Development Bank Research Bulletin

How large is the economic benefit of merging Pakistan with India, Mexico with US....

Professor Enrico Spolaore and Romain Wacziarg published an interesting study on the economic effect of merging two countries on economic growth.  They conduct simulations for large number of potential mergers of geographic neighboring countries.  Some results are quite  interesting.

In general, small countries benefit from merging with larger countries, and poorer countries benefit from merging with their richer neighbors.

According to the simulation, were Bangladesh to merge with India, she would grow faster by 1-2 % per year, and in the long run, she may double her income. The merger of Argentina (or Bolivia, or Peru, or Paraguay, or Uruguay) with Brazil, or Mexico (or Canada) with the U.S. would create economic benefits of similar magnitude for these smaller neighbors as they get full access to larger markets.

Pakistan’s economic growth rate will increase by 1.2-1.5 % per year, and long-run income level will be double, if she were to merge with India. India on the other hand will not gain much. Indian growth rate would be raised by 0.1%, and in the long run become 10% richer. (This may explains why Indians in general are less interested in signing free trade arrangement with smaller countries such as Thailand.)

Certainly the merger of these two countries with different culture and religion will create social problems that certainly will outweigh the economic benefit. But on the other hand this also sadly highlights the huge economic costs of two countries hating each other for half a century.

Borders and Growth  (PDF file)
Abstract: This paper presents a framework to understand and measure the effects of political borders on economic growth and per capita income levels. We present a model that provides a theoretical foundation to estimate empirically the effects of political borders on growth. In our model, political integration between two countries results in a positive market size effect and a negative effect through reduced openness vis-à-vis the rest of the world. We estimate the growth effects that would result from the hypothetical removal of national borders between pairs of adjacent countries. We also identify zones of mutually beneficial political integration, and discuss the applicability of our framework to European political integration.

Economic growth is ultimately good for the environment! Cross-country evidence

Princeton economics professors Gene Grossman and Alan Krueger discover that economic growth is ultimately good for environment. Once the per capita income of your country reaches $8,000, enviromental quality will start to improve because now you can better afford those enviromental luxuries!

Their  study covers four types of indicators: urban air pollution, the state of the oxygen regime in river basins, fecal contamination of river basins, and contamination of river basins by heavy metals.

They find that economic growth brings an initial phase of deterioration followed by a subsequent phase of improvement.

The turning points for the different pollutants vary, but in most cases they come before a country reaches a per capita income of $8,000.

Reference:
Economic-growth and the environment (published in the Quarterly Journal of Economics)
China’s Pearl River smells, but mayor vows to swim (earlier in this Bulletin)
Saving the environment from the environmentalists (also in this Bulletin)

A flexible labor law will help French workers: quantitative evidence

As covered previously in the Bulletin in "Does the new labor law really harm French youth?" , some French youth are unhappy about the new labor law and claim that increasing the flexibility of hiring and firing workers will make more people jobless. Serious quantitative study however contradicts what they naively believe. 

A study done by Robert MacCulloch and Rafael Di Tella  and published in the European Economic Review shows that that if France were to make its labor markets as flexible as those in the US, its employment rate would increase 1.6 percentage points, or 14% of the employment gap between the two countries.

The Consequences of Labor Market Flexibility: Panel Evidence Based on Survey Data   (PDF file)
Abstract: We introduce a new data set on hiring and firing restrictions for 21 OECD countries for the period 1984-90. The data are based on surveys of business people in the countries covered, so the indices we use are subjective in nature. Controlling for country and time fixed effects, and using dynamic panel data techniques, we find evidence that increasing the flexibility of the labor market increases both the employment rate and the rate of participation in the labor force. A conservative estimate suggests that if France were to make its labor markets as flexible as those in the US, its employment rate would increase 1.6 percentage points, or 14% of the employment gap between the two countries. The estimated effects are larger in the female than in the male labor market, although both groups seem to have similar long run coefficients. There is also some evidence that more flexibility leads to lower unemployment rates and to lower rates of long-term unemployment. We also find evidence consistent with the hypothesis that inflexible labor markets produce "jobless recoveries" and introduce more unemployment persistence

How could one of the most successful bank regulatory systems fail so easily? The case of 2001 Argentina

Found an old working paper written by Charles Calomiris (Professor in Columbia University) and Andrew Powell (then Chief Economsit of Central Bank of Argentina) back in 2000, in which they portrayed Argentine banking regulatory system as one of the two or three most successful in emerging economies and a role model for every one to follow.

Browsing through the paper, I am deeply impressed by the quality of Argentine system at that time. The Central bank even had an online database of debtors (I don’t know whether they still supply this service) where general public can enter a company name and know the name of the bank extending the credit, the amount of the credit, the quality category of the loan, and the details of any guarantees extended. Bank depositors, shareholders, and researchers thus were able to monitor banks’ credit exposure at real time. Absolute disclosure as a tool for market discipline! This is what any economists would theoretically advise and seldom expect to be realized in the real world. The Central Bank of Argentina however managed to make it happen. If I read this paper in 2000, I would have invested all my money in these wonderful Argentine banks.

Within a year, however, as everyone has known, Argentine banking system failed. Not the bankers' fault; not the bank regulator's fault. The government screwed up in macro policies and brought down the banking system -- something that Calomiris and Powell thought wouldn't happen, not again!

Several lessons for observers:
(1) It is always more risky to praise a country than criticize it. When you criticize a country, you can never be falsified because you can always argue that the arrival of crisis is just a matter of time. When you praise a county, however, the natural law of mean-reversion will always prove you wrong. Things can only get worse.
(2) As a banker, however smart, honest and hard-working you are, the state is always trying to screw you up by some irresponsible fiscal and exchange rate polices. Don’t under-estimate the evilness of government. In the wake of every crisis, Argentines think: “the government won’t do it (freeze the deposit)  again.”. The government won’t change.
(3) When everything looks so wonderful, something must be wrong! If you cannot find it after doing extensive research, something very big must be wrong.

Can Emerging Market Bank Regulators Establish Credible Discipline? The Case of Argentina, 1992-1999 By Charles W. Calomiris, Andrew Powell
Abstract: In the early 1990s, after decades of high inflation and financial repression, Argentina embarked on a course of macroeconomic and bank regulatory reform. Bank regulatory policy promoted privatization, financial liberalization, and free entry, limited safety net support, and established a novel mix of regulatory and market discipline to ensure stable growth of the banking system during the liberalization process. Argentina suffered some fallout from the Mexican tequila crisis of 1995, but its response to that crisis (allowing weak banks to close) and the redoubling of regulatory efforts to promote market discipline after the crisis made Argentina’s banking system quite resilient during the Asian, Russian, and Brazilian crises. Argentina’s bank regulatory system now is widely regarded as one of the two or three most successful among emerging market economies. This paper traces the evolution of the regulatory policy changes of the 1990s and shows that the reliance on market discipline has played an important role in prudential regulation by encouraging proper risk management by banks. There is substantial heterogeneity among banks in the interest rates they pay for debt and the rate of growth of their deposits, and that heterogeneity is traceable to fundamental attributes of banks that affect the riskiness of deposits (i.e. asset risk and leverage). Moreover, market perceptions of default risk are mean-reverting, indicating that market discipline encourages banks to respond to increases in default risk by limiting asset risk or lowering leverage.

Hepatitis B: the reason why China has higher male-to-female ratio

In many Asian countries the ratio of male to female population is higher than in the West -- as high as 1.07 in China and India, and even higher in Pakistan. Most people blame the parental preference for boys in these countries and one-child policy in China for creating the gender imbalance. Chicago University professor Emily Oster has new explanation, that the sex ratio imbalance is caused by hepatitis B virus that are prevalent in these countries.

Existing medical literature indicates that carriers of the hepatitis B virus have offspring sex ratios as high as 1.55 boys for each girl. Hepatitis B is common in many Asian countries, especially China, where some 10 to 15% of the population is infected.

Professor Oster  finds that hepatitis B can explain about 45% of the “missing women”: around 75% in China, between 20% and 50% in Bangladesh, Egypt, and West Asia, and under 20% in India, Pakistan and Nepal.

For governments that are worrying about potential social unrest and threats created by tens of millions of bachelors, the solution is to vaccinate their people agaisnt Hepatitis B virus, which will naturally bring more girls into the "marriage market".

Hepatitis B and the Case of the Missing Women  (PDF file)
Published in the Journal of Political Economy
Abstract:  In many Asian countries the ratio of male to female population is higher than in the West -- as high as 1.07 in China and India, and even higher in Pakistan. A number of authors (most notably Sen, 1992) have suggested that this imbalance reflects excess female mortality and, as a result, have argued that as many as 100 million women are ``missing. This paper proposes an explanation for much of the observed over-representation of males: the hepatitis B virus. Evidence drawn from the existing medical literature as well as new studies of recent vaccination efforts indicate that carriers of the hepatitis B virus have offspring sex ratios as high as 1.55 boys for each girl. This is strongly supported by cross-country evidence on hepatitis B prevalence and sex ratios at birth. Hepatitis B is common in many Asian countries, especially China, where some 10 to 15% of the population is infected. Using data on viral prevalence by country as well as estimates of the effect of hepatitis on sex ratio drawn from a wide range of sources, I find that hepatitis B can explain about 45% of the missing women: around 75% in China, between 20% and 50% in Bangladesh, Egypt, and West Asia, and under 20% in India, Pakistan and Nepal.

Presidential democracies were 4.9 times more likely to default than parliamentary democracies

What types of countries are more likely to default on their sovereign debts? It is a multi-billion dollar question.  Professor Emanuel Kohlscheen has a new finding: Presidential democracies were 4.9 times more likely to default on external debts between 1976 and 2000 than parliamentary democracies.  The reason is, as he argues, that  parliamentary democracies are less likely to default on their liabilities as the confidence requirement creates a credible link between economic policies and the political survival of the executive.

Why are there serial defaulters? Quasi-experimental evidence from Constitutions (PDF file)
Abstract: Presidential democracies were 4.9 times more likely to default on external debts between 1976 and 2000 than parliamentary democracies. This paper argues that the explanation to the pattern of serial defaults among a number of sovereign borrowers lies in their constitutions (on serial defaults see Reinhart, Rogo. and Savastano (2003) and Reinhart and Rogo. (2004)). Ceteris paribus, parliamentary democracies are less likely to default on their liabilities as the confidence requirement creates a credible link between economic policies and the political survival of the executive. This link tends to strengthen the repayment commitment when politicians are opportunistic. I show that this effect is large and statistically significant in the contemporary world even when comparison is restricted to countries that are twins in terms of colonial origin, geography and economic variables. Moreover, the result persists if OECD democracies are excluded from the sample. Since the form of government of a country is typically chosen at the time of independence and highly persistent over time, constitutions can explain why debt policies in developing countries are related to individual histories.

The lasting legacy of colonial land tenure system in India

Why are some parts of India more productive than the rest of the country? Professors Abhijit Banerjee and Lakshmi Iyer have a new explanation.

They trace it back to colonial times. Back then, areas where the land revenue collection was taken over by the British between 1820 and 1856 are much more likely to have a non-landlord system, for reasons that have nothing to do with factors that directly influence agriculture investment and yields. They show that areas in which proprietary rights in land were historically given to landlords have significantly lower agricultural investments and productivity in the post-independence period than areas in which these rights were given to the cultivators.

Map (click to enlarge)

History, Institutions, and Economic Performance: The Legacy of Colonial Land Tenure Systems in India (PDF file)
Abstract: We analyze the colonial land revenue institutions set up by the British in India, and show that differences in historical property rights institutions lead to sustained differences in economic outcomes. Areas in which proprietary rights in land were historically given to landlords have significantly lower agricultural investments and productivity in the post-independence period than areas in which these rights were given to the cultivators. These areas also have significantly lower investments in health and education. These differences are not driven by omitted variables or endogeneity problems; they probably arise because differences in historical institutions lead to very different policy choices.

Red states, blue states, and the welfare state: geography rules!

The divide of “Red states, blue states” exists not only in the UnitedStates, but almost everywhere in the democratic free world. It is also true in every country that liberal parties always concentrate their support in urban areas, even in countries where urban areas are in much richer than rural areas. Another stylized fact we always observe is that in countries that adopt plurality electoral rule as opposed to proportionate representation electoral rule, socialist candidates are less likely to take power.

Why is it so? Professor Jonathan Rodden (MIT) provides an explanation based on economic geography. By economic of scale and agglomeration economy, it is natural that manufacturing bases always cluster together and form what will be later called urban metropolitan areas. Workers, who reside in these urban areas are more likely to be mobilized around a redistribution agenda. This is why liberal parties have to rely on urban voters.

Business interests in some countries, when they extended franchise to workers more than 100 years ago, however build a safeguard in the electoral system to prevent socialists and communists from taking power. This safeguard is the so-called “plurality electoral rule” and “small single-member electoral district”.

Because workers are concentrated in urban areas, pro-redistribution candidates usually have a lot of surplus vote in urban area. Single-member districts however make it difficult for workers (who are usually concentrated in small number of urban districts) to translate votes into seats, because a victory with 30% margin or 5% margin is not different when it comes to allocation of seats.

Another geography law that goes against leftist parties is that, in single-member district system, for a party to win, the pivotal voter is the median voter in the median district (which happens to be suburban area), who are usually politically to the right of the national median voter. If the leftist party wants to win over this voter by moving their platform to the right, another more fundamentalist leftist party will enter from the far left to steal away lefties votes; If it doesn’t move to the right, however, it will never win a majority. This creates a dilemma and a mission impossible for leftist parties.

In many continental European countries, proportionate representation (PR) electoral rule combined with multi-member large electoral districts, however, help workers to pull together their votes. This is why in these countries, socialist pro-redistribution candidates are more likely to be elected. Professor Rodden predict that, in two otherwise identical countries, the one that uses single-member district plurality electoral rule will less likely to develop a redistribution welfare state.

As a matter of fact, in the UnitedStates, we can also observe the effects of the two different electoral systems. Electoral districts for the House of Senate are state-wide and combine rural, urban and suburban areas. Workers in urban states thus can effectively translate their numbers into seats, and pro-redistribution Senate candidates are more likely to be elected. This is why in U.S. Senate, although rural states by design are overrepresented, the political orientation is still biased to the left compared to the House of Congress where congressmen are elected from small single-member districts.

Reference:

Jonathan Rodden: Read states, blue states, and the welfare states (PDF file)

Edward Glaeser: Myths and Realities of American Political Geography (PDF file)

Why Has There Been Less Financial Integration In Asia Than In Europe? Geography matters

Why Has There Been Less Financial Integration In Asia Than In Europe? Professor Barry Eichengreen has a geographic explanation.  His study shows that: distance between countries, whether they share a common language, and whether they share a land border, explain a good deal of the difference in financial integration between the two regions.

He also points out that recent surge of intra-regional trade in Asia is a good sign for further financial integration, because evidence that finance follows trade suggests that Asia is less financially integrated than Europe because it has done less to promote the growth of intra-regional trade.

You may also want to check out our previous commentary in the Bulletin: "A single Asian common currency?"

Why Has There Been Less Financial Integration In Asia Than In Europe? (PDF file)
Abstract: This paper asks why there is less financial integration in Asia than in Europe, taking as a case study the cross-border lending and investment activities of national banking systems. Our results suggest that different levels of economic development in Asia and Europe, along with other differences in regional circumstance that are largely predetermined from the point of view of policy (distance between countries, whether they share a common language, and whether they share a land border), explain a good deal of the difference in financial integration between the two regions. The rest of the gap is explained by policy variables. Evidence that finance follows trade suggests that Asia is less financially integrated than Europe because it has done less to promote the growth of intra-regional trade. Our results also suggest that controls on capital account transactions can have a lingering effect on the volume of cross-border claims and that their shadow is longest where those controls were maintained for the greatest number of years. The underdevelopment of financial markets and institutions in some potential lending countries also appears to be an impediment to financial integration in the region.

New evidence: Politically Connected Firms are prevalent around the world

Professor Mara Faccio’s new paper (publisehd in the American Economic Review)  shows that politically connected firms are prevalent around the world (not only in Thailand, Indonesia), and the announcement of a new political connection (e.g. businessmen entering politics) results in a significant increase in value.

Politically connected firms (PDF file)
Abstract: Examination of firms in 47 countries shows a widespread overlap of controlling shareholders and top officers who are connected with national parliaments or governments, particularly in countries with higher levels of corruption, with barriers to foreign investment, and with more transparent systems. Connections are diminished when regulations set more limits on official behavior. Additionally, I show that the announcement of a new political connection results in a significant increase in value.