Conflict Minerals, Consumers and Industry Lobbying

For years a number of academics and advocacy groups have highlighted the role of minerals in civil wars.  Minerals like tin, tantalum, tungsten and gold often provide rebel groups with a valuable source of finance. For example a number of armed groups in the Democratic Republic of the Congo control the mining and trade of Coltan, a local abbreviation for the ore columbite-tantalite, from which tantalum is extracted. It is used in many electronic devices, for example mobile phones. Coltan is exported and processed in Europe and Asia. Consumers should have the right to know that they are buying products free from “conflict minerals” and Global Witness and other advocacy groups have campaigned to restrict the trade of minerals from conflict areas. In the US the Dodd–Frank Wall Street Reform and Consumer Protection Act requires companies to report and make public the use of so-called “conflict minerals”. In Europe, industry lobbing has been much stronger and prevents any binding regulation. In March 2014 the EU Commission proposed a system of self-certification for importers of tin, tantalum, tungsten and gold but stopped short of making it a legal requirement.

7589159588_eee701a1c6_o croppped“Democratic Republic of the Congo (DRC) Colton/Tantalum” by Responsible Sourcing Network, used under CC BY-NC (https://www.flickr.com/photos/sourcingnetwork/7589159588) (cropped image)

The German public broadcaster (ARD) investigated the links between industry and EU politicians. This short film documents how the German lobby group BDI (“The voice of German Industry”) prevented a European anti “conflict minerals” law.  I was one of the experts interviewed in this documentary and I stated that although a number of voluntary agreements already exist, “conflict minerals” are still finding their way into consumer goods. Thus, I suggest that it is now time to adopt legally binding regulation to restrict the access to finance for armed groups.

 

Link to EU self-certification proposal

http://europa.eu/rapid/press-release_IP-14-218_en.htm

Link to the ARD Report page (like BBC1 Panorama)

http://www.br.de/fernsehen/das-erste/sendungen/report-muenchen/videos-und-manuskripte/buergerkriege-mineralien-wirtschaftslobby100.html

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State Capacity in Developing Countries

A state that is able to protect its citizens, enforce property rights and provide public goods acts as the backbone of a functional economy. Researchers call this ability of the state to carry out its objectives ‘state capacity’, and there is more and more exciting research being done on its determinants,  on the outcomes associated with high or low capacity, and on how to ‘engineer’ state capacity. This year, the CSAE conference dedicated its closing plenary panel, featuring Timothy Besley, Stefan Dercon and Kieran Holmes and chaired by Paul Collier, to this research.  As Tim Besley pointed out during his introductory remarks, we know that markets take care of themselves, it is a (mal)functioning government we need to be worried about.

One of the most important dimensions of state capacity is the ability to raise taxes. Not just any taxes, but taxes that guarantee as much ‘production efficiency’ as possible (Diamond & Mirrlees, 1971). This capacity is not a given, witnessed by the fact that developed countries raise significantly more income taxes as opposed to trade taxes than developing countries. More broadly, we know that the total tax revenue as a percentage of GDP or the extent to which property rights are protected are highly positively correlated with prosperity (Besley & Persson, 2011 and figure 1 in Acemoglu, 2005, below).

 8614798Figure 1: Tax revenue and GDP. Source: Acemoglu (2005)

Developing countries routinely struggle to raise half of their annual budget, increasing their reliance on foreign aid. So how do we, in practice, extend the capacity of states to raise taxes? First and foremost, all panellists agree that there has to be a willingness to expand the tax base and collection efficiency. In many countries, elites feel their privileged positions threatened by such reforms and, since they hold power, successfully block them (see for instance Acemoglu & Robinson, 2012). Because of these concerns DFID takes an explicit political economy perspective, focusing on helpring countries to self-finance their way out of poverty. Central to self-financing your way out of poverty is, of course, the ability to raise taxes.

It is this ability to raise taxes that the last panellist, Kieran Holmes, has spent most of his career advancing. Kieran currently works with the Burundi government to (re)build its tax capacity. He emphasizes a practical approach, from removing walls in between offices in the tax department to having tax officers report their income. He does, however, emphasize that elite opposition, inexperience and a general fear of accountability are major obstacles.

All panellists pointed to the role of culture, something Besley has recently worked on in the context of the (in)famous Thatcher poll tax. How to accomplish this is not clear, but a culture of tax compliance is, in the end, the most effective way to ensure a sustainable fiscal state. The debate has shown us that state capacity should indeed be at the heart of any development efforts and that significant progress has already been made. However, much more research into measurement of capacity and lack thereof, effective policy tools and the role of culture is needed!

References

Acemoglu, Daron (2005). Politics and economics in weak and strong states. Journal of Monetary Economics, 52 pp. 1199–1226

Acemoglu, Daron and James A. Robinson (2012), Why Nations Fail, New York: Crown Business.

Besley, Timothy and Torsten Persson (2011). Pillars of prosperity: The political economics of development clusters. Princeton: Princeton University Press.

Diamond, Peter A. and James Mirrlees (1971). Optimal taxation and public production I: Production efficiency. The American Economic Review 61(1), 8—27.

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What Schooling Did: The effect of education on the educated, their families and their communities

In the most optimistic view of the world, education is meant to be transformative, changing the fortunes of individuals and their families, and spreading by example to the peers of the educated. While this view accords with the policy rhetoric around education, and with much anecdotal evidence, rigorous evidence is hard to come by especially in developing countries: the decision to open a school or enrol a child is rarely random and so, even if we did observe individuals over a long period of time, it is hard to be convinced that the differences in fortunes did really arise from education and not something else.

Leonard Wantchekon and coauthors’ paper on education in colonial Benin changes that. It asks a big question – what was the causal effect of the introduction of schools in colonial Benin in the early 1900s on the first children enrolled, their descendants, their neighbours and their extended families?

Slide3Figure 1: religious class in Zagnanado

Perhaps the most impressive part of the empirical exercise is the innovativeness and richness of the data collection. The authors identify a set of schools which were the first `Western’ schools in the area and identify reasonable other comparison villages in the same area (arguing persuasively based on historical records that the school placement was exogenous). Within the villages, they identify the first two cohorts of children in these schools and all their cohort members in the `treated’ villages.   This second part is hard (there were no census records or European-style parish registers to be looking back to) and so they create a record of the cohort members by interviewing current village residents about their grandparents and extended families. They argue, based on historical record that elites did not want their children to go to Western schools when they were first introduced, that student selection was either happenstance or random. Having asked a big question, the authors created a dataset going back a hundred years to answer it.

 

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                                              Figure 2: treatment and control groups

The effects are staggeringly large. Those children who were educated in the first cohorts had much better income outcomes and living standards and were overwhelmingly likely to work outside agriculture. As importantly, they were much more likely to be politically active – to join and campaign for political parties or to stand for elections. In this cohort at least, education does lead to empowerment. These effects persist – children of these initially treated individuals continue to get more education and have higher living standards.

If the paper had ended there, these results could have been a source for at least some disappointment: a random shock (being enrolled in a school that just opened) to one generation permanently privileges individuals and their descendants. The rhetoric around education is often about diffusion, the externalities that accrue to peers and to communities. And it is in those areas, that Wantchekon and co-authors provide some of their most interesting findings: a generation later, the gaps between the children of the initially-educated and the initially-uneducated individuals in the villages where a school was opened seemed to have dramatically reduced with the descendants of the uneducated “catching up, and catching up fast, especially in terms of income and social networks.” They document also diffusion through the extended family network with the nieces and nephews of the initially-educated benefiting as much as the children. Taken together, results in this paper seem to suggest quite strongly that being educated early on had large effects on the future outcomes of these individuals and their children, and eventually on their extended families and neighbours; education also brought a greater voice and political participation. This accords with even the most optimistic claims about the effects of education.

Wantchekon and coauthors do a great job of documenting the causal effects on the specific individuals and families who benefited from being early recipients of education. The implications for the returns to education under different circumstances ­— say a different country or a different time, perhaps one where the levels of education were not quite so low — are not clear. These initially treated individuals benefited perhaps by being `early-birds’, valued greatly because their skills were so rare and provided a great mark of distinction, and maybe such results are an upper-bound of what returns to education might be in most contexts today. And that is without engaging with the issues about the quality of education imparted in schools. Still, for this one cohort at a historically opportune moment, education did indeed prove transformative – that is an immensely valuable result in its own right.

Leonard Wantchekon delivered the Keynote Address at the CSAE 2014 Conference titled Education and Human Capital Externalities: Evidence from Colonial Benin.

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Mobile technologies in Africa

Sub-Saharan Africa has the lowest levels of infrastructure quality in the world. However, 80% of adults in Kenya, Ghana, Nigeria, and Senegal have a mobile phone, despite the fact that a large proportion of them live in poverty with no access to electricity. As shown in figure 1.a and 1.b, mobile phone subscriptions in sub-Saharan Africa have increased dramatically over the past decade, jumping from 15 million in 2000 to 650 million in 2012.

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Figure 1: GSM Coverage in 1999 and 2008 (GSM Association, taken from Isaac Mbiti’s slides).

Discussing the opportunities brought about by the spread of this new technology was precisely the objective of the panellists for the first keynote address at the 2014 CSAE conference. For this very interesting session, William Jack (Georgetown University) Ignacio Mas-Ribo (University of Oxford Tufts University) and Isaac Mbiti (Southern Methodist University) were chaired by Simon Quinn (who, ironically, seemed more at ease with computers than the three IT specialists).

The speakers identified four main mechanisms through which mobile phones can provide benefits to their users in Sub-Saharan Africa (see below for a list of references).

First, mobile phones create new business and job opportunities through improved communication and increased access to information. In remote rural areas, farmers are now able to instantaneously learn crop prices in a distant city market without having to pay otherwise unaffordable transport costs. This may in turn increase their bargaining power against intermediaries and stabilize their revenue (provided that the intermediary is not monopolist). Similarly, thanks to mobile phones, day labourers are now able to call peers who live in cities to find out about job opportunities.

Second, mobile phones provide a very practical platform for improving governance and democracy. In India for example, mobile phones have been successfully used to facilitate the reporting of cases of corruption. In Burundi, Kenya, Mozambique and Nigeria, citizen-based monitoring schemes were put in place in order to report cases of electoral fraud and violence. In a similar way, mobile phones have been used to facilitate election monitoring and increase electoral turnout.

Third, the mobile phone technology improves the quality and the outreach of development programmes related to health, education and emergency response. In high-prevalence countries, people living with HIV can now receive text messages daily, reminding them to take their antiretroviral medication. Mobile phones have also been used all around Africa for monitoring and tracking epidemics outbreaks, for supporting diagnosis and treatment by health workers and for sending health education messages.

Finally, and this was the most important part of this keynote address, mobile phones can improve informal insurance mechanisms and facilitate access to modern banking services via the development of mobile money accounts. Mobile money accounts usually involve a set of applications facilitating financial transactions via mobile phone, including paying bills and transferring money and airtime between individuals. As underlined by Isaac Mbiti, there are now more registered mobile money accounts than bank accounts in Cameroon, DRC, Gabon, Kenya, Madagascar, Tanzania, Uganda, Zambia and Zimbabwe, thereby demonstrating the attractiveness of this service.

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Figure 2: % of cell phone owners who regularly make or receive payments on their phones

The mobile money programme that has received the most attention in the literature (and during this session) is the programme M-Pesa which was launched in 2007 in Kenya. As of September 2009, M-Pesa had 8 million subscribers, with almost 40 percent of Kenyans having ever used the service to send or receive money.

As shown by William Jack, the M-PESA programme allows its users to smooth consumption across income shocks, suggesting that M-PESA reinforces considerably informal insurance mechanisms. In line with this, William Jack showed that remittance networks are larger thanks to M-PESA. Thanks to the programme, remittances are more numerous, larger and travelling further. As show by Isaac Mbiti, money accounts not only improved informal insurance mechanisms directly, they also reduced the cost of remittances in general. Since the introduction of M-Pesa in Kenya, fees charged for domestic transfers by Western Union and MoneyGram fell by about 50%; pressure from M-Pesa accounts for about 60% of this drop.

Of course, the expansion of mobile money did not occur without any difficulties, and the highly-publicized success of M-Pesa is still suffering from replication troubles. As explained by Ignacio Mas-Ribo, since the benefit of joining a network is directly proportional to the number of people already on it, the set-up of mobile money services may be quite complicated. Mobile money therefore needs to reach a critical mass of customers in order to be viable and profitable. Furthermore, current mobile money systems suffer from their limited capacity of storage of value and their limited integration. There remains the question of whether these difficulties should be solved by increased competition or by public action (or both)…

Aker, Jenny C., and Isaac M. Mbiti. 2010. “Mobile Phones and Economic Development in Africa.” Journal of Economic Perspectives, 24(3): 207-32.

Dermish, Ahmed and Kneiding, Christoph and Leishman, Paul and Mas, Ignacio, Branchless and Mobile Banking Solutions for the Poor: A Survey (January 23, 2011). Innovations, Vol. 6, No. 4, Fall 2011.

Jack, William, and Adam Ray, and Tavneet Suri (2013). Transaction networks: Evidence from mobile money in Kenya. American Economic Review: Papers and Proceedings. 103(3): 1–8

Jack, W., & Suri, T. (2014). Risk Sharing and Transactions Costs: Evidence from Kenya’s Mobile Money Revolution. The American Economic Review, 104(1), 183-223.

Mas, Ignacio and Radcliffe, Daniel, Scaling Mobile Money (May 31, 2011). Journal of Payments Strategy & Systems, Vol. 5, No. 3, September 2011.

 

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Short-term Migration and India’s Employment Guarantee

 The National Rural Employment Guarantee Act (NREGA) is one of the world’s biggest anti-poverty public workfare programmes, provisioning for 100 days of guaranteed employment in a year to every rural household in India. The idea behind this programme has been to generate employment opportunities for the rural unskilled workers who remain unemployed or under-employed due to seasonality of agriculture and for the creation of rural assets. Ultimately, this programme intends to smooth consumption and eventually reduce the level of poverty.

nrega_20120116

Figure 1: NREGA work (http://www.outlookindia.com/printarticle.aspx?279467)

In his CSAE seminar of the 4th February, 2014, Clément Imbert presented a joint paper with John Papp which studies the effect of the NREGA on short-term migration. He further examined the connectedness between work availability and the likeliness of migrants to work for NREGA, and examined the importance of seasonality in these decisions.

The possible links between the NREGA programme and short-term migration is explained by a simple model which identifies the individuals who are likely to reduce their time spent working outside the village as a result of the NREGA programme. It splits time endowment between work within and outside of the village. It predicts that a migrant leaves his village for work if the net return from working outside is greater than the earnings one get from spending entire time within the village. Following the introduction of government work at fixed minimum wage, migrants will spend more time in village and work for government programme provided daily wage offered is greater than net earnings per day from outside work. And people will stop migrating if the wage offered under NREGA is more than marginal earnings per day outside work and if the total earnings from in-village work including NREGA is more than net earnings from in-village work in the absence of NREGA and outside work together.

In order to test their model, Clément Imbert and John Papp use survey data from a reportedly high out-migration area sampled 705 households living in 70 villages at the border of three major states of India- Rajasthan, Madhya Pradesh and Gujarat. The participants in the age-group 14-69 years have reported to migrate 28 percentage points more against average 3 per cent for rural India. To capture the seasonality effect of NREGA on short-term migration and participants’ likeliness to work for NREGA, individuals were interviewed for one complete agriculture year.

The descriptive statistics show that the NREGA work is concentrated during lean season of summer. And a quite significant proportion of adults – as high as 80 per cent – expressed desire to work more for NREGA. Among those who do not want to work for NREGA, 67 per cent are engaged in other works inside the village, specifically during Monsoon season which is the main time for agriculture activity.

Migrants mostly do jobs of short-term nature and work for multiple employers at different wages. Introduction of government employment via NREGA succeeded in reducing the migration for 20 per cent of adults. Further, during summer 2009, 88 per cent of the migrants reported that they would have worked more for NREGA had it been available.

The regression estimates reveal that education and salaried adults are less likely to want work for NREGA. Further, migrants are 15 percentage points more likely to report willingness to work for the programme. Importantly, working for the NREGA is negatively correlated with time spent outside the village: one day increase in NREGA work corresponds to a fall of around 0.20 days outside village time spent.

The creation of employment under this programme varies across the country with some parts doing well against others. Using cross-state differences in implementation of NREGA across States’ borders, they perform an IV analysis to better identify the impact of NREGA on temporary migration. In their first stage regression, they find that adults in Rajasthan worked almost 9 additional days for NREGA compared to MP and Gujarat. Their second stage regression confirms the important impact of the NREGA programme on days spent outside village work: one day of additional NREGA work reduces migration approximately by 0.75 days. Moreover, this difference is noticeable for summer season during which most of the government work is provided, indicating the importance of seasonality in the decision to migrate temporary for work. However noting the other differences among adults living across these states, the differences in migration could be to a great extent due to these pre-existing differences and unrelated to NREGA.

In conclusion, government work seems an attractive alternative to migrants to date despite the wage offered under NREGA is as low as half of the wage received per day of work outside the village suggests that the migration costs is high. The study shows a significant impact of off-season work on private employment through its impact on short-term migration. Consequently, notwithstanding the welfare gains, the net income effect of the programme is much less than the wage offered by the programme.

Deepak Kumar is a visiting research student at the Department of Economics, University of Oxford from India on Commonwealth Scholarship. He is doing his PhD in economics from Jawaharlal Nehru University, New Delhi.

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Early life circumstances affect later-life mental health in Ghana

The economic losses due to mental health disorders in low-income countries are staggeringly large. Depression alone generates an estimated loss of 55.5 million disability-adjusted life years (DALYs) in low- and middle-income countries. That number is less than a fifth as large—10 million DALYs—in high-income countries. Investment in prevention and treatment remains low, but developing country governments and aid organizations are beginning to turn their attention to mental health policy. For example, Ghana, where our study is based, passed a landmark Mental Health Act in 2012. It’s crucial, then, as the tide of policy begins to shift, to understand the origins of mental health disorders in low-income country contexts.

James Fenske, Anant Nyshadham, and I set out to do exactly that in a recent CSAE working paper titled “Early Life Circumstance and Mental Health in Ghana.” We study the relationship between early life conditions and adult psychological distress. Medical evidence suggests that some components of mental health are coded during fetal development. Changes to the fetal environment, if they alter or disrupt this coding process, may have long-lasting impacts on mental health. These “disruptions” may be particularly common in low-income populations, whose smoothing and coping mechanisms are limited.

The households we focus on are cocoa farmers. They, and millions like them across the developing world, are commodity suppliers to global markets. The wide and persistent price fluctuations that characterize these markets directly affect the livelihoods of smallholder suppliers, leaving households (and especially young children) vulnerable.

Cocoa is Ghana’s chief agricultural export commodity, and its price is a key determinant of farm households’ income in regions where it is produced. We show that in these regions, low cocoa prices at the time of birth substantially increase the incidence of severe psychological distress, as classified by the Kessler Scale, an internationally validated measure of anxiety-depression spectrum mental distress. We estimate large impacts of these price fluctuations. A one standard deviation drop in the cocoa price increases the probability of severe mental distress by 3 percentage points, or nearly 50 percent of mean severe distress incidence.

Perhaps the best way to summarize the relationship between prices in early life and adult mental distress is through the following figure. We graph real cocoa prices over the birth years of individuals in our data. On this time series, we superimpose the rate of severe mental distress for each birth year cohort in cocoa regions relative to the same rate for the same cohort in non-cocoa regions. This trend tells us the extent to which the relative rate of mental distress across these regions fluctuated over birth cohorts. There is a clear negative relationship between the two: when cocoa prices at birth are high, the relative rate of mental distress is low, and vice versa.

 

price_severe

What drives the large and long-lasting impacts we uncover? We find evidence consistent with the hypotheses that maternal nutrition, reinforcing childhood investments, and adult circumstance are all operative channels of impact. We also take a careful look at selective fertility and mortality, both of which could explain some part of the mental health impact. Our results suggest that fertility does indeed respond to cocoa prices, but that selective fertility cannot account for the bulk of our estimated effects. Since this issue arises in essentially every “fetal origins” study, we suggest several ways in which future studies could both deal with selection as well as estimate the extent to which it explains the long-run impacts of early life shocks.

We hope our results will aid in the design of better prevention policies for mental health disorders in the developing world. We also show that certain groups are more susceptible to long-run mental health impacts, and thus should perhaps be targeted by policy interventions: impacts are largest for men, for farmers, and for the Akan, the biggest ethnic group in Ghana.

In sum, mental health disorders constitute a substantial problem across the developing world, with regard to population health as well as the economy. We show that in addition to ongoing efforts by governments to improve mental health care infrastructure, attention must be devoted to tackling the long-run causes of these disorders, particularly in vulnerable populations like agricultural commodity producers.

Achyuta Adhvaryu is an assistant professor of business economics and public policy at the University of Michigan’s Stephen M. Ross School of Business. His co-authors, James Fenske and Anant Nyshadham, are assistant professors of economics at the University of Oxford and the University of Southern California, respectively.

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How do African incomes compare to the rest of the world?

How poor are people in Sub-Saharan Africa compared to the rest of the World? International comparisons of GDP per capita do not provide an answer to this question because they ignore within-country inequality (i.e. every individual in a country is assumed to have the same level of income) and because GDP is not the same as disposable income, which more accurately reflects living standards.

In a recent analysis of the global income distribution, Branko Milanovic and I have compiled a new database of more than 550 household surveys between 1988 and 2008. Household surveys collect information on disposable income. Because there are few household surveys in Sub-Saharan Africa before 1993, we concentrate on the period between 1993 and 2008 in this blog post. Our data come mostly from the World Bank’s PovcalNet database, which we supplement with data from the Luxembourg Income Study. Every person in the world is assigned the average income of his or her income decile (in the country of residence). Incomes are measured in per capita terms and adjusted for purchasing power parity differences across countries.

Average per capita incomes in Sub-Saharan Africa (SSA) have barely changed over this 15-year period, moving from $742 to $762 per year (measured in 2005 Purchasing Power Parity-adjusted USD). When we exlude South Africa and the Seychelles, we actually see a decline from $608 to $556, which makes SSA the poorest region in the world (even more so than than India). Sub-Saharan Africa ( stillexcluding South Africa and Seychelles) is also the second most unequal region after Latin America & Caribbean. However, while in this group of African countries differences between countries account for almost 30% of inequality (as measured by the Theil-L index), they only explain 7% of observed inequality in Latin America. That is, the dispersion in average incomes across countries is very important in Sub-Saharan Africa. Nevertheless, high levels of inequality within countries is still common: in 2008 six African countries have a Gini index in excess of 50% (Central African Republic, Rwanda, Swaziland, Seychelles, South Africa, and Zambia).

By contrast to slow growth rates in SSA, between 1988 and 2008 average incomes trebled in China, increased by 34% in India and by 68% in the rest of Asia. Because different regions have developed at such different speeds, the regional composition of the global income distribution has changed dramatically between 1993 and 2008 (Figure 1). To construct Figure 1, we divided the world distribution in 1993 and 2008 into 20 income groups (or income ventiles), each representing 5% of world population. Figure 1 shows where the people in each of these income groups live. Note that the ventile categories refer to different money amounts in 1993 and 2008, so the fact that the richest Indians were in the 15th ventile in 1993, but only in the 14th ventile in 2008, does not imply that their incomes declined.

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In Figure 1 we can clearly see the upward movement of China. In 2008, the top income group in China reaches as far as the 17th ventile (i.e. between 80th and 85th percentile), compared with between 70th and 75th percentile in 1993. At the same time, by 2008 China had grown out of the poorest 5% of the world population while in 1993 it made up almost 30% of the population in that income class. Because our database consists of country-deciles (in the case of China, separated by rural/urban), this means that the average income of the poorest Chinese decile exceeds the global income cut-off for the poorest 5%. However, if we had a continuous Chinese distribution, it would of course be possible that some Chinese would have incomes below that cut-off.

Another way to illustrate the relative performance of Sub-Saharan Africa is to compare the position of its various country-deciles in the global distribution over time. This reshuffling in the global distribution arises precisely because different countries (and different deciles within these countries) have developed at very different speeds. For every decile in the national distribution, Figure 2 shows the position in the global distribution in 1993 and 2008. The top-left panel shows the remarkable upward movement of China, which we already discussed: for example, the richest 10% living in urban China jumped from the 73rd percentile globally to the 83rd percentile. The top-right panel shows how Côte d’Ivoire and Ghana have developed very differently.

In 1993, Côte d’Ivoire was substantially richer than Ghana. As a result of the decline in Côte d’Ivoire and the growth in Ghana, this ranking reversed by 2008 (2003 in the case of Ghana). Incomes in both Swaziland and Uganda grew strongly over this period. In Swaziland, the income groups around the middle of the distribution have gained most, although inequality remains very high (Gini index of 51%). Tanzania and Nigeria have both slid down the global income distribution.

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Our analysis shows that over the last 20 years Sub-Saharan Africa has lagged behind compared to other regions. As a result, an increasing proportion of the poorest people in the World live in Africa. While the region as whole has lagged behind, some countries – and some income groups within those countries – have been more successful than others. Of course this also applies globally. Hence our paper suggests natural case studies, both amongst African and other similar countries, to derive policy implications.

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A new way of measuring the different benefits of going to school

Photo by Eric Socolofsky, licensed under Creative Commons Attribution-NonCommercial-ShareAlike 2.0 Generic (CC BY-NC-SA 2.0)

Designing effective schooling policies requires understanding what motivates school enrolment decisions. This partly explains why so many empirical studies have attempted to measure the wage benefits that individuals receive from an additional year of schooling (or the rate of return on schooling investment). Until quite recently, most such studies found that the returns to schooling decreased as students advanced to higher schooling years: the schooling-earnings profile was concave. More recent studies suggest that the shape of this earnings profile has changed from concave to convex: the returns to schooling are now relatively low for early schooling years and only start to increase at higher schooling years. This convex shape is particularly pronounced in African labour markets.

Theoretical models of human capital investment have been slow to adapt to this new evidence. Most such models maintain the assumption that the earnings profile is concave, and also that schooling enrolment decisions are made by individuals who have perfect foresight about future wage offers and schooling costs (either monetary or psychological). Under these assumptions, the only benefit of an additional year of schooling is the wage increase associated with the current school year. However, such models find it difficult to explain why most individuals in African countries choose to complete early, low-yielding schooling years, but then decide to drop out before completing the more advanced, higher-yielding years.

If the earnings profile is actually convex then this endows lower schooling years with a second benefit: the option of continuing on to more advanced schooling years. Furthermore, acknowledging that schooling decisions are made with imperfect foresight about future wage offers and schooling costs means that there is also a second option value to schooling: even if a student anticipates dropping out of school after the current year, staying in school will allow them to proceed to the next year of schooling if it turns out that either outside wage offers or schooling costs turn out to be lower than expected the next year. The fact that these two option values make earlier school years more beneficial can potentially go some way in explaining the pattern of enrolment decisions we observe.

Recent theoretical models have relaxed the concavity and perfect foresight assumptions and speculate that these option values may be important determinants of enrolment decisions. In our recent CSAE working paper, Francis Teal and I1 go one step further and develop a decomposition technique2 that calculates the relative importance of different benefits of completing additional schooling years, including both types of option value. These components are then estimated on a sample of workers with a highly convex schooling-earnings profile, and who face considerable uncertainty regarding future wage offers: young, black South African men.

Plotting these three benefits across the different schooling levels gives us the graph below. The line indicates the height of the stacked components, which represents the total discounted expected value of investing in a particular schooling year (expressed in terms of current period log earnings). The higher the net expected value of a specific schooling year, the more likely potential learners will be to enrol in this year of schooling.

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In our model, the immediate (or myopic) benefit of additional schooling is initially low, but then gradually increases with additional years of primary and secondary schooling. This expected benefit turns negative after years 12 of education, at which point the relatively high wage and employment benefits are more than offset by the large estimated costs of tertiary education. The relatively small myopic net benefit of completing early schooling years is dominated by the larger positive option value associated with the convexity of the earnings profile.

By far the most important reason why young black South African men choose to complete primary and early secondary school, despite the relatively low returns associated with these investments, is the promise of higher returns further up the schooling ladder. The option value attached to uncertainty regarding future wage offers and schooling costs is quite small at low schooling levels, as most are quite certain that they will enrol in school again after the current schooling year. However, as learners approach completed secondary school and the margin between expected costs and benefits starts to shrink, the uncertainty option value increases along with the uncertainty about next year’s enrolment decision. Individuals now attach more value to the opportunity to observe next period’s school cost and wage offers before deciding whether or not to leave the school system.

Most young, black South African men choose to complete primary and early secondary schooling years despite the relatively low returns associated with these investments. Our results show that rationalising these decisions requires large option values of early schooling levels (which are mainly associated with convexity rather than uncertainty), as well as a schooling cost function that increases steeply between schooling phases.

 


[1]Rulof Burger is a Senior Lecturer at the Economics Department, University of Stellenbosch. Francis Teal is a Research Associate, CSAE.

[2] The technical details of this technique can be found in the full paper.

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Lessons from macro-prudential policy in emerging markets

Last week, Donald Kohn, current member of Bank of England’s Financial Policy Committee and former Vice Chairman of the Board of Governors at the FED, gave a seminar at Oxford University on a key challenge faced by policymakers today: how to make macro-prudential regulation (MaPP) work. The policy debate with the students and academics in the seminar room was placed largely, if not exclusively, in the context of the advanced industrial countries. However, emerging markets, having suffered earlier and more frequent financial crises, have had greater experiences with macro-prudential and other policies aimed at ensuring financial stability. As such, emerging markets can also offer valuable lessons.

Why Is Macro-prudential Policy Needed?

Macro-prudential policies aim to dampen the pro-cyclicality of the financial system and to reduce cross-sectional systemic risks, partly by introducing measures to address liquidity and capital shortages, and partly by addressing issues of banks being ‘Too Big to Fail’. The global financial crisis has highlighted that using a mix of micro-prudential regulation, supervision, and market discipline to address potential risks at the level of individual financial institutions does not suffice for financial stability. Neither are traditional macroeconomic management policies (e.g. monetary policy and fiscal policy) necessarily able or the most effective in containing (the build-up) of systemic risks.

As such, macro-prudential policies are promising (for an early analytical review of the need for MaPP, see Brunnermeier, et al (2009) and Hanson, Kayshap, and Stein (2011)). Their use does require, however, a clear identification of the fundamental causes of systemic risk. Systemic risk can be cyclical—whereby financial institutions and markets over-expose themselves to risks in the upswing of the financial cycle and become overly risk averse in the downswing, rendering the entire financial system vulnerable to booms and busts. Or it can be cross sectional—whereby individual institutions’ actions and problems can have spillover effects on the rest of the financial network. While both types of risks can arise from as well give rise to externalities and market failures, appropriate policy tools can vary between the two (Allen and Carletti (2011), Bank of England (2011), and Schoenmaker and Wierts (2011) provide alternative classifications of market failures).

The Macro-Prudential Toolkit

Table 1 categorizes the possible macro-prudential policies by the intended target and method, namely a) capital and provisioning requirements; b) quantitative restrictions on bank balance sheets; c) quantitative restrictions on borrowers, instruments or activities; d) taxation of activities, and e) other measures such as accounting changes, changes to compensation, etc. (for another classification of MaPP see Bank of England (2011), and IMF (2011)).

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In thinking about different types of MaPP, most analysts find it useful to distinguish among measures that consist of correcting those factors that contribute to the adverse financial sector dynamics (such as the pro-cyclicality of Basel capital requirements); measures that aim to reinforce the resilience of the financial sector to such cycles—i.e., capital buffers; those that aim to dampen the amplitude of the cycles (which constitute the bulk of the measures countries have used so far); and finally those that aim to ensure the internalization of the spillovers/externalities by financial agents to dampen the build-up of the dynamics in the first place (De la Torre, 2011).

Macro-prudential Policies at the Bank of England

Donald Kohn’s message at the seminar was that the Bank of England is trying to mitigate systemic risk using micro-prudential policy tools in a new way – setting standards so that agents internalize risk, and preventing the buildup of tail risk, – while also coordinating macro-prudential policy with monetary policy. Kohn stressed the importance of thinking about the interaction between monetary policy and macro-prudential policy, and their possible trade-offs. For example, tighter regulation in form of more intensive macro-prudential policy can have feedbacks on consumption, putting even more pressure on monetary policy to go even further. Therefore, it is very important, in his view, that macro-prudential policy is carefully complemented by appropriate macroeconomic policies, as well as other financial sector measures. In light of diminishing the possible trade-offs, Kohn stressed that the BoE’s Financial Policy Committee and the Monetary Policy Committee share board members, in order to enhance policy coordination.

What about the Emerging Markets?

The policy debate is in general taking place largely in the context of the advanced industrial countries. However, emerging markets face different conditions and have key structural features that can have a bearing on the relevance and efficacy of the policy measures being discussed. Also important, emerging markets have had much greater experiences with macro-prudential policies, primarily because they have also experienced more pronounced business and financial cycles. This greater pro-cyclicality is due to their greater exposures to international capital flow volatility, commodity price shocks, and other risks, and external and internal transmission channels that operate more adversely (for more details on sources of risk in emerging markets, see Claessens and Ghosh, 2012).

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This issue has been recently extensively explored in a World Bank publication entitled “Dealing with the Challenges of Macro-Financial Linkages in Emerging Markets”. The book, a comprehensive collection of articles by Hyun Shin, Viral Acharya, Stijn Claessens, Swati Ghosh, and others, discusses the challenges of dealing with macro financial linkages, and explores the policy toolkit available for dealing with systemic risks with particular reference to emerging markets.

Empirical Evidence on the Effectiveness of MaPPs in Emerging Markets

There are five things to notice in the empirical research on the effectiveness of specific macro-prudential instruments. First, substantial research on the effects of MaPP looks at tools targeting the real estate sector, and documents a positive relationship between limits on LTV or debt-to-income (DTI) ratios – particularly when they are actively managed – and house price dynamics. This link is found to be significant in both industrial and emerging market countries (Claessens et. al (2013) for a large set of EMs, Crowe et al. (2011a), and Igan and Kang (2011) for Korea). The problem with these results is that many countries either do not have time-varying LTV ratios, or they are not available at all. In the cases when they are available, some LTV ratios are not mandatory, but rather just guidelines.

Second, work on emerging market countries suggests that limits on foreign currency lending are also effective in smoothing large swings in credit and bank capital over time, with strong examples coming from Central and Eastern European countries (IMF, 2013).

Third, there is evidence that dynamic provisioning might act as a buffer, rather than as a counter-cyclical capital tool. Research suggests it can strengthen both individual banks and the banking system as a whole, even though it seems to have only a limited impact on restraining credit growth (Fernandez de Lis et. al (2012), Columba et al. (2012)).

Fourth, there is tentative evidence that other counter-cyclical buffers (such as reserve requirements, or restrictions on profit distribution) used in part for financial stability purposes may have been successful in smoothing private sector credit growth and in stabilizing capital flows (Montoro and Moreno (2011) for the case of Latin America).

Finally, although macro-prudential policies help mitigate increases in bank leverage and asset growth (dimensions of financial sector vulnerability) in the upswing, few macro prudential tools help stop declines in these bank variables in adverse times (Claessens et. al, 2013). These results suggest that macro-prudential tools are best used as ex ante tools. That is, for reducing the buildup in bank risks in boom periods, rather than for mitigating declines when the cycle turns.

The current global conjecture with global liquidity driven by lax monetary policy in advanced economies renders the topic of macro prudential policies in emerging markets even more important and pressing than usual. Learning from the experience of emerging markets and the effectiveness of tools used there can shed light on how to adapt such tools to prevent the build-up of systemic risk in advanced economies.

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Banking in Africa: taking stock and looking forward

Banking in Africa has undergone dramatic changes over the past 20 years. While dominated by government-owned banks in the 1980s and subject to restrictive regulation – including interest rate ceilings and credit quotas – financial liberalization, institutional and regulatory upgrades and globalization have changed the face of financial systems across the region. Today, most countries have deeper and more stable financial systems, though challenges of concentration and limited competition, high costs, short maturities, and limited inclusion persist.

In a recent CSAE working paper, we take stock of the current state of banking systems across Sub-Saharan Africa and discuss recent developments including innovations that might help Africa leapfrog more traditional banking models. Our analysis shows a glass half-full rather than half-empty.  Figures 1 and 2 summarize this assessment. Figure 1 shows that the median African country has a significantly shallower financial system than the median non-African country, as measured by three different standard measures of financial depth.  Figure 2, on the other hand, shows that the median African country has made marked improvements over the past decade across all three indicators. And if one drills deeper, one can see that this improvement holds across the whole distribution, not just for the median country. Obviously, when talking about financial systems in Africa, one has to take into account the enormous variation within the region, which also implies different challenges for countries at different levels of economic and financial development, of different sizes and of different economic structures.

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Using other indicators of financial depth confirms the assessment that African banking systems have still some way to catch up. Recent data on the use of financial services by households and enterprises show lower access to and use of financial services.  Banks in Africa are less efficient than in other parts of the developing world and focus on the short end of the yield curve.  On the other hand, African banking systems have proven stable and resilient to global financial shocks in the recent crises. Greater stability is also illustrated in the aggregate balance sheet indicators of African banks, with very high levels of liquidity and capitalization, corresponding to the relative low level of intermediation.

While sharing many characteristics of non-African developing countries, many African financial systems face the quadruple problems of (i) small scale, (ii) high political and economic volatility, (iii) high incidence of informality, and (iv) governance challenges in both private and public sectors. As pointed out by previous analyses, this makes African economies unlikely hosts for efficient and stable financial systems. The combination of these four challenges might also explain why benchmarking exercises that relate country-level financial development to an array of country characteristics fail to explain why African banking systems are less developed than those of other low-income countries.

Critically, these challenges underline the need for innovative solutions in deepening and broadening financial systems in Africa. Recent papers have documented the success of some of these innovative approaches in fostering financial inclusion and deepening across the continent. Kenya’s Equity Bank has expanded its branch network and focused its business model on the provision of financial services to population segments that are typically ignored by commercial banks, with a resulting increase in financial inclusion in the country. Several randomized control trials in Kenya and Malawi have shown how commitment savings accounts can not only help overcome social barriers to savings, but also increase investment and entrepreneurial productivity. An experiment in Ghana showed that rainfall insurance counters farmers’ risk aversion and improves decision making, though effects were largest when insurance was combined with subsidized capital. Finally, mobile-based payment systems can reduce the costs of sending remittances and facilitate risk sharing within the country, as illustrated in the case of the Lake Kivu earthquake in 2008 in Rwanda, which caused individuals living outside the affected area to transfer a large and significant volume of airtime to people living close to the earthquake’s epicenter. Evidence from Niger and Zambia shows that electronic cash transfer via a mobile based system can work as alternative to traditional payment systems, with positive effects on households’ consumption patterns.  These are only a few examples of the financial innovation across the region, in the form of new providers, new products and new delivery channels, that is so critical for financial deepening and inclusion.

Documenting these different innovations and their effects provide a richer picture than the aggregate indicators provided in Figures 1 and 2. However, they also point to a broader challenge for African banking systems: maintaining the momentum towards deeper, more efficient and more inclusive financial systems without losing the stability they have gained over the past decade.

Researchers have helped document the advances of African banking systems over the past decade. But more challenges await for analysts and policy makers alike, including (i) the challenge of long-term finance to meet African investment needs in infrastructure and housing, (ii) the expansion of the financial inclusion agenda from micro- to small enterprises, (iii) an appropriate context-specific response to the regulatory reform wave coming out of Basel, (iv) the challenge to reap the benefits from globalization while minimizing risks, and (v) the political economy of financial sector reform.  While the glass of financial sector development in Africa is indeed half full rather than half empty, there is a lot more to fill!

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