1. Private appropriability issues: Government and market failures
Elena Ianchovichina
PRMED
March 25, 2009

2. Government failures Macroeconomic risks Microeconomic 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: IMF’s 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 risks Examples
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. Brazil’s 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, )
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 Tax base Complexity of tax rules Tax administration
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
Mongolia’s 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 Benin’s 2004 ICA report
Nearly 85 percent of firms identified corruption as a severe obstacle to their operations
Benin’s rank on voice and accountability, political stability, government effectiveness, regulatory quality, and rule of law declined during the period
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
While Benin scores higher than other SSA countries in terms of voice and accountability, political stability, government effectiveness, regulatory quality, and rule of law, Benin’s rank on all these indicators has declined during the period (Table 22). There has been a particularly big drop in the past few years in Benin’s score on rule of law, control of corruption and political stability. [1] According to Transparency International in 2007 Benin ranked below Africa’s good performers - Ghana and Uganda. While its regional rank is mid-range, its global ranking is lower with two third of countries performing better than Benin.

17. Market failures Coordination failures Information 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 what’s new to a country’s 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 R&D
Researchers in R&D
Researchers per million population
R&D 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”?
Mongolia’s manufacturing base has been narrow but this is not because firms have not attempted to export new products
Every year in the period
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
New exports discontinued following year
Source: Staff estimates using UN COMTRADE data, HS 4 digits.