Posts Tagged 'Political Economy'

The Rise of the Failed Middle Income State and the Growing Divide between Economic and Political Governance

Earlier today Foreign Policy and the Fund for Peace released their annual ranking of the world’s failed states. The list is based on indicators of 12 different measures of state failure, ranging across social, economic, political, and military factors. This year 34 countries fall into the “Alert” category, denoting those in the worst shape. Somalia and DRC lead the way; the bottom five countries are all in sub-Saharan Africa.

What I think is most interesting about this year’s list is the fact that 12 of the “Alert” states – over a third – are middle-income countries. This is a new high, and indeed the emergence of failed middle income states is a relatively new phenomenon; back in 2006 there were only 3 of these countries. Whereas the failed states list used to be populated almost entirely by desperately poor countries like Somalia, Afghanistan, and Haiti, today we increasingly see a number of countries which combine moderate affluence with dysfunctional political governance, such as Nigeria, Pakistan, and Yemen.

The experiences of these failed middle-income countries present a challenge to a lot of established development thinking. There are two ways to approach this trend, depending on whether you’re a glass-half full or glass-half empty person. On the one hand, it’s possible to ask, how have these countries managed to achieve some economic success, despite the fact that they fare so badly in so many other metrics of state quality and good governance? On the other hand, one can look at these countries and say, why are their political institutions doing so poorly when in economic terms they’re not so badly off? While untangling the causality between economic and political governance has always been an extremely complicated question, it’s generally been assumed that the two improve together; indeed this is the heart of modernization theory. But for the Nigerias and Pakistans of the world, that doesn’t seem to be what’s going on.

Here’s a quick graph I pulled together using the new FP/Fund for Peace data that shows this divide between economic and political governance for failed middle income states. The graph shows the average score for failed middle income states compared to failed low income states for a selection of the indicators used to measure state capacity. The first two columns are the indicators which best cover a state’s ability to deliver on bread and butter economic issues; the Poverty and Economic Performance category includes variables such as unemployment, GDP growth, inflation, and government debt, while the Provision of Public Services category includes infrastructure, energy reliability, education, and policing. As can be seen, in these two categories the failed middle income states do considerably better than the failed low income states (a lower score on the index is an improvement in governance – details on the indicators can be found here [PDF]).

What’s really interesting, though, is that despite their ability to deliver economic growth and provide the public services necessary for a functioning economy, for these middle income countries economic success is not translating into improved political outcomes. Across the four indicators that most closely measure a state’s political stability and competence, the failed middle income countries do just as badly – indeed a little bit worse – than the failed low income countries. While their economies are relatively strong, these 12 states have very low state legitimacy (which includes democracy, corruption, political participation, and government effectiveness), fail to protect human rights and the rule of law (including press freedom, civil liberties, and political freedoms), lack a monopoly on the legitimate use of force (including internal conflict, military coups, riots, and protests), and have highly factionalized elites (including power struggles, flawed elections, and defectors).

Understanding just what’s going on in these failed middle income countries is an important question in contemporary political economy, and it’s something that I’ll be researching more closely with a colleague over this summer; look out for a new paper on these issues later in the year…

This post also appears on Politics in Spires, the joint Oxford/Cambridge politics and international relations blog.

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Independent Central Banking and the Other Great Moderation

Has independent central banking jumped the shark? That’s the question Dan Drezner poses to his readers, in response to this op-ed from Pascal-Emmanuel Gobry arguing that central banks’ collective failure during the Great Recession should encourage us to return to more political central banking. This is actually a topic I spend a fair bit of time thinking about, and indeed wrote about back in January when Hungary was considering a shift away from independent central banking. I won’t rehash what I said then, but here are two additional thoughts on the question:

– The first is that Drezner is spot on in emphasizing that the dichotomy between “independence” and “political control” isn’t really all that clear cut. I think as societies we should be having more open and engaged discussions about monetary policy and the normative, distributive questions surrounding the inflation/unemployment trade-offs. These issues matter a lot, and when central banking is viewed as a purely technical domain they tend to fade to the background, allowing certain groups – generally the financial class – to quietly shape these debates in their own interests; it’s far better that they be addressed consciously and out in the open. But it’s not clear that this means central banks should be more closely under the thumb of our legislative institutions, and I’m particularly not eager to give the current US Congress much more power over monetary policy. To put it another way, there are a lot of issues that I think are overpoliticized in contemporary Western society – global warming, religion, culture, etc. Monetary policy is one of the rare issues which is underpoliticized; particularly with the current state of the economy, debates over monetary policy should play out not just in economics blogs but amongst the public in broader society. Like supreme courts, central banks shouldn’t necessarily be closely controlled by elected politicians, but they should be more engaged in their societies and reflect the interests and demands of the general public, including over contentious distributive issues.

– The second point is that when judging the value of independent central banking as a concept it’s worth looking beyond just the OECD countries and to the developing world as well. One of Gobry’s key points is that the financial crisis has revealed that the Great Moderation – the reduction in business cycle volatility in Western economies since the mid-80s, hailed as the great success of independent central banking – was something of a mirage. Now maybe this is true and maybe it isn’t, but it’s worth pointing out that the concept of independent central banking also deserves considerable credit for what I might call the Other Great Moderation, the one which took place in the developing world. Simply put, the quality of monetary policy has greatly improved across the developing world over the last couple decades, underpinning the widespread economic success of developing countries in recent years. As with the Western Great Moderation, there are a lot of potential explanations for this development, but the greater independence of central banks is a pretty big part of the story. And importantly, unlike the Western Great Moderation, the Other Great Moderation appears to have survived the crisis intact.

Here’s the Other Great Moderation in one graph, showing the share of developing countries with inflation above 20 percent and above 80 percent from 1980 until today (data from the IMF’s latest WEO):

Back in the 1980s it was common for about a quarter of developing countries to be experiencing average annual inflation above 20 percent, and for a non-negligible number to see inflation above 80 percent. In the early 90s, with the crisis in the former Soviet Union, these figures picked up considerably. Since then, however, episodes of high inflation have declined dramatically, and except for a small bump during the 2008 crisis have all but disappeared. (Two small asides on the graph: First, the thresholds were rather arbitrarily selected, but as a quick robustness test I also tried other levels for “high” and “very high” inflation, and the picture always looks about the same. Second, it’s worth noting that because of data availability issues and the changing number of countries in the world (i.e. FSU), I had to make the graph the share of developing countries with high inflation rather than the absolute number, and this probably understates how big the change has been, as I imagine the countries missing data in the early period systematically have higher inflation than the rest of the sample.)

I don’t necessarily think this fact should hugely weigh on debates about whether to preserve independent central banking in the West, other than perhaps as a reminder that what really matters is the interaction between the independence of the central bank and the general quality and competence of political institutions. But I do think it’s very important for our understanding of the value of central bank independence as an abstract idea, and should be noted before we start writing a eulogy for independent central banks.

France and the New Balance of Power in a Crisis-Stricken Europe

So the main reason I’ve been neglecting my blogging duties of late is because I’ve been preoccupied studying for an exam on international relations theory and history. With the exam safely behind me I’m back to blogging, but still have academic IR debates on the mind, so today I want to write about what the history of early 20th century European relations can tell us about the continent’s current political economy.

To grossly oversimplify, back in the pre-WWI days Europe was controlled by a number of Great Powers of roughly equal strength, who were in continual competition with one another to run the world. They typically pursued their goals by forming loose and shifting alliances; whenever any one state seemed to be getting too strong, a collection of the others would team up to balance against it (hence the “balance of power”). Britain, which then as now prized its position as being of but not in Europe, considered itself the ultimate balancer, frequently weighing in against the strongest continental power to ensure no state could establish hegemony over the mainland.

Now fast-forward to the Europe of today, as the debt crisis stretches into its third year. Of everything that has been written on the Euro crisis so far, I think one of the most perceptive and insightful pieces was an op-ed by Anne Applebaum all the way back in September 2010 (doesn’t that feel like a long time ago?), which made one simple but important point: thanks to the crisis, the East-West divide, which had dominated intra-European relations since at least the end of World War II, has now been overtaken by the North-South divide. The “North” – represented by Germany, Scandinavia, and some Eastern European economies like Poland and Estonia – are ruled by budget hawks committed to fiscal discipline; the “South” – including Greece, Portugal, Spain, Italy, and perhaps Bulgaria and Hungary – are home to bloated public sectors and seem unable to get their public finances under control. The geography doesn’t match up perfectly, of course, and it’s easy to argue about which countries belong on which side, but the fundamental divide is hard to ignore. And while the two groups aren’t anything like formal alliances, the economic interests within each group are more closely aligned than those across the divide, and hence it’s easy to imagine the major disagreements about how to manage the European economy over the coming years falling more or less along this fault line.

As Applebaum noted at the time, “France floats somewhere in between”. I think this means that France is positioned, if it wanted to, to play something like the role Britain played 100 years ago, able to weigh in – perhaps decisively – on the side of either the North or the South. The analogy isn’t watertight – Britain’s role as balancer was based in its fundamental strength, whereas for France today it’s more about being considerably weaker than Germany but aspiring to be viewed as its neighbour’s equal. (Which, incidentally, is another theme that reappears throughout European history…) But still, in the new North-South Europe France could represent the crucial swing vote, and throw some political clout behind the interests of the South, preventing Germany from fully setting the economic agenda for the continent.

In any case, up until now France has clearly sided with the North, epitomized in the “Merkozy” romance. But as the French prepare to head to the polls it appears increasingly likely Sarkozy is on his way out, which could dramatically shake up the picture. From many of the campaign statements he’s made to date, it seems at least possible a Hollande government would rupture the informal Franco-German alliance and move the French into the “South” camp. (It’s worth noting that I’m not particularly talking about whether Hollande would actually harm the French economy and investment culture, as some seem to fear, but rather whether France will continue to stand behind Germany in intra-European political economy battles or rather take up the cause of the Southern nations.)

To bring back some academic IR terms, the impetus for such a transition can be understood in both realist/materialist terms and constructivist/identity terms. From a realist point of view, it could be that France’s interests no longer lie with the Northern interests of tight money and imposed austerity. From a constructivist point of view, it’s easy to imagine the French self-identity under Hollande evolving from Germany’s little brother to the champion of the downtrodden South. As these two forces interact, I don’t think it’d be that surprising to see France pivot from backing up Germany to balancing against the strongest power on the continent, and challenging the Germans on their vision for the future of the European economy.

Over the past several months the Eurozone has entered a strange period of stasis, what has effectively become a period of permanent crisis. Since the crisis first erupted pretty much every policy measure adopted has been an effort to “buy time”, but nothing’s really been accomplished with this time, and so nothing’s really changed. There aren’t a lot of ways to break out of this status quo; you could have some sort of surprise, disorderly default from a periphery economy, but no one really wants that outcome (though I’m starting to think it might be better than continuing down the current path). One thing that could really shake up this political equilibrium, though, would be if France decidedly announces that it no longer supports the current Northern establishment position of forcing austerity on the South.

I’m not saying this necessarily will happen, or even that it’s particularly likely to. But I definitely think it’s a storyline worth watching, and a reason we should all be paying close attention to the upcoming French election…

File Under “Austerity Doesn’t Work Without Political Buy-in”

So it turns out the Greeks aren’t the only ones capable of skirting austerity-friendly legislation, driving a wedge between de jure and de facto fiscal tightening. The latest from Ireland (via NYT):

DUBLIN — Anti-austerity protesters are claiming victory after the government acknowledged that around 50 percent of Ireland’s estimated 1.6 million homeowners failed to pay a new, flat-rate $133 property tax by the March 31 deadline. […]

Introduced on Jan. 1, the household charge was intended as a forerunner to a comprehensive property tax next year. It has become a lightning rod for widespread disenchantment on an assortment of issues like cuts to services, findings of political corruption, taxpayer liability for debts to private banks and even European legislation intended to enhance wastewater treatment from septic tanks. […]

The Irish government argues that it has no choice but to introduce the interim tax at the behest of its lenders and has vowed to identify and prosecute those who have refused to pay.

“We will begin with sending out letters and then escalate it from there to the maximum fine of 2,500 euros” — $3,330 — “on top of the outstanding amounts due in late fees and interest,” a spokesman for the Department of Environment said in an interview on Monday. “We will be taking people to court if necessary, and if there is refusal to pay, then that could be seen by a judge as contempt of court.”

That last sentence hints at the hidden costs of unpopular austerity programs, in the form of compliance costs. How much does it cost to have a judge make a ruling on whether a failure to pay a small fine is a contempt of court? I’d imagine pretty high, undoubtedly way way too high to have anything like half of the population held in contempt.

Obviously the government’s plan isn’t to hold half the population in contempt, but rather to turn up the social pressure in hopes of getting people to come forward and pay themselves  (though it’s worth noting that even this can come at a pretty high administrative cost, just in terms of keeping track of who’s paid, finding those who haven’t, etc). Maybe this will work, but I’m not too optimistic, especially for the Irish. Other peripheral economies with deep structural problems can (somewhat) convincingly spin a story of the need for shared sacrifice for the national good. But the Irish for the most part have a reasonably well-functioning economy, and are being asked to swallow deep-cutting austerity simply to pay off the misguided 2008 all-encompassing bank guarantee, much of which went to pay back foreigners. That’s a tough sell.

Prospects for Chinese Economic Reform: It’s the Politics, Stupid

Last week the World Bank released a massive 400-page report, China 2030, outlining a vision for reforming the country’s economy over the next two decades to ensure continued success. As is typical in these kinds of reports, the main findings are completely reasonable if not exactly ground-breaking: China needs to increase the share of consumption in its economy, lessen the grip of state-owned enterprises, move toward letting the market more accurately price energy and capital, deal more seriously with environmental degradation, and just generally become a more market-oriented economy.

All of which makes perfect sense, and indeed very sensible people have been suggesting more or less this same package of reforms for several years now. But this is all easier said than done, which is why, despite the fact that everyone knows that China needs to shift its development path, there hasn’t really been much progress. The problem is that translating these abstract, widely accepted economic principles into actual concrete policy basically means turning against the country’s exporting class, the very people who have been driving – and profiting handsomely from – China’s economic emergence.

The political economy challenges here are huge. It’s difficult for any government to pursue a reform agenda that will cut into the profits of entrenched special interests. (For exhibit A, see the process of healthcare reform in the US, which we can safely say has been considerably less than Pareto optimal.) But when those special interests are deeply entwined with the government – which, under state capitalism, is pretty much true by definition – it’s exponentially more difficult. Changes in economic policy create winners and losers; when the would-be losers are a powerful bloc within the government, the push for reform is going to have trouble finding traction. You don’t have to be an expert in public choice theory to understand that when the government owns companies that directly benefit from economic distortions, the incentives to remove those distortions are pretty low.

To come back to the China 2030 report, what’s most interesting about it is perhaps not what’s actually said but who’s saying it: the report was co-authored by China’s Development Research Council, a government think tank. So we can start to see some hints about which elements of the government are in the pro-reform camp. And the report has engendered considerable pushback from precisely those groups which a straight forward political-economy analysis would suggest should be opposed, namely the State-Owned Assets Supervision and Administration Commission. The battle lines are being drawn for the fight over economic policy which will play out over this transitional period for China’s leadership.

Understanding these internal political dynamics also raises interesting questions about which Western foreign policy strategies are likely to be most effective in encouraging economic reform within China. Take, for example, the contentious issue of currency appreciation. Let’s assume, perhaps overly charitably, that US politicians routinely raise the issue of China’s currency because they legitimately believe yuan appreciation would be in the United States’ national interest, rather than because they’re simply trying to score some cheap domestic political points via China-bashing. Given the domestic political debate within China, does such a strategy make sense?

To the extent that it allows the opponents of reform to paint the issue of currency appreciation as bowing to outside pressure, the answer is likely no. Given the rise of nationalism in China in recent years – and particularly economic nationalism – it’s easy to see how such a strategy could backfire. Indeed, there’s a parallel to the debate over how enthusiastically the US should endorse opposition political movements looking to overthrow Middle Eastern dictators, where the drawbacks of too close an embrace are more immediately apparent. The last thing Iran’s Green Movement needs is a stamp of approval from the US, which will only undercut their domestic political support. Similarly, the more currency appreciation is perceived as “the policy which the United States is asking for”, the more difficult it will likely be for the reform-oriented wing within China to win the internal political fight. So instead of issuing laughably ill-informed statements on the need for China to increase the value of its currency, maybe politicians should just shut up and let the currency quietly appreciate, as it’s in fact been doing rather nicely of late…

This post also appears on Politics in Spires, the joint Oxford/Cambridge politics and international relations blog.

Did the German Finance Minister Seriously Just Suggest Greece Postpone Elections?

I didn’t think it was possible, but the situation between the Greeks and the Germans just grew considerably more ridiculous. German finance minister Wolfgang Schäuble said in a radio interview that the Greeks should postpone national elections planned for April and instead adopt a technocratic government that leaves out the country’s major political parties (h/t Tyler Cowen, who correctly files this under ‘Department of Yikes’, and it’s worth noting that the Finns and the Netherlands are also apparently on board with this plan).

Good lord. Due to the Eurozone crisis a lot of things which would have seemed unthinkable a few years ago are now plausible, but even by our new 2012 standards this is just insane. Suffice it to say, the German finance ministry should not be in charge of determining whether Greece is a democracy or not! A situation where the Greek people want to choose their own government and the German finance ministry tells them they cannot is completely untenable. For anyone who forgets their European history, the response from Greek President Karolos Papoulias was a not-so-subtle reminder: “[W]e cannot accept insults from Mr Schäuble. Who is Mr Schäuble to insult Greece? … We have always defended not only the freedom of our own country, but the freedom of Europe.”

What’s particularly bizarre is that the current fight comes down to the Germans demanding various Greek politicians sign letters saying they’ll stick to austerity after the next election, and not all the politicians are happy about it. For the life of me I don’t understand why the Germans care about these letters. It’s clear that Greek politicians have a problem credibly committing to undertaking wide-sweeping austerity measures, and for good reason – their people don’t want them, and austerity without political buy-in doesn’t really work. But how are signed letters supposed to solve that problem? What magical powers are these letters supposed to have?

The most logical explanation is probably that, like with the call to impose a budget commissioner a few weeks back, this is ultimately another attempt by the Germans to accelerate the Greek endgame. Both the Germans and the Greeks seem to be inching toward the realization that they could live with Greece outside of the Eurozone, at least relative to other available alternatives. The simple fact is, real relative wages in Greece need to fall a lot if the Greek economy is going to sustainably grow again. This can happen one of three ways: through Greek nominal wage cuts (which the Greeks can’t accept), through high Eurozone inflation and stable Greek nominal wages (which the Germans won’t accept), or through Greece getting control over its own currency, which will depreciate considerably relative to the Euro. It increasingly appears the only question left is how to get to the latter option with minimal collateral damage to the European banking system.

This post also appears on Politics in Spires, the joint Oxford/Cambridge politics and international relations blog.

The Race for the World Bank Presidency is On – Will it be an Open Competition this Time?

Earlier today Robert Zoellick announced he would be leaving the World Bank at the conclusion of his five year term as President at the end of June. The news shouldn’t come as a surprise; in the history of the World Bank only two Presidents – Bob McNamara and Jim Wolfensohn – have survived for more than a term, and there was no particular reason the Obama administration would keep a Bush appointee around when they didn’t have to. Zoellick leaves a mixed legacy – he brought some much needed stability to the Bank after the fiasco that was the Wolfowitz Presidency and did a good job quietly raising money from rich countries. But he never showed particular leadership or foresight on where the Bank fit into a 21st century global economy, always seemed a step behind in responding to the financial crisis, and, at least by my count, holds considerable responsibility for blowing the food price “crisis” out of proportion. (That last point is perhaps not widely shared, but I think the whole narrative of a food price crisis – which was driven by the Bank and a number of aid advocacy groups like Oxfam – is mostly wrong. But that is a post for another day.)

It will be very interesting to see if Zoellick’s announcement kicks off a real campaign to choose his successor. As we all knew this was coming, I’d been surprised how quiet this front had been to date. Other than the long-standing rumours of Hilary Clinton eyeing the job, there’s been very little written on who wants to be in the running, and particularly on the critical twin questions of how hard the US will fight to hold on to its long-standing privilege of picking the President and how much of a fight the developing world will put up to get their own candidate in. When Strauss-Kahn was leaving the IMF there were huge debates over who would take his place, and specifically whether the tradition of allowing Europe to choose the Fund’s top position should persist. So why has there been such little debate so far, and how come those of us (myself included) who want to see developing countries given bigger stakes in the Bretton Woods institutions aren’t making a bigger fuss this time around?

One possible reason is that many people (probably correctly) see the Fund as having more power than the Bank in the world today, and so there are higher stakes over the rights to name its head. But it’s worth noting that the best chance for breaking Europe’s lock on the Fund is by first ending US control of the Bank Presidency. The current situation can only persist so long as the US and Europe stand behind each other and both tacitly agree not to rock the boat (or, to switch the metaphor up a little, to keep everyone else off the boat). If it’s true that the Fund Managing Directorship is a more politically powerful position than World Bank President, it stands to reason that Europe will fight harder to hold on to it than the US will fight for the Bank Presidency, and thus the Bank Presidency is an easier target. And once the US has given up its right to name the head of the Bank, it will undoubtedly side with the rest of the world against the Europeans next time the Fund MD position is open.

But putting all that aside, for those of us who care a lot about the World Bank, ensuring the organization has a legitimate and effective President is an important goal in its own right, regardless of its potential instrumentality in bringing down Europe’s claims on the Fund. So it’s time to start making a push for the Obama administration, and specifically Lael Brainard, the undersecretary of international affairs at the Treasury Department who has been tasked with drawing up a list of potential candidates, to do the right thing and open the competition up. The administration claims (genuinely, as far as I can tell), to really care about development, but, for well known reasons, doesn’t have a lot of money to spend these days. Here’s a chance to do something that will actually make a difference at zero cost, and they should jump on it.

Which non-Americans might be a good fit? A few names come to mind initially. One is ex-Brazilian President Lula da Silva. Or Ngozi Okonjo-Iweala, who’s been in-and-out of Nigeria’s government and also spent time in senior positions at the World Bank. But my favourite choice is probably Sri Mulyani Indrawati, the former Indonesian Finance Minister who’s currently one of three #2’s at the World Bank. On substantive grounds, she knows finance and did a remarkable job guiding Indonesia’s economy through difficult but necessary reforms that paid off, including tackling widespread corruption, always an issue on the Bank’s radar. On symbolic – but still important – grounds, she’s a woman, from the world’s most dynamic region (Asia) and is from a large but not dominant developing country; one can imagine the Chinese blocking an Indian appointee and the Indians blocking a Chinese, but both being able to get behind an Indonesian. (Turkey’s Kemal Dervis benefited from a similar dynamic in his aborted bid to replace Strauss-Kahn at the Fund.) So if anyone  with any clout is reading this (like Andrew Sullivan !!), let’s get the campaign underway…



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