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.      

A SIMPLER CONSUMPTION-BASED ALTERNATIVE TO THE INCOME TAX FOR SOCIALIST ECONOMIES IN TRANSITION

The tax systems of socialist economies in transition will distortresource allocation, create inequities, and cause administrativeheadaches if not reformed. These countries have weak tax administrations,lack experience with mass taxes based on voluntary compliance,and need to encourage domestic saving and foreign investment.This article suggests an alternative to the conventional incometax that is more suited to these conditions. Attempting to tax real economic income raises complicated timingissues (when to recognize income and allow deductions) and mayrequire complex adjustments for inflation. The simplified alternativetax (SAT) avoids these complications and provides a generalincentive for saving and investment less subject to abuse ordistortions than tax holidays and other tax gimmicks in voguein countries emerging from socialism. The key elements of the SAT are separate taxes on income fromlabor and capital, immediate deduction for all business expenditures,no deduction for interest, and no taxation of interest or dividends.(Interest could be treated as under an income tax, at some cost.)Although the marginal effective tax rate is zero, the governmentshares in extraordinary returns to investment. The article discussespotential problems (including distributional implications, taxlosses, and foreign tax credits) as well as advantages of theSAT.      

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.      

CASH FLOW OR INCOME?: The Choice of Base for Company Taxation

Cash flow and equity income (or income) are two alternativebases advocated for taxes on businesses throughout the world.Although in practice most tax systems are hybrids with elementsof both types of taxes, recent literature has stressed the meritsof the cash flow tax because it is simple in concept and itdoes not distort decisions about capital expenditures and financing.But international issues and administrative complexities—particularlytax evasion—present problems that must be sorted out beforea cash flow tax can be implemented.      

Foreign Bank Entry: Experience, Implications for Developing Economies, and Agenda for Further Research

In recent years foreign banks have expanded their presence significantlyin several developing economies. In Argentina and Chile in LatinAmerica and in the Czech Republic, Hungary, and Poland in EasternEurope, foreign-controlled banks now hold more than half oftotal banking assets. In other regions the trend is similar,though foreign bank entry has been slower. Despite the growingnumber of countries embracing foreign bank entry, importantquestions are still being debated: What draws foreign banksto a country? Which banks expand abroad? What do foreign banksdo once they arrive? How do foreign banks' mode of entry andorganizational form affect their behavior? This article summarizescurrent knowledge on these issues. Because the existing literaturefocuses heavily on developed economies, it also puts forth anagenda for further study of the causes and effects of foreignbank entry in developing economies.      

ENTREPRENEURS AND ENTREPRENEURSHIP IN AFRICA

The article examines the widespread belief that indigenous entrepreneurshipis less well represented in African countries than in otherparts of the developing world. The evidence shows no dearthof ability among Africans to identify business opportunitiesand to act upon them—the two quintessential characteristicsof entrepreneurship. But the management problems these businesseshave sometimes encountered suggest that there may be a continuingrole for expatriates, provided the industries are fundamentallysound. Small businesses appear to have a better chance of successand are more viable than some of the heavily protected and subsidizedtransnational enterprises. The article finds that successful industrial entrepreneurs havecome from a variety of religious, cultural, and educationalorigins. It casts doubt on the efficacy of training programsto teach entrepreneurial skill and argues instead that a liberaleconomic regime is more likely to encourage entrepreneurship.Equally important is a well-grounded and widely dispersed growthof income, especially among small-scale cultivators, which leadsto a growth of demand for what small businesses produce.      

Housing Policy in Developing Countries: Conjectures and Refutations

This article discusses housing policy in developing economies.It examines recent research findings in light of earlier argumentsas to the benefits of more market-oriented approaches. It alsolooks at whether the recommendations of earlier work have beenrefuted or developed in subsequent analyses and policy measures.In particular, it reviews the empirical analysis of the effectsof policy on housing supply, the richer understanding of theeffects that land market regulations have on housing affordabilityand the functioning of urban areas, and the alleged mysteriouseffects that researchers claim effective property rights haveon housing policy and on development more generally. It alsoexamines the effects of the increased emphasis on communityparticipation, showing how it helps to more fully reconcilethe incentives faced by beneficiaries of housing policy anddonors. Finally, it examines recent literature on the welfareeffects of rent control. The article shows that some of theconjectures as to the likely benefits of more market-based policyhave been refuted, but large welfare gains for poor people canstill be realized by adapting this approach. Furthermore, thisapproach appears to be gaining ground as the consensus approachto effective housing policy.      

Deregulating the Transfer of Agricultural Technology: Lessons from Bangladesh, India, Turkey, and Zimbabwe

Many transition and developing economies have reduced directpublic involvement in the production and trade of seed and otheragricultural inputs. This trend creates opportunities for farmersto realize improved access to inputs, including technology frominternational private research. Unfortunately, input regulationsoften derail these opportunities by blocking private entry andthe introduction of private technology. This study looks atthe experience in Bangladesh, India, Turkey, and Zimbabwe tosee whether regulations make a difference in agriculture andinput industries in developing economies. In all countries,companies and farmers responded to regulatory reforms by introducingand adopting more new technology and by expanding the production,trade, and use of inputs. The increased use of private technologyhas brought higher yields and incomes, allowing farmers andconsumers to reach higher levels of welfare. These results challengegovernments to open their regulatory systems to allow marketentry and the introduction of private technology through seedsand other inputs.      

From Prices to Incomes: Agricultural Subsidization without Protection?

Drawing from the experience of the direct income support programsrecently introduced in the European Union, Mexico, and the UnitedStates, this article highlights problems that may arise whenthe agricultural sector of a developing economy moves from price-basedsubsidization to less distorted income support. Such programsare a step in the right direction, but as currently implemented,they have many shortcomings. Moreover, developing countriesmay lack the necessary supporting arrangements needed to makesuch programs effective. The article argues that the programsshould not restrict the use of land, that the programs shouldlast for a stipulated period of time, and that the fiscal costsshould be contained by linking income support payments to worldprices.      

CHANGES IN POVERTY AND INEQUALITY IN DEVELOPING COUNTRIES

This paper presents new data on poverty, inequality, and growthin those developing countries of the world for which the requisitestatistics are available. Eco-nomic growth is found generallybut not always to reduce poverty. Growth, however, is foundto have very little to do with income inequality. Thus the "economiclaws" linking the rate of growth and the distribution of benefitsreceive only very tenuous empirical support here.      

Domestic Bond Market Development: The Arirang Bond Experience in Korea

This study contrasts the development of the Republic of Korea'smarket for won-denominated foreign bonds (Arirang) with similarmarkets in the Asia-Pacific region. It discusses the problems,concerns, and key issues related to the development of thismarket within the broader context of domestic, regional, andglobal bond market development. Korea's experience providesvaluable lessons for other emerging market economies also seekingto build bond markets for local and foreign issuers. The sophisticationof the local bond market is not enough to make it appealingto foreign borrowers. Market development demands ensuring anenabling infrastructure and a background of macroeconomic stability,nurturing local and international demand, deregulating capitalflows, and minimizing exchange restrictions. JEL codes: F34, G18     

THE MARKET FOR DEVELOPING COUNTRY DEBT: The Nature and Importance of Its Shortcomings

There are two problems in the market for developing countrydebt: one is the immediate crisis. What do we do about the largevolume of outstanding debt? A more subtle but no less importantproblem is that because contracts are un-enforceable and lendershave incomplete information about risk, capital is mis-allocated.This article examines the latter problem and reviews the natureand causes of the unenforceability. It shows that unenforceabilityresults in higher interest rates on smaller and shorter-termloans than would otherwise be available and discourages investmentin developing countries. Similarly, unenforce-ability can explainthe perverse timing of capital flows to developing countries,causing credit to flow into the country when income is high,and out when income is low. The article then analyzes the riskassociated with three types of information asymmetries: informationabout the borrowers' ability to repay, willingness to repay,and use of the loan proceeds. These asymmetries, the authorargues, reinforce the effects of unenforceability. The prospectsfor remedying the immediate crisis are discussed, as is theneed to be certain that the proposed solutions do not aggravatethese problems.      

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.      

STABILIZATION POLICIES IN DEVELOPING COUNTRIES

The article focuses on the design of stabilization measuresto correct excessive balance of payments deficits and moderatethe rate of inflation. It distinguishes three sources of balanceof payments difficulties—excessively expansionary aggregatedemand policies; domestic supply shocks stemming, for example,from increases in real wages in excess of productivity growth;and external terms of trade shocks. It also analyzes the effectsof devaluations. The second part of the article discusses policiesaimed at reducing the rate of inflation and summarizes the theoreticalliterature on the dynamics and the transitional costs of adjustmentto lower rates of inflation in closed economies. Evidence onthe adjustment costs of disinflationary policies is reviewed,and the discussion is extended to some recent analysis of adjustmentin open economies.      

Much Ado about Nothing? Do Domestic Firms Really Benefit from Foreign Direct Investment?

Governments the world over offer significant inducements toattract investment, motivated by the expectation of spilloverbenefits to augment the primary benefits of a boost to nationalincome from new investment. There are several possible sourcesof induced spillovers from foreign direct investment. This articleevaluates the empirical evidence on productivity, wage, andexport spillovers in developing, developed, and transition economies.Although theory can identify a range of possible spillover channels,robust empirical support for positive spillovers is at bestmixed. The article explores the reasons and concludes with areview of policy aspects.      

Rural Poverty: Old Challenges in New Contexts

Poverty is still a predominantly rural phenomenon. However,the context of rural poverty has been changing across the world,with high growth in some economies and stagnation in others.Furthermore, increased openness in many economies has affectedthe specific role of agricultural growth for rural poverty reduction.This paper revisits an ‘old’ question: how doesgrowth and poverty reduction come about if most of the poorlive in rural areas and are dependent on agriculture? What isthe role of agricultural and rural development in this respect?Focusing on Sub-Saharan Africa, and using economic theory andthe available evidence, the author comes to the conclusion thatchanging contexts has meant that agricultural growth is onlycrucial as an engine for growth in particular settings, morespecifically in landlocked, resource-poor countries, which areoften also characterized by relatively low potential for agriculture.However, extensive market failures in key factor markets andlikely spatial effects give a remaining crucial role for ruraldevelopment policies, including focusing on agriculture, toassist the inclusion of the rural poor in growth and development.How to overcome these market failures remains a key issue forfurther research. JEL codes: O41, Q10, O55     

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.      

Why OECD Countries Should Reform Rules of Origin

With preferential trade agreements on the rise worldwide rulesof origin—which are necessary to prevent trade deflection—areattracting increasing attention. At the same time, preferenceerosion for Generalized System of Preferences (GSP) recipientsis increasing resistance to further multilateral negotiations.Drawing on different approaches, this article shows that thecurrent system of rules of origin that is used by the EuropeanUnion and the United States in preferential trade agreements(including the GSP) and that is similar to systems used by otherOrganisation for Economic Co-operation and Development countriesshould be drastically simplified if developed economies reallywant to help developing economies integrate into the world tradingsystem. In addition to diverting resources for administrativetasks, current rules of origin carry significant compliancecosts. More fundamentally, it is becoming increasingly clearthat they are often been designed to force developing economiesto buy inefficient intermediate products from developed economiesto "pay for" preferential access for the final product. Theevidence also suggests that a significant share of the rentsassociated with market access (net of rules of origin compliancecosts) is captured by developed economies. Finally, the restrictivenessof rules of origin is found to be beyond the levels that wouldbe justified to prevent trade deflection, suggesting a captureby special interest groups. The article outlines some alternativepaths to reforms. JEL codes: F13, F15     

THE RELEVANCE FOR DEVELOPING COUNTRIES OF RECENT DEVELOPMENTS IN MACROECONOMIC THEORY

This article reviews recent developments in macroeconomic theoryand considers their relevance for developing countries. Particularemphasis is given to the rational expectations revolution. Thearticle asks whether government policies are systematic andsuggests the need to study the expectations on which governmentsbase their decisions. Also discussed are the neo-Ricardian theorem,the implications of real wage rigidity and of supply side modelswith sectoral income effects, and recent models involving largegroup interaction.      

The Potential and Limitations of Self-Targeted Food Subsidies

Can self-selection ofsubsidized commodities be used as a mechanismto transfer income to the poor? Evidence from two self-targetingprograms, one in South Africa and one in Tunisia, shows thatalthough self-targeting can clearly improve the distributionof food subsidies to the poorest members of society, its powerto alleviate poverty and reduce income disparities is limitedby preference patterns, income inequality, and the size of theindividual subsidies. Self-targeting through quality and productdifferentiation can be a useful means to reform existing universalsubsidy schemes, but it should be considered a transitionaltool while the capacity for implementing more precise mechanisms is developed.