REFORMING FINANCE IN TRANSITIONAL SOCIALIST ECONOMIES

Financial reforms initiated in most transitional socialist economiesdo not yet adequately provide many of the financial servicesassociated with market-oriented financial systems. Such services—mobilizingresources, selecting firms and allocating capital, monitoringfirm managers, and facilitating the management of transactionsand risk—are a necessary condition for economic reformto improve living standards. This article envisages four central strategies to guide reformof the financial sector: • Building an infrastructure based on clear and enforceableproperty rights, modern accounting and auditing standards, reliablepayments systems, sound prudential and enforcement regulations,and professionals trained in finance • Ending the shell game of trying to hide the losses ofstate-owned enterprises, and separating government decisionsto finance "priority" firms from the allocation decisions ofindependent financial institutions • Privatizing some financial institutions early—althoughnot necessarily precipitously—in concert with the privatizationof firms and supervisory capabilities, meanwhile cleaning upbank loans to maximize the chances that firms and banks willsucceed as private entities • Improving the tax system and stressing a prudent interestrate policy to reduce uncertainty, distortions, and excessiverepression of the financial sector.      

Crisis, Adjustment, and Reform in Thailand's Industrial Firms

New data on Thailand's industrial firms shed light on the originsof the East Asian financial crisis and on the response of themanufacturing sector to the structural adjust-ment program supportedby the international financial institutions. Before the crisis,Thai firms had declining profitability, but they neverthelessmaintained high levels of investment, often in domesticallyoriented areas (notably the auto sector). Thai firms financedthese investments with short-term borrowing from financial institutions,which in turn borrowed short term on foreign markets. That only40 percent of firms provided audited financial statements totheir banks meant that the financial sector had poor informationfor assessing the true riskiness of these investments. The financialstructure was thus vulnerable even to small shocks. How well did the adjustment program deal with the crisis? Thaifirms had difficulty increasing their exports quickly becauseof investment in the wrong sectors, a decline in regional demand,and bottlenecks that included red tape and poor customs administration.Because of the poor export response, the brunt of adjustmenthad to come through compression of demand and of imports. Inretrospect, the macroeconomic program— which assumed quickexport recovery— was too tight.      

Choosing a System of Unemployment Income Support: Guidelines for Developing and Transition Countries

Mounting evidence suggests that excessive job protection reducesemployment and labor market flows, hinders technological innovations,pushes workers into the informal sector, and hurts vulnerablegroups by depriving them of job opportunities. Flexible labormarkets stimulate job creation, investment, and growth, butthey create job insecurity and displace some workers. How canthe costs of such insecurity and displacements be minimizedwhile ensuring that the labor market remains flexible? Eachof the main unemployment income support systems (unemploymentinsurance, unemployment assistance, unemployment insurance savingsaccounts, severance pay, and public works) has strengths andweaknesses. Country-specific conditions—chief among themlabor market and other institutions, the capacity to administereach type of system, and the size of the informal sector—determinewhich system is best suited to developing and transition countries.      

HOW MUCH DOES TRADE WITH THE SOUTH AFFECT WORKERS IN THE NORTH?

Does trade with developing countries have a small and benigneffect on workers in industrial countries, as most economistshave maintained, or a large and adverse effect, as the generalpublic and advocates of protection believe? A review of theevidence suggests that neither of these positions is tenable.The methods that economists have conventionally used to measurethe effect of North-South trade are biased downward. The truesize of this effect remains uncertain, but some recent studiessuggest that it is much larger than previously estimated. Tradewith the South has probably significantly altered the sectoralcomposition of employment in the North, shifting workers outof manufacturing and into nontraded services. More important,it has probably significantly worsened the relative economicposition of unskilled workers in industrial countries, and mayalso have aggravated the problem of reconciling low inflationwith low unemployment. Even so, the adverse side effects oftrade with the South are much smaller than is popularly supposed.And the popular remedy—protection—is clearly wrong.What is needed instead is more action by governments to offsetthe reduction in the relative demand for unskilled labor throughtraining and education, job creation, and income redistribution.      

WHO WINS AND WHO LOSES FROM VOLUNTARY EXPORT RESTRAINTS?:The Case of Footwear

Voluntary export restraints have been a popular resort of industrialcountries faced with increasing competition from exports ofdeveloping countries. As a strategy for circumventing the rulesof the GATT (whose regulations preclude increases in tariffs),these nontariff barriers have been rather successful; whetherthey have been as successful in their aim of protecting andstimulating the industry concerned is another matter. This article looks at what happened when industrial countriesimposed—and then removed—voluntary export restraintson the footwear industry during the 1970s and 1980s. Why didprotectionism spread so fast and then dissipate almost as rapidly,and what effects did this coming and going have on the exportingcountries We suggest that industrial countries removed the restraintsbecause they found ?them either superfluous (the expected employmenteffect failed to materialize) or ineffective (the principalexporters maintained their market share during the height ofthe restrictions), or else because the industry was able toadjust by importing footwear at a profit. Predicting the effect of VERs, and determining how best to managethem, are critical questions for developing countries strugglingto improve their export performance in the 1990s. The resultsof detailed study of a representative industry, summarized here,may assist in the prediction and determination.      

Economic Reform and Labor Unions: A General-Equilibrium Analysis Applied to Bangladesh and Indonesia

Noting the trend toward more independent trade unions in developingcountries, this article examines whether the presence of unionsstrengthens or weakens the benefits to be gained from economicpolicy reform. We show that the presence of "passive" unions—onesthat choose their wage-employment contract given the firm'scost-minimizing strategy—increases the welfare gains fromtrade liberalization, because trade reform lowers the wage premiumenjoyed by the unionized sector, reducing a distortion in thelabor market. These gains are amplified when the unions are"active", namely, when they negotiate a contract with the firmthat is off its labor demand curve. Such a contract resultsin featherbedding—paying workers more than their marginalproduct—and trade reform reduces the amount of featherbedding.The policy implication for Bangladesh—a country with strongtrade unions and a protected unionized sector—is thatthe benefits of further trade liberalization may be greaterthan otherwise predicted. In Indonesia, where both unionizationand import tariffs are low, allowing greater independence tounions may preserve flexibility and reward workers better thanthe current minimum-wage policy.     

The Politics of Russian Enterprise Reform: Insiders, Local Governments, and the Obstacles to Restructuring

Russia and other countries in the Commonwealth of IndependentStates that have implemented voucher privatization programshave to account for the puzzling behavior of insiders—manager-owners—who,in stripping assets from the firms they own, appear to be stealingfrom one pocket to fill the other. This article suggests thatasset stripping and the absence of restructuring result frominteractions between insiders and subnational governments ina particular property rights regime, in which the ability torealize value is limited by uncertainty and illiquidity. Asthe central institutions that govern the Russian economy haveceded their powers to the provinces, regional and local governmentshave imposed a variety of distortions on enterprises to protectlocal employment. To disentangle these vicious circles of control, this articlesconsiders three sets of institutional changes:; adjustmentsto the system of fiscal federalism by which subnational governmentswould be allowed to retain tax revenues generated locally; legalimprovements in the protection of property rights; and the provisionof mechanisms for restructuring and ownership transformationin insider-dominated firms. The aim of these reforms would beto change the incentives that local governments, owners, andinvestors face; to convince subnational governments that a moresustainable way of protecting employment lies in protectinglocal investment; to raise the cost of theft and corruptionby insiders and local officials; and to allow investors to acquirecontrolling stakes in viable firms.      

Formal and Informal Markets for Water: Institutions, Performance, and Constraints

Water markets—either formal or informal—can be anefficient method for reallocating scarce water supplies. Atthe same time certain constraints can raise the transactioncosts of trading water. This paper reviews the conditions necessaryto establish successful water markets, identifies potentialproblems, and offers mitigating strategies. It also uses examplesof several informal and formal water markets already in operationto illustrate these problems and the solutions to them.      

The Evolution of Poverty and Inequality in Indian Villages

This paper examines the evolution of poverty and inequalityin rural India by reviewing longitudinal village studies. Itexplores the main forces of economic change—agriculturalintensification, changing land relations, and occupational diversification—froma wide range of disciplinary perspectives, and it considersthe roles of various institutions as conduits of change. Althoughmost village studies support the survey-based judgment thatrural poverty declined in India during the 1970s and 1980s,they find that progress has been slow and irregular and thatinequalities within villages have persisted. These continuedinequalities may constrain both the scope for further povertyreduction from economic growth and the impact of policy interventions.      

GOVERNMENT SPENDING IN DEVELOPING COUNTRIES: Trends, Causes, and Consequences

Throughout the twentieth century governments have been spendingever larger proportions of national income. Three issues arisein discussions about the growth of such spending as it pertainsto developing countries: How does it compare with expenditurein industrial nations? What explains the growth in spendingby developing country governments? And what are the effectson economic growth? Government expenditure as a share of GDPin low- and middle-income countries, on average, is lower thancomparable shares in industrial market economies and, with fewexceptions, is growing. Many factors, including ideology, demographics,a positive income elasticity for public goods, the rising costof public goods relative to private goods, and perhaps developmenttheory and practice, explain this growth. As for the relationshipbetween government expenditure and economic growth, the empiricalevidence does not reveal any strong correlation. The size ofgovernment may engender strong ideological debate, but the positionthat the aggregate level of government expenditure is a significantdeterminant of growth rates receives little support.      

URBAN LABOR MARKETS AND DEVELOPMENT

Economic growth and the distribution of its benefits dependon how well the labor market mobilizes human resources in newactivities, locations, and skills. This article surveys theliterature on the functioning of labor markets in developingcountries. It shows that broad analyses of population, nationalincome, and urbanization dominated early thinking, but therewas little detail on how rural and urban labor markets functioned.The urban economies were seen as being dominated by high-wagemodern sector employment, which provided the motive for rural-urbanmigration. Although migrants swelled the ranks of the urbanunemployed, wages were said to remain high because of organizedpressures that spanned the urban economy and encouraged a chronicexcess of job seekers and urban problems. Current research, in contrast, shows that the urban economyis quite diverse and economic growth has increased the rangeof opportunities. A considerable number are in viable self-employmentand small-scale economic activity with variable economic returns.However, many are denied access to opportunity because of thelimited employment, credit, and educational infrastructure.Accelerated development and broadened access will thus strengthenthe effectiveness of the labor market in a strategy of growthwith equity.      

Paths of Institutional Development: A View from Economic History

This article surveys an influential new research program onhistorical paths of institutional development and their consequencesfor growth. The research program exploits the experience ofEuropean colonialism as a kind of "natural experiment" whoseresults bear on the way institutions affect development. Thecentral hypothesis of this research is that societies that beganwith more extreme inequality were more likely to develop institutionsallowing much of the population only limited access to economicopportunities. The research has uncovered a striking reversalof fortune among the areas colonized by Europe; those that wererelatively rich in the 1600s are today far poorer than the areas(such as the United States and Canada) that initially were viewedas relatively undesirable. The timing of the reversal—atthe onset of the Industrial Revolution, when there was probablya premium on broad participation in commercial activity—suggeststhat institutions associated with high inequality may be a causalfactor in low aggregate incomes. This research program is stillin its early stages. But studies of institutions in India usingdata rich enough to permit hypothesis-testing provide evidencesupporting the hypotheses developed in the analysis of the Europeancolonial experience.      

Competition and Scope of Activities in Financial Services

This article analyzes the costs and benefits of different degreesof competition and different configurations of permissible activitiesin the financial sector and discusses the related implicationsfor regulation and supervision. Theory and experience demonstratethe importance of competition for efficiency and confirm thata competitive environment requires a contestable system—meaningone that is open to competition—but not necessarily alarge number of institutions. A competitive banking system canimprove the distribution of consumer credit, enhance the corporatesector's access to financing, and mitigate the risks of financialcrises. In an open market, in which services and products areprovided in response to market signals, financial institutionsrespond by offering a wider scope of financial services. Theoptimal institutional design for supervisory functions is lessobvious.      

Income Risk, Coping Strategies, and Safety Nets

Poor rural and urban households in developing countries facesubstantial risks, which they handle with risk-management andrisk-coping strategies, including self-insurance through savingsand informal insurance mechanisms. Despite these mechanisms,however, vulnerability to poverty linked to risk remains high.This article reviews the literature on poor households' useof risk-management and risk-coping strategies. It identifiesthe constraints on their effectiveness and discusses policyoptions. It shows that risk and lumpiness limit the opportunitiesto use assets as insurance, that entry constraints limit theusefulness of income diversification, and that informal risk-sharingprovides only limited protection, leaving some of the poor exposedto very severe negative shocks. Public safety nets are likelyto be beneficial, but their impact is sometimes limited, andthey may have negative externalities on households that arenot covered. Collecting more information on households' vulnerabilityto poverty—through both quantitative and qualitative methods—couldhelp inform policy.      

Counting the World's Poor: Problems and Possible Solutions

As recent discussions have made clear, the apparent lack ofpoverty reduction in the face of historically high rates ofeconomic growth—both in the world as a whole and in specificcountries (most notably India)—provides fuel for the argumentthat economic growth does little to reduce poverty. How confidentcan we be that the data actually support these inferences? Atthe international level, the regular revision of purchasingpower parity exchange rates plays havoc with the poverty estimates,changing them in ways that have little or nothing to do withthe actual experience of the poor. At the domestic level, theproblems in measuring poverty are important not only for theworld count but also for tracking income poverty within individualcountries. Yet, in many countries, there are large and growingdiscrepancies between the survey data—the source of povertycounts—and the national accounts—the source of themeasure of economic growth. Thus economic growth, as measured,has at best a weak relationship with poverty, as measured.      

DEVELOPMENT, THE ENVIRONMENT, AND THE SOCIAL RATE OF DISCOUNT

This article examines the role of the discount rate in makingdecisions that will have significant implications for the environment.The authors begin by providing a rationale for discounting ingeneral and by describing the main factors that determine thediscount rate. These factors—the private and social ratesof time preference, the opportunity cost of capital, risk anduncertainty, and the interests of future generations—allhave an environmental dimension. The article goes on to examinethat dimension and to explore the connections between the choiceof the discount rate and environmental concerns, such as excessiveexploitation of natural resources, inadequate investment inconservation, and insufficient attention to the irreversibleloss of certain environmental resources. The authors conclude that, in general, environmental concernsare not best addressed by lowering the discount rate—anaction that might have both benefits and costs for the environment.A more promising course would be to incorporate a criterionof sustainability into certain aspects of decisionmaking. Howsuch a criterion could be made operational is touched upon butnot developed in this article.      

Globalization, Poverty, and Inequality since 1980

One of the most contentious issues of globalization is the effectof global economic integration on inequality and poverty. Thisarticle documents five trends in the modern era of globalization,starting around 1980. The first trend is that growth rates inpoor economies have accelerated and are higher than growth ratesin rich countries for the first time in modern history. Developingcountries’ per capita incomes grew more than 3.5 percenta year in the 1990s. Second, the number of extremely poor peoplein the world has declined significantly—by 375 millionpeople since 1981—for the time in history. The share ofpeople in developing economies living on less than $1 a dayhas been cut in half since 1981, though the decline in the shareliving on less than $2 per day was much less dramatic. Third,global inequality has declined modestly, reversing a 200-yeartrend toward higher inequality. Fourth, within-country inequalityin general is not growing, though it has risen in several populouscountries (China, India, the United States). Fifth, wage inequalityis rising worldwide. This may seem to contradict the fourthtrend, but it does not because there is no simple link betweenwage inequality and household income inequality. Furthermore,the trends toward faster growth and poverty reduction are strongestin developing economies that have integrated with the globaleconomy most rapidly, which supports the view that integrationhas been a positive force for improving the lives of peoplein developing areas.      

Fiscal-monetary policy interactions in the presence of unionized labor markets

This paper develops a framework for studying the interactions between labor unions, fiscal policy, monetary policy and monopolistically competitive firms. The framework is used to investigate the effects of labor taxes, the replacement ratio, labor market institutions and monetary policymaking institutions on economic peformance in the presence of strategic interactions between labor unions and the central bank. Given fiscal variables, higher levels of either centralization of wage bargaining, or of central bank conservativeness are associated with lower unemployment and inflation. However the forward shifting of changes in either labor taxes or in unemployment benefits to labors costs is larger the higher are those institutional variables. The paper also considers the effects of those institutions on the choice of labor taxes and of unemployment benefits by governments concerned with the costs of inflation and unemployment, as well as with redistribution to particular constituencies. A main result is that, normally, higher levels of centralization and conservativeness induce government to set higher labor taxes. JEL Classification: E5 · E6 · H2 · J3 · J5 · L1     

FINANCIAL MARKETS, PUBLIC POLICY, AND THE EAST ASIAN MIRACLE

Many factors contributed to the rapid growth of the economiesof East Asia in the past quarter century. This article examinesone important aspect of that growth—commonly referredto as the "East Asian miracle"—public policies affectingthe financial markets. East Asian governments intervened extensivelyin financial markets at all stages of their development. Whatsets their actions apart from those of other developing countriesthat have not fared as well? We do not have the informationto answer conclusively what effect particular actions had (thatrequires a counterfactual test of what growth would have beenwithout the particular intervention). But we can identify themarket failures the East Asian governments addressed, assesssome of the theoretical reasons why each policy might be growthenhancing, and provide some data attesting to the impacts ofthe policy. Several characteristics of financial sector interventionsin East Asia stand out: they incorporated design features thatimproved the chances of success and reduced opportunities forabuse; interventions that did not work out were dropped unhesitatingly;and policies were adapted to reflect changing economic conditions.