Economic and Political Liberalizations Francesco Giavazzi and Guido Tabellini

2 Study economic and political liberalizations Do they improve govt incentives and economic performance? Eg: what advice should IMF give to Egypt, or Pakistan Is there an optimal sequencing? Eg: China vs Russia or India What are the interactions?

3 Effects of economic and political liberalizations? Two separate lines of research, on economic outcomes 1.Effects of economic liberalizations? Good for growth, investment, trade (Sachs-Werner, Wacziarg-Welch) 2.Effects of political liberalizations? Disagreement, or no effect This paper: Interactions and feedbacks between economic and political liberalizations Effects on policies, not just economic outcomes Persson (2004): effect of different types of demo on liberalizations and structural policies

4 Specific questions Effects of economic and political liberalizations, separately? On economic outcomes On other structural policies On macro policies Feedback effects, and in which directions? Complementarities? Does sequencing matter?

5 Priors? No theoretical model But priors and questions motivated by previous research –Economic liberalizations improve outcomes Is it trade or other economic policy reforms? –No effect of democracy on outcomes Is it due to opposite policy effects? democratization → less corruption, more public goods democratization → more redistribution, more veto players –Feedbacks: causality could go either way –Interactions and Sequencing: no priors Don’t study heterogeneity among democracies

6 Data on reform Econ. Liberalization: becoming “open” “Closed” if: (i) average tariff > 40%; or (ii) NTB on > 40% of goods; or (iii) socialist economy; or (iv) black mkt premium >20%; or (v) state monopoly in exports Wacziarg and Welch (2003), Sachs and Werner (1995) Political liberalization: becoming “democracy” Polity2 > 0 Sample: about 150 countries in Some always open / closed Others liberalize in

7 Data on performance Economic Outcomes ( ) Growth, investment rate, (trade) Governance ( ) GADP, corruption Macroeconomic policy ( , ) Inflation (in logs), budget deficit (% GDP)

8 Difference in difference estimation (Persson 2004) 2 types of countries: “Controls” & “Treated” Compare before/after reform in “treated”, with “controls” over same period (Y T 1 - Y T 0 ) - (Y C 1 - Y C 0 ) Exploit both cross-country & time variation More credible identification than pure cross-country comparisons / before-after comparison Identifying assumption: no unobserved variable moving over time in different ways between treated / controls Eg.: technological progress does not affect T / C differently Eg.: What triggers reform does not have independent influence on performance

9 Estimation y it = a i + b t +  Reform it + e it Reform =1 in the “treated” after reform Problems: -Are treated / control similar? On average, yes (controls: always open / closed) Condition also on years*continents as regressors - Definition of treated / controls varies with performance -Reversals ? A few Distinguish between temporary / permanent reforms End of period problems: discard observations if reform at end

10 Results Effects of liberalizations alone Effects of democracy alone Liberalizations and Democracy (multiple treatments) Feedback effects Complementarities and Sequencing

11 Liberalization increases growth and investment

12 liberalization improves gadp and corruption

13 Liberalization reduces inflation and deficit ?

14 No effect of democracy on growth and investment

15 Democracy improves gadp and corruption

16 Mixed effects of democracy on inflation and deficit ?

17 Summary Effects of Liberalizations (after 3 years or more) –Better economic outcomes –Better governance –Better macro-policies Liberalizations preceded by –Worse investment –Worse macro-policies Effects of Democracy –None on economic outcomes –Better governance (after 3 years or more) –Macro-policies? (changes precede reform) Identification: are reforms random?

18 Controls (always) & treated (before liberalization)

Controls (always) and Treated (before democracy)

20 Democracy happens before liberalization….

21 But identification problematic – treated improve in the 1990s relative to controls

22 Multiple treatments: dem & lib Controls: no reform at all Specification: –Mutually exclusive partition (avoid bias due to heterogeneous treatment effects) Eg. Lib_1t = 1 after Lib in single treatment countries Lib_2t = 1 after Lib in double treatment countries… –Test whether sequencing matters –Allow for a few other sources of heterogeneity in treatment effects

23 controls (always) and treated (before first reform)

24 Definitions of dummy variables

25 1. Lib. improves economic outcomes 2. Demo after Lib gives a further boost

26 1. Lib improves macro outcomes 2. But Lib after Demo does not

27 Lib and Demo improve governance, additive effects

28 Summary Sequence matters: Democracies that follows Liberalizations give better results Liberalizations enacted by democracies less effective Eg: China vs Russia; Chile vs India Why? –Better democracy in an open environment? Constraints on redistributive policies by democracies? –More far reaching liberalization in Dictatorship? Dictator who opens up the economy has fewer veto players, does it more effectively?