National Governments, the IMF, and Blame

I was just reading a little bit about the Greek Economy and wanted to highlight the following observation about the IMF that ends up giving it a bad name for government’s mistakes:

One key feature in all this woe has to be a political process that is extremely ineffective, and driven by the fact that no one likes to hear bad news, and that the last thing a politician is able to say is tighten-up your belts now lads and lasses, we are in for a rough ride. But isn’t this just how the IMF gets such a bad name for itself, since the IMF doctors get called in just where the domestic political process breaks down, and where local politicians haven’t the ability to stand up in front of their citizens and say, it’s going to have to be like this, I’m afraid. Isn’t this what just happened in Ukraine, Hungary and Latvia? And then people say, those “nasty folk” at the IMF, they cut pensions everywhere they go, and wages are down 8% in Hungary, and 15% in Latvia once the IMF get to run the show. That is the IMF make for a convenient scapegoat, but people seldom ask themselves why wages needed reducing, or why there is no money to pay the pensions.

Granted, there are other ways to reduce a deficit and the IMF might be biased on how it wants to cut deficits but the general point stands.

Africa and the Financial Crisis

I’ve been writing a lot about the Financial Crisis and relatively little about African development but I found a great short little paper by Shanta Devarajan, Chief Economist of the Africa Region at the World Bank, about the impact of the crisis on Africa that combines the too. If you’re curious about how the crisis has impacted other countries here’s a post about it’s impact in Eastern Europe and Iceland. It’s late and I want to keep this short but here’s the core idea followed by the five ways of how the crisis could have an impact, read the paper for more:

It is argued that the transmission mechanisms between the financial systems in Africa and the rest of the world are weak and will minimize the impact on the crisis. African financial institutions are not exposed to risks emanating from complex instruments in international financial markets because most banks in Sub-Saharan Africa rely on deposits to fund their loan portfolios (which they keep on their books to maturity); the interbank market is small; the market for securitized or derivative instruments is either small or nonexistent, and few rely on foreign borrowing to fund their lending operations. Exceptions to this position are then made for countries like Nigeria and South Africa which are seen as having meaningful transmission mechanisms with the larger financial systems in crisis.

This conventional position is now being challenged. As the immediate crisis faced in the last couple of months subsides, and policymakers begin to consider the longer term impact of the crisis in Africa, an emerging view is that the impact on the financial sector in Africa may actually be more significant and longer lasting than first assumed, and the impact on the non-financial sector in Africa will be more notable.

Impacts:

1. Weakened local investor confidence in equities and bonds on African Stock Exchanges
2. Return to ultraconservative lending practices 
3. Losses arising from central bank reserve management practices 
4. Renewed debate on the role of governments in the financial system 
5. Weakened balance sheets resulting from a downturn in the real economy

Finally, one obvious way the crisis will affect the real economy is through a drop in commodity prices:

Declining demand for commodities will impact African countries significantly. In Zambia for example, the economy is likely to take a hit from a share decline in copper prices (-24%ytd). As the financial crisis surges into all parts of the real economy in developed economies, African countries will experience a substantial decline in exports as the rapid pace of trade expansion in this decade decelerates sharply.

Decentralization And Corruption

Another paper by Ray Fisman, this one together with Roberta Gatti on how government decentralization affects corruption. They use cross country data and find that “fiscal decentralization in government expenditure is strongly and significantly associ-
ated with lower corruption.” I’m not going to go into the actual methodology of the paper here – it’s definitely an area that needs some further study but I wanted to summarize the different theories as to why decentralization might increase or decrease corruption (from the paper):
Decrease:

• Political competition reduces the ability of bureaucrats to extract rents in exchange for services – The Power to Tax, Brennan and Buchanan (1980)
• Competition among localities will more generally discourage governments from establishing interventionist and distortionary policies that might drive away valuable factors of production – Regional Decentralization and Fiscal Incentives, Jin et. al (1999)
• Related to last point: Implement corruption free zones to force other localities to improve their own bureaucracies - Special Governance Zone: A Practical Entry-Point for a Winnable Anti-Corruption Program, Shang-Jin Wei (2000)
• Agents in centralized bureaucracy are responsible for many tasks in many jurisdictions, in decentralized bureaucracy they are responsible for a single task. This makes them more directly accountable while in centralized bureaucracy only the aggregate performance is measured - Constitutional determinants of government spending, Persson and Tabellini (2000)

The Financial Crisis and Human Capital Allocation

Here’s an excellent article by Fareed Zakaria on why the financial crisis also presents a huge opportunity to clean up some of the problems of the political, financial, and economic system of the last decade(s) and how the new administration has (available) the brain power to effect this change:

Volcker has also argued that the highly complex financial system was not nearly as stable as people believed and that far-reaching efforts were needed to regulate and stabilize it. Now these issues will get attention at the highest level. The fear on Wall Street is that a Democratic administration would overregulate. But look at who is advising Barack Obama—Buffett, Volcker, former Treasury secretaries Robert Rubin and Larry Summers. It is more likely that what will come from their efforts will be a better-regulated financial system that, while producing less-extravagant profits, will be more stable and secure.

What I personally find really interesting is his succinct summary of something I have heard over and over in the last few weeks – How the inflated financial industry caused a misallocation of talent into the financial sector:

The financial industry itself is likely to shrink, and that’s not a bad thing, either. It has ballooned dramatically in size. Curry points out that “30 percent of S&P 500 profits last year were earned by financial firms, and U.S. consumers were spending $800 billion more than they earned every year. As a result, most of our top math Ph.D.s were being pulled into nonproductive financial engineering instead of biotech research and fuel technology. Capital expenditures went into retail construction instead of critical infrastructure.” The crisis will stop the misallocation of human and financial resources and redirect them in more-productive ways. If some of the smart people now on Wall Street end up building better models of energy usage and efficiency, that would be a net gain for the economy.

Esther Duflo recently wrote about this for VoxEU and two years ago I read an excellent paper on the incentives for productive and unproductive economic behavior by William Baumol that I cannot recommend strongly enough:

[The] allocation between productive activities such as innovation and largely unproductive activities such as rent seeking and organized crime. This allocation is heavily influenced by the relative payoffs society offers to such activities. This implies that policy can influence the allocation of entrepreneurship more effectively than it can influence its supply.

The world isn’t flat anymore

While The web isn’t flat anymore is one of the slogans of Apture, the startup I co-founded, this post is actually not about that, but about a comment that David Abernethy made during one of his lectures on India on the Stanford Travel podcast. For those of you who don’t know about it, Stanford has a large number of classes and lectures available for free download on iTunes, and I’ve been making my way through them for the last few weeks. I will write more about these other lectures later.

I have never read Tom Friedman’s The World is Flat because it’s a very long book with a relatively simple point and there are so many other fascinating things to read, but I found this particular comment really interesting. Abernathy thinks that “The World is Flat” is actually a misnomer because what the book is really about is certain points of the world being much closer connected to other points, e.g. Bangalore being linked more closely to Palo Alto.

He then goes on to argue that the world was in fact flat before the industrial revolution when economic production dependent almost entirely on human labor and the economic output of a country was roughly proportional to its population. While there were obviously some inequities due to differences in geography, etc. and some minor technological advances gdp-per-capita was relatively uniform throughout the world – the world was flat. Only with the start of the industrial revolution were some countries/regions able to vastly increase their productivity and thereby race ahead of the others and if you look at charts of per region GDP over the last few centuries you really do see them starting at relatively equal levels and then see a big gap opening up. The world isn’t flat anymore. Not rocket science but an interesting thing to keep in mind. I very much recommend the whole lecture, (European “Envasions:” Competition for Wealth and Power, 1498 -1757).