Small and targeted unconditional transfers in India

Dutta, Howes and Murgai argue that unconditional cash transfers for the elderly and widows (pension schemes) in Karnataka and Rajasthan worked due to small size and relatively low level of leakage. Regarding scaling-up of the project, the authors caution that the outcome would depend on the likely impact of increased coverage on both targeting and leakage. They argue that increased coverage would most likely worsen targeting. Currently, leakages are low because levels of discretion are low. As program expands, avenues for leakages (bribes, diversion of funds) will be higher.

If the program is to be expanded, then the authors suggest:

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In the short term, the way forward  would be to expand the coverage among widows and the  elderly and to increase the size of the pension. This is a path  the Government of India has already embarked upon. In the  longer term, the policy question is whether it makes a sense to  expand the categories to whom social pensions are given.

Ultimately, one can imagine a situation in which, say, cash pensions are made to every holder of a BPL card, instead of, or as well as, an entitlement to buy subsidised food and/or to a guarantee to a minimum number of days of public employment.  With the National Right to Employment Guarantee Act, and the  decision of the government to support a Right to Food Act such  a scenario is far-fetched today. Moreover, as stressed above, little is known about how cash transfers would perform if scaled  up. Nevertheless, it is reassuring to know that calls for a greater  role in Indian social security policy for cash transfers are at  least not contradicted by the performance of India’s existing  cash transfers.

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How developed countries can boost LDCs’ exports

Adapted from Katriin Elborgh-Woytek and Robert Gergory’s piece in the latest edition of IMF’s Finance & Development magazine.

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There are steps the poorest economies themselves could take to boost exports—such as reducing the often prevailing antitrade bias in their trade, tax, customs, and exchange rate regimes; issuing more transparent trade and customs regulations; and taking steps to improve such key service sectors as communications and transportation (see World Bank, 2010).

But the poorest exporting economies would benefit considerably if emerging as well as advanced economies gave them better opportunities for trade, which would improve their growth and productivity prospects (see Elborgh-Woytek, Gregory, and McDonald, 2010). There are a number of steps better-off countries could take to boost poor economies’ export potential. Some of them are well known to policymakers—in particular, concluding the current World Trade Organization (WTO) trade-negotiation talks, known as the Doha Round. Wide-ranging multilateral trade liberalization could spur growth and foster secure and open global trading. Poorer countries would gain from successful Doha Round conclusion through better access to advanced and emerging export markets.

Although broad-based multilateral trade liberalization is the ultimate policy target, there are less-obvious intermediate avenues—such as the extension and improvement of duty-free and quota-free (DFQF) trade preferences both by advanced and emerging economies—that could add nearly $10 billion a year to the coffers of poorer economies. These preference systems are designed to offset for the poorest countries some of the high trade barriers in sectors such as light manufacturing and agriculture—areas in which LDCs are likely to export.

There are three main avenues for the more advanced and emerging economies to help integrate LDCs into the global economy:

• Remove all tariffs and quotas on products from LDCs.
• Make the rules that determine whether a product is deemed to originate from an LDC more flexible and consistent—including relaxing so-called cumulation rules, which govern the extent to which inputs from other countries affect compliance with rule-of-origin requirements for LDC exporters.
• Tilt preference benefits more specifically toward poorer economies.

If all exports from developing countries were exempt from tariffs and quotas, LDC exports to both advanced and emerging markets would grow significantly—on the order of $10 billion a year, or about 2 percent of their combined GDP (Laborde, 2008; and Bouët and others, 2010). Broadening the coverage of preferences by major advanced markets could generate increased exports from LDCs of about $2.2 billion a year, or about 6 percent of net official development assistance from industrial countries to LDCs. The potential increase is even larger for exports to emerging markets—about $7 billion a year in additional exports (Bouët and others, 2010). Although the positive impact on LDCs would be sizable, the negative effect on advanced and emerging economies would be tiny because of the low level of LDC exports.

Second, if better-off economies were to make rules of origin more flexible, LDCs would benefit too. Rules of origin determine whether a good “originates” in a country that benefits from a preference system. The rules specify the minimum amount of economic activity that must be undertaken in the country benefiting from the preference and whether inputs from other countries count toward this minimum. Rules of origin differ widely across countries’ preference programs. They are frequently based on the amount of value added in the preference-eligible country or on the transformation a good undergoes in that country (measured by a change in tariff classification). These rules strongly influence where an LDC buys its inputs, which affects the overall economic consequences of a preference program.

To qualify for a preference program, LDC exporters must often limit input sourcing to suppliers in their own country or those from the country granting the preference—even if it would be cheaper to buy inputs elsewhere. This can be difficult for less-diversified LDCs, which depend on intermediate goods, processes, or patents from other countries. Rules of origin can also be a source of distortion, if exporters turn to less-efficient, more costly input sources to qualify for preferences. Moreover, the administrative burden of meeting complex rules of origin can be substantial, costing as much as 3 percent of export value (Hoekman and Özden, 2005). As a result, perhaps a quarter to a third of eligible imports do not gain preference, and some trade that might have benefited from better-designed preferences is likely never undertaken.

More liberal rules of origin allow producers to source inputs flexibly. Such rules implicitly acknowledge LDCs’ low capital intensity and lack of horizontal or vertical integration. Under China’s preference program, for example, origin (and thus preference benefits) can be conferred on a product based either on a minimum local value-added threshold or a change in tariff classification—implicit acknowledgment that the product is different and the LDC has added value. India’s low 30 percent value-added threshold gives potential LDC exporters flexibility in sourcing their inputs.

Moreover, better-off countries could make it even easier to stimulate trade among LDCs if their rules of origin specifically allowed preference-eligible countries to buy inputs from other preference-eligible countries. If these so-called cumulation provisions allowed inputs from two or more countries to be counted together, it would make it easier for the preference-eligible country to meet the minimum requirements under the rules of origin. In contrast, narrow or restrictive cumulation provisions rules do not allow the use of inputs from other countries, often fragmenting established cross-border production relationships. Cumulation provisions therefore determine how easily preference beneficiaries can trade among themselves, using intermediate goods or processes that originate in other countries.

Permitting wider cumulation would assuredly mean that LDCs could meet the rules of origin more easily and at lower cost and would also encourage south-south trade. Allowing the poorest countries to source inputs from all LDCs and other developing countries while remaining eligible for preferences would provide the added flexibility needed for effective use of preference programs.

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The Doha Round and services trade

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Negotiating the liberalisation of services is complicated. Adequate national regulation and international regulatory cooperation will often be necessary. A concerted effort is needed to help countries strengthen and improve service sector regulation and implementing institutions, as well as to cooperate with each other where there are significant regulatory externalities.

Much of what remains to be done to remove developing nation barriers to trade in services will be conditional on such regulatory improvements. An important element of any Doha package on services should therefore be agreement to create mechanisms to promote pro-competitive domestic regulatory reform and thus support liberalisation in the future.

Although comprehensive liberalisation of service markets in all 153 members in the Doha round is neither possible nor at this point in time desirable, the largest services economies (a “G25”) can and should go further.

But the larger players may also need to pursue domestic regulatory reforms before opening up some services sectors to foreign competition, and will need to strengthen regulatory cooperation to facilitate trade in some services.A pre-commitment approach will allow such conditions to be put in place and ensure that there is an agreed timetable to open markets to greater competition. Explicitly recognising that services liberalisation cannot – and should not be – divorced from services regulation will do much to help harness the potential that trade agreements have to expand services trade and investment.

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More on services trade and the Doha Round by Bernard Hoekman and Aaditya Matto here

The path to prosperity: How countries become rich?

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Becoming a rich country requires the ability to produce and export commodities that embody certain characteristics. We classify 779 exported commodities according to two dimensions: (1) sophistication (measured by the income content of the products exported); and (2) connectivity to other products (a well-connected export basket is one that allows an easy jump to other potential exports). We identify 352 “good” products and 427 “bad” products. Based on this, we categorize 154 countries into four groups according to these two characteristics. There are 34 countries whose export basket contains a significant share of good products. We find 28 countries in a “middle product” trap. These are countries whose export baskets contain a significant share of products that are in the middle of the sophistication and connectivity spectra. We also find 17 countries that are in a “middle-low” product trap, and 75 countries that are in a difficult and precarious “low product” trap. These are countries whose export baskets contain a significant share of unsophisticated products that are poorly connected to other products. To escape this situation, these countries need to implement policies that would help them accumulate the capabilities needed to manufacture and export more sophisticated and better connected products.

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Here is a paper by Felipe, Kumar and Abdon. Their analysis is based on Hidalgo et al. (2007) and Hausmann et al. (2007)’s concept of product space, which is an application of network theory that yields a graphical representation of all products exported in the world. Products are linked through lines that represent their proximity, defined as the conditional probability of exporting one products given that they also export the other one. Countries change their export mix by jumping to products that are nearby, in the sense that these other products use similar capabilities to those used by the products in which they excel (those products in which they have revealed comparative advantage [RCA]). A country’s position within the product space signals its capacity to expand to more sophisticated products, thereby laying the groundwork for future growth. Countries that export products that have few linkages with other products or countries that have not accumulated sufficient capabilities to jump to other products cannot generate sustained long-term growth.

The focus is on manufacture and export of sophisticated and better connected products (PRODY) so that structural transformation-- whereby the economy moves from traditional, low wage sector to sophisticated, high wage sector—takes place in the developing countries. Here is more on their ranking of countries based on an “index of opportunities”. Here is a blog about Nepal’s export sophistication. The basic idea behind the whole analysis is that what countries products and export determines who they are in the world. Countries with a more sophisticated export basket growth faster.

So how does structural transformation occur? Basically, the major determinant of a country’s comparative advantage, and its trade pattern, is the relative factor endowment. Changing comparative advantage based on factor accumulation dictates a country’s export basket. If prices are right for the various factors of production so that firms select the most appropriate techniques for production, then factor accumulation leads to factor price changes, leading to changes in the techniques of production.  Countries growth by accumulating physical or human capital or by improving the way various factors of production are mixed (TFP). This brings about a change in the composition of export basket. So, structural transformation is the results of changes in underlying fundamentals such as education, financial resources, and overall productivity. That said, export diversification is not easy.

Those firms that engage in “self discovery” face cost of discovery, leading to a situation where there might be high social returns but high private costs. If new products discovery fails, then the firm incurs the cost. But, if it succeeds, then other enter the market following the discovery. This is where government intervention might be required to offset private costs if there is high social return from any venture. Similarly, export diversification requires large initial investments (high fixed costs), which the government should own up. The government could facilitate information and coordination externalities.

Here are few recommendations (adapted from the same paper) for countries with low product sophistication to escape “low-product trap” :

• Many of the products exported by these countries are nature-made and subject to decreasing returns. Only industrialization can create an effective agricultural sector. None of these countries will ever get rich without an industrial and an advanced service sector.
• In the traditional trap literature (à la Nelson and Myrdal) there were two ways to escape from the low-level equilibrium trap. First, per capita income must be raised, in one go, to the point where the trap would not force income per capita down again to the subsistence level. Second, the growth rate of population must decline (e.g., reduction in the birth rate or emigration), and/or that of national income increase (e.g., through technical progress or capital from abroad).Industrialization greatly increases a country’s ability to sustain a large population.
• To a certain extent and under this view, some of these countries may need a “big push,” that is, a planned large-scale expansion of a wide range of economic activities and achieve a “critical minimum effort” (investment requirements to raise per capita income to the level beyond which the further growth of per capita income will not be associated with income-depressing forces exceeding income raising forces).
• The above will not be enough: simply “pumping money” will not help unless a critical mass in an increasing returns sector is created. These countries will need their governments to take “strategic bets” by getting directly involved in the development of new sectors (big leaps). This, however, will be difficult for many countries in this group, as, by definition, they lack the required capabilities. These capabilities are: (i) human and physical capital, the legal system, institutions, etc. that are needed to produce a product (hence, they are product-specific, not just a set of amorphous factor inputs); (ii) at the firm level, they are the “know-how” and working practices held collectively by the group of individuals comprising the firm; and (iii) the organizational abilities that provide the capacity to form, manage, and operate activities that involve large numbers of people.
• For this reason, it is imperative that these countries focus their efforts on accumulating new capabilities. This will require: (i) human capital to acquire skills, technology, and knowledge (in many cases, basic management, accounting, and record keeping); (ii) a higher drive to diversify and to increase sophistication by embracing a realistic industrial vision; and (iii) improvement in organizational abilities (e.g., firm-level organization).

Openness and growth: Mexico versus China

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Following its opening to trade and foreign investment in the mid-1980s, Mexico’s economic growth has been modest at best, particularly in comparison with that of China. Comparing these countries and reviewing the literature, we conclude that the relation between openness and growth is not a simple one. Using standard trade theory, we find that Mexico has gained from trade, and by some measures, more so than China. We sketch out a theory in which developing countries can grow faster than the United States by reforming. As a country becomes richer, this sort of catch-up becomes more difficult. Absent continuing reforms, Chinese growth is likely to slow down sharply, perhaps leaving China at a level less than Mexico’s real GDP per working-age person.

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Full paper by Kehoe and Ruhl here.

Here is an earlier post about why Mexico isn’t rich? Hanson argues that “Mexico’s underperformance is overdetermined”. Though faulty provision of credit, persistence of informality, control of key input markets by elites, continued ineffectiveness of public education, and vulnerability to adverse external shocks each may have a role in explaining Mexico’s development trajectory, we don’t yet know the relative importance of these factors for the country’s growth record, he asserts.

Poverty, Entrepreneurship, and Development

Despite having far more people in developing countries (in proportional terms) engaged in entrepreneurial activities, and having their entrepreneurial skills frequently and severely tested than those of their counterparts in the rich countries, why are these more entrepreneurial countries poorer, wonders Ha-Joon Chang. The answer lies in the poor’s inability to channel the individual entrepreneurial energy into collective entrepreneurship.

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Many people believe that the lack of entrepreneurship is one of the main causes of poverty in developing countries. However, anyone who is from or has lived for a period in a developing country will know that developing countries are teeming with entrepreneurs. On the streets of poor countries, you will meet men, women, and children of all ages selling everything you can think of, and things that you did not even know could be bought—a place in the queue for the visa section of the American Embassy (sold to you by professional queuers), the right to set up a food stall on a particular corner (perhaps sold by the corrupt local police boss), or even a patch of land to beg from (sold to you by the local thugs).

In contrast, most citizens of rich countries have not even come near to becoming an entrepreneur. They mostly work for a company, doing highly specialized and  narrowly specified jobs, implementing someone else’s entrepreneurial vision.

The upshot is that people are far more  entrepreneurial in the developing countries
than in the developed countries. According to an OECD study, in most developing countries, 30-50 per cent of the non-agricultural workforce is self-employed (the ratio tends to be even higher in agriculture). In some of the poorest countries, the ratio of people working as one-person entrepreneurs can be way above that: 66.9 per cent in Ghana, 75.4 per cent in Bangladesh, and a staggering 88.7 per cent in Benin (see 1 under further reading). In contrast, only 12.8 per cent of the non-agricultural workforce in developed countries is self-employed. In some countries, the ratio does not even reach one in ten: 6.7 per cent in Norway, 7.5 per cent in the USA, and 8.6 per cent in France. So, even excluding the farmers (which would make the ratio even higher), the chance of an average developing country person being an entrepreneur is more than twice that for a developed country person (30 per cent versus 12.8 per cent). The difference is 10 times, if we compare Bangladesh with the USA (7.5 per cent versus 75.4 per cent). And in the most extreme case, the chance of someone from Benin being an entrepreneur is 13 times higher than the equivalent chance for a Norwegian (88.7 per cent versus 6.7 per cent).

Collective nature of entrepreneurship

Our discussion so far shows that what makes the poor countries poor is not the lack of raw individual entrepreneurial energy, which they in fact have in abundance. It is their inability to channel the individual entrepreneurial energy into collective entrepreneurship.

Very much influenced by capitalist folklore, with characters like Thomas Edison and Bill Gates, and by the pioneering theoretical work of Joseph Schumpeter, our view of entrepreneurship is too much tinged by the individualistic perspective—entrepreneurship is what those heroic individuals with exceptional vision and determination do. However, if it ever was true, this view is becoming increasingly obsolete. In the course of capitalist development, entrepreneurship has become an increasingly collective endeavour.

To begin with, even those exceptional individuals like Edison and Gates became what they are only because they were supported by a whole host of collective institutions—the whole scientific infrastructure that enabled them to acquire their knowledge and also experiment with it; company law and other commercial laws that made it possible for them subsequently to build companies with large and complex organizations; educational systems that supplied highly trained scientists, engineers, managers, and workers that manned those companies; financial systems that enabled them to raise huge amounts of capital when they wanted to expand; patent and copyright laws that protected their inventions; easily accessible markets for their products, and so on.

Furthermore, in the richer countries, enterprises co-operate with each other a lot more than do their counterparts in poorer countries. For example, the dairy sectors in countries like Denmark, the Netherlands, and Germany have become what they are today only because their farmers organized themselves, with state help, into co-operatives and jointly invested in processing facilities and export marketing. In contrast, the dairy sectors in the Balkan countries have failed to develop, despite quite a large amount of microcredit channelled into them, mainly because their dairy farmers tried to make it on their own. For another example, many small firms in Italy and Germany jointly invest in R&D and export marketing, which are beyond their individual means, through industry associations (helped by government subsidies), whereas typical developing country firms do not invest in these areas because there is not such a collective mechanism.

Even at the firm level, entrepreneurship has become highly collective in the rich countries. Today, few companies are managed by charismatic visionaries like Edison or Gates, but by professional managers. Writing in the mid twentieth century, Schumpeter was already aware of this trend, although he was none too happy about it. He observed that the increasing scale of modern technologies was making it increasingly impossible for a large company to be established and run by a visionary individual entrepreneur. Schumpeter predicted that the displacement of heroic entrepreneurs with what he called ‘executive types’ would sap the dynamism from capitalism and eventually lead to its demise.

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African Exports Successes

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We establish the following stylized facts: (1) Exports are characterized by Big Hits, (2) the Big Hits change from one period to the next, and (3) these changes are not explained by global factors like global commodity prices. These conclusions are robust to excluding extractable products (oil and minerals) and other commodities. Moreover, African Big Hits exhibit similar patterns as Big Hits in non-African countries. We also discuss some concerns about data quality. These stylized facts are inconsistent with the traditional view that sees African exports as a passive commodity endowment, where changes are driven mostly by global commodity prices. In order to better understand the determinants of export success in Africa we interviewed several exporting entrepreneurs, government officials and NGOs. Some of the determinants that we document are conventional: moving up the quality ladder, utilizing strong comparative advantage, trade liberalization, investment in technological upgrades, foreign ownership, ethnic networks, and personal foreign experience of the entrepreneur. Other successes are triggered by idiosyncratic factors like entrepreneurial persistence, luck, and cost shocks, and some of the successes occur in areas that usually fail.

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Full paper by Easterly and Reshef here.