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Growth and Crisis - Building Capacity through Rethinking Development

The Power of Innovation - free Webinar TODAY at 3PM EST

Join Aleem Walji, formerly of Google.org, now the Practice Manager of WBI’s Innovation Team and one of the lead authors for a webinar to mark the launch of a special issue of Development Outreach magazine on “The Power of Innovation.”

In a post-crisis world, innovation may be the single most important driver of economic growth and competitiveness. The time is right to move development forward through creative uses of technology. We now have the capacity to scale up innovative approaches to meet the needs of people at the “bottom of the pyramid” when traditional markets fail to do the job. Our authors share their thoughts on how to mobilize innovative solutions to reduce poverty - smarter, better, faster, and differently. Global experts discuss policy, process, new applications, and projects in social enterprise and innovation.

Webinar - Thursday, July 22, 2010 3pm EST (login opens at 2:45)

To join the meeting:
1. Go to http://worldbankva.na4.acrobat.com/devoutreachlaunch/
2. Click on Guest, and type your name to enter the meeting.

More info at: http://bit.ly/cVVZmU

Policies for Growth E-learning Course - Apply by September 17, 2010

What? E-learning course on
“Policies for Growth”
When? October 1-31, 2010
How to Apply? Please follow this link

Tentative Agenda

The story of growth and poverty reduction is much debated in an ever-changing world. The challenge in the 1960s was how to lift low-income countries from a low-growth trap to a reasonably high-growth path. Fifty years later we have many fast-growing emerging economies but also over a hundred countries unable to move away from low-growth and high-poverty traps.

Between 1960 and 2010, 3 major shifts impacted how we think about growth and poverty. These big shifts were from state-directed ‘commanding heights’ to market-driven approach, from structural issues of deregulation, liberalization and privatization to sectoral sources of growth, particularly agriculture and financial services, and from macroeconomic to microeconomic (and now macro-micro) approaches to growth. Somewhere along these shifts, there was a recognition that poverty reduction is a goal in itself and does not have to depend on how fast or slow a country is growing. The new wave of globalization that has swept the world during the past two decades has aided growth and poverty reduction in the developing world but the ongoing global economic crisis threatens to undo all those gains and much more.

For policy makers, practitioners and students who want to learn more about growth and poverty reduction in development economics today, the World Bank Institute is offering an e-learning course on Policies for Growth.

The application deadline is September 17, 2010. Please note that a nominal fee of $250 will be assessed for accepted participants.

Fiscal Stimulus: Too Little or Ineffective? What Next?

All over the world, countries have put in place fiscal stimulus packages as a response to the global crisis. In the US and UK, despite the large fiscal stimuli, the economies are stalling and unemployment rates are still high. Now, Paul Krugman is advocating a second $800+ billion stimulus as he is worried of a Third Depression (i.e. 1873-4, 1929-30 and now) or at best a low job creation and low GDP growth for the short to medium term. According to Krugman, low growth and high unemployment are shorter term problems that have to be resolved before fiscal austerity and debt reduction (which are longer term issues as bond financiers are still buying US securities). Others of conservative leanings, such as John Taylor and Gary Becker, are of the opinion that the Bush tax relief of 2008 did not work and that the Obama stimulus may not work because of small “fiscal spending multiplier”, and as the package is badly designed.

Carmen Reinhart and Rogoff document eight centuries of financial crisis and come to the conclusion that almost all the time it ends in tears with “deficits, debts and defaults.” Reflecting this view, leaders at the recent G-20 meetings pledged for fiscal austerity as the fiscal stimulus packages are quite unpopular in the western world.

Re-thinking Trade Models - Why did Trade Collapse During this Crisis?

Seventy percent of all trade is trade in goods. World trade volume declined by over 20% from peak levels trough April 2008 to January 2009, and this decline was observed across the board – advanced economies recorded a decline of over 23%, Asia about 25%, and so on. Several explanations were provided. One was that countries were raising tariffs and nontariff measures to protect domestic industries during the global downturn. Now, there is evidence that despite some ‘buy American’ and ‘buy British’ type of fiscal stimulus packages, and notwithstanding the rhetoric of governments, protectionism was muted and almost all countries held up their side of the WTO agreements. Others stressed that decline in economic activity was the primary cause of sharp decline in trade. But as pointed out by Chinn (2009) and others, the decline in US imports was much larger than that warranted by the decline in US GDP. The value of the dollar, as it gained strength during a period of international uncertainty, and the change in relative prices were other plausible explanations, but these too do not fully explain the decline in trade volume across all parts of the world.

The Next Wave of This Crisis

After all is said and done, this crisis had its genesis in US and European countries living beyond their means. This was reflected in large current account deficit which was financed by emerging economies of China, Russia, Brazil, Korea and others. This was in contrast to economic theory which tells us that advanced economies are supposed to generate savings and hence have current account surpluses while developing countries should be borrowing to finance their deficits (as they need foreign capital to finance their infrastructure and other needs).

The world is in the midst of extreme political risk – defined as not only wars and coups but governments rushing in with quantitative easing, banking bailouts, and large fiscal stimulus packages, embarking on industrial policies, and trying to re-regulate without fully understanding the unintended consequences of their actions. These expansive domestic policies have increased sovereign debt risk and raised stock prices in a large number of countries. Governments are trying to find domestic solutions to global problems of market volatility – volatility as reflected in descent of euro vis-à-vis the dollar, large movements in stock market indices, and swings in commodity prices. Markets in turn are looking at how governments are coping with big problems, such as the sovereign debt problems in Greece, Spain and other European countries. California could default on its debt obligations – what then for the global economy?

Poverty is Destiny?

The World Bank estimates that there are more than 1.4 billion people in the world who live below the poverty line of $1.25 per day. It will be interesting to see what happens to children born in poverty: to follow them from womb to tomb, the entire life cycle. We now have several countries with detailed information in the form of living standard measurement and other surveys. There is a lot of country-by-country variation but the trends are unmistakable.

We know from Deaton and Subramanian (1996), the poorest people—the ones in the bottom decline in terms of per capita expenditure—consume on average slightly less than 1400 calories a day, which is almost half of that recommended by poverty specialists. Women, particularly pregnant women still suffer from under-nourishment, iodine and other deficiencies, and lack of pre-natal care (despite the advances made in maternal mortality and pre-natal care in recent years).

South Korea won its first World Cup match, can it score for development, too?

Ngozi Okonjo-Iweala (left) and Il Sakong (right)

At the same time that red jersey fever was building across Korea ahead of the World Cup, Korean officials were building a strategy to score not just on the soccer field (which resulted in Korea's first ever win against an European team away from home), but also in the development arena, where concerns about poverty, climate change and food security trump worries about all else.

So, let's look back at the policy arena in Busan from June 4-5, where G-20 members called for concerted efforts to narrow the economic gap between emerging and developing countries. They seem to have won some initial ground, since growth-oriented development issues are being included in the Toronto meetings later this month, then at the Seoul Summit in November.

The G20, with Korea as Chair, takes its responsibility of bridging the divide between emerging market G20 members and the rest of the developing world very seriously (just like their fans take football very seriously). Their compelling development story – moving from a relatively low-income country to high-income nation within a generation -- makes them the right nation to get the job done.

The job is to put in place a framework for strong, sustainable and balanced growth made at the G20 in Pittsburgh in September last year.

Reflections on Development Economics After the Crisis

Raj Nallari

We took advantage of the recent ABCDE conference in Stockholm during May 31-June 2, 2010 to hold side discussions with 15 high-profile academics and researchers. We were expecting that they would tell us that economic development thinking should be revisited in the light of the crisis, but surprisingly, the responses were that likely no. Views fell in two broad camps – first, that it is too early to say because the evidence has not yet been fully studied; and second, as far as the poor are concerned, the crisis is a ‘tempest in a tea-cup’ as the bottom 20% of the population living close to the poverty line of $1.25 per day are in ‘perennial’ crisis, are always at risk and vulnerable.

The finer grain of the researchers’ reflections highlighted six main aspects:

(1) Those focusing on extreme poverty alleviation underscored that even before the crisis markets were not working for the poor. The crisis unfortunately furthers highlights this and will probably impede further efforts to fight against poverty. Financial markets were singled out as particularly deficient. It was observed that globalization has widened the income inequality with haves at one end and poverty traps at the other end. Some of our interlocutors went further to say that the bottom 20 percent do not have physical capital/assets to use as a stepping stone, and a solid enough human capital base, and therefore end up being forced to eke out a living relying on natural capital (environmental assets) and social capital precluding any possible accumulation.

Recoupling or Switchover

The current recovery in advanced economies is now exhibiting several signs of fragility. Their medium term growth prospects also look difficult. In this environment two questions arise: Will developing economies experience a renewed downward “recoupling” as a result of a low-growth scenario in advanced economies? Or, on the contrary, could developing countries “switchover” to become locomotives in the global economy, providing a countervailing force against an otherwise slowing-down train? As discussed in my new paper, here are some of the factors pushing in these two opposite directions.

Several factors point to a medium-term reduction of both actual and potential growth in most advanced economies. First, sooner or later fiscal consolidation will become a major issue among advanced economies once—or even before—recovery is fully established. Future fiscal contraction negatively affecting the private sector will be the price paid for the role of fiscal stimulus in helping rescue advanced economies from the brink of the abyss during the crisis.

Secondly, the process of US households’ balance-sheet deleveraging and adjustment is far from complete. Consumption spending growth is likely to remain weak and/or wobbly in the absence of large renewed hikes in asset prices.

A third aspect to weigh against a return to a high-growth path is the likely jobless nature of the current recovery in many high-income countries. Slow-to-reverse shocks—a financial crisis combined with a house price bust, cross-sector differentiated job creation/destruction—have been in play and continued macroeconomic uncertainty is also countering employment growth.

Re-thinking Trade Policy

Trade theory has always been lagging behind reality. From Ricardo ‘s (1817) explanation of trade based on relative productivity/technology differences among nations, it took over a century for Eli Heckscher and Bertil Ohlin (1933) to formalize a model that would explain inter- industry trade patterns based on a countries ’natural resources or factor endowments. It was almost 50 years later that Paul Krugman incorporated scale economies and imperfectly competitive markets to explain intra- industry – the observed phenomenon that countries were trading the same product- for example importing and exporting cars. In the last few years, a new paradigm is evolving that moves away from viewing trade as solely the exchange of final goods to one that incorporates the growing role of global supply chains and the international exchange of tasks or activities- off-shoring. All these theories have implications for optimal trade policy, and policy advice that nations receive from trade economists.

The question is how far is the trade field from the reality frontier? Is there sufficient general equilibrium analyses of trade policy in developing economies? How relevant is policy advice based on current models? This note is not an analysis of whether outward-orientation is valid, but instead offers some new trade and trade policy realties, and identifies some areas where more work is needed to provide policymakers with valuable guidance in thinking about trade integration.

A Primer on Export Diversification: Key Concepts, Theoretical Underpinnings & Empirical Evidence

This new paper provides a basic understanding of: (i) the concepts of Export Development and Export Diversification, (ii) what the theory says about Export Development and Diversification? and (iii) what empirical evidence shows on the links (correlates) between export diversification, exports growth, and overall growth.

The role of export development and diversification in growth in developing countries has received considerable attention in development literature over the last 50 years. During the 1950s, 1960s, and 1970s, and largely influenced by R. Presbish (1950) and H.W. Singer (1950), the prevailing development strategy in many developing countries and particularly in Latin America, Africa and South Asia, was in favor of import substitution and extensive use of restrictive trade polices for economic diversification. In the light of the success of China, India, and the East Asian “Tigers”, this view of economic diversification through import substitution evolved considerably towards export promotion and outward orientation in the 1980s, 1990s, and early 2000s.

Because many developing countries are heavily dependant on commodity exports, making them extremely vulnerable to external shocks, a key challenge confronting policy makers in those countries is that of expanding export revenues, stabilizing export earnings, and upgrading value added in a changing North-South trading structure.

The Role of Cultural Heritage in Poverty Reduction

Notre Dame Cathedral in Paris, France

We economists tend to see well-being, and poverty in particular, as a matter of finances and income. But fortunately, at least in the Bank, we have come a long way from that simplistic view. Reducing poverty is not only about increasing productivity and income. It is about enabling people to have a broad sense of well-being and opportunities to express and make choices about their lives.

As the famous Bank series “Voices of the Poor” and the follow up “Moving Out of Poverty” have shown us, poverty is much more than lacking a steady or sufficient source of income. Being poor is being vulnerable: to crime and violence, to the lack of justice and access to services. Being poor means inability to negotiate, bargain, and get paid. Poverty, in a nutshell, is a kind of decline in social connectedness. So that’s why social solidarity and cultural identity are so relevant to poverty reduction.

One aspect of cultural identity is cultural heritage, an issue that was widely discussed at the 13th Annual International Symposium: Economic Benefits, Social Opportunities, and Challenges of Supporting Cultural Heritage for Sustainable Development, held May 20 – 22 at Word Bank headquarters in Washington DC. The conference, organized jointly with the U.S. National Committee of the International Council on Monuments and Sites, explored fascinating topics –from the contribution of cultural heritage to the development of sustainable communities, to the looting and illicit traffic of cultural treasures.

What Drives Productivity

Productivity is the efficiency in converting inputs to outputs. It is also called TFP (total factor productivity) and measured as a residual – the difference between outputs and a set of inputs (e.g. labor, capital, and intermediate goods, including energy, land and buildings). Measurement problems plague both inputs (e.g. how do you account for quality of labor or capital) and outputs.

To wit, managers with MBAs, flexibility in labor and capital markets, fuel efficiency, relatively higher spending in IT (computers) and R&D, and policies that promote market competition, trade liberalization, deregulation of energy, and encouragement of foreign direct investment that brings in technical progress and leads to learning (catch-up) is shown to contribute to higher productivity. Exporting firms tend to have higher productivity. Inefficient firms can still survive in stable industries where technology is static, and where market competition is limited by a variety of local factors and relationships (e.g. China where the protection is afforded by local governments).

Internal Ventures of the Post-Washington Consensus: ?Only Connect?

The post-Washington Consensus has emerged recently as an umbrella denoting the search for pragmatic and context-specific solutions to problems of developing countries. The recent financial crisis, with its epicenter in the rich economies, has demonstrated that the whole world, not just poor countries, is developing. One feature of the new pragmatism is that industrial policy is back. But in contrast to import substitution, it is an open economy industrial policy – the objective is to increase economic openness: enhance flows of knowledge, foster productive innovation, and promote non-traditional exports. Under rubrics such as productive development policies or innovation strategies, governments in developing countries are providing public inputs, each customized and bundled to suit the needs of particular domains of economic activity, but not others.

How are we responding? One way to understand the World Bank’s role in articulating the post-Washington consensus is to imagine a pyramid. At the top are the ‘thinkers’ of DEC, the Bank’s research and data arm. There are encouraging discussions on new structural economics (Justin Lin), empirical work on new trade theory, and – as one would expect – a new open industrial policy. At the foundation are task managers of lending operations. By being responsive to the needs of the client, but without much fanfare, they are in the forefront of the post-Washington consensus in their dialogue with our most sophisticated and demanding clients such as India, China, Argentina, Mexico, Russia, Malaysia or Chile. A new generation of lending technology and innovation operations is quietly emerging which emphasizes selectivity and focus on a few domains and sectors of the economy deemed strategic rather than the across-the-board focus on innovation climate. Practitioners take the need to make ‘’strategic bets” for granted (‘’the entry costs are high, technology is changing rapidly, one can’t do everything, we need to be selective”), so the issue here is to design private-public institutions to share risks and minimize state capture. New institutions of open industrial policy are being self-discovered on a daily basis, yet there is too little contact between the new theory (‘thinkers’) and cutting edge practice (‘doers’).

Export Development, Diversification, and Competitiveness: How Some Developing Countries Got It Right

A Paper for Discussion

In recent decades, export competitiveness in a changed and increasingly changing world has been at the heart of growth and development debates in almost all countries. Drawing upon the lessons of experience of the most successful exporters in the developing world¹, this paper provides an overview of institutions and policy practices successfully experienced for the expansion and diversification of exports, and the strengthening of industrial competitiveness in some developing countries.

Although exports are important for growth and development, developing countries have been struggling with the challenge of expanding and diversifying their export baskets beyond their primary product bases for a long time. Based on research in recent two decades, it is now well established that, openness to trade and integration into global markets is a central element of successful growth strategies; and higher and sustained economic growth is associated with export growth (Dollar and Kraay (2001).

Against the background of growing disparity in income between the developed and the developing world due in large part to divergence in industrial competitiveness, the central question has always been: what can and should be done in developing countries to boost their export growth, accelerate their export diversification and enhance their competitiveness in international markets? While there is considerable agreement on some of the policy lessons learned from successful exporters of the developing world (need for sound macroeconomic management, appropriate exchange rate and general encouragement to exporters), there is more controversy on the role and usefulness of some other policies and particularly on selective policies targeted to specific activities. However, a look at the experience of the most successful exporters of the developing world that were able to reverse more than a hundred years of sluggish development and achieve unprecedented manufacturing performance, suggests that they may have done something right.

The Perennial Crisis in Governance

What do we learn from the troubles of Goldman Sachs, British Petroleum, Enron, Satyam, and other modern day corporations? These are the most sophisticated corporations ever formed yet victims of their own governance failures.

Public sector governance problems are known from time immemorial. The first description of governance problems of the state in the form of bribery, corruption, and other mis-governance is attributed to Patanjali who lived in India around 53 A.D. Corporate governance problems are relatively recent. With the industrial revolution came the need for a corporation to organize and manage capital and labor. The Board of Directors by law is given the full authority in a corporation. In the initial days of industrialization, the family-owned corporations had family members on its Board. However, over time as the corporations became more complex, the management team of chief executive officers and financial officers have managed to gradually erode the power of the Board and made the Board an ‘overseer.’ This is the problem of principal-agent, where the agent (management team) usurps power from the principal (Board of directors and share holders). Even this function of overseeing has been diluted because of complexity of business transactions and provision of inadequate and often ‘obfuscating’ information by the managers. In addition, more and more Boards are stacked with ‘insiders and friends.’ As a result, we have reached a stage in several ‘big and small’ corporations where there is a crisis in corporate governance. The recent financial crisis is but one manifestation of this corporate crisis, where complexity is deliberately created under the name of financial innovation, just to deliberately obfuscate information to Board of directors, stakeholders and public at large.

Making Inclusive Growth Not Elusive

By Dr. Jayanta Roy

India’s economic performance in the last decade has been stellar. The average GDP growth has been about 9% in the last five years, with the same trend foreseen despite the major global economic upheaval. Inflation is stable, with a slight hiccup of rising food prices. Balance of payments is under control with burgeoning foreign exchange reserves. In IT and ITes, India is a recognized world leader. Most economists and institutional investors are projecting China and India to be the super economic powers by the end of the century, surpassing USA. Some economists are predicting that India will even outpace China in this marathon. There is no doubt that India has arrived.

The downside risk of India’s growth momentum is slim, or non-existent. The successive governments since the launch of the reform have steadfastly followed the development strategy, with innovative mid-course corrections when needed. The IMF has applauded the strong rebound of the Indian economy well ahead of other countries from the recent global financial crisis. Although, a few second generation economic reforms need to be implemented, Indian economy is on cruise control mode for high sustained growth. It makes little sense to play with small differences—9% versus 10%—as GDP growth targets. Economists have convincingly argued that high GDP growth in India will be sustained. But it is the quality of growth which is in question.

Managing Bubbles

In 21 industrial economies during 1970-2008, there have been about 47 housing price busts and about 90 stock price collapses. Sometimes they both overlapped, other times not. There is now concern that stock markets in Emerging Markets have expanded rather rapidly since their lows at end-2008. There are worries that the fiscal stimulus packages and monetary easing policies that we put in during the crisis months of October 2008 to June 2009 may have sowed the seeds of the next bubble as private sector credit has increased sharply in several emerging economies.

In several of these episodes of busts, in the run up to the asset price bubbles, there has been a rapid growth in the credit. In the recent crisis, not only in the industrial economies but also in the emerging economies, particularly Emerging Europe, housing prices rose sharply in the run up to the crisis and were often associated with a rapid credit growth resulting in an escalation of household leverage and debt. So asset price rises were accommodated by credit booms. In turn, the credit booms were associated by an increase in capital inflows. Credit booms, in turn, drive increases in housing prices and/or stock prices, and/or exchange rates. There is therefore a feedback loop, that fuels increased household and financial firms’ leverage, and lowering of lending standards (as reflected in the sub-prime loans in the United States). The longer the credit boom goes on the higher the probability that it will end up in a financial crisis.

Paul Collier and his Plundering Planet: When Both Economists and Environmentalists Don?t Get it Right

Do you remember The Bottom Billion, Paul Collier’s 2007 book which became a classic? If you do, you will certainly like his latest work, The Plundered Planet. He came to launch his new book to the Bank this week, and I found it both fascinating and provocative. Let me give some examples of why.

Professor Collier, now the Director of the Centre for the Study of African Economies at Oxford University, declares a two-front war on economists and environmentalists at the same time. He is against what he calls “utilitarian economists,” because if left on their own, they would end up plundering the planet. But Collier also takes on “romantic environmentalists,” who would be unable to eradicate hunger in case they’re given the chance to rule the world. So as you can see, the book’s premises don’t really fit into the script of the blockbuster, Oscar-winning movie Avatar.

For Collier, who also worked as the Bank’s Research Director some years ago, Nature is the lifeline for the countries of the bottom billion – and thus cannot remain untouched. With a strong faith in the power of well-informed ordinary citizens, Collier proposes a series of international standards that would help poor countries rich in natural assets better manage those resources. Technology, which enlarges the capacity of ordinary citizens, is also necessary to turn Nature into assets. But of course, in order to be effective and benefit the bottom billion instead of just the few at the top, regulation, which requires governance, is another seminal element of the equation to create prosperity. If you leave regulation out of the equation, as some Libertarians do, the result is nature plundered. But if you end up with too much regulation – curbing the use of Nature – and thus preventing technology, then the result is hunger. And I’m certainly not one of those radical, romantic environmentalists who can imagine a bottom billion who is hungry but happy.

The Service Revolution

by Ejaz Ghani

China and India are both racing ahead economically. But the manner in which they are growing is dramatically different. Whereas China is a formidable exporter of manufactured goods, India has acquired a global reputation for exporting modern services. Indeed, India has leapfrogged over the manufacturing sector, going straight from agriculture into services.

The differences in the two countries’ growth patterns are striking, and raise significant questions for development economists. Can service be as dynamic as manufacturing? Can late-comers to development take advantage of the increasing globalization of the service sector? Can services be a driver of sustained growth, job creation, and poverty reduction?

Some facts are worth examining. The relative size of the service sector in India, given the country’s state of development, is much bigger than it is in China. Despite being a low-income region, India and other South Asian countries have adopted the growth patterns of middle- to high-income countries. Their growth patterns more closely resemble those of Ireland and Israel than those of China and Malaysia.

India’s growth pattern is remarkable because it contradicts a seemingly iron law of development that has held true for almost 200 years, since the start of the Industrial Revolution. According to this “law” – which is now conventional wisdom – industrialization is the only route to rapid economic development for developing countries.

Re-thinking Fiscal Multipliers

Keynes is best known for suggesting fiscal stimulus policies and programs to increase aggregate demand to get out of a deep recession. Since the marginal propensity to consume is positive and less than one; the bigger it is, the larger the fiscal multipliers will be and the faster we will get out of a recession. Conventional Keynesian multipliers are meant for closed economies (no leakages from demand through imports and the effect of the fiscal expansion on the exchange rate further reduced multiplier) and do not consider the total debt position of the country. More generally, the fiscal multipliers of an expansionary fiscal policy will be bigger if the leakages are minimized, an accommodative monetary policy is implemented, and the fiscal position of the country is sustainable after the initial change in fiscal policy. Historically, multipliers on government spending are estimated to be in the range of 1.5 to 2, while tax-cut multipliers can be much smaller, say 0.5 to 1.

But the world is a drastically changed place, particularly during this global crisis, ant the various multipliers are likely to be much smaller because of leakages in a globalized world in the form of higher imports from rest of the world. Also, the various multipliers may work at cross purposes and the cumulative effect may be much smaller as shown in Vegh et al. (2009). The full effect of fiscal policy multipliers in the first round is smaller in models that incorporate a sensitivity of the private investment to the interest rate. Public investment might crowd-out private investment in implementation of fiscal stimulus packages. The crowding-out is the result of an expansionary fiscal policy causing the interest rates to increase and thereby reducing the private investment as financing becomes expensive.

Re-thinking Economic Policy: An Overview

The global financial and economic crisis of 2008 has brought an urgency to focus on shorter-term policy issues related to managing bubbles, analyzing current development paradigms, and drawing out policy lessons for future action, particularly lessons learned during the past two years. At the same, longer-term development challenges also must be addressed to avoid the mistakes of 1970s and 1980s when managing stabilization issues dominated economic policy making and development economics was pushed aside for a while. For example, with the exception of East Asian countries and more recently India, why are African, Eastern European and Central Asian, and other South Asian countries unable to sustain high growth rates for more than five to seven years? What are the policy implications of demographic changes and climate change? There is a need for policy discussion on frontier topics such as rethinking globalization in trade, finance, and labor; new economic geography; green growth; and inclusive, balanced, and sustainable growth.

The 15th-century Florentine Niccolo Machiavelli is said to be the first to state, “Never waste the opportunities offered by a good crisis.” During a crisis, countries experiment with policies and learn a lot in a hurry. This overview shares this learning on early policy responses to the current economic crisis, focusing particularly on specific issues that are of interest to policy makers and practitioners in the developing countries. The overview is a compilation of notes that staff members of the World Bank Institute have used during global dialogues and international seminars and conferences since October 2008.

What brought the world to the edge of an abyss in September 2008? After quickly recovering from the Asian crisis of 1997-98, world economic growth accelerated during the period 2000-07. However, in hindsight, there was a ‘perfect storm’ in the making as US and European housing defaults began to pile up beginning in late 2006, oil prices doubled in a few months during late 2007 and early 2008, while rice, wheat, and corn prices jumped by 40-50% during the same period.

Conditional Individual Bailouts - a Potential Anti-crisis Instrument

by Rebekka E. Grun

Why save the banks, and not their clients?

The current financial crisis is not the first for economists or central bankers. What was relatively new though is that many proven tools do not seem to work. Monetary impulses, liquidity – for a long time the market did not seem to take notice. Fiscal impulse, stimulus packages and bank bailouts – little success in most places. Increasing the dose – ditto. Maybe it is time to step back and acknowledge this crisis as different, to examine it for specific causes and tailor a new tool.

The root cause of the crisis is known; financially semi-literate clients were talked into mortgages they did not understand and resulted a bigger bite than they could chew. This happened to an extent that generated a crash wave big enough to shake more than one national banking sector.

Why now does the discussion on remedies not focus on this cause? Why not save the individuals that went bust rather than their banks? Unconditional bailouts, of course, would generate the wrong incentives (for the banks as well, by the way). It is therefore important to attach smart conditions to discourage free riding. For example a course in financial literacy and commitment to a program of (maybe painful) debt restructuring, and possibly further measures to improve the education or health of the affected individual or family.

Have Institutions Failed Us?

Institutions matter was the oft chanted mantra for the past fifteen years. We were told that in the presence of social conflict between various groups, between haves and have-nots, political power precedes political institutions, economic institutions and economic policies. But, political power could be de jure (due to constitution, fair elections and smooth transition to political power) or de facto such as dictatorships and authoritarian leaders usurping power by coups and violence. Sixteenth century colonialism established ‘settler’ and ‘exploitative’ institutions depending on the then existing ‘climate’ in the colonized countries. For example, if the climate was unbearable and malaria-stricken, the colonial masters established an exploitative relationship of shipping out natural resources. If the climate was hospitable, they settled in with family in these countries and started administration and other institutions.

More recently good institutions were supposed to emerge when only de jure political power is in place. Also, a political and legal system that places constraints on elites is often conducive for better institutions. Following this logic, institutional economists have reasoned that advanced economies with de jure democratic political institutions have smooth transition, predictability and place constraints on elites and abuse of political power, and have strong institutions that ensure a system of checks on the executive, law and order, property rights, etc. The theory of institutions is that bad policy outcomes are the result of bad institutions and these are common in developing countries, where the distribution of political power needs to be reformed and deeper causes need to be strengthened. Others have argued that market-oriented institutions are important for economic policy management. By this categorization, advanced economies had better institutions that led to sound economic performance and consistently higher economic outcomes.

Brazil Announces Phase Two of the Growth Acceleration Program

(All credits go to SECOM for this information)

President Luiz Inácio Lula da Silva announces US$ 526 billion in public and private investments over 2011-2014

Yesterday, Brazil launched phase two of the Growth Acceleration Program (PAC 2), announcing estimated investments of US$ 526 billion (R$ 958.9 billion) for the period from 2011 to 2014. PAC 2 includes new investment projects for the periods 2011 to 2014 and post-2014, as well as projects initiated during PAC 1 with activities that will conclude after 2010. For the period following 2014, the estimated investment is US$ 346.4 billion (R$ 631.6 billion). The two periods combined reach an amount of US$ 872.3 billion (R$ 1.59 trillion).

PAC is a strategic investment program that combines management initiatives and public works. In its first phase, launched in 2007, the program called for investments of US$ 349 billion (R$ 638 billion), of which 63.3% has been applied.

Similar to the first phase of the program, PAC 2 focuses on investments in the areas of logistics, energy and social development, organized under six major initiatives: Better Cities (urban infrastructure); Bringing Citizenship to the Community (safety and social inclusion); My House, My Life (housing); Water and Light for All (sanitation and access to electricity); Energy (renewable energy, oil and gas); and Transportation (highways, railways, airports).

“I consider PAC 2 as a portfolio of projects that the next administration can build from rather than starting from scratch, as there is no time to lose,” said President Luiz Inácio Lula da Silva during the announcement of the program.

PAC 2 Initiative in Detail...

Re-regulating the Financial Sector

The financial system, measured by assets, profits, contribution to GDP, stock market capitalization, employment etc, has expanded rapidly since 1990. For example, global financial assets were about 50 trillion in 1989 and increased to about 200 trillion by 2007, during the same period financial depth increased from 200% of world GDP to 400% in 2007. The financial crisis has raised a plethora of issues, many of which are inter-twined. There have been failures on all fronts – market failures in the form of financial firms innovating new instruments while neglecting risk management practices, credit rating agencies failing in rating assets without much thought to risk, private auditors not checking Lehman Brothers’ assets and liabilities, government failures in the form of central bank keeping interest rates low in the run up to the crisis, and government entities such as Fannie and Freddie involved in mortgage lending and making enormous losses, and failure by regulators for not checking the books of financial firms such as Lehman Brothers that were moving toxic assets of the balance sheets, and last but least the financial economists who failed to foresee to crisis. There is plenty of blame to go around but one thing is clear: State ownership of financial firms is back. After decades of rising foreign ownership of banks (shrinking state ownership) in almost all regions, except the Middle East and South Asia, the trend could be reversed especially in the developed countries.

The crisis has shifted focus from foreign private ownership to some state ownership, from micro to macro prudential regulations, to re-assessment of deposit insurance, lender of last resort, and implicit guarantees, to consumer protection and taxpayer protection, from mark to market accounting to mark to funding, to revamping of credit rating agencies, to crisis in corporate governance and questioning of remuneration in financial firms, and to strengthening of supervision. These and a number of related issues of interest to policy makers are discussed below.

Given the large set of issues arising from the crisis, the major challenges facing countries are essentially two: (i) Government entities which are subsidizing directed credit (e.g. Frannie and Freddie in USA; similar type of ‘chaebol’ lending to industrial firms triggered the Asian crisis of 1997); and (ii) universality of too big to fail entities, where systemic important firms, often politically powerful conglomerates that are controlled by elites, have to be bailed out, which in turn leads to the moral hazard problem, where the large entity is considered worthy saving at all costs, including use of lender of last resort facilities from the Central Bank and tax payers money from the Treasury. The too big to fail entities also then knowingly max-out on leveraged lending (40 to one in case of USA) and ‘gamble’ on financially innovative instruments (e.g. mortgage-backed securities and credit default swaps in case of USA). The large entities also have the political clout to suppress regulations and/or evade regulations. Successful regulation requires that the regulator should have information on exposure to systemic risks. Too big to fail institutions were exposed to CD swaps (e.g. AIG in USA) and we knew little about its exposure. The reason is that there is data on a firm by firm but there is no agency that can put it all together. But policy makers and politicians are reluctant to address these two problems head on. Instead the focus on a large set of problems, as detailed below, and obfuscate the issues.

The Power of How

What exactly do we mean by Capacity Development?

The United Nations Development Programme (UNDP) and Stichting Nederlandse Vrijwilligers (SNV Netherlands) redefine the concept through this creative new video. Enjoy!

Please visit the Power of How to learn more on this capacity development initiative.

Conflict as Addiction: One Divided Society Helping Another

Addicts are known to be narcissic – they tend to think that their affliction is unique and cannot possibly be compared to anyone else. Long-standing conflict can be usefully understood as an addiction – or so was a claim made by the recent seminar’s core speaker Padraig O'Malley, the John Joseph Moakley Distinguished Professor of International Peace and Reconciliation, University of Massachusetts, a former addict himself. Just like addiction, long-standing conflict is a form of insanity and recognition (which often comes as an epiphany) that the party you are in conflict with is very much the same as you are – is a first step to recovery.

With funding from the Ireland Funds, Padraig brought the warring factions of the Irish conflict to South Africa for a week-long deliberation with Nelson Mandela and his team. The two factions weren’t flying on the same plane, wouldn’t sit on the same table and wouldn’t come together within a half a kilometer for fear of “contamination”. Predictably, the logistics of accommodating the two sides in South Africa was quite a project, which was falling apart continuously, because, say, the size of beer bar in one faction’s hotel appeared to be larger than in the other. The trip to South Africa and the dialogue there helped to open a line of indirect negotiations between the Irish fractions, effectively supported by their South African hosts, which ultimately brought about the peace agreement.

Deadline TODAY: International Essay Competition 2010 on Youth Unemployment

Hurry in and submit your entries for the 2010 International Essay Competition on the topic of "Youth Unemployment", organized by the World Bank and partners.

Finalists will be announced on April 30, 2010.

Winning essays from the 2009 Competition can be found here.

Re-visiting Exchange Rate Regimes

The choice of exchange rate regimes by governments has evolved since the 1990s. In the early 1990s, as transition economies joined the world economy, they pegged to the Deutsche Mark, while the East Asian countries were pegged to the US dollar. The Mexican crisis of 1995, The East Asian crisis of 1997-98, the Russian Ruble crisis and the collapse of Long Term Capital Management both in 1998 revealed that the capital account crises in these countries was the result of a sudden stop or reversal in capital inflows. This brought about the vulnerability of countries with fixed exchange rate regimes.

By 1999, the re-thinking was hard pegs such as the currency board in Argentina (where peso was pegged to US dollar in a one to one basis) or a monetary union were better suited netter for exhibit commitment and discipline among some countries where credibility was historically low. At the other extreme, Asian countries where the macroeconomic fundamentals were strong both before and after the 1997 Crisis, were advised to move to a freely floating exchange rate regimes as the world became more and more integrated into a global economy. So in practice a bipolar exchange rate arrangement was in place in the developing world.

Calvo and Reinhart showed that emerging economies are in fear of floating and de facto maintain a 'managed float.' The fear arises from the fact the when the value of local currency declines significantly the government is worried about imported inflation and balance sheet effects of foreign currency borrowing (both by private and public sectors) as the costs of debt service go up. On the other hand, when the value of local currency rises there is a loss of competitiveness and hence lowers growth.