Former Botswana President Mogae wins the Mo Ibrahim prize

Former Botswana President Festus Mogae was awarded the Mo Ibrahim Prize for Achievement in African leadership, which is also the world’s largest individual award with a price tag of $5 million (the Nobel prize is $1.4 million). This prize is awarded annually to a former African executive Head of State or Government who has demonstrated excellence in African leadership. All this to promote good governance, one of the main factors lacking in Africa!

Key facts about Mogae’s leadership:

- Mogae served two terms in office, nearly 10 years, before handing over to Seretse Khama Ian Khama in a peaceful transition in April 2008. Before that he was vice president for six years.

- He studied economics in Britain, before becoming a civil servant in Botswana. He has held roles at the International Monetary Fund and Bank of Botswana.

- Botswana's GDP per capita is the highest in sub-Saharan Africa, and the country is ranked the continent's least corrupt by Transparency International.

Mo Ibrahim is a Sudanese-born telecommunication tycoon who is the founder of Celtel International, one of Africa’s most successful private companies. He believes that good governance requires an environment conducive to peace, security, and development, based on the rule of law and respect for human rights.

The (limited) impact of foreign investment in the Americas

It is expected that the level of foreign investment has a direct positive relationship with stimulation of investment and hence the economy in a given investment-deficient country. Actually, in reality this depends on whether FDI acts as a complement (crowd in) or substitute (crowd out) to the level of domestic investment in an economy. (more below)

A study (Foreign Investment and Sustainable Development: Lessons from the Americas) by the Working Group on Development and the Environment in the Americas finds that foreign investment has fallen short of stimulating “broad-based” economic growth and sustainable development in Latin America. The working group studies the impact of foreign investment on economic growth, environment policy, and the political economy of Argentina, Brazil, Bolivia, Chile, Costa Rica, Ecuador, Mexico, Uruguay, and Venezuela.

They studied various regional and bilateral agreements like NAFTA, US-Chile FTA, CAFTA, US-Peru FTA, etc and looked at the impact of investment liberalization (a part of the Washington Consensus) on the Americas. What did they find? This wave of liberalization that started in the 1990s did not produce significant results as was expected. Economic growth in per capita terms in the region was slower than in the final decades of the import substitution period, according to the report.

Major findings of the report:

• 80% of all the FDI was concentrated in Brazil, Argentina, Chile, and Venezuela.
• Foreign firms in Mexico were export platforms to the US and those in the South America tended to sell in their own domestic market.
• Foreign firms tended to have higher level of productivity and higher wages.
• FDI fell short of generating spillovers and backward linkages that could help stimulation of domestic economy through emergence of local small and medium sized businesses. In fact, FDI tended to displace and kill local businesses. R&D expenditures in the host economies were not upped.
• Environmental performance of foreign firms was mixed, sometime better and sometimes worse performance than domestic counterparts.

Note that the report does not label that the FDI’s impact on economic growth and environmental sustainability was a complete flop- it had a limited success in Latin American countries. There are cases where FDI has been a crucial factor behind rising economic growth like in China, South Korea, Bhutan, Taiwan, Malaysia, Singapore, and Mauritius, among others. The report slides in a space where there is always a trade off between growth objectives and impact on environment arising from increasing investment (both domestic and FDI). Cost is always high when considering the impact of an investment plan in an environmentally conscious manner.

Important lessons from the Latin American experience:

• FDI is not an end but a means to sustainable development. Simply attracting FDI is not enough to generate economic growth in an environmentally sustainable manner.
• FDI policy needs to be paired with significant and targeted domestic policies that upgrade the capabilities of national firms and provide a benchmark of environmental protection.
• There needs to be policy space to accommodate domestic concerns in international agreements.

One of the lessons from the report is that FDI does not necessarily crowd in domestic investment. Actually, the impact of FDI on domestic investment is mixed. In Latin America, FDI has in crowed out domestic investment, as shown by this report, but in Asia (East Asia especially) and Africa, FDI has led to crowding in of domestic investment. FDI tend to be a substitute for domestic investment when there are lot of domestic firms. Meanwhile, FDI tend to be complementary when there are few domestic firms (whole sorts ancillary firms will emerge because of R&D and knowledge spillovers from MNCs). The existence of backward and forward linkages from the establishment of foreign investors is a key consideration for determining the total impact of FDI on capital formation.

Background working papers leading to the report are available here.

Roads, growth, and development

After reading my latest op-ed, some readers emailed me interesting (and positive) remarks. The piece was about Krugman and application of his New Economic Geography theory in the context of Nepal. Towards the end of the op-ed, I tried to draw in some policy implications and said that for development and poverty reduction, the government should try to induce spread of industries from "core" to "periphery". And, one important step in this direction would be to build, build, and build roads (I mean transportation services). It means high public expenditure and an activist policy. I also suggested the way in which the private sector can be engaged in this effort. Okay!

Today, Shailee Pradhan published an op-ed arguing that "the creation of roads does not always lead to development and prosperity". To be frank, this was the subtitle. The main title was: Road to development. It is up to the readers to judge how contradictory the main title and the subtitle of the op-ed is!

High transportation costs have led to industries clustering in select few locations, creating an uneven development process. The difference between the urbanised "core" and the lesser developed "periphery" is troubling. While the question of how to ensure the formation of such cores in the villages is an important one, it is first necessary to ask where to encourage such cores and what sectors to specialise in.

...However, it is critical to plan where to build roads by identifying and prioritising key areas based on the population and their needs. How important was it to build the road to Jomsom? With a population of less than 10,000, Mustang district (Jomsom is the district-headquarters) is sparsely populated. Mustang is not a high food-producing area either, except for apples of which only about 20,000 tons are produced annually.

Furthermore, the ecosystem around the Annapurna Circuit is very fragile as these are young mountains made of sedimentary rocks. The road construction process involving heavy blasting as well as the additional traffic flowing in now have put serious pressure on the ecosystem and the biodiversity here.

...It is necessary to diversify "cores" for a more even development, but building roads and creating industries is not the only way to diversify such cores. Where the costs of building roads, monetary and environmental, are extremely high, alternative modes of transportation such as cable cars and airplanes should be considered.

Let me take on some of the issues. I agree that there is some form of trade-off between building roads and environment. Also, there is no doubt that health of ecosystem and negative externalities should be kept in mind before building roads. Period.

Regarding this op-ed, I have two points to say: (i) the concept of "core" and "periphery" is primarily related to the nature of location or clustering of industries in one location, (ii) industries tend to cluster around locations where there is relatively easy availability of backward and forward linkages, where there is potential consumer, and where there is low transportation costs. With this, this process is self-sustaining (some form of endogenity will come into play).

To induce spread of industries in other places except in few industrial hubs only, I argued for government intervention to create necessary conditions (one of them to build roads) to decrease transportation costs. This was in context of explaining the theory I was discussing about. It is not possible to have "cores" in an area like Jomsom, where per capita purchasing power is very low and the population itself is not considered to be worthy of generating enough effective demand to fend off associated costs of establishing new industries. By arguing for activist policies to induce spread of industries, I meant to focus on building roads in places where the two conditions discussed above are satisfied.

Yes, there are places like Syangja, Palpa, Butwal, Baglung, etc. where the two conditions are fairly fulfilled. Obviously, this also means that Mustang is out of consideration. Moreover, I not only argued for building roads. Where it is not feasible, it is fruitful to build other means of transportation like cable car, airports, and railways. In places like Jomsom, these means of transportation can only link the outlier districts with the urban places. Except for railways (which is not feasible due to budget constraints and topographical issues), the other two modes of transportation will not decrease transportation costs. It will, in fact, increase the cost of production. Furthermore, road construction project should not be carried out if the marginal cost of making it is higher than the private cost.

Roads are one of the most effective means to link production site to markets  and vice versa. This is actually one of the necessary conditions for long term economic growth. This is essential both for economic growth and long term development. And yes, it can be done in a sustainable fashion.

Ubiquitous Keynes

Keynesianism is in high demand! Come crisis the markets cannot deal with, bank on Keynes, whose life’s mission was “to save capitalism from itself”. Could not agree more!! Even Hayek described him as “the one really great man I ever knew, and for whom I had unbounded admiration”. Here is a nice piece from the FT.

As the world reels from a 1929-style stock market plunge and a 1931-style banking crisis, his words are a fair assessment of the dangers we face once again. Keynes, whose life’s mission was to save capitalism from itself, is more relevant than at any time since his death in 1946.

His renewed influence can be seen everywhere: in Barack Obama’s planned stimulus package, for example. When George W. Bush said his administration’s plan to take equity in banks was “not intended to take over the free market, but to preserve it”, he could have been quoting Keynes directly.

The heart of the book [The General Theory of Employment, Interest and Money, 1936] is the idea that economic downturns are not necessarily self-correcting. Classical economics held that business cycles were unavoidable and that peaks and troughs would pass. Keynes contended that in certain circumstances economies could get stuck. If individuals and businesses try to save more, they will cut the incomes of other individuals and businesses, which will in turn cut their spending. The result can be a downward spiral that will not turn up again without outside intervention.

That is where government comes in: to pump money back into the economy by some means, such as spending on public works, to persuade individuals and businesses to save less and spend more themselves.

Markets are either imperfect or heavily distorted or agents lack incentives or there are rampant failures (or all) in the developing countries. So, the need of Keynesian approach is ever increasing. Remember that the fantasy to institute markets in a place where there was no foundation for it to take place, usually Africa, in the 80s and 90s did not lead to progress in growth and development (also, the number of conflicts at a given point of time did not decrease). What is needed is not austerity but a sensible application of Keynesian approach so that while aggregate demand and economy are stimulated, the market incentives are not tempered as well. The market and government can be complements and save each other from going down. There is no more for one and less for the other. It depends on contexts and circumstances individual countries are in. There are some sectors where letting markets loose bring wonders but there are also some sectors where markets cannot simply work or even if they work, they work for a select few. Government can help create an unsuitable place for market into a suitable place by sharing risks, building perquisites for the markets to function properly, instituting good governance, providing productivity enhancing subsidies, etc.—there are a whole slew of demand management techniques to follow (sensibly).

That being said, there should be no room for failed Marxist ideology. China has already experienced it. So has Vietnam. Now, Nepal (where Maoists party run the government…yes, they were elected by the people) should follow suit rather than getting bogged down on sloppy socialist slogans. Keynesianism is neither socialism nor Marxism. It is a complementary buddy of the market!

A nice description of Keynes:

He was an imposing figure, six feet, six inches tall and full of jokes, gossip and sharp observations. Alongside economics, he had an array of other interests as mathematician, administrator, academic, investor, journalist, art collector, politician, impresario and diplomat. He was even an exemplary husband, devoted to his wife, Lydia Lopokova, a ballerina. In his language he could be carelessly provocative. But, as he said: “Words ought to be a little wild, for they are the assaults of thoughts on the unthinking.”

When bad policies were making economic problems worse, he felt a moral obligation to change them. He worked with distinction at the Treasury during the first world war and at the war’s end argued presciently against the imposition of excessively harsh conditions on Germany. When his advice was ignored, he left and published his views in his first great polemic, The Economic Consequences of the Peace .

Here is a full text link to Keynes’ masterpiece: The General Theory of Employment, Interest, and Monetary Theory. Downloadable version of The Economic Consequences of The Peace. More about Keynes and the current financial crisis here.

Keynes, Keynes, Keynes…

Krugman argues that there is not much the Federal Reserve can do right now because despite repeated interest rate cuts, unemployment is rising and credit market is still tight. So, way out of rising unemployment is to go by the Keynesian rules, i.e. in the face of ineffective monetary policies, use fiscal policies to stimulate aggregate demand by public investment in infrastructure, unemployment benefits, and emergency aid. With this comes deficit, which Krugman says can be forgotten for now.

In other words, there’s not much Ben Bernanke can do for the economy. He can and should cut interest rates even more — but nobody expects this to do more than provide a slight economic boost.

On the other hand, there’s a lot the federal government can do for the economy. It can provide extended benefits to the unemployed, which will both help distressed families cope and put money in the hands of people likely to spend it. It can provide emergency aid to state and local governments, so that they aren’t forced into steep spending cuts that both degrade public services and destroy jobs. It can buy up mortgages (but not at face value, as John McCain has proposed) and restructure the terms to help families stay in their homes.

And this is also a good time to engage in some serious infrastructure spending, which the country badly needs in any case. The usual argument against public works as economic stimulus is that they take too long: by the time you get around to repairing that bridge and upgrading that rail line, the slump is over and the stimulus isn’t needed. Well, that argument has no force now, since the chances that this slump will be over anytime soon are virtually nil. So let’s get those projects rolling.

Here is similar call for Keynes by Jayati Ghosh. Here is Keynes and the Crisis by Axel Leijonhufvud.

Bhagwati on the financial mess

Jagdish Bhagwati calls for a truly independent commission of experts to scrutinize each financial innovation’s potential downside. He terms the back-and-forth appointment of bigwigs from the Wall Sts to Treasury department and then again to the Wall Sts a “Wall Street-Treasury Complex”. Nice naming there!

When the dust has settled, we must ask the question: why did this crisis occur? There are specifics that are not applicable everywhere. The crisis was, for example, kicked off by highly leveraged lending for uncreditworthy mortgages by the quasi-governmental Freddie Mac and Fannie Mae. But the problems became huge because “policy innovations” had been racing ahead of comprehension. The securitisation of mortgages was an innovation that led unwittingly to what Wall Street calls “betting the company”. Credit-default swaps allowed AIG to bring in huge returns but at high risk if things went wrong, which they did.

The Long Term Capital Management crisis had a similar problem. At its heart were derivatives that no one quite understood. …The downside had not been anticipated.

The failure to think about the downside results from what I call the “Wall Street-Treasury Complex”. Robert Rubin went from Goldman Sachs to the Treasury and back to Citigroup. Hank Paulson went from Goldman Sachs to the Treasury and will doubtless return also to Wall Street. This network shares the optimistic scenarios that Wall Street spins. Mr Rubin was in charge of the Treasury during the Asian financial crisis, whereas Mr Paulson was among the five major investment banking chief executives who persuaded the Securities and Exchange Commission not to extend prudential reserve requirements to their companies.

The question is: how can you assess the downsides without first letting the innovation play into real economy? If something is an innovation, then it is a new thing, which essentially means that even the innovator is not fully aware of its full potential or risks or downsides. The innovator can argue that the innovation will work by showing high degree of success (i.e. the probability of success might be pretty high). But this itself is not fully guaranteed because no one can test innovation against unexpected circumstances or yet-to-be-known risks. The best way to assessing downsides of an innovation would be to periodically review its impact on the economy—this means that you cannot test an innovation beforehand because you don’t know the set of circumstances under which it will not work (the innovator might have an idea of the set of circumstances where it can work, but he or she cannot list the full elements of the set). But having a regulatory authority that can assess risks beforehand is a good idea. We are yet to have one of these things in the world! Anyway, thats it for now. Its getting too late. Time to go to bed!

Nice sentences about a good economist

Sourced from The Economist:

In neither contribution did Mr Krugman claim great originality for his ideas or great realism. His achievement was to formalise insights that many people had previously had informally. Ideas that had fluttered in and out of people’s grasp for decades, he pinned down like a butterfly on display. Sometimes a good economist, like a good columnist, succeeds not by making a point before everyone else, but by making it better than anyone else.