has been slower and more diverse. Private sector development is perhaps the area where the transition countries differ the most. Large-scale privatization remains to be completed in many countries in the CIS. In Belarus, even small-scale privatization has been slow. For the transition countries that were early with large-scale privatization, the current challenges of private sector development are different: As production moves closer to the world technology frontier, competition intensifies and innovation and human capital development become key to survival. These transformational pressures require strong institutions, and a business environment that rewards education and risk taking. It becomes even more important that financial sectors are functioning, that the education system delivers, property rights are protected, regulations are predictable and moderated, and that corruption and crime are under control. While the scale of these challenges differ widely across the region, the need for institutional reforms that reduce inefficiencies and increase returns on private investments and savings, are shared by many.

To increase economic growth and to converge towards Western Europe, the key challenges are to both increase productivity and factor input into production. This involves raising the employment rate, achieving higher labor productivity, and increasing the capital stock per capita. The region’s changing demography, due to lower fertility rates and rebounding life expectancy rates, will increase already high pressures on pension systems, healthcare spending and social assistance. Moreover, the capital stock per capita in a typical transition country is only about a third of that in Western Europe, with particularly wide gaps in terms of investment in infrastructure.

Unlocking human potential: gender in the region

Regardless of how well a country does on average, it also matters how these achievements are distributed among the population. A relatively underexplored aspect of transition is to which extent it has affected men and women differentially. Given the socialist system’s provision of universal access to education and healthcare, and great emphasis on labor market participation for both women and men, these countries rank fairly well in gender inequality indices compared to countries at similar levels of GDP outside the region when the transition process started. Nonetheless, these societies were and have remained predominantly patriarchal. During the last 25 years, most of these countries have only seen a small reduction in the gender wage gap, some even an increase. Several countries have seen increased gender segregation on the labor market, and have implemented “protective” laws that in reality are discriminatory as they for example prohibit women from working in certain occupations, or indirectly lock out mothers from the labor market.

Furthermore, many of the obstacles experienced by small and medium-sized enterprises (SMEs) are more severe for women than for men. Female entrepreneurs in the Eastern Partnership (EaP) countries have less access to external financing, business training and affordable and qualified business support than their male counterparts. While the free trade agreements, DCFTAs, between the EU and Ukraine, Georgia, and Moldova, respectively, have the potential to bring long-term benefits especially for women, these will only be realized if the DCFTAs are fully implemented and gender inequalities are simultaneously addressed. Women constitute a large percentage of the employees in the areas that are the most likely to benefit from the DCFTAs, but stand the risk of being held back by societal attitudes and gender stereotypes. In order to better evaluate and study how these issues develop, gendered-segregated data need to be made available to academics, professionals and the general public.

Conclusion

Looking back 25 years, given the stakes involved, things could have gotten much worse. Even so, for the CIS countries progress has been uneven and disappointing and many of the countries are still struggling with the same challenges they faced in the 1990’s: weak institutions, slow productivity growth, corruption and state capture. Meanwhile, the current migration situation in Europe has revealed that even the institutional development towards democracy, free press and judicial independence in several of the CEEC countries cannot be taken for granted. The transition process is thus far from complete, and the lessons from the economics of transition literature are still highly relevant.

Participants at the conference

  • Irina Alkhovka, Gender Perspectives.
  • Bas Bakker, IMF.
  • Torbjörn Becker, SITE.
  • Erik Berglöf, Institute of Global Affairs, LSE.
  • Kateryna Bornukova, Belarusian Research and Outreach Center.
  • Anne Boschini, Stockholm University.
  • Irina Denisova, New Economic School.
  • Stefan Gullgren, Ministry for Foreign Affairs.
  • Elsa Håstad, Sida.
  • Eric Livny, International School of Economics.
  • Michal Myck, Centre for Economic Analysis.
  • Tymofiy Mylovanov, Kyiv School of Economics.
  • Olena Nizalova, University of Kent.
  • Heinz Sjögren, Swedish Chamber of Commerce for Russia and CIS.
  • Andrea Spear, Independent consultant.
  • Oscar Stenström, Ministry for Foreign Affairs.
  • Natalya Volchkova, Centre for Economic and Financial Research.

 

Global Inequality – What Do We Mean and What Do We Know?

Posted on April 24, 2016 | Policy Brief

A black and white image of man begging for help in a dark tunnel representing global inequality

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

JR_fig1

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

JR_fig2Source: 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).

JR_fig3

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.

The Arab Spring Logic of the Ukrainian Revolution

Posted on March 31, 2014 | Policy Brief

20140331 The Arab spring logic of the Ukrainian revolution Image 01

Motivated by the unusual patterns and dynamics of the Arab Spring, we construct a model explaining the vulnerability of the newly established incumbent to popular unrest. Using this model for the case of similar protests in Ukraine, we find that the current combination of availability of information, military capacity of the incumbent and his radicalization, together with the opportunity costs of participation in a protest, are likely to result in the formation of new government that is also vulnerable to popular protests. The persistence of the protests after the formation of a temporal government in Ukraine supports this hypothesis. Additionally, as the policy position of Viktor Yanukovych was relatively mild, his potential successor might be more radical. Exponential growth of social media users, reduction of military capacity, relatively high unemployment and the possible radicalization of the Ukrainian President might put the country into an “instability zone” with recurrent protests.

On the night of 21 November 2013 spontaneous protests erupted in Kiev, the capital of Ukraine, after the Ukrainian government suspended preparations for signing an Association Agreement and a Free Trade Agreement with the European Union in favor of agreements with Russia. The movement concentrated on Independence Square (Maidan Naseljenosti) soon took on the name “Euromaidan”. Soon the protest spread to other cities in the country. The initial agenda of closer relations with the EU was soon encompassed in the wider protest against Viktor Yanukovych, elected President in 2010. He fled the country on February 21 under the pressure of popular protests, exacerbating the leadership crisis. Temporary leadership was taken up by the Speaker of the Supreme Rada – Oleksander Turchinov, while new elections were scheduled to take place on May 25.

Despite the successful removal of Victor Yanukovich from power and a promise of new elections in May, the protests on Maidan did not cease. The major factor of uncertainty comes from the very nature of the protests. For many months, it ran without organizers or formal leadership so that the future course of action remains unclear. It is hard to comply with the demands of Maidan, as no clear set of demands are formulated. Though five figures of Maidan: Tymoshenko, Klitschko, Tyagnybok, Yatsenuk and Yarosh remain the most visible, none of them has sufficient support of Maidan. Whichever course prevails – resumed Eurointegration or an alliance with Russia (which became a less likely option)– the number of people who oppose the new course is likely to be enough to fill a new Maidan.

The swift happenings in Maidan are highly reminiscent of the events of the Arab Spring at its crux: it also was a leaderless protest, coordinated mainly with social media, and encompasses people of vastly different socio-economic, political and demographic characteristics.

Using social media technologies, Euromaidan has created an interactive map of logistics (http://maydanneeds.com/) that provides detailed information on and locations of where to eat, makeshift hospitals, information booths, and the barricades. Clicking on the icons of the map, one discovers not only the locations of the facilities but also their needs, which enables coordination of protesters’ efforts to contribute to the common cause. However, just as in case of Tahrir Square or the Tunisian unrest, the common cause is poorly defined: aside from dissatisfaction with Viktor Yanukovych, the protesters exhibited very different preferences for the future course of action, and the three most prominent figures of the protest – Klitschko, Tyagnybok and Yatsenuk – were shunned as they spoke about the common agenda.

The aftermath of the Arab Spring remains unclear for both protesters and the world. The Syrian social unrest has resulted in ongoing violent conflict, while Libyan society still experiences serious problems with the formation of a new government after the murder of Kaddafi and the end of civil war. Tunisia and Egypt were able to choose new Presidents and form new governments. The latter were themselves dismissed soon after they came to power: the first elected post-Mubarak government collapsed in mid-2013 after a year of almost uninterrupted protests. These two cases are especially interesting as constitutional exits of leaders who were in autocratic office for less than one year were generally caused by coups and not protests between 1945 and 2002 (Svolik, 2009).

Nevertheless, we can apply the knowledge acquired there to the new Ukrainian protest we observed on Maidan and try to predict its development by the means of stylized models suggested in Dagaev, Lamberova, Sobolev and Sonin (2013).

Our approach relies on four simple parameters that drive the dynamics of the protests. First, we consider the costs of collective action – the opportunity costs of spending time on Maidan. The second parameter is the military capacity of the incumbent that can be devoted to the suspension of the protest. The higher it is, the more numerous should the protest be to succeed. The third parameter we use is the degree of the radicalization of the incumbent (the difference between his position and the preferred policy of the majority of the population). Finally, we use an information availability parameter (how many people are aware of the place and time of the occurrence of the protest).

With the electric telegraph, a communication tool of the 19th century, information availability was low and many of those who would have been glad to pay the costs of collective actions to replace the incumbent stay at home as they are not aware of the protest taking place. With Facebook and Twitter, the availability of information is much higher. According to our findings, the crucial role in dynamics of contemporary mass actions is played by the ratio of military capacity to the information availability rather than their values per se.

Our framework assumes that each citizen’s decision of whether to participate in the protest or not is based on the difference between her position and the preferred policy of the incumbent. According to this decision, all citizens can be classified into two groups – those who participate in a protest against the incumbent, and those who do not. We define a person, who has the median position among the protesters, as the expected new incumbent. So if the elections were held among the protesters, he would receive the widest support. If the number of citizens participating in the protest is sufficient to overcome the military capacity of the current incumbent, the protest becomes successful, and the expected new incumbent of the protest becomes the new incumbent. The combination of military capacity, opportunity costs and costs of coordination determine the size of the stability zone – a segment of policy space where the incumbent is not vulnerable to mass protest.

The model allows us to predict the dynamics of the protests that is generated by different combinations of the parameters. For illustrative purposes, the availability of information about the protest is proxied by data on Facebook penetration and military capacity is described by the number of military personnel per capita in 2009 collected by the International Institute for Strategic Studies (Hackett, 2010). The incumbent policy position is proxied by the Legitimacy Index from Polity IV, where a higher index corresponds to lower legitimacy of the incumbent and his regime. Finally, the costs of participation in a protest are proxied by the employment rate. A recent study by Campante and Chor stresses unemployment as important determinants of opportunity costs of taking to the streets during Arab Spring (Campante & Chor, 2012). As unemployed individuals have fewer options of how to spend their time, one should expect that a substantial number of unemployed people corresponds to a relative ease of sparking unrest.

Using these parameters, we can explain success or failure of the protest, and predict some proprieties of its aftermath.

For example, high military capacity, opportunity costs and costs of coordination generate a broad stability zone, so that even a radical incumbent would not face a threat of revolution. The decline of any of three parameters can narrow the zone of stability and make the autocrat vulnerable to mass protest. As the incumbent is highly radical, a significant part of the population takes to the streets. As a result, the new incumbent’s position is sufficiently close to the one of the median voter and is, thus, inside the stability zone. An example of such a scenario is the overturn of Slobodan Milosevic after the fall of communism, when there were eight failed and one successful attempts to form a wide coalition of opposition parties (Spoerri, 2008). The process of finding a common ground started in 1990 with the emergence of the coalition of six parties, the Associated Opposition of Serbia, which broke shortly after a series of power struggles, policy disagreements, and personality clashes. It was only ten years later that the protest which facilitated Milosevic’s downfall took place, as the leader of the united opposition, the Democratic Opposition of Serbia, was able to ensure the non-involvement of the crucial military unit on behalf of Milosevic (Bujosevic & Radanovic, 2003).

In contrast, the events of the Arab Spring had different political dynamics. Low military capacity and high unemployment of Egypt and Tunisia determined a narrow stability zone ex ante. The absence of protests of these long-lived regimes can be explained by the relatively moderate position of the incumbent. In 2010, the Egyptian and Tunisian regimes had scores of 5 and 4 (out of 12) of Political Legitimacy from Polity IV, respectively. However the emergence of social media that enabled the users to coordinate their actions easily narrowed the relatively small stability zone. As the incumbent was less radical, fewer citizens benefit from its replacement and take to the streets. Thus, the new incumbent is defined by protesters, her policy position is more radical and now is out of the stability zone. The new incumbent immediately faces the new social unrest.

Table 1 presents the stylized results of our study. Locating the combination of parameters of the country in the table allows us to make the prediction about the dynamics of the protest. There are several possible courses of events: the protest can be weak and die out soon, with the incumbent staying in place; it can be significant, but yet not large enough to overthrow the incumbent; it can lead to the replacement of the incumbent, followed by the period of stability; and, finally, it can result in the replacement of the incumbent, but not cessation of the protest.

Table 1. Protest Outcome as a Function of Parameters
Table1

What do our findings tell us about Ukraine? The previously used proxy for the information index there is not a good choice, as the majority of users prefer the Russian version of Facebook – Vkontakte – as the major social network of the country. Thus, we rely on the Vkontakte penetration data (as of 2013, 18.5 million of people in Ukraine were using the network, constituting 40.6% of the population, see report of Ukranian IT-news agency AIN.UA: http://ain.ua/2013/11/28/503853).

The military parameter, that reduces the likelihood of successful protest, is low, compared to the countries of Arab Spring and constitutes 2.8 active military per 1000 people (see the Ukrainian law “Armed Forces of Ukraine for 2013”, http://w1.c1.rada.gov.ua/pls/zweb2/webproc34?id=&pf3511=49126&pf35401=283834), which is half of the one in Egypt at the beginning of the protests. The unemployment parameter fell to 8.6 during the incumbency of Victor Yanukovych, which corresponds to the pre-protest unemployment in Egypt in 2010.

The legitimacy measure presents a difficulty for comparison with the Arab Spring cases, as the Legitimacy Index has not yet been updated. However, the harsh actions of Victor Yanukovych during the 2013-2014 protests (including the suppression of the protest and the passage of laws denying freedom of assembly and freedom of expression, as well as the refusal to repeal his earlier changes of the constitution towards more presidential form of government) suggest that his legitimacy level fell by approximately 50% (and was about 20% right before he was ousted from power), which is corroborated by polls (“Ukraine’s future in peril under President Yanukovych”, The Washington Post, 2 December, 2013). Thus, the conservative estimate is that his legitimacy index shifted from 3 to 4 or 5, as shown on Figure 1.

For the purpose of comparison, we plot the Arab Spring countries and Ukraine in the space of our variables in Figure 1. The X-axis shows the incumbent’s departure from the median population-preferred policy (proxied by the Legitimacy Index from Polity IV). We use the value of the index in the year prior to the start of unrest, and the index value in 2010 for countries with no protests (Morocco, Oman, Djibouti). The Y-axis corresponds to the employment level. The size of the bubble corresponds to the ratio of military capacity and Facebook (or Vkontakte) penetration (data from the Arab Spring Social Media Report).

The shading of the bubble reflects the type that country belongs to: striped (no significant protest), light gray (continuing protest), and dark grey (multiple protests). Syria is excluded from the classification and is marked white, because of the civil war and international intervention.

Figure 1. Legitimacy index (X-axis), Employment (Y-axis), Military capacity / Social media penetration (size of the bubble) in Arab Spring countries and UkraineFigure 1

Figure 1 illustrates that countries appear in tight clusters in line with our theoretical predictions. The countries with continuing protests that did not lead to the downfall of the incumbent are divided into two groups. The first group (Kuwait, Jordan, Lebanon, and Bahrain) has relatively a moderate incumbent policy position and extremely high level of development of new media. The reasons why these countries are not «striped» is high military capacity of the government that could be employed against protesters, combined with high opportunity costs of protesting (low unemployment rates).

The second group of countries (Syria, Algeria, Iraq, Yemen, and Mauritania) has more radical incumbents and higher unemployment rates (so the incentives to protests are higher there), but is poor in terms of IT development. The ratio of military capacity and Facebook (Vkontakte) penetration is high, which is reflected by the size of bubbles that are much larger than in the first groups. That is why in a country with a small military capacity (such as Yemen), the protests did not lead to the incumbent’s replacement.

Two Arab Spring countries belong to the “multiple protests” group. Both Egypt and Tunisia had relatively mild incumbents in the pre-protest era, with Tunisia’s Bashar al-Assad being the milder of the two. Both countries had relatively high unemployment rates and wide Facebook coverage, both factors alleviating the problem of organizing a collective action. Despite the fact that before the start of the protests Facebook coverage in Egypt had close to average values among the countries of Arab Spring, they grew at exponential rates and Egypt attained leading positions in the region in usage of new media several months later. Moreover, low rates of military capacity made protest activity less risky in both Tunisia and Egypt. The remaining differences in Facebook coverage and employment rates in Egypt and Tunisia account for the different structure of recurrent protests, predicted by our model.

Comparison of the Arab Spring countries data with the Ukrainian case shows that high military capacity, new media penetration and unemployment generate even more narrow stability zones than one observes in the cases of Egypt and Tunisia. The reason why the incumbent was not vulnerable to mass protests can be explained by the political legitimacy of Yanukovych as the winner of relatively free elections in 2010.

But if the Arab Spring protests were triggered by rapid growth of new (cheap) communication technologies, the successful protest against Yanukovych can be explained by his radicalization. The radicalization took the form of parliamentary acts that put significant constraints on political rights and civil liberties and violent suppression of dissident actions.

Employing the proposed approach and contrasting the Ukrainian case with the countries of the Arab Spring allows us to draw several conclusions.

Firstly, the current combination of availability of information, military capacity of the incumbent and his radicalization, together with the opportunity costs of staying on Maidan, are likely to result in successful and recurrent protest. The persistence of the protests after the formation of a temporal government supports this hypothesis.
Secondly, it is worthwhile to note that as the policy position of Viktor Yanukovych was relatively mild, his potential successor might be more radical.

Thirdly, the exponential growth of social media, the reduction of military capacity and relatively high unemployment puts Ukraine into an “instability zone”. This implies that the 2004 scenario of the Orange Revolution is unlikely to repeat. The protest of 2004 resulted in a general election, and the elected president Viktor Yushchenko served his term without interruption. The protests of 2013 are more likely to result in a rapid change of incumbents and a period of instability.

One factor can strengthen the possible incumbent’s vulnerability. The external pressure of the Russian government reduces costs of collective resistance to the new Ukrainian authorities among pro-Russian citizens, while the promise of Western countries to support fast EU integration can incentivize politicians to accelerate reforms opposed by significant parts of the population.

References

  • Bujosevic, D., & Radanovic, I. (2003). The fall of Milosevic: the October 5th revolution. Palgrave Macmillan.
  • Campante, F. R., & Chor, D. (2012). Why was the Arab world poised for revolution? Schooling, economic opportunities, and the Arab Spring. The Journal of Economic Perspectives, 167–187.
  • Dagaev, D., Lamberova, N., Sobolev, A., & Sonin, K. (2013). Technological Foundations of Political Instability. Centre for Economic Policy Research Working Paper Series
  • Hackett, J. (2010). The Military Balance 2010: The Annual Assessment of Global Military Capabilities and Defense E conomics. London: The International Institute for Strategic Studies.
  • Spoerri, M. (2008). Uniting the opposition in the run – up to electoral revolution – Lessons from Serbia 1990 – 2000. Totalitarismus Und Demokratie, 5(2005), 67–85.
  • Svolik, M. (2009). Power sharing and leadership dynamics in authoritarian regimes. American Journal of Political Science, 53(2), 477–494

Are Natural Resources Good or Bad for Development?

Policy Brief

Open pit mine industry representing natural resources and development

Natural resources undoubtedly play an important role in the economy of many countries. Whether their contribution to development is positive or negative is, however, a contested and difficult question. Arguably countries like Australia, Botswana and Norway have gained enormously over long periods from their natural resources, others like Azerbaijan, Kazakhstan and Russia have gained in economic growth terms but maybe at the expense of institutional development, while in some countries, such as Angola and Sierra Leone, natural resources have been at the heart of violent conflicts with devastating effects for society. With many developing countries being highly resource-dependent a deeper understanding of the sources and solutions to the potential problem of natural resources is highly relevant. This brief reviews the main issues and points to key policy challenges for turning resource rents into driver rather than a detriment for development.

Is it good for a country to be rich in natural resources? Superficially, the answer to this question would obviously seem to be “yes”. How could it ever be negative to have something in addition to labor and produced capital? How could it be negative to have something valuable “for free”? Yet, the answer is far from that simple and one can relatively quickly come up with counterarguments:  “Having natural resources takes away incentives to develop other areas of the economy which are potentially more important for long-run growth”; “Natural resource-income can cause corruption or be a source of conflict”, etc.

Looking at some of the starkest cases, the “benefits” of resources can indeed be questioned. Take the Democratic Republic of Congo for example. It is the world’s largest producer of cobalt (49% of the world’s production in 2009) and of industrial diamonds (30%). It is also a large producer of gemstone diamonds (6%), it has around 2/3 of the world’s deposits of coltan and significant deposits of copper and tin. At the same time, it has the world’s worst growth rate and the 8th lowest GDP per capita over the last 40 years.[1] The picture for Sierra Leone and Liberia is very similar – they possess immense natural wealth, yet they are found among the worst performers both in terms of economic growth and GDP per capita. While the experiences of countries such as Bolivia and Venezuela are not as extreme their resource wealth in terms of natural gas and oil respectively seem to have brought serious problems in terms of low growth, increased inequality and corruption. When one, on top of this, adds that some of the world’s fastest-growing economies over the past decades – such as Hong Kong, South Korea and Singapore – have no natural wealth the picture that emerges is that resources seem to be negative for development.

These are not isolated examples. By now, it is a well-established fact that there is a robust negative relationship between a country’s share of primary exports in GDP and its subsequent economic growth. This relationship, first established in the seminal paper by Sachs & Warner (1995) is the basis for what is often referred to as the resource curse, that is, the idea that resource dependence undermines long-run economic performance.[2]

Based on the World Development Indicators database (World Bank). Primary exports consist of agricultural raw materials exports, fuel exports, ores and metals, and food exports.

At the same time, there are numerous countries that provide counterexamples to this idea. Being the second largest exporter of natural gas and the fifth largest of oil, Norway is one of the richest world economies. Botswana produces 29% of the world’s gemstone diamonds and has been one of the fastest-growing countries over the last 40 years. Australia, Chile, and Malaysia are other examples of countries that have performed well, not just despite their resource wealth, but, to a large extent, due to it.

Given these examples the relevant question becomes not “Are resources good or bad for development?” but rather “Under what circumstances are resources good and when are they bad for development?. As Rick van der Ploeg (2011) puts it in a recent overview: “the interesting question is why some resource-rich economies [.] are successful while others [.] perform badly despite their immense natural wealth”. To begin to answer this question it is useful to first review some of the many theoretical explanations that have been suggested and to see what empirical support they have received. Clearly, our overview is far from complete but we think it gives a fair picture of how we have arrived at our current stage of knowledge.[3]

Theories and Evidence

The most well-known economic explanation of the resources curse suggests that a resource windfall generates additional wealth, which raises the prices of non-tradable goods, such as services. This, in turn, leads to real exchange rate appreciation and higher wages in the service sector. The resulting reallocation of capital and labor to the non-tradable sector and to the resource sector causes the manufacturing sector to contract (so-called “de-industrialization”). This mechanism is usually referred to as “Dutch disease” due to the real exchange rate appreciation and decrease in manufacturing exports observed in the Netherlands following the discovery of North Sea gas in the late 1950s. Of course, the contraction of the manufacturing sector is not necessarily harmful per se, but if manufacturing has a higher impact on human capital development, product quality improvements and on the development of new products, this development lowers long-run growth.[4] Other theories have focused on the problems related to the increased volatility that comes with high resource dependence. In particular, it has been suggested that irreversible and long-term investments such as education decrease as volatility goes up. If human capital accumulation is important for long-run growth this is yet another potential problem of resource wealth.

The empirical support for the Dutch disease and related mechanisms is mixed. Some authors find that a resource boom causes a decline in manufacturing exports and an expansion of the service sector (e.g. Harding and Venables (2010)), others do not (e.g. Sala-i-Martin and Subramanian (2003)). But even the studies that do find evidence of the Dutch disease mechanism, usually do not analyze its effect on the growth rates. In principle, Dutch disease could be at work without this hurting growth. Another problem is that the Dutch disease theory suggests that natural resources are equally bad for development across countries. This means that the theories cannot account for the great heterogeneity of observed outcomes, that is, they cannot explain why some countries fail and others succeed at a given level of resource dependence. The same goes for the possibility that natural resources create disincentives for education. Gylfason 2001, Stijns (2006) and Suslova and Volchkova (2007) find evidence of lower human capital investment in resource-rich countries but the theory cannot explain differences across (equally) resource-rich countries.

As a result, greater attention has been devoted to the political-economic explanations of the resource curse. The main idea in recent work is that the impact of resources on development is heavily dependent on the institutional environment. If the institutions provide good protection of property rights and are favourable to productive and entrepreneurial activities, natural resources are likely to benefit the economy by being a source of income, new investment opportunities, and of potential positive spillovers to the rest of the economy. However, if property rights are insecure and institutions are “grabber-friendly”, the resource windfall instead gives rise to rent-seeking, corruption and conflict, which have a negative effect on the country’s development and growth. In short, resources have different effects depending on the institutional environment. If institutions are good enough resources have a positive effect on economic outcomes, if institutions are bad, so are resources for development.

Mehlum, Moene and Torvik (2006) develop a theoretical model for this effect and also find empirical support for the idea. In resource-rich countries with bad institutions incentives become geared towards “grabbing resource rents” while in countries where institutions render such activities difficult resources contribute positively to growth. Boschini, Pettersson and Roine (2007) provide a similar explanation but also stress the importance of the type of resources that dominate. They show that if a country’s institutions are bad, “appropriable” resources (i.e., resources that are more valuable, more concentrated geographically, easier to transport etc. – such as gold or diamonds) are more “dangerous” for economic growth. The effect is reversed for good institutions – gold and diamonds do more good than less appropriable resources. In turn, better institutions are more important in avoiding the resource curse with precious metals and diamonds than with mineral production. The following graph illustrates their result by showing the marginal effects of different resources on growth for varying institutional quality. Distinguishing the growth contribution of mineral production in countries with good institutions with the effect in countries with bad institutions, the left panel shows a positive effect in the former and a negative one in the latter case. The right-hand panel illustrates the corresponding, steeper effects when isolating only precious metals and diamond production.

Even if these papers provide important insights and allow for the possibility of similar resource endowments having variable effects depending on the institutional setting, two major problems still remain. First, the measures of “institutional quality” are broad averages of institutional outcomes (rather than rules).[5] Even if Boschini et al. (2007), and in particular Boschini, Pettersson and Roine (2011) test the robustness of the interaction result using alternative institutional measures (including the Polity IV measure of the degree of democracy) it remains an important issue to understand more precisely which aspects of institutions that matter. An attempt at studying a particular aspect of this question is the paper by Andersen and Aslaksen (2008), which shows that presidential democracies are subject to the resource curse, while it is not present in parliamentary democracies. They argue that this result is due to higher accountability and better representation of the parliamentary regimes.

A second remaining issue is that even if one concludes that the impact of natural resources differs across institutional environments it is an obvious possibility that natural resources have an impact on the chosen policies and institutional arrangements. For example, access to resource rents may provide additional incentives for the current ruler to stay in power and to block institutional reforms that threaten his power, such as democratization. In a well-known paper with the catchy title “Does oil hinder democracy?” Ross (2001) uses pooled cross-country data to establish a negative correlation between resource dependence and democracy.

However, one needs to be careful in distinguishing such a correlation from a causal effect. There are at least two issues that can affect the interpretation: First, there could be an omitted variable bias, that is, the natural resource dependence and institutional environment can be influenced by an unobserved country-specific variable, such as historically given institutions (which in turn could be the result of unobserved effects of resources in previous periods), culture, etc. For the same reason, cross-country comparisons may also be misleading. One way of dealing with this problem is to use fixed-effect panel regressions to eliminate the effect of the country-specific unobserved characteristics. This approach produces mixed empirical results: in the analysis of Haber and Menaldo (2011) the effect of resources on democracy disappears, while Aslaksen (2010) and Andersen and Ross (2011) find support for a political resource curse.

Second, the measures of natural resource wealth may be endogenous to institutions and, in particular, its level of democracy. For example, the level of oil production and even the efforts put into oil discovery can be affected by the decisions of (and constraints on) those in power. Thereby one would need to find instrumental variables that influence the level of democracy only through the resource measures.[6] Tsui (2011) investigates the causal relationship between democracy and resources by looking at the impact of oil discovery event(s) on a cross-country sample. His identification strategy is based on using the exogenous variation in oil endowments (an estimate of the total amount of oil initially in place) to instrument for the amount of total discovered oil to date. The idea is that, while the amount of oil discovered could well be influenced by the institutional environment, the size of the oil endowment is determined only by nature. Tsui’s findings also support the political resource curse story.

There are also numerous studies about the effect of resources on particular institutional aspects and policies. For example, Beck and Laeven (2006) find that resource wealth delayed reform in Eastern Europe and the CIS, Desai, Olofsgård and Yousef (2009) point to natural resource income as central for the possibilities of autocratic governments to remain in power through buying support, Egorov et. al. (2009) show that there is fewer media freedom in oil-rich economies, with the effect being the strongest for the autocratic regimes. Andersen and Aslaksen (2011) find that natural resource wealth only affects leadership duration in non-democratic regimes. Moreover, in these countries, less appropriable resources extend the term in power (in line with the ruler incentive argument above), while more appropriable resources, such as diamonds, shorten political survival (perhaps, due to increased competition for power). Several papers show that in a bad institutional environment natural resources increase corruption (e.g., Bhattacharyya and Hodler (2010) or Vincente (2010)), and reduce corporate transparency (Durnev and Guriev (2011)).

Implications for Policy

Overall the literature points to potential economic as well as political problems connected to natural resources. Even if some issues remain contested it seems clear that many of the economic problems are solvable with appropriate policy measures and in general that natural resources can have positive effects on economic development given the right institutional setting. However, it seems equally clear that natural resource wealth, especially in initially weak institutional settings, tends to delay diversification and reforms, and also increases incentives to engage in various types of rent-seeking. In autocratic settings, resource incomes can also be used by the elite to strengthen their hold on power.

Successful examples of managing resource wealth, such as the establishment of sovereign wealth funds that can both reduce the volatility and create transparency and also smooth the use of resource incomes over time, are not always optimal or easily implementable. Using the money for large investments could be perfectly legitimate and consumption should be skewed toward the present in a capital-scarce developing setting (as shown by van der Ploeg and Venables, 2011). But no matter what we think we know about the optimal policy it still has to be implemented and if the institutional setting is weak the problems are very real. This is just because of potentially corrupt governments but also due to the difficulty to make credible commitments even for perfectly benevolent politicians (see e.g. Desai, Olofgård and Yousef, 2009).

Many political leaders in resource-rich countries have pointed to the hopelessness of their situation and have expressed a wish to rather be without their natural wealth. Such conclusions are unnecessarily pessimistic. Even if it is true that the policy implications from the literature more or less boil down to a catch-22 combination of 1) “Resources are bad (only) if you have poor institutions, so make sure you develop good institutions if you have resource wealth” and 2) “Natural resources have a tendency to impede good institutional development”, there are possibilities. Some countries have succeeded in using their resource wealth to develop and arguably strengthen their institutions. Even if it is often noted that Botswana had relatively good institutions already at the time of independence, it was still a poor country with no democratic history facing the challenge of developing a country more or less from scratch. And at the time of independence, they also discovered and started mining diamonds which have since been an important source both of growth and government revenue. This development has to a large part been due to good, prudent policy.

There is nothing inevitable about the adverse effects of natural resources but resource-rich developing countries must face the challenges that come with having such wealth and use it wisely. The first step is surely to understand the potential problems and to be explicit and transparent about how one intends to deal with them.

References

Footnotes

[1] Based on World Development Indicators database (World Bank).

[2] Its robustness has been confirmed in, for example, Gylfason, Herbertsson and Zoega (1999), Leite and Weidmann (1999), Sachs and Warner (2001) and Sala-i-Martin and Subramanian (2003). Doppelhoefer, Miller and Sala-i-Martin (2004) find that the negative relation between the fraction of primary exports in total exports and growth is one of 11 variables which is robust when estimates are constructed as weighted averages of basically every possible combination of included variables.

[3] The interested reader should consult more extensive overviews such as Torvik (2009), Frankel (2010) or van der Ploeg (2011).

[4] This assumption has been criticized by, for example, Wright (1990), David and Wright (1997), and Findlay and Lundahl (1999) who all point to historical examples where resource extraction has been a driver for the development of new technology. On the other hand others, e.g. Hausmann, Hwang and Rodrik (2007), provide evidence that export product sophistication predicts higher growth.

[5] The distinction between using institutional outcomes rather than institutional rules has been much debated in the literature on the importance of institutions in general. It is, for example, possible for a dictator to choose to enforce good property rights protection even if this is something typically associated with democracy.

[6] The studies by Boschini, Pettersson and Roine (2007) and (2011) also use instrumental variables to try to account for the potential endogeneity problems. The results are in line with the OLS results but instruments are weak in this setting.

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.

What Do Recent Insights From Development Economics Tell Us About Foreign Aid Policy?

Posted on October 3, 2011 | Policy Brief

Policy Brief Image Representing Insights from Development Economics

The short answer is: quite a lot, but different parts of the literature offer different recommendations. The problem is that these different recommendations are partly in conflict, and that political and bureaucratic incentives may reinforce these frictions when putting aid policy into practice. It follows that reforms aiming at improving aid effectiveness have to find a way to deal with this conflict and also balance the tendency of institutional sclerosis within bureaucratic agencies against short sighted incentives of politicians.

The currently predominant field of development economics focuses on impact evaluation of different economic and social interventions. These studies are all micro-oriented, looking at the impact on the level of the individual or household, rather than at the nation as a whole. One example is evaluations of the effects of different interventions on school participation, such as conditional cash transfers, free school meals, provision of uniforms and textbooks, and de-worming. Other well-known studies have looked at educational output, moral hazard versus adverse selection on financial markets, how to best allocate bed-nets to prevent malaria, and the role of information in public goods provision and health outcomes.

What has sparked the academic interest in these types of impact evaluations is the application of a methodology well known from clinical trials and first introduced in the field of economics by labor economists, randomized field experiments. The purpose of impact evaluation is to establish the causal effect of the program at hand. Strictly speaking this requires an answer to the counterfactual question; what difference does it make for the average individual if he is part of the program or not. Since an individual cannot be both part of, and not part of, the program at the same time, an exact answer to that question cannot be reached. Instead evaluators must rely on a comparison between individuals participating in the program and those that do not, or a before and after comparison of program participants. The challenge when doing this is to avoid getting the comparison contaminated by unobservable confounding factors and selection issues. For instance, maybe only the most school motivated households are willing to sign up for conditional cash transfer programs, so a positive correlation between program involvement and school participation may all be due to a selection bias (these households would have sent their children to school anyway). In this case participation is what economists refer to as “endogenous”, individual characteristics that may impact the outcome variable may also drive participation in the program.

To get around this problem, the evaluator would want strictly “exogenous” variation in the participation in the program, i.e. individuals should not get an opportunity to self-select into participation or not. The solution to this problem is to select a group of similar individuals/households/villages and then randomize participation across these units. This creates a group of participants in the program (the “treated”, using the language of clinical studies) and a group of non-participants (the “control group”) who are not only similar in all observable aspects thought to possibly affect the outcome, but who are also not given the opportunity to self-select into the program based on unobservable characteristics. Based on this methodology, the evaluator can then estimate the causal effect of the program. Exactly how that is done varies, but in the cleanest cases simply by comparing the average outcome in the group of treated with that in the group of controls.

So what has this got to do with aid policy? A significant part of aid financing goes of course to projects to increase school participation, give the poor access to financial markets, eradicate infectious diseases, etc. Both the programs evaluated by randomization, and the randomization evaluations themselves, are often financed by aid money. The promise of the randomization literature is thus that it offers a more precise instrument to evaluate the effectiveness and efficiency of aid financed projects, and also helps aid agencies in their choice of new projects by creating a more accurate knowledge bank of what constitutes current best practices. This can be particularly helpful since aid agencies often are under fire for not being able to show what results their often generous expenditures generate. Anyone who has followed the recent aid debate in Sweden is familiar with this critique, and the methodology of randomization is often brought forward as a useful tool to help estimate and make public the impact of aid financed development projects.

Limits to Randomization

Taken to the extreme, the “randomization revolution” suggests that to maximize aid effectiveness all aid should be allocated to clearly defined projects, and only to those projects that have been shown through randomization to have had a cost-effective causal effect on some outcome included in the aid donors objective (such as the millennium development goals). Yet, most aid practitioners would be reluctant to ascribe to such a statement. Why is that? Well, as is typically the case there are many potential answers. The cynic would argue that proponents of aid are worried that a true revelation of its dismal effects would decrease its political support, and that aid agencies want to keep their relative independence to favor their own pet projects. Better evaluation techniques makes it easier for politicians and tax payers to hold aid agencies accountable to their actions, and principal-agency theory suggests that governments then should put more pressure on agencies to produce verifiable results.

There are other more benevolent reasons to be skeptical to this approach, though, and these reasons find support in the more macro oriented part of the literature. In recent papers studying cross national differences in economic growth and development almost all focus is on the role of economic and political institutions. The term “institutions” has become a bit of a catch-phrase, and it sometimes means quite different things in different papers. Typically, though, the focus lies on formal institutions or societal norms that support a competitive and open market economy and a political system with limited corruption, predictability and public legitimacy. Critical components include protection of property rights, democracy, honest and competent courts, and competition policy, but the list can be made much longer. Also this time the recent academic interest has been spurred by methodological developments that have permitted researchers to better establish a causal effect from institutions to economic development. Estimating cleanly the effect of institutions on the level or growth rate of GDP is complicated since causality is likely to run in both directions, and other variables, such as education, may cause both. What scholars have done is to identify historical data that correlates strongly with historic institutions and then correlated the variation in current institutions that can be explained by these historical data with current day income levels. If cross national variation in current institutions maps closely to cross national variation in historical institutions (“institutional stickiness”) and if current day income levels, or education rates, do not cause historical institutions (which seems reasonable) then the historical data can be used as a so called “instrument” to produce a cleaner estimate of the causal effect of institutions.

Note that randomization and instrumentation are trying to solve the same empirical challenge. When randomization is possible it will be superior if implemented correctly (because perfect instruments only exist in theory), but there is of course a fairly limited range of questions for which randomized experiments are possible to design. In other cases scholars will have to do with instrumentation, or other alternatives such as matching, regression discontinuity or difference-in-difference estimations to better estimate a causal effect.

A second insight from this literature is that what constitutes successful institutions is context specific. Certain economic principles may be universal; incentives work, competition fosters efficiency and property rights are crucial for investments. However, as the example of China shows, what institutions are most likely to guarantee property rights, competition and the right incentives may vary depending on norms and historical experiences among other things. Successful institutional reforms therefore require a certain degree of experimentation for policy makers to find out what works in the context at hand. To just implement blueprints of institutions that have worked elsewhere typically doesn’t work. In other words, institutions must be legitimate in the society at hand to have the desired effect on individual behavior.

Coming back to aid policy, the lesson from this part of the literature is that for aid to contribute to economic and social development, focus should be on helping partner country governments and civic society to develop strong economic and political institutions. And since blueprints don’t work, it is crucial that this process involves domestic involvement and leadership in order to guarantee that the institutions put in place are adapted to the context of the partner country at hand, and has legitimacy in the eyes of both citizens and decision makers. Indeed, institution building is also a central part of aid policy. This sometimes takes an explicit form such as in financing western consultants with expertise in say central banking reform or how to set up a well-functioning court system. But many times it is also implicit in the way the money is disbursed, through program support rather than project support (where the former is more open for the partner country to use at their own priorities), through the partner country’s financial management systems and recorded in the recipient country budget. Also in the implementation of projects there is an element of institution building. By establishing projects within partner government agencies and actively involving its employees, learning and experience will contribute to institutional development.

Actual aid policy often falls short of these ambitions, though. Nancy Birdsall has referred to the impatience with institution building as one of the donors’ “seven deadly sins”. The impatience to produce results leads to insufficient resources towards the challenging and long term work of creating institutions in weak states, and the search for success leads to the creation of development management structures (project implementation units) outside partner country agencies. The latter not only generates no positive spill-overs of knowledge within government agencies, but can often have the opposite effect when donors eager to succeed lure over scarce talent from government agencies. The aid community is aware of these problems and has committed to improve its practices in the Paris declaration and the Accra Agenda, but so far progress has been deemed as slow.

Micro or Macro?

So, I started out saying that there is a risk that these two lessons from the literature may be in conflict if put into practice for actual aid policy. Why is that? At a trivial level, there is of course a conflict over the allocation of aid resources if we interpret the lessons as though the sole focus should be on either institutional development or best practice social projects respectively. However, most people would probably agree that there is a merit to both. In theory it is possible to conceive of an optimal allocation of aid across institutional support and social project support, in which the share of resources going to project support is allocated across projects based on best practices learned from randomized impact evaluations. In practice, however, it’s important to consider why these lessons from the literature haven’t been implemented to a greater extent already. After all, these are not completely new insights. Political economy and the logic of large bureaucratic organizations may be part of the answer. Once these factors are considered, a less trivial conflict becomes apparent, showing the need to think carefully about how to best proceed with improving the practices of aid agencies.

As mentioned above, one line of criticism against aid agencies is that they have had such a hard time to show results from their activities. This is partly due to the complicated nature of aid in itself, but critics also argue that it is greatly driven by current practices of aid agencies. First of all there is a lack of transparency; information about what decisions are made (and why), and where the money is going is often insufficient. This problem sometimes becomes acute, when corruption scandals reveal the lack of proper oversight. Secondly, money is often spent on projects/programs for which objectives are unclear, targets unspecified, and where the final impact of the intervention on the identified beneficiaries simply can’t be quantified. This of course limits the ability to hold agencies accountable to their actions, so focus instead tends to fall on output targets (have all the money been disbursed, have all the schools been built) rather than the actual effects of the spending. So why is this? According to critics, a reason for this lack of transparency and accountability is that it yields the agencies more discretion in how to spend the money. Agencies are accused of institutional inertia, programs and projects keep getting financed despite doubts about their effectiveness because agency staff and aid contractors are financially and emotionally attached.

In this context, more focus on long run, hard to evaluate institutional development may be taken as an excuse for continuing business as usual. Patience, a long run perspective and partner country ownership is necessary, but it cannot be taken as an excuse for not clearly specifying verifiable objectives and targets, and to engage in impact evaluation. It is also important that a long term commitment doesn’t have to imply an unwillingness to abandon a program if it doesn’t generate the anticipated results. It is of course typically much harder to design randomized experiments to evaluate institutional development than the effect of say free distribution of bed-nets. But it doesn’t follow that it is always impossible, and, more importantly, it doesn’t preclude other well founded methods of impact evaluation. The concern here is thus that too much emphasis on the role of institutional development is used as an excuse for not incorporating the main lesson from the “randomization revolution”, the importance of the best possible impact evaluation, because actual randomization is not feasible.

The concern discussed above is based on the implicit argument that aid agencies due to the logic of incentives and interests within bureaucratic institutions may not always do what is in their power to promote development, and that this is made possible through lack of transparency and accountability. The solution would in that case seem to be to increase accountability of aid agencies towards their politicians, the representatives of the tax payers financing the aid budget. That is, greater political control of aid policy would improve the situation.

Unfortunately, things aren’t quite that easy, which brings us to the concern with letting the ability to evaluate projects with randomized experiments being a prerequisite for aid financing. We have already touched upon the problem that programs for institutional development are hard to design as randomized experiments. It follows that important programs may not be implemented at all, and that aid allocation becomes driven by what is feasible to evaluate rather than by what is important for long run development. But there is also an additional concern that has to do with the political incentives of aid. The impatience with institution building is often blamed on political incentives to generate verifiable success stories. This is driven by the need to motivate aid, and the government policies more generally, in the eyes of the voters. It follows that politicians in power often have a rather short time horizon, that doesn’t square well with the tedious and long run process of institution building. Putting aid agencies under tighter control of elected politicians may therefore possibly solve the problem outlined above, but it may also introduce, or reinforce, another problem, the impatience with institution building.

Unfortunately, the perception that randomization makes it possible to more exactly define what works and what doesn’t, may have further unintended consequences if politicians care more about short term success than long term development. We know from principal-agent theory that the optimal contract gives the agent stronger incentives to take actions that contribute to a project if it becomes easier to evaluate whether the project has been successful or not. Think now of the government as the principal and the aid agency as the agent, and consider the case when the government has a bias towards generating short run success stories. In this case the introduction of a new technology that makes it easier to evaluate social projects (i.e. randomization) will make the government put stronger incentives on the aid agency to redirect resources towards social projects and away from institutional development. This would not be a problem if the government had development as its only objective, because then the negative consequences on effort at institution building would be internalized in the incentive structure. But in a second best world where politics trump policy, the improved technology may have perverse and unintended consequences. Greater political control will lead to less focus on institutional development than what is desired from a development perspective. A very benevolent (naïve?) interpretation of the motivation behind aid agencies’ tendencies to design social projects such that their effects are hard to quantify could thus be that it decreases the political pressure to ignore institutional development.

Concluding Remarks

The challenge to heed the two lessons from the literature thus goes beyond the mere conflict of whether to allocate the resources to institutional development or to best practice social projects once political economy and bureaucratic incentives are considered. Improved agency accountability may be necessary to avoid “institutional sclerosis” in the name of institution building and make sure that best practices are followed, but too much political meddling may lead to short sightedness and a hunt for marketable success stories. It is even possible, that the “randomization revolution” may make matters worse, if it becomes an excuse for neglecting the tedious and long term process of institution building and reinforces the political pressure for short term verifiable results.

What is then the best hope for avoiding this conflict of interest? That is far from a trivial question, but maybe the best way to make sure that agency accountability towards their political principals doesn’t lead to impatience with institution building is to form a broad-based political consensus around the objectives, means and expectations of development aid. The pedagogical challenge to convince tax payers that aid helps and that they need to be patient remains, but at least the political temptation to accuse political opponents of squandering tax payers money without proven effects and to pretend to have the final solution for how to make aid work, should be mitigated. But until then the best bet is probably to stay skeptical to anyone claiming to have the final cure for aid inefficiency, and to allow some trust in the ability of experienced practitioners to do the right thing.

Recommended Further Reading

  • Acemoglu, D., S. Johnson and J.A. Robinson (2001) “The Colonial Origins of Comparative Development: An Empirical Investigation“, American Economic Review 91(5), 1369-1401.
  • Banerjee, A. (Ed.) (2007), “Making Aid Work”, MIT Press.
  • Bannerjee, A. and E. Duflo (2008), “The Experimental Approach to Development Economics”, NBER Working Paper 14467.
  • Birdsall, N. (2005), “Seven Deadly Sins: Reflections on Donor Failings”, CGD Working Paper 50.
  • Birdsall, N. and H. Kharas (2010), “Quality of Official Development Assistance Assessment”, Working Paper, Brookings and CGD.
  • Duflo, E., R. Glennerster and M. Kremer (2007), “Using Randomization in Development Economics Research: A Toolkit”, CEPR Discussion Paper 6059.
  • Easterly, W. (2002), “The Cartel of Good Intentions: The problem of Bureaucracy in Foreign Aid”, Journal of Economic Policy Reform, 5, 223-50.
  • Easterly, W. and T. Pfutze (2008), “Where Does the Money Go? Best and Worst Practices in Foreign Aid”, Journal of Economic Perspectives, 22, 29-52.
  • Knack, S. and A. Rahman (2007), “Donor fragmentation and bureaucratic quality in aid recipients”, Journal of Development Economics, 83(1), 176-97.
  • Rodrik, D. (2008), “The New Development Economics: We Shall Experiment, but how Shall We Learn?”, JFK School of Government Working Paper 55.

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.