Determinants of Consumption and Savings Behavior in Developing Countries

The determinants of savings generally and the specific effectsof government policies on savings and consumption are pivotalforces in investment and economic growth. The Hall hypothesisstates that consumption is a function of lifetime ("permanent")income, rather than income in each period independently. Changesin interest and tax rates, money supply, or government expenditurewill affect permanent income and hence consumption and savingsonly if they are unexpected and thus not already incorporatedin the estimation of permanent income. We are unable to rejectthe Hall hypothesis in tests for developing countries when weallow for varying interest rates. We do find evidence of a negativeeffect of inflation on consumption, and a positive relationshipbetween the real interest rate and consumption. The evidencefor the Hall hypothesis also suggests that Ricardian equivalencemay be valid—this is Barro's hypothesis that the effecton savings is the same whether government deficits are financedthrough taxation or debt. Our preliminary testing, however,does not support Ricardian equivalence.     

THE ECONOMICS OF NATURAL RESOURCE EXTRACTION: A PRIMER FOR DEVELOPMENT ECONOMISTS

As developing countries become major consumers of the globalsupply of commercial energy, it is essential to understand thedeterminants of future energy prices. At the same time, manydeveloping countries are relying on exports of their own naturalresources—tropical hardwoods, oil, tin, gold, and otherminerals—to generate badly needed foreign exchange. Governmentpolicies influence how much of a resource is extracted todayand how much is saved for the future. Flawed policies needlesslywaste precious national wealth.      

Policy Selectivity Forgone: Debt and Donor Behavior in Africa

We assess the dynamics behind the high net resource transfersby donors and creditors to Sub-Saharan African countries. Analyzingthe determinants of overall net transfers for a panel of 37recipient countries in 1978–98, we find that country policiesmattered little. Donors—especially bilateral donors—actuallymade greater transfers to countries with high debt, largelyowed to multilateral creditors, when policies were "bad." Weconclude that comprehensive debt relief has the potential, thoughnot the certainty, to restore selectivity in support of goodpolicies. That would make development assistance more effectivegoing forward—and increase public support in donor countries.     

The Resource Curse Hypothesis: Dynamic Heterogeneous Approach

Natural resources influence economic performance through many different mechanisms, both beneficial and harmful. Some of these mechanisms tend to set in fast while others are rather slow. This suggests that pooling the long- and short-run effect as typical in the resource empirical literature may lead to incorrect inferences. This article provides an evaluation of the income contribution of natural resources using a panel cointegration approach that allows for short-run dynamic heterogeneity while imposing the restriction of long-run homogeneity. It finds, in a sample of developing countries over the period 1990–2012, that natural resources are a curse in the long run. The evidence is robust to alternative dynamic specifications, different measures and types of natural resource wealth, and controlling for regional effects.     

Use of migrants' remittances in labor-exporting countries

For many developing countries, migrant workers' remittances comprise a substantial proportion of foreign exchange earnings. The most important macroeconomic requisite for inducing remittances through official channels is a realistic single rate of exchange for the currency of the labor exporting country. Convenient facilities for holding remittances in approved foreign currency accounts with banks in the country of origin are another useful incentive for attracting migrants' funds. In addition, policies must be formulated to ensure the optimal use, sectoral and regional, of cash remittances. There is a choice between consumption, saving, and investment. Generally, remittances have contributed little to the longterm development potential of most labor exporting countries. This reflects the lack of a coherent policy to mobilize the savings from remittances into productive investment. The 1st priority, given the lack of financial and managerial skills in many migrant households, is the creation of a specialized institution or specialized units within existing banks for remittances. It is important as well to ensure that remittances are utilized to inculcate a savings psychology among recipients. This can be achieved through the creation of contractual savings schemes and the linkage of savings to credit facilities. Such measures are contingent upon an adequate spread of banking facilities in rural areas and the development of an appropriate intermediate financial technology in the labor exporting countries. Institutional banking will have to adapt lending procedures to the viability of projects rather than to the availability of collateral. Advantageous interest rates in rural areas are also necessary to redress the urban bias of the financial system in developing countries.     

Infrastructure Privatization and Regulation: Promises and Perils

Infrastructure is crucial for generating growth, alleviatingpoverty, and increasing international competitiveness. For muchof the twentieth century and in most countries, the networkutilities that delivered infrastructure services—suchas electricity, natural gas, telecommunications, railroads,and water supply—were vertically and horizontally integratedstate monopolies. But this approach often resulted in extremelyweak services, especially in developing and transition economiesand especially for poor people. Common problems included lowproductivity, high costs, bad quality, insufficient revenue,and shortfalls in investment. Over the past two decades manycountries have implemented far-reaching institutional reforms—restructuring,privatizing, and establishing new approaches to regulation.This article identifies the challenges involved in this massivepolicy redirection within the historical, economic, and institutionalcontext of developing and transition economies. It also reviewsthe outcomes of these policy changes, including their distributionalconsequences—especially for poor households and otherdisadvantaged groups. Drawing on a range of international experiencesand empirical studies, it recommends directions for future reformsand research to improve infrastructure performance.      

INTERPRETING RECENT RESEARCH ON SCHOOLING IN DEVELOPING COUNTRIES

Policymakers in developing countries have long been troubledby the undesirable, but apparently unavoidable, choice betweenproviding broad access to education and developing high-qualityschools. Recent evidence, however, suggests that this is a badway to think about human capital development. Grade repetitionand high dropout rates lead to a significant waste of resourcesin many school systems. Students in quality schools, however,respond in ways that reduce such inefficiencies, perhaps evensufficiently to recoup immediately investments in quality. Promoting high-quality schools, however, is more difficult thanmany have thought, in part because research demonstrates thatthe traditional approach to providing quality—simply providingmore inputs—is frequently ineffective. Existing inefficienciesare likely to be alleviated only by the introduction of substantiallystronger performance incentives in schools and by more extensiveexperimentation and evaluation of educational programs and schoolorganizations. Incentives, decentralized decisionmaking, andevaluation are alien terms to education, in both industrialand developing countries, but they hold the key to improvementthat has eluded policymakers pursuing traditional practices.      

FISCAL DEFICITS AND MACROECONOMIC PERFORMANCE IN DEVELOPING COUNTRIES

Although fiscal adjustment was urged on developing countriesduring the 1980s to lead them out of economic malaise, considerableuncertainty remains about the relations between fiscal policyand macroeconomic performance. To illustrate how financial markets,private spending, and the external sector react to fiscal policies,the behavior of holdings of money and public debt, private consumptionand investment, the trade balance, and the real exchange rateis modeled for a sample of ten developing countries. The studiesfind strong evidence that over the medium term, money financingof the deficit leads to higher inflation, while debt financingleads to higher real interest rates or increased repressionof financial markets, with the fiscal gains coming at increasinglyunfavorable terms. Consumers respond differently to conventionaltaxes, unconventional taxes (through inflation or interest andcredit controls), and debt financing, in ways that make fiscaladjustment the most effective means of increasing national saving.Private investment—but not private consumption—issensitive to the real interest rate, which rises under domesticborrowing to finance the deficit. Contrary to the popular presumption,in some countries private investment increases when public investmentdecreases. There is strong evidence that fiscal deficits spillover into external deficits, leading to appreciation of thereal exchange rate. Fiscal deficits and growth are self-reinforcing:good fiscal management preserves access to foreign lending andavoids the crowding out of private investment, while growthstabilizes the budget and improves the fiscal position. Thevirtuous circle of growth and good fiscal management is oneof the strongest arguments for a policy of low and stable fiscaldeficits.      

Political Influence on the Central Bank: International Evidence

Political influence on the central bank is measured here bylooking at the probability that a central bank governor willbe replaced shortly after a political change of government.The governor changes about half the time within six months ofa nonconstitutional or other radical change of government—amilitary coup or a restoration of democracy. The governor ismuch less likely to change within six months following a routinechange in the head of government—about one-fourth of thetime in developing countries and one-tenth in industrial countries.These indicators vary across countries and correlate statisticallywith inflation and its variability and with real growth andreal interest rates. Differences in the vulnerability of thecentral bank to political instability, in political instabilityitself, and in central bank turnover in nonpolitical periodsseem to be a major part of the explanation for why developingcountries have, on average, higher and more variable inflationthan industrial countries do.     

New Models for Old-Age Security: Experiments, Evidence, and Unanswered Questions

The escalating costs of traditional social security systemsare forcing countries to reevaluate the formal programs thatprovide income maintenance support to the aging. This articlesuggests a reform strategy built around three systems, or "pillars,"to provide old-age security—a public pillar with mandatoa private, mandatory savings plan, and a voluntary savings system.Three variations of this model are being implemented in differentcountries: the Latin American model, in which individual workerschoose an investment manager for their retirement finds; theOECD model, in which employers, union trustees, or both choosethe investment manager for an entire company or occupation;and the Swedish notional account model, a reformed pay-as-you-gofirst pillar that may be supplemented by a second, funded pillar.Preliminary empirical evidence on the efficiency and growtheffects of pension reform, mostly from Chile, indicates thatthe impact on national saving and financial market developmentand, through these, economic growth, has been positive and possiblylarge. Problems concerning high administrative costs and regulationsthat distort investment decisions remain to be resolved, however.      

A SURVEY OF THE COSTS OF WORLD SUGAR POLICIES

The world sugar market has long been characterized by volatileprices and widespread intervention. Controls on domestic prices,demand, and supply have created an inefficient pattern of worldproduction, consumption, and trade. Without government controls,production would shift from the countries with higher cost,subsidized production (especially the European Community, Japan,and the United States) to the countries with lower costs (suchas Australia, Brazil, and Thailand). The resources saved couldthen be directed to other activities. Sugar policies in countries with high costs reduce world sugarprices quite substantially in the long run and increase pricevariability significantly; production controls in countrieswith low costs increase world prices somewhat and also increasetheir variability. What would happen if all interventions ceased? Average worldsugar prices would probably— but not definitely—rise. World prices would definitely vary less, and economicconditions would definitely improve, especially in developingcountries that depend heavily on sugar exports. But the prospectsfor substantial reform of the sugar market are not promising,even though the GATT Uruguay Round continues. This article putsforward some modest proposals for changing the existing interventionsto lessen economic distortions and reduce costs.      

USING RANDOMIZED CONTROL DESIGNS IN EVALUATING SOCIAL SECTOR PROGRAMS IN DEVELOPING COUNTRIES

Seven case studies—from Bolivia, Colombia, Indonesia,Mexico, Nicaragua, Taiwan (China), and Turkey—demonstratethe feasibility of conducting rigorous impact evaluations indeveloping countries using randomized control designs. Thisexperience, covering a wide variety of settings and social programs,offers lessons for task managers and policymakers interestedin evaluating social sector investments. The main conclusions are: first, policymakers interested inassessing the effectiveness of a project ought to consider arandomized control design because such evaluations not onlyare feasible but also yield the most robust results. Second,the acute resource constraints common in developing countriesthat often make program rationing unavoidable also present opportunitiesfor adopting randomized control designs. Policymakers and programmanagers need to be alert to the opportunities for buildingrandomized control designs into development programs right fromthe start of the project cycle because they, more than academicresearchers or evaluation experts, are in the best positionto ensure that opportunities for rigorous evaluations are exploited.      

THE COMMON AGRICULTURAL POLICY: A Review of Its Operation and Effects on Developing Countries

Policy changes in the European Community (EC)—the world'slargest importer and, since 1986, exporter of agricultural commodities—mayhave significant effects on world markets and developing countries.This article investigates the EC's Common Agricultural Policy(CAP), its history, mode of operation, and the prospects andpossibilities for change, to bring out the implications of thepolicy for developing country exporters and importers. The hypothesisthat evolves differs from that of many studies in proposingthat an agricultural liberalization in the EC is unlikely toeffect any great change in world market prices over the firstfew years. Developing countries' principal gain from a liberalizationof the CAP would derive from increased stability of world marketprices, improved access to export markets, and a reduction inthe uncertainty currently caused by discretionary measures inthe EC.      

What have we learned from a decade of empirical research on growth? Comment on It's Not Factor Accumulation: Stylized Facts and Growth Models,' by William Easterly and Ross Levine

When economists in the 1950s and 1960s used growth models tounderstand the experience of developing countries, they allowedfor the possibility of technology differences between developingcountries and the United States. But because they did not havea good theory for talking about the forces that determined thelevel of the technology—in the United States any morethan in developing countries—technology factors tendedto be pushed into the background in policy discussions.     

WHEN DO HETERODOX STABILIZATION PROGRAMS WORK?: Lessons from Experience

What advantages and disadvantages does the heterodox strategyoffer to stabilization programs in countries with chronic highinflation? Heterodox stabilization programs, in our definition,are those that support orthodox policies— that is, tightfiscal policy and a fixed exchange rate—with the initial,temporary use of incomes policies— that is, price andwage controls. This evaluation, based on several heterodox programs,successful and unsuccessful, from the 1960s and 1980s in LatinAmerican countries and Israel, affords four principal lessons: * The rapid reduction in inflation at the beginning of heterodoxprograms (which usually comes about at small cost) is the easypart; the problem is to maintain price stability over time. * Incomes policies in heterodox stabilization programs are justifiedonly in countries with high chronic inflation, where persistentinflation is more pervasive and problematic. * There is a case for a bigger fiscal adjustment in heterodoxthan in orthodox programs because of the risk that a programwith price controls may be misperceived as a populist devicefor achieving price stability without adjusting. * The failure of a heterodox program is more likely to destabilizeinflation than is the failure of an orthodox program.      

INCOMPLETE MARKETS AND COMMODITY-LINKED FINANCE IN DEVELOPING COUNTRIES

This article provides a framework for appraising new financialinstruments and evaluating the extent to which they can helpalleviate problems of incomplete credit markets and contingentclaims markets in developing countries. Although the issuesinvolved apply to any new financial instrument, we give particularattention to commodity-linked securities because many developingcountries specialize in producing a handful of primary commoditiesand are therefore exposed to substantial commodity price risks.The article looks at the supply of, demand for, and pricingof commodity-linked securities and discusses some issues thataffect their use by developing countries: their special legalstatus as sovereign debt; their feasibility (since to becometruly effective they will require liquid secondary markets);and the construction of an optimal portfolio of external debtobligations. It also discusses the potential for new financialinstruments—particularly commodity-linked securities—asa tool for risk management in developing countries.      

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.      

Economic, Demographic, and Institutional Determinants of Life Insurance Consumption across Countries

Life insurance has become an increasingly important part ofthe financial sector over the past 40 years, providing a rangeof financial services for consumers and becoming a major sourceof investment in the capital market. But what drives the largevariation in life insurance consumption across countries remainsunclear. Using a panel with data aggregated at different frequenciesfor 68 economies in 1961–2000, this article finds thateconomic indicators—such as inflation, income per capita,and banking sector development—and religious and institutionalindicators are the most robust predictors of the use of lifeinsurance. Education, life expectancy, the young dependencyratio, and the size of the social security system appear tohave no robust association with life insurance consumption.The results highlight the importance of price stability andbanking sector development in fully realizing the savings andinvestment functions of life insurance in an economy.     

Insights on Development from the Economics of Happiness

The literature on the economics of happiness in developed economiesfinds discrepancies between reported measures of well-beingand income measures. One is the so-called Easterlin paradox:that average happiness levels do not increase as countries growwealthier. This article explores how that paradox—andsurvey research on reported well-being in general—canprovide insights into the gaps between standard measures ofeconomic development and individual assessments of welfare.Analysis of research on reported well-being in Latin Americaand Russia finds notable discrepancies between respondents’assessments of their own well-being and income- or expenditure-basedmeasures. Accepting a wide margin for error in both types ofmeasures, the article posits that taking such discrepanciesinto account may improve the understanding of development outcomesby providing a broader view on well-being than do income- orexpenditure-based measures alone. It suggests particular areaswhere research on reported well-being has the most potentialto contribute. Yet the article also notes that some interpretationsof happiness research—psychologists’ set point theory,in particular—may be quite limited in their applicationto development questions and cautions against the direct translationof results of happiness surveys into policy recommendations.      

Asset pricing during pandemic lockdown

This paper examines the implications of lockdown policies during early stages of pandemics for asset prices. We build a simple susceptible-infected-recovered model with microeconomic foundations, which allows us to obtain qualitative results with economic implications. In our model, lockdown policies reduce (i) labour income by decreasing working hours and (ii) precautionary savings by decreasing susceptible agents’ probability of getting infected in the future. We qualitatively show that strengthening lockdown measures negatively impacts asset prices at the time of implementation. Our empirical analysis using data from advanced countries supports this finding. Depending on parameter values, our numerical analysis displays a V-shaped recovery of asset prices and an L-shaped recession of consumption. The rapid recovery of asset prices occurs only if the lockdown policies are insufficiently stringent to reduce the number of new periodic cases. This finding implies the possibility that lenient lockdowns have contributed to rapid stock market recovery at the beginning of the COVID-19 pandemic.