Private appropriability issues: Government and market failures

1
Private appropriability issuesGovernment and
market failures

• Elena Ianchovichina
• PRMED
• March 25, 2009

2
Government failures

• Macroeconomic risks
• Macro stability is a necessary condition for
  growth
• Elements of macro stability
• Microeconomic risks

3
Macroeconomic risks

• Macro stability is a necessary condition for
  growth
• Poor macro management could result in macro
  volatility which has a negative impact on long
  run growth
• Poor macro management could discourage long term
  investments by making it hard to predict future
  outlook
• Elements of prudent macro management

4
Elements of prudent macro management

• Fiscal policy discipline
• Is the fiscal policy consistent with monetary
  policy?
• Is fiscal policy consistent with debt
  sustainability?
• Price stability with low inflation rates
• Interest rates that are positive, but moderate in
  real terms
• Competitive real exchange rates
• Adequate international reserves

5
Issues are country specific and change with time

• Difference between market-access and low income
  countries relying on official aid
• Most countries ensured macro stability in recent
  years, but the current financial crisis calls for
  renewed focus on macroeconomic management
• Good starting point IMFs special issues papers
  as well as any country analytic papers and CPIA
  discussions

6
Links between constraints

• Poor macroeconomic management may be a reason for
  low domestic savings or high spreads on foreing
  borrowing
• In this case it is poor macro management that is
  the actual constraint manifesting itself in high
  cost and poor access to finance
• But macro stability does not preclude problems in
  the financial sector

7
Macroeconomic risksExamples

• Zambia RER appreciation a threat to inclusive
  growth before 2008
• Brazil a case of an over-borrowing state

8
Main macroeconomic concerns in Zambia 2007 and
first half of 2008

• The appreciation of the Kwacha
• Stable path from 2002 to early 2005
• Rapid rise from 2005 to first half of 2008
• Depreciation in the second half of 2008
• Led to substantial real exchange rate
  appreciation

9
Real exchange rate appreciation in Zambia

• Factors driving these movements included
• Debt relief (Zambia passed HIPC completion point
  in 2005)
• Scaling up of aid
• Foreign direct investment flows into mining
• Strong export perfomance
• Tight monetary policy
• At the time this effect was considered a major
  constraint to inclusive growth due to negative
  impacts on employment and exports in the
  tradeables sectors, e.g. agriculture
• Underscored the need for productivity improvements

10
Changes in the second half of 2008

• Kwacha significantly depreciated
• Strengthening of the US dollar
• Falling copper prices
• Large withdrawal of portfolio investment
• Domestic political uncertainty
• This depreciation represents a correction of the
  overvaluation observed earlier

11
Brazils macroeconomic problems and links to the
cost of capital story

• Brazil faced the problems of a liquidity
  constrained country due to excessive debt
  accumulation
• As foreign debt accumulates concerns crop up
  about the ability or willingness to pay
• Cost of foreing borrowing rise or there may be a
  sudden stop (Brazil, 2002-2003)
• High real exchange rate volatility
• Instability in the access to foreign savings may
  be an important source of exchange rate
  volatility
• RER appreciation foreing savings increase
  demand for all goods but they typically fund
  imports
• Price of tradables falls relative to
  non-tradables
• Negative impact on growth

12
Microeconomic risks

• High and distortionary taxes
• Government ineffectiveness
• Corruption
• Poor regulatory quality
• Poor contract enforcement
• Labor market rigidities

13
When does the tax code become a constraint to
growth?

• Firm surveys often identify taxes as one of the
  top-most constraints to growth
• Subjective firm and household data cannot be used
  as the only evidence that the tax code is a
  bottleneck to growth
• Use indirect data size of informal sector is an
  indicator that tax rates distort incentives and
  creat activities designed to avoid paying taxes
• Use objective data on several aspects of the tax
  code and enforcement
• Tax rates
• Tax base
• Complexity of tax rules
• Tax administration

14
Indicators

• Taxes
• Corporate income tax
• Labor tax
• Other taxes
• Total tax burden ( of profit)
• VAT
• Trade taxes
• Tax base
• Number of firms paying 90 of tax revenues
• Number of firms reporting no profit or loss
• Complexity of tax rules
• Number of payments
• Time to pay taxes
• Tax administration
• Number of days spent meeting tax inspectors

15
Tax code a binding constraint in Mongolia 2006

• Mongolias informal sector was large and growing,
  signaling indirectly that the tax code is a
  binding constraint to growth
• The tax base was narrow 100 taxpayers provided
  over 90 of revenues
• Tax administration was weak rent-seeking and tax
  evasion were wide spread
• The tax code created
• incentives to avoid paying taxes by staying small
• disincentives to start-up businesses
• The windfall profit tax on copper and gold
  created issues with foreign investors
• Export tax on raw cashmere encouraged smuggling
  to China, not downstream processing

16
Government effectiveness Major obstacle to
growth in Benin

• Corruption was cited as the third most binding
  constraint to business growth in Benins 2004 ICA
  report
• Nearly 85 percent of firms identified corruption
  as a severe obstacle to their operations
• Benins rank on voice and accountability,
  political stability, government effectiveness,
  regulatory quality, and rule of law declined
  during the period 1998-2006
• Courts wer not operating in a transparent and
  independent fashion
• Weak contract enforcement distorted incentives
  and raised transaction costs
• According to Doing Business (2008), it costs 60
  of a claim to enforce a contract in Benin. This
  is higher than all regional averages

17
Market failures

• Coordination failures
• markets fail to respond to potential investors
  demand for services enabling scaling up,
  innovation and marketing of products
• Information failures
• firms fail to discover which products they can
  produce at low enough cost to be profitable and
  competitive
• Innovation efforts
• Defined in terms of whats new to a countrys
  sector or groups of firms
• Not defined as a shift of the global production
  frontier

18
Different types of coordination activities

• Examples
• Prioritizing the development of different types
  of infrastructure
• Making decisions on the location of basic
  infrastructure to support agglomeration
• Providing marketing training and information
• Providing product quality and safety information
• Establishing and supporting institutions involved
  in research and development, agricultural
  extension services
• Limited incentives for firms in an industry to
  provide these kinds of services efforts require
  multi-industry collaboration

19
The role of knowledge clusters

• Network organizations or knowledge clusters
  are the main strategic competitive assets of the
  Swedish forest industry
• The network of institutions is essential to
• developing and maintaining international
  competitiveness
• dissemination of skills and research from
  universities and research organizations to the
  industry
• Undertaking multi-industry projects

20
Negative coordination externalities in Mongolia
in 2006

• Large informal exports of raw cashmere to China
  were indirect signal that the government had
  failed to address coordination issues in the
  cashmere industry
• Herders lacked finance, information and
  infrastructure to improve raw cashmere quality
• Processors lacked incentives and were reluctant
  to form strategic links with herders
• Some of the consequences were
• Shortages of quality raw cashmere
• forced processors to operate below capacity
• Were an obstacle to FDI from luxury makers of
  cashmere goods
• Environmental degradation
• Coordination of transit trade and logistics had
  been poor
• SPS restrictions on meat products in China and
  Russia had eliminated meat exports from Mongolia
  to these markets
• Firms were competitive in global markets as they
  did not have access to modern technologies,
  market, and product quality information

21
Rural-urban differentials in connectivity service
provision in Zambia in 2007

• Poor access and high cost of basic services were
  major constraints to growth
• Rural areas were at a disadvantage relative to
  urban areas

Number of households with access to facilities
within 5 km

• Farm level productivity was negatively
  correlated with weak service performance
• Examples where there were positive coordination
  externalities (e.g. outgrower schemes)

22
Coordination externalities were not a binding
constraint to growth in Benin in 2008

• Effective coordination with domestic and
  international partners
• Benin had taken an active role in coordinating
  its policies, laws and regulations with WAEMU and
  ECOWAS
• Success stories where coordination had created
  positive externalities
• Mutual saving and loan associations were
  established to remedy the lack of financing
  through official channels
• Common facilities workshops were established to
  provide production services on a fee-paying basis
  for some types of equipment
• The networks enabling re-export trade were
  dynamic, organized, sophisticated and ingenious,
  indicating high potential for a thriving market
  economy The challenge is to steer this
  creativity and energy in a productive direction
  and away from illegal activities

23
Innovation strategies

• Draw on global knowledge
• Create and disseminate knowledge domestically
• Innovation activities depend on
• Broader economic incentives and institutional
  regime
• Education and training
• Underlying ICT infrastructure

24
Indicators of innovation efforts

• Measures of innovation efforts
• Number of new exports
• Number of new exports that disappear the next
  year
• Education
• Skilled labor training
• Tertiary education
• Acquiring Global Knowledge - Trade
• Trade as a share of GDP
• Exports as a share of GDP
• Tariff and non-tariff barriers
• Export processing arrangements

25
Indicators of innovation efforts

• Acquiring global knowledge FDI and licensing
• FDI as a share of GDP
• Royalty and license fee payments/million
  population
• Number of export processing zones and number of
  firms in export processing zones
• Investing in domestic RD
• Researchers in RD
• Researchers per million population
• RD spending as a percent of GDP
• Scientific and technical articles
• Patents per million population

26
Disseminating knowledge

• Wide productivity differences across firms in any
  sector in developing countries
• Raising the average level to the best local use
  can lead to sizable gains in efficiency
• Still more can be gained by raising average best
  local use to global best practice

27
Did Mongolian firms innovate?

• Mongolias manufacturing base has been narrow but
  this is not because firms have not attempted to
  export new products
• Every year in the period 2002-06
• New exports were 30 of exports at the 4 digit HS
  level
• Of these, 70 to 80 were new manufactured exports
• But half of new exports were discontinued the
  following year, and manufactured exports
  represented a large share of these discontinued
  exports
• The process of self-discovery has been hampered
  by limited access to new technology knowledge
  and access to markets

28
Did Beninese firms innovate?

• Innovation efforts in Benin have been low
  relative to other countries in the region and the
  rest of the world
• Contribution of manufacturing to value added was
  insignificant and stagnated
• Exports of manufactured goods declined
  dramatically as a share of gross exports (from
  22 to 1)

Measuring innovation effort in Benin
Source Staff estimates using UN COMTRADE data,
HS 4 digits.