Gorging on Investment, Choking on Red Tape

Academic economists usually air their new ideas first in working papers. Here, before the work gets dusty, a quick look at transition policy research in progress.

Photo by OLIVER LANG/AFP/Getty Images
Photo by OLIVER LANG/AFP/Getty Images

Good Riddance to the License Raj. Prior to India’s economic reforms in 1991, businesses needed government permission to do just about anything — to enter an industry or leave one, to grow, to shrink, to import machinery, etc. The nominal goal was to protect small firms from big bad ones, though, the "License Raj" rapidly devolved into a honey pot for ethically challenged bureaucrats. One of the few virtues of the four-decade experiment was that its end has given researchers a chance to measure just how distorting India’s version of capitalism-with-a human-face really was.

The answer, according to Laura Alfaro (Harvard Business School) and Anusha Chari (University of North Carolina) was very distorting. No surprise there, but their analysis is enlightening in other ways. Post-1991 deregulation increased both the number of small firms, which were no longer blocked from entering industries, and the number of large firms, presumably because the efficient medium-size ones were also no longer blocked from growing. Overall, industries became less concentrated rather than more, as measured by the index used by antitrust authorities. One other striking point: The failure to fill in the missing middle in the years since deregulation suggests that small firms still face substantial hurdles to growth — principally, lack of competitive access to credit. Harvard Business School Working Paper 13-056. Download free here.

The Rising Tide. The price of economic growth in emerging market countries, we’ve been told time and again, is rising inequality. The best one can hope for is that the tide will carry all boats, even if the poor occupy less buoyant craft. And that’s certainly been true in China, where a half-billion people have been rescued from abject poverty, yet migrant workers still huddle in the shadows of flashy skyscrapers.

But happily, it’s not true everywhere. According to World Bank researchers Nora Lustig, Luis F. Lopez-Calva and Eduardo Ortiz-Juarez, most of Latin America has been bucking the trend over the last decade, growing fairly briskly even as inequality shrinks. And since much of the inequality on the continent has been associated with lack of competition, the decline actually went hand in hand with greater efficiency.

Why the good news, and why now? The three economists offer a close look at Mexico, Brazil and Argentina. Argentina’s a bit of an anomaly; the country benefitted enormously from the temporary run-up in export prices for grain and meat early in the decade, and its Peronist government distributed much of the windfall to the party’s labor union constituents. But in Mexico and Brazil, declining inequality seems to be in large part a durable payoff for very well targeted social benefits for the poor. World Bank Policy Research Working Paper 6248. Download free here.

Future Shock. Other things equal, global financial integration makes emerging market economies (EME) more vulnerable to financial shocks.  If you doubt that, think about what happened to East Asia — and then in Russia and Brazil — in 1997.

But all things aren’t equal. Since the 1997 debacle, most EMEs have pulled their socks up, avoiding big budget deficits and inflationary monetary growth, while imposing tighter regulation on banks. So, are these economies more or less susceptible to external shocks than they were two decades ago?

According to Gustavo Adler and Camilo Tovar of the IMF, EMEs are, on balance, less vulnerable: Improved macroeconomic management paid off big-time for countries ranging from Indonesia to Brazil to Egypt during the 2008 global financial crisis. The only glaring exceptions are the western-oriented Eastern European countries that have become ever more integrated with the rich western European economies — notably Germany. But even there, the cloud has a silver lining; European economic integration has dramatically increased productivity and living standards on its eastern periphery.  IMF Working Paper 12/188. Download free here.

Too Much of a Good Thing? China’s economy has been growing by 10 percent annually, give or take a percentage point or two, for three decades. How have they managed it? One reason (among many): By saving a startlingly high 50 percent of national income and plowing it into capital. But as any economist will tell you, there’s such a thing as too much investment — a surfeit in which resources are diverted from consumption, slowing the growth in living standards for the current generation of workers. And according to a new IMF working paper by Il Houng Lee, Murtaza Syed and Liu Xueyan, China is way past the line.  

Government regulations artificially reduce the cost of capital borrowed from the banking system, force-feeding the growth of productive capacity in big, export-oriented factories at the expense of households that are induced to save even more for emergencies and retirement. The IMF economists estimate that the distortion reduces the welfare of the Chinese people by about four percent. Or, to put it another way, simply eliminating the distortions would be equivalent to a four percent increase in national income — real money in a country that only recently achieved middle-income status.  IMF Working Paper WP/12/277. Download free here.

Scrambling for Africa. Did European colonialism spur or retard economic development? There’s pretty much a consensus that it increased the pace of growth in North America and Australia (though little or none of the gravy trickled down to the indigenous peoples). But views on colonialism’s impact on Africa are divided. On the one hand, earlier generations of both Marxists and free-marketeers were wed to the idea that colonialism yielded benefits (purely in terms of GDP growth) because it propelled Africa into the global capitalist economy. On the other, those steeped in the traditions of social democracy typically argue that the benefits of western technology and market institutions were more than offset by the legacy of autocracy and racism left by the colonial powers.

Leander Heldring (Oxford) and James Robinson (Harvard) point out that much depends on educated guesses about the "counterfactual" — that is, about what would have happened if Europe had left Africa alone. Of course, guesses are just that, leaving room for plenty of disagreement. What makes this paper important is that it lays out the plausible counterfactuals in a very disciplined way.

For what it’s worth, Heldring and Robinson conclude that it wasn’t a close call. Colonialism, they say, reduced economic efficiency by focusing enterprise on short-term gains from resource extractive industries, by failing to invest in human capital and by undermining the prospects for good governance once the Europeans departed. There are some ambiguous cases — places lacking virtually any institutions of government like South Sudan and Somalia — and some hard-to-read cases like Sierra Leone. But check out their reasoning yourself: This is a game many can play. National Bureau of Economic Research Working Paper 18566. Download here (for $5).

Jobs and Carbon. To date, the European Union’s commitment to reducing emissions of climate-changing gases has not exacted much in terms of output or employment. But the crunch may come over the next few years, as the European Union reaches to meet the ambitious goals of cutting carbon emissions to 80 percent of the 1990 level and generating 20 percent of energy from renewables by 2020. This is likely to hit Eastern Europe disproportionately hard because much of its industrial and transport capacity is relatively inefficient.

While the adjustment process will be expensive in terms of replacement of factories, electricity generation capacity and vehicles, the long term cost is probably manageable. But in the short run, the new regulations will work like an energy price shock, driving some productive capacity offline and displacing a lot of workers. Here, IMF economists Isil Oral, Indhira Santos and Fan Zhang estimate the impact (albeit temporary) on employment by country, which largely turns on how dependent they are on energy-intensive industries.

Turns out the biggest potential losers in Eastern Europe are the Czech Republic, Slovak Republic, Slovenia, Bulgaria, Hungary and Estonia. The duration and severity of the shock will depend in large part on the flexibility of labor markets — that is, the ease with which workers can move between localities and industries — and on the investment governments make in retraining and job search.  IMF Policy Research Working Paper 6294. Download free here

Peter Passell, the Economics Editor of Democracy Lab, is a Senior Fellow at the Milken Institute.