Friday, 5 August 2016

"Democracy" and "Corruption" in the BRICS




This essay will present some recent numbers on the status of democracy and on corruption for a selected group of countries, covering the BRICS and other emerging markets of systemic importance. The analysis is descriptive, comparing 2015 with 2005 data on country rankings provided by the Bertelsmann Foundation, the Economist Intelligence Unit and Transparency International. It also explores the interaction of (subjective or impressionistic) measures of democracy and perceived corruption by looking at rank correlation coefficients.
Shifting Wealth (defined here[i]) has been in decline. Income per head convergence, social inclusion and the accumulation of foreign assets have slowed down or even reversed in the BRICS and other emerging countries. Nobel laureate Michael Spence has recently attributed the BRICS slowdown to external factors[ii]:
“Developing countries are facing major obstacles – many of which they have little to no control over – to achieving sustained high growth. Beyond the headwinds generated by slow advanced-economy growth and abnormal post-crisis monetary and financial conditions, there are the disruptive impacts of digital technology, which are set to erode developing economies’ comparative advantage in labor-intensive manufacturing activities.”
Other observers have stressed governance issues. Corruptions scandals involving the political leaders in Brazil, Malaysia and South Africa; the strengthening of authoritarian rule in China, Russia and Turkey; and the lack of social inclusion fanning internal conflict top the list of concerns. The Guardian[iii] has recently concluded:
To take their rightful place in the 21st century, the Brics countries must create more open, accountable, and trustworthy systems of governance. This is a challenge of leadership, not profit and loss.“
Both democracy and corruption can matter for sustaining growth and development, although the relationship is much more complicated than many governance zealots would have us believe.
Barro (1996)[iv] has analysed growth and democracy (subjective measures of freedom) for a panel of about 100 countries from 1960 to 1990. His findings suggest a nonlinear relationship in which more democracy enhances growth at low levels of political freedom but depresses growth when a moderate level of freedom has already been attained. He also finds that improvements in the standard of living—measured by GDP, health status, and education—substantially raise the probability that political freedoms will grow.
The Transformation Index of Bertelsmann Foundation (BTI) includes ´democracy status´. This political component tries to quantify an unweighted composite of measures for stateness; political participation; rule of law; democratic institutions; political and social integration. Table 1 reports for the five BRICS (in bold) and seven relevant emerging countries how country rankings have developed in the past decade, from 2005 to 2015.

Table 1: BTI Status Index 2015 v 2005
Country
Change
Rank 2005
Rank 2015
Brazil
+
20
19
China
+
85
84
India
-
24
28
Indonesia
+
52
39
Mexico
-
27
41
Morocco
-
79
94
Nigeria
-
66
85
Russia
-
46
81
Saudi Arabia
-
93
100
South Africa
-
16
26
Singapore
-
22
25
Turkey
0
34
33

For the majority of countries, Barro´s earlier finding that economic progress furthers democracy (´freedom´) is not confirmed. Western press sentiment that the BRICS have failed to become democratic during their Golden Age seems to be confirmed. Country rankings (for a sample of 130 countries) deteriorated (and in most cases the index scores) in eight of the twelve countries selected here. But not always where some would expect it. Sure, Russia scores the worst decline but it is fairly closely followed by OECD members or darlings Mexico and Morocco. Among the BRICS, only China and India kept their ranks, albeit at grossly different levels. The only major emerging country to rise markedly in the BTI rankings over the period is Indonesia.

Table 2: EIU Democracy Index 2015 v 2005
Country
Change
Rank 2005
Rank 2015
Brazil
-
42
51
China
+
138
136
India
-
35
37
Indonesia
+
65
49
Mexico
-
53
66
Morocco
+
115
107
Nigeria
+
124
108
Russia
-
102
132
Saudi Arabia
0
160
160
South Africa
-
29
35
Singapore
+
84
74
Turkey
-
88
97

Table 2 presents the Economist Intelligence Unit (EIU) Democracy Index ratings, again for the thwelve selected countries and the ranks in 2005 versus 2015 for 167 countries. The EIU Democracy Index is based on five categories: electoral process and pluralism; civil liberties; the functioning of government; political participation; and political culture. Based on their scores on a range of indicators within these categories, each country is then itself categorised as one of four types of regime: “full democracies” (20 countries only); “flawed democracies”; “hybrid regimes”; and “authoritarian regimes”. (Note that France is now considered a ´flawed democracy´ by the Economist…).
Among the BRICS, the EIU finds only Russia (??) to have slightly move up in the democracy rankings, from extremely low levels. The score in the other four BRICS deteriorated, as it did in OECD members Mexico (confirming the BTI) and Turkey. (What has the OECD Governance directorate been doing in all those years?). Strong improvements are found over the past decade in Indonesia (BTI agrees), Nigeria, and – WTF! – Saudi Arabia.
Sustained growth can also be endangered by a rise in corruption. Mauro[v] has found some subjective indices of corruption to lower investment, thereby lowering economic growth. According to the media, corruption scandals involving the presidents of Brazil, Russia and South Africa as well as anti-corruption drives in China suggest this is indeed a problem in most BRICS. Transparency International produces a Perceived Corruption Index, again a subjective index (Table 3).

Table 3: TI Perceived Corruption Index 2015 v 2005
Country
Change
Rank 2005
Rank 2015
Brazil
-
70
76
China
-
70
83
India
-
70
76
Indonesia
+
130
88
Mexico
-
70
95
Morocco
-
79
88
Nigeria
+
142
136
Russia
+
121
119
Saudi Arabia
+
70
52
South Africa
-
51
61
Singapore
-
5
8
Turkey
-
60
66

Popular and press sentiment about corruption seem confirmed by the TI index. All BRICS recorded deteriorating country rankings in a sample of 167 countries, except Russia (sic!). OECD members Mexico and Turkey dropped sharply in the corruption rankings, as did Morocco. Strong improvements, by contrasts, were noted in Indonesia and Saudi Arabia.

Table 4: Rank Correlation BTI, TI, & EIU 2015
- Spearman´s Rho (p-value in brackets)-
Year
BTI 2015
TI 2015
BTI 2015
/
/
TI 2015
0.43 (0.165)
/
EIU 2015
0.76* (0.004)
0.18 (0.58)
*denotes significant by normal standards.

Rank correlation measures (Spearman´s ρ) do not indicate a significant relationship between the two democracy measures (BTI, EIU) and the TI corruption rankings. The relationship between democracy and corruption is complicated, as suggested by a vivid debate in India, for example. The only significant relation noted in Table 4 is among the two subjective democracy measures provided by Bertelsmann and The Economist.

Some tentative conclusions: The BRICS have mostly receded in international country rankings on subjective measures of both democracy and corruption. But this finding would not necessarily imply that this undermines long-term growth. The link between more ´democracy´ (as Bertelsmann and The Economist understand it) and more economic prosperity seems weaker than often thought, both over time and across countries. After all, Singapore´s authoritarian capitalism and China´s market socialism have gone a long way along rising wealth. The relationship between corruption and democracy seems weak as well. Or should we say: it´s complicated Maybe the, say, Brazilian corruption scandals will reinforce its independent judiciary and hence democracy in the end.




[i] ShiftingWealth Blogspot, “Defing Shifting Wealth”, 4 April 2011.
[ii] Michael Spence, Growth in a Time of Disruption”, Project Syndicate 27th July 2016.
[iii] The Guardian, “Has the BRICS bubble burst?“, 27 March 2016.
[iv] Robert J. Barro, „Democracy and Growth“,Journal of Economic Growth, March 1996, Vol 1, Issue 1, pp 1-27.
[v] Paolo Mauro, „Corruption and Growth“,The Quarterly Journal of Economics, Vol. 110, No. 3 (Aug., 1995), pp. 681-712.

Wednesday, 20 July 2016

With Romer back to a US-inspired World Bank? (extended)

Paul M. Romer, mostly known for his seminal contribution to endogenous growth theory and defender of special zones (´Charter Cities´), will be the next chief economist of the World Bank. His nomination last Monday was greeted with overwhelming enthusiasm[1], especially by academic peers.
With Romer, the World Bank can strengthen her profile as knowledge bank. That should help to differentiate the multilateral fauna of development banking. It was Paul Romer who enriched growth theory by endogenizing ideas and Know How, rather than treat human capital as an exogenous residual. From his pioneering work it would follow that open economies grow faster in the longer run if they foster institutions and a social model that help create and disseminate know how. From there to Romer´s idea of  “Charter Cities”, new cities in poor countries, is a quick link[2] as urban agglomerations tend to breed the generation and dissemination of ideas.


Romer´s “Charter Cities” are supposed to foster development within poor countries via the creation of new special zones that are free from corruption and where property rights are respected. Europe knows what Romer discovered and re-packaged already since the Middle Ages: Stadtluft macht frei[3]. Serfs could flee the feudal lands and gain freedom in this way, making cities a territory outside the feudal system to a certain extent, similar to “Charter Cities”.
The developmental role of “Charter Cities” is derived from the experiences of the former British crown colony Hong Kong and the Chinese special economic zone Shenzhen. Not only the historical origin of Romer´s concept has a neo-colonial smell, but also the fact that the poor-country government has largely to give up control to foreign investors. Honduras tried the concept in 2011 by modifying the constitution to allow judiciary, police, economics and finance to be removed from central government in new ´special development zones´. Critics have pointed to Honduras´ past as a “banana republic” under US corporate dominance.  Rather than becoming prosperous development poles, special zones or model cities can easily turn into heavens for tax evasion, money laundering, corruption and sweatshops, warned the Neue Zürcher Zeitung already in 2012[4].
I regret that the World Bank reverses the newly-established tradition to select her chief economist from an emerging country. With the former and the current chief economists, the World Bank brought the Chinese and Indian development economists Justin Yifu Lin and Kaushik Basu to DC. To my knowledge, Professor Lin was the first chief economist at the bank who did not come from a North American university[5]. Especially the nomination of Lin had reflected Shifting Wealth, the recalibration of the world toward the East; not just economic or political, but also paradigmatic.
I venture the hypothesis that the choice of a US economist can be explained by multilateral fragmentation, compatible with Hirschman´s exit-voice dichotomy[6]. The US could not prevent establishment of the AIIB, China´s successful attempt to exit the US-led multilateral banking system. Capital-rich China is hard to compete with for the US on the basis of funding alone; but the World Bank may counter the decline in its relative importance on the basis of Know How. Whatever the official rhetoric, the choice of Romer will perhaps help restore the old world of paradigmatic US dominance in development banking.



[1] For a rare criticism, see Norbert Häring, The World Bank on the way back to the Washington Consensus – with Chicago Boy Paul Romer, 19. Juli 2016. Häring equates the poster city Hong Kong with an neocolonial inclination of the future World Bank chief economist.
[2] The Economist, “The World Bank hires a famous contrarian”, 18th July 2016.
[3] For history and English explanation, see https://en.wikipedia.org/wiki/Stadtluft_macht_frei.
[4] Peter Gaupp, “Honduras: Entwicklungspol oder Steueroase?”, Neue Zürcher Zeitung, 4th October 2012.
[5] François Bourguignon came from the Paris School of Economics but had started his academic career in Ontario, Canada.
[6] Helmut Reisen, “Will the AIIB and the NDB Help Reform Multilateral Development Banking?”, Global Policy, Volume 6Issue 3pages 297–304, September 2015.

Tuesday, 14 June 2016

Vorsprung durch Technik: Dealing with China´s Acquisitions

China´s quest to climb up further the value-added chain by acquiring leading-edge technology firms has made Germany a favorite M&A target in the recent past years. Audi´s slogan “Vorsprung durch Technik” (lead by tech), that´s what the Chinese are currently after: producers of high-end machines (Krauss Maffei, Putzmeister), fork-lift trucks (Kion),   LED chip plants (Aixtron), graphic electrodes (SGL Carbon) and now industrial roboters (Kuka). Early 2016, the Chinese conglomerate ChemChina offered to purchase the Swiss agribusiness Syngenta for $43 billion, the biggest deal so far. A storm of protectionist sentiment is greeting these Chinese acquisitions, not only by politicians (EU competition tsar Oettinger, German Economic Minister Gabriel) but also by academics, such as former IFO president Hans-Werner Sinn and Merics (Mercator Institute for China Studies) director Sebastian Heilmann [1].

As summarised in Table 1, China´s old growth model, embracing trade integration with a fairly closed capital account, has come to an end ten years ago. Since then, China´s global inward FDI has first boomed from 2005 to 2010 but since then stagnated as rising dollar wages have reduced its appeal for investment in the manufacturing sector. Meanwhile, China´s outward FDI has been booming and increasingly targeted advanced countries rather than resource-rich developing countries. 

Table 1: China´s FDI flows and FDI Restrictiveness

2005
2010
2015
Inward FDI, $billion
104.1
243.7
249.9
Outward FDI, $billion
13.7
58.0
187.8
FDI Restrictions (0 to 1)
0.56
0.42
0.38

Following (what is now mainstream) economic policy advice, capital-account liberalisation has been gradual but continuous. It is noteworthy that China has received far more inward FDI than it invested abroad, despite being relatively closed as measured by the OECD restrictiveness index. This index, running from 0 (very open) to 1 (closed) indicates a composite of equity restrictions; screening and approval requirements; restrictions on foreign key personnel; and operational restrictions such as on land acquisition and capital repatriation. Despite all the noise from Western industry lobbies and politicians, China has steadily liberalised its capital account, from an index score of 0.56 in 2005 to 0.38 in 2015. Importantly, however, China still allows joint ventures only.
China’s state-guided outbound industrial and technology policies, aimed at technological leapfrogging through acquisitions pose more industrial, competition, and security concerns than acquisitions by SWFs that seek higher risk-adjusted returns and diversification via passive investments[2]. Some of these policy concerns have been thoroughly discussed by Hanemann and Huotari (2015)[3]. The most relevant, in my mind, are:
·         Asymmetry in market access. Between Germany (as part of the EU) and China, there is no level playing field. Germany belongs to the most open economies (the OECD restrictiveness index score is 0.023 since 2010) while high (> 60%) Chinese local content requirements (“Made in China 2025”) hit German companies in sectors where Germany is very competitive: power equipment, new energy, medical technology, industrial robots, large tractors, and IT for connected cars.
·         Subsidies and non-market advantages. Many of China´s globally operating companies are receiving preferential treatment from local or central governments. These subsidies are a source of unfair competition leading, e.g., to distorted bidding processes in global markets.
·         Technology transfer and industrial hollowing out. It is feared that Chinese state-controlled owners will end up absorbing key technologies and know-how, leading to a hollowing out of the industrial base of their Western competitors. As quipped in a comment to Heilmann´s FT article: “Those takeovers are like the giant bug in the movie Starship Troopers. It punches a hole in the head and sucks out the brain, leaving a dead shell.” The erosion of network externalities - strong in the case of Germany´s car upstream suppliers – can punctuate and ultimately destroy an entire industry as well as industrial region.
·         National security threats. Concerns relate to the erosion of national defence industries, the creation of new channels for infiltration, surveillance and sabotage. To be sure, the German AWG (Aussenwirtschaftsgesetz, or Foreign trade & Payments Law)) or CFIUS, the Committee on Foreign Investment in the United States, provide sufficient tools to restrict Chinese FDI.
In the absence of a multilateral agreement on foreign direct investment, these policy concerns, however valid, give easily rise to distortive and discriminatory policy response. It needs strong independent minds to not follow Professor Heilmann´s FT (op.cit.) fatal ad-hoc recommendations such as to combat state-driven Chinese companies through state aid or to build discriminating rules based on the nationality of acquirers. Let´s hope that Angela Merkel did not fall prey to such bad advice on her recent China trip. Given China´s market size, policymakers should be aware of costly retaliation measures.
From an economic (rather than from an industry-lobby) perspective, most of China´s FDI acquisitions provide no reason for policy intervention. An important yardstick to gauge the broad welfare effect of China high-tech acquisitions from a trade theory perspective is how it impacts on Germany´s terms of trade[4]. Welfare gains from international trade are unaffected by China´s acquisitions as long as they don´t move Germany´s terms of trade, present and future. China´s inward FDI and the ensuing technology transfer can even improve Germany´s welfare if it falls on industry branches with a competitive disadvantage (net import position): Germany´s terms of trade improve, as net imports become cheaper. The reverse holds if China acquires high-tech in areas where Germany is a net exporter as its competitive advantage will suffer from lower premium prices; in that case, China´s FDI will likely worsen Germany´s terms of trade. The Kuka acquisition may be such case. Trade theory provides economic food for thought to reset the examination of Chinese FDI.




[1] Sebastian Heilmann (2016), “Europe needs tougher response to China’s state-led investments”, FT 9th June.
[2] Helmut Reisen (2008), “How to spend it: Sovereign wealth funds and the wealth of nations”, Voxeu, 5th June.
[3] Thilo Hanemann and Mikko Huotari (2015), “Chinese FDI in Europe and Germany: Preparing for a New Era of Chinese Capital”, Merics/Rhodium Group, Berlin, June.
[4] See Henning Klodt (2008), „Müssen wir uns vor Staatsfonds schützen?“, Wirtschaftsdienst, Vol. 88, Iss. 3, pp. 175-180, http://dx.doi.org/10.1007/s10273-008-0772-z for excellent analysis (in German).